Reading: Extensions and FAQ

Another question is why we take all the effort to compile a cash flow statement when most firms already prepare such a statement in their annual report. Of course we should use the information provided in the accounting cash flow statement from the annual report. Often, these statements contain more detailed information about changes in the operating assets and liabilities as well as the investment policy.

The problem with the accounting cash flow statement is that they treat several items differently:

• Accounting cash flow statements do not distinguish between operating and excess cash.  As we have just argued, we should make that distinction for valuation purposes because not all available cash can be paid out to shareholders without affecting the firm's operating activities.

• More importantly, the accounting cash flow statements treat interest expenses as operating expenses. Put differently, they do not add-back (after-tax) interest expenses to net income when computing the operating cash flow. This implies that firms with identical operating activities have different accounting operating cash flows depending on their financing policy. Clearly, interest expenses are the result of a financing decision. To maintain our distinction between operating, investment, and financing activities, we therefore have adjust net income for after-tax interest expenses.