Financial Accounting: An Integrated Statements Approach, 2nd Edition

Chapter 3 Accrual Accounting Concepts 119

experiences negative cash flows from operations, even though it may report net in-

come. In other words, a business must generate positive cash flows from operations

in order to survive. In the case of Family Health Care, the negative cash flows from

operations for November was due in large measure to prepaying insurance premi-

ums of $8,400. Thus, the negative cash flows from operations is temporary for

Family Health Care and not a matter of major concern. This illustrates why the fi-

nancial statements must be analyzed and interpreted together, rather than individ-

ually and why we use the integrated financial statements approach throughout this

text. For example, long-run profitability is best analyzed by focusing on the net in-

come reported under the accrual basis, while the availability of cash to pay debts as

they become due is best analyzed by focusing on the net cash flows from operating

activities.

THE ACCOUNTING CYCLE

The process that begins with analyzing transactions and ends with preparing the ac-

counting records for the next accounting period is called the accounting cycle. The

most important output of the accounting cycle is the financial statements. The basic

steps in the accounting cycle are listed below.

1. Identifying, analyzing, and recordingthe effects of transactions on the accounting
   equation (financial statement accounts).


2. Identifying, analyzing, and recordingadjustment data.


3. Preparingfinancial statements.


4. Preparingthe accounting records for the next accounting period.

The Accounting Cycle

Identifying,

Analyzing,

Recording

Preparing

Financial

Statements

Getting Ready

for the

Next Period

Steps 1 & 2 Step 3 Step 4

Describe the accounting
cycle for the accrual basis
of accounting.

6

We have described and illustrated steps 1–3 in this chapter. In Chapter 4, we com-

plete the discussion of the accounting cycle by describing how the accounting records

are prepared for the next accounting period using closing entries.