{"id":239,"date":"2021-01-26T22:28:59","date_gmt":"2021-01-26T22:28:59","guid":{"rendered":"https:\/\/courses.lumenlearning.com\/wm-managerialaccounting\/?post_type=chapter&#038;p=239"},"modified":"2021-06-11T22:50:24","modified_gmt":"2021-06-11T22:50:24","slug":"cash-flows","status":"publish","type":"chapter","link":"https:\/\/courses.lumenlearning.com\/suny-clinton-managerialaccounting\/chapter\/cash-flows\/","title":{"raw":"Cash Flows","rendered":"Cash Flows"},"content":{"raw":"<div class=\"textbox learning-objectives\">\r\n<h3>Learning Outcomes<\/h3>\r\n<ul>\r\n \t<li>Understand the focus on cash flows for capital investment decision making<\/li>\r\n<\/ul>\r\n<\/div>\r\n<h3>Phase 2 - Step 5: Determine the cash flows the investment will return.<\/h3>\r\nUnder accrual accounting, revenues and expenses are reported based on accounting principles that are designed to be consistent from company to company and are also designed to report historical results. Revenues are reported when they are earned, and expenses are matched to the periods of the revenue. For capital investment analysis, however, we want a simpler but yet accurate measure of the results of our investment so we can compare options. Cash flows give us a solid basis for that analysis.\r\n\r\nFor instance, let\u2019s say we are now four years in the future. Becker had to invest $43,800 in her business to buy the van. She then worked 20 hours per week for four years, taking two weeks off each year, so she worked a total of 4,000 hours, making $26,000 in delivery fees each year for a total gross cash inflow of $104,000. If she had chosen a minimum wage job instead, at $12 per hour, she would have earned only $48,000 but she would still have the $43,800 she invested in the van, for a total of $91,800. In addition, although she earned $104,000 in fees, she had to pay $49,000 in expenses (fuel, maintenance, etc.). In addition, if she had invested the $43,800 in a mutual fund that returned 6% per year, that $43,800 would have grown to $55,296.49.\r\n\r\nLet\u2019s take a look at what Becker\u2019s Form 1040 \u201cSchedule C - Self-employment Income\u201d might look like for the four years she owned this particular van:\r\n<div align=\"left\">\r\n<table class=\"fin-table acctstatement fw\"><caption>Income Statement (accrual basis)<\/caption>\r\n<thead>\r\n<tr>\r\n<th class=\"r\" scope=\"col\"><\/th>\r\n<th class=\"r\" scope=\"col\">YR 1<\/th>\r\n<th class=\"r\" scope=\"col\">YR 2<\/th>\r\n<th class=\"r\" scope=\"col\">YR 3<\/th>\r\n<th class=\"r\" scope=\"col\">YR 4<\/th>\r\n<\/tr>\r\n<\/thead>\r\n<tbody>\r\n<tr>\r\n<td>Delivery Revenue<\/td>\r\n<td class=\"r\">$\u00a0 26,000<\/td>\r\n<td class=\"r\">$\u00a0 26,000<\/td>\r\n<td class=\"r\">$\u00a0 26,000<\/td>\r\n<td class=\"r\">$\u00a0 26,000<\/td>\r\n<\/tr>\r\n<tr>\r\n<td><\/td>\r\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span><\/td>\r\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span><\/td>\r\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span><\/td>\r\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span><\/td>\r\n<\/tr>\r\n<tr>\r\n<td>Fuel<\/td>\r\n<td class=\"r\">\u00a0 \u00a0 \u00a0 8,000<\/td>\r\n<td class=\"r\">\u00a0 \u00a0 \u00a0 8,000<\/td>\r\n<td class=\"r\">\u00a0 \u00a0 \u00a0 8,000<\/td>\r\n<td class=\"r\">\u00a0 \u00a0 \u00a0 8,000<\/td>\r\n<\/tr>\r\n<tr>\r\n<td>Maintenance<\/td>\r\n<td class=\"r\">\u00a0 \u00a0 \u00a0 1,000<\/td>\r\n<td class=\"r\">\u00a0 \u00a0 \u00a0 2,000<\/td>\r\n<td class=\"r\">\u00a0 \u00a0 \u00a0 3,000<\/td>\r\n<td class=\"r\">\u00a0 \u00a0 \u00a0 4,000<\/td>\r\n<\/tr>\r\n<tr>\r\n<td>Repairs<\/td>\r\n<td class=\"r\">\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 -<\/td>\r\n<td class=\"r\">\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 -<\/td>\r\n<td class=\"r\">\u00a0 \u00a0 \u00a0 4,000<\/td>\r\n<td class=\"r\">\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 -<\/td>\r\n<\/tr>\r\n<tr>\r\n<td>Depreciation<\/td>\r\n<td class=\"r\">\u00a0 \u00a0 \u00a0 8,450<\/td>\r\n<td class=\"r\">\u00a0 \u00a0 \u00a0 8,450<\/td>\r\n<td class=\"r\">\u00a0 \u00a0 \u00a0 8,450<\/td>\r\n<td class=\"r\">\u00a0 \u00a0 \u00a0 8,450<\/td>\r\n<\/tr>\r\n<tr>\r\n<td>Tires\/etc.<\/td>\r\n<td class=\"r\">\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 750<\/td>\r\n<td class=\"r\">\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 750<\/td>\r\n<td class=\"r\">\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 750<\/td>\r\n<td class=\"r\">\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 750<\/td>\r\n<\/tr>\r\n<tr>\r\n<td>\u00a0 Total expenses<\/td>\r\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>18,200<\/td>\r\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>19,200<\/td>\r\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>24,200<\/td>\r\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>21,200<\/td>\r\n<\/tr>\r\n<tr>\r\n<td><\/td>\r\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span><\/td>\r\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span><\/td>\r\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span><\/td>\r\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span><\/td>\r\n<\/tr>\r\n<tr>\r\n<td>Net operating income<\/td>\r\n<td class=\"r line-single line-double\"><span class=\"u-sr-only\">Single Line<\/span>$\u00a0 \u00a0 7,800<span class=\"u-sr-only\">Double line<\/span><\/td>\r\n<td class=\"r line-single line-double\"><span class=\"u-sr-only\">Single Line<\/span>$\u00a0 \u00a0 6,800<span class=\"u-sr-only\">Double line<\/span><\/td>\r\n<td class=\"r line-single line-double\"><span class=\"u-sr-only\">Single Line<\/span>$\u00a0 \u00a0 1,800<span class=\"u-sr-only\">Double line<\/span><\/td>\r\n<td class=\"r line-single line-double\"><span class=\"u-sr-only\">Single Line<\/span>$\u00a0 \u00a0 4,800<span class=\"u-sr-only\">Double line<\/span><\/td>\r\n<\/tr>\r\n<\/tbody>\r\n<\/table>\r\n&nbsp;\r\n\r\n<\/div>\r\nOne noticeable difference is that accounting income, and the tax code, allocate the cost of the asset over its useful life. In this case, Becker has divided the initial cost less the residual value by 4 years (($43,800 - $10,000) \/ 4 = $8,450) and is reporting that as an expense each year. This is just a simple example. There are many more differences between accounting income and cash flows. In any case, in capital budgeting, we use cash flows in our decision-making process for both simplicity and accuracy.\r\n\r\nHere again, are the cash flows Becker has estimated. Notice that cash flows include the initial cost of the van in the year of purchase, not prorated over the life of the van (depreciation):\r\n<div align=\"left\">\r\n<table class=\"fin-table acctstatement fw\"><caption>Capital Investment<\/caption>\r\n<thead>\r\n<tr class=\"u-sr-only\">\r\n<th scope=\"col\">Description<\/th>\r\n<th scope=\"col\">Amount<\/th>\r\n<\/tr>\r\n<\/thead>\r\n<tbody>\r\n<tr>\r\n<td>Van<\/td>\r\n<td class=\"r\">$\u00a0 35,000<\/td>\r\n<\/tr>\r\n<tr>\r\n<td>Cargo lift\/Custom paint<\/td>\r\n<td class=\"r\">\u00a0 \u00a0 \u00a0 5,000<\/td>\r\n<\/tr>\r\n<tr>\r\n<td>Sales tax at 8%<\/td>\r\n<td class=\"r\">\u00a0 \u00a0 \u00a0 3,200<\/td>\r\n<\/tr>\r\n<tr>\r\n<td>Vehicle registration<\/td>\r\n<td class=\"r\">\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 600<\/td>\r\n<\/tr>\r\n<tr>\r\n<td><\/td>\r\n<td class=\"r line-single line-double\"><span class=\"u-sr-only\">Single Line<\/span>$\u00a0 43,800<span class=\"u-sr-only\">Double line<\/span><\/td>\r\n<\/tr>\r\n<\/tbody>\r\n<\/table>\r\n<\/div>\r\n&nbsp;\r\n\r\nOperating costs are determined on a cash basis. For Becker\u2019s capital investment project, she has projected the following:\r\n<div align=\"left\">\r\n<table class=\"fin-table acctstatement fw\"><caption>Annual Cash Flows<\/caption>\r\n<thead>\r\n<tr>\r\n<th class=\"r\" scope=\"col\"><\/th>\r\n<th class=\"r\" scope=\"col\">YR 1<\/th>\r\n<th class=\"r\" scope=\"col\">YR 2<\/th>\r\n<th class=\"r\" scope=\"col\">YR 3<\/th>\r\n<th class=\"r\" scope=\"col\">YR 4<\/th>\r\n<\/tr>\r\n<\/thead>\r\n<tbody>\r\n<tr>\r\n<td>Fuel<\/td>\r\n<td class=\"r\">$\u00a0 \u00a0 8,000<\/td>\r\n<td class=\"r\">$\u00a0 \u00a08,000<\/td>\r\n<td class=\"r\">$\u00a0 8,000<\/td>\r\n<td class=\"r\">$\u00a0 8,000<\/td>\r\n<\/tr>\r\n<tr>\r\n<td>Maintenance<\/td>\r\n<td class=\"r\">\u00a0 \u00a0 \u00a0 1,000<\/td>\r\n<td class=\"r\">\u00a0 \u00a0 \u00a0 2,000<\/td>\r\n<td class=\"r\">\u00a0 \u00a0 \u00a0 3,000<\/td>\r\n<td class=\"r\">\u00a0 \u00a0 \u00a0 4,000<\/td>\r\n<\/tr>\r\n<tr>\r\n<td>Repairs<\/td>\r\n<td class=\"r\">\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 -<\/td>\r\n<td class=\"r\">\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 -<\/td>\r\n<td class=\"r\">\u00a0 \u00a0 \u00a0 4,000<\/td>\r\n<td class=\"r\">\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 -<\/td>\r\n<\/tr>\r\n<tr>\r\n<td>Tires\/etc.<\/td>\r\n<td class=\"r\">\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 750<\/td>\r\n<td class=\"r\">\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 750<\/td>\r\n<td class=\"r\">\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 750<\/td>\r\n<td class=\"r\">\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 750<\/td>\r\n<\/tr>\r\n<tr>\r\n<td>\u00a0 Total cash out<\/td>\r\n<td class=\"r line-single line-double\"><span class=\"u-sr-only\">Single Line<\/span>$\u00a0 \u00a0 9,750<span class=\"u-sr-only\">Double line<\/span><\/td>\r\n<td class=\"r line-single line-double\"><span class=\"u-sr-only\">Single Line<\/span>$\u00a0 10,750<span class=\"u-sr-only\">Double line<\/span><\/td>\r\n<td class=\"r line-single line-double\"><span class=\"u-sr-only\">Single Line<\/span>$\u00a0 15,750<span class=\"u-sr-only\">Double line<\/span><\/td>\r\n<td class=\"r line-single line-double\"><span class=\"u-sr-only\">Single Line<\/span>$\u00a0 12,750<span class=\"u-sr-only\">Double line<\/span><\/td>\r\n<\/tr>\r\n<tr>\r\n<td><\/td>\r\n<td><\/td>\r\n<td><\/td>\r\n<td><\/td>\r\n<td><\/td>\r\n<\/tr>\r\n<tr>\r\n<td>Delivery Revenue<\/td>\r\n<td class=\"r line-double\">$\u00a026,000<span class=\"u-sr-only\">Double line<\/span><\/td>\r\n<td class=\"r line-double\">$\u00a0 26,000<span class=\"u-sr-only\">Double line<\/span><\/td>\r\n<td class=\"r line-double\">$\u00a0 26,000<span class=\"u-sr-only\">Double line<\/span><\/td>\r\n<td class=\"r line-double\">$\u00a0 26,000<span class=\"u-sr-only\">Double line<\/span><\/td>\r\n<\/tr>\r\n<\/tbody>\r\n<\/table>\r\n&nbsp;\r\n\r\n<\/div>\r\nFinally, we determine any residual cash flows, such as the estimated sales price of the van when Becker is done with it, and we can tally up all of the cash in and out during the time horizon of the decision. Let\u2019s say she estimates the residual value of the van to be $10,000 at the end of 4 years.\r\n\r\nYear 1 cash inflows are revenues of $26,000. Cash outflows are the operating expenses of $9,750 plus the total initial investment of $43,800:\r\n<div align=\"left\">\r\n<table class=\"fin-table acctstatement fw\">\r\n<thead>\r\n<tr>\r\n<th class=\"r\" scope=\"col\"><\/th>\r\n<th class=\"r\" scope=\"col\">Cash in<\/th>\r\n<th class=\"r\" scope=\"col\">Cash out<\/th>\r\n<th class=\"r\" scope=\"col\">Net Cash Flow<\/th>\r\n<\/tr>\r\n<\/thead>\r\n<tbody>\r\n<tr>\r\n<td>Year 1<\/td>\r\n<td class=\"r\">$\u00a0 26,000<\/td>\r\n<td class=\"r\">$\u00a0 53,550<\/td>\r\n<td class=\"r\">$ (27,550)<\/td>\r\n<\/tr>\r\n<tr>\r\n<td>Year 2<\/td>\r\n<td class=\"r\">$\u00a0 26,000<\/td>\r\n<td class=\"r\">$\u00a0 10,750<\/td>\r\n<td class=\"r\">$\u00a0 15,250<\/td>\r\n<\/tr>\r\n<tr>\r\n<td>Year 3<\/td>\r\n<td class=\"r\">$\u00a0 26,000<\/td>\r\n<td class=\"r\">$\u00a0 15,750<\/td>\r\n<td class=\"r\">$\u00a0 10,250<\/td>\r\n<\/tr>\r\n<tr>\r\n<td>Year 4<\/td>\r\n<td class=\"r\">$\u00a0 36,000<\/td>\r\n<td class=\"r\">$\u00a0 12,750<\/td>\r\n<td class=\"r\">$\u00a0 23,250<\/td>\r\n<\/tr>\r\n<tr>\r\n<td><\/td>\r\n<td><\/td>\r\n<td><\/td>\r\n<td class=\"r line-single line-double\"><span class=\"u-sr-only\">Single Line<\/span>$\u00a0 21,200<span class=\"u-sr-only\">Double line<\/span><\/td>\r\n<\/tr>\r\n<\/tbody>\r\n<\/table>\r\n&nbsp;\r\n\r\n<\/div>\r\nThe final year\u2019s cash inflows include the $10,000 sales price of the van.\r\n\r\nHere is a quick theoretical review of the use of cash flows in capital budgeting:\r\n\r\n<iframe src=\"\/\/plugin.3playmedia.com\/show?mf=6352599&amp;p3sdk_version=1.10.1&amp;p=20361&amp;pt=375&amp;video_id=MH8PRGgyN6w&amp;video_target=tpm-plugin-iocrd1sn-MH8PRGgyN6w\" width=\"800px\" height=\"450px\" frameborder=\"0\" marginwidth=\"0px\" marginheight=\"0px\"><\/iframe>\r\n\r\nYou can view the <a href=\"https:\/\/oerfiles.s3.us-west-2.amazonaws.com\/Managerial+Accounting\/Transcripts\/CapitalBudgetingRelevantCashFlows_transcript.txt\" target=\"_blank\" rel=\"noopener\">transcript for \"Capital Budgeting - Relevant Cash Flows\" here (opens in new window)<\/a>.\r\n\r\nThere are other issues to take into account here, such as taxes, and even qualitative issues for Becker such as the pride that comes from being her own boss. However, on the face of it, just looking at cash flows, without even taking into account the time value of money, she would have been far better off to put the $43,800 into a savings account and get a part-time job.\r\n\r\nOnce we have gathered all of the quantitative and qualitative data, we are ready to assess the project. As you can see, total cash flows for Becker\u2019s four-year project are $21,200, but is that acceptable? Does it make sense?\r\n\r\nTo answer these questions, we have to assess the risk and rewards and compare this to our alternatives, which we will do in the next section.\r\n\r\nFirst, check your understanding of the reasoning behind using cash flows to analyze investment options rather than financial accounting rules.\r\n<div class=\"textbox tryit\">\r\n<h3>Practice Question<\/h3>\r\n[ohm_question hide_question_numbers=1]221571[\/ohm_question]\r\n\r\n<\/div>","rendered":"<div class=\"textbox learning-objectives\">\n<h3>Learning Outcomes<\/h3>\n<ul>\n<li>Understand the focus on cash flows for capital investment decision making<\/li>\n<\/ul>\n<\/div>\n<h3>Phase 2 &#8211; Step 5: Determine the cash flows the investment will return.<\/h3>\n<p>Under accrual accounting, revenues and expenses are reported based on accounting principles that are designed to be consistent from company to company and are also designed to report historical results. Revenues are reported when they are earned, and expenses are matched to the periods of the revenue. For capital investment analysis, however, we want a simpler but yet accurate measure of the results of our investment so we can compare options. Cash flows give us a solid basis for that analysis.<\/p>\n<p>For instance, let\u2019s say we are now four years in the future. Becker had to invest $43,800 in her business to buy the van. She then worked 20 hours per week for four years, taking two weeks off each year, so she worked a total of 4,000 hours, making $26,000 in delivery fees each year for a total gross cash inflow of $104,000. If she had chosen a minimum wage job instead, at $12 per hour, she would have earned only $48,000 but she would still have the $43,800 she invested in the van, for a total of $91,800. In addition, although she earned $104,000 in fees, she had to pay $49,000 in expenses (fuel, maintenance, etc.). In addition, if she had invested the $43,800 in a mutual fund that returned 6% per year, that $43,800 would have grown to $55,296.49.<\/p>\n<p>Let\u2019s take a look at what Becker\u2019s Form 1040 \u201cSchedule C &#8211; Self-employment Income\u201d might look like for the four years she owned this particular van:<\/p>\n<div style=\"text-align: left;\">\n<table class=\"fin-table acctstatement fw\">\n<caption>Income Statement (accrual basis)<\/caption>\n<thead>\n<tr>\n<th class=\"r\" scope=\"col\"><\/th>\n<th class=\"r\" scope=\"col\">YR 1<\/th>\n<th class=\"r\" scope=\"col\">YR 2<\/th>\n<th class=\"r\" scope=\"col\">YR 3<\/th>\n<th class=\"r\" scope=\"col\">YR 4<\/th>\n<\/tr>\n<\/thead>\n<tbody>\n<tr>\n<td>Delivery Revenue<\/td>\n<td class=\"r\">$\u00a0 26,000<\/td>\n<td class=\"r\">$\u00a0 26,000<\/td>\n<td class=\"r\">$\u00a0 26,000<\/td>\n<td class=\"r\">$\u00a0 26,000<\/td>\n<\/tr>\n<tr>\n<td><\/td>\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span><\/td>\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span><\/td>\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span><\/td>\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span><\/td>\n<\/tr>\n<tr>\n<td>Fuel<\/td>\n<td class=\"r\">\u00a0 \u00a0 \u00a0 8,000<\/td>\n<td class=\"r\">\u00a0 \u00a0 \u00a0 8,000<\/td>\n<td class=\"r\">\u00a0 \u00a0 \u00a0 8,000<\/td>\n<td class=\"r\">\u00a0 \u00a0 \u00a0 8,000<\/td>\n<\/tr>\n<tr>\n<td>Maintenance<\/td>\n<td class=\"r\">\u00a0 \u00a0 \u00a0 1,000<\/td>\n<td class=\"r\">\u00a0 \u00a0 \u00a0 2,000<\/td>\n<td class=\"r\">\u00a0 \u00a0 \u00a0 3,000<\/td>\n<td class=\"r\">\u00a0 \u00a0 \u00a0 4,000<\/td>\n<\/tr>\n<tr>\n<td>Repairs<\/td>\n<td class=\"r\">\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 &#8211;<\/td>\n<td class=\"r\">\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 &#8211;<\/td>\n<td class=\"r\">\u00a0 \u00a0 \u00a0 4,000<\/td>\n<td class=\"r\">\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 &#8211;<\/td>\n<\/tr>\n<tr>\n<td>Depreciation<\/td>\n<td class=\"r\">\u00a0 \u00a0 \u00a0 8,450<\/td>\n<td class=\"r\">\u00a0 \u00a0 \u00a0 8,450<\/td>\n<td class=\"r\">\u00a0 \u00a0 \u00a0 8,450<\/td>\n<td class=\"r\">\u00a0 \u00a0 \u00a0 8,450<\/td>\n<\/tr>\n<tr>\n<td>Tires\/etc.<\/td>\n<td class=\"r\">\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 750<\/td>\n<td class=\"r\">\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 750<\/td>\n<td class=\"r\">\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 750<\/td>\n<td class=\"r\">\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 750<\/td>\n<\/tr>\n<tr>\n<td>\u00a0 Total expenses<\/td>\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>18,200<\/td>\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>19,200<\/td>\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>24,200<\/td>\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>21,200<\/td>\n<\/tr>\n<tr>\n<td><\/td>\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span><\/td>\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span><\/td>\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span><\/td>\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span><\/td>\n<\/tr>\n<tr>\n<td>Net operating income<\/td>\n<td class=\"r line-single line-double\"><span class=\"u-sr-only\">Single Line<\/span>$\u00a0 \u00a0 7,800<span class=\"u-sr-only\">Double line<\/span><\/td>\n<td class=\"r line-single line-double\"><span class=\"u-sr-only\">Single Line<\/span>$\u00a0 \u00a0 6,800<span class=\"u-sr-only\">Double line<\/span><\/td>\n<td class=\"r line-single line-double\"><span class=\"u-sr-only\">Single Line<\/span>$\u00a0 \u00a0 1,800<span class=\"u-sr-only\">Double line<\/span><\/td>\n<td class=\"r line-single line-double\"><span class=\"u-sr-only\">Single Line<\/span>$\u00a0 \u00a0 4,800<span class=\"u-sr-only\">Double line<\/span><\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n<p>&nbsp;<\/p>\n<\/div>\n<p>One noticeable difference is that accounting income, and the tax code, allocate the cost of the asset over its useful life. In this case, Becker has divided the initial cost less the residual value by 4 years (($43,800 &#8211; $10,000) \/ 4 = $8,450) and is reporting that as an expense each year. This is just a simple example. There are many more differences between accounting income and cash flows. In any case, in capital budgeting, we use cash flows in our decision-making process for both simplicity and accuracy.<\/p>\n<p>Here again, are the cash flows Becker has estimated. Notice that cash flows include the initial cost of the van in the year of purchase, not prorated over the life of the van (depreciation):<\/p>\n<div style=\"text-align: left;\">\n<table class=\"fin-table acctstatement fw\">\n<caption>Capital Investment<\/caption>\n<thead>\n<tr class=\"u-sr-only\">\n<th scope=\"col\">Description<\/th>\n<th scope=\"col\">Amount<\/th>\n<\/tr>\n<\/thead>\n<tbody>\n<tr>\n<td>Van<\/td>\n<td class=\"r\">$\u00a0 35,000<\/td>\n<\/tr>\n<tr>\n<td>Cargo lift\/Custom paint<\/td>\n<td class=\"r\">\u00a0 \u00a0 \u00a0 5,000<\/td>\n<\/tr>\n<tr>\n<td>Sales tax at 8%<\/td>\n<td class=\"r\">\u00a0 \u00a0 \u00a0 3,200<\/td>\n<\/tr>\n<tr>\n<td>Vehicle registration<\/td>\n<td class=\"r\">\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 600<\/td>\n<\/tr>\n<tr>\n<td><\/td>\n<td class=\"r line-single line-double\"><span class=\"u-sr-only\">Single Line<\/span>$\u00a0 43,800<span class=\"u-sr-only\">Double line<\/span><\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n<\/div>\n<p>&nbsp;<\/p>\n<p>Operating costs are determined on a cash basis. For Becker\u2019s capital investment project, she has projected the following:<\/p>\n<div style=\"text-align: left;\">\n<table class=\"fin-table acctstatement fw\">\n<caption>Annual Cash Flows<\/caption>\n<thead>\n<tr>\n<th class=\"r\" scope=\"col\"><\/th>\n<th class=\"r\" scope=\"col\">YR 1<\/th>\n<th class=\"r\" scope=\"col\">YR 2<\/th>\n<th class=\"r\" scope=\"col\">YR 3<\/th>\n<th class=\"r\" scope=\"col\">YR 4<\/th>\n<\/tr>\n<\/thead>\n<tbody>\n<tr>\n<td>Fuel<\/td>\n<td class=\"r\">$\u00a0 \u00a0 8,000<\/td>\n<td class=\"r\">$\u00a0 \u00a08,000<\/td>\n<td class=\"r\">$\u00a0 8,000<\/td>\n<td class=\"r\">$\u00a0 8,000<\/td>\n<\/tr>\n<tr>\n<td>Maintenance<\/td>\n<td class=\"r\">\u00a0 \u00a0 \u00a0 1,000<\/td>\n<td class=\"r\">\u00a0 \u00a0 \u00a0 2,000<\/td>\n<td class=\"r\">\u00a0 \u00a0 \u00a0 3,000<\/td>\n<td class=\"r\">\u00a0 \u00a0 \u00a0 4,000<\/td>\n<\/tr>\n<tr>\n<td>Repairs<\/td>\n<td class=\"r\">\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 &#8211;<\/td>\n<td class=\"r\">\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 &#8211;<\/td>\n<td class=\"r\">\u00a0 \u00a0 \u00a0 4,000<\/td>\n<td class=\"r\">\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 &#8211;<\/td>\n<\/tr>\n<tr>\n<td>Tires\/etc.<\/td>\n<td class=\"r\">\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 750<\/td>\n<td class=\"r\">\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 750<\/td>\n<td class=\"r\">\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 750<\/td>\n<td class=\"r\">\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 750<\/td>\n<\/tr>\n<tr>\n<td>\u00a0 Total cash out<\/td>\n<td class=\"r line-single line-double\"><span class=\"u-sr-only\">Single Line<\/span>$\u00a0 \u00a0 9,750<span class=\"u-sr-only\">Double line<\/span><\/td>\n<td class=\"r line-single line-double\"><span class=\"u-sr-only\">Single Line<\/span>$\u00a0 10,750<span class=\"u-sr-only\">Double line<\/span><\/td>\n<td class=\"r line-single line-double\"><span class=\"u-sr-only\">Single Line<\/span>$\u00a0 15,750<span class=\"u-sr-only\">Double line<\/span><\/td>\n<td class=\"r line-single line-double\"><span class=\"u-sr-only\">Single Line<\/span>$\u00a0 12,750<span class=\"u-sr-only\">Double line<\/span><\/td>\n<\/tr>\n<tr>\n<td><\/td>\n<td><\/td>\n<td><\/td>\n<td><\/td>\n<td><\/td>\n<\/tr>\n<tr>\n<td>Delivery Revenue<\/td>\n<td class=\"r line-double\">$\u00a026,000<span class=\"u-sr-only\">Double line<\/span><\/td>\n<td class=\"r line-double\">$\u00a0 26,000<span class=\"u-sr-only\">Double line<\/span><\/td>\n<td class=\"r line-double\">$\u00a0 26,000<span class=\"u-sr-only\">Double line<\/span><\/td>\n<td class=\"r line-double\">$\u00a0 26,000<span class=\"u-sr-only\">Double line<\/span><\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n<p>&nbsp;<\/p>\n<\/div>\n<p>Finally, we determine any residual cash flows, such as the estimated sales price of the van when Becker is done with it, and we can tally up all of the cash in and out during the time horizon of the decision. Let\u2019s say she estimates the residual value of the van to be $10,000 at the end of 4 years.<\/p>\n<p>Year 1 cash inflows are revenues of $26,000. Cash outflows are the operating expenses of $9,750 plus the total initial investment of $43,800:<\/p>\n<div style=\"text-align: left;\">\n<table class=\"fin-table acctstatement fw\">\n<thead>\n<tr>\n<th class=\"r\" scope=\"col\"><\/th>\n<th class=\"r\" scope=\"col\">Cash in<\/th>\n<th class=\"r\" scope=\"col\">Cash out<\/th>\n<th class=\"r\" scope=\"col\">Net Cash Flow<\/th>\n<\/tr>\n<\/thead>\n<tbody>\n<tr>\n<td>Year 1<\/td>\n<td class=\"r\">$\u00a0 26,000<\/td>\n<td class=\"r\">$\u00a0 53,550<\/td>\n<td class=\"r\">$ (27,550)<\/td>\n<\/tr>\n<tr>\n<td>Year 2<\/td>\n<td class=\"r\">$\u00a0 26,000<\/td>\n<td class=\"r\">$\u00a0 10,750<\/td>\n<td class=\"r\">$\u00a0 15,250<\/td>\n<\/tr>\n<tr>\n<td>Year 3<\/td>\n<td class=\"r\">$\u00a0 26,000<\/td>\n<td class=\"r\">$\u00a0 15,750<\/td>\n<td class=\"r\">$\u00a0 10,250<\/td>\n<\/tr>\n<tr>\n<td>Year 4<\/td>\n<td class=\"r\">$\u00a0 36,000<\/td>\n<td class=\"r\">$\u00a0 12,750<\/td>\n<td class=\"r\">$\u00a0 23,250<\/td>\n<\/tr>\n<tr>\n<td><\/td>\n<td><\/td>\n<td><\/td>\n<td class=\"r line-single line-double\"><span class=\"u-sr-only\">Single Line<\/span>$\u00a0 21,200<span class=\"u-sr-only\">Double line<\/span><\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n<p>&nbsp;<\/p>\n<\/div>\n<p>The final year\u2019s cash inflows include the $10,000 sales price of the van.<\/p>\n<p>Here is a quick theoretical review of the use of cash flows in capital budgeting:<\/p>\n<p><iframe loading=\"lazy\" src=\"\/\/plugin.3playmedia.com\/show?mf=6352599&amp;p3sdk_version=1.10.1&amp;p=20361&amp;pt=375&amp;video_id=MH8PRGgyN6w&amp;video_target=tpm-plugin-iocrd1sn-MH8PRGgyN6w\" width=\"800px\" height=\"450px\" frameborder=\"0\" marginwidth=\"0px\" marginheight=\"0px\"><\/iframe><\/p>\n<p>You can view the <a href=\"https:\/\/oerfiles.s3.us-west-2.amazonaws.com\/Managerial+Accounting\/Transcripts\/CapitalBudgetingRelevantCashFlows_transcript.txt\" target=\"_blank\" rel=\"noopener\">transcript for &#8220;Capital Budgeting &#8211; Relevant Cash Flows&#8221; here (opens in new window)<\/a>.<\/p>\n<p>There are other issues to take into account here, such as taxes, and even qualitative issues for Becker such as the pride that comes from being her own boss. However, on the face of it, just looking at cash flows, without even taking into account the time value of money, she would have been far better off to put the $43,800 into a savings account and get a part-time job.<\/p>\n<p>Once we have gathered all of the quantitative and qualitative data, we are ready to assess the project. As you can see, total cash flows for Becker\u2019s four-year project are $21,200, but is that acceptable? Does it make sense?<\/p>\n<p>To answer these questions, we have to assess the risk and rewards and compare this to our alternatives, which we will do in the next section.<\/p>\n<p>First, check your understanding of the reasoning behind using cash flows to analyze investment options rather than financial accounting rules.<\/p>\n<div class=\"textbox tryit\">\n<h3>Practice Question<\/h3>\n<p><iframe loading=\"lazy\" id=\"ohm221571\" class=\"resizable\" src=\"https:\/\/ohm.lumenlearning.com\/multiembedq.php?id=221571&theme=oea&iframe_resize_id=ohm221571\" width=\"100%\" height=\"150\"><\/iframe><\/p>\n<\/div>\n\n\t\t\t <section class=\"citations-section\" role=\"contentinfo\">\n\t\t\t <h3>Candela Citations<\/h3>\n\t\t\t\t\t <div>\n\t\t\t\t\t\t <div id=\"citation-list-239\">\n\t\t\t\t\t\t\t <div class=\"licensing\"><div class=\"license-attribution-dropdown-subheading\">CC licensed content, Original<\/div><ul class=\"citation-list\"><li>Cash Flows. <strong>Authored by<\/strong>: Joseph Cooke. <strong>Provided by<\/strong>: Lumen Learning. <strong>License<\/strong>: <em><a target=\"_blank\" rel=\"license\" href=\"https:\/\/creativecommons.org\/licenses\/by\/4.0\/\">CC BY: Attribution<\/a><\/em><\/li><\/ul><div class=\"license-attribution-dropdown-subheading\">All rights reserved content<\/div><ul class=\"citation-list\"><li>Capital Budgeting - Relevant Cash Flows. <strong>Authored by<\/strong>: Ronald Moy. <strong>Located at<\/strong>: <a target=\"_blank\" href=\"https:\/\/youtu.be\/MH8PRGgyN6w\">https:\/\/youtu.be\/MH8PRGgyN6w<\/a>. <strong>License<\/strong>: <em>All Rights Reserved<\/em>. <strong>License Terms<\/strong>: Standard YouTube License<\/li><\/ul><\/div>\n\t\t\t\t\t\t <\/div>\n\t\t\t\t\t <\/div>\n\t\t\t <\/section>","protected":false},"author":364389,"menu_order":5,"template":"","meta":{"_candela_citation":"[{\"type\":\"original\",\"description\":\"Cash Flows\",\"author\":\"Joseph Cooke\",\"organization\":\"Lumen Learning\",\"url\":\"\",\"project\":\"\",\"license\":\"cc-by\",\"license_terms\":\"\"},{\"type\":\"copyrighted_video\",\"description\":\"Capital Budgeting - Relevant Cash Flows\",\"author\":\"Ronald Moy\",\"organization\":\"\",\"url\":\"https:\/\/youtu.be\/MH8PRGgyN6w\",\"project\":\"\",\"license\":\"arr\",\"license_terms\":\"Standard YouTube License\"}]","CANDELA_OUTCOMES_GUID":"","pb_show_title":"on","pb_short_title":"","pb_subtitle":"","pb_authors":[],"pb_section_license":""},"chapter-type":[],"contributor":[],"license":[],"class_list":["post-239","chapter","type-chapter","status-publish","hentry"],"part":37,"_links":{"self":[{"href":"https:\/\/courses.lumenlearning.com\/suny-clinton-managerialaccounting\/wp-json\/pressbooks\/v2\/chapters\/239","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/courses.lumenlearning.com\/suny-clinton-managerialaccounting\/wp-json\/pressbooks\/v2\/chapters"}],"about":[{"href":"https:\/\/courses.lumenlearning.com\/suny-clinton-managerialaccounting\/wp-json\/wp\/v2\/types\/chapter"}],"author":[{"embeddable":true,"href":"https:\/\/courses.lumenlearning.com\/suny-clinton-managerialaccounting\/wp-json\/wp\/v2\/users\/364389"}],"version-history":[{"count":7,"href":"https:\/\/courses.lumenlearning.com\/suny-clinton-managerialaccounting\/wp-json\/pressbooks\/v2\/chapters\/239\/revisions"}],"predecessor-version":[{"id":2218,"href":"https:\/\/courses.lumenlearning.com\/suny-clinton-managerialaccounting\/wp-json\/pressbooks\/v2\/chapters\/239\/revisions\/2218"}],"part":[{"href":"https:\/\/courses.lumenlearning.com\/suny-clinton-managerialaccounting\/wp-json\/pressbooks\/v2\/parts\/37"}],"metadata":[{"href":"https:\/\/courses.lumenlearning.com\/suny-clinton-managerialaccounting\/wp-json\/pressbooks\/v2\/chapters\/239\/metadata\/"}],"wp:attachment":[{"href":"https:\/\/courses.lumenlearning.com\/suny-clinton-managerialaccounting\/wp-json\/wp\/v2\/media?parent=239"}],"wp:term":[{"taxonomy":"chapter-type","embeddable":true,"href":"https:\/\/courses.lumenlearning.com\/suny-clinton-managerialaccounting\/wp-json\/pressbooks\/v2\/chapter-type?post=239"},{"taxonomy":"contributor","embeddable":true,"href":"https:\/\/courses.lumenlearning.com\/suny-clinton-managerialaccounting\/wp-json\/wp\/v2\/contributor?post=239"},{"taxonomy":"license","embeddable":true,"href":"https:\/\/courses.lumenlearning.com\/suny-clinton-managerialaccounting\/wp-json\/wp\/v2\/license?post=239"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}