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Consider the following extract from a profit and loss account.

-	20XX
-	拢尘
Turnover	161.6
Cost of sales	(115.8)
Gross profit	45.8
Administrative expenses	(20.7)
Operating profit	25.1
Interest receivable	4.3
Interest payable	(7.6)
Profit on ordinary activities before taxation	21.8
Tax on profit on ordinary activities	(4.6)
Profit for the financial year	17.2

Other information is as follows:

1. Cost of Sales includes the following items:

• Depreciation on plant and machinery of 拢11.4m. Capital expenditure on plant and machinery during the year was 拢8.4m.
• Amortisation of purchased goodwill of 拢3.5m. This goodwill arose on the acquisition of a competitor鈥檚 business.
• Amortisation of patent of 拢0.2m. This intangible asset is being amortised over a ten-year period.

1. Interest receivable is generated mainly by the placement of surplus operating cash on the overnight money markets.

In the light of the above information, interest cover (as a measure of cash-flow) would be calculated as follows:

Item	Comment	Amount included in calculation of interest cover (拢尘)
Depreciation on plant and machinery	The replacement of plant and machinery is an important feature in the company鈥檚 business, as shown by the amount spent in the year on new equipment. A third-party lender may decide to add back the depreciation expense and instead deduct the value of actual capital expenditure.	Add back 拢11.4m and deduct 拢8.4m
Amortisation of goodwill	Amortisation of goodwill is a non-cash transaction. Purchased goodwill arises where a business is acquired, and the purchase consideration exceeds the fair value of net assets acquired. The acquisition of a business is unlikely to result in future cash payments.	Add back 拢3.5m
Amortisation of intangible asset	This is also a non-cash transaction which - depending on the facts, is unlikely to result in future cash payments.	Add back 拢0.2m
Interest receivable	The interest receivable seems to be a temporary and varying source, so a lender is unlikely to rely on its continued existence.	Interest receivable should not be netted against interest payable, but it may be added to operating profit.

On the basis of the above comments, the interest cover figure is calculated as follows:

Adjusted operating profit (including interest receivable) = 拢36.2m (拢25.1m+拢11.5m-拢8.4m +拢3.5m+拢0.2m+拢4.3m)

Interest cover = 4.8 (拢36.2m/拢7.6m)

If netting of interest receivable with interest payable had been allowed, the interest cover would be 9.7 (拢31.9m/拢3.3m) - a significant difference.