One of the Schweser mock question subtracted profit from sales of equipment from the cash flow calculation, can someone please explain why this is so?. Why subtract and not add? Confusing.
By using indirect method (which differ from DM only in CFO domain), adding means - adjustment NI for non-cash operating items such as depreciation or other non-cash accruals. Selling equipment is cash transaction so cannot be adjusted in same manner.
Using substracting is tehnique of removal from CFO items that does not belong to CFO than in other CF (CFF or CFI).
I have checked and USGAAP treats selling property, plant and equipment (LTA) as CFI, not as CFO item.
Gains and losses from sale of equipment are on CFO. Subtract for gains, add for losses using indirect method.
Statement of Cash Flows
SFAS 95, November 1987 “Statement of Cash Flows” SFAS 102, February 1989 “Statement of Cash Flows - Exemption of Certain Enterprises and Classification of Cash Flows from Certain Securities Acquired for Resale - an amendment of FASB Statement No. 95”
- Acquisition of debt instruments of other entities 2. Sale of debt instruments of other entities 3. Acquisition of equity instruments of other entities 4. Sale of equity instruments of other entities 5. Acquisition of property, plant and equipment 6. Sale of property, plant and equipment 7. Capital expenditures 8. Payment for purchase of another entity
I get this now, it is to remove the double counting.
Anyway, even if selling PPE would be considered as a CFO item (and it is not), substracting CFO cash item from CFO would make no sense.
I think it goes like this. When you sell an equipment, it is CFI inflow, but the gains/losses from it are on Net Income, which are on the CFO. To avoid double counting, you have to subtract(add) the gains(losses) on CFO.
All revenues and expenses are contained on Net Income, income after taxation (not confuse with Operating income - EBIT), thus selling of equipment, too. To extract CFO by using Indirect method, beside adding back non-cash records which had been prior deducted in calculating NI (depreciation, non cash provisions and accruals etc), you have to substract cash flow items that does not belong to CFO than to CFI or CFF. The result is EBITDA which is a proxy for pure CFO.
I wrote an article on the indirect method of computing CFO that may be of some help here: http://financialexamhelp123.com/cfo-indirect-method/
You are right, but only in the indirect method.
Its clear now, thanks guys.