Accruals Calculation using the Cash Flow approach states that Accruals(CF) = NI - CFO - CFI What’s the intuition behind this formula?
I wish someone would answer this one, they dont’ explain it very well.
I wish someone would answer this one, schweser doesn’t explain it very well.
CFO and CFI have no accruals built in. It is strictly a measure of cash (except for the financing cash flows). NI contains a whole host of accruals built in – by removing CFO + CFI from Net Income - you get a measure of the accruals.
wow… nice. Thanks cpk
Yeah that was a good one CPK. Its weird how things like this are so simple when you see a different perspective on how to describe the formula.
remember to use the right direction (including sign for the cfi)… just a thing to be careful about. Actually might be easier to use the formula in the text = NI - (CFO+CFI)
cpk, i understand earnings = accruals + cf component. why would mean reversion occur faster when earnings are largely comprised of accruals?
Thanks CPK, and lastly, put it together. The reason you want to the ratios smaller is in part because the more of the cash component you take out (leaving a small accrual component in the numerator) the more persistent the earnings? Sound right fellas?
accruals are not expected to continue on forever - since these are not persistent and generally are lower quality earnings. so if you had a whole bunch of them earlier - as time goes on, these would have to disappear. once they disappear - the earnings of the company would kinda mean revert…
Because accruals are something that should reverse in the future if accounted for correclty. So if the mean earnings of the industry is EPS = 5 and a particular company A (having larger accrual component in their earnings) has an extraordinary high EPS of 25 and other firm B (having small accrual component in their earnings) which also has an EPS of 25. The firm A’s accruals will start reversing and the earnings will come back to it’s mean reversion value quicker than a firm B, which hardly has any accrual component to reverse in the near future.
LOVE IT!!! Something is starting to make sense…amazing! studying at the office so much less distracting than at home!
thnx cpk and swaption.
cpk123 Wrote: ------------------------------------------------------- > remember to use the right direction (including > sign for the cfi)… just a thing to be careful > about. > > Actually might be easier to use the formula in the > text = NI - (CFO+CFI) Just so I don’t mess this up, CFI is usually negative, so does this formula mean NI minus the net of CFO and CFI? ie if NI = 1000 CFO = 500 CFI = -400 1000 - (500 + (-400)) = 900 of accruals present? I think that would be right, as if you have 500 coming in from operations, 400 going out to investments, you would have net 100 cash and if NI is 1000, 900 has to be in accruals. . .
+1 Phil