I still don’t get it. Please help. 
If you have the below info: Net income was $850,000. Depreciation expense was $200,000. Interest paid was $100,000. Income taxes paid were $50,000. What’s your CFO, using the indirect method? The answer is $1,000,000 and the calculation is: Cash flow from operations is ($850,000 + $200,000 – ($100,000 − $50,000)) = $1,000,000. Why should we consider interest & income taxes here? Aren’t they already factored in NI?
interest paid and interest expense are different. its the differences in payables we look at.
I believe the answer should be 1,050,000 cause like you said interest and income taxes are already factored in.
Well well well …interesting While using the indirect method to calculate CFO, we need to include working capital changes. Changes in income tax payable and interest payable come under working capital changes. Since 50,000$ was paid in tax, taxes payable reduced by 50,000. 100,000$ was paid in interest, interest payable reduced by 100,000 Net income 850,000 Depreciation 200,000 Decrease in Interest payable (100,000) Decrease in taxes payable (50,000) Net cash 900,000 How did they get $1,000,000?
Right? This is driving me so mad. I checked the curriculum and I still can’t get this monkey off my back. This question is taken from the SchweserPro Qbank. The full answer is: Cash flow from operations (CFO) using the indirect method is computed by taking net income plus non-cash expenses (i.e. depreciation) less gains from the equipment sale. Note that cash flow from operations must be adjusted downward for the amount of the gain on the sale of the equipment. Cash flow from operations is ($850,000 + $200,000 – ($100,000 − $50,000)) = $1,000,000. Note that interest and income taxes paid are expenses shown on the income statement and will already be factored into net income. I seriously need some enlightenment on this. I struggle so much when it comes to CFO, Interests and Taxes coming altogether in one “package”. Exhibit 9, vol 3., p275, I can’t derive the answer for this question from the exhibit either.
Do you mind posting the complete question from the Qbank?
An analyst compiled the following information for Universe, Inc. for the year ended December 31, 20X4: Net income was $850,000. Depreciation expense was $200,000. Interest paid was $100,000. Income taxes paid were $50,000. Common stock was sold for $100,000. Preferred stock (eight percent annual dividend) was sold at par value of $125,000. Common stock dividends of $25,000 were paid. Preferred stock dividends of $10,000 were paid. Equipment with a book value of $50,000 was sold for $100,000. Using the indirect method and assuming U.S. GAAP, what was Universe Inc.’s cash flow from operations (CFO) for the year ended December 31, 20X4? A) $1,050,000. B) $1,015,000. C) $1,000,000. Your answer: A was incorrect. The correct answer was C) $1,000,000. Cash flow from operations (CFO) using the indirect method is computed by taking net income plus non-cash expenses (i.e. depreciation) less gains from the equipment sale. Note that cash flow from operations must be adjusted downward for the amount of the gain on the sale of the equipment. Cash flow from operations is ($850,000 + $200,000 – ($100,000 − $50,000)) = $1,000,000. Note that interest and income taxes paid are expenses shown on the income statement and will already be factored into net income. The other information relates to financial and investing cash flows. Well, I didn’t want to post the whole question but since you asked, please allow me to add this line: This question is taken from SchweserPro Qbank, a product of Kaplan Companies. The purpose is purely for self-learning and non-commercial. I got A) like CFAbooked said, too…
ok, now it becomes simple. Net income 850,000 Depreciation 200,000 Gain on sale of Equipment (50,000) CFO 1,000,000 They assume that there is no changes to income tax payable/interest payable. Common stock sale/Preferred stock sale/Dividend payments go out of CFF
You know what, I just got a chance to re-read the question and I admit I didn’t see the line about the sale of equipment!!! UGH!!! Sorry for taking your time and thank you for it.
Ok so that means that for the indirect method you shouldnt take the Interest paid and the taxes paid because they are already reflected in NI?
JCM Yes. They have already been factored into NI. You are adjusting CFO for non-cash expenses. (Amort, Depreciation etc)
Thanks