Financial Statement Series: How to Prepare a Cash Flow Statement Using Your Income Statement and Balance Sheet: A Step-by-Step Guide

Rylan Kaliel
Sep 18
8 min read

Blue wallet with cards and cash inside on a pink background. Green and pink arrows encircle the wallet, suggesting motion.

In the previous blogs we have learned about Balance Sheet, Income Statement and Cash Flow Statement. In this blog we will learn how to put them all together. You might ask yourself why you need to know this. The reason is that running a business means understanding not just how much money you make, but how money flows in and out of your hands. For many business owners, terms like “Cash Flow Statement,” “Income Statement,” and “Balance Sheet” can sound intimidating. But with clear instructions, anyone can learn how to connect these core financial statements to get a clear picture of their cash movement. In this guide, we at KLV Accounting will walk you step-by-step through exactly how to prepare a Cash Flow Statement, using your Income Statement and Balance Sheet, in a way that’s simple, practical, and detailed—no accounting background required.

Understanding the Three Main Financial Statements

Before jumping into the Cash Flow Statement, let’s quickly revisit what each of the three financial statements tells you:

Income Statement (Profit & Loss Statement): Shows your revenues, expenses, and profit for a period (month, quarter, or year). It answers: “Did I make money?”
Balance Sheet: A snapshot of your business’s assets (what you own), liabilities (what you owe), and equity (your investment and retained earnings) at a specific point in time. It answers: “What’s my business worth right now?”
Cash Flow Statement: Reveals how cash moves into and out of your business over a period. It answers: “Where did my cash actually go?”

Many business owners look at their profit and wonder why their bank account doesn’t match. The Cash Flow Statement bridges that gap by showing how non-cash items (like depreciation) or changes in receivables and payables affect the cash you really have. Let’s first do a quick re-cap on the Income Statement and Balance Sheet to remind ourselves of these critical statements.

Income Statement

An Income Statement, like the one presented below, typically highlights only the major categories of revenue and expenses, grouping smaller or less frequent items together for clarity and brevity. This is often viewed as a simplified Income Statement.

In contrast, a (full) Income Statement offers a more detailed breakdown—listing discrete sources of income, operating and non-operating expenses, and individual line items for interest, taxes, and unusual gains or losses.

The simplified version provides a straightforward overview of your profitability, while the full statement offers deeper insight, which is essential for analyzing trends, identifying opportunities, and fulfilling external reporting requirements. For our demonstration, we’ll use the simplified Income Statement, making it easier to follow each step as we connect it to the Balance Sheet and Cash Flow Statement.

A financial statement, starting with headers for Acme Supplies, Income Statement, and For the Year Ended December 31, 2024. This is followed by three columns: Item, 2024, and 2023. The rows then list the following: Sales, $120,000, $105,000; Cost of Goods Sold (60,000), (52,000); Gross Profit, 60,000, 53,000; Operating Expenses, (25,000), (23,000); Depreciation Expenses, (5,000), (4,000); Interest Expense, (3,000), (2,000); Income Tax Expense, (6,000), (5,000); Net Income, $21,000, $19,000. — Example Income Statement for the year ended December 31, 2024

Balance Sheet

A Balance Sheet, such as the one shown below, typically presents only the major categories of assets, liabilities, and equity, often combining smaller line items for clarity and brevity. This is often viewed as a simplified Income Statement.

In contrast, a (full) Balance Sheet provides a more detailed breakdown of each account—for example, listing separate components for various types of assets (like inventory, prepaid expenses, or property categories), distinct liabilities (such as accounts payable, accrued expenses, and long-term debt), and a comprehensive equity section.

The simplified version is useful for a high-level overview, while the full version offers greater transparency and is crucial for in-depth analysis or external reporting requirements. For our purposes here we will use the simplified Balance Sheet as it will make it easier for us to work through it.

A financial statement, starting with headers for Acme Supplies, Balance Sheet, and As of December 31, 2024. This is followed by a list of items with two columns: 2024 and 2023. The rows then list the following: Assets; Cash, $15,000, $10,000; Accounts Receivable, 8,000, 7,000; Inventory, 12,000, 10,000; Fixed Assets (net), 35,000, 30,000; Total Assets, $70,000, $57,000; Liabilities & Equity; Accounts Payable, $11,000, $9,000; Short-term Loan, 7,000, 8,000; Equity, 52,000, 40,000; Total Liabilities & Equity, $70,000, $57,000. — Example Balance Sheet as of December 31, 2024

What Is a Cash Flow Statement and Why Does It Matter?

The Cash Flow Statement isn’t about profits on paper—it’s about cash in your pocket. Cash flow is the lifeblood of a business: it’s how you pay bills, buy inventory, and grow. Even a profitable business can fail if it runs out of cash.

The Cash Flow Statement breaks things down into three sections:

Operating Activities: Day-to-day business (collecting from customers, paying suppliers)
Investing Activities: Buying or selling assets (equipment, property)
Financing Activities: Borrowing and repaying loans, owner investments, or distributions

There are two methods to prepare the cash flow statement:

Direct Method: Lists actual cash receipts and payments (rarely used by small businesses, but easy to understand)
Indirect Method: Starts with net income and adjusts for non-cash items and working capital changes (most common in practice)

Let’s walk through both.

Step-by-Step: Preparing a Cash Flow Statement (Direct and Indirect Methods)

Step 1: Collect Your Income Statement and Balance Sheets

You need your Income Statement for the year and Balance Sheets for the beginning and end of the year.

Step 2: The Direct Method

The direct method simply adds up all the cash you received and subtracts all the cash you paid out. It’s straightforward but requires detailed cash records.

Cash Flow from Operating Activities

This represents the cash flow that arises from regular operating activities, such as sales less cost of goods sold and other recurring costs.

Cash Received from Customers: This is not always the same as sales. Some sales are on credit, so you need to adjust for changes in accounts receivable.

Formula: Sales + Beginning Accounts Receivable – Ending Accounts Receivable

A table noting: Sales of $120,000; Plus: Beginning accounts receivable of 7,000; Less: Ending accounts receivable of (8,000); Summing to cash received from customers of $119,000. — Calculation of cash received from customers

Cash Paid to Suppliers: Like sales, cost of goods sold may not match cash paid if you bought inventory on credit.

Formula: Cost of Goods Sold + Ending Inventory – Beginning Inventory + Beginning Accounts Payable – Ending Accounts Payable

A table noting: Cost of goods sold of $60,000; Plus: Ending inventory of 12,000; Less: Beginning inventory of (10,000); Plus: Beginning accounts payable of 9,000; Less: Ending accounts payable of (11,000); Summing to cash paid to suppliers of $60,000. — Calculation of cash paid to suppliers

Cash Paid for Operating Expenses: Operating expenses, excluding non-cash items like depreciation.

Formula: Operating Expenses + Interest Expense + Income Tax Expense

A table noting: Operating expenses of $25,000; Plus: Interest expense of 3,000; Plus: Income tax expense of 6,000; Summing to cash paid for operating expenses of $34,000. — Calculation of cash received from customers

Now, we can total the cash from the operating activities:

A table noting: Cash received from customers of $119,000; Less: Cash paid to suppliers of (60,000); Less: Cash paid for operating expenses of (34,000); Summing to cash from operating activities of $25,000. — Calculation of cash from operating activities

When we review the above, we know that our operations produced positive cash flow, mainly due to our collecting cash from customers. This was reduced for cash paid to suppliers and for operating expenses, however, understanding that our cash from customers outweighed our cash outflows is valuable knowledge as part of monitoring our business.

Cash Flow from Investing Activities

This represents the cash flow that arises from investments, such as purchasing or selling fixed assets or marketable securities.

Cash Flow from Investing Activities: This represents the cash paid from investing, including changes in fixed assets acquired during the year.

Formula: Beginning Fixed Assets (net) – Ending Fixed Assets (net) – Depreciation Expense

A table noting: Beginning fixed assets (net) of $30,000; Less: Ending fixed assets (net) of (35,000); Less: Depreciation expenses of (5,000); Summing to cash flow from investing activities of ($10,000). — Calculation of cash flow from investing activities

As this is the only line for investing activities in our example financial statements, we will leave this as the amount noted above. If there are other investments, such as a purchase of sale of marketable securities, these would be included as a separate line in this section.

From this section, we understand that we had negative cash flow for investments, as we invested more into new fixed assets during the year. This helps us understand that we are growing our business with investments during the year.

Cash Flow from Financing Activities

This represents the cash flow that arises from financing, such as receiving or repaying loans or payment of dividends.

Cash Flow from Loans: This represents the cash paid or received from financing activities, including changes in long-term loans.

Formula: Ending Short-term Loan – Beginning Short-term Loan

A table noting: Ending short-term loan of $7,000; Less: Beginning short-term loan of (8,000); Summing to cash flow from financing activities of ($1,000). — Calculation of cash flow from loans

Dividends Paid During the Year: This represents the cash paid as dividend during the year, which can be determined by checking net income against the equity.

Formula: Ending Equity - Net Income – Beginning Equity

A table noting: Ending equity of $52,000; Less: Net income of (21,000); Less: Beginning equity of (40,000); Summing to cash flow from financing activities of ($9,000). — Calculation of dividends paid during the year

Now, we can total the cash flow from financing activities:

A table noting: Cash flow from loans of ($1,000); Dividends paid during the year of (9,000); Summing to cash flow from financing activities of ($10,000). — Calculation of cash flow from financing activities

When we review the above, we know that we had negative cash flow from financing activities, mainly due to dividends being paid but also to reduce our debt. This helps us understand that we are using our cash to compensate ourselves and also pay down debt.

Change in Cash During the Year

Once we have calculated the amounts for these three sections we can add them up to determine our change in cash during the year, as follows:

A table noting: Cash from operating activities of $25,000; Cash flow from investing activities of (10,000); Cash flow from financing activities of (10,000); Summing to change in cash during the year of $5,000. — Calculation of change in cash during the year

This change in cash during the year will match exactly what our actual change in cash was on the Balance Sheet ($5,000 = $15,000 - $10,000). The added benefit is we now understand exactly where our cash came from. We now know that we had positive cash flows from operations, which was used to fund our investments into growing our business and to paying off debt and compensating ourselves.

Step 3: The Indirect Method

Most companies use the indirect method, which is an alternative method that can be used for cash flow from operating activities. The value of the indirect method is that it tends to be easier than the direct method in the calculation of the cash flow from operating activities. It starts with net income and adjusts it for non-cash items and changes in working capital.

A table noting: Net income of $21,000; Plus: Depreciation expenses of 5,000; Working capital adjustments; Plus: Beginning accounts receivable of 7,000; Less: Ending accounts receivable of (8,000); Plus: Beginning inventory of 10,000; Less: Ending inventory of (12,000); Plus: Ending accounts payable of 11,000; Less: Beginning accounts payable of (9,000); Summing to cash flow from operating activities of $25,000. — Calculation of cash flow from operating activities under the indirect method

As we can see, under the indirect method we arrive at the same cash flow from operating activities as we did under the direct method. This method focuses more on the change in non-cash and working capital adjustments, rather than the source of cash flows. Investing and financing activities remains the same under the indirect method.

Pulling the Cash Flow Statement Together

Now that we have determined the separate sections of the cash flow statement under both the direct and indirect method let’s look at them as a full statement you would expect to see in your financial statements, starting with the indirect method.

A financial statement, starting with headers for Acme Supplies, Cash Flow Statement (indirect), and For the Year December 31, 2024. This is followed by a list of items with one column: 2024. The rows then list the following: Operating Activities; Net income of $21,000; Plus: Depreciation expenses of 5,000; Plus: Beginning accounts receivable of 7,000; Less: Ending accounts receivable of (8,000); Plus: Beginning inventory of 10,000; Less: Ending inventory of 10,000; Plus: Ending accounts payable of 11,000; Less: Beginning accounts payable of (9,000); Sum of these total to Net cash from operating activities of 25,000; Investing Activities; Purchase of fixed assets of (10,000); Sum of this is Net cash from investing activities of (10,000); Financing Activities; Loan repayment of (1,000); Dividends paid of (9,000); Sum of these two is Net cash from financing activities of (10,000); Sum of the three sections is Net increase in cash of 5,000; Beginning cash balance of 10,000; Sum of these two is the Ending cash balance of $15,000. — Illustration of the Cash Flow Statement under the indirect method

Now that we have prepared the Cash Flow Statement under the indirect method, let’s see the Cash Flow Statement under the direct method.

A financial statement, starting with headers for Acme Supplies, Cash Flow Statement (direct), and For the Year December 31, 2024. This is followed by a list of items with one column: 2024. The rows then list the following: Operating Activities; Cash received from customers of $119,000; Cash paid to suppliers of (60,000); Cash paid for operating expenses (34,000); Sum of these total to Net cash from operating activities of 25,000; Investing Activities; Purchase of fixed assets of (10,000); Sum of this is Net cash from investing activities of (10,000); Financing Activities; Loan repayment of (1,000); Dividends paid of (9,000); Sum of these two is Net cash from financing activities of (10,000); Sum of the three sections is Net increase in cash of 5,000; Beginning cash balance of 10,000; Sum of these two is the Ending cash balance of $15,000. — Illustration of the Cash Flow Statement under the indirect method

As we can see, only the operating activities change under these two methods. Despite this, we do get very different information between the two versions of the statements, with the direct method focused more on the source of the cash and the indirect method more on a reconciliation of the cash movements from net income. The different versions can provide information that is more helpful in different contexts, so it can be important to consider which version is best for your needs.

Key Lessons and Takeaways

The Cash Flow Statement links the Income Statement and Balance Sheet, showing what really happens to your money.
Direct method is simpler to understand but less used due to its complexity in calculations; indirect is less complex and tends to be more common; both start with net income.
Always check your math by comparing your calculated cash increase to the change in cash on the Balance Sheet.
Don’t forget to include non-cash expenses and changes in how much you’re owed or owe others!

Final Thoughts

Even if you’re not an accountant, understanding your Cash Flow Statement helps you make smarter decisions and stay in control. Use your Income Statement and Balance Sheet as your guide, and work through the numbers step by step as we’ve done here. If you ever get stuck, KLV Accounting is always here to help—you don’t have to do it alone.

By learning how the numbers connect, you’ll be better prepared to keep your business healthy, spot problems early, and sleep better at night knowing exactly where your cash goes.

In the next blog we will discuss the importance of controls and how they fit into your business and accounting.

KLV Accounting, a Calgary-based accounting firm, is here to help. Contact us today to enhance your financial strategy, minimize your taxes, and drive business success! For a free consultation, call us at 403-679-3772 or email us at info@klvaccounting.ca.