Net Income, Cash Flows, Reduced Balance Sheet and WCR (Working Capital Requirements)

Abstract

The Spanish version of this paper is available at: http://ssrn.com/abstract=895267. The net income of a company in a given year is an arbitrary number which depends on several decisions on the accounting of expenses and revenues. By contrast, each cash flow (money going out of the cash of the company into someone's pocket: shareholders, debt owners...) is a single number not subject to any particular criterion. The case of Madera Inc. is presented and different flows are calculated. The Equity Cash Flow (ECF) is the money which comes out of the cash and gets into the pockets of the shareholders. The FCF (Free Cash Flow) is the hypothetical ECF if the company had no debt. The Capital Cash flow is the Debt Cash Flow plus the Equity Cash Flow. The Debt Cash Flow consists of the sum of the interest plus the repayment of principal (or less the increase in principal). The reduced balance sheet and the WCR (“Working Capital Requirements”) are also calculated. They allow us to interpret more easily and quicker the accounting statements.The following questions arise: Does the dividend come from the net income? Where are the retained earnings and the reserves? What is the depreciation?