Cash Flow Statement: What It Is and How to Make One

Your cash flow statement shows the real movement of money in and out of your business. Different from profit, a cash flow statement is an essential tool for managing your business and keeping money moving. It highlights liquidity, showing whether your business can pay its immediate bills, fund growth, or sustain its operations without taking on debt.

Small business owners, freelancers, and LLC owners should use this guide to learn how to read a cash flow statement, how to calculate theirs, and why it's critical for financing and long-term planning.

What is a Cash Flow Statement?

A cash flow statement is a document that collects all data from day-to-day operations to report on the business’s liquidity and financial health at any given moment.

Cash flow statements are not concerned with long-term profitability or projections but with actual cash inflows and outflows. They report money received and money spent.

Cash Flow Statement vs. Income Statement vs. Balance Sheet

While used together, cash flow statements differ from income statements and balance sheets.

Why Do Small Businesses Need Cash Flow Statements?

Business owners need cash flow statements to keep them informed about the health of their businesses. Accurate and timely data on your cash activity can help you stop a potential crisis before it starts. Cash flow statements can also help businesses project their future cash flow and make better decisions for growth.

If you don't understand your business's cash flow, you might find yourself stuck without any working capital when you need it most. Financing cash flow statements are crucial for any long-term small business risk management strategy.

You’ll also need to produce a cash flow report to demonstrate your company’s health to potential investors. This gives them a snapshot of your business operations and its sustainability. According to a U. S. Bank study, 82% of business failures stem from poor cash flow management.

How Cash Flow Statements Work

Reports of cash inflow and outflow present an accurate image of your company’s health. The cash flow statement shows your net earnings, expenses, and where funds flow.

Investors and accountants will gauge a business’s health by looking first to see whether your net cash flow is negative or positive. They look to see how sustainable and successful your company is and how likely you are to pay your debts.

Negative Cash Flow

Negative cash flow means that you are spending more money than your net earnings. You might still have plenty of working capital on hand, but if your outgoing cash transactions are far larger than your incoming cash transactions, that’s not a sustainable position.

A business investing in its growth may have to manage a negative operating cash flow for a short time, but this is not a position you want to be in for the long term.

Positive Cash Flow

Having a positive cash flow means more cash inflow than cash outflow. This is an indicator of positive financial health.

More surplus business cash on hand because of a positive cash flow also means you have resources available to work on expanding your operations.

Structure of a Cash Flow Statement

You should split your actual cash flow statement into several categories. This way, managers and investors can quickly get a sense of where you are making money and where you are spending it.

Operating Activities

Most of your regular business activity will show up under your operating cash flow. This category includes all cash paid and earned for your ordinary day-to-day operations as a business.

Inflows here will include receipts from selling current assets. Many of your outflows will be supply and labor expenses. Anything you spend on raw materials, wages, income taxes, or even rent payments will count as an operating expense.

Investing Activities

The next category is your cash flow from investing activity. This section includes cash paid for more significant assets, loans to vendors, and any other money spent on equipment or investment changes.

Most transactions in this category tend to be expenses, although you may see inflows here from equipment or investments you choose to sell.

Financing Activities

Then there are your cash flows from financing activities. This category includes all the cash flowing into your company from investors funding your operation. Outflows here will consist of paying dividends, repaying principal, and most other debt- or equity-related expenses.

Your cash flows from financing activities should demonstrate how money flows between you and your creditors, investors, and stockholders.

Non-cash Activities

To give a complete picture of your company’s financial health, you may also need to include a separate category for non-cash activities. This should include scheduled inflows and outflows that haven’t yet been processed.

Much of this category will consist of your net income parts that don’t show up in other categories. If you’ve sold several products or bought new inventory but haven’t yet received or paid for those cash transactions, you can include them here as accounts receivable and accounts payable.

These are not yet technically part of your cash activity, but they are still relevant data to include under non-cash activities.

How to Calculate Cash Flow: Direct vs. Indirect Method

Cash flow is not the same as net income. Keeping accurate records of your debits and credits is essential, but that doesn’t tell you how much liquid capital you have available at any given time.

There are two primary ways of calculating your cash flow.

Direct Method

The direct cash flow method adds up all the cash inflows and outflows from each category to total your net cash flow. The formula:

Operating Cash Flow = Total Cash Receipts - Total Cash Payments

For example, take a small bakery's performance last month:

• Cash received from customers: $10,000

• Cash paid to suppliers: $4,000

• Cash paid for employee wages: $2,500

• Cash paid for rent: $1,000

In this scenario, the bakery has $2,500 in net cash flow.

You can get a basic idea of your net cash flow this way by checking for the net change in each of your account balances from the beginning to the end of a set period.

Indirect Method

The direct method can be challenging for some businesses, especially for those using the accrual method of financial accounting instead of the cash-basis method. If you record transactions at the point of purchase before the cash has been exchanged, those records don’t reflect your actual cash flow.

In such cases, you can use more indirect methods to measure your cash flow. You would simply take your net income for a period from your income statement and then adjust it to reflect your cash flow. The formula:

Operating Cash Flow = Net Income + Non-Cash Expenses +/– Changes in Working Capital

For example, a business reported $50,000 in net income. Start with $50,000 and add back $10,000 in depreciation. Depreciation reduces net income but doesn't spend any cash, so it is added back to reflect the real cash remaining. Then, adjust $5,000 in accounts receivable. This means the company made sales on credit, but hasn't yet collected the cash. Because the credit sales are in the net income but the cash hasn't arrived, this increase is subtracted. In the final step, accounts payable increased by $3,000. This means the company recorded an expense but hasn't paid the cash out yet. Because cash was retained, it is added back, contributing to $58,000 net cash flow.

Which Method Should You Use?

The Financial Accounting Standards Board (FASB), via ASC 30, known for the Generally Accepted Accounting Principles (GAAP), encourages small businesses to use the direct method as it provides greater transparency and superior cash flow forecasting. Because the indirect method works from data already on the income statement and balance sheet, most small business owners use that instead.

Accounts Receivable and Cash Flow

To understand the difference between net income and cash flow, you need to know how accounts receivable work.

Accounts receivable are payments due to your business that have yet to be received. This is money that you have already earned, but that hasn’t yet become cash. As soon as you sell a product or service and issue an invoice, you have essentially opened an account receivable. However, that account won’t produce any cash until the invoice is paid.

Accounts receivable are not included as a part of your cash flow.

Inventory Value and Cash Flow

Another critical part of your income that doesn’t factor into cash flow is your inventory value. Spending money on inventory is an essential investment, and that inventory has value even before you sell it.

However, inventory only factors into your cash flow as an expense until it has been sold. Cash flow measures only the money you have immediately at hand and ready to spend.

Common Cash Flow Statement Mistakes to Avoid

Avoid these common cash flow statement mistakes that tend to trip up small businesses when you create yours.

• Confusing profit with cash on hand.

• Leaving out non-cash adjustments like depreciation.

• Failing to update the statement regularly or build a forward-looking cash flow forecast.

• Mismatching the timing of receivables and payables for your business.

Where Do Cash Flow Statements Come From?

Some business owners put together their own cash flow statements, but that’s not the only way to manage them. If a business wants to streamline accounting processes to save time and improve bookkeeping accuracy and efficiency, using accounting software or working with an accountant can produce regular reports.

FAQs About Cash Flow Statements

What is the difference between cash flow and profit?

Profit shows what remains after subtracting operating expenses from revenues, while cash flow tracks the actual physical movement of money in and out of your business. Profit is an indicator of long-term success, whereas cash flow reveals whether you can pay your short-term bills.

Do I still need a cash flow statement if I use accounting software?

Yes, because even the best accounting platforms primarily organize data, and you still need a cash flow statement to forecast your liquidity proactively. The software can compile the raw numbers, but the statement itself helps you spot payment delays and make confident, data-backed decisions. Instead of choosing one over the other, it's best to use them together.

How often should a small business prepare a cash flow statement?

Most small businesses should prepare and review their cash flow statement at least monthly to monitor liquidity and ensure smooth daily operations. If your business has complex financials or tight profit margins, it is highly recommended to run them on a weekly or bi-weekly basis. A tax professional can help you run the numbers, ensuring accuracy.

What does a healthy cash flow look like for a small business?

A healthy cash flow features positive cash generated from core operations. This means more money is consistently flowing into your business than out of it. It also means you have a solid cash reserve, often recommended to cover three to six months of operating expenses, to handle slow periods or unexpected emergencies seamlessly.

Can a business be profitable and still run out of cash?

Yes, a business can easily be profitable on paper but run out of cash. This can be due to timing mismatches, such as slow-paying customers or heavy upfront inventory purchases. If your earnings are tied up in unpaid invoices or hard assets, you will struggle to cover your immediate payroll or rent.

Should a small business use the direct or indirect method?

Small businesses typically prefer the indirect method because it is easier to calculate using your existing Profit and Loss statement and balance sheet. The direct method requires individually tracking all actual cash transactions, which is often too tedious for small operations without advanced ERP systems. The FASB recommends that small businesses use the direct method due to better transparency and forecasting.

Turning Your Cash Flow Statement Into a Growth Tool

The cash flow statement, along with the balance sheet and income statement, is an essential financial document that your business needs to create. Now that you know how to read and calculate yours, you will have a better idea of where your business stands during a specific period. While many owners track and calculate their own cash flow statements in the beginning, professional support is optimal as the business grows.

If you're ready to take that step, see how 1-800Accountant's full-service bookkeeping solution tracks accounts payable and receivable, along with other transaction data, that supports accurate cash flow statements whenever you need it.