.net barcode sdk PART ONE Business Valuation in Software

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PART ONE Business Valuation
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five years ago for $1000, last year s depreciation expense would have been $200 ($1000 5-year life) However, the next machine, assuming 3 percent per year growth in equipment cost, will cost $1159 Thus, capital expenditures run ahead of depreciation by the price increases in the equipment, which itself is mostly driven by inflation in the US economy This is all the more true for a growing business, where capital expenditures will exceed depreciation by the inflationary rise in prices and the real increase in the amount of property, plant, and equipment (PP&E) the business will buy For a business in decline, capital expenditures may be greater than, equal to, or less than depreciation, depending on the degree of the decline Later in the chapter, I will explain how to easily forecast the difference between capital expenditures and depreciation expense Increases in net working capital, the final term in the shortcut equation, are an adjustment that accounts for the cash drain of increasing current assets (receivables, inventory, etc) more than current liabilities (accounts payable, short-term notes payable, accrued salaries, etc) As businesses grow, they need to stock more inventory, extend more credit to customers (this means more receivables), and maintain larger cash balances to pay bills Increasing these current assets requires cash This cash can come from sources of debt, like suppliers (accounts payable), banks (notes payable), or it can come from the company s own pockets, ie, from its profits
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Let s begin by illustrating the dynamics of changes in net working capital Suppose your sales increased from $12 million per year ($100,000 per month) in 2001 to $15 million per year ($125,000 per month) in 2002 Let s also suppose that your customers pay their bills in 30 days, on average Then your accounts receivable should have increased from $100,000 on December 31, 2001, to $125,000 on December 31, 2002, ie, receivables increased $25,000 If you use accrual based accounting, you will be showing all of your sales, but you did not
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CHAPTER 4 Defining and Measuring Economic Cash Flow
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collect $25,000 of those sales4 Thus, using the shortcut equation above as our starting point to calculate cash flow, net income overstates cash flow by $25,000, and we have to subtract it to calculate cash flow Accounts receivable is part of net working capital, and therefore the increase in receivables is part of the increase in net working capital in the equation Let s look at inventory If inventory increases, let s say, $50,000, that increase does not show up in net income, as we have not yet sold the inventory But we did have to use cash to buy it Therefore, we would have to subtract the $50,000 from net income to calculate cash flow Now let s look at the right-hand side of the balance sheet Increases in liabilities are a source of cash Increases in accounts payable are an increase in cash flow, because we have bought inventory or services on credit, but we have not paid for them yet Or, if we borrowed (short-term) money from the bank, the increase in the current liability indicates that we increased our cash Thus, if your supplier finances the $50,000 purchase of inventory with credit, you will have a corresponding $50,000 accounts payable, which is a source of cash In this case, the $50,000 use of cash from the increase in inventory and the $50,000 source of cash from the increase in accounts payable will cancel each other out, for a net zero effect It is important to note that we add only the increase in the balance sheet items, ie, the net working capital (if they decrease, then we subtract them), while we add the full amount of depreciation expense and subtract the full amount of capital expenditures
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