We prepare a basic, bare-bones funds statement by ( 1 ) determining the amount and direction of net balance sheet changes that occur between two balance sheet dates, (2) classifying net balance sheet changes as either sources or uses of funds, and (3) consolidating this information in a sources and uses of funds statement format. In the first of these steps, we simply place one balance sheet beside the other, compute the changes in the various accounts, and note the direction of change - an increase (+) or decrease (-) in amount. In step 2, each balance sheet item change is classified as either a source or use of funds, as follows:

Sources pf Funds

• Any decrease (-) in an asset item

• Any increase (+) in a claim item (i.e., a liability or shareholders' equity item)

Uses of Funds

• Any increase (+) in an asset item

• Any decrease (-) in a claim item (i.e., a liability or shareholders' equity item)

For example, a reduction in inventory (an asset) would be a source of funds, as would an increase in short-term loans (a claim). An increase in accounts receivable (assets) would be i use of funds, and a reduction in shareholders' equity (claims) - through, for example, a shar; repurchase - would also be a use of funds.

Walks us through the first two steps necessary to produce a funds statement for the Aldine Manufacturing Company, our example in the preceding chapter. The amount and direction of balance sheet changes are determined. Notice that total sources of fund($263,000) equals total uses of funds ($263,000). Because total sources must always equal total uses, it provides a check on our work.