How to Prepare a Cash Flow Statement

The Statement of Cash Flows is basically divided into 3 major categories: operating activities, investing activities, and financing activities.  The statement is a basic summary of these activities for a given period of time, usually 1 month, or quarterly or annually.

The format for reporting cash flow activity may be either direct or indirect, and these formats will be discussed in more detail during a later article; for now, we will use the direct method of reporting, as it is the most common format used.

The order in which the financial statements are prepared is as follows: income statement, statement of owner's equity, balance sheet and the final document prepared is the statement of cash flows. There reason the statements are prepared in this particular order lies with the fact that information flows from each report to the next based on the order of reporting.  Therefore, the statement of cash flows cannot be completed, until the other three are finished.

The information required to put together the statement of cash flows comes from these reports, and general ledger transactions that are recorded each month.

So where do we look to obtain our information, and how do we put it together?

For the operating activities information, we look to the customer receipts for sales, the cost of merchandise sold, and cash payments for operating expenses.

For investing activities information, we look to any transactions involving the fixed assets of the business that are land, equipment, and building sales or purchases.

For financing activities information, we look at any transactions that involve the common stock of the company, dividends, bonds, or preferred stock.

All of this information is provided via the general ledger and journal and brought together for the preparation of the statement of cash flows; why then, must we complete the other financial statements, prior to the completion of the statement of cash flows?  Because the cash asset figure shown on the balance sheet, must reconcile to the net cash flow cash balance computed on the statement of cash flows.  There is no way to reconcile the statement, unless you have previously completed and reconciled the other financial statements.

It never fails to amaze me at the entwined relationship these statements have upon each other, and the fact that reconciliation is not only possible, but must be accomplished.  Using the figures and information that we obtain when completing these series of reports, analysts and business leaders are able to set courses for businesses that increase profitability in the best case scenario, and prevent disaster and failure in the worst case scenario.

Effective utilization of these reports, especially during this era of accounting is a must.  Given the complexity of the corporate accounting and reporting environment today, the failure to responsibly evaluate and report findings could lead to error, if not charges of illegal conduct.  More of our time in education should be spent in learning how to prepare these statements, and then to effectively analyze them.

Information is for educational and informational purposes only and is not be interpreted as financial or legal advice. This does not represent a recommendation to buy, sell, or hold any security. Please consult your financial advisor.