How to prepare a cash flow statement (with example)
In business, cash holds the key. Have you ever wondered how a company handles wads of cash while doing business? A cash flow statement addresses that. It is an accounting practice that reports what a company is doing with its cash. Cash flows in two directions: It either enters a company or goes out. When cash enters a company, it is treated as a positive amount. When it leaves, it is considered negative.
A cash flow statement provides relevant information in assessing a company’s liquidity, quality of earnings, and solvency. It forms the core of a company’s accounting practice. Businesses need to monitor their cash flow statement properly. Otherwise, a business can go bankrupt in no time.
How to prepare a cash flow statement
Cash flow statements are prepared by either the direct method or the indirect method. The indirect method is the more preferred one. A reason is it reconciles reported net income to cash provided by operations.
Understanding the components
While preparing a cash flow statement, you must understand its four basic components:
1. Cash flow from operations: This is the core of the business. It comprises cash receipts generated from customers or interest received by the company. It also includes payments made to suppliers and interest paid by the company.
2. Cash flow from investing: This section covers the investment a company is making to buy assets. For example, a company’s may spend on buying a new office building. It will also include sale proceeds from an investment the company had made in the past.
3. Cash flow from financing: This takes into account the source of cash needed to buy assets. The source could be owners’ equity or loans (liability) taken from banks. It also includes cash flowing out for servicing loans.
4. Net cash (increase or decrease): This is calculated for a particular period. The cash available with the company at the beginning of the period and at the end of the period is noted.
As a next step, let us look at the format of a cash flow statement.
Cash flow statement example
Company ABC Ltd
Cash flow statement for the year ended 31 March 2016
Figures in Rupees
The example above is a simple cash flow statement of a company that follows the indirect method. The three broad categories here are cash flow from operations, cash flow from investing, and cash flow from financing. But preparation of a cash flow statement does not focus on cash alone. Cash flow statements take into account cash equivalents as well.