Cash Flow Statements: How to Prepare and Read One

When it comes to understanding the financial health of a business, the cash flow statement is one of the most vital tools available. It provides a clear view of how money moves in and out of your business, helping you stay on top of your cash position, plan and avoid financial surprises.

In this blog, we’ll break down what a cash flow statement is, how to prepare one, and most importantly how to read and interpret it effectively.

What Is a Cash Flow Statement?

A financial report called a cash flow statement illustrates how money comes into and goes out of a company over a given time frame, usually monthly, quarterly, or annually. Unlike profit and loss statements, which include non-cash items like depreciation, the cash flow statement focuses solely on actual cash transactions.

It’s divided into three main sections:

• Operating Activities
• Investing Activities
• Financing Activities

Together, these sections provide a full picture of a company’s liquidity and ability to manage its cash efficiently.

Why Is the Cash Flow Statement Important?

A business might appear profitable on paper, but if it’s not managing its cash flow properly, it can quickly run into trouble. Here’s why the cash flow statement matters:

• Tracks Liquidity: It shows whether a business can cover its expenses.
• Supports Decision Making: Cash availability impacts hiring, expansion, and purchasing decisions.
• Highlights Financial Health: Investors and lenders often review cash flow to assess a company’s stability.
• Reveals Timing Issues: You may be profitable but still have cash flow problems if clients delay payments.

How to Prepare a Cash Flow Statement

The direct technique and the indirect method are the two primary approaches used to create a cash flow statement. Businesses employ the indirect way the most.

Step 1: Start with the Cash Flow from Operating Activities

This section shows how much cash your core operations generate or consume. If you’re using the indirect method, begin with your net income and adjust for non-cash items and changes in working capital:

• Add back non-cash expenses like depreciation or amortization.
• Adjust for changes in accounts receivable, inventory, and accounts payable.

Example:

If your net income is £10,000, depreciation is £2,000, receivables increase by £3,000, and payables increased by £1,500:

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Net Income: £10,000 

+ Depreciation: £2,000 

– Increase in Receivables: £3,000 

+ Increase in Payables: £1,500 

= Net Cash from Operating Activities: £10,500

Step 2: Add Cash Flows from Investing Activities

This section covers the cash spent or earned through long-term investments such as buying or selling property, equipment, or securities.

Examples:

• Purchase of new machinery (cash outflow)
• Sale of an asset (cash inflow)

Be sure to include only actual cash transactions—depreciation or revaluation doesn’t go here.

Step 3: Include Cash Flows from Financing Activities

Financing activities reflect how your business raises capital and pays it back. This might involve:

• Loan proceeds (cash inflow)
• Loan repayments (cash outflow)
• Issuing or buying back shares
• Paying dividends

Step 4: Calculate Net Cash Flow

Once you have all three sections, sum them up to calculate the overall change in cash:

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Net Cash from Operating Activities 

+ Net Cash from Investing Activities 

+ Net Cash from Financing Activities 

= Net Change in Cash

Then, add this to your opening cash balance to determine your closing cash balance for the period.

How a Cash Flow Statement Should Be Read and Interpreted

Preparing a cash flow statement is one thing knowing how to read it effectively is just as important.

Here’s what to look for:

1. Positive Cash Flow from Operating Activities

This is a good sign. It means your core business operations are generating more cash than they’re using. A consistently negative figure here is a red flag.

2. Investing Activities

Cash outflows from investing activities can indicate growth and expansion (like buying equipment), which is often a positive sign if your operating cash flow supports it. Repeated inflows from asset sales might mean you’re selling off assets to stay afloat.

3. Financing Activities

Look at where your funding comes from. Heavy reliance on loans could indicate debt dependence. Regular dividend payments show shareholder confidence, but they must be sustainable.

4. Net Increase or Decrease in Cash

If your net cash flow is negative, dig into the details. It might be due to planned investments or seasonal changes, or it could indicate financial trouble.

5. Compare with Other Financial Statements

Use the cash flow statement in conjunction with your profit & loss and balance sheet. For instance, high profits but poor cash flow might mean you have unpaid invoices piling up.

Common Cash Flow Mistakes to Avoid

• Confusing profit with cash flow: Profit includes non-cash items. Always check the cash flow for real liquidity.
• Ignoring working capital: Cash flow is significantly impacted by changes in inventories, payables, and receivables.
• Failing to plan for taxes and loan repayments: These are real outflows that must be factored into your forecast.
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Tips for Managing Cash Flow Better

• Send invoices promptly and follow up on payments.
• Consider early payment discounts or incentives.
• Lease instead of buying expensive equipment.
• Monitor cash flow regularly monthly reviews can highlight issues early.

Final Thoughts

Cash is the lifeblood of any business, and the cash flow statement acts as its health check. By learning how to prepare and read this essential document, you gain valuable insight into how your business truly operates beyond what your income statement or balance sheet might show.