On the Differences between Accrual Accounting Figures and Cash Flows: The Case of Working Capital

Abstract

'See, for example, Bierman and Smidt [2], pp. 153-154; Levy and Sarat [6], p. 69; and Brealey and Myers [3], p. 85. various accounting procedures to evaluate the level of current assets. Therefore, it would not be surprising if, practical capital budgeting analysis, there would be a wide use of accounting procedures to evaluate the level of working capital. The use of these methods raises many crucial conceptual and practical difficulties. For example, should one use market or cost basis to evaluate inventories and receivables? Should one use FIFO, LIFO, or other methods to evaluate inventories? Which costs should be capitalized: fixed costs, variable costs, out-of-pocket costs, administrative, selling, etc.? The purpose of this paper is not to raise arguments for or against the various accrual accounting methods, but to investigate the relationship between some of these methods and the cash flows of a given project. It is shown here that if the actual cash flows occur only at the beginning and end of the accrual accounting periods, then there is a simple relationship between the