Open AccessNet Operating Working Capital, Capital Budgeting, And Cash Budgets: A Teaching Example
Author(s) -
James A. Turner
Publication year - 2016
Publication title -
american journal of business education
Language(s) - English
Resource type - Journals
eISSN - 1942-2512
pISSN - 1942-2504
DOI - 10.19030/ajbe.v9i1.9575
Subject(s) - operating cash flow , cash flow statement , cash flow forecasting , cash on cash return , cash flow , cash management , cash and cash equivalents , cash conversion cycle , depreciation (economics) , capital budgeting , net present value , terminal value , finance , economics , business , accounting , financial capital , microeconomics , capital formation , project appraisal , production (economics) , profit (economics)
Many introductory finance texts present information on the capital budgeting process, including estimation of project cash flows. Typically, estimation of project cash flows begins with a calculation of net income. Getting from net income to cash flows requires accounting for non-cash items such as depreciation. Also important is the effect of changes in net operating working capital on cash flow. While students readily understand how to account for depreciation when calculating cash flow, they typically have much more difficulty understanding how and why changes in working capital affect cash flows. This paper develops a teaching example to show exactly how and why changes in net operating working capital affect cash flows. The example shows how to derive operating cash flows for a proposed project using the accrual accounting method and then shows a cash budget for the same project. Finally, the example shows that the discrepancy between the cash flows shown in the cash budget and the operating cash flows can be resolved by accounting for changes in working capital. A survey of students in an MBA managerial finance course indicates student satisfaction with the teaching example and gives evidence that students prefer the teaching example to explanations of the effect of working capital on project cash flows given in the assigned text.