How to Prepare a Detailed Cash Flow Statement for Small Businesses

Ezra Cabrera

Updated: November 23, 2020
A cash flow statement is one of the most important documents any business should have. It helps you keep track of the money that goes in and out of your business. If you know where you spent your money, you can focus on making excess cash and increasing your profits. To prepare a cash flow statement, it’s important to understand what it is and how it helps your business.

What is a Cash Flow Statement?

A cash flow statement is a document that tells you the inflows and outflows of your company’s finances. It shows how much money you have on hand and how that changes over time. Generally, cash flow statements are shown on a monthly basis.

Why Do You Need One?

If you plan to apply for small business loans, you’ll need to provide a business plan. And one of the most crucial components of every business plan is a detailed cash flow statement. Lenders and investors want to see how much cash is moving in and out of your business. It also helps you understand how much money you need before you apply for a loan.

Aside from loans and investors, you can use cash flow statements to prevent cash flow issues. If you regularly review your cash flow statement, you’d know when you’re running low on capital. You can plan ahead and apply for financing options before you run out of cash.

What Should Your Cash Flow Statement Contain?

There are three types of cash flows that you’d want to include in your cash flow statement:

    • Operating Activities: This pertains to your business’ income and spending on a day-to-day basis. In other words, you record the money you earned and the cash you spent on expenses.
    • Financing Activities: Financing activities include the money that moves between shareholders, creditors, and investors.
    • Investing Activities: Long-term assets, marketable securities, and other financial instruments are some of the investment activities you should record on your cash flow statement. It could be anything from buying or selling real estate or equipment and other related purchases and sales.

If other types of cash flows don’t fit in the categories mentioned, you could include them under “other activities”.

A Guide to Preparing a Cash Flow Statement

Cash Flow Statement

Before anything else, you need to know whether you’re going to use the direct or indirect method. There’s no right or wrong answer; choose the one that makes the most sense for your business.

However, the method you choose will only apply to the operating activities section of your cash flow statement. The financing and investing parts will look the same whether you choose direct or indirect.

It’s still important to carefully consider which method to use by weighing the pros and cons of each method. For instance, the indirect method is more common because it’s simpler and more efficient. But if you want a more detailed statement with more valuable insights, a direct method would be a better option.

The Indirect Method

In the indirect method, you use accrual basis accounting. This means that your revenue and expenses are calculated before the money changes hands. Simply put, you already record the money even if the products/services are still being delivered and no cash has been paid out. The majority of businesses already use accrual accounting, which is why this method is more popular.

For operating activities, the indirect method shows the company’s net income, which you can find on your business income statement. You demonstrate the noncash inflow and outflow adjustments you need to make to calculate the operating activities.

Some of the most common adjustment you can make include the following:

  • Accounts Payable
  • Accounts Receivable
  • Changes in Working Capital
  • Inventory Purchases – make sure to subtract inventory expenses from net income
  • Depreciation – add this to the net income because it’s not considered as an outflow of cash

The Direct Method

If the indirect method relies on accrual basis accounting, the indirect method, on the other hand, relies on cash basis accounting. This means that you count revenue and expenses when money changes hands or when you’ve received cash payments and receipts.

As we’ve already established, the direct method is more time consuming because rather than adjusting the net income, you’re subtracting cash outflows from inflows. Here are some of the items you consider in a direct method:

  • Income Tax Payments
  • Dividends and Interest Earned
  • Supplier Payments
  • Receipts from Customers
  • Employee Payments

While the direct method takes more time and effort, it offers a more detailed look into your business finances. For instance, you’ll know exactly how much money was spent on employee payroll or the exact value of customer sales rather than having those two categories fall under “net income”.

Which Method Should You Choose?

The direct method is a more complicated way of preparing cash flow statements but it’s also more informative. Since most companies already use accrual basis accounting, the indirect method naturally fits their accounting practices.

Also, the Financial Accounting Standard Board (FASB) requires companies that use the direct method to provide proof on how their net income would adjust to net cash on a different. This means that if you’re using the direct method, you’ll still have to adapt to the indirect method.

However, most accounting stand-setting organizations prefer the direct method because it provides a thorough report on company finances.

If you choose to go with the direct method, you’ll need to start tracking the money that goes in and out of your business. In this way, it’ll be easier and less time consuming to create a cash flow statement.

To effectively track your cash flow and to easily assemble your statement, you can use accounting software like Zoho or Intuit Quickbooks.

The Bottom Line

Understanding where your money goes and knowing when you need more are the keys to running a successful business. Cash flow statements can measure the profitability and the financial future of your company. You’ll see whether you have enough liquid cash to pay for operating expenses. Additionally, you can use a cash flow statement to create a budget and financial forecasts.

Ezra Cabrera
Ezra Neiel Cabrera has a bachelor’s degree in Business Administration with a major in Entrepreneurial Marketing. Over the last 3 years, she has been writing business-centric articles to help small business owners grow and expand. Ezra mainly writes for SMB Compass, but you can find some of her work in All Business, Small Biz Daily, LaunchHouse, Marketing2Business, and Clutch, among others. When she’s not writing, you’ll find her in bed eating cookies and binge-watching Netflix.

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