How to Read a Cash Flow Statement?: You shouldn’t have to be a bookkeeping professional as a company owner to understand your financial statements (but yeah, you can if you want to be!). However, you should be able to use these to make well-informed business decisions. In this post, we’ll teach you how to read and prepare cash flow statements.

What a Statement of Cash Flow is and what it looks like.

  1. A description of the different categories and the knowledge found in each (with a reference sample statement).
  2. Questions and scenarios to help you understand how to make business decisions using the statement.

What Is a Cash Flow Statement?

The Cash Flow Statement is a comparison of the details in the Income & Loss Statement and Balance Sheet. It is a summary of all the transactions that move cash into and out of bank accounts in your business.

Here is a sample of  how to prepare cash flow statements, which we will refer to later:

Cash Flow Statement

To prepare cash flow statements, bookkeepers (or software) take and modify the net profit reported on the Profit & Loss Report, so the new amount represents the actual cash that changed hands. The Cash Flow Report is also where there is recording of investments, selling shares, and interest earned on an investment.

This statement takes all the knowledge and provides you with a different viewpoint than the other papers. It helps you to verify and check that the bank account numbers actually suit your financial activities. Around the same time, it gives you an indication of the cash situation of the business — by taking out expenses that have not yet necessarily happened (such as credit card purchases, accounts payable, accounts receivable) and reflecting all forms of revenue (such as dividend income).

Breaking down groups of cash balance statements

Your Cash Flow Statement will vary in depth and complexity, depending on your business expenses and revenue. But the statement’s five principal components are always constant. We cover:

  • Net earnings
  • Functional cash balance
  • Money production from sales
  • Money production from finance operations
  • Final sum in cash.

Let’s take a look at what’s going into each of those categories and what it’s for your business.

Net Income

Net Income

Also if you don’t spend any time reading a financial statements to prepare cash flow statements, net profit is a number common to most company owners. It represents your net earnings after the deduction of your expenses from the total sales. You might call it “income” or “down line,” too.

Net income is where each Cash Flow Statement starts, and it comes directly from the Income Statement (also known as the Profit & Loss Report). If you use accrual accounting (as many companies do), considering non-cash transactions will be your net income. That means it isn’t going to match how much cash your bank account actually has. It often covers:

  • You earned the revenue but have not actually received it yet.
  • Expenses that you incurred, but still have not paid.
  • Many changes that affect your net profit (like depreciation) but do not require a cash transaction.

To prepare cash flow statements anyone needs to make net income adjustments — so your net cash (or final cash value) matches your bank account.

Operating Cash Flow

Operating Activities

The first portion to prepare cash flow statements is to reflect cash transactions that are linked to your business’ routine operational operations — the cash that you invest and earn as a result of doing what your company does every day. To need to prepare cash flow statements you need adjusts your net income based on the monthly cash-movement transactions. Such sources include:

  • Depreciation expenses (transactions not in cash)
  • Accumulated marketing expenses (transactions not in cash)
  • Net improvement in accounts receivable for the month
  • Credit cards, paid within one month
  • Annual Prepaid Phone Access

In short, the net cash flow arising from business activities reflects the difference between the cash you got from consumers and the cash you paid out for operating costs. It is the most critical and valuable section of the Cash Flow Report for many firms, as it shows you how everyday activities impact the amount of cash that you have on hand.

Based on the above example, you made a $5,000 prepayment which reduces your cash flow. You have spent $10,000 on your credit card, accumulated $7,000 in taxes, and accumulated $20,000 in payroll, all of which increases your cash flow. You’ll end up with an operating cash balance of $532,000 when compared with your net profit.

Cash Flow from Investing Activities

Investing Activities

The following group catalogs adjust the cash from business operations (otherwise known as capital expenses). It’s important to note: this section of the Cash Flows Statement is about investing in your business — not what others are investing in you (which comes next, in the section on funding).

Activities to invest will include cash inflows and outflows from:

  • Buying or selling an asset (such as computer equipment or office space);
  • Acquire or integrate with another company.
  • Dividends earned from stock ownership in another enterprise.

Security deposits for office space (like in the above example) are considered to invest cash flow as they reflect a business investment and its potential growth.

These investments and earnings together reflect your net cash flows from the investment activities.

To prepare cash flow statements from financing activities

Financing Activities

Financing activities are the third category of transactions to prepare cash flow statements  and it deals with the cash involved in borrowing, repaying or raising capital. This is where other investments in your company are registered, and that may include:

  • Receiving venture capital or other funding
  • Bank loans — all investment receipts (cash inflow) and loan repayments (cash outflows)
  • Sold company stock
  • Shareholders were paid dividends.

This section of the statement culminates in your finance activities’ net cash flows.

For instance, if you raised $500,000 in venture capital funding and paid out $40,000 in dividends to shareholders, your net cash flow would be + $460,000 from finance.

Net Cash Flow

Net Cash Flow

To prepare cash flow statements you need to represents changes in cash over a given period of time (often a month, quarter, or year). The final part of the statement incorporates the previous parts (including net income) and reflects the true cash value at the end of the time in the company reports. The balance can be either positive or negative.

Make choices based on your Estimate of Cash Flow

Now that you have a better option of what the sections and transactions on your Statement of Cash Flows represent, it’s time to interpret them. Here, we’ll talk about four big questions you might ask about your Cash Flow Statement.

Which Cash Flow Would Be Negative?

Whether you call it “net cash flow” or “net cash increase/decrease over the period,” there are many reasons why net cash flow can be negative for your business.

Since net cash flow is an indication of cash change over a period of time (and does not include current cash), a net cash decrease doesn’t automatically mean that you won’t have enough cash to pay the bills.

Your business could be doing very well, for example, so you have decided to invest heavily in growth right now. This would trigger your cash flow at the moment to be negative, but wouldn’t imply an area of concern because you know this your company is healthy and growing.

How Can You Increase Cash Flow?

While negative cash flow is not always a cause for concern, it can be when it persists over several periods because each period depletes the cash balance you have available to spend.

Cash flow negative or tight is mostly more about timing than anything else. One way to increase the company cash flow is to reduce customer payment terms, so less time passes between receiving revenue and actually being paid. A review of your operating expenses and investments can also be useful in managing the cash flow as well.

How can you reinvest positive cash flow in business growth?

One way to expand your company is by taking your money and using the cash to further invest in your business. This could involve recruiting more employees, buying better equipment, or increasing marketing efforts.

If you don’t reinvest profits back into increasing your company, it may result in slower growth. That may fit well with your business model, but it would be cause for concern for other businesses, such as high-growth startups.

If you begin to see a particularly large positive cash flow trend, ask yourself if there is something you would like to do to reinvest the cash and turn it into future growth.

Make sense when you need to prepare cash flow statements Many company proprietors are not specialists in accounting. That’s all right-for that you can hire someone else. But knowing key financial statements means that you can use them to get a full picture of the financial results of your company and make the right decisions that will help it grow. Hopefully, this guide to understanding your Cash Flow Statement will help you in that process.

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