FIN3702
NOTES
,FIN3702 Revision Notes
Analyzing a Firm’s Cash Flow
Module Objectives
By the end of this module, students should be able to:
Describe tax depreciation methods and explain how they influence a firm’s cash
flow
Distinguish between the cash flow statement and the income statement
Compile a cash flow statement
Calculate operating cash flows (OCF) and free cash flows (FCF)
Introduction to Cash Flow Analysis
1. Why Cash Flow Is Critical to a Business
Cash flow is the foundation of a firm’s financial health because it:
Supports daily business operations such as paying suppliers, employees, and
expenses
Enables informed strategic decisions that enhance long-term shareholder value
Is closely monitored by management, particularly operating cash flow, as it
reflects core business performance
Is carefully analyzed by investors and capital markets, since cash—not
accounting profit—is required to meet financial obligations
In simple terms, profits are theoretical, but cash is real.
,. Major Factors That Influence a Firm’s Cash Flow
Key elements that affect cash flow include:
Depreciation expenses
Other non-cash accounting items
Although these items reduce accounting profit, they do not involve actual cash outflows
and therefore must be adjusted when calculating cash flow.
Depreciation
Meaning of Depreciation
Depreciation refers to the systematic allocation of the cost of a fixed asset over its
useful life. Rather than expensing the full cost immediately, the asset’s value is spread
over several accounting periods to match revenue generation.
Depreciation from an Accounting Perspective
Depreciation is based on the historical cost of the asset
It is recorded annually as an expense in the income statement
The chosen depreciable life can significantly influence reported profits and cash
flow patterns
A longer depreciable life results in lower annual depreciation, while a shorter life
increases annual depreciation charges.
, Depreciation for Tax Purposes
Tax depreciation is governed by SARS regulations
Known as the Wear and Tear Allowance (WTA)
May differ from accounting depreciation methods
Applies to both newly acquired and second-hand assets
Tax depreciation affects cash flow because it reduces taxable income, thereby lowering
tax payments.
Calculating Tax Depreciation (Wear and Tear Allowance)
Step 1: Determine the Depreciable Value of the Asset
The depreciable value represents the total amount to be written off over the asset’s life
and is calculated as follows:
Initial purchase cost of the asset
Plus: Installation and related setup costs
Less: Estimated residual (salvage) value
Example:
Item Amount
(R)
Purchase price 400,000
Installation costs 20,000
Less: Salvage (5,000)
value
Depreciable 415,000
value
NOTES
,FIN3702 Revision Notes
Analyzing a Firm’s Cash Flow
Module Objectives
By the end of this module, students should be able to:
Describe tax depreciation methods and explain how they influence a firm’s cash
flow
Distinguish between the cash flow statement and the income statement
Compile a cash flow statement
Calculate operating cash flows (OCF) and free cash flows (FCF)
Introduction to Cash Flow Analysis
1. Why Cash Flow Is Critical to a Business
Cash flow is the foundation of a firm’s financial health because it:
Supports daily business operations such as paying suppliers, employees, and
expenses
Enables informed strategic decisions that enhance long-term shareholder value
Is closely monitored by management, particularly operating cash flow, as it
reflects core business performance
Is carefully analyzed by investors and capital markets, since cash—not
accounting profit—is required to meet financial obligations
In simple terms, profits are theoretical, but cash is real.
,. Major Factors That Influence a Firm’s Cash Flow
Key elements that affect cash flow include:
Depreciation expenses
Other non-cash accounting items
Although these items reduce accounting profit, they do not involve actual cash outflows
and therefore must be adjusted when calculating cash flow.
Depreciation
Meaning of Depreciation
Depreciation refers to the systematic allocation of the cost of a fixed asset over its
useful life. Rather than expensing the full cost immediately, the asset’s value is spread
over several accounting periods to match revenue generation.
Depreciation from an Accounting Perspective
Depreciation is based on the historical cost of the asset
It is recorded annually as an expense in the income statement
The chosen depreciable life can significantly influence reported profits and cash
flow patterns
A longer depreciable life results in lower annual depreciation, while a shorter life
increases annual depreciation charges.
, Depreciation for Tax Purposes
Tax depreciation is governed by SARS regulations
Known as the Wear and Tear Allowance (WTA)
May differ from accounting depreciation methods
Applies to both newly acquired and second-hand assets
Tax depreciation affects cash flow because it reduces taxable income, thereby lowering
tax payments.
Calculating Tax Depreciation (Wear and Tear Allowance)
Step 1: Determine the Depreciable Value of the Asset
The depreciable value represents the total amount to be written off over the asset’s life
and is calculated as follows:
Initial purchase cost of the asset
Plus: Installation and related setup costs
Less: Estimated residual (salvage) value
Example:
Item Amount
(R)
Purchase price 400,000
Installation costs 20,000
Less: Salvage (5,000)
value
Depreciable 415,000
value
