The balance sheet identity

The balance sheet identity is true every year. Let CA = Current Assets; GFA =
Gross Fixed Assets; AccumDep = Accumulated Depreciation; CL = Current
Liability. The simplified balance sheet at time t (end of year t, or EOYt) is
given by:

CAt GFAt AccumDept CLt Debtt Equityt

(1)

Define Net Working Capital: NWC = CA CL. The equation can then be
written as:

NWCt GFAt AccumDept Debtt Equityt

(2)

For the prior year, t-1 the equation can be similarly written as:

NWCt 1 GFAt 1 AccumDept 1 Debtt 1 Equityt 1

(3)

Subtract the t-1 identity from year t to get the changes in balance sheet
during year t:

NWC GFA AccumDep Debt Equity

(4)

If the firm does not issue any new stock during the year, then the change in
the equity account is solely due to the addition to retained earnings during
the year. Note that:

AccumDep Deprt

and

Equity Addn to RRt NI t Divt

Inserting these definitions into equation (4), we get:

NWC GFA Deprt Debt NI t Divt

NWC GFA Div Debt NI Depr
Or,

(5)
(5)

Thus, the balance sheet changes and appropriate income statement account
directly lead to the Sources and Uses of Funds as an identity. The LHS of (5)
would typically capture the uses of funds and the RHS typically captures the
sources of funds, in the absence of issuance of new stock.
Free Cash Flow: Cash produced without taking into account how the business
is financed.
Profit After Taxes
+ Depreciation
+ Net After Tax Interest Payment
- Increase in Current Assets
+ Increase in Current Liabilities

- Increase in Fixed Assets

Uses of Free Cash Flow
Debt repayments
Net Interest Payment after Taxes
Dividends
Difference between the Sources and Uses of FCF s the addition to Cash and
Marketable Securities.