Cash Flow Statement: What It Is and How To Understand It

Cash is the lifeline of every business—especially new and small businesses.

Limited or inconsistent cash flow is one of the most significant challenges that small businesses face. That’s why understanding and managing cash flow is a prerequisite for success.

To get a grasp of the cash flows going in and out of your business, you need a cash flow statement. If you’re having a hard time with financial statements, you’re in luck. This guide offers a detailed explanation of the ins and outs—plus a free cash flow statement template to download and customize.

What is a cash flow statement?

A cash flow statement is a financial statement that summarizes the inflows and outflows of cash transactions during a given period of business operations.

“Cash flow statements easily show business owners where their cash came from and where it went,” says Melissa Pedigo, a certified public accountant with more than 20 years of experience. “To figure out where the cash came and went by looking at the other financial statements (the balance sheet and income statement) is nearly impossible.

“The cash flow statement will show owners if there are liquidity issues with cash flow shortages. Owners can also use data from the cash flow statement to compare against their budgets or forecasts. Since cash flow statements show the company’s historic performance, this information is useful to know if you’re staying within budget.”

Recording cash movements is easier if you use a cash flow statement template for small businesses. A cash flow statement template typically comes in spreadsheet format, pre-loaded with the necessary formulas for easy calculations.

How cash flow is calculated

There are three main methods used to calculate cash flow:

Operating cash flow (OFC)

OCF = Net Income + Depreciation – Changes in Working Capital + Non-cash Items

OFC measures how much cash a business generates from its core operations. It starts with net income, adds back non-cash expenses like depreciation, and then adjusts for changes in working capital (inventory, accounts receivable/payable). A typical healthy business may aim for a net operating cash flow ratio of 1.2 to 2.0.

For example, increasing inventory reduces cash flow since you’ve spent money stocking up.

Free cash flow (FCF) 

FCF = Operating Cash Flow – Capital Expenditures

FCF shows how much cash is available to investors and owners after accounting for business needs. By subtracting capital expenditures (like buying new equipment or buildings) from OCF, you see what’s left for dividends, debt repayment, or reinvestment. 

Many investors consider it the most important measure. Small businesses generally aim for positive free cash flow of at least 10% of revenue.

Net cash flow

Beginning Cash Balance

+ Cash Inflows (from operations, investments, financing)

– Cash Outflows (operating expenses, investments, debt payments)

= Net cash flow

Net cash flow tracks all cash movement over a period. Think of it like a checkbook. Start with your beginning balance, add deposits (sales, investments, loans received), subtract payments (expenses, equipment purchases, loan payments), and you get your ending balance. It shows your total cash position change. 

Elements of a cash flow statement

1. Operating activities
2. Investing activities
3. Financing activities

The cash flow statement shows the three main types of cash flows:

Operating activities

Operating activities in the cash flow statement include core business activities. This section measures the cash flow from a company’s provision of products or services. Examples of operating cash flows include sales of goods and services, salary payments, rent payments, and income tax payments.

Investing activities

Investing activities include cash flows from the acquisition and disposal of long-term assets and other investments not included in cash equivalents. These represent long-term investments in the company’s growth. For instance, purchasing or selling physical assets like real estate or vehicles, and non-physical property like patents.

Financing activities

Cash flows related to financing activities typically represent cash from investors or banks, issuing and buying back shares, and dividend payments. Whether you’re getting a business loan, paying interest to service debt, or distributing dividends, all of these transactions fall under financing activities.

Cash flow statement example

Below is a hypothetical cash flow statement example that provides a comprehensive view of the cash inflows and outflows from operating, investing, and financing activities. It highlights the company’s liquidity and cash management for the year.

Example notes

Here are some examples notes for the hypothetical cash flow statement example above:

• Net income: This is the profit of the business after all expenses have been deducted.
• Depreciation and amortization: Non-cash expenses that reduce the value of fixed assets and intangible assets over time.
• Changes in working capital: Reflect adjustments in current assets and liabilities, impacting the company’s liquidity.
• Investing activities: Involves the purchase and sale of long-term assets.
• Financing activities: Reflect changes in the capital structure of the business, such as issuing stock, borrowing, and repaying debt.
• Currency: All figures are in USD. 

How to prepare a cash flow statement

There are two core ways to prepare a cash flow statement: the direct method and the indirect method. Both are accepted by generally accepted accounting principles (GAAP) and International Financial Reporting Standards (IFRS).

No matter which method you choose, only the operating activities section of your cash flow statement will be affected. The two other sections—cash from investing and financing activities—will remain the same.

Direct method

The direct method adds up all the cash inflows and outflows from operating activities. It’s based on the cash basis accounting model that recognizes revenues when cash is received and expenses when they are paid. The direct method for cash flow calculation is straightforward, but it requires tracking every cash transaction, so it might require more effort.

1. Start with cash receipts. List your receipts of cash made from all customers. This doesn’t include any sales made on credit, just cash collected from sales or services.
2. Add interest or dividends received. Add any income you received from interest or earned from dividends during the accounting period.
3. Subtract cash payments made to employees or suppliers. List all cash payments you made to employees, including salaried employees, contract laborers, and freelancers. This also includes any income tax you paid and any payments made to suppliers during the accounting period, including any fees or interest paid.
4. Calculate cash flow. Add the cash collected and subtract the cash payments made during the accounting period. This will give you a clear picture of the cash flow available. You can do this using the free Shopify cash flow calculator. 

Based on that number, you can figure out if cash increased or decreased for the period. This is a big indicator of how well your company is doing financially, and how much cash it can generate to pay bills and invest for the future.

Indirect method

The indirect method of preparing a cash flow statement uses net income as a base and adjusts it based on non-cash expenses like depreciation and amortization. The majority of businesses use the indirect method because it’s easier to prepare. 

This method is suitable for businesses using accrual accounting, where revenue is recorded when it’s earned rather than when it’s received. When using the indirect method, begin with the net income from your income statement, then make adjustments to undo the impact of accruals made during the period.

1. Start with net income. Net income is calculated by subtracting all operational expenses, interest payments, taxes, and other expenses from total revenue. It’s important because it’s the basis for cash flow adjustments. Although net income is a measure of profitability, it doesn’t equal cash flow.
2. Add non-cash expenses. Non-cash expenses—like depreciation and amortization—are adjustments made to net income to reflect the actual cash position of your business. Depreciation is how you spread the cost of tangible assets over their useful lives, while amortization is how you spread the cost of intangibles. You may also include losses from the sale of assets, even though they might not have resulted in a cash outflow.
3. Subtract changes in working capital. Working capital is the difference between current assets (like cash, inventory, and receivables) and liabilities (like accounts payable and short-term debt), and may fluctuate from one period to the next.
4. Add other cash items. This step involves adjusting for other cash inflows and outflows not included in net income and working capital. These include dividends paid, interest paid, and any other cash investments or payments.
5. Calculate cash flow. The final step is to calculate the total cash flow for the period. This is done by combining the net income, adjustments for non-cash expenses, changes in working capital, and other cash items.

How to read a cash flow statement

The goal of the cash flow statement is to show the amount of cash generated and spent over a specific period of time, helping you analyze liquidity and long-term solvency. The goal is to maintain a cash buffer that covers at least three to six months of operating expenses.

When you summarize all cash transactions, you can get a positive or a negative cash flow. Here’s what to do in each scenario: 

Look for positive cash flow

Positive cash flow means you have more money coming in than going out. This opens up opportunities, such as reinvesting excess cash into business growth. However, positive cash flow doesn’t necessarily mean that your business is profitable. There are cases where the company has a negative net income, but a positive cash flow due to borrowing activities.

Investigate negative cash flow

Negative cash flow indicates that you’ve spent more cash than you’ve generated during a specific period of time. Negative cash flow isn’t necessarily a bad thing, especially if it results from investment in future growth.

For instance, venture-capital-funded startups often exhibit negative cash flow, or burn rate, as they work to gain market share, win customers, and generate higher long-term profits. However, if you have a negative cash flow in more than one accounting period, you should consider it a red flag for your business’s financial health.

Make cash flow statement notes

Annotate your cash flow statement with important and helpful information for anyone trying to read and understand it. You might include notes about important definitions, how the numbers were calculated, which currency you’re using, and if you’re showing numbers in thousands or millions. This will mitigate misinterpretation. 

Cash flow statement vs. other financial statements

Financial statements are reports that summarize the financial performance of your business. A cash flow statement is one of the main types of financial statements, alongside an income statement, a balance sheet, and a profit and loss statement.

All three financial statements are different but relate to each other in important ways:

Cash flow statement vs. income statement

An income statement measures revenue, expenses, and profitability over a specific period, highlighting its profitability through net income. A cash flow statement shows the actual cash inflows and outflows over the same period, focusing on liquidity and cash management. 

The income statement includes non-cash items like depreciation, while the cash flow statement adjusts for these to reflect actual cash movement. The income statement measures financial performance, while the cash flow statement measures cash availability.

Cash flow statement vs. balance sheet

A company’s balance sheet includes total assets and liabilities, including money your business owes and money owed to you. Cash flow simply shows the money that came in and out of your business over a given span of time. Unlike an income statement, a balance sheet provides a detailed view of your assets and liabilities.

Cash flow statement vs. profit and loss 

Cash flow statements are different from profit and loss (P&L) statements. Profit reflects revenue after subtracting all costs during a set period, such as a quarter or year. Cash flow only records cash going in and out of a company. A P&L statement is also an income statement. 

Cash flow limitations

Cash flow analysis has a few limitations. It doesn’t show the timing of cash movements within a period. A company might look healthy based on monthly cash flow but face weekly shortages. 

“Cash flow analysis doesn’t consider non-cash items like depreciation or stock-based compensation,” Melissa explains. “It can also get distorted for large one-time cash events (like selling a large asset or taking out a huge loan). Cash flow analysis focuses mainly on liquidity and solvency (ability to meet short- and long-term obligations) and ignores profitability.”

Cash flow statement template

You don’t need to start from scratch when preparing a statement of cash flows. Download the free cash flow statement template and start tracking your business’s finances today.

It’s easy to use, with simple instructions, and you can customize it to suit your business’s accounting periods.

Here’s how to use it:

1. Gather relevant documentation

To fill out the template, you need financial information like receipts, invoices, and bank statements.

2. Fill out the template

As you input your numbers, the spreadsheet’s formulas will update automatically. The template also includes the starting balance so it can be carried forward, giving you an accurate calculation of your cash flow in each period.

3. Review the cash flow statement

Once your cash flow statement is ready, do some cash flow analysis. Ask yourself:

• Does the statement reveal any seasonal variations in cash flow?
• Are customers or clients making payments consistently or inconsistently?
• Do you need to account for any large, one-time cash inflows or outflows that may otherwise skew the numbers?
• How often do you have unexpected expenses and how are you managing them?
• Can you eliminate or reduce any variable expenses (utilities, subscription fees, etc.)?

Asking these questions will help you get a better sense of your business’s cash flow management strategy and predict future cash flows.

Keep an eye on your company’s cash flow

Cash flow statements may be complex, but there are many ways you can use Shopify, a suite of small business accounting tools, and apps to simplify the process. When you prepare your cash flow statements regularly, you can spot trends, maintain positive cash flow, and set yourself up for endless growth opportunities.