Chapter 2, Problem 23QP

Summary Introduction

To construct: The cash flow identity.

Introduction:

Cash flow refers to the difference between the cash that comes into the business and the cash that goes out of the business. The following are the different types of cash flows in a corporation:

• Cash flow from assets:

  It refers to difference between the revenues from the sale of assets and the money invested in purchasing the assets.

• Cash flow to creditors:

  It refers to the interest paid to the creditors minus the net fresh debt borrowed by the company.

• Cash flow to stockholders:

  It refers to the dividend paid to the shareholders of the company minus the fresh equity raised by the company.

• Operating cash flow:

  It refers to the cash flow from operating activities of the firm.

Cash flow identity:

The cash flow from the assets of the company must be equal to the cash flow to the shareholders and creditors of the company. This equality is known as cash flow identity. The cash flow identity equation is as follows:

$\text{Cash flow from assets}=\text{Cash flow to creditors}+\text{Cash flow to stockholders}$