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CH8 Process Engineering Economics - James R. Couper

CH8 Process Engineering Economics - James R. Couper - 8...

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8 Cash Flow Concept The term cash flow is in common use today in the news media and in company financial statements. Much confusion has arisen over the definition and use of cash flow. Cash flow may be expressed on the basis of before taxes or after taxes but the basis must be stated. The after-tax cash flow is defined as net income (profit) after taxes plus depreciation and depletion. Accountants use the concept of funds or money flow that includes cash flow and other noncash items . Cash flow is important to people preparing financial and engineering cost analyses. For an engineer to be able to prepare economic evaluations of ventures or projects, it is necessary to identify the sources of cash flow and the disposition of monies. Simple diagrams analogous to the flow of materials through a process may be used to illustrate the cash flow concept. The diagrams and discussion leading to the cash flow model may be found in Figures 8.1 to 8.3. 8.1 CASH FLOW MODEL A cash flow model can be developed similar to the process flow model in Figure 8.1 [1]. In this figure, raw materials are charged into a process and finished goods exit. So, too, revenue from sales and intellectual property is fed into the operation and, if cash operating expenses are deducted, operating income results. Figure 8.2 illustrates this process [1,2]. In any industrial process, it is essential to have a supply of funds available to meet the demands of current expenses. These funds, called working capital , are used to purchase raw materials, pay wages and salaries as well as other operating expenses. In this model, Figure 8.3, although working capital is charged into an
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operation at start-up, it is replenished from revenue or sales. Over a period of time, a dynamic equilibrium is established and the net flow of working capital into and out of an operation is zero, with none of it going into net annual operating expenses or operating income. If the above concept is expanded to include a company’s entire operation, a money flow diagram can be developed to demonstrate the sources and movement of cash flow. One should recognize that the money flow diagram in Figure 8.4 has been idealized [3,4]. Let’s examine this diagram more closely. If the cash operating expenses are subtracted from the sales or revenue , the result is the operating income . If depreciation and depletion are then subtracted from then operating income, the gross profit is the result. Since depreciation is an allowance, it is handled as an annual operating expense by tax laws and appears as an expense item on annual operating expense reports. Depreciation then is considered as an internal expense and it is retained in the company. When income taxes are subtracted from gross profit net income after taxes results. If depreciation and depletion are added to the net income after taxes, after-tax cash flow occurs. It is customary to separate depreciation from net income after taxes because a part of the net income may leave the company.
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