0 The Statement of Cash Flows: Show Me the Money!

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Many businesses use accrual accounting to reflect a reasonably complete picture of their economic performance over the accounting period. Nonetheless, at some point all accrual assets and liabilities must be reducible to cash. Assets that could not be converted into cash would have limited value. A firm’s ability to convert assets to cash is critical to its long-term survival. Because of the importance of cash flow, GAAP requires that companies prepare a financial statement that shows cash flows for the accounting period. Joint Ventures’ Statement of Cash Flow follows.

The statement divides cash flows into three components: cash flows from operations, cash flows from investing activities and cash flows from financing activities.
Operating activities are the ordinary buying and selling activity of a business. Investing activities comprise the purchase and retirement of fixed assets, as well as investments in other businesses. Financing activities are cash flows derived from the issuance and repayment of long-term debt, and cash flows from equity contributions and draws from owners.

These cash flow categories prevent the users of financial statements from drawing false conclusions about a business, simply because of the net cash increase or decrease over the accounting period. A business always seeks a positive cash flow, particularly from operating activities. However, short-term negative cash flows from operating activities do not necessarily mean that a business is unhealthy.

In fact, during periods of rapid expansion it is not uncommon for

companies to experience negative cash flow, because as credit sales increase, so do accounts receivable. Similarly, economic growth often is accompanied by increases in inventory, which also uses up cash. For these reasons, a user of financial statements must be careful not to jump to conclusions about the meaning of positive or negative cash flows.

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