Introduction to Finance

Cash Flow from Operations 
Cash fl ow from operations is a measure of the cash 
entering and leaving the fi rm as a result of the fi rm’s business. Cash fl ow from operations 
equals net income plus depreciation plus funds from sources arising from changes in current 
asset and liability accounts, minus uses from changes in current asset and liability accounts 
for a given period of time. A period-by-period project income statement can estimate the net 
income from a project as in 
Table 17.6
.
All sales revenues may not be cash infl ows. For example, if customers buy the fi rm’s 
products with credit, some of the increase in sales revenue may increase accounts receivable 
rather than cash. Similarly, not all costs refl ect cash outfl ows. Such is the case if the fi rm buys 
sunk cost 
project-related expense 
not dependent upon whether or not 
the project is undertaken

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17.9 Estimating Project Cash Flows
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supplies or raw materials on credit. Some expenses may be paid in cash and others may create 
changes in accounts payable. For these reasons, to compute cash fl ow, we need to include an 
adjustment, the change in net working capital, to refl ect such situations.
Depreciation is a noncash expense. Accounting rules allow us to compute taxable income 
by deducting depreciation expense from revenues, although no cash leaves the fi rm. Since it 
is a noncash expense, when we compute operating cash fl ows, we add depreciation back after 
we have computed net income.
Thus, a project’s operating cash fl ows are computed in the following way:
Cash fl ow from operations = Net income + Depreciation – Change in net working capital (17-4)
Net income, as seen in Table 17.6, equals (Sales – Costs – Depreciation – Taxes); if 
T
represents 
the fi rm’s tax rate, this relationship for net income will become [(Sales – Costs – Depreciation)
(1 – 
T
)].
In most cases of capital budgeting analysis, operating cash fl ow is calculated in part by 
using the traditional net working capital measure of current assets minus current liabilities. 
This occurs since, typically, a project’s cash fl ows are immediately returned to the fi rm. The 
project’s balance sheet cash account always will be zero. 
Thus, current sources and current 
uses can be summarized in the period-by-period change in a project’s net working capital.
Some might wonder, or be confused by, why we subtract the change in net working cap-
ital when computing operating cash fl ow. To illustrate the reasoning for this, suppose current