Chapter 2 Cash Flow Identities 1

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3 What Is The Essence Of Each Side? Asset = Debt + Equity Use of CashSource of Cash

4 Cash Flow Cash in Cash out Cash flow ≠ Net Income (Profit or Earnings) Throughout this textbook and the study of financial management, cash flow will be fundamental Therefore, we will have to be able to derive cash flow from the information on the balance sheet and the income statement We will look at how cash is generated from utilizing assets and how it is paid to those that finance the purchase of the assets

5 How To Determine A Firm’s Cash Flow From Its Financial Statements Cash flow identity: More 

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7 Notes On Identities: Operating cash flow = Cash flow from day to day activities – Don’t include interest payments because that goes to bondholders (it properly is a financing expense – different than accountant CFO) – Add back the noncash expense, depreciation – Taxes are paid in cash Capital spending = net spending on fixed assets (purchases - sales) – Add depreciation back because the net amount has it subtracted out Change in NWC – CA – CL in beginning and ending period, then take the difference

8 Notes On Identities: Net new borrowing = (End long-term debt) – (beg LTD) Net new equity raised = (End common stock & Paid-in surplus) – (end CS & PIS) Amounts in calculations can be positive or negative – A negative cash flow from assets may indicate that a firm is buying profitable assets! – A negative amount from change in NWC, could mean that firm is managing inventory or receivables or payables more efficiently! – A negative amount to stockholders could mean that the firm issued an amount of new stock that is more than dividends paid! Handout #3 

9 Handout #3

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