How to prepare a cash flow statement

What is a Statement of Cash Flows?

The statement of cash flows is one of the main financial statements produced by a business, alongside the the income statement and balance sheet. It is an essential document for evaluating the sources and uses of cash for an organization. It is especially important for deriving a business valuation, since many valuation methods are based on a firm’s net cash flows.

A statement of cash flows contains information about the flows of cash into and out of a company, and the uses to which the cash is put. The statement is comprised of three sections, in which are presented the cash flows that occurred during the reporting period relating to the following topics noted below. The statement of cash flows is closely examined by financial statement users, since its detailed reporting of cash flows can yield insights into the financial health of a business.

Cash Flows from Operating Activities

Cash flows from operating activities refer to the primary revenue-generating activities of an entity, such as cash received from the sale of goods or services, royalties on the use of company-owned intellectual property, commissions for sales on behalf of other entities, and cash paid to suppliers.

Cash Flows from Investing Activities

Cash flows from investing activities contains the sum total of the changes that a company experienced during the reporting period in investment gains or losses, as well as from any new investments in or sales of fixed assets.

Cash Flows from Financing Activities

Cash flows from financing activities contains the sum total of the changes that a company experienced during a designated reporting period that were caused by transactions with owners or lenders to either provide long-term funds to the company or to return those funds to the owners or lenders.

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The Statement of Cash Flows

Indirect Cash Flow Method

The most commonly used format for the statement of cash flows is called the indirect method. This approach requires less effort to complete than the direct method (which is discussed next), and so is preferred by most organizations. The general layout of an indirect method statement of cash flows is shown below, along with an explanation of the source of the information in the statement. The sources of information appearing in the table can be used to prepare a cash flow statement.

ABC Company
Statement of Cash Flows (indirect method)
for the year ended 12/31/20X1

Line Item Derivation
Cash flows from operating activities
 
Net income
From the net income line on the income statement
Adjustments for:
 
  Depreciation and amortization
From the corresponding line items in the income statement
  Provision for losses on accounts receivable
From the change in the allowance for doubtful accounts in the period
  Gain/loss on sale of facility
From the gain/loss accounts in the income statement
  Increase/decrease in trade receivables
Change in trade receivables during the period, from the balance sheet
  Increase/decrease in inventories
Change in inventories during the period, from the balance sheet
  Increase/decrease in trade payables
Change in trade payables during the period, from the balance sheet
Cash generated from operations
Summary of the preceding items in this section
   
Cash flows from investing activities
 
Purchase of fixed assets
Itemized in the fixed asset accounts during the period
Proceeds from sale of fixed assets
Itemized in the fixed asset accounts during the period
Net cash used in investing activities
Summary of the preceding items in this section
   
Cash flows from financing activities
 
Proceeds from issuance of common stock
Net increase in the common stock and additional paid-in capital accounts during the period
Proceeds from issuance of long-term debt
Itemized in the long-term debt account during the period
Dividends paid
Itemized in the retained earnings account during the period
Net cash used in financing activities
Summary of the preceding items in this section
   
Net change in cash and cash equivalents
Summary of all preceding subtotals

Direct Cash Flow Method

A less commonly-used format for the statement of cash flows is the direct method. The general layout of the direct method statement of cash flows is shown below, along with an explanation of the source of the information in the statement. This information can be used to prepare a cash flow statement.

ABC Company
Statement of Cash Flows (direct method)
for the year ended 12/31/20X1