KPMG Spark Blog

How to Read a Cash Flow Statement

If you don’t understand how to read financial statements, the numbers and columns scattered across the pages can seem like an unsolved puzzle, broken into hundreds of meaningless pieces. Yet, with some basic knowledge, those pieces can tell you a brilliant story about where your business has been and where it is going.

Most introductory business or accounting classes only cover the two basic financial statements: the balance sheet and the income statement. Balance sheets are a quick snapshot of an organization’s financial position (assets, liabilities, and equity); and an income statement shows profitability of operations over a period of time. While these financial documents are vital to understand, most classes never touch or only skim the surface of one of the most telling financial statements, the cash flow statement. Here are some tips on how to understand this vital statement:

What is a cash flow statement?

What is a cash flow statement? A statement of cash flows, of course...seriously though, it’s pretty simple; a cash flow statement reconciles the income statement and balance sheet to look specifically at cash transactions. A cash flow statement doesn’t necessarily cover all business incomes and expenses (since some exchanges come from credit), but still tells a valuable story about your business.

Cash transactions come from many different business operations. These operations are broken down into separate categories, which can result in positive or negative amounts of cash flow. These categories include:

Operating Activities

This section covers normal business activities that are paid for in cash, such as buying and selling products or services. Think of the normal operations at your business core.

Investing Activities

This section includes the cash buying and selling of any asset that produces income for a business. Things like buying materials to make products, or selling an older piece of equipment or another line of business would be included in Investing Activities. These are often known as capital transactions.

Financing Activities

Not to be confused with Investing Activities, financing activities covers cash transactions within a company and its creditors. An example of this is when a company pays out dividends to its investors. If a company has negative cash flow in this section it could represent paying out cash dividends to investors, which is typically a good thing, but it could also represent the company paying interest on previous debt. This is an example of why it’s important to understand where your numbers are coming from and what they represent, because a positive or negative doesn’t tell you anything unless you know where it’s coming from.

Most organizations have many different cash transactions across all lines of operation, so it’s important to know where your cash is going. Once a business can identify how much cash they do or don’t have on hand, they can reassess their strategy in areas like financing, payments, and investing.

What a Cash Flow Statement Isn’t

The cash flow statement does not tell you about profits or losses, because those calculations are made up of other non-cash items on the income statement. Although cash flow is important to analyze, a cash flow statement is not a reliable metric for overall financial well-being of a company.

Large accrual based accounts that can greatly distort a company's financial well being, such as accounts payable and accounts receivable, are not taken into account on a statement of cash flows.

Breaking it Down

Now that we’ve determined what goes into a cash flow statement, let’s take a look at an example. We’ll it break down into 5 main parts:

  1. Net income
  2. Operating Cash Flow
  3. Cash Flow from Investment Activities
  4. Cash Flow from Finance Activities
  5. Final Cash Amount

1) Net Income

This number is conceived and brought over from the income statement. It represents your “profit” or “bottom line” after paying all expenses from total sales. Net income often includes accrual accounts, or non-cash accounts, so that’s why it’s at the start of your cash flow statement. From here, net income will be adjusted into “net cash” to represent only cash transactions.

2) Operating Cash Flow

Often, the “cash flow from operations” section can be the most useful area for small business owners to analyze. Your regular day-to-day cash business transactions will be recorded in this section (for example, depreciation, paying credit cards, or changes in accounts receivable).

3) Investment Cash Flow

This section deals with what your business is investing in, not to get confused with what others are investing in you (that comes in Finance Cash Flow). These investments include anything that grows your business. This can include things from buying new equipment to merging or acquiring another business. This can be useful to determine if a big chunk of cash has been received or spent on some sort of investment activity. Often times companies with low or negative cash flows are investing in better facilities or operations for the future (remember, it’s important to understand the story behind the positive or negative number).  Altogether, this section results in your net cash flow from investing activities.

4) Finance Cash Flow

This section is critical to understanding how a company deals with debt. Borrowing cash, repaying cash, and raising capital are all included here. Positive inflows to this section would include funding activities like bank loans, venture capital fundraising, or selling company shares. Outflows of cash would include activities like paying dividends or repurchasing company stock.

If a company has high positive cash flow from financing, it likely means it is taking on debt for further business operations.

5) Final Cash Amount

A cash flow statement concludes with a couple bottom-line numbers. First, by summing each of the previous categories, you’ll be able to determine a net increase or decrease in cash for the period you’ve been looking at. The next line combines the starting amount of cash with the net change in cash, resulting in your ending amount of cash for that period in time. When it comes to making decisions, the size and sign of these numbers is less important than understanding the story that they convey.

Making Decisions

All financial statements contain vital information for your business. However, unlike balance sheets and income statements, a statement of cash flows tells a brilliant story about where your business is spending and receiving cash, and isn’t as concerned with bottom line numbers. Understanding each line of a cash flow statement is the best way to understand your cash’s story, but positive and negative numbers can hint to certain things. Remember that a negative net cash flow shouldn’t concern you if you know your business is healthy. This could often mean that you’re investing heavily in new sources of assets or income to keep your business moving forward. However, if those investments don’t pay off, you could be spending too much on growth and should keep an eye on your negative cash flow.

Positive cash flows also aren’t necessarily good or bad. It could mean you’ve taken out loans or raised capital that will need to be paid back later. Conversely, you could be running at high profit margins and raking in the dough! A careful understanding of each section of the cash flow statement can help you determine how a positive number is being produced.

Understanding and using cash flow statements to make educated decisions for your business could be the difference between IPO and bankruptcy. Luckily, KPMG Spark is here to help. Our proprietary software combined with a personal bookkeeper makes viewing up-to-date financial statements easy and understandable. Let KPMG Spark help your small business or non-profit flourish by scheduling a demo today.

This blog article is not intended to address or provide advice concerning the specific circumstances of any particular individual or entity and does not constitute an endorsement of any entity or its products or services.

Some or all of the services described herein may not be permissible for KPMG audit clients and their affiliates or related entities.

KPMG SparkMarch 25, 2020Posted In: Accounting Info

Subscribe

This site is protected by reCAPTCHA and the Google Privacy Policy and Terms of Service apply.

KPMG Spark is an online accounting service that saves you time so you can focus on what’s most important for your business.

Planning to Pay Taxes Helps Build a Strong Financial Foundation

In order to run a successful business, you need to have a solid financial foundation. Planning to pay taxes is an important part of building this foundation. Join us as we discuss tax planning strategies to help your business plan for tax season.

KPMG SparkOctober 26, 2021Posted In: Tax Tips

How You Know it's Time to Hire a Bookkeeper

When you first open your business, you might be able to run everything by yourself. Eventually, hiring a bookkeeper will become a vital step to help ensure continual growth for your business. Continue reading for 5 signs that indicate it’s time to hire a bookkeeper for your business.

Alexandra OjalvoOctober 19, 2021Posted In: Business Tips

How Managing Cash Flow Can Help You Build a Strong Financial Foundation

Maintaining a healthy business cash flow is one of the most important building blocks for any business to be able to build a strong financial foundation. Continue reading for a few best practices for ensuring your organization has enough cash on hand.

KPMG SparkOctober 13, 2021Posted In: Business Tips

Why your bookkeeping may be holding you back from business success

Join us to learn how your bookkeeping may be holding back your business from functioning at its peak performance.

Aubry BlackOctober 5, 2021Posted In: Business Tips

Building a Strong Financial Foundation: Stay on Top of Bookkeeping

KPMG Spark works with many business owners and executives to simplify their bookkeeping. Continue reading to learn how keeping up with your bookkeeping will help you build a solid financial foundation for your business.

KPMG SparkSeptember 29, 2021Posted In: Business Tips

Hiring Help: How To Know Whether To Hire an Employee or Contractor?

There are many important differences between an employee and an independent contractor that can affect the financial foundation of your business. Continue reading to learn some of the financial impacts you should consider when making this decision.

KPMG SparkSeptember 22, 2021Posted In: Business Tips

Selecting an Entity Structure Helps Build a Strong Financial Foundation for Your Business

Running a successful business depends on a solid financial foundation. You can have the most sought-after products or services, a killer marketing strategy, and loyal customers, but if you don’t have a solid financial foundation to manage cash flow and support other business decisions, it can all come crumbling down. Continue reading to learn how selecting an entity structure can help build your financial foundation.

KPMG SparkSeptember 1, 2021Posted In: Business Tips

Real-Time Bookkeeping: 5 Valuable Insights You Can Gain From Real-Time Bookkeeping

Real-time bookkeeping uses live data to give you visibility into your current income and expenses, balances, and more. The visibility that real-time bookkeeping provides allows business owners to gain valuable insight into both their finances and businesses. Continue reading for 5 valuable insights you can gain from real-time bookkeeping.

Alexandra OjalvoAugust 24, 2021Posted In: Tax Tips

The importance of having a personalized bookkeeper

Having a personalized bookkeeper can provide valuable benefits to any business owner. A personalized bookkeeper can monitor and organize your business’s daily transactions. Not only that, they can also give you the reassurance and security you want to have about your company’s finances. Join us to learn more about the importance of having a personalized bookkeeper.

Aubry BlackAugust 17, 2021Posted In: Business Tips