Corporate Finance 2.4

Formula for operating cash flow

Earnings before interest and taxes + Depreciation - Taxes = Operating cash flow

Change in net working capital equation

Ending NWC - Beginning NWC = Change in NWC

The net capital spending equation

Ending net fixed assets - Beginning net fixed assets + Depreciation = Net capital spending

Change in net working capital

It measures as the net change in current assets relative to current liabilities for the period being examined and represents the amount spent on net working capital.

Operating cash flow

It refers to the cash flow that results from the firm's day-to-day activities of producing and selling. Expenses associated with the firm's financing of its assets are not included because they are not operating expenses.

Capital spending

It refers to the net spending on fixed assets (purchases of fixed assets less sales of fixed assets).

Could net capital spending be negative?

The answer is yes. this could happen if the firm sold off more assets than it purchased. The net here refers to purchases of fixed assets net of any sales of fixed assets.

Cash Flow

The difference between the number of dollars that came in and the number that went out.

Cash flow to creditors is sometimes called...

cash flow to bondholders.

Cash flow from assets involves three components:

1). Operating cash flow 2). Capital spending 3). Change in net working capital

It wouldn't be at all unusual for a growing corporation to have a negative cash flow.

A negative cash flow means that the firm raised more money by borrowing and selling stock than it paid out to creditors and stockholders during the year.

Free cash flow

Another name for cash flow from assets. "Free" refers to cash that the firm is free to distribute to creditors and stockholders because it is not needed for working capital or fixed asset investments.

The cash from the firm's assets must equal the sum of the cash flows to creditors and the cash flow to stockholders (or owners):

Cash flow from assets = cash flow to creditors + Cash flow to stockholders. This is the cash flow identity.

Cash flow from assets equation

Operating cash flow - Net capital spending - Change in NWC = Cash flow from assets. The total cash from from assets is give n by operating cash flow less the amounts invested in fixed assets and net working capital.

You will often see capital spending called CAPEX, which is an...

acronym for capital expenditures. It usually means the same thing.

Operating cash flow is not the same as net income because...

depreciation and interest are subtracted out when net income is calculated. We don't subtract these out in computing operating cash flow because depreciation is not a cash expense and interest paid is a financing expense, not an operating expense.

Calculation for stockholders is...

dividends paid less net new equity raised. Dividend paid - New equity raised = Cash flow to stockholders

Calculation for cash flow to creditors is...

interest paid less net new borrowing. Interest paid - Net new borrowing = Cash flow to creditors.

As the firm changes its investment in current assets,...

its current liabilities will usually change as well. to determine the change in net working capital, the easiest approach is just to take the difference between the beginning and ending net working capital (NWC) figures.

The cash flow is negative primarily because of a...

large investment in fixed assets. If these are good investment, the resulting negative cash flow is not a worry. Also, the company raised more money in the form of new debt and equity than it paid out for the year.

Net capital spending is just...

money spent on fixed assets less money received form the sale of fixed assets.

Operating cash flow is an important number because it tell us...

on a very basic level, whether a firm's cash inflows from its business operations are sufficient to cover its everyday cash outflows. For this reason, a negative operating cash flow is often a sign of trouble.

The cash flow identity means that...

the cash flow from the firm's assets is equal to the cash flow paid to suppliers of capital to the firm. What it reflects is the fact that a firm generates cash through it s various activities, and that cash is either used to pay creditors or paid out to the owners of the firm.

The cash flows to creditors and stockholders represent...

the net payments to creditors and owners during the year.

To calculate operating cash flow (OCF),

we want to calculate revenues minus costs, but we don't want to include depreciation because it's not a cash outflow, and we don't want to include interest because it's a financing expense. We do want to include taxes because taxes are (unfortunately) paid in cash.