Cash Flow...

CFA Level I
#1

Spent a LOT of hours in the cash flow section in FRA today. Mostly because I was distracted at points (ADD ? ADHD? probably one of those things)

Is there a trick to memorizing any of this stuff?

Having some trouble remembering if an item should be added or subtracted (i.e. decrease in notes payable) and to which cash flow (operating, financing, investing).

I know repetition is probably the key here, making some notes cards, more questions etc… But I just wanted to ask and hear some thoughts.

Thanks in advance!

#2

Hey fellow cfa candidate, I’m also reading FRA and is currently behind schedule (need to complete by this Friday)

I read your post and I wish to share with you some of my thoughts.

I think we should, as far as possible, restrain ourselves to memorising; especially the classification of cash flows (i.e. CFO?CFI?CFF?) . This is because the classifications are not something ‘casted in stone’ and it depends on other factor such as the nature of the business in consideration. In other word, the classification of a particular cash flow may varies across different businesses. The same hold true for other financial statements such as income statement and balance sheet. I hold the view that, as long as the financials are prepared within the stipulated “boundaries” set forth by the governing accounting standards, it will be fine.

As to your questions on differentiating between when to add/subtract, perhaps you can try thinking from the cash perspective.

If account payables (current liabilities) increases, this tell us that more purchases are made on credit. From the cash perspective, you are not paying out as much cash as you will have been if you have made cash purchases. Hence, it will be logical to increase.

If current asset account such as account receivables increases, this tells us that you made more credit sales. From the cash perspective, you are not receiving as much cash as you will have been if you have made cash sales. Thus, it will be more logical to decrease.

#3

Thanks for the response Snow.

You think you are behind because your not done with FRA? I was thinking to be done with FRA by end of this week would be a blessing!

#4

yeah, I allocated around 1.5 month for FRA and sadly to say, I still cant finish the whole book. I dunnoe whether was it only me; i need to read a few times a particular concepts before understanding. I guess my main problem lies with having insufficient accounting background and the fact that I tend to think a lot at times.

#5

Will not make your life easier but I spent 2 months on FRA and when later I took it to review and started doing QBank from Schweser I realized how many things I missed or did not clearly understand. With no accounting background it sucks. Especially to figure out the answers for some (most) questions in not much more than 60 secs.

#6

EPhilly,

I was studtying same section today and also felt it was diffitcult to retain. Not much help just letting you know you’re not alone

#7

Not sure if this helps, but a couple thoughts I’ve been focusing on for retaining cash flow concepts: Assets have an inverse relation w/ cash flows (increases are deducted) . Liabilities have a direct relation (increases are added). Unless the starting point is an expense (e.g. COGS for direct method), then this dynamic is reversed and liabilities are inverse and assets are direct.

#8

Alright, so I thought I would share a few thoughts.

I posted this topic before I had started the EOC questions from CFAI or read any of the CFAI chapter. I am using the Schweser notes, and CFAI as a complement.

After digging into the CFAI chapter and taking the EOC questions I feel MUCH better. I ended up scoring 90% on EOC. Apparently, I was getting hung up on the Schweser notes, sometimes their notes are too general for a particular topic.

Although I did end up spending A LOT of time on this chapter, I feel as if it will pay off in the end.

Just some thoughts…

#9

Here’s how I tell my students to remember the Statement of Cash Flows. It’s not comprehensive, but usually allows them to get to the right answer.

Start off by realizing that there are three ways to get cash - earn it (operations), hock your stuff (investments) (or the reverse counterpart - buy stuff), or borrow it (financing).

I. Let’s start with operating activities:

  1. Net Income - profits from operations

  2. Since Depreciation is a non-cash expense, Net Income doesn’t reflect cash - it’s decreased by Depreciation expense. So, add it back.

  3. Likewise, if we have a non-cash gain, subtract it

  4. Then, we look at all the operating activities that also aren’t reflected in Net Income. These are Current Asset and Current Liability changes other than (1) cash, and (2) Notes Payables (this is a financing activity) or the Current Portion of Long-term Debt (this is a financing activity)

To remember what’s what, I think in terms of inventory - if you buy inventory (an asset), it costs you cash. So, asset increases are cash outlays, and decreases are inflows. Likewise, if an asset increase is a decrease in cash, a liability increase (like Accounts payables) is an increase, and a Liability decrease is a decrease.

II. Next, on to Investing activities

These are changes in long-term (i.e. Fixed) assets. Just like with inventory, and increase is an outflow, and a decrease is an inflow. Just remember - use Gross Fixed Assets, not Net Fixed Assets (NFA includes the effects of Depreciation).

III. Finally, to Financing Activities

These include any cash paid out to or received from long-term debt or equity holders. We’ve already taken care of interest expense in the calculation of Net Income. So, it’s either Dividends Paid, New issues of Debt or Equity (i.e. the changes in these accounts), or Decreases in Debt or Equity. And don’t forget that Debt included here includes Notes Payables and the Current Portion of Long-term Debt.

If you’ve done it right, the sum of these three - Operating, Investing, FInancing - will give you the change in cash.

#10

I’ll echo busprof’s thoughts.

When I teach the indirect method for CFO, I note that it’s _ Cash Flow _ from _ Operations _. Thus, starting with the income statement, we need to remove anything that isn’t cash, or isn’t related to operations.

The primary non-cash items are depreciation and amortization. The sneaky non-cash items are income from affiliates (using the equity method), and amortization of bond premia/discounts (which are included in interest expense).

The primary non-operating items are gains/losses from the sale of assets, and gains/losses from the sale of discontinued operations.

In either case, you need to reverse what you showed on the income statement:

  • add non-cash and non-operating expenses and losses
  • subtract non-cash and non-operating revenues and gains

Then you have to handle the working capital changes; these are non-cash items, but they come from the balance sheet (just to keep you on your toes). If you relate everything to cash, you’ll get it correct:

  • Increases in assets reduce cash (e.g., A/R increases: you booked sales (on the income statement) but didn’t get the cash yet
  • Decreases in assets increase cash (e.g., A/R decreases: customers paid off their accounts)
  • Increases in liabilities increase cash (e.g., A/P increases: you bought stuff, but you haven’t paid the cash for it yet)
  • Decreases in liabilities decrease cash (e.f., A/P decreases: you paid your suppliers)

busprof nailed the investing and financing stuff.

#11

Nice - I’ll use that next time.

#12

Be my guest.

#13

S2000 and bus, thank you both very much. Your explanations have provided some much needed clarity!

#14

My pleasure.

#15

Opposite ends of the automotive performance spectrum.