Cash Flow Statements: How to Read and Understand Them

The cash flow statement is a part of a company’s financial statement that tracks its actual cash movements, providing a clear picture of liquidity and its financial lifeblood. Cash flow statements may vary significantly depending on the timing and seasonality of the business activities. These variations can make it difficult to compare the cash flow statements of different periods or different businesses.

Key metrics and ratios to calculate

The Statement of Cash Flows provides a clear picture of how a business generates and uses its cash how to read andunderstand a cash flow statement over a specific period. It is one of the three primary financial statements, alongside the Income Statement and the Balance Sheet. Unlike the Income Statement, which reports profits based on accrual accounting, the cash flow statement focuses solely on the actual movement of money. Understanding this statement is important for assessing a company’s financial health and stability.

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To calculate your company’s OCF, divide operating cash flow by current liabilities. Cash flow statements are key to maintaining good business financial health. But creating these documents manually can be time-consuming and can introduce errors.

• This also includes any debt the company repays, as well as certain tax payments related to equity awards.
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• It’s also useful to help determine how a company raises cash for operational growth.
• Analysing this section helps assess a company’s growth, expansion strategies, and potential mergers.

Automation can help with cash flow—and cash flow statements

The direct method starts with the net income and adjusts it for changes in current assets and current liabilities, such as accounts receivable, inventory, accounts payable, and accrued expenses. The direct method provides a detailed breakdown of the cash inflows and outflows from operating activities, but it requires more information and calculations than the indirect method. The indirect method starts with the net income and adjusts it for non-cash items, such as depreciation, amortization, gains and losses on asset sales, and changes in deferred taxes. The indirect method provides a simpler and more consistent way of calculating the operating cash flow, but it does not show the individual sources and uses of cash from operating activities. The cash flow statement is one of the most important financial statements for any business. It shows how much cash is generated and used by the business in a given period, and how it affects the balance sheet and the income statement.

How Cash Flow Statements Are Prepared

• By analyzing the operating cash flow, we can gain insights into the efficiency, profitability, and quality of the business.
• Understanding this statement is important for assessing a company’s financial health and stability.
• The cash flow statement reports the cash generated and spent during a specific period of time (e.g., a month, quarter, or year).
• The cash flow from operating activities is the most important section, as it reflects the ability of the business to generate cash from its normal operations.
• Additionally, investing cash flow shows how a company allocates funds for growth.

That’s why understanding cash flow—not just profit—is key to staying solvent. This is usually the best indicator that your business model is working. Even if you’re not yet profitable on paper, strong operational cash flow means your business is sustainable. This tells us how well the business managed its cash during the month, balancing income, expenses, investments, and loans. Even though it’s technically an expense on the books, it doesn’t actually take any cash out of our pocket—it’s just accounting doing its thing to spread out the cost of equipment over its useful life.

Understanding the Cash Flow Statement

A business can be profitable but have negative cash flow, or vice versa. For example, a business may have high sales but low cash flow if it sells on credit and has to wait for customers to pay. Or, a business may have low profit but high cash flow if it has high depreciation expenses that reduce its taxable income but do not affect its cash flow. Cash flow statement analysis is a vital tool for assessing the financial health and performance of a business. In this section, we will discuss some of the common difficulties and pitfalls that analysts and investors face when interpreting and comparing cash flow statements.

But the reality is that as the product is built and shared with customers, flaws in their concept are discovered that – if not overcome – will kill the business. Suddenly, that $50K of profit feels kind of meaningless, because in the real world, you are down fifteen grand in cash. 9 International wire transfers are only available to legal entity customers (LLCs, corporations, and partnerships). 2 Accounting, tax preparation and invoicing software is available to Lili Smart and Lili Premium account holders only; applicable monthly account fees apply.

For example, accounts receivable and accounts payable are both included in this section, and any deferred revenue is accounted for here as well. Financing activities encompass cash flows related to your startup’s funding, including loan repayments, equity investments, and dividend payments (if applicable). This section is particularly important for startups, as it often reflects fundraising activities and company capital structure changes. This section includes cash inflows from sales and outflows such as payments to suppliers, employee salaries, and other operating expenses.

But it does mean you are funding operations with loans, investor money, or your savings, and that is a temporary, not a reliable and future-proof plan. Just by knowing how to read a cash flow statement, you can easily spot the shortcomings and possible ways to manage cash more efficiently. Simplify your bookkeeping with instant transaction categorization, and gain clarity about your business’s financial status with income & expense insights and auto-generated financial reports. To give you a head start in preparing a cash flow statement, we’ve created 3 different statement templates, including monthly, quarterly, and annual formats. Cash from operating activities is often the best indicator of business performance, as these activities denote the day-to-day, primary activities of a business. Learn how to read your cash flow statement, and you’ll never be caught gasping for breath.

A positive cash flow from operations typically means your business is generating enough revenue to cover its regular expenses. But if this number is consistently negative, it may signal problems with profitability, pricing or cash management. Cash flow and profit are not the same thing, and they can differ significantly for a given business. Profit is the difference between revenue and expenses, and it is affected by accounting rules and assumptions. Cash flow is the actual amount of cash that flows in and out of the business, and it is affected by the timing and nature of cash transactions.

This includes money received from customers for goods or services, and cash paid out for day-to-day expenses. Examples include payments to suppliers, employee salaries, and utilities. These cash flows directly measure a company’s ability to sustain itself through its core business.

This inflow can fund expansion, repay existing obligations, or support operations. While providing immediate liquidity, persistent reliance on financing activities could signal underlying issues if not accompanied by strong operating cash flow. A cash flow statement is a record of how much money flows into and out of a business during a particular period. These are the main components of a cash flow statement and how they affect the cash balance of a company.