How to Prepare a Cash Flow Statement

Understanding how to prepare a cash flow statement is crucial for any organization when evaluating its financial situation. This document provides a clear view of where your money is coming from and where it’s going, helping you make informed decisions that keep operations running smoothly and plans on track. 

Whether you're assessing your organization's liquidity, preparing for future projects, or ensuring you can meet financial obligations, a cash flow statement is an excellent guide for handling the complexities of financial management.

However, preparing a cash flow statement can feel daunting, especially for local governments and nonprofit organizations juggling multiple funding sources and obligations. That’s where treasury management software comes in. DebtBook’s Cash Management solution helps organizations like yours save time, reduce errors, and gain clarity by simplifying financial reporting and centralizing your data. 

Now let’s explore what makes a cash flow statement so important and how you can create one step by step.

What is a Cash Flow Statement?

A cash flow statement is one of the most important financial documents for any organization. It’s a financial statement report that tracks the movement of cash in and out of your organization over a specific period. 

In simple terms, it shows where your cash is coming from and where it’s going. 

Unlike an income statement, which focuses on profitability, a cash flow statement zeroes in on actual cash activity, making it essential for understanding your organization’s liquidity.

Why does this matter? 

Tracking cash inflows and outflows gives you a clear picture of your financial health. Are you generating enough cash to cover your expenses? Do you have the liquidity needed to seize new opportunities or weather unexpected challenges? A cash flow statement answers these critical questions and helps you plan for the future with confidence.

For governments and nonprofits, where funding sources can be unpredictable and financial obligations complex, cash flow statements are indispensable financial documents. They ensure you can meet payroll, fund community programs, and maintain essential services. 

Whether you’re presenting your financials to stakeholders or making day-to-day operational decisions, a cash flow statement is your guide to financial stability and success.

Key Components of a Cash Flow Statement

A cash flow statement breaks down your organization’s cash movements into three main categories: operating, investing, and financing activities. Understanding these components is key to getting a complete picture of your financial performance and stability. 

Here’s a closer look at each:

1. Operating Activities

This section covers the cash flow from your core day-to-day operations. It includes money coming in from services provided or grants received, as well as cash going out for expenses like salaries, utilities, and supplies. 

Essentially, operating cash flow activities show whether your regular operations are generating enough cash to sustain your organization.

2. Investing Activities

Investing activities track cash flows related to the acquisition or sale of long-term assets. Think of things like buying or selling property, equipment, or other significant investments. For local governments or nonprofits, this might involve purchasing new facilities. 

This section highlights how you’re using cash to invest in your organization’s future.

3. Financing Activities

This category focuses on cash flows from funding sources. It includes activities like borrowing money, repaying loans, or receiving contributions from stakeholders. For governments and nonprofits, this could involve issuing bonds, repaying debt, or receiving major endowments. 

Financing activities provide insight into how you’re funding your operations and investments.

Methods to Prepare a Cash Flow Statement

When it comes to preparing a cash flow statement, there are two primary methods you can use: the direct method and the indirect method. Both approaches provide the same bottom-line result but take different paths to get there. 

Here’s how they work:

Direct Method

The direct method provides a straightforward view of cash flow by listing actual cash receipts and payments during the reporting period. It’s like looking at your organization’s cash activity in real-time. 

This method breaks down cash flows from operating activities into categories like cash received from customers, grants, or program revenues, and cash paid for expenses such as salaries, utilities, and supplies.

The direct method offers clarity and precision, making it easier to see exactly where your cash is coming from and where it’s going. However, it can require more detailed record-keeping since you need to track every cash transaction directly.

Indirect Method

The indirect method starts with your organization’s net income (or net surplus) and adjusts for non-cash items and changes in working capital. It essentially “translates” your income statement into a cash flow statement by adding back non-cash expenses like depreciation and accounting for shifts in accounts receivable, accounts payable, and inventory.

This method is more commonly used because it’s easier to prepare with existing financial records. It also provides valuable insights into the relationship between your net income and cash flow, making it a popular choice for many organizations.

Both methods have their advantages, and the choice often depends on the level of detail you need and the complexity of your financial activities. Whether you prefer the simplicity of the indirect method or the granular detail of the direct method, the goal is the same: to provide a clear picture of your organization’s cash flow and improve cash visibility.

What are the Steps to Prepare a Cash Flow Statement?

Here’s a step-by-step guide to ensure accuracy and clarity when preparing your cash flow statement:

Step 1: Gather Financial Data

Start by collecting all the financial records you’ll need, such as income statements, balance sheets, and cash transaction reports. These documents provide the foundation for identifying cash inflows and outflows. 

Ensuring your data is up-to-date and complete will save you time and reduce errors later in the process.

Step 2: Categorize Cash Flows

Organize your cash flows into the three main categories: operating, investing, and financing activities. This involves identifying which transactions and payments fall under day-to-day operations, long-term investments, or funding activities. Proper categorization is crucial for creating an accurate and meaningful cash flow statement.

Step 3: Calculate Net Cash Flow

Next, determine the net cash flow for each category. This involves subtracting the total outflows from the total inflows for operating, investing, and financing activities. 

Summing these three categories gives you the overall net cash flow for the reporting period, showing whether cash increased or decreased.

Step 4: Review and Verify Accuracy

Before finalizing the statement, double-check all calculations and ensure that transactions have been properly classified. Cross-referencing your cash flow statement with your balance sheet and income statement can help identify discrepancies. 

Example of a Cash Flow Statement

To bring the concepts of cash flow statements to life, let’s walk through a simple example using both the direct and indirect methods. This will show how the two financing approaches arrive at the same result, but with different paths.

Direct Method Example

Here’s how a cash flow statement for an example nonprofit organization might look using the direct method:

Operating Activities:

• Cash received from program revenues: $120,000
• Grants received: $50,000
• Cash paid for salaries: $(80,000)
• Cash paid for utilities and supplies: $(20,000)
• Net Cash from Operating Activities: $70,000

Investing Activities:

• Purchase of new office equipment: $(10,000)
• Sale of old equipment: $5,000
• Net Cash from Investing Activities: $(5,000)

Financing Activities:

• Loan received: $30,000
• Loan repayment: $(15,000)
• Net Cash from Financing Activities: $15,000

Total Net Cash Flow: $80,000

Indirect Method Example

Using the same scenario, the indirect method starts with net income and adjusts for non-cash items and changes in working capital:

Operating Activities:

• Net income: $65,000
• Add back depreciation: $10,000
• Increase in accounts receivable: $(5,000)
• Decrease in accounts payable: $0
• Net Cash from Operating Activities: $70,000

Investing Activities:

(Same as direct method)

• Purchase of new office equipment: $(10,000)
• Sale of old equipment: $5,000
• Net Cash from Investing Activities: $(5,000)

Financing Activities:

(Same as direct method)

• Loan received: $30,000
• Loan repayment: $(15,000)
• Net Cash from Financing Activities: $15,000

Total Net Cash Flow: $80,000

Both methods ultimately show that the organization experienced a net cash inflow of $80,000 during the reporting period. The direct method provides a more granular view of cash transactions, while the indirect method focuses on reconciling net income with cash flow.

Common Mistakes to Avoid When Preparing a Cash Flow Statement

Here are three key cash flow balance sheet mistakes to watch out for—and how to avoid them:

1. Ignoring Non-Cash Items

One of the most frequent financing mistakes is overlooking non-cash items like depreciation, amortization, or gains and losses on asset sales. 

While these items don’t directly involve cash, they still impact your cash flow statement, especially when using the indirect method. Always adjust for these items to ensure your statement accurately reflects cash activity.

How to Avoid It:

Double-check your income statement for non-cash expenses and reconcile them when preparing your cash flow statement.

2. Misclassifying Cash Flows

Accurate categorization is crucial, but it’s easy to misclassify transactions between operating, investing, and financing activities. 

For example, recording loan repayments as operating activities instead of financing activities can distort your cash flow data and make it harder to identify trends.

How to Avoid It:

Refer to your organization’s accounting policies or a reliable guide to confirm the correct category for each transaction. Properly accounting for these changes ensures that your financial statements reflect accurate cash flow information. When in doubt, seek advice from an accountant or financial advisor.

3. Omitting Changes in Working Capital

Changes in working capital, like shifts in accounts receivable, accounts payable, and inventory, are essential for understanding cash flow, particularly under the indirect method. Failing to account for these changes can result in an incomplete picture of your organization’s financial health.

How to Avoid It:

Carefully track and include adjustments for changes in working capital to reflect the true movement of cash in and out of your organization.

DebtBook’s Modern Cash Management Solution

Managing cash flow shouldn’t feel like a constant battle against outdated spreadsheets and scattered data. Too often, treasury teams are stuck in time-consuming workflows that leave little room for strategic decision-making. 

DebtBook’s Cash Management solution changes the game, offering a purpose-built, secure solution designed to streamline workflows and elevate your approach to cash flow and liquidity management.

How DebtBook Helps You Take Control of Cash Management:

• Build Accurate Cash Forecasts: Easily create reliable projections to understand your organization’s financial future. Discover more cash forecasting benefits.
• Catch Fraudulent Transactions: Leverage centralized data and advanced safeguards to detect and address anomalies.
• Automate Daily Cash Positioning: Simplify your daily workflows with automated tools that save time and improve accuracy.
• Gain Control Over Future Cash Flow: Track upcoming cash flow, adjust as needed, and ensure financial clarity.

Maintain Financial Health and Stability with DebtBook

A well-crafted cash flow statement provides invaluable insights into your organization’s liquidity, helps you anticipate challenges, and supports informed decision-making. Whether you’re tracking day-to-day operations, planning long-term investments, or managing funding sources, this tool is essential for maintaining financial health and stability.

Take control of your cash flow today with DebtBook’s Cash Management solution and ensure your organization is equipped for a financially confident future.