The operating flows are cash inflows and outflows

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Unformatted text preview: e cash inflows and outflows directly related to sale and production of the firm’s products and services. Investment flows are cash flows associated with purchase and sale of both fixed assets and business interests. Clearly, purchase transactions would result in cash outflows, whereas sales transactions would generate cash inflows. The financing flows result from debt and equity financing transactions. Incurring (or repaying) either short-term or longterm debt would result in a corresponding cash inflow (or outflow). Similarly, the sale of stock would result in a cash inflow; the payment of cash dividends or repurchase of stock would result in a financing outflow. In combination, the firm’s operating, investment, and financing cash flows during a given period affect the firm’s cash and marketable securities balances. Classifying Inflows and Outflows of Cash The statement of cash flows in effect summarizes the inflows and outflows of cash during a given period. Table 3.3 classifies the basic inflows (sources) and outflows (uses) of cash. For example, if a firm’s accounts payable increased by $1,000 during the year, the change would be an inflow of cash. If the firm’s inventory increased by $2,500, the change would be an outflow of cash. A few additional points can be made with respect to the classification scheme in Table 3.3: noncash charge An expense deducted on the income statement but does not involve the actual outlay of cash during the period; includes depreciation, amortization, and depletion. 1. A decrease in an asset, such as the firm’s cash balance, is an inflow of cash, because cash that has been tied up in the asset is released and can be used for some other purpose, such as repaying a loan. On the other hand, an increase in the firm’s cash balance is an outflow of cash, because additional cash is being tied up in the firm’s cash balance. 2. Depreciation (like amortization and depletion) is a noncash charge—an expense that is deducted on the income statement but does not involve the actual outlay of cash during the period. Because it shields the firm from taxes by lowering taxable income, the noncash charge is considered a cash inflow. From a strict accounting perspective, adding depreciation back to the firm’s net profits after taxes gives cash flow from operations: Cash flow from operations Net profits after taxes TABLE 3.3 Depreciation and other noncash charges The Inflows and Outflows of Cash Inflows (sources) Outflows (uses) Decrease in any asset Increase in any asset Increase in any liability Decrease in any liability Net profits after taxes Net loss Depreciation and other noncash charges Dividends paid Sale of stock Repurchase or retirement of stock (3.1) CHAPTER 3 Cash Flow and Financial Planning 103 Note that a firm can have a net loss (negative net profits after taxes) and still have positive cash flow from operations when depreciation (and other noncash charges) during the period are greater than the net loss. In the statement of cash flows, net profits after taxes (or net losses) and depreciation (and other noncash charges) are therefore treated as separate entries. 3. Because depreciation is treated as a separate cash inflow, only gross rather than net changes in fixed assets appear on the statement of cash flows. This treatment avoids the potential double counting of depreciation. 4. Direct entries of changes in retained earnings are not included on the statement of cash flows. Instead, entries for items that affect retained earnings appear as net profits or losses after taxes and dividends paid. Preparing the Statement of Cash Flows The statement of cash flows for a given period is developed using the income statement for the period, along with the beginning- and end-of-period balance sheets. The income statement for the year ended December 31, 2003, and the December 31 balance sheets for 2002 and 2003 for Baker Corporation are given in Tables 3.4 and 3.5, respectively. The statement of cash flows for the year TABLE 3.4 Baker Corporation Income Statement ($000) for the Year Ended December 31, 2003 Sales revenue $1,700 Less: Cost of goods sold Gross profits 1,000 $ 700 Less: Operating expenses Selling expense $ General and administrative expense Lease expensea Total operating expense Earnings before interest and taxes (EBIT) Less: Interest expense Net profits before taxes 40%) Net profits after taxes Less: Preferred stock dividends Earnings available for common stockholders Earnings per share (EPS)b aLease 120 40 Depreciation expense Less: Taxes (rate 70 100 330 $ 370 70 $ 300 120 $ 180 10 $ 170 $1.70 expense is shown here as a separate item rather than included as interest expense as specified by the FASB for financialreporting purposes. The approach used here is consistent with taxreporting rather than financial-reporting procedures. bCalculated by dividing the earnings available for common stockholders by the number of shares of common stock outstanding ($170,000 100,000 shares $1.70 per share). 104 PART 1 Introdu...
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This document was uploaded on 01/19/2014.

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