Page 108 - Finance for Non-Financial Managers

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The Cash Flow Statement: Tracking the King
Add Back Depreciation
Do you remember the way equipment and other assets are
charged to expense? Depreciation—the gradual charging of the
cost to expense over their useful life, as discussed in Chapter
5—is recorded each month after the asset is put into use, yet no
cash changes hands as a result of those depreciation entries,
because the cash was all paid out when the asset was bought.
So the monthly charge for depreciation expense must be
removed from reported net income, in effect increasing income
by the $7,500 that had no effect on cash. (We call these non-
cash items.) So depreciation expense is always added back to
net income, usually as the first adjustment on this report.
Increase in Accounts Receivable
Some of the customer balances Wonder Widget had at the
beginning of the month were collected during the month and
some were not. Similarly, some of the sales made during the
month were paid for by their customers, although typically
credit sales on 30-day terms would not (retail cash businesses
aside, of course). At the end of the month, the company had
some of the opening customer balances still outstanding, as
well as some of the new balances.
Look at this another way. If all their opening customer bal-
ances and all sales during the month were collected in cash,
there would be no ending accounts receivable and the month’s
cash receipts from customers would be equal to their opening
balances plus sales. However, since there were still outstanding
balances at the end of the month, the amount of cash they took
in must be reduced by those outstanding balances. Here it is as
a formula:
beginning accounts receivable + sales – ending accounts receivable =
cash collections
But remember that sales are all included in net income; this
adjustment is to show how much of the period’s sales must be
removed from the presumption of cash flow because the cash