What is a cash flow statement? How to prepare it, analysis and tips

Tracking the movement of money in and out of your business is key to understanding how your enterprise is faring. 

Whether you’re in the hospitality sector, a freelance designer juggling clients, or working on any number of side hustle ideas online, keeping up with the financial comings and goings of your business allows you to make informed decisions on how to progress and prosper.

This is where cash flow statements can be invaluable. Each statement will offer a dynamic view of your business’s financial activities. It acts as a detailed map, showing where every penny is earnt or spent. 

In this guide, we’ll explore the what, why, and how of cash flow statements, cutting through the financial jargon to give you clear, actionable information. You’ll know how to define a cash flow statement, how to create one for your business, and better still, how to use it to your advantage.

What is a cash flow statement?

A cash flow statement is like a financial diary for your business. It records all the money flowing in and out over a set period, detailing the cash generated from selling products and services, the cash going out for expenses and purchases, and financial movements from activities like loans and investments.

Also known as a statement of cash flows, or CFS, a cash flow statement offers a comprehensive overview of your small business finances, revealing if you have plenty of cash, are just scraping by, or need to tighten your belt.

It doesn’t matter if you’re learning how to start a business from home or scaling an existing venture – in practically any business scenario, it’s important to understand how cash flow statements work.

Why cash flow statements are important

Whether you work in the food and drink industry or manage an online store, running a small business comes with plenty of paperwork, and the last thing you might want is to take on more. So why is cash flow important?

The answer is that having an awareness of cash flow allows you to measure the continuing liquidity and viability of your enterprise. Like many aspects of how to run a business, it might take a little while to master, but it’s worth the effort.

Just as learning how to do market research for small business lets you understand your customers and market better, analysing your cash flow statement sheds light on your business’s financial health and needs. It can help you to:

Spot trends

Cash flow statements allow you to see the bigger picture, revealing profitable patterns and inspiring new small business ideas based on actual financial data.

Imagine you spot a nice boost in cash flow whenever your online beauty store sends out its monthly email to customers, but then a dip two weeks later. If you’re looking at how to make extra money, this info might nudge you to refine your approach to email marketing for small business and send fortnightly emails instead.

Develop operating strategies

Having clear insights into your cash flow and liquidity puts you in great shape to take the big decisions that steer the course of your business.

Suppose the cash flow statement for your computer repair and accessories shop shows that service income far outweighs product sales. This could suggest revisiting how to price a service that’s particularly popular but may also highlight a need for you to understand how to identify your target market better.

Having an awareness of your liquidity also means you can make informed decisions on when to invest in new equipment and materials.

Master your budget

Having accurate cash flow statements means preparing your small business budget won’t be just guesswork. You’ll have solid data to back up your plans for everything from pricing strategies to customer acquisition spend.

For instance, if your cash flow statement reveals that advertising campaigns have significantly boosted sales for your gardening business, you can feel justified in allocating more budget towards marketing. 

This approach helps in figuring out how to advertise your business effectively, ensuring every pound spent helps to grow your customer base.

Improve your business analysis

A cash flow statement doesn’t just help with budgets; it also feeds into other analytical processes like performance reviews and risk management plans.

For example, details from your statement can help with a SWOT analysis for small business success. This looks at your company's strengths, weaknesses, opportunities, and threats. By seeing where money comes in and out, you can understand what you're good at, what needs work, where you can grow, and what could be risky.

In other words, a cash flow statement acts as a financial alarm system. Spot a dwindling cash reserve early, and you’ve got time to fix it before it becomes a full-blown crisis.

For example, if you notice from your bakery’s cash flow statement, that, unlike previous years, February’s Valentine’s sales didn’t significantly boost March’s cash reserves, it could signal an issue – perhaps Valentine’s specials were less popular, or there was a dip in customer loyalty. Early detection enables timely intervention.

Boost your credibility

A clear cash flow statement improves your business’s credibility, making it easier to secure loans and investment.

Say you sell online courses alongside your in-person tutoring business. Showing regular cash inflow from your passive income ideas, alongside core revenue, builds your case for financing. Statements can also aid investors in understanding how to value a business, making them more likely to chip in for your expansion plans.

Simplify your taxes

When tax deadlines approach, having clear cash flow statements can simplify the process of working out what you owe.

Perhaps you’ve set up as a hairdresser. Just like knowing how to use social media for small business can simplify marketing, keeping clear cash flow statements charting the money spent on kit, cosmetics and energy costs makes identifying income and expenses easier, ensuring accurate tax returns. No more last-minute scrambles – just clear, organised financial history at your fingertips.

How often should you create a cash flow statement?

There’s no hard and fast rule when it comes to how often you should prepare a cash flow statement. Here are your options.

Weekly

If you deal with lots of transactions or have very tight margins, putting in the extra effort to prepare weekly cash flow statements might make sense. For example, if you own a restaurant where factors such as weekly specials and events can significantly impact revenues and expenses.

Monthly

A monthly cash flow statement is the most common frequency for small businesses and sole traders. Monthly checks provide a good balance between staying informed and keeping paperwork to a manageable level.

Quarterly

For steadier ships or larger businesses, quarterly statements might suffice, aligning with tax periods and reviews of business growth strategies. However, even if opting for quarterly statements, it’s wise to monitor things informally more frequently.

Annually

While most businesses need more frequent updates, an annual statement is still important for your year-end review. It supports tax prep, annual reports, and strategic planning – especially important if you’re implementing strategies for expansion.

Anatomy of a cash flow statement

Cash flow statements are split into three main parts: 

• Operating activities 

• Investing activities 

• Financing activities

Cash from operating activities

The cash from operating activities (CFO) section of the cash flow statement refers to day-to-day income and expenses, and answers the big question of whether you’re making money from your core operations.

Operating activities include the cash generated by the sale of products and services, as well as the cash spent on things like stock, raw materials and wages. Even that fortnightly bag of freshly roasted coffee beans, AKA how to motivate employees on Monday mornings, is counted here.

Cash from investing activities

As the phrase suggests, cash from investing activities (CFI) shows the money spent or made from investments. It’s important to note “investments” here doesn’t just refer to purely monetary matters like buying stocks and bonds. It also covers the flow of money related to physical assets, like new premises and equipment.  

So, if you were to invest in a new sales interface like a self-service kiosk in order to cut queues and boost the number of orders per customer, the transaction would be listed in this part of the cash flow statement.

Cash from financing activities

Cash from financing activities (CFF) concerns how you fund your business and reward investors. It includes money borrowed from lenders, money raised by issuing shares, debt repayments, and dividends paid out to shareholders.

For small business owners, especially those in the early days of setting up a limited company, financing activities may include taking out a bank loan or securing investment through small business crowdfunding. This section is also used for everyday actions like using a business credit card or repaying part of that debt.

The bottom line

By putting these three sections together, you’ll be able to see the net increase or decrease in your cash during the period, as well as identify where most of your incomings and outgoings lie.

A total net increase means you have positive cash flow, with more cash flowing in than out – often a sign of effective operations management. A net decrease, denoting negative cash flow, might be a heads up to rein things in or look at ideas for second income streams to boost revenues.

However, negative cash flow isn't always a red flag, especially for startups. It might signify investments in future business opportunities, such as purchasing new equipment. So, while it’s vital to monitor cash flow, understanding the context behind the numbers is just as important.

How to build a cash flow statement

The question of how to prepare cash flow statements might seem daunting, but – just like when looking into other important processes like how to write a business plan – you can break it down into manageable steps. Here, we’ll guide you through assembling your statement, choosing the right method, and keeping everything organised.

1. Gather your data

Collecting the necessary figures for the period in question is the first, fundamental step. You’ll need details of cash coming in from sales or services, invoices you’ve sent, cash going out for expenses, and data relating to investing and financing activities. 

This information can come from your sales records, expense receipts, and bank statements, as well as from other financial statements for your business.

For example, if you’re wondering how to calculate interest paid for cash flow statements, you can look at the relevant bank statements or loan documents to find the exact amounts paid as interest on any loans or debt.

2. Choose your method

There are two possible ways you can record the data on cash from operating activities: direct or indirect. Both reveal your net cash from operations but present the information differently.

Cash flow statement direct method

The direct method of recording cash from operating activities entails listing all cash payments and receipts relating to your products and services.

Let’s consider a cash flow statement example based on a hypothetical small retail business selling handmade homeware items. Last month, it made £8,000 in sales but spent £5,000 on things like stock, salaries, and tax, netting £3,000.

This is what the statement will look like using the direct method, with the brackets signifying money leaving the business:

Cash flow statement indirect method

The indirect method of recording cash from operating activities is based on accrual accounting, which recognises revenues and expenses when they are earnt and incurred, rather than when the actual cash enters or leaves your business account.

You start with your net income, as recorded on your business’s profit and loss statement (also known as the income statement). You then reconcile it with your cash flow figure by adjusting for non-cash factors like changes in what you owe or are owed, which will be recorded on your business’s balance sheet.

Staying with the example of our hypothetical homeware business, we’ll say net income starts at £4,000. After adjustments for depreciation and amortisation, and changes in accounts receivable (unpaid sales), accounts payable (unpaid bills),  inventory (stock), and income tax paid, net cash from operating activities totals £3,000.

Using the indirect method, our sample cash flow statement looks like this:

Which cash flow statement format is best for small businesses?

The direct method provides a more detailed and transparent look at the cash transactions of your business in a given time period, and is more intuitive since you won’t have to deal with non-cash items. 

However, it requires the painstaking recording of each and every cash transaction, so it’s best suited to small-scale businesses with relatively few transactions.

The indirect method is typically quicker to put together since it draws on data from your profit and loss statement and balance sheet, so is well suited to businesses which handle many transactions. It offers a more holistic overview of your business, since it takes into account unpaid amounts – for example, what you’re owed from invoices.

Ultimately, your choice will come down to the method you personally find aligns more efficiently with your business. Most enterprises utilise the indirect method.

3. Complete your cash flow statement

In cash flow statements, the investing and financing sections are displayed the same way regardless of how you calculate operating activities.

Cash flow statement example

So, let’s bring everything together for our sample cash flow statement. We’ll continue with the popular indirect method, imagining that the business has £2,700 at the start of the period, spends £2,500 on new woodworking equipment, and takes out a £4,000 bank loan.

When it comes to how to calculate a cash flow statement, the process is simple. Just tot up the net cash from the three sections to see the net increase or decrease in cash over the period covered. Add this to your starting cash to know your net cash flow.

Tips for simplifying the process

Creating a cash flow statement for your business doesn’t have to make your head spin. Here’s how to keep things simple.

Stay up to speed with bookkeeping

Diligent bookkeeping for small businesses allows entrepreneurs to stay on top of incomings and outgoings. Setting aside time, say every week, to record cash transactions means you won’t have a backlog of financial information to sift through when preparing your cash flow statement.

Use cash flow management tools

There are accounting tools for small business use which can optimise the process of collating data and working out cash flow. Alternatively, you can download free cash flow statement templates for spreadsheets.

Whether you prefer an all-in-one financial analysis solution or a simple spreadsheet, leveraging these kinds of tools can offer a straightforward answer to the question of how to calculate cash flow statements.

Seek support if you need it

It’s understandable that many entrepreneurs prefer not to involve themselves too deeply in the accounting side of things. Hiring an accountant can effectively free you up to concentrate on other aspects of your business, like how to get clients and maintaining small business cyber security.

As your business grows, you might decide to bring this expertise in-house by looking at how to hire employees who specialise in financial operations.

The essential financial trio for small businesses

The cash flow statement is one of three key financial statements that should be on your radar as a small business owner. The other two are the profit and loss statement and the balance sheet.

As we’ve seen, the cash flow statement shows the cash incomings and outgoings relating to all aspects of your business over a set time period. Let’s take a look at what the other two statements offer.

Profit and loss statement (P&L)

Also known as the income statement, this provides an overview of the financial performance of your business in a given period.

It shows whether your business is pulling in a profit by subtracting total expenses from your revenue. Unlike the cash flow statement, which tracks actual cash movements, the P&L statement captures all income and expenses, regardless of cash transactions.

It provides you with your net income for the period, which can then be utilised when preparing an indirect method cash flow statement.

Balance sheet

In contrast to the cash flow statement, the balance sheet provides a snapshot of your business’s financial health at a specific point in time. In other words, it doesn’t provide any information regarding financial trends across a particular time period.

It breaks down your company’s assets (what you own), liabilities (what you owe), and shareholder equity (your share in the business). It can help to think of the balance sheet as the outcome of all past business decisions and activities up to that date.

Cash flow statement analysis

Whether you’re brainstorming additional online business ideas or expanding existing ventures, careful analysis of cash flow statements can help identify untapped revenue streams and clever cost-saving measures.

Assess cash inflows and outflows

Look at where your cash comes from and where it gets spent. Are you seeing sales or financing generate more cash? Do your biggest expenses come from operating costs or investment activities? Tracking these transactions can help you spot areas for improvement.

Let’s say sales show up as the primary source of cash on your statement but profit margins are slim. This might prompt you to explore how to price a product more effectively to boost profitability, or engage with a new customer pool by exploring how to make money online.

Compare with previous periods

Comparing current cash flow figures against past statements can reveal important trends for your business, helping you anticipate your future cash flow needs.

For example, if comparing quarterly cash flow statements shows increased sales but also higher operating costs, it may be a sign that you need to look into how to scale a business so that your growth is sustainable.

It may also prompt you to take a closer look at areas like employee retention, since high staff turnover can inflate costs. Improving workplace culture might help reduce expenses and stabilise cash flow.

Pay attention to cash flow from operations

The money your business makes from its everyday activities is a key sign of its health. If cash flow from operations is strong, it typically means your business is too.

Let’s say that your café’s cash flow statement shows consistent cash inflow from customer sales alongside stable supply costs. This indicates your core activities are profitable, signifying that your business is in excellent shape.

Look at liquidity

Check your statement’s ending cash balance to gauge your business's liquidity – in other words, how well you can cover short-term obligations with the cash you have available. 

A healthy ending balance suggests good liquidity, which is important, not just for day-to-day operations, but also to ensure your business can handle unexpected costs.

Healthy cash reserves can also support efforts in customer retention, as you’ll have the liquidity to accommodate promotions, discounted deals and other initiatives for keeping customers engaged and loyal.

Analyse statements regularly

Making the time to assess your cash flow statements regularly can help uncover business ideas with low investment requirements, highlighting areas where your business consistently excels financially without incurring significant upfront costs.

For example, if your statement shows consistent income from a particular service with minimal associated costs, this could indicate a potential area for expansion or give you the impetus to pivot to new, low cost business ideas.

Disclaimer: The contents of this page are intended for informational purposes only and should not be construed as professional advice. For matters requiring legal or financial expertise, it’s recommended to seek guidance from qualified professionals.