Before You Start

This guide assumes you have access to a company’s complete Balance Sheet and Income Statement for the period you wish to analyze.

Overview

40 min
Estimated Time
Intermediate
Difficulty
Comprehensive
Detail Level

What You’ll Learn

  • The three core sections of a Statement of Cash Flows (Operating, Investing, Financing)
  • How to prepare a Statement of Cash Flows using the indirect method
  • Identifying and adjusting for non-cash activities
  • Interpreting cash flow data for better business decisions

1. Prerequisites and Data Gathering

You’ll need these financial documents readily available:

Required Documents

  • Income Statement (for the period)
  • Balance Sheet (current and prior period)
  • Statement of Retained Earnings (current and prior period, optional but useful)

Helpful (but not strictly required)

  • Detailed General Ledger transaction data
  • Schedules for fixed assets and long-term debt

2. Direct vs. Indirect Method

You have two primary approaches for preparing the Operating Activities section.

Method A: The Direct Method

This method reports major classes of gross cash receipts and gross cash payments.

Pros:
  • Clearer picture of cash sources and uses.
  • Easier for non-accountants to understand.
  • Provides valuable insights into operations.
Cons:
  • More complex and time-consuming to prepare.
  • Requires extensive transaction data.
  • Less common in practice for U.S. companies.

Method B: The Indirect Method

This method starts with net income and adjusts it for non-cash items and changes in working capital.

Expert Tip: For most small to medium businesses, we strongly recommend the Indirect Method. It’s generally easier to prepare as it leverages existing financial statements and focuses on reconciling net income to net cash flow from operations.

3. Understanding the Statement’s Structure

The Statement of Cash Flows is divided into three main sections: Operating, Investing, and Financing activities.

Here is a sample data structure often used for internal financial reporting.

{
  "fiscal_period": "Q3-2025",
  "cash_flow_from_operations": {
    "net_income": 150000.00,
    "depreciation_amortization": 10000.00,
    "changes_in_working_capital": {
      "accounts_receivable": -5000.00,
      "inventory": 2000.00,
      "accounts_payable": 8000.00
    },
    "total_operating_cash_flow": 165000.00
  },
  "cash_flow_from_investing": {
    "purchase_of_ppe": -30000.00,
    "sale_of_investments": 10000.00,
    "total_investing_cash_flow": -20000.00
  },
  "cash_flow_from_financing": {
    "issuance_of_debt": 25000.00,
    "payment_of_dividends": -15000.00,
    "total_financing_cash_flow": 10000.00
  },
  "net_increase_decrease_in_cash": 155000.00,
  "beginning_cash_balance": 50000.00,
  "ending_cash_balance": 205000.00
}

4. Step-by-Step: Preparing the Statement (Indirect Method)

  1. 1

    Start with Net Income

    Retrieve the Net Income figure from your Income Statement for the period. This is your starting point for Operating Activities.

  2. 2

    Adjust for Non-Cash Items

    Add back non-cash expenses like depreciation and amortization. Subtract non-cash gains (e.g., gain on sale of assets) and add back non-cash losses.

  3. 3

    Adjust for Changes in Working Capital

    Analyze changes in current assets (like Accounts Receivable, Inventory) and current liabilities (like Accounts Payable) from the Balance Sheet. A decrease in a current asset or increase in a current liability adds cash; the opposite subtracts cash.

  4. 4

    Calculate Investing Activities

    Record cash inflows/outflows from the purchase or sale of long-term assets (property, plant, equipment) and investments.

  5. 5

    Calculate Financing Activities

    Account for cash from issuing debt or equity, and cash used for repaying debt, repurchasing shares, or paying dividends.

Common Error: Ignoring Non-Cash Transactions

A frequent mistake is forgetting to adjust net income for non-cash expenses like depreciation or amortization. These reduce net income but don’t involve cash, so they must be added back in the operating activities section.

5. Reviewing and Analyzing Your Statement

Review Checklist

  • Does the ending cash balance match the Balance Sheet?
  • Are all non-cash expenses and gains properly adjusted?
  • Do changes in current assets/liabilities accurately reflect cash impact?
  • Does the statement provide clear insights into cash generation and usage?

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