How to Prepare, Read, and Understand a Cash Flow Statement for Small Business

Feb 194 min read

Whether you're a small business owner, entrepreneur, or investor, understanding a cash flow statement is essential for assessing the financial health of your business. Cash flow statements help track the movement of cash in and out of your business, ensuring you have enough liquidity to cover expenses, invest in growth, and sustain operations.

For small businesses, cash flow management is particularly crucial, as limited resources make it vital to maintain a positive cash balance. A well-prepared cash flow statement can guide budgeting, investment decisions, and long-term financial planning.

Here’s everything you need to know about preparing, reading, and understanding a cash flow statement for small businesses.

What Is a Cash Flow Statement?

A cash flow statement (CFS) is a financial document that shows how cash moves in and out of a business over a specific period. It helps business owners track where their money is coming from and how it is being spent.

Unlike a profit and loss statement, which records income and expenses, a cash flow statement focuses only on actual cash transactions. This distinction is important because even a profitable business can face cash shortages if its cash inflows and outflows are not well managed.

A small business cash flow statement is typically divided into three sections:

Operating Activities – Cash earned or spent from daily business operations (e.g., sales revenue, supplier payments, employee salaries).
Investing Activities – Cash used for purchasing or selling assets (e.g., buying equipment, selling property).
Financing Activities – Cash from funding activities (e.g., loans, issuing shares, repaying debt).

By analyzing these sections, small business owners can assess their financial health and make informed decisions.

How to Prepare a Cash Flow Statement for a Small Business

1. Gather Your Financial Data

To prepare a cash flow statement, you’ll need financial records, including:

Income statement
Balance sheet
Bank statements

These documents provide details on revenue, expenses, asset purchases, loan payments, and other financial transactions.

2. Determine Your Opening Cash Balance

The starting cash balance is the amount of cash your business had at the beginning of the reporting period (e.g., start of the month or year). This can be found on the previous cash flow statement or bank statement.

3. Calculate Cash Flow from Operating Activities

Operating activities include all transactions related to your day-to-day business operations. There are two ways to calculate cash flow from operations:

Direct Method

This method lists all cash inflows and outflows from operations, such as:

Cash received from customers
Payments to suppliers
Employee wages and rent payments

The formula: Cash Inflows – Cash Outflows = Net Cash from Operations

Indirect Method

This method starts with net income from the income statement and adjusts for non-cash expenses (e.g., depreciation) and changes in working capital (e.g., accounts payable, inventory).

Formula: Net Income + Non-Cash Adjustments + Changes in Working Capital = Net Cash from Operations

4. Calculate Cash Flow from Investing Activities

This section includes cash spent on or received from business investments, such as:

Purchasing or selling equipment
Acquiring or selling property
Investing in other businesses

If your small business is growing, investing activities might show a negative cash flow, which isn't necessarily bad—it's a sign that you’re reinvesting in the business.

5. Calculate Cash Flow from Financing Activities

This section tracks cash from funding sources, such as:

Business loans received or repaid
Owner’s equity contributions or withdrawals
Dividends paid to shareholders

If your business is taking on debt or repaying loans, this section will show cash inflows and outflows related to financing.

6. Determine the Closing Cash Balance

The final step is to calculate your ending cash balance using the formula:

Starting Cash Balance + Cash Flow from Operating Activities + Cash Flow from Investing Activities + Cash Flow from Financing Activities = Ending Cash Balance

Your ending cash balance should match the cash in your business bank account at the end of the period.

How to Read & Analyze a Small Business Cash Flow Statement

1. Identify Cash Flow Trends

Positive Cash Flow: Your business is generating more cash than it’s spending, which is a healthy sign.
Negative Cash Flow: More cash is going out than coming in, which could indicate problems (unless it’s due to growth investments).

2. Compare Operating Cash Flow with Net Income

Ideally, your operating cash flow should be higher than your net income.
If net income is high but cash flow is low, you might have too many unpaid invoices or excessive inventory.

3. Understand Investing & Financing Cash Flows

If investing cash flow is negative, ensure it’s due to growth-related expenses rather than poor financial management.
If financing cash flow is negative, check if your debt repayment is too high for your current cash position.

4. Watch for Warning Signs

Consistently negative operating cash flow – You may struggle to cover daily expenses.
Heavy reliance on financing cash flow – If you're using loans to cover expenses, your business may be at risk.
Uncollected receivables – If customers delay payments, you may face cash shortages.

The Importance of Managing Cash Flow for Small Businesses

Understanding and managing cash flow is crucial because many small businesses fail due to cash shortages—not because they are unprofitable.

How to Improve Cash Flow in a Small Business

Invoice customers promptly and set clear payment terms.
Reduce unnecessary expenses to maintain positive cash flow.
Negotiate better payment terms with suppliers.
Build a cash reserve to handle slow periods.
Use cash flow forecasting to anticipate financial challenges.

Example: Small Business Cash Flow Statement

Here’s a simplified cash flow statement for a small business using the indirect method:

Example of Cash Flow Statement for Small Business

For the Year Ended December 31, 2024

Final Thoughts

A cash flow statement is one of the most critical financial reports for small businesses. It helps business owners track cash movement, plan for future expenses, and ensure financial stability.

By learning how to prepare, read, and analyze cash flow statements, you can make better financial decisions, improve cash management, and set your small business up for success.