Business Templates
Direct cash flow statement

What is a direct cash flow statement?

The cash flow statement is one of the three major financial statements businesses use to understand their financial health. The purpose of a cash flow statement is to show how money is moving in and out of the business. 

While an income statement shows you the net income for a period of time, it doesn’t capture all of the cash activity that occurs in a business. For example, it doesn’t show you loan payments, interest earned, or payouts to shareholders.

Cash flow statements provide the complete picture. If you’re wondering why your real world cash situation doesn’t match your profit, a cash flow statement holds the answer.

Cash flow is broken up into three sections:

  1. Operating activities is the cash generated from day-to-day business operations.
  2. Investing activities is the cash generated from investments or used in the investment of assets with long-term value including stocks, property, and equipment.
  3. Financing activities is any money that comes from or is being used to pay down any financing from a line of credit, loan, or other repayment of debt.

By breaking up cash flow into these three sections, you get complete visibility into how each aspect of your business is contributing to your net cash flow. This is the perfect starting point for learning how to optimize your finances and maintain a healthy cash flow.

There are two methods of calculating cash flow: the indirect method and direct method.

What is the direct method of cash flows?

The direct method of cash flow statements involves tallying up all cash activity for each of the three sections on the cash flow statement.

Typically, this means summing up all cash activity for each of the three sections on the cash flow statement.

For example, calculating your cash from operating activities would start with reviewing your cash deposits from sales or any accounts receivables that were paid in the period. Then you would subtract any cash expenses or payments towards an accounts payable balance.

The direct method is most often used by businesses that use the cash basis method of accounting. 

With the cash basis of accounting, only transactions where cash has changed hands are reported on the income statement. Because of that, they can start by looking at their net income and make any adjustments based on what’s happening on their balance sheet.

For businesses that use the accrual basis method of accounting, net income is affected by any revenue or expenses tied up in accounts receivables or accounts payable respectively. They most often use the indirect method of cash flow to save themselves the work of manually tallying up cash transactions.

What are the advantages of the direct method of cash flow?

Direct cash flow statements and indirect cash flow statements are better fits for different businesses.

Generally speaking, smaller, less complex businesses opt for the direct method because of these advantages:

  1. Straight forward calculation: A direct cash flow statement is approachable no matter your level of financial reporting know-how. You can easily calculate your direct cash flow with a ledger of transactions and some manual summing.
  2. Complete transparency: Compared to the indirect method, the direct method gives you a more in-depth breakdown of your cash flows with line-by-line breakdowns. With more information, you get the complete picture at a glance rather than digging for more details.
  3. Less prone to mistakes: With less calculations required to get to the final result, you’re less likely to make mistakes due to human error.
  4. Greater accuracy: Given that a direct cash flow statement is less prone to mistakes and provides more detail, they’re considered to be more accurate. For this reason, they’re often preferred by investors or creditors when evaluating a business.

How to create a cash flow statement: Direct method

Once you’re ready to generate a direct cash flow statement, follow our step-by-step guide and get a valuable overview of your cash flow.

Step 1: Download the direct cash flow statement Excel template

This direct cash flow statement is usable in both Excel and Google Sheets.

Simply open the file in Excel once it’s downloaded or open the file directly from your downloads folder.

To open the template in Google Sheets, follow these steps:

  1. Click “File” and then select “Open”
  2. Select “Upload”
  3. “Browse” for the file and select the download

Step 2: Determine the time period for the direct cash flow statement

Cash flow statements are generated for different periods of time. The most commonly used are monthly, quarterly, and annual cash flow statements.

Once you’ve decided on the period of time, fill out that section of the template. You can create additional columns each time period you’re interested in looking at. This way, you can compare your cash flow across multiple months, quarters, or years.

Cash flow statement period of time

Step 3: Fill in the operating activities

Work through each line of the operating activities section. 

This information can be found on your income statement, but remember to only include cash activity. This means only including transactions where a bank account, credit card, or cash on hand is being credited or debited.

Let’s breakdown what each line covers:

  • Cash received from customers: Sales revenue or payments received from outstanding accounts receivables.
  • Cost of revenue: Cost of goods sold or cost of service; any costs that are used and exhausted in facilitating a sale.
  • SG&A: Selling, general, and administrative expenses.
  • R&D: Costs of research and development.
  • Other operating expenses: Any other costs of operations not covered by the other buckets.

You should expect “Cash received from customers” to be the only positive value on the cash flow statement. The exception would be if you experienced returns in an expense category (for example, you received a refund on some R&D expenses that netted you a positive cash flow).

Operating activities on cash flow statement

Step 4: Fill in the investing activities

This information is going to be found on your balance sheet in the “assets” section.

Depending on your chart of accounts, you may have a separate line item for property, plant, and equipment (PP&E) expenses. Otherwise, manually tally up cash expenses that fall into this category (examples include real estate, vehicles, and intangible assets like trademarks).

An increase in these line items represent expenses—cash flowing towards that asset type. If the value increases, the cash flow should be negative in the cash flow statement.

Expenses fall under payments, but any money earned from the sale of assets will go in the “Proceeds” line item on the cash flow statement. These will be positive values.

Investing activities on cash flow statement

Step 5: Fill in the financing activities

Similar to investing activity, this information will be found in your balance sheet in the “liabilities” or “equity” sections. For this section, an increase in balances represents positive cash flow while a decrease in balances is negative cash flow.

Long-term debt includes anything to be paid down in greater than one year.

Financing activities on cash flow statement

Step 6: Calculate net cash flow

With each of the sections filled out, our formulas handle the rest. Your net cash flow is automatically summed based on the information you already provided.

Step 7: Add your beginning cash balance

The last information you need to provide is the beginning cash balance. This can be taken from a past cash flow statement or from your balance sheet.

Simply add up the cash on hand and held in bank accounts. These balances should be taken from the day before the period begins (e.g. December 31, 2022 for a cash flow statement covering January 1 to December 31, 2023).

Cash balance in cash flow statement

Step 8: Review and confirm your ending cash balance

Finally, review your work by seeing if the ending cash balance matches what’s on your balance sheet.

Calculate your ending balance on your balance sheet just as you calculated the starting balance. If it doesn’t match what’s on your direct cash flow statement, there’s likely a mistake in the calculation and you’ll need to troubleshoot.

Direct cash flow statement FAQ

What is the purpose of a direct cash flow statement?

The purpose of a direct cash flow statement is to provide a detailed breakdown of how cash flows in and out of a business over a specific period of time. 

It’s common to try and understand a business’s financial health through their profitability, but profit doesn’t always equate to more money in the bank. As the old adage goes, “revenue is vanity, profit is sanity, but cash is king.”

With a direct cash flow statement, you understand how sustainable a business is based on its activity. Even profitable companies will struggle to keep themselves afloat if they’re consistently generating negative cash flow.

What information does a direct cash flow statement include?

 A direct cash flow statement breaks down your cash flow into three different sections:

  • Cash flows from operating activities
  • Cash flows from investing activities
  • Cash flows from financing activities

These sections are then broken up into different, customizable line items for you to get a more in-depth breakdown of what drove your net cash activity.

What are the limitations of the direct method?

The direct method of calculating cash flow isn’t the right fit for everyone. These are a couple of shortcomings to consider when choosing between the direct and indirect method of cash flow statements:

  • Time-consuming to generate: Many of the line items on a direct cash flow statement require manual calculations rather than information easily found on an existing financial statement.
  • Prone to mistakes: Manual calculations are prone to human error. The time spent making a direct cash flow statement quickly increases if you need to review and troubleshoot repeatedly.
  • Lacks context: The direct cash flow statement doesn’t show your net income, a valuable piece of context to understand your cash flow relative to your profitability. 

Unsustainable for large operations: Small businesses using the cash basis favor the direct method. The larger the operations, the greater the complexity in using the direct method. For consistency’s sake, you may want to start with using the indirect method as it’ll be more reliable as you scale up.

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