Introduction to Corporate Finance

PArT 1: INTrODuCTION

Two additional points about the classifications in Table 2.4 are worth noting:

1 A decrease in an asset (such as inventory) 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. In contrast, an

increase in inventory (or any other asset) is an outflow of cash, because additional inventory ties up

more of the company’s cash. Similar logic explains why an increase in any liability is an inflow of cash

and why a decrease in any liability is an outflow of cash.

2 Our earlier discussion noted why depreciation and other non-cash charges are considered cash

inflows. Logic suggests that if net income is a cash inflow, then a net loss (negative net profits after

taxes) is a cash outflow. The company must balance its losses with an inflow of cash from, say, selling

off some of its fixed assets (reducing an asset) or increasing external borrowing (increasing a liability).

Can a company have a net loss (negative NOPAT) and still have positive operating cash flow? Yes: as

Equation 2.2 indicates, this can occur when depreciation and other non-cash charges during the

period are greater than the net loss. The statement of cash flows treats net income (or net losses) and

depreciation, and other non-cash charges as separate entries.

At 30 June 2014, Cochlear reported the following

balances, in thousands of dollars, in certain current

asset and liability accounts.

Account 30 June 2014 30 June 2013

Cash and cash equivalents $ 56,127 $ 52,689

Trade and other receivables 214,953 203,748

Inventories 128,613 131,574

Trade and other payables 78,644 81,874

Loans and borrowings 3,141 3,309

If we look at total current asset accounts for Cochlear,

we find they increased during the fiscal year 2013–14,

causing outflows of cash for the company. It may seem

strange to think of an increase in cash balances as a

use of cash, but it simply means that Cochlear used

some of its cash flow to invest in liquid resources. On

the liabilities side, accounts payable decreased and

short-term debt increased, but the overall impact was

a fall, representing higher cash outflows for Cochlear.

Source: Cochlear Annual Report 2014. http://www.cochlear.com/wps/

wcm/connect/6b6bd77e-3708-4b3f-bc90-81a83da03663/ en_

corporate_2014annualreport_ financial_1.88mb. pdf?MOD=AJPERES&CONVERT_

TO=url&CACHEID=6b6bd77e-3708-4b3f-bc90-81a83da03663

example

2-2b DEVELOPING AND INTErPrETING THE STATEMENT OF

CASH FLOWS

Accountants construct the statement of cash flows by using the income statement for a given year along

with the beginning- and end-of-year balance sheets. The procedure involves classifying balance sheet

changes as inflows or outflows of cash; obtaining income statement data; classifying the relevant values

into operating, investment and financing cash flows; and presenting them in the proper format.

Global Petroleum Corporation’s statement of cash flows for the year ended 30 June 2016 appears

in Table 2.5. Note that the statement assigns positive values to all cash inflows and negative values to

all cash outflows. Notice that the calculation of ‘Cash provided by operating activities’ includes more

detail than the OCF calculation in Equation 2.1, and therefore these two measures differ. Notice also

that, in the investment activities section, the statement of cash flows records the increase in gross fixed

assets – rather than net fixed assets – as a cash outflow. Depreciation accounts for the difference between

changes in gross and net fixed assets, but depreciation expense appears in the operating activities section

of the statement. The focus on changes in gross fixed assets avoids double-counting depreciation in the

LO2.2

Why does cash management

matter for the financing of a

company?

thinking cap

question