Of the three, the statement of cash flows may be the most important because it’s the one document that tells you whether you’re going to have the money you need to run your business. It describes the flow of funds in and out of your business in the given accounting period and shows you where the business is trending—what’s working well and where improvements are needed.
The Difference Between the Balance Sheet and Statement of Cash Flows
Sometimes business owners at the beginning of their careers find the differences between these documents a little confusing, especially the balance sheet versus the statement of cash flows. Essentially, the balance sheet is a static document. It gives you a snapshot of the business at a given point in time—its assets, liabilities, and owner’s equity. It doesn’t say anything about how the business is trending, just that this is where it is at this particular moment. The statement of cash flows, on the other hand, is dynamic—more like a video showing you how the business is changing over time. Income, for instance, may be trending upward and wages or materials costs may be trending upward as well. This tells you what you need to do next to assure the continuing success of the business.
How to Develop a Cash Flow Statement
Before you can prepare a statement of cash flows, you’ll need to prepare two other accounting documents, the income statement and the balance sheet. The income statement should be prepared as often as you need the information. Most businesses require either a weekly or monthly income statement. Here’s what a DJ’s monthly income statement might look like: GrandMaster Local Guy’s Income Statement for the Month Ending August 31, 2022 The balance sheet, by establishing the difference between all company assets and all company liabilities, gives you a snapshot of the worth of the business on a given date. Here’s a simple example that shows the essence of the balance sheet document: GrandMaster Local Guy Balance Sheet as of August 31, 2022 Why? This is because you are looking for changes from one accounting period to the next. Is revenue up or down? What about expenses? How does that affect your company’s net worth? Comparing the earlier balance sheet with the later balance sheet tells you where your business is heading. Preparing two balance sheets (or comparative balance sheets) connects directly to the next step: the development of the statement of cash flows.
Stating your net income for the periodAccounting for your non-cash expensesMaking appropriate adjustments for gains (or losses) on sales of assetsNoting changes in all current assets (that is, the difference between the earlier and later balance sheet entries)Accounting for changes in liabilities (the difference between the earlier and later balance sheet entries)
