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To: Trey McAtee who wrote (39515)	10/1/1998 8:56:00 PM
From: Skeeter Bug	Read Replies (1) \| Respond to of 53903

>>to me, this says that they make no money on operations...AND...have 1b in depr. << that was my understanding too.

To: Trey McAtee who wrote (39515)	10/2/1998 8:16:00 AM
From: Carl R.	Read Replies (1) \| Respond to of 53903

At this point I am not sure there is further point trying to explain it, but if in my example of the company with $0 in profit, they have no loses nor profits. Tax refunds, loss carry forwards, etc are not the issue. Lets start over on the example: They have $1 billion in depreciation and $0 in profit. At the end of the year then they have $1 billion in cash in the bank (before ordering new equipment) because their $0 in profit included a non-cash expense, depreciation. With normal expenses like wages or supplies in order to incur the expense, you have to give the money to someone. With depreciation you make a book entry showing the expense - you don't take money and give it to someone. Now in order to keep the plant up and remain competitive this company will have to buy new equipment periodically, of course. But when it says "we plan to invest $1 billion in equipment" it doesn't need to go out and find the cash even though it is reporting $0 in profit, because it really has a $1 billion cash flow. Maybe in some years it won't buy any equipment, in which case it will end up with cash in the bank, and in other years it will buy more than $1 billion in equipment, in which case the cash balance will fall. Now turn to the real estate example one last time. The rent was $10,000, and the depreciation was $10,000. The reported profit is $0 for the year, yet $10,000 is in the bank at the end of the year. Where did it come from? The rent of course. Why isn't there a reported profit? Because the depreciation (which is a non-cash book entry) causes the reported profit to be zero. In the fictitious semi example above the same is true - The $1 billion came from operations, but the non-cash entry of depreciation causes the reported profit to be zero. Note that while this has everything to do with taxes, it has nothing to do with taxes. Depreciation is a concept invented for determining tax liability, but the description of depreciation as a "source of funds" does not come from getting refunds back on taxes. Note that neither example above involves tax refunds. The important point is that if you look at "net income" you are looking at a number that includes a non-cash deduction. Do not confuse cash flow with net income. Depreciation is a deduction that comes out in determining net income, but does not affect cash flow. Thus a company can generate cash from operations, but have a negative net income. When the fiction of "depreciation" is working ideally (which it never does), this loss indicates that while the company is generating some cash, it is not generating enough cash to replace equipment. But depreciation is a fiction. In real estate depreciation overstates the loss of value of the underlying asset, which may actually increase in value. In the semiconductor business where the life may be short indeed, and where succeeding generations of equipment may get increasingly expensive, depreciation may well understate the loss of value of the equipment. Cash flow is very different that net income. Besides depreciation, as Zeev points out, there are numerous other items that affect cash flow. Some affect cash flow without affecting net income at all, such as increases or decreases in inventory, AR, etc. Understanding cash flow and the factors that affect it is critical in terms of determining a companies staying power. There have been companies that report positive net income yet have been forced to sell out because they ran out of cash, and others that have lost money for year after year, yet had plenty of cash for operations. Carl