What is a cash flow statement?

A cash flow statement is a financial report that shows how much cash moves in and out of your business during a specific period. Also known as a statement of cash flows (CFS), it's 1 of the 3 core financial statements, alongside the balance sheet and income statement.

Unlike the income statement, which includes non-cash items like depreciation, the cash flow statement focuses only on actual cash transactions. It answers a straightforward question: where did your money come from, and where did it go?

For small business owners, this distinction matters. Your income statement might show a profit, but if customers haven't paid their invoices yet, you could still struggle to cover rent or payroll. The cash flow statement closes that gap by showing your real cash position.

Why cash flow statements matter

Cash is what keeps your business running. Understanding where it comes from and where it goes helps you make smarter decisions about spending, saving, and growth.

Planning for expenses

A cash flow statement helps show how well you can cover expenses like bills and employee wages. When you can see exactly when money arrives and leaves, you're better equipped to time big purchases or negotiate payment terms with suppliers.

According to Xero Small Business Insights, US small businesses were paid an average of 7.8 days late in Q4 2025, down from 9.3 days at the start of the year.

Late payments directly affect your cash flow. Tracking these patterns on your cash flow statement helps you build a buffer for slow-paying customers.

Budgeting and troubleshooting

These reports can help you set budgets and troubleshoot cash flow problems. If you notice cash dipping at the same time each quarter, you can plan ahead by adjusting payment schedules or lining up a short-term credit facility.

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Xero Small Business Insights data shows US small business sales growth averaged 2.4% year-over-year in 2025, about half the long-term average of 5.5%, with significant month-to-month swings.

That kind of volatility makes regular cash flow monitoring essential. Without it, a slow month can catch you off guard.

Building confidence with investors and lenders

Banks and investors want to see that your business generates enough cash to repay loans and fund operations. A healthy cash flow statement demonstrates that your business isn't just profitable on paper; it actually brings in cash consistently.

If you're applying for a loan or seeking investment, expect lenders to review your cash flow statement closely. Strong operating cash flow tells them you're a lower-risk borrower.

Parts of a cash flow statement

Every cash flow statement is divided into 3 sections. Each one captures a different type of cash movement, giving you a complete picture of how money flows through your business.

Operating activities

This section covers cash generated or spent through your core business operations. It's the most important section because it shows whether your everyday activities produce enough cash to sustain the business.

Examples of operating cash flows include:

Cash received from customers for products or services
Payments to suppliers and vendors
Employee wages and salaries
Rent, utilities, and insurance payments
Tax payments

Investing activities

This section tracks cash spent on or received from long-term assets. These are purchases or sales that affect your business's future capacity, not day-to-day operations.

Examples of investing cash flows include:

Buying equipment, vehicles, or property
Selling a piece of equipment you no longer need
Purchasing or selling investments like stocks or bonds
Spending on software or technology upgrades

Financing activities

This section shows cash moving between your business and its owners or lenders. It reflects how you fund your business and return money to stakeholders.

Examples of financing cash flows include:

Proceeds from a bank loan or line of credit
Loan repayments
Owner investments or capital contributions
Dividend payments to shareholders
Owner withdrawals or distributions

How to prepare a cash flow statement

There are 2 methods for preparing a cash flow statement: the direct method and the indirect method. Both arrive at the same final number, but they calculate operating cash flow differently.

The direct method lists every cash receipt and payment individually. It's straightforward but requires detailed transaction records. The indirect method starts with net income from your income statement and adjusts for non-cash items. Most small businesses and accountants prefer the indirect method because it's easier to prepare using standard accounting reports.

1. Choose your reporting period

Decide the time frame your statement will cover. Most businesses prepare cash flow statements monthly, quarterly, or annually. Pick a period that matches your reporting needs and aligns with your other financial statements.

2. Gather your financial records

You'll need your income statement and balance sheets for the start and end of the period. If you're using the direct method, you'll also need access to your bank statements and transaction records. Xero accounting software pulls these records together automatically, helping save you from hunting through spreadsheets.

3. Calculate cash from operating activities

Using the indirect method, start with your net income. Then adjust for non-cash expenses like depreciation and amortization by adding them back. Next, account for changes in working capital: increases in accounts receivable reduce cash, while increases in accounts payable add cash.

Using the direct method, list all cash received from customers, then subtract all cash paid to suppliers, employees, and for other operating expenses.

4. Calculate cash from investing activities

List any cash you spent on long-term assets like equipment or property. Then add any cash received from selling assets. The net total is your cash from investing activities, which is often negative for growing businesses since you're investing in future capacity.

5. Calculate cash from financing activities

Record any cash received from loans, investments, or owner contributions. Subtract any loan repayments, dividend payments, or owner withdrawals. The result shows how much cash your financing activities generated or used.

6. Calculate your net cash flow

Add together the totals from operating, investing, and financing activities. This gives you your net increase or decrease in cash for the period. Add this figure to your opening cash balance to get your closing cash balance, which should match the cash on your balance sheet.

How to read a cash flow statement

Knowing how to read a cash flow statement helps you spot trends, catch potential problems early, and make decisions backed by real data rather than guesswork.

Positive vs negative cash flow

Positive cash flow means more money came in than went out during the period. Negative cash flow means the opposite. Positive cash flow from operations is generally a good sign, but negative cash flow isn't always bad.

For example, a business investing heavily in new equipment might show negative cash flow overall, even though the investment could pay off later. The key is understanding why cash flow is positive or negative.

Key indicators to watch

Focus on these signals when reviewing your cash flow statement:

Operating cash flow trend: is it growing, steady, or declining over multiple periods?
Cash flow vs net income: a big gap between profit and operating cash flow could mean you're earning revenue you haven't collected yet.
Free cash flow: subtract capital expenditures from operating cash flow to see how much cash is truly available for growth or debt repayment. Use a cash flow projection to plan ahead.

Red flags to look for

Certain patterns on a cash flow statement can signal deeper issues. Watch out for these warning signs:

Consistently negative operating cash flow, even when the income statement shows profit
Growing accounts receivable without a matching increase in revenue
Heavy reliance on financing activities to cover operating shortfalls
Declining cash reserves over multiple consecutive periods

Cash flow statement example

Here's a simplified cash flow statement for a small consulting business covering 1 quarter. You can also download a cash flow statement template to create your own. This example uses the indirect method, starting with net income and adjusting for non-cash items.

Operating activities:

Net income: $15,000
Add back depreciation: $1,500
Increase in accounts receivable: -$3,000
Increase in accounts payable: $2,000
Net cash from operating activities: $15,500

Investing activities:

Purchase of new laptop and software: -$2,500
Net cash from investing activities: -$2,500

Financing activities:

Loan repayment: -$1,000
Owner withdrawal: -$5,000
Net cash from financing activities: -$6,000

Summary:

Net increase in cash: $7,000
Opening cash balance: $10,000
Closing cash balance: $17,000

In this example, the business generated $15,500 in cash from operations, spent $2,500 on equipment, and used $6,000 for loan repayment and owner withdrawals. The result is a healthy $7,000 net increase in cash for the quarter.

Cash flow statement vs balance sheet vs income statement

The 3 core financial statements each serve a different purpose. Understanding how they work together gives you a fuller picture of your business's financial health.

The income statement (also called a profit and loss statement) shows your revenue, expenses, and profit over a period. It tells you whether your business is profitable, but it includes non-cash items and doesn't show when you actually received or spent the money.

The balance sheet is a snapshot of what your business owns (assets), what it owes (liabilities), and the owner's equity at a single point in time. It shows your overall financial position but doesn't reveal how cash moved during the period.

The cash flow statement bridges the gap. It starts where the income statement leaves off and explains the change in cash shown on the balance sheet. Together, these 3 statements give you, your accountant, and any potential lenders or investors a complete financial picture.

Tips to improve your cash flow

Healthy cash flow doesn't happen by accident. These practical steps can help you keep more cash in your business and avoid shortfalls.

Invoice promptly: send invoices as soon as you deliver a product or complete a service. The sooner you invoice, the sooner you get paid.
Offer early payment incentives: a small discount for paying within 10 days can encourage customers to pay faster.
Follow up on overdue invoices: set up automatic payment reminders so late invoices don't slip through the cracks. Xero's invoicing software can send these reminders for you.
Negotiate longer payment terms with suppliers: if your suppliers offer 30-day terms, ask for 45 or 60 days. This keeps cash in your account longer.
Review recurring expenses: cancel subscriptions or services you're not actively using. Small savings add up over a year.
Build a cash reserve: set aside a portion of each month's cash inflow as a buffer for slow periods or unexpected expenses.
Monitor your cash flow regularly: don't wait until the end of the quarter. Weekly or bi-weekly reviews help you spot issues before they become urgent.

Manage your cash flow with Xero

Tracking cash flow manually with spreadsheets takes time and leaves room for errors. Xero accounting software connects to your bank, automatically categorizes transactions, and gives you a real-time view of your cash position.

With Xero, you can generate cash flow statements and other financial reports in a few clicks. Automatic bank reconciliation, invoice reminders, and expense tracking help you stay on top of the daily details so you can focus on running your business. Get one month free.

FAQs on cash flow statements

Here are some frequently asked questions about cash flow statements.

What are the 3 parts of a cash flow statement?

The 3 parts are operating activities, investing activities, and financing activities. Each section tracks a different category of cash movement to give you a complete picture of where your money comes from and where it goes.

What is the difference between direct and indirect cash flow methods?

The direct method lists individual cash receipts and payments, while the indirect method starts with net income and adjusts for non-cash items. Most small businesses use the indirect method because it's easier to prepare from standard accounting reports.

How do you calculate cash flow?

Add together the net cash from operating, investing, and financing activities for the period. Then add the result to your opening cash balance to arrive at your closing cash balance.

Why is a cash flow statement important for small businesses?

It shows whether you have enough cash to pay bills, employees, and other obligations on time. A profitable business can still run out of cash if revenue is tied up in unpaid invoices or slow-moving inventory.

How often should you prepare a cash flow statement?

Monthly preparation is ideal for most small businesses, with quarterly and annual reviews for bigger-picture planning. More frequent monitoring helps you catch cash shortfalls early and adjust before they become serious. Xero's cash flow forecasting tools can help you stay ahead.