Introduction To Cash Flow Statement
I have worked with small UK businesses for the last two decades as their trusted Chartered Certified Accountant and cash flow expert. From this experience, I am sharing how to gain complete cash flow clarity, control, and confidence so that you can manage your business cash flow. You can do this by using the power of a cash flow statement.
First, I will share the importance of cash flow statements for you as a small business owner with case studies.
Then, I will share a quick way to prepare the cash flow statement in under 60 seconds. Use this when you are pressed for time and want a rough idea about your cash.
Then I will also show a detailed way if you want to go into details. I highly recommend you do this if you can ensure the sound financial health of your business.
Then, once you have made the cash flow statement, I will show you how to use it. You can use the statement to analyze cash flow metrics and KPIs that matter to you. This way, you can make informed decisions based on a strong understanding of your cash flow.
Sounds good?
Before we go further, you might wonder why you should listen to me?
Whether you sell products or provide a service, I have been working with clients across various sectors. They have annual revenue of £40k to £53.8m. They use cash flow statements to see their current cash and forecast future cash.
I do this all day, every day, for a living using my proprietary cash flow maximisation software, Hungry Cash Flow.
So don’t worry, you are in safe hands.
Let’s dive in.
From what I have seen working with my clients, small business owners like you find it easier to understand the business from a cash viewpoint.
You may find accrual basis accounting confusing because it is based on income and expenses incurred, including non-cash expense items like depreciation.
In other words, most of my clients prefer to use cash, not accrual accounting.
If that’s you, then let’s proceed.
Key Takeaways
- Understanding Cash Flow Statements is Essential. The guide stresses the critical role of cash flow statements. They give a clear view of a business’s cash, which is key for good decisions.
- Step-by-Step Cash Flow Statement Preparation: It offers a practical, step-by-step approach to preparing and analyzing cash flow statements, which is crucial for managing business finances effectively, even for those without formal financial training.
- Strategic cash flow management is key for business growth. The article highlights the importance of managing cash flow. It’s key for liquidity, solvency, and growth. It underscores its role in long-term financial health and planning.
Understanding Cash Flow Statement as a Small Business Owner
- Maybe you want to calculate cash flow to using a robust calculation method to stop bleeding cash. You want to know which operating expenses or expenses are leaking money. Or maybe you want to know if you have enough cash to invest in capital expenditures right now.
- Perhaps you want to predict future cash balance in a calendar date so that you know whether your business will have enough working capital to fund your business operations.
- Possibly, you are at a stage where you need to make crucial financial decisions to take your business to the next level.
In either case, understanding the debits and credits in a cash flow statement shows your current cash position. This lets you make financial decisions based on data, not just gut feelings.
What Is a Cash Flow Statement?
Cash Flow statement is a document that records actual cash inflows from various sources of cash income and cash outflows to various sources of cash outgoings and is presented in a format that shows the summary of cash collection and cash payments in a specific time period.
A cash flow statement is a bit like a mark sheet that tells how well you have created and controlled cash in your business in a specific period of time, just like you get a mark sheet for how well you have performed in an exam.
It is also called a cash flow report, which is one of the three financial statements. The other two are the Income Statement and Balance Sheet.
All three statements follow UK GAAP. But, making a cash flow statement is not mandatory under GAAP. These three financial accounting statements are used collectively for business reporting purposes.
What Is the Purpose of the Cash Flow Statement?
The cash flow statement aims to identify cash flow gaps and help a business owner make informed cash flow decisions. In simple terms, if you want to know what your cash flow situation is, a cash flow statement will give you the answer to that question.
If you are wondering what a cash flow statement looks like and want to see an example, check out this cash flow statement example.
Example Of A Cash Flow Statement
Here is an example of a cash flow statement for a cafe business.
We will discuss the different sections of this cash flow statement in the relevant sections below.
Before we do that, you might wonder why a cash flow statement is important.
Why Is Cash Flow Statement Important?
The cash flow statement is important as it plays into navigating three crucial areas of cash flow management:
- Liquidity
- Solvency
- Sustaining business growth
- Liquidity refers to your ability to meet short-term funding needs to cover operating cash flow requirements. For example, inventory, interest expense, salary, monthly loan payments, and credit card payments.
- Solvency refers to your business’s ability to cover short-term and long-term financial obligations such as long-term debt and tax liability payments like PAYE, National Insurance Contributions, VAT, Corporation taxes.
- Sustaining business growth – While your business grows, the need for cash also grows as you will have more operating expenses to cover.
How?
A cash flow statement lets you see trends, spikes, and patterns of your cash inflows and outflows. You’ll also see where you are losing and gaining cash, which helps you make strategic decisions.
For example, you will see from the cash flow statement extract below, Uber eat cash receipts of £20,625 is bigger than Just Eat’s £16,394.
On the other hand, EATING IN of £477,146 comprises most of the cash receipts out of a total of £518,210.
This means that the cafe mainly relies on diners eating in the cafe, not takeaway or catering for a special occasion, as other income is only £3,890.
You can only have this level of cash flow clarity when you have prepared the cash flow statement.
Analyzing the cash flow information like the above lets you know which product or avenue you must focus on to ensure positive cash flow.
Consider cash flow statements as a problem solving tool for identifying causes of cash flow problems to fix them
What are the key components of the cash flow statement?
There are three major components of the cash flow statement.
They are :
- Cash Flow from operating activities
- Cash Flow from Investing activities
- Cash Flow financing activities
Cash Flow From Operating Activities
Cash from Operating activities includes cash balance arising from your trading activities. An example is customer cash collection. It is a type of cash flow from operating activities. It is the main source of cash. The balance comes from cash collected from trade receivables or customers at the point of sale, as in the example below.
In this example below, you can see cash collection from:
- Eating In – £477,146
- Just Eat- £16,394
- Uber Eats- £20,625
- Other income – £,3,894
You can also see cash payments made to trade payables.
Trade payables are divided into two categories:
- Direct costs payables– these are costs incurred from buying what you sell- In this case, eggs, sausages, and raw materials to prepare other foods. etc
- Overheads are operating expenses you pay regardless of whether you make sales. For example, rent, accountancy fees, bank charges, salaries, etc., as you can see below.
Cash Flow From Investing Activities
Investing activities include buying fixed assets such as premises and motor vehicles. It also includes investing in other businesses and sometimes things like patents and other intellectual property.
When one buys assets, money goes out. However, recurring cash inflow from investments generates cash flow.
In this example above, there is no cash coming in under cash flow from investing activities, whereas there are cash outflows to :
- Plant and Machinery- £11,352
- Long Term HP liabilities- £3,728
Cash Flow From Financing Activities
The simplest of the three will mention your loan payments to financial institutions.
Examples of cash flow from financing activities are borrowing business loans from the bank or investor.
You can see above there is funding from the owner of £18,000 in November 2022 and £13,020 in April 2023.
You can also see that the business has repaid Santandar’s loan of £1,705 in the financial year.
Furthermore, the business owner has withdrawn £18,062 in the same period as a dividend.
This is what everyone follows.
When I work with my clients, I like to extend to three more micro categories for further instant cash flow clarity.
They are:
- Tax Refunds and Payments
- Intercompany transfers
- Intra bank account transfer
By doing this, I have discovered that it is easy to follow how cash is spent and received across different sections of the cash flow.
For example, you can easily see that this business has paid VAT of £71,289 in a specific accounting period from June 2022 to May 2023.
What Do You Look for in a Cash Flow Statement?
In the cash flow statement, you are looking for areas of cash flow improvement by identifying areas to fix.
I do this by following T.I.P.S.
It is an acronym that I coined to make it easy to understand. Let’s see what the letter T, I, P, and S stand for in this acronym.
- T = Trends, What is the trend of cash inflow and cash outflow
- I = Irregular activities, One-off activities, or irregular activities you should be aware of
- P = Patterns, Cash flow Patterns of few accounts e.g. subscription/software/coaching payments
- S = Spikes Are there any spikes in any given month in terms of cash collection and cash payments
Although the cash flow statement isn’t the end-all and be-all, it can often provide a long-term picture of your business health.
How Do You Know if a Cash Flow Statement Is Correct?
Check your business bank statement to check whether the cash flow statement is correct. It is a reflection of that organized into different cash inflows and outflows.
What do I mean by that?
If you look at the opening bank balance in your bank statement, this should be the same balance of cash in your cash flow opening balance. The same is true for the closing bank balance.
In the example below, on 1 June 2022, the opening balance of £9,480 should be the same as the cash flow and bank statements. This is the first check you are going to do.
Then, compare the total cash received balance in the bank statement to the cash flow statement. In this case, June 2022- £56,292, July 2022- £56,393, August- £71,556 and so on.
Do the same for total cash payments as well. In this case, June 2022- £49,712, July 2022- £68,505, August- £60,290 and so on.
Do they agree?
If yes, then the cash flow statement is correct. It gives you an accurate picture of cash flow.
You can go back and check in the previous months if you have prepared cash flow for the last months.
If you are unsure how to prepare a cash flow statement, I will show you how.
How Will A Cash Flow Statement Help Your Business?
A cash flow statement helps capture all cash coming in and going out in one place and gives you a bird ‘ s-eye view of your cash flow.
A cash flow statement gives answers to many key cash flow questions. It saves time. You’d rather spend that time with your family.
It helps you determine whether you have managed cash flow effectively or not.
It’s like taking a test and getting a mark sheet of your performance. The test is running your business, and the mark sheet is a cash flow statement.
For example, your cash flow statement will reveal your ability to shorten the cash receipt cycle.
Let me demonstrate with an example.
Let’s say you start working with your client on 1st June, and it takes ten days to complete the work. You sent an invoice on 10th June, and your client paid on 17th June. So, the cash receipt cycle is 17 days.
Now the question is, how can you collect cash in 10 days instead of 17 days?
You can do it simply by having an engagement letter stating payment is due upon completing the work if you finish it in 10 days. Then, you can send an invoice online with a link to pay on that day.
I started using this approach in 2007. I remember working with a new client then. When I worked at the client’s premises, I would log in to my remote computer using LogMeIn, generate invoices, and email him immediately. So, the client had the invoice within 5 minutes of completion of work, payable on the same day.
You need to manage cash flow effectively and efficiently for the short term and look at long-term cash requirements.
It’s a bit like reviewing your mark sheet semester by semester to get a bigger picture of what you need to do and focus on to get good grades at the end of the final exam.
So, a short-term cash-flow focus ensures you have enough cash to cover your working capital requirement. A long-term cash flow focus ensures that your cash position is optimum for sustained business growth.
Also, have a cash flow forecast in place.
Cash flow forecasting will help you understand your cash position in a three to six-month time period today.
You can use this insight to do cash flow planning and execute business growth based on future cash projections.
How do you prepare a cash flow statement step by step?
If you don’t prepare the cash flow statement regularly, start doing it now because you won’t know how effectively you manage your cash flow without it.
Before I show you the step-by-step process to create a cash flow statement, let me tell you the prerequisites of preparing a cash flow statement.
Prerequisite Of Preparing Cash Flow Statement
To prepare a cash flow statement, you must complete bank reconciliation in your accounting software.
Why?
It is important to reconcile actual transactions from bank accounts to transactions processed in your accounting application software. Otherwise, there may be not only minor discrepancies but also material transactions.
For example, one of my clients, a bookkeeper, prepared a cash flow statement. When I reviewed the bank transactions processed in QuickBooks online accounting software, it had many unreconciled transactions. Some expense items were double-counted. It was a mess.
So follow the step-by-step method I am sharing with you next.
How To Prepare A Cash Flow Statement step by step using Shishir Khadka's Process
Let’s start with step 1 of cash flow statement preparation.
STEP 1: Collect the sources of cash flow data
To prepare a cash flow statement, first, you need to collect the sources of cash flow data.
What are the sources of data to prepare a cash flow statement?
The data sources to prepare a cash flow statement are taken from your accounting system’s bank transactions of cash inflow and cash outflow.
STEP 2: Decide whether you will use the direct or indirect cash flow method.
You might be thinking.
What is the difference between the direct cash flow method and the indirect cash flow method?
The direct method is based on how much cash is collected minus how much cash is paid in a given time. It records the cash movement by allocating cash receipts and payments to various sections such as direct costs, overheads, taxes, intercompany etc.
The example I shared in the article above is an example of a direct method using a cash basis.
The indirect method uses changes in balance sheet accounts, such as current assets and current liabilities’ movements, to prepare the cash flow statement.
The indirect method starts from the net profit reported on the income statement, adding or subtracting the movement of debtors and creditors to work out the cash flow position.
Personally, as an entrepreneur, I recommend using the direct method as it’s simple to use by focusing on what’s coming in and what’s going out from the business excluding non-cash items and change in
Step 3:Decide on the frequency of the cash flow statement.
Whether you need a monthly cash flow statement, weekly cash flow statement, or even a quarterly cash flow statement.
As a general rule of thumb, if your business has more than 100 transactions, do it monthly, or if less, do it weekly.
STEP 4: Based on steps 2 and step 3, prepare a cash flow statement template.
I have created one for you if you don’t have a statement template. You can download this monthly cash flow template and make it your own.
STEP 5: Export bank transactions from your online banking as a CSV or Excel file into two columns: CASH IN AND CASH OUT.
Download the bank statement from your online banking portal as a CSV or Excel file. You will see the cash-in and cash-out columns with opening and closing bank balances.
Download data from the banking portal and not from accounting software because bank transactions are facts that happened in a particular month, whereas the data you pull from your accounting software may have unallocated or misallocated transactions.
STEP 6: Organize cash inflow by four types of receipts
- Cash from customers
- Government Grants
- Business owner capital
- Bank loans
This brings us to step 7.
STEP 7: Organize cash outflow into seven types of cash outflow
- Direct suppliers
- Indirect Suppliers
- Sales Tax, Social security, Corporate tax
- Loan repayments
- Owner drawings
- Refunds to clients
- Intercompany transfers
Then, we move to the final step of preparing a cash flow statement.
STEP 8: Post Opening Balance And Check Closing Balance
Post the opening bank balance in the cash flow statement template and compare the closing bank balance with the cash left balance in the cash flow statement to agree.
Follow the monthly cash flow template to record cash inflow and outflow, then post-opening bank balance.
By completing these steps, you would have prepared a cash flow statement.
Sometimes, a cash flow statement is also called a cash flow spreadsheet or a cash flow report. So, do not get confused by the terms.
As a result of preparing a cash flow statement, you will find net cash, the difference between cash inflow and cash outflow.
Net cash flow formula = Total cash inflow – Total cash outflow in a specific period.
Why Is Net Cash Important?
If the net cash is positive, the business has positive cash flow, whereas if the net cash is negative, the business has negative cash flow.
Going through these eight steps gives you a complete picture of what’s going on with your cash flow.
You can do this in less than 15 minutes without the usual anxiety or hassle of organizing your cash flow.
I have added a link in the resource section to download this monthly cash flow statement template and make it your own.
Cash Flow Statement vs. Income Statement vs. Balance Sheet
Although cash flow statement, income statement and balance sheet are the main components of financial statements, cash flow statement is different as it does not have to follow the accrual accounting method.
An accrual accounting method is a method of recording income and expenses when they are incurred rather than when they are paid. In this case, gross income is recorded when you send the invoice to the customer, not when the customer pays you.
As the cash flow statement is based on cash movement, it is difficult to manipulate the figures unlike the other two financial statements.
For example, an Income statement includes provisions made against stock, bad debts, etc, which can be subjective, whereas a statement of cash flow is objective. It is based on actual cash inflows and outflows, making it less easy to manipulate.
The only thing that may not make the statement of cash flow inaccurate is if the unpresented cheque has not been cashed yet. So you need to watch out for that.
If you want to dig deeper into how these three financial statements are linked, you can follow the financial statements linkage guide. I explain in detail how money flows from the income statement and statement of cash flow are affected and, eventually, how they are included in the balance sheet, ultimately showing the shareholder’s equity statement.
