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Net income for year 1,509,601
Less dividends (50,000)
Retained earnings,
December 31, 19xx 9,845,951

the stock is selling for right now on the open market. While it™s
customary to assign a par value to stock, as A.I. did, the number
doesn™t have much meaning. It™s a relic from the pre-Depression
era, when stock had to be sold at
BT its par value.
ip Securities regulations nonethe-
less still require par value to be
Don™t even try to figure out
accounted for separately from
what relation “par value” has
other types of additional paid-in
to anything. Accountants have
capital, which is why A.I.™s bal-
a hard time explaining it!
ance sheet carries an account
called “capital in excess of par
value.” Because A.I. sold some of its stock for more than the
$1.00 par value per share, the excess is shown in that account.
Then there are retained earnings, the profits A.I.™s manage-
ment has plowed back into the business over the years. Last
January™s retained earnings, plus the net income or profit that
the company made this year (which is carried over here from
the income statement), minus dividends, equals the retained earn-
ings on the balance sheet date of December 31. And when you
add in the par value of its common stock and the capital re-
ceived in excess of par, you have the total stockholders™ equity.

A Balancing Act
As Figure 3-1 shows, the balance sheet really does balance.
That is, A.I.™s total assets equal the sum of the creditors™ claims
against them (liabilities) and the stockholders™ claims against them
(the owners™ or stockholders™ equity). The balance sheet, in fact,
always balances, even when liabilities exceed assets. In that case,
equity is a negative number”and the company is dead or close
to it, barring an infusion of capital.
Theoretically, if Avaricious Industries were sold today, the sale
would bring in $19,534,490. Creditors would be paid $5,438,539
to take a hike, and the stockholders would divvy up the remain-
ing $14,095,951 (or $5.64 per share) among themselves.
Understand the Balance Sheet

Theory and reality are two different things, however, so the
sale could bring in quite a bit more money”or quite a bit less.
A selling price depends on the industry, long-term profitability,
the company™s prospects, and a host of other concerns to buyers.

The Agile Manager™s Checklist
A balance sheet is a one-day “snapshot” of the com-
pany™s assets, debts, and owners™ equity.
A balance sheet shows assets (what the company owns)
and sets them equal to its liabilities (what the company
owes) plus the owners™ equity in the business.
Theoretically, stockholders™ equity is what the stockhold-
ers would collect if the company were sold on the
balance sheet date.
Retained earnings on December 31 is last year™s re-
tained earnings plus this year™s net income.
Chapter Four

The Cash-Flow Statement

“If your outgo exceeds your inflow, then your
upkeep will be your downfall.”

“Now we™re getting into it, Stevie,” said the Agile Manager
rubbing his hands together. “Cash flow is what it™s all about. If
cash flow is healthy, it covers a lot of sins.”
“I don™t get it. Doesn™t every company have a lot of cash flowing
in and out of it?”
“Yeah, but cash flow usually refers to the excess of cash coming
in over the cash going out. It means you have cash in the bank to
pay bills, fund initiatives, sock a little away for a rainy day, and so
on”no matter what your income statement says about your prof-
its.” The Agile Manager leaned back.
“I once worked for a company that didn™t make a profit five
years in a row,” he said. “But the owner never missed her yearly
trip to Bermuda, and she leased a Benz every two years. And we
were all paid well and had good equipment to work with.”


“But how™d she do it?” Steve interjected excitedly.
“Great cash flow. She was absolutely brilliant at timing income
with outflow. When one product was selling great, she™d shovel
the cash into R&D and product development. When nothing was
happening, she™d lay low for a while and cut back on expenses.
She also had a pretty sharp accountant who knew how to spread
losses around, as well as a few other tricks”all legal”for reduc-
ing the profit.”
“But isn™t profit good?”
“It™s necessary, especially for publicly held companies. But profit
is one of those things that can be manipulated up or down. And
sole owners tend to like it down, so they don™t have to pay taxes
on it.” He straightened up again.
“Your cash flow, however, never lies. Let me show you what I
mean . . .”

A cash-flow statement shows where the company™s cash came
from (sources of cash) and where it went (uses of cash). Like an
income statement, the cash-flow
BT statement covers a block of time,
ip such as a month or year. Avari-
cious Industries™ cash-flow state-
The income statement and
balance sheet don™t tell you as ment appears in Figure 4-1 on the
following page.
much as you need to know
As you™ll see, net income is
about your financial position.
only the starting point for figur-
ing out actual cash on hand at the
end of the year.

Cash Flow: It™s a Big Deal
As our whimsical opening quote implies, a company™s cash
flow deserves plenty of attention. There are cases of companies
that had millions of dollars in noncash assets”and profitability
on paper”but which had to close down because they couldn™t
keep enough cash on hand to pay their regular monthly bills
and run the company day to day.
Understand the Cash-Flow Statement

Figure 4-1
Avaricious Industries
Cash Flow Statement
For Year Ended December 31, 19XX

Cash flows from operations:
Net income $1,509,601
Adjustments to reconcile net income to net cash
Increase in accounts receivable (221,275)
Decrease in inventories 940,000
Increase in notes receivable (30,000)
Decrease in accounts payable (202,500)
Depreciation on equipment 477,750
Net cash provided by operations 2,473,576

Cash flows from investing activities
Purchase of property and equipment (2,080,695)
Proceeds from sale of equipment 160,000
Net cash used for investing activities (1,920,695)

Cash flows from financing activities
Sale of common stock 25,000
Sale of bonds 65,750
Cash dividends paid (50,000)
Net cash inflow from financing activities 40,750
Net increase (decrease) in cash 593,631
Cash balance, December 31, 19XX (last year) 677,600
Cash balance, December 31, 19XX (this year) $1,271,231

Businesses, like people, sometimes spend recklessly, anticipate
sales from uncertain sources such as landing that “big contract”
(the corporate version of winning the lottery), expect rapid pay-
ment of accounts receivable (ha), and otherwise live beyond their
Businesses sometimes also pay too much attention to their
income statements to make decisions. That can be dangerous,
because virtually all corporations keep their books on an “ac-
crual” basis. This means they record income when they make
the sale, and not when they receive the cash. Similarly, they record
expenses when they incur them, not when they pay them. (Re-

cording income when you receive it and expenses when you
pay them is called “cash-based” accounting. It™s probably how
you manage your home finances.)
That™s why a company can be profitable on paper, while strug-
gling to come up with the cash to fund growth or pay bills.
What It™s Good For
Because a cash-flow statement shows sources and uses of cash,
it can be used to:
1. Forecast future cash flows. How? Previous cash receipts
and disbursements establish a pattern. Management can use it to
predict where cash is most likely to come from and go to next
2. Show the company™s owners and creditors how much man-
agement invested last year in new equipment and facilities. Busi-
nesses need to invest in such state-

BT of-the-art technology as CAD/
ip CAM, CIM, robotics, and bar-
code inventory tracking sys-
Use the cash-flow statement to tems”not to mention update
anticipate cash shortages or their existing software and hard-
excesses”months before they ware”to stay on the cutting edge
hit. of productivity and pare operat-
ing costs to the bone. (The slo-
gan of companies that don™t upgrade their facilities and equip-
ment might be, “Answering yesterday™s challenges tomorrow or
the next day.”)
The cash-flow statement can also be used to confirm whether
a company has enough cash available to pay interest to bond-
holders and dividends to stockholders. If a firm has bonds out-
standing, management will have to contribute enough cash to a
sinking fund each year”an account set up specifically to hold
money used to pay off both bond interest and principal. (Compa-
nies usually invest the money in their sinking funds with the hopes
that they can earn returns good enough to retire bonds early.)
Understand the Cash-Flow Statement

Dissecting a Cash-flow Statement
Let™s take a look at each part of A.I.™s cash-flow statement to
see what happened last year.
Cash flows from operations. This section shows how much
cash came into the company and how much went out during
the normal course of business. Figure 4-2 below starts with A.I.™s
net profit (the “bottom line” of the income statement).
Several other aspects of the company™s operations either in-
creased or decreased its cash, however, and those are shown un-
der the “adjustments” heading. Generally Accepted Accounting
Principles (GAAPs) as well as logic dictate how these adjust-
ments are made on the cash-flow statement and whether they
increased or decreased the company™s supply of cash.
While not venturing too far into the technical forest, let™s
look at the adjustments and their consequences.
A.I.™s ending accounts receivable balance this year (you™ll find
that on the balance sheet on page 30) was $221,275 higher than
last year™s, which acted to decrease its cash balance. The logic
here: An increase in receivables is money earned and reflected
in the net income. But Avaricious doesn™t actually have that
money yet, hence the decrease in actual cash on hand.
For the same reason, the increase in the notes receivable bal-
ance also signals a reduction in cash.
A decrease in accounts payable balance also decreases cash

Figure 4-2
Cash flows from operations:
Net income $1,509,601
Adjustments to reconcile net income to net cash
Increase in accounts receivable (221,275)
Decrease in inventories 940,000
Increase in notes receivable (30,000)
Decrease in accounts payable (202,500)
Depreciation on equipment 477,750
Net cash provided by operations $2,473,576


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