Preparing the Statement of Cash Flows

Preparing the statement of cash flows begins with a return to the balance sheet, covered

in Chapter 2.The statement of cash flows requires a reordering of the information

presented on a balance sheet.The balance sheet shows account balances at the end of

an accounting period, and the statement of cash flows shows changes in those same

account balances between accounting periods (see Figure 4.1).The statement is called

a statement of flows because it shows changes over time rather than the absolute dollar amount of the accounts at a point in time. Because a balance sheet balances, the changes

in all of the balance sheet accounts balance, and the changes that reflect cash inflows

less the changes that result from cash outflows will equal the changes in the cash

account.

The statement of cash flows is prepared in exactly that way: by calculating the

changes in all of the balance sheet accounts, including cash; then listing the changes in

all of the accounts except cash as inflows or outflows; and categorizing the flows by

operating, financing, or investing activities.The inflows less the outflows balance to and

explain the change in cash.

In order to classify the account changes on the balance sheet, it is first necessary to

review the definitions of the four parts of a statement of cash flows:

* Cash

* Operating activities

* Investing activities

* Financing activities

Cash includes cash and highly liquid short-term marketable securities, also called

cash equivalents. Marketable securities are included as cash for R.E.C. Inc., because

they represent, as explained in Chapter 2, short-term highly liquid investments that can

be readily converted into cash. They include U.S. Treasury bills, certificates, notes, and

bonds; negotiable certificates of deposit at financial institutions; and commercial

paper. Some companies will separate marketable securities into two accounts: (1) cash

and cash equivalents and (2) short-term investments.When this occurs, the short-term

investments are classified as investing