CHAPTER 3 Cash Flow and Financial Planning 107Looking at Equation 3.4, we can see that if the depreciation during a year is less
than the decreaseduring that year in net fixed assets, the NFAI would be nega-
tive. A negative NFAI represents a net cash inflowattributable to the fact that the
firm sold more assets than it acquired during the year.
The net current asset investment (NCAI)represents the net investment made
by the firm in its current (operating) assets. “Net” refers to the difference
between current assets and spontaneous current liabilities, which typically
include accounts payable and accruals. Because they are a negotiated source of
short-term financing, notes payable are not included in the NCAI calculation.
Instead, they serve as a creditor claim on the firm’s free cash flow. Equation 3.5
shows the NCAI calculation.
NCAIChange in current assetsChange in spontaneous
current liabilities (Accounts payableAccruals) (3.5)EXAMPLE Looking at the Baker Corporation’s balance sheets for 2002 and 2003 in Table
3.5, we see that the change in current assets between 2002 and 2003 is$100
($2,000 in 2003$1,900 in 2002). The difference between Baker’s accounts
payable plus accruals of $800 in 2003 ($700 in accounts payable$100 in
accruals) and of $700 in 2002 ($500 in accounts payable$200 in accruals) is
$100 ($800 in 2003$700 in 2002). Substituting into Equation 3.5 the
change in current assets and the change in the sum of accounts payable plus
accruals for Baker Corporation, we get its 2003 NCAI:
NCAI$100$100$0
This means that during 2003 Baker Corporation made no investment ($0) in its
current assets net of spontaneous current liabilities.
Now we can substitute Baker Corporation’s 2003 operating cash flow (OCF)
of $350, its net fixed asset investment (NFAI) of $300, and its net current asset
investment (NCAI) of $0 into Equation 3.3 to find its free cash flow (FCF):
FCF$350$300$0$50
We can see that during 2003 Baker generated $50,000 of free cash flow, which it
can use to pay its investors—creditors (payment of interest) and owners (pay-
ment of dividends). Thus, the firm generated adequate cash flow to cover all of
its operating costs and investments and had free cash flow available to pay
investors.
Further analysis of free cash flow is beyond the scope of this initial introduc-
tion to cash flow. Clearly, cash flow is the lifeblood of the firm. We next consider
various aspects of financial planning for cash flow and profit.Review Questions
3–1 Briefly describe the first four modified accelerated cost recovery system
(MACRS) property classes and recovery periods. Explain how the de-
preciation percentages are determined by using the MACRS recovery
periods.
3–2 Describe the overall cash flow through the firm in terms of operating
flows, investments flows, and financing flows.