The Cash Flow Statement is one of the three primary financial statements. It outlines the sources & uses of cash by the company and has three main categories of cash flows:
- Operating activities: cash flows related to the core business activities of the company (e.g., collections from clients, payments to suppliers, payroll expenses, gains from asset sales, and others)
- Investing activities: cash flows related to investments (e.g., purchases of property, plant, and equipment, M&A deals, development of software, and others)
- Financing activities: sources and uses of cash related to investors and banks (e.g., debt repayment or new debt utilization, distribution of dividends, issuing new shares, and others)
The Cash Flow Statement is an integral part of the company’s financial statements, alongside the Income Statement and the Balance Sheet. It adds more detail to the business performance and shows investors and lenders if the company has a solid financial foundation.
While the Income Statement shows how well we sell and manage expenses, the Cash Flow Statement shows how well we collect receivables and manage our liquidity and liabilities.
Additionally, the Income Statement is easier to manipulate (e.g., issuing more invoices before year-end and effectively moving sales from next year to this one). On the other hand, the Cash Flow Statement shows a much clearer picture of the company’s performance as it only considers cash generated and received from the annual sales.
Direct vs. Indirect Method
Two ways to prepare a Cash Flow Statement are the Direct and Indirect methods. These are two approaches to the same goal – to show the net amount of cash generated or used by a business during the period. The difference between the two methods is how we calculate and present Cash from Operating activities.
The Direct Method focuses on the sources and uses of cash, while the Indirect Method focuses on the differences between Net Income and cash flow. The Direct Method of preparing a Cash Flow Statement starts with cash receipts from clients and cash payments to suppliers based on when the cash transactions occurred, which requires more detailed data. The Direct Method is favored by some investors and lenders, as it provides a more detailed and accurate picture of the company’s cash flow.
On the other hand, the Indirect Method of Cash Flow Statement preparation uses the company’s Net Income as the starting point to calculate the operating cash flows. Most companies prefer it because it requires less information to prepare – we can usually create it with input from the Income Statement and the Balance Sheet of the company and little to no additional data. A Cash Flow Statement utilizing the Indirect Method acts as a sort of reconciliation between the Income Statement and the Balance Sheet. It also makes it easier to analyze the financial statements as a whole.
However, the Indirect Method is not very popular with governing bodies as it provides less detail on how cash flows through the business.
Overall, both the Direct and Indirect Methods of Cash Flow Statement preparation can provide valuable insights into a company’s financial performance.
Cash Flow Statement using the Indirect Method
The Indirect Method is more intuitive for many companies, as it starts from Net Income, which most businesses report on an accrual basis. We then apply adjustments to convert it to a cash basis, which we need for the Cash Flow Statement.
After we get our Net Income, we adjust it for non-cash items such as depreciation, amortization, interest, and others. Next, we add or subtract any changes in working capital, such as accounts receivable, accounts payable, and inventory. With those adjustments, we transform the Net Income from an accrual basis to a cash basis, arriving at the net cash flow from operating activities.
For example... Most businesses present Sales Revenue on an accrual basis, meaning revenue is recorded whenever a sale occurs regardless of when the corresponding cash is received. This revenue passes through to the reported Net Income for the period. On the other hand, the related money to be received in the future goes to Accounts Receivable. In the Cash Flow Statement, we start from Net Income (which has this sale's effect), and then we decrease this by the increase in Accounts Receivable that came from the cash yet to be received. That way, we remove the effect of this sale from the cash flows, effectively converting Net Income to a cash basis.
After calculating the net cash flow from operating activities, we move to the cash flows from investing and financing activities, which are calculated similarly under the Direct Method. We subtract any cash investments in capital assets to calculate the net cash flows from investing activities. We then add any cash received from financing activities, such as issuing stock or taking out a loan, to calculate the net cash flow from financing activities. Similarly, we would deduct any cash we paid to settle a loan or buy back our own shares.
Once these three items have been calculated, we can determine the total cash flow for the period by adding the net cash flows from operating, investing, and financing activities.
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Using Magnimetrics’ Cash Flow Statement Template
We have prepared an Indirect Method Cash Flow Statement template within the Magnimetrics platform, where you can import and map your financials (Income Statement and Balance Sheet only). Best thing? It will generate a Cash Flow Statement for you.
To use the template, head over to your Dashboard and select the Cash Flow Statement (Indirect Method) template.
This will open the prompt to copy the template within your projects. Here, you can change the name of your project, add an image if you want to brand it, and decide if you wish to import the available sample data.
I will switch that off in this case, as I plan to import my own data.
Clicking Create will copy the template to my projects and take me to the Project dashboard.
The newly created project has the entire template structure, including all formulas, line items, assumptions, report logic, etc. It will also import the periods from the template but no financial data.
First, we will focus on the Import Your Data section of the project dashboard, starting from the Income Statement import template.
As I will only be importing data for the past three years, I can delete the periods I don’t need, leaving 2020, 2021, and 2022.
The next step is importing my file and mapping it to the template structure. First, I will click the Import File button and select my file, ensuring I am on the right Excel tab for the Income Statement.
Here’s the file I will use in case you want to follow along.
Then I will click on the Next button, and the app will identify my line item names and data columns. I will go ahead and click Next again and confirm that I don’t have any predefined codes in my file by clicking on Proceed in the modal that will pop up.
Next is the mapping screen. It looks a bit daunting initially, but it’s pretty simple once you try it. And the best part is that once you map your input file structure to a template, this mapping is saved. So, next time you use the same structure to add an additional period or update some numbers, everything will be mapped immediately.
Whenever you use a template, you have predefined line items and formulas; for this to work with zero adjustments, you must map your data to the predefined structure.
Additionally, the app identifies formulas and empty lines in your files and switches them off by default.
I will then map all my imported lines to lines in the template with the dropdowns. Remember, if you introduce a unique line that doesn’t fit anywhere in the template, you can still import it as New. However, then you will have to adjust the formulas and logic of the template to ensure your new line participates in the template calculations and reports.
I click Next, and it takes me to the period selection screen. Here I will grab all three periods I am importing and click Next again.
The final step shows me a preview of what I am about to import. Click the Import button and select Replace on the modal that will pop up, as we are replacing the 0s in the empty template periods.
And this is my Income Statement data imported into the app.
Next, I will go over the same process with my Balance Sheet. Remember, it’s just a one-time mapping exercise. And here it is.
So far, I’ve imported my Income Statements and Balance Sheets for 2020, 2021, and 2022. Now, if I go to the Reports section of my project, right-click the Cash Flow Statement report, and click on Launch Report, it will calculate the template based on my imported data.
The report starts with the Income Statement and Balance Sheet. However, as I scroll down, I can see my generated (and reconciling, mind you) Cash Flow Statement at the bottom. As you see, it doesn’t have the 2020 cash flow numbers because the changes in working capital calculation require the previous period. We don’t have a Balance Sheet for 2019 imported, so the template cannot calculate the 2020 Cash Flow Statement.
Next year, all I need to do is upload my new files using the same mapping I created, run the report again, and have my 2023 Cash Flow Statement in a matter of minutes.
Conclusion on Preparing Cash Flow Statements using the Indirect Method
Preparing a Cash Flow Statement is essential to any business’s financial statements. It is a tool to analyze and understand a company’s financial health. Investors and analysts can use it to determine the sources and uses of cash and the company’s liquidity. Furthermore, we can use the cash flow statement to compare financial performance to industry benchmarks and forecast future cash flows.
A Cash Flow Statement is valuable for assessing a company’s financial health. The Indirect Method of preparing a Cash Flow Statement is a straightforward and efficient way to get the information needed to properly report on the business’s financial performance and make informed decisions about its financial health.
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Hi! I am a finance professional with 10+ years of experience in audit, controlling, reporting, financial analysis and modeling. I am excited to delve deep into specifics of various industries, where I can identify the best solutions for clients I work with.
In my spare time, I am into skiing, hiking and running. I am also active on Instagram and YouTube, where I try different ways to express my creative side.
The information and views set out in this publication are those of the author(s) and do not necessarily reflect the official opinion of Magnimetrics. Neither Magnimetrics nor any person acting on their behalf may be held responsible for the use which may be made of the information contained herein. The information in this article is for educational purposes only and should not be treated as professional advice. Magnimetrics and the author of this publication accept no responsibility for any damages or losses sustained in the result of using the information presented in the publication.