Question

. Ledger Properties has the following financial information:

	Current Year				Prior Year
Revenues		$	48,915				$	43,610
Administrative expenses			12,106					11,602
Interest expense			816					468
Cost of goods sold			29,715					26,309
Depreciation			1,408					1,387
Net fixed assets			32,711					31,984
Current liabilities			14,652					14,625
Common stock			15,000					14,000
Current assets			16,506					14,687
Long-term debt			12,200					?
Retained earnings			7,365					4,246
Dividends paid			290					275

What is the cash flow of the firm for the current year if the tax rate is 22 percent?

A) $1,885

B) $1,042

C) $2,297

D) $2,096

E) $2,517

Answer 1

Cash flow of the firm means the operating cash flows. Operating Cash Flow is cash generated from normal operations i.e. day to day operations of the firm.

Operating Cash flow = Operating Income ( Gross Income - operating expenses, which include selling, general and administrative expense (S G & A), depreciation and amortization) + Depreciation - Taxes (+/-) Change in Working Capital

Particulars	Current Year ($)	Prior Year ($)
Current Assets	16506	14687
(Less) Current Liabilities	(14652)	(14625)
Net Working Capital	1854	62

Change in Working Capital = Working Capital of Previous Year - Working Capital of Current Year

= $ 62 - $ 1854

= ($1792) i.e. Negative Working Capital

Now, Operating Income / Taxable Income = Revenues - Cost of Goods Sold - Administrative Expenses - Depreciation - Interest Expenses

= $ 48915 - $ 29715 - $ 12106 - $ 1408 - $ 816

= $ 4870

Taxes @ 22% = Taxable Income * Tax Rate = $ 4870 * 22%

= $ 1071.40

= $ 1071 (Approx.)

Net Income = Taxable Income - Tax = $ 4870 - $ 1071 = $ 3799

Now, To calculate the Operating cash flow (OCF), we want to calculate Revenues minus costs, but we don't want to include depreciation because it's not a cash outflow, and we don't want to include interest because it's a financing expense. We do want to include taxes because taxes are (unfortunately) paid in cash which will decrease our cash.

Operating Cash Flows = Net Income + Depreciation + Interest - Change In working (Since Negative)

= $ 3799 + $ 1408 + $ 816 - $ 1792

= $ 4231