64 Part 2 Fundamental Concepts in Financial Management
Here is a line-by-line explanation of the statement shown in Table 3-3:
a. Operating Activities. This section deals with items that occur as part of normal
ongoing operations.
b. Net income. The! rst operating activity is net income, which is the! rst source of
cash. If all sales were for cash, if all costs required immediate cash payments, and
if the! rm were in a static situation, net income would equal cash from operations.
However, these conditions don’t hold; so net income is not equal to cash from
operations. Adjustments shown in the remainder of the statement must be made.
c. Depreciation and amortization. The! rst adjustment relates to depreciation and
amortization. Allied’s accountants subtracted depreciation (it has no amorti-
zation expense), which is a noncash charge, when they calculated net income.
Therefore, depreciation must be added back to net income when net cash " ow
is determined.
d. Increase in inventories. To make or buy inventory items, the! rm must use cash.
It may get some of this cash as loans from its suppliers and workers (payables
and accruals); but ultimately, any increase in inventories requires cash. Allied
increased its inventories by $200 million in 2008. That amount is shown in
parentheses on Line d because it is negative (i.e., a use of cash). If Allied had
reduced its inventories, it would have generated positive cash.
e. Increase in accounts receivable. If Allied chooses to sell on credit, when it makes
a sale, it will not immediately get the cash that it would have received had it
not extended credit. To stay in business, it must replace the inventory that it
sold on credit; but it won’t yet have received cash from the credit sale. So if the
! rm’s accounts receivable increase, this will amount to a use of cash. Allied’sAllied Food Products: Statement of Cash Flows for 2008 (Millions
of Dollars)Tabl e 3 - 32008
a. I. Operating Activities
b. Net income $117.5
c. Depreciation and amortization 100.0
d. Increase in inventories (200.0)
e. Increase in accounts receivable (60.0)
f. Increase in accounts payable 30.0
g. Increase in accrued wages and taxes 10.0
h. Net cash provided by (used in) operating activities ($ 2.5)i. II. Long-Term Investing Activities
j. Additions to property, plant, and equipment ($230.0)
k. Net cash used in investing activities ($230.0)l. III. Financing Activities
m. Increase in notes payable $ 50.0
n. Increase in bonds outstanding 170.0
o. Payment of dividends to stockholders (57.5)
p. Net cash provided by financing activities $162.5q. IV. Summary
r. Net decrease in cash (Net sum of I, II, and III) ($ 70.0)
s. Cash and equivalents at the beginning of the year 80.0
t. Cash and equivalents at the end of the year $ 10.0
Note: Here and throughout the book, parentheses are sometimes used to denote negative numbers.