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Cash flow

The Beginner’s Guide to Cash Flow

As the name suggests, cash flow refers to the cash that flows in and out of a business. It may sound simple but it’s one of the most essential concepts to understand for business owners. After all, if a business does not have enough cash to pay its bills, there could be trouble. 

A cash flow statement makes up one of the three required financial reports that publicly traded companies are legally obligated to create and retain in order to provide visibility over the company’s financial position. 

All together the three financial reports are the income statement, the cash flow statement and the balance sheet

Income statements show net income. Balance sheets show assets, liabilities, and shareholder’s equity, and cash flow statements show a company's cash position on a monthly, quarterly or annual basis across three activities - operating activities, investing activities, and financing activity. We’ll dive deeper into cash flow below:

What is Cash Flow?

In short, cash flow is money in and money out. To understand cash flow better, it is best to first understand two different accounting methods - accrual accounting and cash basis accounting. Accrual accounting records transactions as they are made and considers non-cash items such as depreciation. Cash basis accounting records transactions when money is exchanged. For example, if a business owner makes a sale but the money is not due on the invoice for 30 days, under accrual accounting the sale will be recorded as soon as it is made even though the money has not yet been received. Under cash basis accounting, the transaction will be recorded once the item is paid for. Through understanding the two different methods, you can see how there might be a difference between net income which may take into account sales and expenses not yet paid for, and cash flow, which shows how much money the company has on hand.

What is a cash flow statement?

A cash flow statement is a financial document that details the cash and cash equivalents that a company made and spent over a period of time known as the accounting period. This can be annual, monthly, quarterly etc. The cash flow statement is often broken into three sections - cash flow from operations, cash flow from investing and cash flow from financing. The cash flow statement will start with an opening balance, list cash in and cash out across the three activities mentioned above, and end with an ending cash balance. 


It’s important to note that ending with a negative cash balance is not always a bad sign, just as ending in a positive cash balance is not always a good sign. For example, if you took out a loan during the accounting period and thus experienced an influx of cash, your cash flow statement may show a high amount of cash on hand but it is actually a high amount of liability. Over time, you’ll want the main source of cash inflow to be from operating activities, not loans. It’s important to understand trends as well, the occasional negative cash flow is likely not cause for concern but consistent negative cash flow, particularly in operating activities, can mean you’re not making enough money to cover your expenses.


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How do you create a cash flow statement

There are two ways to prepare a cash flow statement: the direct method and the indirect method.

The direct method

Creating a cash flow statement using the direct method involves using cash basis accounting and recording all transactions at the time when money was exchanged. Common transactions include:


  • Cash collected from sales
  • Cash paid to vendors and suppliers
  • Salaries paid out to employees
  • Cash received from a loan


While the direct method is often simpler to think of as it is the typical money in money out scenario, many businesses use the indirect method as it can be easier calculated from the income statement and balance sheet and is based on accrual accounting. The direct method may be better suited for small businesses that have fewer daily transactions, less diverse income sources and expenses, and fewer fixed assets.

The indirect method

Creating a cash flow statement using the indirect method involves using accrual accounting and gathering information from the income statement and balance sheet. With the indirect method, accountants start with the net income of a company and then add or deduct balance sheet items to determine cash flow. In this way, things like depreciation and accounts receivable are considered in the cash flow statement, where they wouldn’t be with the direct method. Common transactions include:


  • Depreciation
  • Accounts receivable
  • Accounts payable


Both the direct and indirect methods are accepted by GAAP and IFRS though the direct method is often preferred as it contains more information and is often more accurate. As most large companies use the accrual method of accounting and navigate complex transactions, the indirect method is more popular.


See more about Cash Flow statements and download a template.

Why do you need a cash flow statement?

Running a small business involves juggling many financial aspects. A cash flow statement helps navigate this landscape and keep your finger on your business’s financial pulse. Cash flow statements offer:

  • Clear Financial Insight: A cash flow statement provides a clear picture of how money moves in and out of your business. It breaks down where your cash comes from (income) and where it goes (expenses) in a specific period.
  • Better Decision Making: With accurate cash flow information at your fingertips, you can make informed decisions. It helps you plan for upcoming expenses, avoid cash crunches, and seize growth opportunities when they arise.
  • Debt Management: Managing loans and credit lines is easier when you can anticipate your cash flow. A cash flow statement helps you plan repayments and avoid unnecessary interest costs.
  • Budgeting and Forecasting: Creating a realistic budget becomes more achievable when you have past cash flow data. Forecasting future cash flows allows you to set achievable financial goals.
  • Attracting Investors or Lenders: If you ever seek external funding, investors or lenders will want to see your cash flow statement. It demonstrates your business's ability to generate consistent revenue and manage its finances.
  • Tax Planning: Understanding your cash flow can aid in tax planning. It helps you ensure you have enough funds to meet tax obligations and avoid penalties.


In summary, a cash flow statement is your financial GPS for navigating the often turbulent waters of small business. It empowers you to make sound financial decisions, manage your business more effectively, and ultimately, secure a brighter financial future.

Positive vs negative cash flow

Positive cash flow occurs when your business brings in more money than it spends during a specific period. In other words, your cash inflow (from sales, investments, loans, etc.) exceeds your cash outflow (expenses, debt payments, etc.). Positive cash flow is a sign of financial health, allowing you to cover costs, invest in growth, and build reserves.


Negative cash flow, on the other hand, happens when your expenses surpass your income. In this scenario, your business is spending more than it's earning within a given timeframe. It can be a red flag, indicating potential financial trouble, as it may lead to difficulties paying bills, debts, or even meeting day-to-day operational needs.


In the world of small business, mastering cash flow is a game-changer. QuickBooks is here to empower you on this financial journey. Our intuitive tools simplify cash flow management, helping you track income, expenses, and more. Sign up for a free 30-day trial today and experience firsthand how QuickBooks can be your trusted partner in helping to generate a healthy and positive cash flow. Start now and pave the way for a more prosperous financial future.

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