What is a Cash Flow Statement? How to Prepare One
A Practical Guide to Understanding and Creating Cash Flow Statements
A cash flow statement is one of the three fundamental financial statements that shows how changes in balance sheet accounts and income affect cash during an accounting period.
Understanding Cash Flow Statements
The cash flow statement (officially called the Statement of Cash Flows) measures how well a company generates cash to pay its debt obligations and fund operating expenses.
Key Purposes:
- Shows the actual cash position (different from profit)
- Reveals liquidity and solvency of the business
- Helps predict future cash flows
- Identifies cash flow problems early
- Essential for financial planning and decision making
The Three Sections of a Cash Flow Statement
1. Cash Flow from Operating Activities
Shows cash generated from core business operations:
- Cash receipts from sales
- Cash paid to suppliers and employees
- Interest and taxes paid
- Adjustments for non-cash items (depreciation, changes in working capital)
2. Cash Flow from Investing Activities
Reports cash used for investments in the business:
- Purchase/sale of property, plant and equipment
- Purchase/sale of securities or other businesses
- Loans made to others
3. Cash Flow from Financing Activities
Shows cash from investors and banks:
- Proceeds from issuing shares
- Repayment of debt principal
- Dividends paid to shareholders
- Repurchase of company shares
How to Prepare a Cash Flow Statement
- Gather financial statements – Balance sheets and income statements for current and previous periods
- Determine net cash from operating activities – Use either direct or indirect method
- Calculate cash flow from investing activities – Analyze changes in long-term assets
- Determine cash flow from financing activities – Examine changes in debt and equity
- Reconcile with beginning and ending cash balances
Pro Tip: Most companies use the indirect method for operating activities, which starts with net income and adjusts for non-cash items and changes in working capital.
Cash Flow Statement Example
Here’s a simplified example for ABC Ltd for the year ending December 31, 2024:
| ABC Ltd – Cash Flow Statement | Year Ended Dec 31, 2024 (£) |
|---|---|
| Cash flows from operating activities | |
| Net income | 150,000 |
| Adjustments for: | |
| Depreciation | 25,000 |
| Increase in accounts receivable | (15,000) |
| Increase in inventory | (10,000) |
| Increase in accounts payable | 12,000 |
| Net cash from operating activities | 162,000 |
| Cash flows from investing activities | |
| Purchase of equipment | (50,000) |
| Net cash used in investing activities | (50,000) |
| Cash flows from financing activities | |
| Proceeds from bank loan | 30,000 |
| Dividends paid | (20,000) |
| Net cash from financing activities | 10,000 |
| Net increase in cash | 122,000 |
| Cash at beginning of period | 50,000 |
| Cash at end of period | 172,000 |
Direct vs. Indirect Method
| Feature | Direct Method | Indirect Method |
|---|---|---|
| Starting Point | Actual cash receipts and payments | Net income |
| Popularity | Less common | More commonly used |
| Presentation | Lists actual cash inflows/outflows | Adjusts net income for non-cash items |
| Ease of Preparation | More difficult (requires detailed cash records) | Easier (uses existing accounting data) |
Need Help With Cash Flow Management?
Our accounting team can prepare accurate cash flow statements and help improve your business’s financial health.
Email: accounting@mhcandco.co.uk
Phone: +44 333 789 1010
