Response to the following :
Todd Manning is the president of Under Wraps, Inc., a chain of sandwich shops. Manning was meeting with his bank loan officer, Kim Wells. The following conversation took place:
Kim: Todd, I was looking at your income statement and you generated a loss during the last year. I'm really concerned about this.
Todd: I know, but you also need to look at the statement of cash flows. Our cash flow from operating activities was positive. Net income is just an accounting number. It's cash that's important. Wouldn't you agree?
Kim: Well, yes... cash is important. We want you to generate cash so you can pay back our loan. But your cash from operations, while positive, is not the end of the story.
Todd: What do you mean?
Kim: Well, don't you need cash for updating and replacing equipment in your shops? I don't think that's part of cash provided from operations.
Todd: I think that's why the accountant added back the depreciation. With the depreciation added back, we must be accounting for replacement of productive capacity somehow. Is Kim's concern valid?
Comment on Todd's analysis of Kim's concern.