A cash flow statement shows how money flows in and out of a business. They’re used to understand how a business is performing financially and whether they are using their money efficiently.
Cash flow is different from net income.
While net income is the difference between sales revenue and expenses, cash flow tracks cash that enters and leaves the business regardless of its source. Some examples of additional sources of cash flow are external investment and financing from loans.
When you create a cash flow statement, you get a clear breakdown of where your money is coming from and why you may have more or less money in the bank than you expect. This is a stepping stone in establishing a healthy cash flow for your business.
An indirect cash flow statement is one methodology of generating a cash flow statement.
The indirect method of cash flow starts with the business’s net income (taken from an income statement) and then applies adjustments to capture only cash activity. It’s most commonly used by businesses using the accrual basis accounting method where their net income includes accounts payables and accounts receivables, transactions where cash hasn’t changed hands yet.
The most common adjustments made include changes to:
What connects these items is that they are found on a balance sheet (except for non-cash expenses). How their balance changes indicates whether cash has flowed towards or from those accounts.
Once you adjust for all of these factors, you’ll be left with your net change in cash: how much money left or entered your business over the reporting period.
The difference between an indirect and direct cash flow statement is in how they prepare the operating activities section of the statement of cash flows:
The most common reason the indirect method for generating a cash flow statement is because the business uses the accrual basis of accounting.
When a business uses the accrual method, the net income line on an income statement contains a lot of non-cash activity that needs to be adjusted for.
But there’s still benefit in using the indirect method regardless of your accounting method.
The process of generating an indirect cash flow statement gives you an itemized breakdown of where cash is flowing from and to within the business.
While you can understand whether your business was cash positive or negative by comparing how much cash you held at the start and end of a reporting period, there’s more value in understanding what the driving forces behind that result were.
When you generate an indirect cash flow statement, you might catch something that’s taking up more of your cash than you expected.
An indirect cash flow statement and calculation breaks down your cash flow into three separate components.
Cash flows from operating activities is the money generated from your day-to-day operations. You start with your net income and adjust for all non-cash operating activities, such as depreciation, amortization, accounts receivables, accounts payable, and inventory.
Cash flows used in investing activities covers management of capital assets within the business or investment outside of the business. Examples include purchasing equipment, buying or selling stocks, or spending on intangible assets (like a trademark).
Cash flows used in financing activities includes any activity that the business uses to finance its operations. Common examples include receiving a new loan, paying down a loan, issuing stock, or repurchasing stocks.
The process of calculating your cash flow using the indirect method means calculating your cash flow from each section and then summing up those values.
Using our template, you’ll be walked through each step of the process so you know what to look for and where to find it for a simplified cash flow calculation experience.
If you’re ready to generate an indirect cash flow statement, read on for a step-by-step process of using our template to start understanding your cash flow on a deeper level.
Our indirect cash flow statement template can be used in both Excel and Google Sheets.
You can easily use the template in Excel by either opening the file directly from your downloads or opening Excel and selecting the file through there.
To open the template in Google Sheets, follow these steps:
Cash flow statements can be generated for any period of time. Most commonly, businesses will generate a cash flow statement for a certain month, quarter, or year.
Once you’ve decided what period of time you’re looking at, fill in the period in the template. Each column represents a different period so you can generate a cash flow statement for multiple months, quarters, or years.
Your net income is found at the bottom of the income statement.
Remember that the net income number you’re looking for must correspond for the period of time you’re looking at. So if you’re generating an indirect cash flow statement for 2024, you would use your net income for that same period.
Listed in the template are all the different variables you would need to consider to calculate your cash flow. Not all of these will be relevant to your unique operations.
Browse through the list and look for which line items you’ll need to include in your calculation.
Each item in operating activities will be found on either your income statement or balance sheet.
The items in investing activities and financing activities will be found on your balance sheet only.
Line items that are from your income statement can be easily added in. For example, if your income statement shows a depreciation value of $50,000 and an amortization value of $100,000 for the desired period, simply add those numbers to get $150,000 in the statement.
However, the values for line items on your balance sheet are calculated by taking the difference between the number at the start and end of the period.
If you’re generating an indirect cash flow statement for 2024, this means comparing the value on December 31, 2024 to the value on January 1, 2024.
Looking at accounts receivables as an example, if your balance was $60,000 on December 31 and $50,000 on January 1, the value is $10,000 ($60,000 - $50,000).
Here’s where it gets a bit tricky: an increase in assets should be negative on the cash flow statement. For our accounts receivables example, you’re entering -$10,000 as it’s an asset that’s increasing.
This is the same for investing activity. If your PP&E is increasing, it’s negative on the cash flow statement.
However, the opposite is true for liabilities: an increase in liabilities is a positive on the cash flow statement. If instead it was accounts payable that increased by $10,000, it would be entered as $10,000.
Look at where each line item is contained to know whether it should be entered as a positive or negative in the sheet.
The last piece of information you need to provide is your beginning cash balance. This is found by adding up all cash held in your accounts on your balance sheet on day 1 of the period you’re looking at.
The formulas we’ve used in the indirect cash flow statement template does the rest. You now have your net change in cash as well as your cash ending balance.
You can check your work by verifying the calculated cash balance on the template against the cash balance you calculate on your balance sheet for the end of the period.
If these numbers don’t match, there’s likely an error in your work that needs some troubleshooting. Start by looking at the line items found on balance sheets that require a manual calculation as there’s the potential for human error.
The purpose of an indirect cash flow statement is to give businesses a new angle to understand their financial health.
Your net income doesn’t tell you the full story about how money entered and left your business. You could show a profit on your income statement and end up with less money in the bank account.
By adjusting for non-cash activity and looking beyond the income statement, you’ll understand what are the main driving factors behind your present day cash balance. Once you understand this, you’ll have a better idea of what strategies will help your business manage its cash more effectively.
An indirect cash flow statement contains information from the two other main financial statements: the income statement and the balance sheet.
From the income statement, you get net income and adjustments for non-cash expenses.
From the balance sheet, you get adjustments for changes in accounts payable and accounts receivables, amounts received from financing or to pay down debts, and changes to working capital.
By taking elements from both the income statement and balance sheet, you get one of the most robust and encompassing views of a business’s finances.
Both the direct and indirect methods of generating cash flow statements will tell you how much your cash levels have changed. But the indirect method can be both more informative and easier to generate if you use the accrual basis accounting method.
For businesses using the cash basis, the accounting methodology that records transactions only when cash changes hands, the direct method is often easier since there’s not any non-cash activity to adjust for.
Otherwise, you’re likely to have a better experience with the indirect method.
While the indirect method for cash flows is widely used, it does have some downsides to consider:
Possible inaccuracies: Since you’re working off of financial statements, certain nuances get lost in the process; any inaccuracies in the bookkeeping or accounting pass through and result in an inaccurate cash flow statement.