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Operating cash flow

$547

U.S. Corporation thus had a 2002 operating cash flow of $547.

PART ONE Overview of Corporate Finance

Operating cash flow is an important number because it tells us, on a very basic level, whether or not 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.

There is an unpleasant possibility of confusion when we speak of operating cash flow. In accounting practice, operating cash flow is often defined as net income plus depreciation. For U.S. Corporation, this would amount to $412 + 65 = $477.

The accounting definition of operating cash flow differs from ours in one important way: interest is deducted when net income is computed. Notice that the difference between the $547 operating cash flow we calculated and this $477 is $70, the amount of interest paid for the year. This definition of cash flow thus considers interest paid to be an operating expense. Our definition treats it properly as a financing expense. If there were no interest expense, the two definitions would be the same.

To finish our calculation of cash flow from assets for U.S. Corporation, we need to consider how much of the $547 operating cash flow was reinvested in the firm. We consider spending on fixed assets first.

Capital Spending Net capital spending is just money spent on fixed assets less money received from the sale of fixed assets. At the end of 2001, net fixed assets for U.S. Corporation (Table 2.1) were $1,644. During the year, U.S. wrote off (depreciated) $65 worth of fixed assets on the income statement. So, if the firm didn't purchase any new fixed assets, net fixed assets would have been $1,644 - 65 = $1,579 at year's end. The 2002 balance sheet shows $1,709 in net fixed assets, so U.S. must have spent a total of $1,709 - 1,579 = $130 on fixed assets during the year:

Ending net fixed assets

$1,709

- Beginning net fixed assets

1,644

+ Depreciation

0 0

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