Cash flow statement explained

A cash flow statement offers a definitive look at the financial health of a business to show how well it’s performing during the current reporting period and over time.

Understanding the layout is not just important for anyone wanting to know more about the financial health of a company. Being able to read a cash flow statement can also benefit any potential employees wanting to join a firm, or small businesses doing their own market research.

Cash is the lifeblood of a company, so the management team needs to monitor the cash flow at all times to ensure survival balanced with growth.

Financial statements are vital to inform decision-making for leadership, investors and creditors.

This guide covers how to read a cash flow statement and how to prepare one.

To get a head start, you can also download our cash flow template.

Here’s what we’ll cover

What is a cash flow statement?

A cash flow statement is a simple report that discloses your business’s cash outflows and inflows during a reporting period.

It shows how the business received and spent cash, providing a complete picture of what occurred with the business’s cash during the time frame in question. It also confirms whether the organization can pay its expenses and debts.

Also known as a statement of cash flows, this document is part of a set of required primary statements, along with the balance sheet and income statement.

We’ll compare these three reports in depth below, but essentially:

• Cash flow statements show how much cash is in hand, and how the business uses its cash
• Balance sheets show the business’s assets, liabilities, and equity
• Income statements show the business’s profitability

All cash flow statements use standardized formats and formulas.

US-based companies using GAAP (generally accepted accounting principles) follow ASC 230 (Accounting Standards Codification 230) as a guide for developing cash flow statements.

Organizations using IFRS (International Financial Reporting Standards) follow IAS 7 (International Accounting Standard 7: Statement of Cash Flows) when creating this report.

Although these two sets of guidelines are similar, they differ in how they classify various reporting activities. We’ll detail the differences below.

What is a cash flow statement used for?

This financial statement serves several purposes for internal and external decision makers:

• Creditors may use it to assess the organization’s liquidity (e.g. the amount of cash on hand)
• Investors may use it to measure the company’s financial health and inform their valuation
• Shareholders may use it to monitor the strength of their investments over time
• Accounting staff may use it to confirm whether the company can successfully process payroll
• Potential employees may use it when interviewing to confirm the company can afford their salaries
• Market research may use it to assess the state of the market and the performance of their direct or indirect competitors.

Because cash flow statements follow accounting standards, they can also be used as comparative tools.

In other words, you can use them to compare the performance and efficiency of two or more companies. You can also use them to compare a single company’s performance over multiple reporting periods.

Companies may produce cash flow statements monthly, quarterly, or annually.

At the very least, the Securities and Exchange Commission (SEC) requires companies to include this statement in quarterly and annual reports.

Note that only publicly listed companies have to comply with SEC reporting requirements. Private companies are not required.

What does a cash flow statement show you about your business?

A statement of cash flow answers many important questions about the health of your business.

For example:

How liquid is your business? This statement tells you exactly how much cash your business has on hand at the end of the reporting period. It confirms if you can pay debts and operating expenses in cash.

What are your biggest sources of cash inflow and outflow? The simplicity of this report makes it easy to see which activities contribute most to your business’s income and expenses.

How is your cash flow likely to look in the future? You can compare multiple consecutive statements to identify patterns, anticipate future cash flow, and make data-driven decisions about business plans.

Is your business likely to receive financing? Investors and lenders often review cash flow to make decisions about providing loans, lines of credit, and funding.

What should a cash flow statement include?

Cash flow statements follow a structure that lists the business’s operating, investing, and financing activities.

Each activity type appears in a dedicated section. This way, it’s easy to see which has the biggest impact on the business’s cash flow.

After listing the business’s activities, the statement shows the total increase or decrease in cash and cash equivalents. A positive number reflects a net increase, while a negative number reflects a net decrease.

The statement also includes the opening balance of cash and cash equivalents for the reporting period.

This figure equals the closing cash balance for the previous period and can be placed either at the top of the statement or at the end with the closing balance.

At the end of the statement is the closing balance of cash and cash equivalents for the current reporting period.

This closing balance figure will become the opening balance for the subsequent reporting period.

Cash flow statements also disclose non-operating non-cash activities, an example of this is renegotiating debt as a debt/equity swap.

However, the accounting standard the organization uses determines where this disclosure appears.

IFRS places non-operating non-cash investing activities in a footnote. GAAP allows these disclosures to appear either on the statement or a footnote.

The 3 main activities of a cash flow statement

Every cash flow statement includes three main sections. Each details a specific type of cash inflow or outflow.

Operating activities

Operating activities refer to standard business activities. This section of the statement shows how much cash the company’s offerings (e.g., products or services) generate.

Cash from operating activities includes:

• Selling goods or services
• Paying suppliers and vendors
• Making interest or income tax payments
• Paying wages or salaries to employees
• Making rent payments for company facilities

Investing activities

Investing activities refer to investments the company has made using free cash rather than debt.

This section of the statement shows how much cash the company generates from buying or selling investments or assets.

Cash flow from investing activities includes:

• Buying or selling assets (e.g., real estate and equipment)
• Issuing to and collecting loans from subsidiaries of the company
• Purchasing marketable securities such as IP rights, or contracts
• Engaging in mergers and acquisitions

For investment companies, investing is part of doing business. In this case, any cash paid or owed for investments appears in the operating activities section.

Financing activities

Financing activities refer to investments other organizations have made in the company. This section of the cash flow statement shows how much cash the company generates from raising funds and repaying debt.

Cash flow from financing activities includes:

• Financing from loans or investors
• Repaying debt principal
• Making payments to shareholders
• Issuing stock

What are cash equivalents?

A cash flow statement includes both cash and cash equivalents.

Cash equivalents are short-term investments that are highly liquid. To fit this definition, they must be easy to convert to cash or so close to maturity that the risk of valuation changes are low.

Some examples of cash equivalents include:

• Currency
• Bank accounts
• Treasury bills
• Short-term government bonds

Opening and closing balances include both cash and cash equivalents.

There are two ways to calculate cash flow from operating activities. Both GAAP and IFRS accept either preparation method, but IFRS prefers the direct method.

Direct method

The direct method is the more straightforward of the two. It’s optimal for businesses using the cash basis accounting method, especially those following IFRS.

This method is essentially a tally of cash collected minus cash disbursed. To use this method, simply list out and add up all cash payments and receipts from the reporting period.

Indirect method

The indirect method is a little more complex than the direct method. However, companies using the accrual basis accounting method may find it to be less time-intensive.

This is because the indirect method uses the company’s income statement as the starting point for calculating cash flow. The income statement counts income and expenses when they’re accrued.

To use this method, start with the net income. Then, adjust it by adding or subtracting all non-cash items.

Asset depreciation and amortization are some of the most common adjustments. Both of these items decrease income, but they aren’t cash expenses.

An April 2024 amendment to IFRS requires companies to begin using the operating profit subtotal as the starting point for the indirect method. This change affects annual periods starting on or after January 1, 2027.

How to read a cash flow statement

On reading this statement, finance professionals typically draw one of two conclusions.

The organization has either a positive or negative cash flow.

However, the cash flow statement reflects the organization’s cash flow at a moment in time.

Compare multiple statements to gain a more complete picture of the organization’s financial health over time.

A comparison shows if the business is growing, going through a period of decline, or transitioning between these two states.

It also reveals if the business is on a path to bankruptcy.

Negative cash flow

A statement showing negative cash flow indicates the business is spending more cash than it’s receiving.

Although this outcome may seem undesirable, it doesn’t always signal a serious problem.

The business’s growth or funding stage may negatively affect cash flow for a limited time.

While cash flow may be negative during this period, ideally, the trend will reverse.

As an example, additional context or deeper analysis may reveal that the business is undergoing rapid growth or expansion.

In addition, early-stage startups often have a higher burn rate before becoming profitable.

Positive cash flow

A statement showing positive cash flow indicates the business is bringing in more cash than it’s paying out. On a surface level, more cash flowing in than out reflects a financially healthy business.

However, positive cash flow doesn’t always equal a profitable business.

As a result, it’s essential to review the company’s income statement and balance sheet to analyze the underlying factors.

As an example, a business can achieve a positive cash position by taking out a large loan to mitigate cash flow problems.

This position may be temporary—and it may reverse once the repayment period begins.

Some fluctuation is inevitable. But businesses with uneven cash flow over multiple reporting periods often appear unstable.

Investors may view their risk level as too high and decline to fund them.

Cash flow statement vs. income statement vs. balance sheet

As useful as cash flow statements are, they tell only part of the story of a company’s financial health.

That’s why it’s helpful to review them alongside two other financial statements: balance sheet and income statement.

Cash flow statement

This statement reflects the reality of the company’s cash position at the end of the reporting period.

It details what happened to the cash and if the company has enough on hand to operate effectively.

It only includes cash inflows and outflows that have already occurred.

A cash flow statement doesn’t include credit-based sales or other income or expenses that haven’t yet flowed into or out of the business.

As a result, income statements and cash flow statements can show seemingly contradictory results.

An income statement may show a profit if the business has incurred substantial income, while a cash flow statement may show negative cash flow if the business has spent more cash than it received.

Income statement

An income statement serves as the starting point for the indirect method of calculating cash flow.

Also called a profit and loss (P&L) statement, it reflects the company’s net income at the end of the reporting period. It shows the cumulative effect of all revenue and expenses.

It includes several components that don’t factor into cash flow, such as credit-based sales and depreciation.

Neither of these line items reflect cash flowing into or out of the business.

That’s because the accrual method that most businesses use to record income when it’s earned and expenses when they’re incurred. Often, this timing doesn’t align with when the cash arrives or leaves the account.

Balance sheet

A balance sheet reflects the company’s current resources and their worth. Think of a balance sheet as a report that calculates the company’s value.

It reveals the company’s available resources, including assets, liabilities, and owner equity. In other words, it tallies how much the company owns and how much it owes.

This report doesn’t include revenue, expenses, or cash inflow and outflow.

The differences between US GAAP and IFRS

GAAP (ASC 230) and IFRS (IAS 7) accounting standards both require cash flow statements as part of the financial reporting process. And both use similar rules to prepare these statements.

However, the two standards have important differences. Namely, IFRS classifies cash flow based on the nature of the activity. If using the indirect method, GAAP looks at the income statement for net income and non-cash expenses like depreciation and amortization.

Here are some ways cash flow statements reflect these differences:

• Cash equivalents: IAS 7 includes both cash and cash equivalents. ASC 230 requires the disclosure of cash, cash equivalents, or restricted cash on the cash flow statement to be the same as how those items are presented on the balance sheet. 
• Interest and dividend payments: IAS 7 permits interest and dividends paid to be part of either operating or financing activities. ASC 230 requires interest payments to be part of operating activities. But dividend payments are financing activities.
• Interest and dividend receipts: IAS 7 allows interest and dividends received to be classified as operating, or investing activities. The classification must remain consistent between reporting periods.
• Bank borrowings: IAS 7 may consider overdraft fees part of cash equivalents instead of financing activities. This rule is country-specific and depends on the company’s location.

It’s important to note that an April 2024 amendment to IAS 7 removes presentation alternatives for dividends and interest. This change applies to annual periods starting on or after January 1, 2027.

Both IFRS and GAAP allow either the direct or indirect method of calculating cash flow. However, GAAP prefers the direct method.

Cash flow statement example

This example illustrates how a typical cash flow statement looks.

You can download a cash flow statement template here.

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This article was verified by a US-based Certified Public Accountant (CPA). Accounting rules are complex and change frequently and we recommend you seek any accounting advice from a qualified CPA.