Bookkeeping 101: Understanding Your Cash Flow Statement 

What goes in a cash flow statement?

To help you understand the cash flow statement, let’s break down the terminology within each statement. Cash refers to money in its liquid form. The cash account has money that is available immediately, unlike other asset accounts (i.e., accounts receivable, investments, prepaid expenses, and inventory).

For example, a business might be asset-rich but cash-poor if the owner has paid off the mortgage and owns a large fleet of new vehicles, but only has $1,000 in spendable money on hand.  

Cash flow statements look at both the cash on hand and cash equivalents of a business. Cash equivalents refer to money in the bank, short-term investments, and other assets that can be converted into cash quickly.

With that in mind, cash flow statements report on the movement (flow) of cash and cash equivalents into and out of a business. Three types of cash flow are reported:

1. Cash flows from operating activities – These refer to the cash flows related to your primary business activities that involve generating revenue and paying day-to-day expenses.
2. Cash flows from investing activities – These are the cash flows related to your long-term assets and investments. That would include the acquisition or disposition of equipment, vehicles, and real estate.
3. Cash flows from financing activities – These refer to the cash flows related to debt and equity financing, such as payments toward outstanding debts and proceeds from the sale of securities.

Cash flow statements track incoming and outgoing cash flows. For example, when a business raises a new round of capital from investors, that shows as a cash inflow because the company has more liquid funds. When these investors are paid back, the statement shows a cash outflow because money left the business.

Example cash flow statement.

Here’s an example of a cash flow statement for an imaginary business to help you understand what yours might look like in practice.

How to calculate cash flow.

Most businesses have relatively few transactions related to investing and financing in a given accounting period. As a result, calculating your net cash flow for these activities is usually straightforward: simply subtract your cash outflows from your cash inflows.

Unfortunately, calculating your net cash flows from operating activities is often more complicated. Since it involves the cash receipts and disbursements related to your business’ day-to-day activities, there are typically many more transactions involved.

As a result, there are two ways to calculate the net cash flow from your operating activities: the direct and indirect methods.

The direct method ignores all non-cash transactions and involves identifying your cash receipts and disbursements, then netting them. If you use the cash basis of accounting or have few cash transactions, the direct method may be a good option for you.

However, the direct method is usually too time-consuming when you use the accrual basis of accounting or have a regular number of cash transactions. In these cases, you’re probably better off using the indirect method.

The indirect method involves pulling your net income from the income statement and making adjustments to convert it into your net operating cash flow. For example, that may require subtracting earned but uncollected revenues, adding non-cash expenses like depreciation, and reversing the effect of any gains or losses.

Interpreting a cash flow statement.

Business owners must track their cash flow over multiple quarters to get a clear picture of how their cash comes and goes. Let’s explore how you might interpret a cash flow statement that shows a positive or negative cash flow for an extended period.

Positive cash flow.

Having a positive net cash flow indicates that your business is healthy. It suggests that you’re collecting more revenue than you spend, or at least generating enough cash through your financing and investing activities to pay your bills. That’s essential for maintaining your business, scaling your operation, and repaying creditors or investors.

The longer you maintain a positive cash flow, the more your cash reserves grow. Eventually, you should deploy your excess cash to improve your business. For example, that might mean purchasing new equipment, expanding your sales team, or investing in income-producing assets.

Negative cash flow.

Negative net cash flow indicates that your business is spending more cash than it’s generating. Since running out of money is one of the most common causes of business failure, you should monitor your reserves closely during periods of negative cash flow. If they get too low, you may need to reduce your spending or apply for financing.

That said, negative cash flow doesn’t necessarily mean that your business is failing. For example, a company might have negative net cash flows in the months before it opens. During this time, there are often expenses without significant income.

How do lenders use the cash flow statement?

Lenders often look at the cash flow statement when determining whether or not a business qualifies for a loan. Healthy cash flows can assure a lender that the company is making strategic spending decisions, reducing the perceived risk of lending to them.

Creating your cash flow statements may become challenging as your company matures. Once you’ve grown sufficiently, consider hiring a bookkeeper and consulting with a Certified Public Accountant. That will ensure your financial statements are accurate and help you get the financing you need to continue growing your business.