STATEMENT OF CASH FLOWS (SCF)
1.The basic financial statements (income statement, retained earnings statement andthe balance sheet) are prepared under the accrual basis. Under this basis revenueis recorded when earned and expenses are recorded when incurred. These basicfinancial statements were difficult for managers to utilize since you could possibly have a high level of income but a low level of cash since under theaccrual basis concept, the revenue was recorded when earned and not when it wasreceived.2.Does net income under accrual basis equate to high levels of cash?
Why?(a)The revenue could be awaiting collection in the form of receivables on the balance sheet(b)Investment is made in plant and equipment will require the use of cash but does not reduce income, since the equipment is an asset. When willthe cost of the equipment acquisition be recovered? The recovery of theinitial acquisition of the equipment begins, and the reduction of incomeoccurs, as the equipment is being depreciated.(c)Cash received could be used to pay for additional inventory.Inventory can remain in stock for up to two months or more, until it issold. Once the inventory is sold, the a receivable is created and thisreceivable can remain outstanding (uncollected) for three months or longer. As a result a company may have to wait five months or longer toturn the initial investment in inventory back into cash when the receivableis collected.(d)Payment of liabilities for general operating expenses. The payment of theliability reduces cash but does not reduce net income when paid.3. Therefore a company could be profitable under accrual basis accounting and havea significant cash flow problem.4.Cash is the necessary element which runs the business. We need to know wherethe cash comes from (sources, or inflows) and where it is spent (uses or outflows).5.Presenting a comparative balance sheet and income statement does not show anydetails of what occurred during the year. All we know is the beginning andending balances. We can derive a net change based upon dollar amount and percentages but the details are not disclosed.1