The first step is to determine operating cash flow. Start with net income and add back any non-cash items like depreciation. Then determine the changes in the balance sheet accounts that are part of the earnings cycle.
| Operating Cash Flow | |
| Net Income After Tax | $34,000 |
| Depreciation | 40,000 |
| Increase in Accounts Receivable | (41,000) |
| Increase in Inventory | (18,000) |
| Decrease in Accounts Payable | (23,000) |
| Increase in Accrued Expenses | 4,000 |
| Total Operating Cash Flow | (4,000) |
This business actually used funds in its operations during the year. Where did the money come from? Let's look at the investing and financing activities to see what else was going on. From the Balance Sheet, calculate the changes in the other accounts (those that are not a part of daily operations). Investing activities typically include long term assets used in the business:
| Investing Cash Flow | |
| Purchase of Equipment | (100,000) |
| Decrease in Notes Receivable | 50,000 |
| Total Investing Cash Flow | (95,000) |
The business added new equipment during the year. The financing activities will show us where the money came from:
| Financing Cash Flow | |
| Increase in Long Term Notes Payable | 126,000 |
| Increase in Term Loan | 24,000 |
| Conversion of Note to shareholder to Paid in Capital | 0 |
| Total Financing Cash Flow | 150,000 |
Note that the conversion of the note to shareholder to paid in capital did not require the use of funds. The owner may have made this conversion from debt to equity to help him obtain the loans that were used to buy the equipment and to provide working capital for the growing business.
Put the three components together to determine the total cash flow for the year:
| Operating Cash Flow | |
| Net Income After Tax | $34,000 |
| Depreciation | 40,000 |
| Increase in Accounts Receivable | (41,000) |
| Increase in Inventory | (18,000) |
| Decrease in Accounts Payable | (23,000) |
| Increase in Accrued Expenses | 4,000 |
| Total Operating Cash Flow | (4,000) |
| Investing Cash Flow | |
| Purchase of Equipment | (100,000) |
| Decrease in Notes Receivable | 5,000 |
| Total Investing Cash Flow | (95,000) |
| Financing Cash Flow | |
| Increase in Long Term Notes Payable | 126,000 |
| Increase in Term Loan | 24,000 |
| Conversion of Note to shareholder to Paid in Capital | 0 |
| Total Financing Cash Flow | 150,000 |
| Total Cash Flow | $51,000 |
| Cash at beginning of the period | 1,000 |
| Cash at end of the period | $52,000 |
The cash flow statement is an important management tool for running your business. It tells you how much income you made, whether operations generated cash or used cash, what assets were acquired and how everything was financed.
You may find it tricky to determine how increases or decreases in assets and liabilities impact your cash flow statement. Look at a cash flow worksheet to answer this question and to help you prepare your own cash flow statement.
