One of the biggest pain points of managing a small business is the countless lists of financial statements to prepare. It can all be overwhelming.
To run a successful and profitable business, it’s a good idea to get an understanding of balance sheets, income statements, and cash flow statements. Although linked to one another, each one serves a unique purpose.
There’s one other thing that’s commonly overlooked, yet is just as important as a balance sheet and an income statement. And that’s running out of cash from improper cash flow management. This is one of the top reasons why small businesses and startups fail.
Cash is the lifeblood of any business, and this article provides an in-depth overview of how to prepare, read, and analyze a cash flow statement. But first, let’s look at the goal of a cash flow statement.
The cash flow statement explained
In financial accounting, a cash flow statement—also known as a statement of cash flow—provides businesses with a snapshot of their company’s current cash on hand.It shows how much cash was made and how it was spent during a given period. It also shows how well a company is managing its cash to pay back debt and fund operating expenses.
Cash flow statements enable you to identify cash flow trends—so you can make better decisions on how to better use cash to drive business growth. For instance, if your cash flow indicates that your business has less cash on hand in the first quarter of the year, then it may not be the right time to purchase new, expensive office equipment. Instead, you’d need to focus your efforts on growing revenue to improve profitability.A cash flow statement is used to attract new investments, improve your fundraising efforts, and get more access to financing options.
How is a cash flow statement used?
For those who are investing in your business, a cash flow statement shows how your company’s operations are running, where your money is coming from, and how you’re spending your money.
For banks and creditors, your cash flow statement demonstrates how much cash (also known as liquidity) is available. This provides some reassurance that your company is able to pay back its loans or fund its own operating expenses.
How to create your cash flow statement
You can use a spreadsheet or a template to organize your income and expenses into a cash flow statement. Our detailed cash flow statement template can help you organize your business data in an efficient way.
With accounting software, you can create a cash flow statement using an accounting system. Before you’re able to create a cash flow statement, you need to record all balance sheet-related activity—such as income and expenses—on a regular basis. From there, your accounting software will have the information you need to generate a comprehensive cash flow statement.
Accounting software removes the hassle of having to manually input each income or expense item from your business activities. And it can help keep you better informed about what each category and account description means.
How to prepare a cash flow statement
You’ll need to decide whether to use the direct or indirect method of creating a cash flow statement. The difference between the two methods is how you handle your operating activities.
Regardless of the method, investing and financing activities are handled in the same manner.
This method targets the inflows and outflows from operating activities. This means you subtract the money you spend from the money you received.
The direct method, lists the amounts of cash paid and received by your business. In this case, your cash flow statement will include cash received from customers and cash spent on employee salaries, interest, and vendors.
This method starts with your company’s net income (or profit) and factors in depreciation.
To use the indirect method, the cash flow statement begins with your company’s net income.Then adjustments are made to convert your accrual net income (income you earned but haven’t yet received) to calculate your operating cash flow.
Some common line items you’ll find in an indirect method cash flow statement could include: adding back depreciation expenses, adding an increase in accrued expenses payable, adding the decrease in accounts receivable, and deducting any increase in inventory from net income.
Larger U.S. corporations prefer the indirect method when preparing their statement of cash flows because it’s easier to prepare from an accountant’s perspective. It’s also presented in a simpler format.
With the direct method, companies have to report all cash receipts and cash payments from operating activities. Under the same method, firms would be required to separately disclose cash receipts and cash payments with detailed subcategories, which can complicate the cash flow statement.
With the indirect method, future cash flow projections are simplified due to its consolidated reporting format.
The basics of a cash flow statement
A cash flow statement is broken down into 6 fundamental elements. We’ll examine all 6 to help you understand how each element plays a significant role in managing your business cash flow.
Reviewing and projecting cash flows
Reviewing historical financial statements is useful for identifying trends and learning from previous business decisions. Historical and current data allows you to make future projections — in the coming quarters or years — to meet both short- and long-term obligations.
Cash flow projections helps to keep you informed so that you can make better decisions, whether it’s making a big purchase to improve operational efficiency, reducing expenses, or seeking new financing as you grow.
Now that you know more about what’s involved in creating, preparing, reading, and analyzing a cash flow statement, you can make more informed decisions and practice proper cash flow practices.
With all these tools, resources, and information QuickBooks can make it easier for you to manage your cash flow as a small business owner.