Basic Concepts of Cash Flows and Income Statements PDF

BASIC CONCEPTS OF CASH FLOWS AND INCOME STATEMENTS Exercise 1 Outflow, but no expense (1): A cash purchase of a new production machine is a ca...

BASIC CONCEPTS OF CASH FLOWS AND INCOME STATEMENTS Exercise 1 Outflow, but no expense (1): A cash purchase of a new production machine is a cash outflow, but no expense. By definition, expenses must result in a decrease in equity. The purchase of a new machine is just the exchange of cash (a current asset) for a non-current asset (machine). This is not considered an expense. Outflow and expense (2): Most expenses are also cash outflows. A good example is a salary payment, i.e., a cash transfer from the company account to an employee's private account. Non-cash expenses (3): Non-cash expenses are expenses that are not related to cash. A common non-cash expense is depreciation. For example, suppose an asset with a five-year life and no resale value is purchased for !1,000. According to accountants, the !1,000 cost must be expensed over the useful life of the asset. If straight-line depreciation is used, there will be five equal instalments, and !200 of depreciation expense will be incurred each year. Non-operating expense (4): A non-operating expense is a business expense unrelated to core operations. Example: If a company sells a building, and it's not in the business of buying and selling real estate, the sale of the building is a non-operating activity. If the building were sold at a loss, the loss is considered a non-operating expense. Operating costs (5): Operating costs include both costs of goods sold (COGS) and other operating expenses—often called selling, general, and administrative (SG&A) expenses. COGS is based only on the costs that are directly utilized in producing a revenue, such as the company’s inventory or labor costs that can be attributed to specific sales. SG&A expenses are incurred in day-to-day business operations and may be required as part of operating any type of business. Imputed costs (6): Imputed costs are hidden costs as they are not explicit and, therefore, do not appear on financial statements. Example: A company owns cash that earns only 2.50% interest in a money market account. Meanwhile, alternative risk-free securities are yielding 3.00%. The imputed cost is 0.50%. Sources: Investopedia; Hillier et al. (2020), p. 62 11