Introduction to Corporate Finance

Ross et al.: Fundamentals

of Corporate Finance, Sixth

Edition, Alternate Edition

II. Financial Statements

and Long−Term Financial

Planning

3. Working with Financial
   Statements

© The McGraw−Hill^87

Companies, 2002

A little common sense is useful here. A firm uses cash by either buying assets or
making payments. So, loosely speaking, an increase in an asset account means the firm,
on a net basis, bought some assets, a use of cash. If an asset account went down, then,
on a net basis, the firm sold some assets. This would be a net source. Similarly, if a lia-
bility account goes down, then the firm has made a net payment, a use of cash.
Given this reasoning, there is a simple, albeit mechanical, definition you may find
useful. An increase in a left-hand–side (asset) account or a decrease in a right-hand–side
(liability or equity) account is a use of cash. Likewise, a decrease in an asset account or
an increase in a liability (or equity) account is a source of cash.
Looking again at Prufrock, we see that inventory rose by $29. This is a net use be-
cause Prufrock effectively paid out $29 to increase inventories. Accounts payable rose
by $32. This is a source of cash because Prufrock effectively has borrowed an additional
$32 payable by the end of the year. Notes payable, on the other hand, went down by
$35, so Prufrock effectively paid off $35 worth of short-term debt—a use of cash.
Based on our discussion, we can summarize the sources and uses from the balance
sheet as follows:

CHAPTER 3 Working with Financial Statements 55

PRUFROCK CORPORATION TABLE 3.1

Balance Sheets as of December 31, 2001 and 2002

($ in millions)

2001 2002 Change

Assets

Current assets

Cash $84 $98 $14

Accounts receivable 165 188  23

Inventory 393 422  29

Total $ 642 $ 708 $66

Fixed assets

Net plant and equipment $2,731 $2,880 $149

Total assets $3,373 $3,588 $215

Liabilities and Owners’ Equity

Current liabilities

Accounts payable $ 312 $ 344 $32

Notes payable 231 196 
 35

Total $ 543 $ 540 
$3

Long-term debt $ 531 $ 457 
$74

Owners’ equity

Common stock and paid-in surplus $ 500 $ 550 $50

Retained earnings 1,799 2,041  242

Total $2,299 $2,591 $292

Total liabilities and owners’ equity $3,373 $3,588 $215

Company financial

information can be

found many places on

the Web, including

http://www.financials.com,

http://www.equityweb.com,

and http://www.wsrn.com.