Business Finance Online

Cash Flow from Assets

The Cash Flow from Assets measures the cash flows generated by the firm's assets. It is also known as the Cash Flow of the Firm. These cash flows will be further categorized as Operating Cash Flow, Capital Spending, and Additions to Net Working Capital. The calculations illustrated on this page will refer to the Balance Sheet and Income Statement which follow.

Balance Sheet ($ in Millions)
Assets 1998 1997 Liabilities and Owners' Equity 1998 1997
Current Assets     Current Liabilities    
Cash 690 600 Accounts Payable 530 460
Accounts Receivable 340 300 Notes Payable 240 240
Inventory 120 100 Total Current Liabilities 770 700
Total Current Assets 1150 1000 Long-Term Liabilities    
      Long-Term Debt 571 710
Fixed Assets     Total Long-Term Liabilities 571 710
Property, Plant, and Equipment 1210 1200 Owners' Equity    
Less Accumulated Depreciation 357 280 Common Stock ($1 Par) 122 120
Net Fixed Assests 853 920 Capital Surplus 218 210
      Retained Earnings 322 180
      Total Owners' Equity 662 510
Total Assets 2003 1920 Total Liab. and Owners' Equity 2003 1920
Income Statement ($ in Millions)
  1998
Sales 1710
Cost of Goods Sold 1100
Administrative Expenses 100
Depreciation 77
Earnings Before Interest and Taxes 423
Interest Expense 50
Taxable Income 373
Taxes 30
Net Income 343
Dividends 201
Addition to Retained Earnings 142

Operating Cash Flow

Operating Cash Flow measures the cash flows generated by the firm's main operations. (In effect, the ability of the firm to sell its products for more than the cost of production.) Operating Cash Flow can be determined as follows:

Operating Cash Flow = EBIT + Depreciation - Taxes

The calculation begins with EBIT (Earnings before Interest and Taxes) because Interest Expense is not a cash flow that operations are dependent upon. Interest Expense reflects how the firm chooses to finance its assets, not its ability to operate them successfully. Depreciation Expense (from the Income Statement) is added back because it is a non-cash expense which was subtracted out in the determination of EBIT. Finally, the taxes which the firm actually paid in cash during the period are subtracted.

Operating Cash Flow Example

Using information from the above Balance Sheet and Income Statement.

Solution:

Operating Cash Flow = $423 + $77 - $30 = $470

 

Capital Spending

Capital Spending reflects the firm's net investment in fixed assets during the period. It can be calculated as follows:

Capital Spending = Ending Net Fixed Assets
  - Beginning Net Fixed Assets
  + Depreciation

In this calculation, Depreciation Expense (from the Income Statement) must be added back because the balance for Ending Net Fixed Assets on the Balance Sheet is reduced by the Depreciation Expense which was incurred during the period.

Capital Spending Example

Using information from the above Balance Sheet and Income Statement.

Solution:

Capital Spending = $853 - $920 + $77 = $10

 

Additions to Net Working Capital

Additions to Net Working Capital measure the firm's investment in Net Working Capital during the period. Net Working Capital (NWC) is defined as Current Assets minus Current Liabilities.

Additions to NWC = Ending NWC - Beginning NWC

Additions to Net Working Capital Example

Using information from the above Balance Sheet and Income Statement.

Solution:

Ending NWC = Ending CA - Ending CL = $1150 - $770 = $380

Beginning NWC = Beginning CA - Beginning CL = $1000 - $700 = $300

Additions to NWC = $380 - $300 = $80

 

Cash Flow from Assets

Once the above items have been determined, the Cash Flow from the Firm's Assets can be calculated as follows:

Cash Flow from Assets = Operating Cash Flow
  - Capital Spending
  - Additions to NWC

A healthy firm would be expected to generate positive cash flow. However, if the firm is young and/or is investing heavily to promote growth, then a negative Cash Flow from the Firm's Assets may be excused.

Cash Flow from Assets Example

Using information from the previous examples.

Solution:

Cash Flow from Assets = $470 - $10 - $80 = $380

 

 

© 2002 - 2010 by Mark A. Lane, Ph.D.