How to Prepare a Cash Flow Statement

The cash flow statement provides key information about the financial performance of your business. By assimilating inputs from the balance sheet and the income statement, the cash flow statement summarizes the cash inflows and outflows of your company to help you evaluate the financial health of your business.

Typically, the cash flow statement is analyzed using the indirect method. If you report your revenues under Generally Accepted Accounting Principles (GAAP), you use the accrual basis of accounting that requires revenues to be reported when earned and expenses to be recorded when incurred.

Key Components of Cash Flow Statement

Cash flow from Operating Activities - This section summarizes cash inflows and outflows generated by your principle line of business, and it adjusts net income to reflect changes in revenues, expenses and credit transactions. Your income statement may include credit sales that have not been collected yet or non-cash expenses. To calculate operating cash flow, you have to re-evaluate non-cash items such as accounts receivable, inventory, accounts payable and accruals.

For example:

1. Accounts Receivable -If accounts receivable decrease, your suppliers have paid off their credit and you have collected more cash, which should be added to the net income. If accounts receivable increase, you have collected less cash, and this amount should be deducted from net income.

2. Inventory - if you report increase in inventory, you have spent cash to purchase raw materials, and this amount should be deducted from net income. Under the GAAP principles, inventory is not considered to be an expense until the inventory is sold. If you report decrease in inventory, the amount should be added to the net income.

To accurately calculate operating cash flow, you should:

Add:
- Decrease in accounts receivable.
- Decrease in inventory.
- Increase in accounts payable.
- Increase in accruals.

Deduct
- Increase in accounts receivable.
- Increase in inventory.
- Decrease in accounts payable.
- Decrease in accruals.

3. Cash Flow from Investing Activities - summarizes capital expenditures for your company's property, plant and equipment, purchases of securities, sales of securities and collection of principal on loans.

4. Cash Flow from Financing Activities - includes cash flows related to your company's debt and equity financing . If you raise capital from bond or stock issuance, these funds are recorded as cash inflows. If you make dividend payments, or repurchase of stocks, these funds are considered cash outflows.

The net cash flow is calculated by adding the cash flows from operating, investing and financing activities.

Important Considerations for Investors

- To be in good standing, a company should unfailingly report positive net cash flow.

- The operating cash flow should always be greater than zero to indicate strong growth potential. However, if a company unfailingly reports growth on income statement but has negative cash flow, it may lack the capacity to translate its growth into cash. This may cause liquidity problems in the short term.

- To be innovative, a company should generate positive cash flow from investing activities.

- Investors should compare current debt financing with past periods in financing activities to evaluate if the company has effectively managed its debt over the years.

Sources:

http://www.investopedia.com/terms/a/accrualaccounting.asp

http://www.investopedia.com/terms/o/operatingcashflow.asp

http://www.investopedia.com/terms/c/cashflowfinvestingactivities.asp

http://www.investopedia.com/terms/c/cashflowfromfinancing.asp

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