What is a cash flow statement?

What is a cash flow statement?

Your business is thriving—sales are up, and it’s growing.

Yet, you’re struggling to pay bills.

Why? Because despite being profitable on paper, your cash is tied up in unpaid invoices and inventory.

This is where the Cash Flow Statement (CFS) becomes essential.

Unlike the income statement, which focuses on profitability, the CFS is about cash movement in and out of your business.

It provides a clear picture of your liquidity (ability to meet short-term financial operations), allowing you to understand whether you have enough cash to cover operational expenses and fund your growth.

Jump to:

What is the purpose of the CFS?

The CFS plays a vital role in demonstrating your company’s ability to generate cash, fund operations, and meet financial obligations.

Here’s why it’s essential:

• Assessing liquidity: the CFS clearly views cash movements, helping assess both short- and long-term cash management.
• Supports decision-making: understanding your cash position can help you make better-informed decisions about managing cash flow, maintaining liquidity, and shaping a sustainable financial strategy.

How to use the Cash Flow Statement

The CFS can be used to gauge the health of your finances, helping you do three things that manage your business finances more efficiently.

• Evaluate liquidity: check if your core operations generate enough cash to meet daily needs without external financing.
• Assess your investment strategy: a negative cash flow in investments could be okay because it might indicate a heavy investment in growth, balanced with sufficient operating cash to avoid liquidity issues.
• Manage your capital structure: financing cash flows reveal how your company funds growth through debt or equity and help evaluate any impact on shareholder value.

Sources of cash in the Cash Flow Statement

The CFS categorizes cash flow into 3 primary activities.

• Operations: cash inflows from sales and outflows like wages, rent, and taxes show if your core operations generate enough cash for daily expenses.
• Investments: shows cash from buying or selling long-term assets, investments, or acquisitions. The investing cash flow indicates if your company is actively investing in future growth.
• Financing: cash flows related to raising or repaying capital, such as issuing shares, taking loans, or paying dividends, highlight how your company manages its capital structure.

Examples from a Cash Flow Statement

Operating activities

Operating cash flow reflects how much cash your company generates from its core business operations.

Strong cash flow from operations shows that your company can meet short-term obligations without relying on external financing or selling assets.

Changes in working capital directly impact liquidity and must be monitored carefully.

Category	Amount
Net income	$50,000
Depreciation	$5,000
Change in working capital	-$2,000
Net cash from operating activities	$53,000

What this means:

• Net income: The company’s core operations are generating this profit. However, because net income includes non-cash items (like depreciation), it doesn’t fully represent cash flow.
• Depreciation: Although it reduces net income, depreciation doesn’t affect cash flow. Adding it back offers a more accurate view of cash from operations.
• Change in working capital: Changes in working capital—such as accounts receivable and inventory—affect cash flow.

A decrease in working capital (e.g., collecting receivables or reducing inventory) increases cash, while an increase (e.g., higher receivables or inventory buildup) reduces available cash.

Cash from investing activities

Cash flows from investing activities provide insight into your company’s growth and asset management strategy.

Negative cash flow from investing is standard for growth-oriented companies investing in future capacity.

However, if investing cash outflows are too high without sufficient operating cash flow or external financing, it can lead to liquidity issues.

Category	Amount
Purchase of equipment	-$15,000
Sale of investments	$5,000
Net cash from investing activities	-$10,000

What this means:

• Purchase of equipment: Capital expenditures, like purchasing equipment, represent cash outflows for long-term assets expected to support future growth.
• Sale of investments: Proceeds from selling investments are cash inflows that may help fund future operational or strategic initiatives.

Cash from financing activities

Cash flows from financing activities highlight how your company manages its capital structure.

Raising cash through issuing shares or taking on debt can support expansion, but the financing costs (e.g., interest payments) must be carefully balanced with the benefits.

Regular dividend payments are a positive signal for investors but can strain cash reserves if operating cash flow weakens.

Category	Amount
Issue of shares	$20,000
Loan repayment	-$5,000
Dividend paid	-$8,000
Net cash from financing activities	$7,000

What this means:

• Issue of shares: raising capital through issuing equity increases cash but dilutes ownership.
• Loan repayment: paying off debt reduces cash but strengthens the company’s balance sheet by lowering liabilities.
• Dividend paid: dividends represent cash outflows to shareholders and indicate the company’s commitment to returning value to investors.

Reviewing the Cash Flow Statement

In this example, the business generated $53,000 from its operations, spent $10,000 on investments, and had $7,000 of net cash inflows from financing activities. When you add these together:

• $53,000 (from operations)
• -$10,000 (from investments)
• $7,000 (from financing)

The result is a net increase in cash of $50,000.

This positive cash flow is generally a good sign, indicating that the company generates enough cash from its core operations to support investment and financing activities.

• Operations: generating $53,000 from core operations shows financial health and stability, as the business can meet its obligations without needing external financing.
• Investments: spending $10,000 on investments suggests the company is allocating resources to future growth, though this needs careful monitoring to avoid potential liquidity issues.
• Financing: with a $7,000 inflow, the company effectively balances capital needs, supports expansion while managing debt, and provides shareholder returns.

Overall, the positive cash flow suggests that the company is in a solid financial position and can support growth while maintaining liquidity.

Methods of calculating cash flow: Direct versus indirect

There are two primary methods for calculating cash flow: direct and indirect.

Traditionally, finance teams would manually compile data for both methods, which can be time-consuming and prone to error, especially if you have complex financial activities.

Direct method

The direct method tracks actual cash receipts and payments.

• This method provides a detailed view of cash movements, including cash collected from customers, cash paid to suppliers, and other operational cash flows.
• While this method offers the most accurate cash flow picture, it’s labor-intensive without automation.
• Gathering the raw data from various sources (such as sales records, accounts payable, and accounts receivable) can be challenging, cumbersome, and prone to human error.

Indirect method

The indirect method starts with net income from the income statement.

• It adjusts for non-cash items like depreciation and changes in working capital (such as accounts receivable and payable).
• It provides a less granular but faster way to assess cash flow and is often preferred because it aligns directly with the income statement and balance sheet.
• Although more straightforward to prepare than the direct method, the indirect method can still be inefficient when done manually, especially when adjustments for non-cash items and working capital are not automated.

How tech can improve your cash flow calculation

With financial management platforms, you can automate direct and indirect cash flow calculation methods.

• Automating the direct method: This is where you pull real-time data from various operational sources, like sales and accounts receivable, providing accurate, up-to-the-minute cash flow tracking.
• Simplifying the indirect method: Financial management software can automatically adjust for non-cash transactions, like depreciation, and calculate changes in working capital, making it faster and more reliable.
• Key benefits of automation: Automation saves time, reduces calculation errors, and provides real-time financial insights, allowing your finance team to focus on strategic decisions instead of manual calculations.

Limitations of the Cash Flow Statement

Despite its importance, the CFS has limitations, especially if considered alone:

• Profitability is not captured: The CFS only tracks cash movement, but profitability metrics, such as non-cash expenses or accruals, aren’t included.

If not supplemented by other financial statements, this can lead to a misunderstanding of your overall financial performance.

• Incomplete view of financial health: The CFS provides valuable insights into liquidity, but you can’t fully understand your company’s financial position without the income statement and balance sheet.

CFS versus income statement versus balance sheet

While the CFS is a critical financial document, it’s only one part of the complete financial picture.

Understanding how the CFS compares to the income statement and balance sheet is crucial for comprehensive financial analysis.

1. Cash Flow Statement (CFS)

Focus: tracks actual cash inflows and outflows during a specific period.

Purpose: assesses liquidity and cash management by showing how cash is generated and used in operations, investing, and financing activities.

Importance: it is crucial to understand whether a company can meet its short-term obligations, reinvest in the business, and manage debt.

The CFS emphasizes cash availability, differentiating survival and bankruptcy in tough times.

2. Income statement (profit and loss statement)

Focus: measures profitability over a specific period by showing revenue, expenses, and net income.

Purpose: highlights how well the company generates profit from its operations by subtracting costs from revenue.

Importance: it helps assess your operational efficiency and profitability but includes non-cash items like depreciation, which don’t provide insight into actual cash on hand.

A company can show profit on the income statement but face liquidity issues due to poor cash flow.

3. Balance sheet

Focus: provides a snapshot of the company’s financial position at a specific point in time.

Purpose: lists your company’s assets, liabilities, and equity, showing what you own and owe at a given time.

Importance: offers insight into the company’s financial stability and how you are financed (through debt or equity).

The balance sheet is crucial for understanding your company’s long-term financial health, solvency, and capital structure.

Why you need all 3 statements to understand your company’s financial health

• Cash Flow S: tells you how much cash is available and how it’s being managed.
• Income statement: shows how well your company performs in terms of profit generation.
• Balance sheet: reflects your company’s overall financial position and the balance between assets and liabilities.

For example:

• The income statement might show profitability, but the CFS will reveal if your company has the cash to sustain operations.
• The balance sheet shows your company’s long-term viability by balancing assets and liabilities, while the CFS helps ensure your company’s liquidity and short-term financial stability.

How tech makes managing financial statements easier

Compiling the CFS, income statement, and balance sheet in the past required manual data collection, often from disparate systems.

This process was inefficient and prone to human error, leading to delays in financial reporting and making it difficult to react quickly to liquidity issues or operational inefficiencies.

Financial management software simplifies these processes today by automating data collection and reconciliation while providing real-time insights across all financial statements.

Here’s how tech can help manage these tasks better:

Automated data integration

Ideally, you’ll want all financial data integrated from multiple sources without manual data entry or reconciliation between systems.

This makes generating all three financial statements easier, meaning you can access consistent, accurate information across the CFS, income statement, and balance sheet.

Real-time financial visibility

Tech can give you real-time access to financial statements, allowing you to monitor your company’s financial health continuously.

This real-time visibility helps finance teams identify issues early, whether liquidity concerns flagged by the CFS or balance sheet imbalances.

Automated reporting and compliance

Financial management software can automatically generate reports that align with regulatory and accounting standards, reducing the time spent preparing for audits and ensuring that all financial statements include legal requirements.

This reduces the risk of human error and supports compliance.

Predictive analytics

AI-driven tools can analyze historical data to predict future trends in cash flow, profitability, and balance sheet strength.

By combining CFS, income statement, and balance sheet data, you can make more informed strategic decisions about capital allocation, investment opportunities, and managing liabilities.

Final thoughts

The cash flow statement has always been essential for managing your company’s liquidity.

But it can only provide a comprehensive view of your financial health when combined with the income statement and balance sheet.

Automating these statements with the right tech could boost your speed and accuracy, giving you the time and space to focus on the big strategic decisions that drive long-term growth.

Read more on how manage your cash flow: 

• 5 ways to manage your cash flow
• Get paid faster and maintain cash flow
• Cash flow statement explained
• How to use business intelligence to get paid and improve cash flow
• Understanding small business financial management
• How to prepare a cash flow statement and download our cash flow template