It is an essential financial document that offers insights into an organization’s liquidity and financial health. Knowing how to prepare a cash flow statement is important for businesses, investors, and financial analysts. So, keeping this in mind, let’s learn how to prepare a cash flow statement and why a cash flow statement is prepared
Understanding the Statement of Cash Flow
It’s crucial to first grasp its basic concept to prepare a cash flow statement. Cash flow represents the net cash and cash equivalents moving in and out of a company within a specific timeframe. These flows are classified into three primary categories: operating, investing, and financing activities.
What are the benefits of a Cash Flow Statement?
The purposes of preparing cash flow statements are many:
- Financial Health Analysis: Investors and creditors use cash flow statements to assess a company’s financial health. However, positive cash flow indicates that the company is generating more cash than it’s spending, signifying stability and potential for growth.
- Budgeting and Planning: Businesses can use historical cash flow data to create accurate financial forecasts. By understanding past cash flow patterns, companies can plan for future expenses, investments, and growth initiatives more effectively.
- Identifying Cash Flow Drivers: By analyzing the components of operating, investing, and financing activities, businesses can identify the key drivers of their cash flow. This insight helps optimize processes, improve collection cycles, and manage expenditures.
- Tax Planning: Cash flow statements help in tax planning by identifying the actual cash transactions during a specific period. This data assists in accurately estimating tax liabilities and managing cash flows to meet tax obligations.
How to Prepare a Cash Flow Statement?
There are mainly two procedures for preparing a cash flow statement. They are: –
- Direct Method
- Indirect Method
According to the experts, whichever method you choose, the result will be under all three activities: financing, investing, and operating.
Steps to Prepare Cash Flow Statement Under Indirect Method
1. Preparing the Operating Activities Section
The core of the cash flow statement is its operating activities section, which demonstrates a company’s cash generation from its main operations. To compute this, consider the net income and make adjustments for elements that don’t involve actual cash transactions, such as depreciation and amortization.
Accurately managing alterations in working capital, such as accounts receivable, accounts payable, and inventory, is crucial. Thorough documentation and reconciliation of these changes are essential to ensuring the cash flow statement’s accuracy and reliability.
2. Detailing Investing and Financing Activities
The investing activities section outlines the cash flows from buying and selling long-term assets. This includes investments in property, equipment, and securities. On the other hand, financing activities deal with cash transactions with investors and lenders, such as issuing or repurchasing stock, paying dividends, and borrowing or repaying loans.
A Precise recording of these activities is essential to providing a complete picture of the company’s financial dealings.
3. Ensuring Accuracy and Compliance
Ensuring precision and compliance with accounting norms is vital when creating a cash flow statement. It’s essential to rely on trustworthy financial information, follow suitable accounting guidelines like Generally Accepted Accounting Principles or International Financial Reporting Standards, and meticulously check the statement for correctness and wholeness.
Cross-checking with other financial documents, such as the balance sheet and income statement, is necessary. This practice helps in pinpointing discrepancies and upholding uniformity in the financial records.
Example of a Cash Flow Statement Under the Indirect Method
XYZ Corporation’s cash flow statement is prepared for the Year Ended December 31, 20XX.
| Cash Flows from Operating Activities | ||
| Net Income | $150,000 | |
| Adjustments for Non-Cash Items: | ||
| Depreciation | $30,000 | |
| Changes in Working Capital: | ||
| Increase in Accounts Receivable | ($20,000) | |
| Increase in Accounts Payable | $10,000 | |
| Net Cash Provided by Operating Activities | $170,000 |
| Cash Flows from Investing Activities | ||
| Purchase of Equipment | ($50,000) | |
| Sale of Investments | $20,000 | |
| Net Cash Used in Investing Activities | ($30,000) |
| Cash Flows from Financing Activities | ||
| Issuance of Common Stock | $50,000 | |
| Repayment of Long-Lasting Debt | ($25,000) | |
| Payment of all dividends | ($40,000) | |
| Net Cash Used in Financing Activities | ($15,000) |
| Net Increase or Decrease in Cash and related | $125,000 | |
| Cash and related things, beginning of year | $80,000 | |
| Cash and related things, end of year | $205,000 |
Example of a Cash Flow Statement Under the Direct Method
Making cash flow statements under the direct method is similar to the indirect method, which is presented uniquely.
XYZ Corporation Statement of Cash Flows (Direct Method) for the Year Ended December 31, 20XX
| Cash Flows from Operating Activities | ||
| Cash Collected from Customers | $600,000 | |
| Cash Paid to Suppliers | ($350,000) | |
| Cash Paid to Employees | ($120,000) | |
| Other Operating Expenses Paid | ($50,000) | |
| Interest Paid | ($10,000) | |
| Income Taxes Paid | ($30,000) | |
| Net Cash Provided by Operating Activities | $40,000 |
| Cash Flows from Investing Activities | ||
| Purchase of Equipment | ($60,000) | |
| Sale of Investments | $20,000 | |
| Net Cash Used in Investing Activities | ($40,000) |
| Cash Flows from Financing Activities | ||
| Issuance of Common Stock | $50,000 | |
| Repayment of Long-Term Debt | ($30,000) | |
| Payment of Dividends | ($20,000) | |
| Net Cash Used in Financing Activities | $0 |
| Net Increase in Cash and Cash Equivalents | $0 | |
| Cash and Cash Equivalents, Beginning of Year | $30,000 | |
| Cash and Cash Equivalents, End of Year | $30,000 |
The Bottom Line
Crafting a cash flow statement is crucial for both financial experts and entrepreneurs. Grasping the intricacies of operating, investing, and financing activities while upholding accuracy and accounting standards allows for a transparent financial overview.
Consistent scrutiny of this essential document enables businesses to make educated choices, helps investors assess potential investments, and allows stakeholders to evaluate the company’s stability. Embracing the insights offered in this guide equips you with the confidence to navigate the complexities of cash flow management effectively.