Question

Your friend, Diana Wood, recently completed the second year of her business and just received annual financial statements from her accountant. Wood finds the income statement and balance sheet informative but does not understand the statement of cash flows. She says the first section is especially confusing because it contains a lot of additions and subtractions that do not make sense to her. Wood adds, “The income statement tells me the business is more profitable than last year and that's most important. If I want to know how cash changes, I can look at comparative balance sheets.

”Write a half-page memorandum to your friend explaining the purpose of the statement of cash flows. Speculate as to why the first section is so confusing and how it might be rectified. Any sources used to support the information included in your memorandum should be cited using APA Style.

Answer 1

TO: (Name of your Friend)

FROM:            (Your Name)

SUBJECT:      Cash Flow Statement

DATE:            _________________

I'm glad to learn that this year the company is more profitable. However, I thought about what you said about the cash flow statement and have a few thoughts on why you consider it confusing.

Cash flows from operating activities can be made using two: direct method or indirect method. It is likely that you will prepare the cash flow statement using indirect method. This approach displays net cash flows in the (first) financial segment by listing the net income figure and making a variety of accounting changes. These reforms might not make sense to those who have no knowledge of accounting or finance.

I recommend that you submit a statement of the cash flows compiled using a direct method from your accountant. This will show just how much cash was obtained from things such as purchases. It will also help illustrate how much cash was expended on operating expenses including supplies, salaries, debt and taxes. It will calculate the net cash balance by simply reducing the cumulative outflows from these inflows.

Be aware of the importance of sound cash management for success in business and development. The cash flow analysis offers you much more detail than the balance sheet can provide on your funds. You will see just where your cash has come from, where it has gone, and how much it has changed. These are classified into working, funding and acquisition groups. This cash information organization would allow you to prepare and plan ahead better.

For better business decisions, please review the importance of the Cash Flow Statement.