Finance Terms In Practical Language

I wrote this document for my students in 2018. I used to tutor athletes at Mississippi State. I am posting it for random finance students on the internet who may be struggling with homework.

Cash Flow to Creditors accounts for debt financing (you go under debt to get money). If a student took out 20,000 for college, cash flow would be -20,000 in that year because that much money came out of the creditor’s bank account. 4 years later, when he pays interests back, let’s say $2000/year, cash flow would be, $2000/ year. Look for interest and amount borrowed.

Cash Flow to Stockholders accounts for cash collected when you sell shares, cash lost when you buy shares, and cash lost when you pay dividend. As long as the direction of cash transfer is from the company to stockholders, the amount would be positive. Look for dividends and equity raised.

EBIT means Earnings before interest and taxes. If my bank balance at the end of last year was 10,000, my real earing would have been 10,000 + education loan Interest I paid + income taxes. It would have been much more than 10,000.

That’s why, EBIT = Net income + interest + taxes

Since net income on an income statement already accounts for tax and expenses, to find EBIT, you need to go back and add both.

You may also see EBIT = Revenue – Operating Expenses

Recall, Revenue – Expenses = Net Income. In expenses here, you deduct all the expenses, operating expenses, capital expenses (interest), and other expenses (taxes).

That’s why removing operating expenses from revenue gives you the same amount as adding interest and taxes back to Net income.

Operating Cash Flow tells you about your cash balance, not about your income:

OCF = Revenue (how much you sold) – operating expenses (everyday business expenses) - taxes (cash used to pay taxes) + depreciating (it is included in operating expenses but you never actually make a cash payment. You show that expense just to lower your tax liability)

We just saw that revenue – operating expense is EBIT, so

OCF = EBIT – taxes + depreciation

Here, you do not add interests back because interest is not an operating expense. I would not add education loan interest. These are capital expenses, so they cannot be a part of operating cash flow.

Net Capital Spending: this reflects the amount you spend to acquire more capital (fixed assets to make the stuff you sell) or the amount you get back when you sell fixed assets,

so total spending would be Ending – beginning fixed assets + depreciation (again, you devalue your assets to save taxes but never actually spend that amount)

If you are a student looking for help, feel free to reach out to me.