The Cash Flow Statement: Where the Money Actually Went

Short Answer: A cash flow statement starts from profit and explains the change in your bank balance in three sections. Operating activities show the cash the business itself produced or used, after customers who haven't paid and stock you bought ahead. Investing activities show equipment you bought or sold. Financing activities show loans, loan repayments and money the owner put in or took out. The three add up to the change in cash.

The profit and loss statement tells you whether the work paid. The cash flow statement takes that profit and shows, line by line, why the bank balance moved by a different amount. If you have ever looked at a profitable month and a shrinking account, this is the statement that answers the question.

What Is a Cash Flow Statement?

A cash flow statement is a report of every dollar that entered or left the business in a period, grouped by why it moved. Accountants use three groups because each one answers a different question an owner or a lender asks:

• Operating activities: does running the business bring cash in?
• Investing activities: how much is going into trucks, tools and other long-lived assets?
• Financing activities: how is the business funded, and how much is going to lenders and to the owner?

A Worked Example: Greenline's April, Sorted Into Three Sections

Take a hypothetical landscaping company, Greenline Landscaping: one owner, a crew of four, two trucks, about $520,000 a year in revenue. In Profit Is Not Cash we walked its April: a $10,000 profit, and a bank balance that fell from $30,000 to $4,500. That walk had five gaps. The cash flow statement puts the same five gaps into their three sections:

Every number comes from the April walk. The statement adds the grouping.

How Do I Read the Operating Section?

The operating section starts with profit and adjusts it for anything that changed profit without moving cash, or moved cash without changing profit.

At Greenline, the business billed $48,000 but collected $29,000. The money customers owe you, called accounts receivable, grew by $19,000, so that amount is subtracted. The company also bought $4,000 of mulch and plantings for May jobs; those sit as inventory (materials on hand) until they're used, so that's subtracted too.

You can check the same result from the bank side. Cash collected was $29,000. Cash paid out for running the business was $20,000 of crew wages, $16,000 of materials and $6,000 of fuel, insurance, loan interest and other costs, which is $42,000. That leaves −$13,000, the same figure. Accountants call the profit-first layout the indirect method and the bank-side layout the direct method. Most small-business statements use the indirect one.

On a full statement you'll also see depreciation added back here. Depreciation spreads the cost of equipment over its working life, so it lowers profit each month while no cash leaves. Greenline's April share is small and sits inside the other-costs line, so it has no line of its own in this example.

How Do I Read the Investing Section?

This section holds purchases and sales of long-lived assets: vehicles, mowers, a building, software you capitalize. The $7,000 mower is here because it will work for several seasons. Its full price left the bank in April, while the profit and loss statement will carry it a sliver at a time.

A negative number here is normal for a business that runs on equipment. The question is whether operations earn enough over a year to pay for it.

How Do I Read the Financing Section?

Financing covers the money that funds the business: new loans, loan repayments, money the owner puts in, and money the owner takes out. Greenline repaid $1,500 of truck-loan principal (the interest is an expense, already inside operating costs) and the owner drew $4,000.

In a sole proprietorship or single-member LLC, the owner's draw lands here rather than in operating costs, because it's the owner taking profit out, not a cost of running the business. If the owner had borrowed to buy the mower, the loan proceeds would appear here as a positive number and offset the $7,000 in investing.

What Does April Tell Greenline's Owner?

Read top to bottom, April says three things.

First, operations used $13,000 of cash in a month that made $10,000 of profit. That isn't a problem in itself. Spring is when Greenline bills commercial clients on 30-day terms for the first time in months, so receivables jump. The $28,000 still owed arrives in May. What matters is whether operating cash catches up with profit over the whole season.

Second, operations plus investing came to −$20,000. That combined figure is often called free cash flow: the cash left after running the business and keeping its equipment up to date. Free cash flow is what's actually available for loan payments and the owner.

Third, the financing section paid out $5,500 in a month when free cash flow was negative. The draw and the principal came out of the opening balance, which is how $30,000 became $4,500.

What Does a Full Year Look Like?

Over a single month, operating cash can swing far from profit. Over a full year it usually lands much closer, because receivables and stock that build in spring get collected and used by winter. A seasonal business like Greenline will typically see operating cash below profit from April to June and above it from September to November, as the last commercial invoices come in after the work has slowed.

A yearly statement tells you whether the business funds itself. A monthly one tells you when you'll be short.

What to Look For

• Operating cash against profit over 12 months. They should be close. If operating cash runs well below profit year after year, customers are paying slower or stock is piling up, and the business is growing its receivables instead of its bank balance.
• Investing against depreciation. Spending far less than depreciation for several years means the fleet is aging without being replaced; the bill comes later, all at once.
• Draws and principal against free cash flow. If the financing section pays out more than free cash flow brings in over a year, the difference is coming from savings or new debt.

What a Finance Consultant Would Do Next

A consultant reading Greenline's April would set the monthly picture against the season: how low cash gets in May if commercial clients pay on day 45 instead of day 30, whether the mower should have been financed to keep free cash flow from going negative in the first busy month, and what draw the business can support once the whole year's operating cash is known.

That analysis is what Occam's Model runs on your own books. It reads the spreadsheets you already keep and lays out the path from revenue down to cash, then lets you test a change, such as faster collections, on a copy of your numbers before you commit to it. Full financial statements are part of the paid plans. When you need extra help, an expert can review it with you.

Common Questions

What are the three sections of a cash flow statement?
Operating activities (cash from running the business), investing activities (buying or selling equipment and other long-lived assets) and financing activities (loans, repayments, and money the owner puts in or takes out). Together they explain the change in your bank balance.

Why is depreciation added back on a cash flow statement?
Depreciation lowers profit without any cash leaving that month. The cash left when the equipment was bought, and that purchase already shows in the investing section.

Where do owner's draws go on a cash flow statement?
In the financing section. A draw is the owner taking money out of the business, not a cost of running it, so it doesn't reduce profit or operating cash.

Is negative operating cash flow bad?
Not in one month, especially in a growing or seasonal business. Several negative quarters in a row, with profit positive, usually mean customers are paying too slowly or stock is building up.