How to Prepare a Cash Flow Statement
The cash flow statement, also known as the statement of cash flows, is one of the three main financial statements used by businesses and investors. It provides information about a company’s cash inflows (receipts) and outflows (payments) during a specified period. The cash flow statement is divided into three sections: operating activities, investing activities, and financing activities.
Here are the general steps to prepare a cash flow statement:
- Header: Start with the company’s name, the title of the statement (Statement of Cash Flows), and the period of time the statement covers.
- Operating Activities: This section shows cash flow from the company’s primary business operations, such as selling goods or services. Start with net income, then adjust for non-cash items (like depreciation) and changes in working capital (current assets and current liabilities).
- Investing Activities: This section shows cash flow from the purchase and sale of long-term assets like property, plant, and equipment, or investment securities. This could include money spent on acquiring these assets or money received from selling them.
- Financing Activities: This section shows cash flow from activities related to the company’s capital structure. This can include issuing or repaying debt, issuing or repurchasing equity, and paying dividends.
- Net Increase or Decrease in Cash: Add up the net cash provided by (or used in) each of the three sections to get the total change in cash for the period.
- Reconciliation with the Balance Sheet: Start with the opening cash balance at the beginning of the period (from the balance sheet), add the change in cash you just calculated, and this should equal the ending cash balance on the balance sheet for the same period. If it doesn’t, there’s likely an error somewhere.
- Review and Finalize: Check all your calculations and entries to ensure they’re accurate, and make sure you’ve included all relevant transactions in the appropriate sections.
It’s important to note that while the income statement and balance sheet can be prepared using either the accrual method or cash method of accounting, the cash flow statement, as the name suggests, is always prepared using the cash method. This makes it a valuable tool for understanding the actual flow of cash in and out of a business.
Example of How to Prepare a Cash Flow Statement
Let’s construct a simplified cash flow statement for a hypothetical company “LMN Inc.” for the year ended December 31, 2023:
LMN Inc. Statement of Cash Flows For the Year Ended December 31, 2023
Cash Flows from Operating Activities
Net Income: $50,000
Additions (Sources of cash):
Depreciation: $10,000
Increase in Accounts Payable: $5,000
Subtractions (Uses of cash):
Increase in Accounts Receivable: $7,000
Increase in Inventory: $3,000
Net Cash Provided by Operating Activities: $55,000
Cash Flows from Investing Activities
Purchase of Equipment: -$20,000
Net Cash Used in Investing Activities: -$20,000
Cash Flows from Financing Activities
Issuance of Long-Term Debt: $15,000
Payment of Dividends: -$5,000
Net Cash Provided by Financing Activities: $10,000
Net Increase in Cash: $45,000
Beginning Cash Balance: $10,000
Ending Cash Balance: $55,000
The sum of cash flows from operating, investing, and financing activities results in a net increase in cash of $45,000. This, added to the beginning cash balance of $10,000 equals the ending cash balance of $55,000.
This example is greatly simplified. In reality, there would likely be many more line items under each category, especially for larger businesses. The basic structure, however, remains the same. The statement of cash flows provides valuable insights into a company’s ability to generate cash and how it uses that cash in its operations, investments, and financing activities.
