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For simplicity, suppose the company is a new one that has raised money from owners and creditors
The company uses cash to purchase raw material and hire workers; it makes the product and stores it in inventory
When the company sales a product, inventory turns into cash; if the sale is for cash, otherwise, cash is not realized until accounts receivable is collected; the movement of cash to inventory, to cash receivable, ad back to cash is the firm’s working capital cycle.
On the other hand, over a period of time, fixed assets are consumed; thr accountant recognize the process by continually reducing the value of asets and increasing the value of merchandise flowing into inventory by an ammount called depreciation
To maintain productive capacity, the company must invest part of its newly received cash in new fixed assets.
Profit do not equal cash flow. The profitability of a company is not an anssurence that its cash flow will be sufficient to maintain solvency. For example, if the company loses control of its accounts receivable by allowing clients more time to pay, or the company makes more merchandise than it sells, then, though the firm is selling at a profit, its sales may not be generating sufficient cash to replenish the cash for production and investment
= Costs directly attributable to the selling and delivering goods to customers.
Sale employees salaries and commissions
Advertising and promotion expenses
General and administration expenses
= Expenses of providing management and administration for the business.
Salaries of office staff (corporate function such as HR, Finance)
Total cost of an long term assetmust be spread over the asset’s expected useful life
Charging the full cost of a long-term asset to one yera distors reported income. Example: suppose in 2002 a company buys a facility expected to be in use for 12 years, for 10 mil EUR. If the entire cost is assign to 2002,income in 2002 will apear depressed, while income in the following years will look too high.