Why We Subtract the Change in Working Capital When Defining Cash Flows? A Pedagogical Note

7 Pages Posted: 12 May 2005 Last revised: 11 Jan 2015

See all articles by Ignacio Velez-Pareja

Ignacio Velez-Pareja

Grupo Consultor CAV Capital Advisory & Valuation

Date Written: May 11, 2005

Abstract

In this short teaching note I explain why we subtract the change in working capital from the proper item (Earnings before interest and taxes (EBIT) or Net income) in the Income Statement. I show in detail how departing from the sales revenues and the cost of goods sold we have to subtract the change in working capital. This explanation might be seen as unnecessary given it is a common practice. However, my experience in teaching this subject indicates that some additional explanations are needed.

Note: The Spanish version of this document can be found at http://ssrn.com/abstract=722259

Keywords: Cash flows, free cash flow, cash flow to equity, working capital

JEL Classification: M21, M40, M46, M41, G12

Suggested Citation

Velez-Pareja, Ignacio, Why We Subtract the Change in Working Capital When Defining Cash Flows? A Pedagogical Note (May 11, 2005). Available at SSRN: https://ssrn.com/abstract=718741 or http://dx.doi.org/10.2139/ssrn.718741

Ignacio Velez-Pareja (Contact Author)

Grupo Consultor CAV Capital Advisory & Valuation ( email )

Ave Miramar # 18-93 Apt 6A
Cartagena
Colombia
+573112333074 (Phone)

HOME PAGE: http://cashflow88.com/decisiones/decisiones.html

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