A cash flow statement is one of the three financial statements.
The other two are the Profit and Loss Statement and Balance Sheet.
According to Investopedia, a cash flow statement is a financial statement that provides aggregate data regarding all cash inflows a company receives from its ongoing operations and external investment sources. It also includes all cash outflows that pay for business activities and investments during a given period.
Most Cash flow statement definitions make it sound complex, which is very difficult for creative entrepreneurs to understand.
Here’s a simple cash flow statement definition.
In simple terms, a cash flow statement is like a mark sheet that tells how well you have been able to create and control cash in your business in a specific period, just like you get a mark sheet for how well you have performed in an exam.
A cash flow statement is also called a cash flow report.
What Is the Purpose of the Cash Flow Statement?
In other words, what are the objectives of a cash flow statement? The purpose of a cash flow statement is to record cash inflow and cash flow outflows from all sources so that it provides a business owner clarity on cash flow gaps and helps him make informed cash flow decisions. When you have cash flow clarity, you will also utilize existing cash flow fully and protect your cash flow.
In simple terms, if you want to know what your cash flow is, a cash flow statement will give you the answer to that question.
If you are wondering what a cash flow statement looks like and want to see a cash flow statement example, check out this cash flow statement example.
THE IMAGE OF THE CASH FLOW TEMPLATE GOES HERE
Why Is the Cash Flow Statement Important?
Although preparing a cash flow statement is not mandatory, preparing a cash flow statement is crucial to making cash flow and business decisions. A cash flow statement allows you to see trends, spikes, and patterns of your cash inflow and outflow.
Cash flow statements are one of the most important documents any business prepares and files. It gives a lot of insight into the health of your business.
By inspecting your cash flow statement, regulators, business investors, and other stakeholders can estimate where you are falling short.
You’ll also see where you are losing and gaining cash, which helps you make strategic decisions. For example, you might find that product A has been making a loss. This is because it costs more to make than you are selling it, and it hasn’t sold that much. On the other hand, product B might cost less but makes a good profit margin. So you would use this knowledge from the cash flow statement to invest more in B than A.
By analyzing the cash flow information, you know what you can afford to do and what changes you need to make to have a positive cash flow.
Cash Flow Control Using the M.A.P. Method
A cash flow statement allows you to take three key actions to control your cash flow, which is equal to controlling your business and controlling its success.
These three keys actions are:
- Managing Your Cash Flow (which you can remember with the letter M)
- Analyzing Your Cash Flow (that you can remember with the letter A)
- Projecting Your Cash Flow (You can remember with the letter P)
Because of these letters, I call it the MAP Method of Controlling the cash flow, using the cash flow statement.
Let’s see how to implement the MAP method in your business.
M = MANAGE
I remember when I was learning to drive a car. I learned in a very quiet place with no one around. There was no traffic. It was just me in that quiet, safe place.
At first, I had to learn to control the car using gears, the steering, clutch, accelerator, brakes, etc. Then, when I was comfortable controlling the car, I felt confident in moving ahead.
You do the same in your business by learning to manage cash flow.
CASH FLOW MANAGEMENT = CASH FLOW CONTROL
CASH FLOW CONTROL = CONTROL IN YOUR BUSINESS
A = ANALYSE
Once you know how to control the car, you get on the road and drive slowly. Your ability to scan the road and analyze the situation is essential. Otherwise, you may run into an accident.
Similarly, in business, you’ve got to analyze cash flow and understand what has happened in the last three months, last six months, and the previous year.
Analyzing the statement of cash flows helps you understand the past happenings in your business. As a result, you can avoid any pitfalls and cash problems.
You will notice patterns and trends in your surroundings. This will help you anticipate your cash flow in the coming month. You can use your understanding to project it. We’ll talk more about it in the next step.
P = PROJECT
Once you become confident in your ability to scan the road and analyze how other vehicles around you are moving, you feel like accelerating. However, you also learn to go slow based on driving conditions and traffic.
And, once you learn to pace your vehicle, you know how long it will take for you to reach your destination. The modern GPS has made this simple, but you still need to rely on your understanding of road and traffic conditions to drive and choose whether to go past or stay behind a vehicle.
In the same way, once you analyze cash flow, you get in an excellent position to project your cash flow. Because by analyzing, you can see where you are today in a cash position. You know what has happened in the last three months, in six months. So now you are in an excellent place to predict your cash flow for the next three or six months today. And that is powerful.
What Do You Look for in a Cash Flow Statement?
In the cash flow statement, you are looking for T.I.P.S. It is an acronym that I coined to make it easy to understand. Let’s see what the letter T, I, P, and S stand for in this acronym.
- T = Trends, What is the trend of cash inflow and cash outflow
- I = Irregular activities, One-off activities, or irregular activities you should be aware of
- P = Patterns, Cash flow Patterns of few accounts e.g. subscription/software/coaching payments
- S = Spikes Are there any spikes in any given month in terms of cash collection and cash payments
Although the cash flow statement isn’t the end-all and be-all, it can often provide a long-term picture of your business health.
Investors can use the cash flow statement to see the trajectory of your business. For example, if more cash is leaving than coming in, this can sometimes hint at a looming loss.
You can break down the cash flow statement into three categories; operating, investing, and financing activities. Let’s take a closer look at each of these.
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Cash Flow From Operating Activities
This is the cash balance arising from your trading activities. Examples of cash flow from operating activities are cash collection from customers, paying suppliers, etc.
Cash Flow From Investing Activities
This is cash flow from purchasing assets, selling assets, and sometimes things like patents and other intellectual property. Of course, when one buys assets, cash flows out. However, recurring cash inflow from investments generates cash flow.
Some investing activities are buying premises, motor vehicles, and investing in other businesses.
Cash Flow From Financing Activities
The simplest of the three will mention your payments to financial institutions for loans.
Examples of cash flow from financing activities are borrowing business loans from the bank or investor.
How Do You Know if a Cash Flow Statement Is Correct?
To check whether the cash flow statement is correct, check your business bank statement. It is a reflection of that organized into different cash inflows and outflows.
What do I mean by that?
If you look at the opening bank balance in your bank statement, this should be the same balance in your cash flow opening balance. The same is true for the closing bank balance.
This is the first check you are going to do.
Then look at the total cash received balance in the bank statement and total cash payments and compare it to the cash flow statement. Do they agree? If yes, then the cash flow statement is correct, although there may be an individual categorization of cash inflows and outflows not correct. But in a nutshell, the overall cash flow statement is accurate.
You can go back and check in the previous months if you have prepared cash flow for the last months.
If you are unsure how to prepare a cash flow statement, I will show you how.
How To Prepare a Cash Flow Statement Step by Step?
If you don’t prepare the cash flow statement regularly, start doing it now because, without it, you won’t know how effective you are in managing your cash flow.
Before I show you the step-by-step process to create a cash flow statement, let me help you understand some basics.
How To Use a Cash Flow Statement?
Use it to measure whether you have effectively managed cash flow or not.
It’s like taking a test and getting a mark sheet of your performance. The test is running your business, and the mark sheet is a cash flow statement. So, for example, your cash flow statement will reveal your ability to shorten the cash receipt cycle.
Let’s say you start working with your client on 1st June and it takes ten days to complete the work. You send an invoice on 10th June, and your client pays on 17th June. So the cash receipt cycle is 17 days.
Now the question is, how can you collect cash in 10 days instead of 17 days?
You can do it simply by having an engagement letter stating payment due on completing the work if you finish the job in 10 days. Then you can send an invoice online with a link to pay on that day.
I started using this approach in 2007. I remember working with a new client then. As soon as I did the work while at the client’s premises, I would log in to my remote computer using LogMeIn, generate invoices, and email him straight away. So the client had the invoice within 5 mins of completion of work, payable on the same day.
You need to manage cash flow effectively and efficiently for the short term and look at long-term cash requirements.
It’s a bit like reviewing your mark sheet semester by semester to get a bigger picture of what you need to do and focus on, to get good grades at the end of the final exam.
So short-term cash-flow focus ensures you have enough cash to cover your working capital requirement. And long-term cash flow focus makes sure that your cash position is optimum for sustained business growth.
Also, have a cash flow forecast in place.
This cash flow forecast will help you understand what your cash position will look like in 3 months, six months, or even 12 months today.
You can use this insight to plan and execute business growth based on future cash projections.
How Will a Cash Flow Statement Help You and Your Business?
A cash flow statement helps capture all cash coming in and going out in one place and gives you a birds-eye view of your cash flow?
With a cash flow statement, you’ll have answers to many important cash flow questions without having to waste hours, the time you’d rather spend with your family.
Cash Flow Statement Step by Step Preparation With a Time-Tested Monthly Cash Flow Statement Template
This template follows the exact process that I use to help my clients with a revenue range of £40k to £40m to prepare a monthly cash flow statement in their business.
By going through this section, you will have answers to these questions:
- What is the format of the cash flow statement?
- What are the steps to prepare a cash flow statement?
- What are the sources of the cash flow statement?
- What are the closing and opening balances?
- How do you find your opening balance?
- How do I calculate net cash flow?
- What is the Net increase/decrease in cash?
- Who should prepare a cash flow statement?
- What is a good cash flow statement?
- What happens when the net change in cash on the cash flow statement goes negative?
So, let’s dive in and start with step 1 of cash flow statement preparation.
Collect the sources of cash flow data
To prepare a cash flow statement, first, you need to collect the sources of cash flow data.
So what are the sources of data to prepare a cash flow statement? It’s the bank transactions of cash inflow and cash outflow from your accounting systems from Quickbooks online or Xero as these are the most popular accounting software.
Decide whether you are going to use the cash flow direct method or cash flow indirect method
What is the difference between the direct cash flow method and the indirect cash flow method?
According to Investopedia, “The cash flow direct method determines changes in cash receipts and payments, which are reported in the cash flow from the operations section. The indirect method takes the net income generated in a period and adds or subtracts changes in the asset and liability accounts to determine the implied cash flow.”
It means the direct method is based on how much cash is collected minus how much cash is paid in a given time.
Whereas the indirect method is based on starting from net profit in the profit and loss account, adding or subtracting the movement of debtors and creditors to work out the cash flow position.
Personally, as an entrepreneur, I recommend using the direct method as it’s simple to use by focusing on what’s coming in and what’s going out from the business.
Decide on the frequency of the cash flow statement, whether you need a monthly cash flow statement, weekly cash flow statement, or even a quarterly cash flow statement.
As a general rule of thumb, if your business has more than 100 transactions, do it monthly, or if less, do it weekly.
Based on steps 2 and step 3, prepare a cash flow statement template. I have created one for you if you don’t have a statement template. You can download this monthly cash flow template and make it your own. (We link to our sub-topic cash flow template download section)
Export bank transactions from your online banking as a CSV or excel file into two columns CASH IN AND CASH OUT.
For this, download the bank statement from your online banking portal as a CSV or excel file. You will see the cash in and cash out columns with opening and closing bank balances.
Download data from the banking portal and not from accounting software; because bank transactions are facts that happened in a particular month, whereas the data you pull from your accounting software may have unallocated, misallocated transactions.
Organize cash inflow by four types of receipts:
- Cash from customers
- Government Grants
- Business owner capital
- Bank loans
This brings us to step 7.
Organize cash outflow into seven types of cash outflow:
- Direct suppliers
- Indirect Suppliers
- Sales Tax, Social security, Corporate tax
- Loan repayments
- Owner drawings
- Refunds to clients
- Intercompany transfers
And, then we move to the final step in preparing a cash flow template.
Post opening bank balance in the cash flow statement template and Compare closing bank balance with the cash flow statement cash left balance to agree.
Follow the monthly cash flow template to record cash inflow and cash outflow, then post-opening bank balance.
By completing these steps, you would have prepared a cash flow statement.
Sometimes a cash flow statement is also referred to as a cash flow spreadsheet.
As a result of preparing a cash flow statement, you will find net cash, the difference between cash inflow and cash outflow.
Net cash flow formula = Total cash inflow – Total cash outflow in a specific period.
Why Is Net Cash Important?
If the net cash is positive, the business has positive cash flow, whereas if the net cash is negative, the business has negative cash flow.
By going through these eight steps, you’ll have a complete picture of what’s going on with your cash flow.
You can do this in less than 15 mins without the usual anxiety or hassle that comes with organizing your cash flow.
I have added a link in the resource section to download this monthly cash flow statement template and make it your own.
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This section looked at a cash flow statement, its objectives, and how to prepare it.
As discussed, a cash flow statement is like a mark sheet of your cash flow performance. Regular updates and checks can help you measure the cash flow metric.
There’s a saying, “What gets measured gets done.”
So, pay attention to your cash flow.
If you need any help, reach out to me.