How to Prepare a Cash Flow Statement using the Direct Method

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The cash flow statement is one of the basic financial statements, along with the balance sheet and income statement. The purpose of the cash flow statement is to show the sources and uses of cash during the reporting period, which is different from reporting profits and losses. The following steps describe how to prepare a cash flow statement using the direct method.

Things You'll Need

• A detailed general ledger report for your cash and bank accounts, or your cash receipts and disbursements journals, or other records of all your cash receipts and disbursements for the reporting perio

Instructions

1. Obtain a detailed general ledger report showing all the entries to the cash and bank accounts for the period — month, quarter, or year — for which you want to prepare a cash flow statement. You could also use the cash receipts and disbursements journals. If you do not keep complete accounting records, use a record of all your cash receipts and disbursements for the period.

2. Set up a worksheet to separate all your cash receipts and disbursements into the following categories: cash flows from operating activities, cash flows from investing activities, and cash flows from financing activities.

3. Cash receipts from operating activities relate to your principal line of business and generally include cash sales, payments from credit and debit card merchant accounts and collections on accounts receivable. Cash disbursements from operating activities include payments to suppliers, contractors and employees, and payments for rent, utilities, taxes and other expenses.

4. Cash disbursements for investing activities include purchases of property, plant and equipment and purchases of investments, such as stock or other securities. Cash receipts from investing activities include proceeds from the sale of property, plant and equipment, and proceeds from the sale or redemption of stock or other securities.

5. Cash receipts from financing activities include the proceeds from loans or other debt, and cash received for issuing stock or equity in your business. Cash disbursements from financing activities include installment payments on loans or other debt repayment, and dividend payments or returns of capital.

6. Once you have classified your cash receipts and disbursements into categories, summarize each category and prepare the cash flow statement. Adapt the descriptions and level of detail of the following example to suit your particular reporting needs.

   Cash flows from (used in) operating activities:

   Cash receipts from customers
   Cash payments to suppliers for inventory
   Cash paid to employees
   Cash paid for operating expenses
   Taxes paid
   Interest paid
   Net cash flows from operating activities

   Cash flows from (used in) investing activities:

   Proceeds from the sale of equipment
   Dividends received
   Net cash flows from investing activities

   Cash flows from (used in) financing activities:

   Loan proceeds
   Loan repayments
   Net cash flows from financing activities
   Net increase (decrease) in cash and cash equivalents
   Cash and cash equivalents, beginning of period
   Cash and cash equivalents, end of period

7. If you keep complete accounting records, you could also use a worksheet with each line item from the cash flow statement and eliminate the effects of accrual basis accounting in order to determine the net cash flow for each line item for the period.

8. Calculate cash receipts from customers.

   Net sales per the income statement
   plus the opening balance in accounts receivable
   minus the ending balance in accounts receivable
   equals cash receipts from customers.

9. Calculate cash payments to suppliers for inventory.

   Ending inventory balance
   minus opening inventory balance
   plus opening balance in accounts payable to vendors
   minus ending balance in accounts payable to vendors
   equals cash payments to suppliers for inventory.

10. Calculate cash paid to employees.

    Salaries and wages per the income statement
    plus opening balance in salaries and wages payable
    minus ending balance in salaries and wages payable
    equals cash paid to employees.

11. Calculate cash paid for operating expenses.

    Total operating expenses per the income statement
    minus depreciation and amortization expenses
    plus the increase or minus the decrease in prepaid expenses
    plus the decrease or minus the increase in accrued expenses
    equals cash paid for operating expenses.

12. Calculate taxes paid.

    Tax expense per the income statement
    plus the opening balance in taxes payable
    minus the ending balance in taxes payable
    equals taxes paid.

13. Calculate interest paid.

    Interest expense per the income statement
    plus the opening balance in interest payable
    minus the ending balance in interest payable
    equals taxes paid.

14. Similar calculations to eliminate the effects of accrual accounting in other balance sheet accounts may be made to determine cash flows from investing and financing activities.

Tips & Warnings

• Short-term investments, such as marketable securities or short-term certificates of deposit, are considered cash equivalents and should be included as cash receipts and disbursements in your cash flow statement.

References

• How to Prepare a Cash Flow Statement - Edward Lowe Foundation