Certified Valuation Analyst (CVA) Practice Exam

What impact does capital expenditure have when calculating cash flow?

1. It increases cash flow

2. It has no effect on cash flow

3. It decreases cash flow

4. It affects only operating expenses

The correct answer is: It decreases cash flow

When assessing the impact of capital expenditure on cash flow, it is essential to recognize that capital expenditures typically represent funds used by a company to acquire, upgrade, and maintain physical assets such as property, plants, and equipment. These expenditures are necessary for sustaining and expanding business operations but require cash outflows at the time of the investment. Capital expenditures are not categorized as operating expenses, and while they may be necessary for long-term growth, they reduce the cash available for business operations at the time they are incurred. Each capital expenditure represents a significant investment outlay that diminishes cash flow in the period it occurs, as cash is spent without immediate corresponding revenue generation. This means that when preparing cash flow statements, capital expenditures are shown as cash outflows in the investing activities section, thereby decreasing overall cash flow for that period. Understanding this relationship is crucial for financial analysis and valuation purposes, as it helps stakeholders evaluate a company's cash-generating capacity and financial health over time.