Here we have two balance sheets one at the end of year 1 and the other at the end of year 2.

And we can see that there has been an increase in cash of 15.

So our cash flow statement for year two would show a net cash inflow of 15.

What we want to know is why cash has increased by 15. Where does that increase come from? We are going to reconcile this change in cash to the changes in the various balance sheet items.

What does the change in each of the balance sheet items mean for cash flow? First up, let's look at accounts receivable.

We can see that there has been an increase of 5 from you one to your two.

That is bad for cash.

My customers owe me more money. Meaning that I have received less cash from my sales.

So that would be a cash outflow or a decrease in cash.

Next we see that inventory has increased by 20.

Again, this is bad for cash.

20 more of my cash has been tied up or invested in infantry so that 20 would be a cash outflow.

Moving on to the liability and equity items on the balance sheet date has increased by 20 from 240 to 260.

This means we must have borrowed more i.e. received cash from the bank or another lender.

That is good for cash flow and represents an increase in cash of 20 and last we have share capital which we can see has increased from 400 to 420. So an increase of 20 again, this is good for cash.

An increasing share capital means we have received more money from shareholders.

So to sum up we have a decrease in cash of 5 relating to accounts receivable.

A decrease of 20 relating to inventory so we are down 25 so far, but then we have an increase of 20 relating to debt. So now we are only down five and a further increase of 20 relating to share capital.

Getting us to a net increase in cash of 15.

So we ended year one with a cash balance of 360.

We have had a net increase of cash of 15 for year two which results in a cash balance at the end of your two of 360 plus 15, which is 375.

Something you may have noticed is that an increase in an asset item is bad for cash.

While an increase in a liability or equity item is good for cash.

And the opposite also holds true a decrease in an asset item is good for cash cash has been released from being tied up in that asset and a decrease in a liability or equity account is bad for cash.