CFAI books talk about differences in cash flow, defined as change in cash position i.e. not CFO, CFI, CFF. Consolidation/ proportianate consolidation makes sense because all we are doing is combining accounts or proportionate share of accounts minus intercompany transactions. However, is there some rule of thumb in understanding how it compares to the equity method? The CFAI books more or less say that each method has different impacts on cash flow. My second question is are we supposed to be able to understand a rule such as the profitability and leverage ratios between the two methods? Or is it more arbitrary, i.e we just do the math???
The answer to your question is on page 35 of CFAI text book 2, fifth paragraph from the top begins (italics in the original): “Reported cash flows also differ [between the equity method and consolidation].” You should definitely re-read this paragraph (I’m glad I just did), but it doesn’t work out to an “rule of thumb” that would definitely increase or decrease cash flows under either method. Some have pointed out the differences in cash flow due to taxation on purchase versus pooling (ie: purchase method may have an add’l depreciation expense and therefore lower tax cash outflow), but I don’t think the equity vs consolidation methods have such an outcome. Even if they did, I don’t think, based on the LOS’s, that they are the focus of testing (nothing in the LOS’s mentions cash flows, although they do talk about “effects… on a company’s financial statements” – so we can’t count on that I guess). By the way, if you have Schweser, page 147 of Book 2 lists states the following: “The reported cash flow will not differ between the two methodologies [equity method and cost method]”. So at least that one’s easy.
Thanks plyon. You would think that in all circumstances with consolidation, cash flow would improve since you are combining accounts? With the equity method, you do not change any of the accounts except for “investment in X”. Can anyone think of a situation where it would not improve with con vs equ?
Which component of cash flow would always improve? And why can’t a firm have negative cash flow? …
I thought about negative cash flow, but how can a company have a negative cash position? This is really a new way to measure cash flow, in this section. They specifically say this is not the indirect method. Maybe I am looking too far into it…
rowaytonite Wrote: ------------------------------------------------------- > I thought about negative cash flow, but how can a > company have a negative cash position? You don’t have to have a negative cash position to have negative cash flow: Beginning cash: $100 Cash flow from operations: ($50) Cash flow financing: $0 Cash flow investing +$10 Net cash flow ($40) Ending cash $60
Understood- but the text does not calculate CF using the indirect method- it bases it on change in cash.
I guess I’m missing something because if the change in cash is negative, then cash flow is negative, and then consolidation would decrease cash flow.