Reference no: EM132916125

The case of W.T. Grant is a classic in cash flow analysis. During the 1960s and 1970s, Grant was one of the largest retailers in the United States, with more than 1,200 store nationwide. Grant was a stable New York Stock Exchange firm that had paid cash dividends every year since 1907. However, the inability of Grant's operations to generate positive cash flow indicated the existence of serious problems. From 1966 through 1973, while Grant's net income was steady at about $35 million per year, cash flow from operations was negative in every year except 1968 and 1969, and even in those years the positive cash flow generated was insignificant in amount. The results for the fiscal year ended January 31, 1973, are the most striking. Net income for the year was $38 million. A frequently used measure of "cash flow" (net income and depreciation) suggested that W.T. Grant's operations generated $48 million in cash. However, actual cash flow generated by operations for the year was negative $120 million. In October 1975, Grant filed for bankruptcy, and by early 1976, the company was liquidated and ceased to exist.

Question 1: What might have caused the "net income + depreciation" measure of cash flow to be positive when in fact actual cash flow from operations was negative? Under what circumstances is the "net income + depreciation" measure of cash flow a good estimate of actual cash flow from operations? When is it a bad measure?