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Because we are interested in the combined effects of investment, operating, and financing decisions, analyzing both the income statement for the period and the balance sheets at the beginning and the end of the period together provides more basic insights than either statement alone. Management decisions not only affect the profit for the period, but cause accompanying changes in most assets and liabilities, particularly in the accounts making up working capital, such as cash, receivables, inventories, and current payables. The statement that captures both the current operating results and the accompanying changes in the balance sheet is the cash flow statement, statement of cash flows, or funds flow statement. It gives us a dynamic picture of the ultimate changes in cash resulting from the combined decisions made during a given period.
The statement is prepared by comparing beginning and ending balance sheets and using key items of the income statement for the period, all interpreted in terms of uses and sources of cash:
•    Cash generated by profitable operations or drained by unprofitable results.
•    Cash impact of changes in working capital requirements.
•    Commitments of cash to invest in assets or to repay liabilities.
•    Raising of cash through additional borrowing or by reducing asset investments.
•    Cash impact of issuance of new shares or repurchase of shares.
•    Cash impact of dividends paid.
•    Adjustments for accounting allocations, write-offs, and other noncash elements in the income statement and the balance sheets.
•    Net impact of the period’s cash movements on the company’s cash balance.
The cash flow statement thus offers a ready overview of the combined cash impact of all management decisions during the period. The user can judge both the magnitude and the relationships of these cash movements, such as the company’s ability to fund investment needs from operational results, the magnitude and appropriateness of financing changes, and disproportional movements in working capital needs. Observing the cash flow patterns can stimulate questions about the effectiveness of management strategies as well as the quality of operational decisions. The amount of detail can vary widely, depending on the nature of the business and the different types of movements emphasized.
In the past, basic formats for these statements differed widely as well. In more recent times, the FASB and SEC required that all published cash flow statements follow a common format, listing uses and sources by the familiar three decision areas: investments, operations, and financing. This rule recognized the usefulness of this arrangement in understanding the dynamics of the business system, as described earlier.
One aspect of the cash flow statement that requires some explanation is the treatment of accounting write-offs. From a cash flow standpoint, write-offs such as depreciation and amortization merely represent bookkeeping entries that have no effect on cash. The reason is simply that the assets being amortized by these entries represent cash that was committed in past periods. Consequently, the write-off categories, insofar as they had reduced net profit, must be added back here as a positive cash flow, thus restoring the cash generated by operations to the original level before the write-off was made. The reader will recall that we recognized the cash flow implications of the depreciation effect in the earlier discussion of the business system.
The cash flow statement has the same inherent limitations as the balance sheet and the income statement, because it’s derived from the accounting data contained in these statements. However, because it focuses on the changes incurred during the period, the limitations due to historical valuation are usually not significant. However, we must remember that by displaying the net change from the beginning to the end of the chosen period in each asset, liability, and owner- ship account reported, the statement might “bury” major individual transactions that occurred during the period and perhaps offset each other. Normally, however, material transactions of this kind (such as major investments, acquisitions, or divestitures) are noted specifically in the company’s cash flow statement. The statement therefore affords the user the most detailed picture of the impact of major events of the period.

When economists analyze the firm’s costs, they often present a highly mechanical- some would say unrealistic- view that doesn’t take into account the subjective nature of costs and the uncertainty about the future payoffs of many choices decision makers really face.
It is important to keep in mind that costs are incurred when choices are made.
When business decision makers choose to purchase raw materials, hire new employees, or renew the lease on a plant, they incur costs. All these decisions, like other choices, must be made under conditions of uncertainty. Of course, past experience can help business decision makers anticipate the likely costs of various decisions. But the world is constantly changing; the future may differ substantially from the past.
Opportunity costs are expected costs- they represent the highest valued option that the decision maker expects to give up as the result of a choice. Think for a moment of what the cost curves developed in this series of posts really mean. The firm’s short-run MC curve represents the opportunity cost of expanding output, given the firm’ s current plant size. The firm’s long-run ATC curve represents the opportunity cost per unit of output associated with varying plant sizes and rates of output, given that the alternative plants are still on the drawing board. Opportunity costs look forward, reflecting expectations of what will be forgone as a result of current decisions. At the time decisions must be made, neither the short-run MC nor the long-run ATC can be determined from accounting records, since accounting costs look backward. Accounting figures yield valuable information about historical costs, but, as the following section illustrates, they must be interpreted carefully when they are used to forecast future costs.