Textbook Problem

Operating cash flows rather than accounting income are listed in Table 12.1. Why do we focus on cash flows as opposed to net income in capital budgeting?

Summary Introduction

To explain: The reason to focus on cash flow instead of net income in capital budgeting.

Introduction:

Operating Cash Flow:

The amount of cash used in or generated from the operations of the business is reported under the category of operating cash flow in the statement of cash flow. This is prepared as a part of financial statement at the end of an accounting period. The net balance is calculated and depicted as net cash from operating activities.

Answer to Problem 1Q

Cash flow is used instead of accounting income because actual cash is required and spent for the projects or expansion plans of a company.

Explanation of Solution

• The capital budgeting is a process to estimate the cash generated and used from a project or new plant.
• The net income is just a measure of profitability and doesn’t reflect the actual cash that is available for investment.

Conclusion

So, the reason to consider cash flow is that actual cash is required and spent for the projects or expansion plans of a company.