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
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
40 Depreciation expense Less: Taxes (rate 70 100
$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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