No matter the size of your business, your cash flow is your lifeblood. It’s the factor that determines your ability to expand your offerings and services, affects how you can increase your reach to new audiences, and impacts your ability to keep your business running. And a cash flow statement can help make sure you’re on the right track to meet these goals.
From small businesses to multimillion-dollar enterprises, your cash flow speaks to the health and well-being of your business. That’s why it goes without saying that tracking your cash flow to ensure you stay in the positive each month is a good business practice to adopt early on in your entrepreneurial journey. If you’re not sure how to do that, you’ve come to the right place—read on to learn everything you need to know about cash flow statements.
What is a cash flow statement?
A cash flow statement is a document that communicates how much money is coming into and out of your business bank account in a given period of time, whether that be a month, quarter, or year. Along with the balance sheet and income statement, the cash flow statement rounds out the three most important financial documents for a small business owner.
While the income statement and balance sheet tell you essential information about the success of your business, they don’t always convey the amount of money you actually have available to you at a specific moment in time. The cash flow statement, on the other hand, is designed to reflect not only what’s come in or gone out, but also what is currently available. For example, most small businesses account for depreciation as a monthly expense in order to show the cost of owning it over time, even though there’s no money actually leaving your account for that expense.
The cash flow statement is most commonly structured to include the following four components: cash flow from operating activities, investments, financing, and (if relevant) non-cash business activities. This makes your business’s current cash position super clear, in addition to your incoming and outgoing trends for a given period.
What are the advantages of cash flow statements?
There are different opinions on whether or not tracking cash flow in this way is necessary for everyone, but since it provides more reliable insight than accrual-based accounting, it can be a useful tool for the vast majority of business owners. Here are a few compelling reasons why you should consider making use of the cash flow statement in your company:
- Maintain ongoing knowledge of liquidity: In the event that an unexpected business expense comes up—maybe a piece of equipment needs repair or replacement—you’ll need to know exactly how much money is currently available. This document quickly communicates your liquidity so you can easily determine how much you can afford to spend in fixing the situation.
- Document your business spending: The cash flow statement provides a complete picture of a company’s spending, including principal payments and transactions made in cash that may not be reflected elsewhere. Depending on the accounting system you use, the cash flow statement may give you more specific insight into your business’s spending and financial standing than you’d be able to access elsewhere.
- Monitor changes in your business assets, liabilities, and equity: The information included in your cash flow statement will provide a snapshot of each of these elements, quickly giving you a well-rounded glimpse into your financial standing.
- Helps project future cash flow: Not only does this document give you important information about where your business is at the moment, it can also help you project your business’s future cash flow. This can be valuable in making complex plans for the future of your business, as well as compelling evidence to get investors to deploy capital to help your business grow.
If you’re looking for an easy way to track a complex assortment of financial information related to your company, this document could prove to be just the thing you’ve been searching for.
How to prepare your cash flow statement
If you’re interested in using cash flow statements for your company, there are two approaches you can take: the direct method or the indirect method.
When using the direct method, all transactions within a given period of time are simply added or subtracted from your end-of-period balances in order to establish how much cash has flowed into and out of your business:
- Begin by adding up all cash payments received from customers.
- From this number, subtract wages and salaries paid to employees, as well as payments made to vendors.
- Add any income derived from interest to determine your total income prior to taxes.
- From this number, subtract income taxes paid, as well as interest payments made, to arrive at your net cash for the period in question.
The indirect method works a little differently. You begin by determining net income, then indirectly adjust for the various expenses that affect that number (not involving cash)—for example, changes in assets, current liabilities, and other items included in determining net income that did not affect cash. This gives you your net cash increase or decrease for the period.
Neither the direct nor indirect method of calculating your cash flow is necessarily better than the other—though a benefit of the indirect method is that it provides an easy way to reconcile your information, tracking increases or decreases in the balance sheet due to non-cash transactions. This is enough of an incentive for some business owners to choose the indirect method.
No matter how you choose to go about calculating and managing the cash flow of your business, this article has provided the information you need to understand what exactly a cash flow statement is, determine the value such a document could contribute to your business, and know how exactly to go about preparing one. In the world of business, where so much information and documentation is available to you, it can be difficult to determine where to put your energy and effort, but the cash flow statement helps point you in the right direction.