You've got the gigs lined up, the invoices sent, and your profit and loss statement looks like a chart-topper. Yet somehow, you're still scrambling to cover next week's expenses. Welcome to the brutal reality that trips up countless Australian creatives and business owners: profit doesn't always equal cash in the bank.
While your income statement might be singing a sweet tune, your actual cash position could be hitting some seriously sour notes. That's precisely why understanding how to prepare cash flow statements isn't just accounting busy work - it's the difference between sustainable growth and financial crisis. Unlike the accrual-based income statement that recognises revenue when earned (not when collected), a cash flow statement tracks the actual money flowing through your business, revealing whether you can pay the bills, invest in new equipment, or finally afford that studio upgrade you've been eyeing.
According to AASB 107 (Statement of Cash Flows), Australian entities must prepare a cash flow statement as an integral part of their financial statements for each reporting period. But beyond mere compliance, this document tells the real story of your business's financial health - one that many profitable companies wish they'd paid attention to before running into serious liquidity problems.
Think of your cash flow statement as the rhythm section of your financial reports - it might not get the spotlight like your profit and loss statement, but without it, the whole ensemble falls apart. As Harvard Business School Online defines it, "The purpose of the statement of cash flows is to provide a more detailed picture of what happened to a business's cash during an accounting period."
Here's the critical distinction that every creative professional and business owner needs to understand: profit and cash flow are fundamentally different concepts. You can be profitable on paper yet face serious liquidity problems if cash isn't flowing effectively. According to MYOB, sales made on credit terms appear fully on a P&L statement, but only collected cash appears on a cash flow statement. That $50,000 project you invoiced three months ago? It's already boosting your profit figures, but until the client actually pays, it's doing absolutely nothing for your ability to cover rent, salaries, or supplier bills.
The cash flow statement breaks down into three mandatory sections under AASB 107:
Operating Activities track your core business operations - the cash from customer sales, payments to suppliers, employee wages, rent, and everyday running costs. This section is like your main setlist; it shows whether your core business model actually generates cash.
Investing Activities capture purchases or sales of long-term assets - equipment, property, investments. Bought new recording equipment? That's here. Sold an old company vehicle? Also here.
Financing Activities reflect how you're funding the business - loans taken out or repaid, equity invested, dividends paid to shareholders. This section reveals your relationship with external funders and investors.
Together, these three sections paint a complete picture of how cash moves through your business, something neither your balance sheet nor income statement can do alone.
AASB 107 paragraph 18 permits two acceptable approaches for calculating cash flow from operating activities: the direct method and the indirect method. Both arrive at the same final number, but they take dramatically different routes to get there.
The direct method is the more straightforward approach - it simply lists all major classes of gross cash receipts and payments. You record actual cash received from customers, then subtract actual cash paid to suppliers, employees, for taxes, and other operating expenses. The formula is beautifully simple: Total cash receipts minus total cash payments equals net cash from operating activities.
While AASB 107 paragraph 19 notes entities are "encouraged" to use this method, it's less common in practice because it requires detailed transaction-level data and takes more time to compile. However, for smaller creative businesses and start-ups tracking every dollar, the direct method offers unmatched transparency about actual cash movements.
Important note: When using the direct method, AASB 107 paragraph 20 requires a reconciliation of cash flows from operating activities to profit or loss be disclosed in the financial report.
The indirect method - the preferred approach for most Australian businesses - starts with net profit from your income statement, then adjusts for non-cash items and changes in working capital. It's like remixing a track; you start with the original recording (net profit) and layer in adjustments until you arrive at the actual cash version.
This method adds back non-cash expenses like depreciation and amortisation (they reduced your profit but didn't involve actual cash leaving), then adjusts for changes in working capital accounts. According to NetSuite Australia, it's the preferred approach for larger organisations because it aligns seamlessly with information already in the income statement and balance sheet.
Here's how working capital adjustments work:
Most Australian businesses use the indirect method because it's faster to prepare and closely linked to the balance sheet and income statement. Both methods produce the same operating cash flow result - it's purely a presentation difference.
Following guidance from business.gov.au and AASB 107, here's the practical process for preparing your cash flow statement:
Before you start, assemble all necessary source documents: balance sheets (current and prior period), income statement for the reporting period, bank statements, previous cash flow statements, statement of changes in equity, and supporting transaction records. This ensures no important cash-affecting information gets overlooked.
Identify the opening cash and cash equivalents at the beginning of the reporting period. This becomes the closing balance from the previous period. Per AASB 107 paragraph 7, cash comprises cash on hand and demand deposits, while cash equivalents are short-term, highly liquid investments readily convertible to cash with insignificant risk of value changes (generally with original maturities of three months or less).
Using either the direct or indirect method, calculate net cash from operations. If using the indirect method (most common), start with net profit, add back depreciation and amortisation, then adjust for changes in accounts receivable, inventory, and accounts payable. Include interest paid and income taxes paid as operating activities.
Identify all transactions involving acquisition or disposal of long-term assets. Did you purchase equipment? That's a cash outflow. Sold an investment? That's a cash inflow. Per AASB 107.21, major classes of investing cash flows should be reported separately as gross amounts - don't net purchases against sales.
Track all transactions with equity holders and creditors. Took out a business loan? Cash inflow. Made loan repayments? Cash outflow. Paid dividends to shareholders? Cash outflow. Issued new shares? Cash inflow. Again, AASB 107.21 requires separate reporting of major classes.
The formula that brings it all together:
Ending Cash = Opening Cash + Operating Cash Flow + Investing Cash Flow + Financing Cash Flow + Effects of Foreign Exchange (if applicable)
This ending balance must reconcile to the cash and cash equivalents shown on your balance sheet as of the reporting date. This reconciliation is a critical control point to ensure accuracy.
Per AASB 107 paragraphs 43-44, investing and financing transactions that don't involve cash must be excluded from the cash flow statement but disclosed elsewhere (typically in notes). Examples include asset acquisitions through assumption of liabilities, share issuances to acquire assets, debt-to-equity conversions, and lease arrangements resulting in right-of-use assets.
The ending cash on the cash flow statement must tie to the balance sheet. AASB 107 paragraphs 45-47 also require disclosure of the components making up cash and cash equivalents, including any restrictions on cash usage, undrawn borrowing facilities available, and components held in different locations or currencies.
Research from BDO Australia and ICAEW identifies several frequent errors that trip up even experienced preparers:
Misclassification of cash flows tops the list. This includes incorrectly categorising transactions between operating, investing, and financing activities - like classifying equipment sales proceeds as operating activity (should be investing), or treating lease payments as operating instead of financing.
Non-cash transaction errors come in second. Common mistakes include incorrectly handling depreciation (remember, it's added back because it's not a cash expense), mishandling stock-based compensation, or incorrectly treating asset acquisitions through equity issuance.
Working capital adjustment mistakes frequently occur, particularly confusing bad debts with collection timing changes, or getting the directional signs wrong on inventory, receivables, and payables movements.
Interest and tax payment oversights happen when preparers forget to separately disclose interest paid or fail to adjust accrued interest to a cash basis. Per Thomson Reuters, interest and income tax paid must be separately disclosed either on the face of the statement or in notes.
Incorrect netting represents another common pitfall. AASB 107.21-22 generally requires gross presentation of cash flows, though some items may be netted under specific circumstances. Incorrect netting can mask financing risks or misrepresent operational performance.
GST treatment confusion is particularly relevant for Australian businesses. Per business.gov.au, financial statements must clearly state whether figures include or exclude Goods and Services Tax. Typically, cash flow statements show actual cash movements after GST, with GST refunds and payments tracked separately.
| Error Type | What Goes Wrong | Correct Treatment |
|---|---|---|
| Misclassification | Equipment sale shown as operating activity | Report as investing activity cash inflow |
| Non-cash items | Depreciation shown as cash outflow | Add back to net profit (indirect method) |
| Working capital | Accounts receivable increase added to cash | Subtract from net profit (cash not collected) |
| Interest/tax | Interest paid not separately disclosed | Disclose separately in statement or notes |
| Netting | Grossing up dealer-financed purchases | Report only actual cash portion in investing |
| GST | Unclear whether amounts include GST | State clearly; show GST refunds separately |
The cash flow statement works in concert with your balance sheet and income statement, but serves a distinctly different purpose. Understanding these differences is crucial for comprehensive financial analysis.
Versus the Balance Sheet: Your balance sheet provides a static snapshot at a point in time, showing assets, liabilities, and equity. The cash flow statement, by contrast, is dynamic - it shows the movement and timing of cash over a period. Together they reveal critical insights: A company could have significant assets but poor liquidity if those assets aren't converting to cash quickly enough.
Versus the Income Statement: Your profit and loss statement uses accrual accounting, showing revenue when earned (not when collected) and expenses when incurred (not when paid). It includes non-cash items like depreciation. The cash flow statement shows actual cash collected and paid, excluding non-cash items, making it more reflective of true liquidity.
Here's a real-world example that illustrates the difference: A $1 million sale on 90-day payment terms appears fully on your P&L immediately, potentially making you look incredibly profitable. However, only when your client actually pays after 90 days does that cash appear on the cash flow statement. During those three months, despite showing strong profit, you might struggle to cover operating expenses.
As NetSuite Australia notes, operating cash flow is perhaps the most vital indicator as it shows whether a business brings in more money than it pays out through normal operations - the ultimate test of sustainability.
For Australian businesses, several software solutions have streamlined the cash flow statement preparation process significantly.
MYOB Business, widely used across Australia, automatically classifies transactions by category and can generate statements of cash flows directly. The system allows category classification adjustments for specific transactions, enables comparison periods and customisation, and integrates depreciation and non-cash adjustments automatically.
NetSuite Australia ERP system includes real-time cash flow reporting, automated adjustments for non-cash items, multi-currency and consolidation capabilities, and comprehensive cash management solutions for tracking flows across complex business structures.
However, regardless of the software you're using, human oversight remains essential. Automated systems can misclassify transactions, particularly unusual or one-off items. Best practices include implementing segregation of duties, conducting regular monthly reconciliation of cash flows to bank statements, maintaining audit trails of all adjustments, and having senior finance staff review before finalisation.
Understanding how to prepare cash flow statements transforms from compliance burden to strategic advantage when you recognise what these documents reveal about your business. While your income statement shows whether you're profitable on paper, the cash flow statement reveals whether your business model is sustainable in practice.
Companies with strong positive operating cash flow demonstrate that their core business generates money efficiently. Businesses investing heavily in growth might show negative investing cash flows - perfectly normal and often healthy. Financing activities reveal whether you're relying excessively on external funding or building sustainable internal cash generation.
The cash flow statement also serves critical functions beyond internal management. According to the Australian Government's Department of Business, entities must lodge financial reports with ASIC, making cash flow statements a regulatory requirement under AASB 107 for businesses presenting financial statements. Auditors particularly focus on negative operating cash flow as a concerning signal when assessing going concern. Potential investors or lenders will scrutinise your cash flow statements to evaluate liquidity, financial flexibility, and ability to service debt.
Most importantly for creative professionals and growing businesses, cash flow statements help you avoid the profit-rich-but-cash-poor trap that claims far too many otherwise successful ventures. They enable proactive cash management, reveal seasonal patterns requiring advance planning, and highlight when to delay purchases or accelerate collections.
The distinction between profit and cash isn't academic - it's the difference between sustained success and sudden failure. Companies can be profitable but cash poor, leading to inability to pay bills despite strong sales. Conversely, businesses can be unprofitable yet temporarily cash rich through financing activities, though this situation isn't sustainable long-term.
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