The content of this article is provided for informational purposes only. You should always obtain independent business, tax, financial, and legal advice before making any business decision.
Managing a business's finances can feel daunting at times, especially if you're buried in bank and credit card statements, rows of sales figures, and complex projections. That said, no matter how overwhelming the numbers may seem, it’s essential to keep track of your financial flow – after all, how can you plan for the future if you don't know where your money is going?
Luckily, cash flow statements can help. As a fundamental financial document, they provide a clear snapshot of your cash activity, both in and out, over a period. Cash flow statements can help you understand the financial health of your business so you can make important decisions for your company's future, whether that’s scaling up operations, optimizing costs, or exploring new markets.
Here, we'll explain what a cash flow statement is, why it's important, and how to prepare one for your business.
A cash flow statement is a financial statement that aggregates incoming and outgoing cash from various sources, including operating activities, financing, and investments. It typically covers a set period, like a fiscal year.
Cash flow statements provide an essential snapshot of your company’s financial performance at the liquidity level and are one of three key financial statements every business should have (alongside your income statement and balance sheet).
The purpose of a cash flow statement is to track the changes in your business’s cash movements over a period, helping you gauge the effectiveness of your cash flow management strategies.
By comparing operating cash flow to net income, it can uncover discrepancies that might prompt you to reevaluate your business operations and cost structures. This is critical for avoiding a cash flow crunch and ensuring the business has the necessary funds to continue operating and growing.
For example, if you have a significant amount of cash coming in, but you're only earning a small portion of that cash in profit, you may need to streamline your operations and expenses. On the other hand, strong cash flows might indicate an opportunity for expanding into new product categories or investing in marketing that could solidify your company's market position and increase future profitability.
Cash flow statements are also essential when seeking external financing. Banks and other lenders often require a copy to assess your company's liquidity and cash flow stability before approving loans. A steady cash flow indicates that a business can meet its repayment obligations, which can help you secure more favorable loan terms.
Overall, by using a cash flow statement to anticipate financial needs and plan accordingly, business owners can make more informed decisions that support business growth and ensure long-term success.
The first step to preparing a cash flow statement for your business is understanding what goes on one. Here are the three core business activities covered by a cash flow statement:
Let’s take a closer look at how to calculate cash flow from your operating, investing, and financing activities.
Cash flow from operations includes any cash that is generated from your business' everyday activities, such as selling products and services. It also covers outgoing cash from your business expenses.
This calculation gives you a clear view of how much cash your business is generating from its core operations, which is critical for assessing your company's sustainability and growth potential.
Examples of cash flow from operating activities include sales of goods, inventory payments, income tax payments, employee salaries, and office rent and utilities.
You can calculate cash flow from operating activities using either the direct or indirect method. Each method is suitable for different types of businesses and provides unique insights into your financial status.
The direct method of calculating cash flow involves simply tallying up all your cash receipts and payments, such as those from customers, vendors, and employee salaries. Put more simply, you add up your incoming cash flow from sales and subtract your outgoing cash flow from expenses. In the end, you'll have your net income from cash transactions.
The direct method provides the most straightforward view of cash transactions, making it especially useful for small companies with fewer transactions and simpler financial structures. For example, if you’re a solopreneur Etsy crafts store with only three suppliers or a small local café with straightforward daily sales, you’ll most likely opt for this method.
The indirect method of calculating cash flow is particularly advantageous for larger businesses or those with complex accounting practices where direct cash flows are not readily apparent. It involves starting with your total net income (found on your income statement) and adjusting for non-cash transactions (found on your balance sheet) such as depreciation, changes in inventory, and accounts receivable. This adjustment is necessary because the income statement includes non-cash items that do not affect actual cash flow.
The indirect method allows companies to reconcile their cash on hand with the profit reported on the income statement, providing a comprehensive picture of cash flows influenced by operational performance and financial strategies.
It also helps in creating a bridge between accrual accounting and cash management, which can be tricky for businesses that engage in extensive credit operations, have long-term contracts, or operate in industries where cash receipts do not align closely with the earning of revenues. Think construction firms, large manufacturers, and service providers that work on a project basis where billing cycles and revenue recognition do not necessarily match up with cash movements.
Investing activities provide insights into how your business allocates its capital and manages its long-term investment strategies.
To calculate cash flow from investing activities, simply tally the gains and losses from your business investments. This includes cash spent on or received from the purchase and sale of long-term assets like property, vehicles, securities, and equipment.
It's essential to analyze these transactions separately, as they do not directly reflect day-to-day operational efficiencies but play a pivotal role in long-term growth and asset replacement strategies. Tracking these can also help you identify which investments are yielding positive returns and which might need reassessment.
Calculating cash from financing activities involves adding up debt and equity from creditors and shareholders. This includes inflows from issuing stocks or bonds and outflows for dividends, loan repayments, or bond redemptions. Make sure to also account for interest on debt, which affects the total cash flow and financial health of the business.
Understanding these figures is vital for assessing your company's financial leverage and capital structure. It helps to determine how dependently your business operates on external financing and how effectively it manages financial liabilities and shareholder expectations.
Once you’ve calculated your cash flow from these three main types of business activities – operational, investing, and financing – you can sum them up to calculate your final balance. This final cash balance is the most important figure in your cash flow statement as it represents the net increase or decrease in cash for the period.
Maintaining a clear year-over-year record allows you to measure your performance and capture insights for strategic planning. By regularly comparing these figures, you can spot trends, prepare for future financial needs, and make informed decisions based on historical data.
The result? Greater financial transparency and stronger stakeholder confidence in your company’s fiscal management.
If your cash flow balance is positive, then your business is bringing in more cash than is being spent. With a positive cash flow balance, you’re in a strong position – your business operations are generating enough revenue to cover expenses and still retain surplus funds. Now, you can confidently invest that extra cash in new projects, pay off debts, and continue expanding your business. You now also can enjoy a cushion for unexpected expenses without disrupting your operations.
If your cash flow balance is negative, then more cash is leaving your business than is being received. This might raise flags about the sustainability of your business model or indicate a need for tighter cash management. But remember: a negative cash flow balance does not necessarily spell disaster – it may simply suggest that your business is in a phase of heavy investment, such as in new equipment or market expansion, which could yield higher returns in the future.
Still, if the negative cash flow persists, it might be time to cut some expenses and reevaluate your operating strategies to return to a positive flow. Consider improving your inventory management, renegotiating supplier contracts, optimizing your pricing strategy to enhance revenue, or exploring new funding options.
When it comes to getting the funding you need to make investments, expand your business, or simply improve your cash flow, you have plenty of different options. From business loans to equity financing to government grants, these funding sources can provide the necessary capital. Keep in mind that rather than just committing to the first opportunity that comes through the door, you’ll want to choose one that meets the specific needs and conditions of your business.
Learn how PayPal can provide funding options to help your business manage its cash flow.
Cash flow problems are a large cause of business failures in the United States.1 Meanwhile, 54% of businesses that faced financial challenges named uneven cash flow as one of the problems they navigated,2 highlighting the significant impact that cash flow issues can have not only on the balance sheet but also on personal well-being. It’s clear that robust cash management practices are essential for the survival and health of any business.
Regardless of what stage of growth your business is in, a cash flow statement is instrumental in revealing whether it’s generating enough cash to meet its obligations and support its operational needs. This document is not just an administrative requirement – it’s a vital tool for making informed financial decisions.
While it may sound complex, managing your cash flow effectively is indispensable for business stability and growth. Learn how to optimize business operations, save costs, and boost your financial strategy with our comprehensive tips on accounting for small- and mid-sized businesses.
In partnership with three expert business owners, the PayPal Bootcamp includes practical checklists and a short video loaded with tips to help take your business to the next level.
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