Two business owners of wood workshop checking information on laptop. Concept: Cash flow statement
Jordan Schneir
By: jordan_shneir
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How to Prepare a Cash Flow Statement

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If cash is the lifeblood of a business, then a cash flow statement is something like an EKG. Your business will have inflows and outflows of cash, lines moving up and down on a chart. There’s a rhythm or a pattern that indicates your company’s good health—or reveals signs of distress.

What is a Cash Flow Statement and Why Do You Need One?

A cash flow statement provides a snapshot of the cash moving into and out of your business over a particular period of time. This document shows you the cash you’re taking in (from sales, investments, etc.) and how much you’re sending out (expenses, payroll, rent, etc.). (Make sure you understand the difference between cash flow and profit.) Like your heart rate, cash flow provides excellent insight into your health at a particular moment. It gives you a sense of your business’ liquidity, in other words, your ability to meet imminent financial obligations.

But the cash flow statement does more than that. Like an EKG, it can detect future problems as well as current ones. Irregularities might not prove hazardous in the present moment, but they can become destructive in the long run. A blip on your cash flow statement that seems out of sync with previous trends might foretell a pending setback for your business.

However, if you arm yourself with extensive information about your business’ cash flow, you will be better positioned to head off potential problems before they arise.

That’s why cash flow statements are so critical. They enable you to ensure your business has the cash on hand to meet its immediate expenses, and they empower you to prepare for your long-term cash needs. With a full accounting of how much cash you have and where your cash is coming from, you can invest in your business’ future without compromising its present operational viability.

Who Uses Your Cash Flow Statement?

 You do, of course. But there are many other stakeholders that need your business’ cash flow statement, as well.

  • Accountants
    Keeping track of your books means that accountants maintain a close eye on the cash of your business. In the event of an IRS audit, or simply to ensure that taxes are paid properly, your accountant needs to see and understand where cash is coming from and going to on a highly detailed level. By keeping things organized with a cash flow statement, your accountant doesn’t need to go digging for every scrap of information; he or she doesn’t need to spend hours sifting through receipts and people’s emails. It helps your accountant be more accurate and timely.
  • Lenders/creditors
    Before loaning money to businesses, lenders do their homework. They engage with businesses that have a track record of bringing in cash and paying their bills (when they’re due). So the cash flow statement not only helps them ensure they’d be comfortable lending you money, but it also helps you prove your trustworthiness and dependability. Cash is the metric that lenders and creditors want to see. Without having this information available, they’re less likely to go into business with you—even if your cash flow is good. If you can’t prove your business’ health, then it’s not worth their time (or the risk).
  • Shareholders
    Again, your cash flow statement is your means of proving yourself. It’s your resume, your transcript, your report card. It’s an indicator of your company’s value and a predictor of future earnings. That’s how you acquire new shareholders and how you convince past shareholders to keep their stake in your business. In the cash flow statement, you also track all dividend payments made to shareholders so they can see how their investment is paying off.

Benefits of a Cash Flow Statement

 In addition to giving you insight into the health of your business at the present and in the future, a cash flow statement has other benefits as well:

  • Measures liquidity
    To operate effectively, you need cash on hand. Therefore, the cash flow statement measures how effectively you can operate at any given moment.
  • Benchmarks your business against its peers
    Because cash flow is such a significant measure, other businesses measure it, too. Especially if your business is relatively new and doesn’t have the history of knowing how much cash it needs and when it needs it, it’s a useful exercise to compare where you are relative to businesses similar in size and mission. If you’re in a dramatically different place than comparable successful companies, then that’s a red flag that something needs to change.
  • Determine whether you need a business loan
    Acquiring a business loan can be a difficult decision—one your cash flow statement can make easier to decide. Your cash flow statement tells you how much cash you need relative to how much you’re taking in and sending out, and armed with this knowledge you will know whether you need more cash. If you do, then a business loan might be the right choice to acquire it.

Components of a Cash Flow statement—and How to Prepare Yours

Now that you understand the value of the cash flow statement, you need to know its components and how to put together yours.

Components
Every inflow and outflow of cash needs to be documented in a cash flow statement, including:

  • Operating activities
    These include any cash that you acquire or expend operating your business. This includes revenue from sales (so long as you receive cash rather than credit) and expenses like salary, tax, and rent payments.
  • Investing activities
    Outside of the standard operations of your company, you might take your business’ funds and invest them in real estate, the stock market, or other businesses. While these don’t represent your daily business activities, they are still impacting your cash flow and, therefore, must be represented in your cash flow statement. Any cash you earn and all cash you invest must be accounted for.
  • Financing activities
    This category represents the cash you receive from outside sources to help support the operation of your business. Whether it’s loans or investments, the money you receive from these entities and the money you pay back in the form of dividends or interest needs to be accounted for.

Methods to Prepare a Cash Flow Statement

There are two ways to prepare your cash flow statement:

  • Direct method
    The direct method tallies cash taken in and the cash distributed out from the company. It’s the more straightforward method that captures each individual cash-based transaction.

For a sporting goods store, here’s an example of the operating activities section under the direct method for the month of March:

Activity Cash flow
Sales $25,000
Salaries ($15,000)
Inventory ($5,000)
Taxes Paid ($2,500)
Cash from Operations $2,500

 In this case, the sporting goods store would have a net positive cash flow of $2,500.

  • Indirect method
    The indirect method uses what is known as “accrual accounting.” So rather than tallying individual activities and transactions, this approach begins with net income and then adjusts it by adding back non-cash accrual activities like depreciation.

 For the same sporting goods store, here’s an example of the March cash flow statement using the indirect method.

Net Income ($30,000)
Depreciation $20,000
Provisions for Losses $2,000
Change in Inventory Value $8,000
Taxes Paid $2,500
Cash from Operations $2,500

 

Monitoring a patient’s heart rate with an EKG allows a doctor to observe any irregularities that might indicate something’s wrong in the present moment or that something might become a problem in the future. Similarly, a cash flow statement provides insight for accountants, business owners, and other stakeholders to assess a company’s at-the-moment status and serves as an indicator of future health (or future problems).

With the information provided in a cash flow statement, you can make fully informed decisions to answer key questions about your business. Do you have enough cash on hand to meet your operative expenses? Do you need to take out a business loan to avoid a shortfall of cash flow?

At Camino Financial we provide small business loans to cover your working capital needs. In fact, many of our borrowers use our loans as an immediate source of cash flow and funds to cover their operative expenses. Through a quick and easy online application process, you can receive your funds within 4-10 days, so the healthy rhythm of your business doesn’t get interrupted.

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small business loan?