Cash Flow Statements: How to Prepare and Read

If you run a business, understanding your cash flow statement is not optional; it is a survival tool. A cash flow statement deals with something most practical, your business’s actual money, how it is coming in and going out.

A lot of businesses suffer from a cash crunch, not because they are not profitable on paper, but because they ran out of cash in real life. That is where the cash flow statement comes in.

Let us explain the steps of creating a cash flow statement and how to read it.

What Is a Cash Flow Statement?

A cash flow statement is a financial tool for cash flow reporting, or how cash moved in and out of your business during a certain period.

Now, this statement is not operating in a vacuum. It is part of the big three financial reports:

• Income Statement or the Profit & Loss statement
• Balance Sheet
• Cash Flow Statement

Just because your income statement says you made a profit does not mean you have cash in the bank. You can be ‘profitable’ and still be broke. Because profit is based on accrual accounting, it counts income and expenses when they are earned or incurred, not when cash moves.

The cash flow statement skips the fluff and shows you the actual cash position, the money that hits your account or leaves it.

The Three Parts of a Cash Flow Statement

So now that you know what cash flow is in the context of a business, we need to take a closer look at the components of a cash flow statement.

The cash flow statement is split into three main components such as Operating, Investing and financing activities.

1. Operating Activities

It is the operating cash flow that moves because you are doing what you do, selling things, paying bills, running operations.

Cash in may look like:

• Customers paying invoices
• Subscription renewals
• Sales of your product or service

Cash out may include:

• Paying your team
• Covering rent
• Software subscriptions
• Ordering supplies

If this component is consistently in the red, you have a problem. No matter how much you are selling, if you are spending more than you are bringing in on basic business functions, it is a sign the model needs changes.

2. Investing Activities

This one is less about the daily grind and more about the bigger picture. It covers cash used for long-term investments, think equipment, property, and any assets that are supposed to help your business grow down the line.

Cash out may look like:

• Buying new equipment
• Purchasing property
• Investing in another company

Cash in can be:

• Selling old equipment
• Getting paid out from a prior investment

This component shows whether you are putting money back into the business or liquidating just to survive. It gives you insight into how much of your cash flow is tied up in long-term investment or debt.

3. Financing Activities

This is the component most small businesses either fear or rely heavily on. It is all about your financial lifelines, debt, equity, and anything related to funding the business.

Cash in may include:

• A loan you took out
• Money from investors
• A line of credit you tapped into

Cash out can be:

• Loan repayments
• Dividends to shareholders
• Paying off interest

When you are constantly pulling in cash from financing just to stay afloat, it might be time for a hard look at the business model. On the flip side, smart financing can be the reason a business scales fast without burning out.

How to Prepare a Cash Flow Statement?

Now that you have a fair idea of the cash flow statement format and why it matters, let’s explain the steps to prepare it. Here are the steps to follow.

Step 1: Start With Your Beginning Cash Balance

Think of this as your “money-in-the-bank” snapshot from day one of the period you are tracking. You can grab this number straight from your bank statement and in the cash flow reporting it serves as your baseline.

Let’s say your January 1st bank balance was $15,000. That is your starting point.

Step 2: List Your Cash Inflows

Here is where most people get confused. Remember this is not about invoiced income or projected sales, this is actual cash you received.

So open your bank feed or payment apps and note down the following:

• Payments from customers
• Refunds or rebates received
• Investment income
• Any loans or funding that hit your account

Step 3: Track All Your Cash Outflows

Now go to the other side, and note down what you spent during that same period. Don’t rely on memory. Use your bank and credit card statements to keep it precise.

Here’s what to look for:

• Rent and utilities
• Payroll and contractor payments
• Marketing and ad spend
• Software subscriptions
• Inventory purchases
• Loan repayments
• Equipment upgrades
• Anything that left your account

Step 4: Categorise Your Cash Flow Into Three Buckets

This is the step where your cash flow statement takes shape. We are going to break all that movement into three components:

Operating Activities

This is your day-to-day business stuff, what you earn and spend to keep things running.

All the cash inflow and outflow corresponding to operating activities such as sales revenue, paying vendors, employee wages, software fees, and office rent will be shown here.  

Investing Activities

This covers money spent or earned from long-term assets or investments. So if you bought a new laptop or any equipment, or sold off a office space, these will be mentioned here.

Financing Activities

This is about funding, loans, investors, paying off debt, etc.

If you have a business loan and made repayments against it in installments or at one go, all will come under this.

Step 5: Calculate Your Net Cash Flow

Take your total cash inflows and subtract your total outflows. The result is your net cash flow for the period.

Let’s explain with an example. The total cash inflow stands at $9,800 and the outflows is at $6,920. So your net cash flow will be +$2,880. In this case, it is a good month, since you ended with more cash than you started with.

Step 6: Add Your Ending Cash Balance

Now add your net cash flow to your beginning balance to get your closing cash position.  

If your beginning cash position was $15,000 and now your net cash flow is +$2,880, the ending cash balance will be $17,880. This clearly tells you exactly where your cash position stands at the end of the month.

How to Read a Cash Flow Statement?

Understanding the cash flow of a business becomes easier when you breaks it down into components.   Let us take you through the steps.

1. Start With the Big Picture

Before you even scan the rows, take a look at the bottom line of the cash flow statement, your net cash flow for the period.

That one number tells you whether your business brought in more cash than it spent (positive cash flow), or whether you ended up dipping into reserves or debt (negative cash flow).

If you are seeing consistent positive cash flow, that is a good sign. Negative cash flow on the other hand is a red that deserves a thorough check.  

2. Concentrate on the 3 Components

Most investors and business owners versed with the intricacies of cash flow management will look into these components deeply.  

Operating Activities

All the operating expenses and revenues of a business such as sales income. vendor payments. employee salaries. subscriptions, office rent and several others come under operating cash flow.  

Investing Activities

All the expenses and returns corresponding to long-term business moves like buying new equipment, expanding offices and creating new subsidiaries, will come under this category. When you are selling off assets to stay afloat, will also come under this section.  

Financing Activities

This is about the money you are bringing in or sending out for loans, investors, or repayments. All the swings here must be checked for their real impact on the business growth.  

3. Look for Trends

One cash flow statement is a snapshot. But when you look at a series of them, it brings you a narrative for an effective cash flow statement analysis.  

Compare this month to last. Or this quarter to the same one last year. Are your operating cash flows improving? Are you relying less on loans?

YoY (year-over-year) and MoM (month-over-month) comparisons help you spot early patterns, before they become full-blown issues. Through such comparison, you can see your upward movement or decline in the long-term growth trajectory.

4. What is Changing Your Cash Position?

Sometimes the difference between a good month and a bad one is just one big payment, like a tax refund, a late-paying client finally catching up, or a big equipment purchase.

So if your net cash flow jumps or dips suddenly, scroll back and pinpoint the exact line that caused the swing. Once you do this a few times, you can start spotting the responsible factors easily.

6. Tie It Back to Decision-Making

A cash flow statement is not just a report, it is a decision-making compass. Suppose your operating cash is up for several months in a row, maybe this is the right time to hire that extra team member or increase your ad spend.

Or maybe your investing activity is putting too much strain on your cash position, and it is time to slow down the growth for a month or two. Or maybe financing activity is the only thing keeping your business solvent, and you need to figure out a long-term fix to generate real cash inflow from business.

Wrapping Up

It is not the big losses that knock many businesses out. It is rather the slow, silent cash crunch that quietly eats the strength of a business while everything looks good on paper.

You can be profitable on your income statement and still be gasping when bills hit and payments lag. That is why understanding your cash flow statement is not just a good-to-have option but essential.

Once you start reading cash flow statements like a business owner you balance your decisions with your cash position. Cash flow, at the end of the day, is about having good control of your business like a seasoned strategist.