Financial Statements: Reading a Cash Flow Statement

Small businesses that use the cash accounting method may overlook using cash flow statements. However, those that use the accrual method of accounting should find the cash flow statement an essential measurement of financial health. In the accrual accounting method, income and expenses are accounted for when they are incurred, not necessarily when they are received or expended.

While your Income Statement may show a profitable operating period, if you have income that is booked but not received yet, you could be entering a cash flow crunch. The purpose of a cash flow statement is to view the actual cash situation, the inflows and outflows of cash and current balancesi.

Line Items in a Cash Flow Statement

  • Cash, beginning of period – this is the actual cash on hand at the beginning of the period reported on the cash flow statement.
  • Net income – this is the net income for the period, but any amounts booked but not yet received would be backed out of the line item; only cash actually received is counted.
  • Additions to cash – reverse expenses on the books but not yet paid, the accounts payable.
  • Subtractions from cash – any revenue recorded but not yet received, as in accounts receivable, is subtracted from cash.
  • Net cash from operations – is the amount derived from the previous four calculated amounts.
  • Cash flow from investing activities – any cash in from an investment is added, while any cash out to make an investment is subtracted.
  • Cash at the end of the period – after all of the above, this is the cash on hand at the end of the measured period.

Analysis with Cash Flow Ratios

There are ratios you can use to view your cash flow trends and analyze them for possible adjustments for improvement. They can also warn of impending cash flow problems that can create problems for the business operations.

  • Current liability coverage ratio – this ratio tells you how much cash you have for a defined period as compared to how much debt you need to pay in the short term, typically one year. For this formula, calculate your current average liability. Your current liability can change monthly as you pay down the principle on a debt; calculating an average takes that into account. Take all your current liabilities at the beginning of an accounting period, all your current liabilities at the end of a period, add them together and divide by 2.

    Current Liability Coverage Ratio = Net Cash from Operations / Average Current Liabilities

    If the ratio is less than 1:1, the business is not generating enough cash to pay liabilities.

  • Cash flow coverage ratio – This is the same as the previous calculation except that it takes all debt, short and long term, into account. It is calculated on a longer timeline, usually yearly instead of monthly.

    Cash flow coverage ratio = Net cash flow from operations / Total Debt

    Most experts recommend that a business keep their cash flow coverage ratio above 1.0 to attract investors.

  • Cash flow margin ratio – this ratio tells you how much cash the business earned for every dollar in sales for the reporting period.

    Cash flow margin = Net cash from operating activities / Net Sales

    In this case, the higher the number the better, as it is the amount of cash retained from every dollar in sales.

If your business operates with the accrual accounting method, the cash flow statement is quite important in measuring performance and cash available for payment of obligations and debt.

i How to Read (and Analyze) Financial Statements,


With Tax Hive’s years of experience in tax and business services, we use our expertise to make your life easier so you can focus on building your business. Ever changing rules require a team who knows you, your business and the tax implications. Our tax professionals meet your needs while helping you manage tax risk, control costs and reap maximum benefit. If you’re ready to get started, CLICK HERE to schedule a FREE strategy session with one of our specialists today.

Schedule your FREE 15 minute call now!