The Cash Flow Statement is relatively easy to prepare. It is better to use logic and "common sense" to understand what is happening and how information should be presented in this statement. 

The Income Statement and Balance Sheet are both prepared using Accrual Accounting. This involves making a combination of adjustments to the books, including accruals, deferrals, apportioning costs such as depreciation, and charging Income with future expenditure such as warranty claims and post-retirement benefits. Every time we make an adjustment in the books and records, the resulting financial statements comply with accrual accounting, but are also farther away from cash accounting.

Before 1987 we prepared a third financial statement called the Statement of Changes in Financial Position. This was generally prepared on a Working Capital basis, but could also be prepared on a Cash Flow basis. 

In 1987 FASB mandated the use of the Cash Flow Statement, in place of the Statement of Changes. The Statement of Cash Flows removes all accruals, deferrals and other non-cash adjustments, and provide investors and creditors with information about a company's Sources and Uses of Cash. An Income Statement might show a Profit or a Loss, but that says nothing about how the company's Management managed the company's money.

Today this is more important than every. Managers are frequently caught "cooking the books," hiding losses and liabilities, overstating or understating Income, all for the purpose of influencing the market price of company stock. Managers frequently benefit personally from increases in company stock prices, so there is a high incentive for these people to manipulate information.

The Cash Flow Statement is fairly simple.There are only 3 sections, which report Increases and Decreases in Cash. The sections are always presented in the following order.

Operating Cash Flows - 
Inflows - Money received from customers for sales of products or services.
Outflows - Money paid to suppliers, employees, etc. for normal business expenses.

Investing Cash Flows - 
Inflows - Money received from selling assets, including land, buildings equipment, stocks, bonds. Money received from loans made to others, such as Notes Receivable.
Outflows - Money paid to purchase assets; and money paid out to make loans to others.

Financing Cash Flows - 
Inflows - Money received from stockholders purchasing company stock, from bondholders for bonds payable, and money borrowed from banks and other creditors.
Outflows - Money paid to stockholders for dividends, to bondholders, banks and other creditors.

The Statement of Cash Flows also reconciles the Cash balance from the beginning to end of the year. The beginning and ending Cash balances can be found on the Balance Sheet. 
 

Direct and Indirect Method
There are 2 ways to present the Statement of Cash Flows - Direct and Indirect. Your textbook presents the Direct Method. The Indirect Method is illustrated in the appendix at the end of the chapter. FASB recommends the use of the Direct Method. A recent survey of company shows the following:
 

Companies using the Direct Method	5%
Companies using the Indirect Method	95%

Despite these statistics, most accounting textbooks teach the Direct Method.You should also note that when the Direct Method is used, the statement must also include a supplemental calculation of Operating Cash Flows using the Indirect Method. Accountants should be able to do both methods.

Preparing the Statement of Cash Flows
I generally include the cash flow worksheet as part of my 13-column trial balance worksheet. I use the space in the far right side of the trial balance worksheet to analyze cash flows for all accounts. Calculate the difference between the beginning and ending balances for all accounts, and determine if the change reflects an increase or decrease in cash flow. Mark each account with and O for Operating cash flows, I for Investing cash flows and F for Financing cash flows. 

Next lay out the general format of the statement on a piece of paper or spreadsheet. I generally identify the Investing and Financing activites first, and put them in the appropriate place. There should only be a few items that fall in these categories. Most of the accounts will be Operating activities. These include all Income and Expense accounts - the majority of accounts on the trial balance.

You may need to look at a few Ledger accounts. For instance, the company may have purchased Land and also sold Land in the same year. The purchases would be outflows of cash, and recorded as Debits in the Land account. Sales would be inflows of cash, and recorded as Credits in the Land account.
 
 

Let's analyze the Land account
 

Beginning balance	100,000
Ending balance	110,000
Increase in Land	10,000

If the Land was sold and purchased for Cash, there would be a net decrease in Cash of $10,000, but really we have an Outflow of $30,000 for the purchase of Land, and an Inflow of $20,000 from the sale of Land.

Let's assume the Cash account looks like this for these transactions....

The Investing section of the Cash Flow statement would look like this:

Investing Cash Flows

Cash Inflows:
Sale of Land	$20,000
Cash Outflows:
Purchase of Land	(30,000)
Net Cash used for Investing activities		$(10,000)

 

Analyzing the Cash Flow Statement
Analyzing cash flows is an important part of financial statement analysis. Here are some important things to look for:

1. There should be a net Increase in Cash from Operating Activities. If operations don't produce positive cash flows, the business will soon be in trouble. Without adequate operating cash flows, the company may have to dip into cash reserves or sell investments to meet regular payment of expenses. 

2. If a company shows net Increase in Investing Cash Flows, it means they are selling off assets. That is generally not a good sign. I would also look to see if teh company was posting losses and had negative cash flows from Operating activities. This might indicate that Management is selling off assets to pay bills. More analysis is needed in this case.