Page 110 - Finance for Non-Financial Managers

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The Cash Flow Statement: Tracking the King
ments are expensed over their period of value by periodic
charges to net income, charges that do not require additional
payment of cash. So each monthly charge to income for a por-
tion of prepaid expense is a noncash charge, just like deprecia-
tion, and the company would add it back to net income in the
same fashion.
Of course, in the same month the company might also pay
an insurance premium for the coming year and make a big
cash disbursement that would not be charged to expense, the
opposite of the amortization adjustment above. In this case, it
would reduce net income for cash paid out that was not reflect-
ed in the income statement; this would be a negative adjust-
ment, showing additional outlay of cash beyond what the
income statement contains.
This line in the statement of cash flow is the net of these two
kinds of adjustments. The decrease of $1,500 in Figure 6-2
indicates that the noncash expense for amortization was larger
than any amounts paid out for new prepaid items. As with
accounts receivable, the change in the balance of prepaid
expenses on the balance sheet from beginning to end of month
is a quick way to calculate the net effect of this adjustment on
cash flow.
Decrease in Inventory
You may be able to visualize this one without too much effort. If
Wonder Widget purchased only the merchandise it sold during
the month—sort of the way Dell Computer tries to do it—it
would need to keep essentially no inventory of goods on hand.
Since that doesn’t work for most companies—and even Dell has
some inventories—the change in inventory balances works on
the cash account just like accounts receivable.
Remember: the income statement includes the cost of all
inventory sold during the month. The inventory adjustment on
the statement of cash flow is needed only if the beginning
inventory balance changed by the end of the month, indicating
the company purchased inventory it didn’t sell during the month