How Many Types of Cash Flow Statements?

A client might show a healthy profit on their income statement, but their cash in the bank is steadily decreasing. This common scenario highlights why the statement of cash flows is non-negotiable for understanding a business's true financial position. This article will show you the three fundamental components of any cash flow statement and explain the two distinct methods used to prepare one: the direct and indirect methods.

The Statement of Cash Flows: More Than Just a Bank Statement

While an income statement reports profitability based on accrual accounting, the statement of cash flows gets back to basics: it tracks the movement of actual cash. This statement serves as a bridge between two balance sheets, reconciling the beginning and ending cash balances over a specific period. It reveals precisely where a company's cash came from and where it was spent, offering a clear view of its ability to generate cash, meet obligations, and fund its operations and investments.

Unlike the income statement, which can include non-cash items like depreciation or recognize revenue before payment is received, the statement of cash flows deals only with cash inflows and outflows. It’s a reality check that complements the other financial statements. A business can be profitable on paper but fail due to poor cash management. By analyzing this statement, you can assess a company’s liquidity, solvency, and overall financial flexibility, providing the kind of deep insight that shifts your role from compliance preparer to strategic advisor.

The Anatomy of Cash Flow: Operating, Investing, and Financing Activities

Regardless of the preparation method, every statement of cash flows is structured into three standard sections. Understanding what each section represents is the first step in unlocking the story the numbers are telling.

Cash Flow from Operating Activities (CFO)

This is the engine room of the business. Operating activities include the principal revenue-producing activities and are the primary source of a company's net income. In short, CFO reflects the cash generated by a company’s core business operations. Positive operating cash flow is a strong indicator of financial health, as it shows the company can generate enough cash from its regular business to maintain and grow without relying on external financing.

• Examples of Cash Inflows: Cash receipts from the sale of goods and services, collections on accounts receivable, and cash received from interest or dividends.
• Examples of Cash Outflows: Payments to suppliers for inventory, payments to employees for salaries and wages, payments for rent and utilities, and payments for interest and taxes.

This section is unique because it's the only one that can be presented using either the direct or indirect method, a key distinction we'll cover next.

Cash Flow from Investing Activities (CFI)

This section details the cash spent on or generated from a company's investments in long-term assets. These transactions represent choices to expand, maintain, or contract the company’s asset base and future earning potential. Analyzing CFI provides insight into the company’s strategy for long-term growth and capital allocation.

• Examples of Cash Inflows: Cash from the sale of property, plant, and equipment (PP&E); proceeds from the sale of debt or equity securities of other entities; and the collection of principal on loans made to other parties.
• Examples of Cash Outflows: Purchases of PP&E, investments in the debt or equity securities of other entities, and making loans to other parties.

Consistently negative cash flow from investing is not necessarily a bad sign—it often means a company is actively investing in new equipment or facilities for future growth.

Cash Flow from Financing Activities (CFF)

This component includes transactions with the company's owners and creditors. It shows how a business raises capital and pays returns to its investors. CFF illustrates the flow of capital between the firm and its owners and lenders, providing a look at its capital structure and debt management policies.

• Examples of Cash Inflows: Proceeds from issuing company stock, and cash received from borrowing (e.g., bank loans or issuing bonds).
• Examples of Cash Outflows: Repayment of debt principal, repurchasing the company's own stock (treasury stock), and payments of dividends to shareholders.

A new startup might show high positive cash flow from financing as it raises funds, while an established company might have negative CFF as it pays down debt or distributes profits to shareholders.

The Main Event: The Direct vs. Indirect Method

Now we come to the core of the topic. While there is only one statement of cash flows, there are two accepted ways to present the first section, Cash Flow from Operating Activities. The choice a company makes—between the direct and indirect method—determines how the details of its operational cash flow are communicated. FASB encourages the direct method, but in practice, the vast majority of companies use the indirect method for practical reasons.

Both methods will always arrive at the exact same figure for net cash flow from operating activities. The difference is purely in the presentation.

The Indirect Method: The Practitioner's Go-To

The indirect method is far more common, with over 98% of public companies in the U.S. using it. This method starts with net income and works backward, making a series of adjustments to reconcile it to the net cash flow from operating activities. It's essentially a reconciliation, not a direct report of cash transactions.

It's popular because the necessary information—the income statement and balance sheets—is readily available. Additionally, GAAP/IFRS requires companies using the direct method to also present an indirect method-style reconciliation, so many find it more efficient to just prepare the indirect-method statement in the first place.

Here’s how it works:

1. Start with Net Income: This figure is pulled directly from the company’s income statement.
2. Add Back Non-Cash Expenses: Expenses that reduced net income but didn't involve an outflow of cash must be added back. The most common examples are depreciation and amortization.
3. Adjust for Gains and Losses: Gains and losses from the sale of long-term assets (reported on the income statement) are removed from the operating section because their cash effect is properly recorded under investing activities. A gain is subtracted, and a loss is added back.
4. Account for Changes in Working Capital: This is the final step, adjusting for the changes in current operating assets and liabilities between the beginning and end of the period.
   • An increase in a current asset (like accounts receivable or inventory) represents a use of cash, so it’s subtracted from net income. For example, if A/R increased, it means more sales were made on credit than cash collected.
   • A decrease in a current asset represents a source of cash and is added back. If inventory decreased, it means more was sold than purchased, generating cash.
   • An increase in a current liability (like accounts payable or accrued expenses) is a source of cash and is added back. If A/P increased, it means the company held onto its cash instead of paying suppliers immediately.
   • A decrease in a current liability is a use of cash and is subtracted.

The final number is your net cash provided by (or used in) operating activities.

The Direct Method: Clear, but Uncommon

The direct method presents operating cash flows in a more straightforward format, almost like a summary of a cash-basis income statement. It shows categories of gross cash receipts and gross cash payments. Many users, especially non-accountants and investors, find this method more intuitive and easier to understand because it directly answers the question, "Where did the cash come from and where did it go?"

A typical direct method presentation would include line items such as:

• Cash collected from customers
• Cash received from interest and dividends
• Cash paid to suppliers and employees
• Cash paid for interest
• Cash paid for income taxes

While conceptually simpler, the direct method is rarely used. This is because most companies’ accounting systems are set up for accrual accounting and do not easily track cash inflows and outflows by these specific categories. Compiling this information can be time-consuming. And, as mentioned earlier, companies opting for the direct method must still provide a supplemental schedule that reconciles net income to net operating cash flow—essentially preparing an indirect method statement anyway.

Generating a Statement of Cash Flows in Your Accounting Software

Most modern accounting platforms are designed to produce a statement of cash flows with relative ease, especially using the universally favored indirect method. Software like QuickBooks Online, Xero, or Sage Intacct can automatically generate the report. These applications pull net income from the P&L and changes in asset and liability accounts from the balance sheet to build the reconciliation for operating activities. The investing and financing sections are populated based on how transactions related to asset sales, loans, and equity are categorized throughout the year.

The key to an accurate, software-generated statement is meticulous bookkeeping. Every transaction must be correctly coded. For example, if a principal payment on a loan is miscategorized as an interest expense, it throws off both the operating and financing sections. To deliver truly valuable guidance, your role involves not just running the report but verifying its accuracy by confirming the underlying transactions are classified properly.

Final Thoughts

While a business can prepare its statement of cash flows using either the direct or indirect method for the operating section, both paths ultimately lead to the same result. What truly matters is understanding the story told by the three core activities—operating, investing, and financing—and what they collectively reveal about a company's ability to drive its own success.

Interpreting these statements often prompts complex client questions about the tax consequences of certain cash-generating activities, like the sale of an asset or decisions around financing. As an advisor, you need to provide accurate, citation-backed answers on the spot. We built Feather AI to deliver those authoritative answers instantly, so you can spend less time digging through tax code and more time guiding clients on the very decisions that shape their cash flow statement.