Even a simple cash flow statement can provide you with valuable information. Of course, the preparation of a cash flow statement will vary depending upon the method you choose, the direct method or the indirect method.
The direct method starts with cash transactions that have impacted your general ledger such as cash spent and received while the indirect method starts with net income and adds back in non-cash expenses.
Whichever method you choose, the end result will be the same, the only difference is the way in which the totals are calculated. When choosing between the direct and indirect cash flow format, only the operating section on your cash flow statement will be affected.
Both the investing and financing sections remain the same. While the direct method provides a much clearer view of incoming and outgoing cash, the indirect method is easier to set up and use.
Direct cash flow
Direct cash flow adds up all of your cash transactions such as vendor payments, cash receipts, and salary expenses, as well as taxes and interest paid. These expenses are then listed in the operating activities section on the cash flow statement.
This can be an issue for businesses that use accrual accounting, which is required in double-entry accounting, as you would need to separate cash sales out from credit sales in order to calculate cash flow properly.
Indirect cash flow
Using the indirect cash flow format requires that you make a series of adjustments including adjusting for interest and taxes paid and received, depreciation and amortization, as well as non-cash income such as gains on property, plants, and equipment.
A cash flow statement gives you a lot of information about the health of your business. In fact, if you’re hoping to attract new investors, much of their decision to come aboard or not will be based on your cash flow statement. But what does your cash flow statement tell you? Here are a few things:
What areas may have cash flow problems
Because it offers a view into cash flow in three vital areas of your business; operations, investing, and financing, the cash flow statement provides you with a good indicator of where your business may be suffering. Is your cash flow poor in investing activities?
Have you seen a decrease in cash in operating activities? The cash flow statement directs you to where the biggest increases or decreases are centered, allowing you to take corrective measures if they’re necessary.
How financially healthy your business is
A business is considered financially healthy if it’s bringing in more cash than it’s spending. There are exceptions to this rule, such as when a business is in a growth phase and cash outflow is increased, but looking at cash flow statements over a period of time provides details on information such as:
- Consistency: Has cash flow remained the same in recent months or does it vary widely?
- Profitability: Is the company consistently profitable or is growth stagnant?
- Decline in profits: Has income declined over the last few months?
How well you’re managing cash
Cash flow provides business owners, as well as potential investors or loan officers, with information on both incoming and outgoing cash, providing discover this details on how that cash is being spent.
Best accounting software to create a cash flow statement
The easiest way to create a cash flow statement is by using accounting software. Here are a few options if you’re looking to automate cash flow statement preparation. You can also check out The Blueprint’s small business accounting software reviews for even more software options.
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