What is Cash Flow Statement: Formats and Solution

Without a proper Cash flow statement to keep track of the business’s money, owners will have a difficult time understanding where their money is going and where it is coming from. It would be like walking blindfolded across a minefield; something or the other will blow up at some point if there is no clear view of the cash flow.

It is also pivotal for businesses to understand the different formats of the cash flow statement.  This post will walk you through the basics of a cash flow statement, including its definition, needs, and format of the cash flow statement, along with its pros and cons.

What is a Cash Flow Statement?

A cash flow statement is a financial record that tells the business owners how much cash the business has on hand for a specific period. A business’s income statements, on the other hand, are good for showing how much money it has spent and earned but not for showing how much money it has on hand. 

If the business uses an accrual method for accounting, all incomes and expenses are recorded when they are earned or paid, not when the money is credited or debited from the bank account.

So, even if there is a new income shown on the income statement, its corresponding value may not have reached the bank account of the business. The cash flow statement adjusts the information given in the income statement so that the net cash flow is available. 

For example, imagine depreciation is paid on a monthly basis. However, cash was already paid for the depreciating asset, and it is recorded on a monthly basis. But cash is not getting debited from the bank account every month.

The cash flow statement takes this monthly expense and reverses it so that the business owners see how much cash there is in hand and not how much it has been spent in theory. 

Why Cash Flow Statements Are Important

The following are the main reasons why cash flow statements are important:

• They show liquidity: This means that the business knows exactly how much it has in terms of operating cash flow. This gives a clear idea of what the business can afford and what it cannot.
• They show significant changes: The cash flow statement shows changes to the business’s assets, liabilities, equity in the form of cash outflows and cash inflows, and cash being held. These are at the core of a business’s accounting practices and form the accounting equation that helps measure performance. 
• Let’s predict future cash flows: Current and past cash flow statements of the business can be used to predict future cash flows. This lets the business make long-term plans as per the liquidity of the future.   
• Improves creditworthiness: Banks and other financial institutions may refer to the updated cash flow statement of the business to qualify them for loans.

Difference Between Negative and Positive Cash Flows

When a cash flow statement shows a negative value at the bottom, it is called negative cash flow. This means that the business has lost cash during the accounting period. However, you must understand that long-term negative cash flow is not always a bad thing. It shows that you are putting your cash to use. There is no point sitting on top of a cash reserve when your business is not growing. 

When the number at the bottom of the cash flow statement is positive, it is called a positive cash flow statement. As good as it sounds, positive cash flow is not always a good thing in the long term. While the business may have liquid cash at the moment, there may be negative reasons why the cash is there in the first place.     

How does a Cash Flow Statement Work With an Income Statement and Balance Sheet in Tandem?

The cash flow statement is created with income gathered from the income statement and balance sheet. The income statement shows how much money has been left and entered the business.

In contrast, the balance sheet shows how those transactions affect different accounts like accounts receivables, inventory, and accounts payable. The general process of producing financial statements is:

Income Statement + Balance Sheet = Cash Flow Statement

Cash Flow Statement Formats

The following are the different formats of the cash flow statement used by small, medium, and large businesses alike. 

Cash Flow Statement Indirect Method Format

The cash flow statement indirect method format involves adjusting the net income with changes in the balance sheet accounts. The goal is to arrive at the amount of cash generated by the business’s operating activities.

The indirect method of cash flow statements is very popular because of its simplicity. The information required can easily be gathered from the accounts that a business normally maintains. However, it is not recommended by the standard-setting bodies because it does not clearly show how cash flows through a business. 

Given below is an example of the cash flow statement as per the indirect method: 

Advantages of the Indirect Method

• Ease of preparation: Compared to the direct method, the cash flow statement in the indirect method is easier to prepare because most companies keep their financial records on an accrual basis.
• Reconcile cash income: This method reconciles the accrual-based accounting cash flow with the actual cash flow from the business’s operating activities. This shows the difference between the company’s cash-holding position and its profits. 
• Links financial statements: This method requires a direct link between the business’s income statement and the balance sheet. This helps business owners have a more systematic view of their financial statements. 
• Disclosure of non-cash transactions: The disclosure of non-cash transactions using the indirect method can help businesses better understand how those transactions are factors of the company’s income but not sources of cash flows. 

Disadvantages of the Indirect Method

• Lack of transparency: This is probably the only disadvantage associated with the indirect method as it rarely complies with rules or accepted procedures of accounting. 

How to calculate Cash Flow Using the Indirect Method?

Preparing the cash flow statement using the indirect method consists of preparing three separate sections. They are Cash Flow from Operations, Cash Flow from Investments, and Cash Flow from Financing. After each statement is prepared, they are combined to form one cash flow statement. The sum of all net cash flows from each of the three sections should be positive. 

Cash Flow Statement Direct Method Format  

The direct method of cash flow statements presents specific cash flows associated with items that affect cash flow. Some of such items include cash collected from customers, interest, cash paid to employees, cash paid to suppliers, interest paid, and income tax paid.

The usage of this method is encouraged by standard-setting bodies, but it is rarely used because of the fact that the information in it is difficult to assemble. Businesses do not collect and store information in the manner required for the direct method.

The use of this method may require the chart of accounts to be restructured in order to collect the information mandated by the format. Here is an example of the format of the direct method of cash flow statement:

Advantages of the Direct Method

• Transparency: This method reports the direct sources of cash receipts and payments. This information can be very useful for creditors and investors.
• Accuracy: Using real-time figures for financial reporting is more reliable for tracking cash flows. 
• Assists in prediction models: Studies have concluded that direct method disclosures assist with prediction models. Investors and creditors can use the information in the direct format to estimate future earnings and cash flows.
• No need for adjustments: Since this method gives a more accurate picture of the organization’s operations, there will be no need to make any adjustments for money that have been earned but not yet received. 

Disadvantages of the Direct Method

• Take time to create reports: Since most companies keep their records on an accrual basis, creating reports becomes complex and time-consuming. For example, it might require reconciliation to separate cash flow from net income. 
• Can be costly: It is labor-intensive to create the cash flow statement using the direct method; it usually costs a lot more than the indirect method. 

How to calculate cash flow using the direct method?

Under this method, the cash flow statement is usually grouped into categories of losses and expenses. These comprise cash collections, operating expenses, purchases, and income tax.

The amount for each category is calculated using a basic formula. The cash flow statement usually lists income from sales before listing expenses, leaving a total amount for cash flow at the end.

Key Differences Between the Direct and Indirect Methods of Cash Flow

The following are the main differences between the above two formats of the cash flow statement:

• One of the key differences between the two is the type of transactions used to produce a cash flow statement. The indirect method uses net income as the base to convert the income into cash flow by making adjustments. The direct method, on the other hand, only takes cash transactions into account and produces cash flow from operations. 
• The indirect method makes sure to convert net income in terms of cash flow automatically. The direct method records cash transactions separately to produce the cash flow statement. 
• The direct method needs time to prepare because of the adjustments that need to be made. The time needed to make the cash flow statement as per the indirect method is not much as it only uses cash transactions.
• Since it makes a lot of adjustments, the accuracy of the indirect method is questionable. Therefore, the direct method is more reliable because it makes no such adjustments.

Cash Flow Statement Format as per AS 3

This simply means the cash flow is prepared as per Accounting Standard 3 as notified by the government. Creating the cash flow as per this format is mandatory for businesses. According to this format, the two heads of the cash flow statement (Sources of Cash and Uses of Cash) are divided into Operating Activities, Investing Activities, and Financing Activities. 

Cash flow from operating activities will include most of the business’s cash flow. That is because they are the activities that get the business revenue. For example, for a restaurant, it will be the cash it earns from selling food. 

Cash flow from investing activities includes the investments a company has made by purchasing equipment, real estate, land, or easily liquidating financial assets. For small businesses, this section won’t make up a majority of the cash flow. But it should still be reconciled since it has a direct impact on working capital. 

Cash flow from financing activities refers to revenue earned or assets spent on financing activities. Paying a part of a loan or line of credit or getting a new source of capital are all sources of cash flow from financing activities.

Given below is the format of the cash flow statement as per AS-3: 

Cash Flow Statement as per Companies ACT 2013 

The Companies Act, of 2013 brought in many changes that directly impact the preparations of financial statements and requires a clear understanding of new definitions and provisions. The applicability of Cash Flow statements can be determined under Section 2 (40) of the Companies Act. This section deals with “Financial Statements” and is governed by Companies (Accounting Standard) Rules, 2006. 

Downloadable Cash Flow Statement Formats 

Thanks to the internet and the commitment of companies to provide value to customers and the general public, formats of all financial statements are available for free or for very low prices. This includes the cash flow statement format in excel, cash flow statement form in pdf, and word. 

For example, Lio offers several templates for recording financial information for free. Some of them are: 

• Income Register 
• Expense Register 
• Daily Spent Register 
• Profit and Loss Account Register 

Cash Flow Template In Lio

When it comes to managing the cash flow, you can easily make use of the Lio app which has a great template that lets you keep a track of your money in simple ways. The template is easy to work on where you just have to choose between cash in and cash out and the amount. As you keep filling the sheet, the template would automatically show you the total amount left with you.

This is a great template that keeps your cash calculated so that your accounts are always clear and without any confusion.

How Lio can Help You

Lio is a great platform that can help entrepreneurs, homemakers, students, businessmen, managers, shop owners, and many others. This mobile application helps to organize business data and present them in an eye-catching manner. 

Lio is a great platform for small business owners and can track a wholesome record of employee information for better employee management, customer data, etc. You can handle those data with ease.

If you want to be a professional, then you must save time, you need to learn to arrange all the business strategies in one place. In that case, Lio can be your partner.

Entrepreneurs can also allow multiple authorized users of their office to access the information from various locations within minutes.

Lio is definitely for the win and using it for your business is only going to make your journey smooth and easy to track.

Step 1: Select the Language you want to work on. Lio on Android

Step 2: Create your account using your Phone Number or Email Id.

Verify the OTP and you are good to go.

Step 3: Select a template in which you want to add your data.

Add your Data with our Free Cloud Storage.

Step 4: All Done? Share and Collaborate with your contacts.

Conclusion 

This article has discussed the essential details there are to know about the cash flow statement. The effects of not properly maintaining a cash flow statement are manifold. Business owners should choose what format of the cash flow statement is suitable for their business.

Frequently Asked Questions(FAQs)