“If a company capitalizes interest, then it will have a higher CFO and a lower CFI than an expensing firm?” Why?
Capitalizing interest = holding the interest cost as an asset on the balance sheet, for payment of upcoming interest expense => interest expense becomes an investment cash outflow (buying assets is CFI outflow) Expensing interest = paying out interest => interest expense is an operating cash outflow (as per US GAAP) Hence, Capitalizing interest: lower CFI (because of the CFI outflow for interest expense), and higher CFO (as interest expense is CFI) Expensing interest: higher CFI, lower CFO (interest expense is an CFO outflow) Generally, if one type of cash flow goes up, another must go down.
I get why CFO is higher or lower, but can someone explain why CFI is the opposite???
Amigo, When you capitalized Interest you add them to the asset side. That means asset value in the balance sheet will go up with the amount of capitalized interest. The capitalized interest is considered a cash outflow, a fixed asset expenditures will will deacrease CFI. The firms that expense Interest, they simply deduct the interest expense in the income statement and therefore, CFO will be low and CFI is not affected. So, capitalized firms will have low CFI and high CFO versus expensing firms. Hope it helps
Dude, When interest is capitalized rather than expensed, the cash outflow is moved from operations to investing. Capitalizing interest creates an asset. The negative in CFI represents your investment in that asset. Also, you can’t magically create cash by increasing CFO without changing anything else. Since money is still going out the door it has to be allocated to one of three uses: operations, investing, financing. Since the cash is no longer used for an expense (as interest usually is in CFO) and you are not making principal repayments (therefore it is not going to CFF) it must be going to CFI. Hope that helps, MDD