Page 648 - Accounting Principles (A Business Perspective)

16. Analysis using the statement of cash flows

• The cash flow liquidity ratio tests a company's short-term, debt-paying ability and is equal to the total of
cash, marketable securities, and net cash provided by operating activities divided by current liabilities.

• A work sheet can be used to assist in preparing a statement of cash flows.
• A company's comparative balance sheets, income statement, and additional data are used to prepare the
work sheet.
• The work sheet technique makes the recording of the effects of transactions on cash flows almost a mechanical
process.

Appendix: Use of a working paper to prepare a statement of cash flows
This appendix shows how a work sheet could be used to assist in preparing a statement of cash flows. We use the
comparative balance sheets, income statement, and additional data for the Welby Company, shown on Exhibit 129,
as the basis for this example.
Look at the working paper in Exhibit 132 for Welby Company, which we use to analyze the transactions and
prepare the statement of cash flows. While discussing the steps in preparing the working paper, we describe the

items and trace their effects in the entries.
• Enter the beginning account balances of all balance sheet accounts in the first column and the ending
account balances in the fourth column. Notice that the debit items precede the credit items.
• Total the debits and credits in the first and fourth columns to make sure that debits equal credits in each
column.
• Write "Cash Flows from Operating Activities" immediately below the total of the credit items. Skip

sufficient lines for recording adjustments to convert accrual net income to cash flows from operating activities.
Then write "Cash Flows from Investing Activities" and allow enough space for those items. Finally, write "Cash
Flows from Financing Activities" and allow enough space for those items.
• Enter entries for analyzing transactions in the second and third columns. The entries serve two functions:
(a) they explain the change in each account; and (b) they classify the changes into operating, investing, and
financing activities. We discuss these entries individually in the next section.
• Total the debits and credits in the second and third columns; they should be equal. You will have one pair of
totals for the balance sheet items and another pair for the bottom portion of the working paper. We use the
bottom portion of the working paper to prepare the statement of cash flows.

To complete the working paper in Exhibit 132, we must analyze the change in each noncash balance sheet
account. The focus of this working paper is on cash, and every change in cash means a change in a noncash balance
sheet account. After we have made the proper entries to analyze all changes in noncash balance sheet accounts, the
working paper shows all activities affecting cash flows. The following explanations are keyed to the entry numbers
on the working paper:
Entry 0 In comparing the beginning and ending cash balances, we determine the change in the Cash account
during the year is an USD 11,000 increase. An entry on the working paper debits Cash for USD 11,000 and credits

Increase in Cash for Year near the bottom of the schedule. This 0 entry does not explain the change in cash but is
the "target" of the analysis. The entry sets out the change in cash that the statement seeks to explain. No further
attention need be paid to cash in completing the working paper.

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