Video: Operating Cash Flow Exercise for CFA Exam

Question:

What is the CFO for a company reporting the following data:

Answer:

Since the net income is given, we can try to use indirect method. Recalling the format of an income statement,

Among these items in an income statement, only depreciation is not a real cash flow. So, the CFO = Net Income + Depreciation because there is no cash outflow due to depreciation.

Of course, the above assumed that there is no change in many items in the balance sheet. If there are, we need to adjust the CFO.

So, let’s identify the items that affect CFO in the balance sheet. These include “decrease in A/R”. It means that account receivable is less than last year. How can that be? It must be that you receive some cash from people who owe you so you convert the A/R to cash. So, this will contribute to the CFO. Also “Increase in A/P” means you owe people more compared to last year. This is not reflected in the income statement. But it does mean that you are paying less cash than you supposed to have. So this will contribute to CFO. Increase in inventory will also affect CFO. This is because you are converting cash to goods. So you have less cash, i.e. you have cash outflow. Of course, interest expense is a cash outflow also. But this is taken into account in the Net Income already.

Therefore, CFO

= Net Income (150)

+ Depreciation (8)

+ Decrease in A/R (50)

+ Increase in A/P (18)

– Increase in Inventory (15)

= 211