How to Prepare a Cash Flow Statement, Step by Step

How to prepare a cash flow statement: start with net income, adjust for non-cash items and changes in working capital to get operating cash flow, add investing and financing activities from the balance sheet changes, and confirm that the result ties to the change in cash. This guide shows the indirect method step by step with a complete example. The statement is a core tool in cash flow management, and once you have the pattern you can build one in under an hour.

What you need before you start

• The income statement for the period
• The balance sheets at the start and end of the period
• Notes on unusual transactions such as asset sales, new loans and owner contributions

The principle is that every change in a balance sheet account has a cash effect. By analyzing each change you reconstruct where cash came from and went.

The step-by-step method

Step 1: Set up the three sections

Create blocks for operating, investing and financing activities, followed by a reconciliation of cash at the beginning and end of the period.

Step 2: Start with net income

Take net income from the income statement. This is the first line of operating activities in the indirect method.

Step 3: Add back non-cash expenses

Depreciation and amortization reduce net income but do not use cash. Add them back. Also adjust for other non-cash items such as stock compensation and impairments.

Step 4: Adjust for changes in working capital

Compare each operating asset and liability from the beginning to the end of the period.

Step 5: Remove gains and losses from asset sales

A gain on selling equipment is in net income, but the sale proceeds belong in investing. Subtract gains, and add back losses, in the operating section.

Step 6: Analyze investing activities

Look at the long-term asset accounts. Purchases of equipment are outflows. Proceeds from sales are inflows. Calculate the purchase as the change in gross equipment plus the cost of anything disposed of.

Step 7: Analyze financing activities

Look at debt and equity. Increases in loans are inflows, and decreases are outflows. Owner contributions are inflows, and distributions and dividends are outflows.

Step 8: Reconcile the cash

Add the three sections to get the net change in cash. Add it to beginning cash. The result must equal the ending cash on the balance sheet. If it does not, there is an error to find.

A complete worked example

A hypothetical company has the following data, in thousands of dollars.

Income statement: net income $120, which includes depreciation of $30.

Balance sheets:

Retained earnings rose by $80 even though net income was $120, which tells us owners took distributions of $40. No equipment was sold, so the gross equipment increase of $80 is the purchase.

Operating activities

Investing activities

Financing activities

Reconciliation

Net change in cash = 101 - 80 - 60 = -39. Beginning cash of 89 minus 39 equals ending cash of 50, which matches the balance sheet. The statement is complete and correct.

Handling a sale of equipment

Asset sales add a step because of the gain or loss. Suppose the company above had also sold an old machine with an original cost of $40 and accumulated depreciation of $30 (net book value $10) for $14 in cash. The gain is $4, and it is included in net income.

The gain is removed from operating cash flow because it is not part of ordinary operations, and the full $14 of proceeds appears in investing. Without the adjustment the $4 would be counted twice, once inside net income and once inside the $14. Equipment purchases also change: if gross equipment rose by $80 after disposing of a $40 asset, you purchased $120 of equipment, because the closing balance equals the opening balance plus purchases minus disposals at cost.

Building the statement from a trial balance

Many small companies work from an adjusted trial balance rather than formal statements. The method is the same, and a spreadsheet helps:

1. List every balance sheet account in rows, with beginning and ending balances in columns.
2. Add a column for the change.
3. Add a column that labels each account as operating, investing, financing or cash.
4. Add a column for the cash effect, using the rule that asset increases are negative and liability or equity increases are positive.
5. Sum each label to produce the three sections, and check the total against the change in cash.

The last step acts as an automatic proof. If the sum of the cash effects across all non-cash accounts, plus net income, does not equal the change in cash, an account is misclassified or missing.

Checking your work

A good statement passes several tests.

1. Ending cash matches. This is the primary test.
2. Net income matches the income statement.
3. Every balance sheet change is accounted for. Go through each account and make sure its change appears somewhere.
4. Signs make sense. Asset increases reduce cash, and liability increases raise cash.
5. Investing and financing items are identified. Compare with the notes for loans, asset sales and capital contributions.

If you are out of balance by a small amount, look for a missed account, an arithmetic error, a gain or loss not reversed, or a non-cash transaction.

Common mistakes

• Reversing signs on working capital. Memorize: assets up means cash down; liabilities up means cash up.
• Treating depreciation as a cash flow. It is added back because no cash moved.
• Putting loan principal in operating activities. It belongs in financing.
• Forgetting to separate gains from asset sales. The proceeds go in investing.
• Using ending balances only. The statement is built from changes during the period.
• Ignoring non-cash transactions. If you bought equipment with seller financing, no cash moved. Disclose it in a note.

Direct method alternative

If you prefer to present the direct method, you convert accrual figures into cash figures: cash collected equals sales minus the increase in receivables, and cash paid to suppliers equals cost of goods sold plus the increase in inventory minus the increase in payables. The comparison and when to use each is in direct vs. indirect cash flow statements.

Tips for monthly preparation

• Close the books first, because a statement built on unreconciled accounts inherits their errors.
• Use a consistent template each month, so differences stand out, like the cash flow statement template.
• Review working capital movements with the people who control them. If inventory rose, ask purchasing and planning why. For product companies, aligning purchasing with realistic forecasts is a major driver, covered in demand planning and inventory optimization.
• Compare against the cash forecast, and investigate the biggest variances.
• Keep notes of unusual items so next period's reader understands them.

After you have prepared one, practice reading it with the routine in what cash flow is.

FAQs

What is the easiest way to prepare a cash flow statement?

Use the indirect method with an income statement and two balance sheets. Start with net income, adjust for non-cash items and working capital changes, then add investing and financing items from the balance sheet.

Can I prepare a cash flow statement without a balance sheet?

Not reliably in the indirect method. The balance sheet changes are what you need to reconcile profit to cash. If you track cash receipts and payments directly, you can prepare a direct statement from those records.

How often should I prepare it?

Monthly for most businesses, so that you can compare actual cash to the forecast and spot problems early. Quarterly and annual versions are needed for lenders and tax and reporting purposes.

What if my statement does not balance?

Check that every balance sheet account change is reflected, that the signs are right, and that net income and depreciation match the income statement. Missing a small account is the most common cause.

Do I need an accountant to prepare it?

Not necessarily for internal use. An accountant is helpful for formal statements, unusual transactions such as leases or acquisitions, and for ensuring the classification follows applicable standards.