How Is a Cash Flow Statement Prepared?

What is a cash flow statement?

A cash flow statement is a report that states how much money your business has earned and spent over a certain period. Cash flow statements also show you how much money you have on hand, as well as cash equivalents. This includes bank deposits, short-term investments and other assets that can be converted into cash. It doesn’t include credit items: invoices you’ve sent but haven’t yet received payment on or bills that you’ve received but haven’t yet paid.

“A cash flow statement is a great tool to give business owners insight into where their actual cash is spent, since most businesses are run on an accrual basis,” said Katie Thomas, a certified public accountant and corporate controller at Upward Projects restaurant group.

How to create a cash flow statement, step by step

To build a cash flow statement that accurately reflects your business’s financial situation, follow these steps. We recommend you make use of the best accounting software to help you complete each task as well.

1. Gather your financial records.

Running a cash flow statement requires digging into your financial documentation. Collect all your bank statements, receipts, income records and expense invoices; also, gather any other financial documents that track money coming in and going out of your business. This includes checking and savings account statements, credit card statements, payroll records, tax documents, and sales records. The more comprehensive and organized your records are, the easier it will be to create an accurate cash flow statement.

2. Identify your cash sources.

Cash sources are all the ways money enters your business. For most small businesses, this typically includes sales revenue, client payments, loans, investments and any other income streams. Go through your records and categorize each source of cash. Be sure to distinguish between actual cash received and invoices that haven’t yet been paid. This step is crucial because a cash flow statement tracks real money movement, not just theoretical income like accounts receivable.

3. Track your cash expenses.

Just as you documented cash sources, now you’ll map out where your money is being spent. Categorize your expenses into predictable groups like operating expenses (rent, utilities, salaries), inventory purchases, equipment investments, loan repayments and taxes. Include both regular monthly expenses and occasional or unexpected costs. The goal is to get a clear picture of how much cash is leaving your business and in what areas you’re spending the most.

4. Choose your accounting method.

Small businesses typically use one of two accounting methods: cash basis or accrual basis. In cash basis accounting, you record income and expenses when money actually changes hands. Accrual accounting records income and expenses when they are earned or incurred, regardless of when payment occurs. For most small businesses, the cash basis method is simpler and provides a more direct view of actual cash movement. Decide which method makes the most sense for your business and stick to it consistently.

5. Calculate net cash flow.

To calculate net cash flow, subtract your total cash expenses from your total cash income during the specific time period you’re analyzing; this is usually a month, quarter or year. If the number is positive, you have a cash surplus. If it’s negative, you’re spending more than you’re earning. This calculation gives you a snapshot of your business’s financial health and liquidity.

6. Create your cash flow statement.

Now you’ll organize your findings into a structured statement. Typically, this involves three main sections: operating activities (day-to-day business), investing activities (purchases of long-term assets) and financing activities (loans, investments). List your cash inflows and outflows in each category, making sure to detail the sources and uses of cash. Most accounting software can help automate this process, but you can also create a spreadsheet manually.

7. Analyze and interpret your results.

Don’t just create the statement — study it. Look for patterns in your cash flow. Are there months with significant cash shortages? Are your expenses consistent, or do they fluctuate wildly? Identify potential areas for cost-cutting or opportunities to increase revenue. This analysis can help you make more informed financial decisions and plan for future business growth.

8. Regular maintenance and review.

A cash flow statement isn’t a one-time document. To be truly useful, you should update and review it regularly — ideally monthly or quarterly. Consistent tracking helps you spot trends, anticipate cash crunches and make proactive financial decisions. Consider setting aside time each month to update your statement and reflect on your business’s financial performance.

Methods to prepare a cash flow statement

The easiest way to create a cash flow statement is to use small business accounting software to generate a report. If you don’t like using accounting software, or your program doesn’t have this option, you can find free templates available online.

It doesn’t matter where you choose to get the basic format for your cash flow statements. However, it’s important to decide whether you will use the direct method or the indirect method for the calculation.

Indirect method

Many businesses use the indirect method because it’s simpler. Start with your company’s net income statement, i.e., profit and loss statement. Then, you add or subtract the increases or decreases, using the line items from the balance sheet. Keep in mind that a company’s income statements are done on an accrual basis, so only earned revenue — not received earnings — is considered.

The indirect method includes nonoperating activities that don’t affect a business’s operating cash flow. Depreciation, for example, isn’t a cash expense, but it is used to calculate cash flow.

Direct method

The direct method uses gross cash receipts and gross cash payments to prepare cash flow statements. This includes money paid to suppliers, receipts from customers, interest and dividends received, cash paid out or received, interest paid, and income taxes paid.

The direct method is more time-consuming. This is because, unlike the indirect method, it requires you to track operating cash receipts and payments for every transaction. You also must reconcile your cash flow statement with your income statement. Learn more about what’s included in a cash flow statement below.

What is the purpose of a cash flow statement?

A cash flow statement allows you to see the financial status of your company —  specifically, whether you’re bringing in enough to pay the bills.

For instance, if a cash flow statement indicates you have a deficit, you may need to make some changes to increase your cash flow. Such methods include raising prices or shortening your payment terms. Or, if you have a cash surplus, you may decide now is a good time to buy new equipment.

Additionally, a cash flow statement, along with your balance sheet and income statement, is often required by banks or investors when you seek financing. Using your cash flow statement, the lender can determine if your business is fiscally sound and will be able to repay the loan or investment. [Review this roundup of cash flow problems and how to solve them.]

What is included in a cash flow statement?

A cash flow statement has three parts: operating activities, investing activities and financing activities.

Operating activities

The operating activities section shows how much cash you have coming in and going out as part of your daily business operations within a specific period. It includes money you spend on materials and payroll, as well as money you bring in from sales.

Investing activities

The investing activities section shows the amount of cash you’ve earned or spent on long-term investments within a specific period. In addition to stocks and bonds, investments can include the buying or selling of large assets, such as buildings, property or equipment.

Financing activities

The financing activities section shows how your business raises its capital and pays back its debts. Anything associated with loans or the issuing or buyback of stocks is included in this section.

What are the limitations of a cash flow statement?

A cash flow statement is a good tool for examining your past financial decisions. But, it doesn’t help you predict your business’s future.

“A cash flow statement is historically based,” said Katie Swanson, a certified public accountant, certified valuation analyst and assistant controller at Inter-State Studio & Publishing Co. “It does not help a business look forward to manage cash today, next week or a month from now. Business owners are concerned with the ongoing operations of their business, not what happened last year.”

Swanson also noted that business owners who don’t have a background in accounting may find it hard to understand cash flow statements.

“The information is not presented in a way that makes sense to nonaccountants,” she said. “Therefore, the information is difficult for small business owners to use when making decisions.”

How is cash flow calculated?

The easiest way to calculate cash flow is to run a cash flow report in your accounting software. If you plan to calculate it manually, you’ll need your balance sheet and income statement.

FREE TOOL: Cash Flow Calculator

Cash flow statements are made up of two main parts: operating cash flow and financing cash flow.

Operating cash flow

Operating cash flow comes from the daily work within your business. It is made up of your net profit or loss and changes in assets and liabilities between periods. In its simplest form, operating cash flow comprises the following parts:

Operating cash flow = net income + depreciation + other noncash charges – increase in net working capital

Financing cash flow

Financing cash flow is made up of changes in your bank debt, shareholder debt and other long-term debt between periods. You can use this equation to calculate financing cash flow:

Financing cash flow = cash from equity/debt issuance – (dividends + repurchase of debt/equity)

Net cash flow

In a cash flow statement, the goal is to measure your operating cash flow and financing cash flow. This simple formula leads to your net cash flow:

Net cash flow = operating cash flow + financing cash flow

Operating cash flow and financing cash flow both fluctuate over the short term, depending on the needs and performance of the business. Over the long term, however, cash flow must be positive if the business is to survive.

How do accounts payable and accounts receivable relate to cash flow?

It’s vital to understand the difference between accounts receivable and accounts payable, because both affect your cash flow. Accounts payable refers to the money your company owes its suppliers, and accounts receivable are what your customers owe you.

To calculate the amount of cash flow affected by your accounts payable, subtract the current period’s dollar amount for accounts payable from the last period. If the difference is a positive amount, your cash flow has increased by that number within that period. If the number is negative, it means cash flow has gone down by that dollar amount.

For accounts receivable, the calculation is the same. However, when the difference is a positive number, this is considered the use of cash and represents the dollar amount by which your cash flow has decreased. A negative number represents how much your cash flow has increased.

Tejas Vemparala and Mike Berner contributed to this article. Source interviews were conducted for a previous version of this article.