What is a cash flow statement?
A cash flow statement is a financial report that shows how much cash came into and went out of a business during a period, grouped into operating, investing and financing activities. It explains why the cash balance changed between two dates, which the profit and loss statement cannot do because it is prepared on an accrual basis.
What are the three sections of a cash flow statement?
| Section | What it covers | Typical items |
|---|---|---|
| Operating activities | Cash from day-to-day trading | Cash from customers; payments to suppliers and staff; tax paid |
| Investing activities | Cash spent on or received from long-term assets | Buying or selling equipment, property or investments |
| Financing activities | Cash from or returned to lenders and owners | Loans drawn and repaid; shares issued; dividends and owner drawings |
What goes where
Cash flow statement example (indirect method)
This continues the sample company from our profit and loss guide: revenue $500,000 and net profit $37,500, after $8,000 of depreciation. During the year its receivables rose by $15,000, inventory rose by $10,000 and supplier payables rose by $6,000. It bought $40,000 of equipment, borrowed $20,000, repaid $5,000 of an older loan and paid the owners $10,000. It started the year with $30,000 in the bank.
| Line | Amount |
|---|---|
| Net profit | $37,500 |
| Add back: depreciation (non-cash) | $8,000 |
| Increase in accounts receivable | ($15,000) |
| Increase in inventory | ($10,000) |
| Increase in accounts payable | $6,000 |
| Net cash from operating activities | $26,500 |
| Purchase of equipment | ($40,000) |
| Net cash used in investing activities | ($40,000) |
| New loan received | $20,000 |
| Loan repayment | ($5,000) |
| Distributions to owners | ($10,000) |
| Net cash from financing activities | $5,000 |
| Net change in cash | ($8,500) |
| Cash at start of year | $30,000 |
| Cash at end of year | $21,500 |
Statement of cash flows (indirect method)
The business was profitable, yet its cash fell by $8,500. The statement shows why: $25,000 was tied up in unpaid invoices and extra stock, and $40,000 went into equipment, only partly funded by new borrowing. None of that is visible on the P&L.
The same example by the direct method
The direct method lists the cash itself. Assuming the payables increase relates to stock purchases and that interest and tax were paid during the year, the operating section looks like this, and lands on the same $26,500.
| Line | Working | Amount |
|---|---|---|
| Cash received from customers | $500,000 revenue − $15,000 increase in receivables | $485,000 |
| Cash paid to suppliers for stock | $300,000 COGS + $10,000 inventory build − $6,000 more owed to suppliers | ($304,000) |
| Cash paid for operating expenses | $146,000 overheads − $8,000 non-cash depreciation | ($138,000) |
| Interest paid | ($4,000) | |
| Income tax paid | ($12,500) | |
| Net cash from operating activities | $26,500 |
Operating activities (direct method)
IAS 7 encourages the direct method but permits the indirect method, and most companies use indirect because it is built from the P&L and balance sheet they already have. Investing and financing sections look the same under both. Where interest paid sits (operating or financing) can depend on the framework you report under.
Working capital adjustments: add or subtract?
How balance sheet changes affect operating cash
Subtract (uses cash)
- Increase in accounts receivable
- Increase in inventory
- Increase in prepaid expenses
- Decrease in accounts payable
- Decrease in accrued expenses
Add (frees cash)
- Decrease in accounts receivable
- Decrease in inventory
- Decrease in prepaid expenses
- Increase in accounts payable
- Increase in accrued expenses
The check that proves the statement
Opening cash plus the net change in cash must equal the cash on the closing balance sheet. If it does not, an item has been missed or put in the wrong section.
How do you calculate free cash flow?
Free cash flow is operating cash flow minus capital expenditure: the cash a business generates after investing in the assets it needs. For the sample company it is $26,500 − $40,000 = −$13,500, which is why it needed a loan. A second useful ratio is cash conversion, operating cash flow divided by net profit: $26,500 ÷ $37,500 = 0.71, meaning only 71 cents of each dollar of profit turned into operating cash this year.
- $26,500
- Operating cash flow
- −$13,500
- Free cash flow
- 0.71
- Cash conversion (operating cash ÷ net profit)
What does negative cash flow from operations mean?
| Pattern | What it often means |
|---|---|
| + / − / − | A mature business funding investment, debt repayment or owner payouts from its own trading |
| + / − / + | A growing business investing faster than trading can fund, topping up with loans or equity |
| − / − / + | Trading is consuming cash and borrowing covers it. Common in early start-ups; a warning sign if it persists |
| − / + / − | Selling assets to meet obligations. Investigate before lending or investing |
Reading the signs (operating / investing / financing)
Look at three or more periods rather than one. If profit keeps rising while operating cash flow does not, check receivables and inventory first; those are where profitable businesses most often lose cash.
What changes in 2027 for IFRS reporters?
IFRS 18 Presentation and Disclosure in Financial Statements applies to annual periods beginning on or after 1 January 2027. It amends IAS 7 so that the indirect method starts from operating profit or loss as IFRS 18 defines it, rather than from profit or loss, and narrows the options for classifying interest and dividends. US GAAP (ASC 230) is not affected. If you report under IFRS, confirm the new presentation with your auditor before the first affected year.
The cash flow statement in AccountDesq
AccountDesq prepares the cash flow statement by the indirect method from the same ledger as the P&L and balance sheet, and reconciles the net change in cash to the movement in your cash and bank accounts, so the closing figure ties out.
What are the three sections of a cash flow statement?
Operating activities (cash from day-to-day trading), investing activities (cash spent on or received from long-term assets) and financing activities (cash from or returned to lenders and owners).
Why is depreciation added back on a cash flow statement?
Depreciation reduces profit but no cash leaves when it is recorded. The cash went out when the asset was bought, and that purchase appears under investing activities.
Can a profitable company have negative cash flow?
Yes. Rising receivables or inventory, equipment purchases and loan repayments all use cash without reducing profit. Fast-growing profitable businesses often run short of cash for this reason.
What is the difference between the direct and indirect method?
The direct method lists cash receipts and payments in the operating section. The indirect method starts from profit and adjusts for non-cash items and working capital changes. Both arrive at the same operating cash flow.
What is free cash flow?
Operating cash flow minus capital expenditure. It shows how much cash the business generates after paying for the assets it needs to keep operating and growing.
Is a cash flow statement the same as a cash flow forecast?
No. The statement reports what happened in a past period. A forecast projects future receipts and payments so you can plan ahead.
The P&L tells you whether you made money. The cash flow statement tells you where it went.
Resources
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