Case
2-3 Analysis of Cash Flow for a Small Business
All financial decisions involve
a trade-off between risk and return. The offer to work for an
investment firm for $40,000 per year may be much less risky than
running one's own business. Charles would need to consider, however,
how likely it is that the employment with the investment firm
will continue indefinitely. For example, could a downsizing in
the economy cause the firm to cut Charles's position?
Charles has experienced for himself
the risks and rewards of running a business. To date, the business
has not produced significant profits; only $11,500 over a two-year
period. However, the significant increase in commissions revenue
from one year to the next is very encouraging. This is an example
of the potential rewards from running a business.
This case also illustrates
the difference between income and cash flow. Because depreciation
is not a cash flow, there is a significant difference between
the cash flow for each of the two years and net income. Assuming
the revenues and all of the expenses other than depreciation
result in cash flows to the business, the cash inflow for the
first year is $(11,000) + $15,000 (add back of depreciation)
or $26,000. The cash inflow for the second year is even better,
after adjusting for depreciation: $22,500 + $15,000 or $37,500.
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