CFA Video: Operating Cash Flow – Direct Method Exercise
CFA Video: Operating Cash Flow – Direct Method Exercise
Question:
What is the CFO for a company reporting the following data:
|
Net Sales |
1000 |
|
Cash From Customers |
50 |
|
Tax Rate |
25% |
|
Tax Paid |
30 |
|
Cash Operating Expenses |
150 |
|
Increase in Inventory |
15 |
|
Depreciation |
8 |
|
Interest Expense on Debt |
5 |
Answer:
|
|
|
Although you are given so much information, this question can be easy if you understand what are being tested. For indirect method, please refer to http://minute-class.com/finance/video-operating-cash-flow-cfo-exercise-for-cfa-exam/
Items affect CFO using direct method
• CFO are the cash flows related to operations
• Cash collected from customers
• Interest Paid (NOT CFF)
• Taxes Paid
• Depreciation (Not cash flow, used indirect method only)
Note that only “Paid” interest and taxes are included in CFO. Therefore, CFO = 50 - 30 150 – 5 = -135
for interest expense on Debt, how do you know it’s paid or just a payable? Thanks,
This usually means interest PAID. And for a normal company, interest should not be payable because that will mean it is in default. A company cannot even pay the interest means it is in big trouble. After all, calculating cash flows is to evaluate the healthiness of the company. You won’t think a company has interest payable (meaning higher CFO) is better than a company otherwise. So treating it as interest PAID gives the worst scenario.
This is a good video tutorial, another way of calculating Operating cash flow from operations is by using this formula:
Cash Flow from Operations = Income from Continuing Operations + Non-Cash Expenses – Non-Cash Sales Income from Operations Source: http://www.accountingscholar.com/operating-cash-flow.html
1) Start with total Annual Revenues and subtract Cash expenses & Depreciation to calculate Earnings Before Interest & Taxes (EBIT). EBIT is also referred to as operating income as it is earnings before interest expense & taxes are paid.
2) Calculate Earnings before interest and after taxes (EBIAT) by multiplying EBIT times 1 minus tax rate. For instance, if earnings is $10 and tax rate is 40%, then EBIAT will be: $10 x (1 – 0.40) = $10 x 0.60 = $6. This $6 is your earnings before interest expense and AFTER taxes.
3) Finally to calculate free cash flow, add Depreciation expense to EBIAT less Capital Expenses (CAPEX) and less any investments in Net Working Capital (NWC).