A cash flow statement, formally known as a statement of cash flows, is a primary financial statement that details the liquid cash entering and leaving your business across a specific reporting period. Alongside your profit and loss account and balance sheet, it gives finance leaders and external stakeholders clear visibility over liquidity, financial resilience, and solvency.
While income statements recognise transactions over time, the cash flow statement reflects actual cash movements. It helps you evaluate whether your organisation generates sufficient liquidity to handle routine commitments like payroll, supplier invoices, tax liabilities, and capital reinvestment.
What is a cash flow statement?
A cash flow statement monitors the movement of cash and cash equivalents across an entity. Cash itself comprises cash on hand and demand deposits, while cash equivalents encompass highly liquid investments as defined by relevant financial reporting frameworks.
Organisations should consult official government regulations and relevant standard-setters to verify their statutory reporting mandates and any applicable filing exemptions. Even where exemptions exist, maintaining regular cash flow statements is standard practice for effective internal cash management.
Why is profit different to cash?
A common accounting challenge is assuming operating profit equates to physical cash. Most organisations apply accruals accounting, recognising income and expenses during the period to which they relate rather than when settlement happens.
For example, when you issue an invoice with deferred payment terms, your accounting records show revenue on the profit and loss account straight away, but your cash balances remain unchanged until collection. If settlement stalls, your business can present healthy accounting profits while facing immediate liquidity pressures. According to the Federation of Small Businesses' 'Pay it Forward' report, late payments cost the British economy an estimated £2.5 billion annually. This contrast illustrates why monitoring liquidity through cash flow statements is just as crucial as tracking profitability.
Key components of the cash flow statement
Financial reporting structures cash movements into three distinct components: operating activities, investing activities, and financing activities. Reviewing cash flows across these categories helps your finance team identify where liquidity originates and where you allocate it.
Operating activities
Operating activities encompass day-to-day business operations and trading flows, as detailed in relevant accounting framework guidance. Cash receipts in this section often involve customer collections for delivered products and services, such as the recovery of accounts receivable.
Routine operational cash outflows typically relate to supplier disbursements settled through accounts payable, employee payroll, and general operational overheads. You should refer to your governing accounting standard for exact classification rules.
Investing activities
Under reporting standards, investing activities track cash flows associated with long-term assets and external investments. Cash outflows often involve capital expenditure for tangible assets such as property, plant, and equipment, or intangible assets like software development and licences.
Inflows can occur when an organisation sells equipment, property, or securities, reflecting the liquidation of previously capitalised assets. Relevant accounting standards establish the exact criteria for qualifying investing transactions.
Financing activities
Financing activities encompass cash flows relating to an organisation's funding and capital structure, as outlined in official reporting standards. Inflows can stem from equity contributions or loan drawdowns, while outflows often involve debt and lease settlements.
You should consult applicable accounting guidance for specific transaction treatments. Under FRS 102 paragraph 7.22, entities presenting a statement of cash flows are required to disclose a reconciliation of changes in net debt over the period.
How is cash flow calculated?
When preparing operating cash flows, you generally present them using either the direct method or the indirect method:
- The direct method: Discloses major classes of gross operational cash receipts and payments, as defined in standard accounting frameworks.
- The indirect method: Adjusts profit before or after tax for non-cash items and changes in working capital balances.
The indirect method is widely favoured by businesses because it relies on figures readily available from existing income statement and balance sheet balances.
Under the indirect method, entities often begin the reconciliation with operating profit (profit before interest and tax) or net income from the income statement. You then work through several core adjustments:
- Add back non-cash expenses: Accounting charges such as depreciation and amortisation reduce accounting profit without consuming cash, so they are added back.
- Adjust for working capital movements: An increase in trade debtors is subtracted because revenue has been recorded without immediate cash receipt. An increase in inventory is subtracted because cash was spent to purchase stock. An increase in trade creditors is added back because expenses were recorded but remain unpaid.
- Account for tax and finance payments: Cash disbursed for corporation tax is generally deducted to establish net operating cash flow, while interest payments should be classified in accordance with the entity's governing accounting framework.
- Incorporate investing and financing flows: Net operating cash is combined with net investing and financing totals to establish the net movement in cash across the period.
Cash flow statement example
The following simplified example illustrates how you might structure cash flows under the indirect method in accordance with general reporting conventions:
Section and activity | Illustrative balance (£) |
|---|---|
Cash flows from operating activities | |
Operating profit | 150,000 |
Add: Depreciation | 30,000 |
Less: Increase in trade debtors | (15,000) |
Add: Increase in trade creditors | 10,000 |
Net cash from operating activities | 175,000 |
Cash flows from investing activities | |
Purchase of equipment | (50,000) |
Proceeds from sale of equipment | 10,000 |
Net cash used in investing activities | (40,000) |
Cash flows from financing activities | |
Repayment of loan principal | (25,000) |
Dividends paid | (15,000) |
Net cash used in financing activities | (40,000) |
Net change in cash and cash equivalents | 95,000 |
Opening cash and cash equivalents | 30,000 |
Closing cash and cash equivalents | 125,000 |
In this illustrative model, the operating activities section shows how positive trading inflows support investment and debt commitments, reconciling the opening liquidity position to the closing balance. Transaction classifications in practice depend on applicable reporting standards.
Difference between a balance sheet and a cash flow statement
A cash flow statement explains how cash and cash equivalents moved across an elapsed reporting period. By detailing operational, investing, and financing cash movements rather than static balances, it complements the balance sheet by showing the actual liquidity flows that occurred between reporting dates. Readers should refer to official financial reporting frameworks for guidance on statement interactions and disclosures.