How to Organize a Cash Flow Statement Model That Balances

Suppose I’m looking for potential acquisitions with HoriZen Capital or constructing model-based best practice models. In that case, I frequently find the cash flow statement that aren’t in line against the balance sheet.

The main reason for this is the broad range of data sources utilized by the business, including the tracking software used by sales teams, program, CapEx files maintained by the CFO, as well as inventory reporting data from the procurement department for example. If there is a gap in the line between the sources mentioned above, it quickly leads to critical imbalances within an analysis.

I’ve been involved in several financial due diligence projects in M&A deals in which data authenticity was a challenge. It raises uncertainty and doubts on the part of the buyer. This could be a major issue or reduce trust in an organization’s capacity to carry out. Additionally, it can result in unnecessary expenses because of the additional work needed to locate those missing parts, which results in additional hours of work on both parties to the transaction. This is avoided by following a precise and simple procedure:

Create financial models with the correct interconnectivity among the three main financial statements: the income statement balance sheet as well as P&L.

Here is a step-by-step guideline to make sure your cash flow is always balanced and is in good shape. I will also outline how interconnectedness is between the various areas in the statement of cash flows. In addition, I will explain how the balance sheet and, specifically, Net Working Capital have the most important part in helping to make it all work. To aid you in your understanding I’ve made a spreadsheet that illustrates the need for interconnection.

Building a Cash Flow Statement

There are two common ways to construct an balance sheet of cash flows. The direct method utilizes actual cash flows and outflows from the business’s operations and the indirect method employs the balance sheet and the P&L as an initial point. This is the most frequently that is used because direct methods require the use of a more detailed reporting system which is more complicated.

Here’s a quick overview of the goals we hope to accomplish. It might appear simple however each line represents the results of a variety of previous calculations.

Step 1: Remember the Interconnectivity Between P&L and Balance Sheet

Although it’s not a necessity, it’s worth noting that the all assets should be in line with the total liability (and equity). In the balance sheet, P&L and the balance sheet linked through the equity account on the balance sheet. Any credit or debit to an P&L account immediately impacts the balance sheet as it is recorded in the line of retained earnings.

Step 2: The Cash Account Can Be Expressed as a Sum and Subtraction of All Other Accounts

Due to the irrevocable equality of all assets and total liabilities we know:

Fixed Assets + Receivables + Inventory + Cash = Equity + Financial Debt + Payables + Provisions

Basic arithmetic lets us deduce that:

Cash = Equity + Financial Debt + Payables + Provisions – Fixed Assets – Receivables – Inventory

This implies that the cash movement (i.e. the flow of cash) over two days will equal the total and subtraction of the movements (the delta) of any other account:

Net Cash Flow = D Cash = D Equity + D Financial Debt + D Payables + D Provisions – D Fixed Assets – D Receivables – D Inventory

Step 3: Break Down and Rearrange the Accounts


As mentioned earlier in the context of studying the balance sheet prior to any dividends are paid the equity account will contain the net income for the year in question. Therefore, we’ll need to dissect the equity account in more detail so that the year’s net income more clear.


This line line in net income is comprised of components: Most notably, EBITDA plus depreciation and amortization (D&A) and interest taxes, and interest.


The working capital consists of three parts comprising receivables and inventory on the asset side , and payables on the liability side. When they are netted off against each other and then recalculated, they will equal that net capital balance, which is the daily capital balance that is required to run the business.

It’s no surprise that a greater balance movement in the working capital asset is cash flow outflow and the reverse is true for their counterparts with liabilities.


If we combine all the changes that we’ve made just now and combine them with the same order as follows:

For an accounting professional, it could seem a bit random, so it is recommended to change the order using the same method as the traditional cash flow statement.

Step 4: Convert the Rearranged Balance Sheet Into a Cash Flow Statement

At this point you’ll notice we’ve been using only just one position on the balance sheet, namely an account that has been set at a specific point within time (December 31 of 2019 in our instance). To calculate the cash flow from this position we will require an additional balance sheet with an earlier date. In this case we’ll use the balance sheet in the following example, which was dated the 31st of December, 2018 prior to that dividend distribution for FY18.

Two aspects to be considered here:

  1. In December 18 it was still FY19, and the fiscal year has not begun, so all FY19 P&L accounts will be at zero.
  2. The figure for retained earnings here will include FY18’s net earnings.

To calculate the statement of cash flows it is necessary to examine the changes between December 19 and December 18. Because of the equality we proved in step 2.2, we already are aware that our net flow of cash will the same as 20 – 30 = 10.

Just by using the movements between the balance sheets’ positions and adding subtotals to improve clarity We have created an exciting well-balanced cash flow statements

How to Improve Your Cash Flow Statement Processes?

This is the moment where accounting expertise from the past can be beneficial, even though it’s not necessary. The goal of creating an accounting statement for cash flow like the one shown above is to better analyze and comprehend the cash flows and outflows of the company by classification (e.g. finance, operating or investing). Once you’ve got an cash flow statement that is linked dynamically to your balance sheet, it’s time to explore deeper. To begin you should consider these questions you should ask yourself:

  1. Are All Accounts Correctly Categorized?

This is a very investigative exercise that will have you looking over every line account that is used within an accounting system. After analyzing the data, a conversation with the controller of financials, or CFO, may be held to discuss any disagreements in opinion regarding the proper classification of items.

An excellent example of this situation is trade payables in the form of CapEx (i.e. outstanding payments to providers of fixed assets). It is very common for the account is part of the trade liabilities (in actual liabilities) and, in turn it is designated as net working capital. In the event that this happens, then you must remove this account NWC and then add it into the cash flow in your investing (CFI) section.

If we take a guess that there is a movement in payees for trade in the form of CapEx of +1 between December 18 between Dec-18 and Dec-19, we’d add the following modifications in our statement of cash flows as per the above example:

  1. Is the Presentation Representative of Actual Cash Inflows and Outflows?

The concept that cash is different from non-cash could be confusing to those who aren’t familiar with the concept. For instance If Company A sold an item for $40 that it bought at a cost of $10 in the past year, and its client hasn’t purchased it yet, how do you take as “cash EBITDA”? Should it be 30? (revenue lower than COGS, assuming there’s no other expenses)? Or is it better to be zero (considering it is the fact that what you was paid for in the previous year and that no money has been collected to date). )?

What is often forgotten what they are often unaware of is the fact it is that NWC and EBITDA should be examined together when considering cash generation. If EBITDA is affected by a “non-cash item,” remember that there’s always another balance sheet account that is affected. Your job as an cash flow builder is to determine which. The answer often is found in the accounts that are included in Net working capital!

An example for “non-cash items” are provisions. It is important to remember that provisions are intended to have an impact on the present P&L as they anticipate an expense that is likely to occur in the near future. In light of that it is safe to claim that this item hasn’t had any financial impact during the course of the fiscal year, so it makes sense to take it off our cash flow statements.

In the P&L instance we’ve looked at to date, it appears that the provision was booked over EBITDA. Therefore, if we wish to eliminate the effect of a change to the provision, here’s the procedure we can follow:

However, the problem that we have in this particular presentation is we’d prefer FY19 EBITDA to be in line with EBITDA in accordance with the P&L. To achieve that we’d prefer to show our cash flow statement in the following manner:

I would also suggest to include an explanation of the non-cash items you removed were in reference to. It might also be beneficial to show what is known as the “cash” EBITDA component of the business. It would include the following elements:

Naturally, this could be very complicated, since it requires a perfect matching of all NWC accounts that are linked with EBITDA items. I’m not convinced, however that this additional complexity provides a more clear picture of the cash-generating capabilities of your company however it could be helpful to provide your clients with as much explanation in understanding the numbers as you can.

Take the Rules and Apply Them Practically

I’m hoping this can provide you with the ability to create a successful cash flow report and you have a better understanding of the interrelations with P&L and the balance sheet. Once you have mastered this method it’s your responsibility to reorganize the various accounts and then display them in a manner that is the most sensible for your specific requirements and the specific business you run.

However, the real-world applications could be more challenging due to the amount of accounts on your trial balance and the complicated accounting principles, and any other exceptional circumstances like the M&A transactions, to give an instance. But the fundamental concepts are exactly the same. If adhered to, it can allow you to make use of your time wisely instead of sinking endless hours into an ineffective task of balancing!

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