Understand and Create a Statement of Cash Flows: A Friendly Guide

If you’ve ever peeked at a company’s financial statements and found yourself wondering what a “Statement of Cash Flows” is all about, you’re not alone. While the income statement and balance sheet get most of the attention, the statement of cash flows quietly plays a crucial role in understanding a company’s actual financial health.

In this article, we’ll demystify what a statement of cash flows is, walk you through how to read one, and even show you how to create one from scratch. Whether you’re a small business owner, a student, or just curious, this guide is for you.

What Is a Statement of Cash Flows?

Think of the statement of cash flows as a financial diary that shows how money is moving in and out of a business. While the income statement tells you if the company is profitable and the balance sheet shows assets and liabilities, the cash flow statement answers one simple question:

Where is the cash coming from, and where is it going?

It tracks the actual cash (not just earnings) over a period of time—typically monthly, quarterly, or annually. This matters because a company can be profitable on paper but still run into trouble if it doesn’t manage its cash well.

The Three Sections of a Cash Flow Statement

A cash flow statement is usually divided into three main sections:

  1. Operating Activities

This section shows the cash generated or used by the company’s core business operations—things like selling products, paying suppliers, and covering payroll.

Examples:

  • Cash received from customers

  • Cash paid to suppliers or employees

  • Interest and taxes paid

Why it matters: Positive cash flow from operations is a sign the business is healthy and sustainable.

  1. Investing Activities

This part covers the purchase and sale of long-term investments and assets like equipment, property, or stocks in other companies.

Examples:

  • Buying new machinery (cash out)

  • Selling a building (cash in)

Why it matters: This shows how the company is growing or managing its assets for the future.

  1. Financing Activities

This includes any cash coming in or going out related to funding the business—like loans, issuing stock, or paying dividends.

Examples:

  • Borrowing money (cash in)

  • Repaying debt or issuing dividends (cash out)

Why it matters: It reflects how the business funds its operations and growth, whether through debt, equity, or other means.

How to Read a Cash Flow Statement

Let’s walk through a simplified example to see how the sections come together.

Sample Statement of Cash Flows (for one year):

Section Description Amount
Cash Flows from Operating Activities Net income $25,000
Adjustments for depreciation $5,000
Change in accounts receivable ($3,000)
Change in inventory ($2,000)
Net cash from operations $25,000

Cash Flows from Investing Activities     Purchase of equipment ($10,000) 


         Sale of investments $2,000 


Net cash from investing ($8,000) 

 

Cash Flows from Financing Activities Proceeds from bank loan $15,000


       Dividends paid ($4,000)


 Net cash from financing $11,000 

 

Beginning cash balance $10,000 

Net increase in cash  $28,000

Ending cash balance $38,000 

What can we learn from this?

  • Operations brought in $25,000 in cash: That’s a healthy sign.

  • The company invested in equipment, signaling growth.

  • It took on a loan but also returned value to shareholders through dividends.

  • Cash on hand increased from $10,000 to $38,000: plenty of liquidity.

How to Create a Statement of Cash Flows

Creating a statement of cash flows isn’t as daunting as it sounds. There are two main methods: direct and indirect. The indirect method is most commonly used, and it’s what we’ll focus on here.

Let’s break down the steps:

Step 1: Start with Net Income

Begin with net income from the income statement. This is your starting point for the cash generated by operations.

Step 2: Adjust for Non-Cash Expenses

Add back non-cash expenses like depreciation and amortization. These reduce net income but don’t actually involve a cash outlay.

Example:
 Net income = $25,000
 Depreciation = $5,000
 Adjusted = $30,000

Step 3: Adjust for Changes in Working Capital

This involves current assets and liabilities:

  • If accounts receivable increases, that’s cash out (you haven’t been paid yet).

  • If inventory increases, that’s also cash out.

  • If accounts payable increases, that’s cash in (you haven’t paid yet).

Make these adjustments accordingly.

Step 4: Add Cash Flows from Investing Activities

Include purchases or sales of long-term assets. These are usually found on the balance sheet.

Step 5: Add Cash Flows from Financing Activities

Include activities like issuing shares, borrowing money, or repaying loans.

Step 6: Calculate the Net Change in Cash

Add the totals from all three sections to get the net increase or decrease in cash.

Step 7: Reconcile with Beginning Cash Balance

Take your starting cash (from the previous period) and add the net change to find the ending cash balance. This figure should match the cash on the current balance sheet.

Tips for Success

  • Double-check your figures: Make sure everything reconciles with your balance sheet and income statement.

  • Use spreadsheet tools: Excel or Google Sheets make it easier to track changes over time and automate calculations.

  • Don’t ignore the footnotes: If you’re reading a public company’s statement, the notes can explain unusual transactions or adjustments.

  • Look for trends: A single statement is useful, but comparing multiple periods tells a better story.

Why It Matters (Even If You’re Not an Accountant)

Understanding the cash flow statement helps you:

  • See if a business is financially stable

  • Know where money is really going

  • Spot red flags before they become problems

  • Make smarter investment or management decisions

Wrapping Up

The statement of cash flows may not be flashy, but it’s one of the most honest and revealing financial documents out there. It strips away accounting tricks and focuses on cold, hard cash—what’s coming in, what’s going out, and whether the business can sustain itself.

Whether you’re analyzing a company or managing your own, knowing how to read and create this statement puts you in a strong position to make informed decisions.

So the next time someone brings up a financial statement, you’ll be the one saying, “Let’s look at the cash flow—that’s where the story is.”