Financial Cash Flow Concepts Cash Flow from Assets Cash Flow to Investors Financial Cash Flow Equations Tools & Problems Financial Cash Flow Exercise Financial Cash Flow Quiz

## 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.