Principles of Managerial Finance

102 PART 1 Introduction to Managerial Finance

TABLE 3.3 The Inflows and Outflows of Cash

Inflows (sources) Outflows (uses)

Decrease in any asset Increase in any asset

Increase in any liability Decrease in any liability

Net profits after taxes Net loss

Depreciation and other noncash charges Dividends paid

Sale of stock Repurchase or retirement of stock

operating flows
Cash flows directly related to
sale and production of the firm’s
products and services.

investment flows
Cash flows associated with
purchase and sale of both fixed
assets and business interests.

financing flows
Cash flows that result from debt
and equity financing transac-
tions; includes incurrence and
repayment of debt, cash inflow
from the sale of stock, and cash
outflows to pay cash dividends or
repurchase stock.

noncash charge
An expense deducted on the
income statement but does not
involve the actual outlay of cash
during the period; includes
depreciation, amortization, and
depletion.

inflowsand decreased by cash outflows.Also note that the firm’s cash flows can

be divided into (1) operating flows, (2) investment flows, and (3) financing flows.

The operating flowsare cash inflows and outflows directly related to sale and

production of the firm’s products and services. Investment flowsare cash flows

associated with purchase and sale of both fixed assets and business interests.

Clearly, purchase transactions would result in cash outflows, whereas sales trans-

actions would generate cash inflows. The financing flowsresult from debt and

equity financing transactions. Incurring (or repaying) either short-term or long-

term debt would result in a corresponding cash inflow (or outflow). Similarly, the

sale of stock would result in a cash inflow; the payment of cash dividends or

repurchase of stock would result in a financing outflow. In combination, the

firm’s operating, investment, and financing cash flows during a given period

affect the firm’s cash and marketable securities balances.

Classifying Inflows and Outflows of Cash

The statement of cash flows in effect summarizes the inflows and outflows of

cash during a given period. Table 3.3 classifies the basic inflows (sources) and

outflows (uses) of cash. For example, if a firm’s accounts payable increased by

$1,000 during the year, the change would be an inflow of cash.If the firm’s

inventory increased by $2,500, the change would be an outflow of cash.

A few additional points can be made with respect to the classification scheme

in Table 3.3:

1. A decreasein an asset, such as the firm’s cash balance, 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. On the other hand, an increase
   in the firm’s cash balance is an outflow of cash,because additional cash is
   being tied up in the firm’s cash balance.


2. Depreciation (like amortization and depletion) is a noncash charge—an ex-
   pense that is deducted on the income statement but does not involve the
   actual outlay of cash during the period. Because it shields the firm from taxes
   by lowering taxable income, the noncash charge is considered a cash inflow.
   From a strict accounting perspective, adding depreciation back to the firm’s
   net profits after taxes gives cash flow from operations:
   Cash flow from operations
   Net profits after taxesDepreciation and other noncash charges (3.1)