Question on cash flow from operation

CFA Level I
#1

Dearmy friends,

I still got trouble in dealing with FR&A part, sombody pl help me to clarify the question under:

An analyst has gathered the following information about a company:

Income Statement for the Year 20X4 Sales $1,500 Expenses COGS $1,300 Depreciation 30 Int. Expenses 40 Total expenses 1,370 Income from cont. op. 130 Gain on sale 30 Income before tax 160 Income tax 64 Net Income $96 Additional Information: Dividends paid $30 Common stock sold 20 Equipment purchased 50 Bonds issued 80 Fixed asset sold for (original cost of $100 with accumulated depreciation of $70) 60 Accounts receivable decreased by 30 Inventory decreased by 20 Accounts payable increased by 20 Wages payable decreased by 10

What is the cash flow from operations?

A) $170. B) $150. C) $156.

Your answer: B was incorrect. The correct answer was C) $156.

Net Income +$96 Depreciation +30 Gain on sale of asset -30 Accts. Rec. +30 Inventory +20 Accts. Payable +20 Wages Payable -10 CFO +$156

What I wonder is why a decrease in account receivable is plus 30 in calculating CFO? I had trouble indentify the positive sign(+) is cash outflow or cash inflow ?

#2

If account receivables decreases, its a source of cash mate. Somebody had to pay you more and they have paid a part of it. Thats the only way A/R would decrease… Hope that helps…

#3

Just remember that

If assets acounts are increasing (dont include Cash, thats what you are calculating) that means Cash outflow.

If Liability accounts are increasing (A/c payables, Tax payables, Salary payables) that means Cash inflow.

#4

^

and vice versa :slight_smile:

#5

I highly recommend going back to read (or reread) your Schweser or CFAI books for this section. The cash flow statement chapter goes through ALL the steps to calculate CFO, CFI, CFF (both indirect and direct).

As a thumb rule:

Increasing assets are subtracted. Decreasing assets are added.

Increasing liabilities are added. Decreasing liabilities are subtracted.

#6

Thanks for your comment mates…

#7

Here’s how i will advise you to go through the cash flow problems like this.

Remember that:

Asset = Liability + Equity

this can be broken down further into

Cash + other assets = Liability + Equity.

Cash = Liability + Equity - Other Assets.

Cash = Liability + Beginning retained Earnings +Revenue-Expenses-Dividends -Other Assets.

Now let’s include changes in each account.

Change in (Cash) = Change in (Liability) + Change in (Beginning RE) + Change in (Revenue) - Change in (Expenses) - Change in (Dividend) - Change in (Other Assets).

Now back to your question.

Cash Flow from operation will be calculated as follows.

a) Take your Net Income = $96

b) Add/subtract back non cash transaction i.e(Depreciation and gain on sale) = +30 - 30

C) Adjust for changes in working capital. (using the formula herein).

  • Change in (other assets) = - decrease in account receivables = -(-30)

  • Change in (other assets) = -decrease in Inventory = -(-20)

+changes (in liability) = +increase in accounts payable =+20

+Change (in Liability) = + decrese in wages payable = +(-10)

CFO = 96 +30 -30 +30+20+20-10

oftentimes, it’s always better to derive and understand the rule than just learning it by heart.

#8

Assets Up, CFO Down

Liabilities Up, CFO Up

its pretty logical since you have to pay for an asset, but they have to pay you for a liability, so to speak. that said, I have yet to calculate cfo right by any method. I’m seriously thinking about just skipping that los and coming back to it for a few days during revision :stuck_out_tongue: