Question

Hi-Tech, Inc., reports net income of $51.0 million. Included in that number are depreciation expense of $4.1 million and a loss on the sale of equipment of $1.9 million. Records reveal increases in accounts receivable, accounts payable, and inventory of $1.1 million, $2.1 million, and $3.1 million, respectively. What are Hi-Tech's net cash flow from operating activities?

Answer 1

Answer:

The net cash flows from operating activities is $54.9 million computed as below:

Explanation:

Hi-Tech Corporation

Cash flows from Operating Activities

Net Income                                        51.0

Depreciation                                         4.1

Loss on disposal of equipment          1.9

Increase in receivable                          (1.1)

Increase in payable                          2.1

Increase in inventory                         (3.1)

Net CF from Operating Activities 54.9

The major is here is that in determining the cash flows from operating activities, the net income is adjusted for the impacts of non cash items  by:

1. adding back depreciation and/or amortization, loss on sale of fixed assets, increase in provision and impairment of assets (if any),
2. deducting gains on sale of fixed assets, decrease in provisions and reversal of impairment of assets.

Thereafter, movement in working capital is considered as follows:

1. Deduct Increase/add decrease in current assets (receivables and payable),
2. Add increase/less decrease in payable.

The essence of making these adjustments are that they have have inverse relationship between net income computation and cash flows. For example, while depreciation is deducted to arrive at net income, depreciation does not involvement in cash, hence depreciation charge should be added back to arrive at cash flow from operating activities.

Regarding movement in working capital, an increase in receivable means that the reporting entity have sold its goods or services without collection cash, thus tieing down its cash resources. The same can be said of inventory where the increase in inventory means that the entity have let out cash in stocking up inventory thus reducing its cash inflow or increasing its cash outflows. But the reverse is the case when talking about payable, as an increase in payables means that the reporting entity have held back cash it will have used to settle its obligations hence increasing reducing cash outflows or increasing cash inflows.