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Chapter 10 — CASH FLOW FROM OPERATING ACTIVITIES
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CASH FLOW FROM OPERATING ACTIVITIES

CASH FLOW FROM OPERATING ACTIVITIES

Cash Flows from Operating Activities includes all of the operating activities that are used to describe the income from operating activities.

Cash Flow from Operating Activities

The key difference is that the cash flow statement strips away “paper earnings” and only shows the money. It is calculated like this:

  • Cash Flow from Operating Activities = Net Income + Non-Cash Expenses + Changes in Working Capital

Net Income is the starting point. This number is taken directly out of the Income Statement. Non-Cash items such as Depreciation and Amortization are added back because these are “paper” expenses and not cash expenses. 

Working Capital (also known as Net Current Assets) is described as the money that the company has available to “work” with. It is calculated by taking the following metrics from the balance sheet:

  • Current assets - current liabilities = Working Capital  

The change in Working Capital is what gets added back in. The general rule for changes in working capital is that if the current assets increase, then cash flows from operations will decrease (and the reverse). If current liabilities increase, then cash flows from operations will increase (and the reverse).

When all of these adjustments are completed, what is left over is cash flow from operating activities. It can be used as a complement to net income from operating activities. If the numbers are significantly different, then there may be cause for concern. For example, a firm could show very large income from operating activities, but in reality have most of those sales come from customers that promise to pay later (an increase in accounts payable, which are current assets).

 

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