Question

Explain the following sentences presented below:

1. "Many times a new project involves an additional investment in working capital."

2. "Add depreciation back into net operating income when calculating cash flows."

Answer 1

Working capital is basically a difference in between current assets and current liabilities where it may be sufficient for a current project, but when a new project evolves, and also happens to consider the business expansion, additional working capital is also required to fulfill it's future debt obligations and expense requirements.

We add back depreciation into Net Income when deriving cash flows, because basically it's a spread amount for a period charged over an asset which is considered as an operating expense but in reality it's a value that reduces an asset for each period so that the replacement value can be used to buy a new asset in the old asset's place. This adds on an advantage of benefiting tax reduction.