This method is preferred by most firms because is shows a reconciliation from reported net income to cash provided by operations.
Steps:
1. Start with net income.
2. Add back non-cash expenses. (Such as depreciation and amortization)
3. Adjust for gains and losses on sales on assets.
4. Add back losses
5. Subtract out gains
6. Account for changes in all non-cash current assets.
7. Account for changes in all current assets and liabilities except notes payable and dividends payable.
In general, utilize the following rules:
Increase in assets = use of cash (-)
Decrease in assets = source of cash (+)
Increase in liability or capital = source of cash (+)
Decrease in liability or capital = use of cash (-)
Showing posts with label Direct vs indirect methods. Show all posts
Showing posts with label Direct vs indirect methods. Show all posts
Thursday, November 20
Direct method
Direct Method takes each item from income statement and convert to cash equivalent by adding or subtracting the changes in the corresponding balance sheet.
Cash Flow from Operations
Determine net cash flow by taking cash receipts from sales, adding interest and dividends, and deducting cash payments for purchases, operating expenses, interest and income taxes.
Cash Collections Receipts from Sales
= Sales + Decrease (or - increase) in Accounts Receivable
Cash payments for purchases
= cost of goods sold + increase (or - decrease) in inventory + decrease (or - increase) in accounts payable
Cash payments for operating expenses
= operating expenses + increase (or - decrease) in prepaid expenses + decrease (or - decrease) in accrued liabilities
Cash interest = interest expense - increase (or + decrease) interest payable + amortization of bond premium (or - discount)
Cash interest is the interest paid to debt holders in cash.
Cash payments for income taxes
= income taxes + decrease (or - increase) in income taxes payable
Cash payment for incometaxes is the actual cash paid in the form of taxes.
Note:
· Cash flow from investing and financing are computed the same way it was calculated under the indirect method.
Free Cash Flow (FCF)
Cash flow that a company has left over after it has paid all of its expenses, including net capital expenditures. Net capital expenditures are what a company needs to spend annually to acquire or upgrade physical assets such as buildings and machinery to keep operating.
Free cash flow = cash flow from operating activities - net capital expenditures (total capital expenditure - after-tax proceeds from sale of assets)
The FCF measure gives investors an idea of a company's ability to pay down debt, increase savings and increase shareholder value, and FCF is used for valuation purposes.
Free cash flow to the firm (FCFF)
Cash flow available to all investors including stockholders and debt holders.
Calculated from net income
FCFF = NI + non-cash charges +[Interest expense x (1-tax rate)] – net capital investment – working capital investment
Calculated from operating cash flow
FCFF = CFO +[interest expense x(1-tax rate)] – net capital expenditure
Free cash flow to equity (FCFE)
Cash flow available for distribution to the common shareholders, i.e. after all obligations have been paid.
FCFE = CFP- net capital expenditures +net borrowings
Cash Flow from Operations
Determine net cash flow by taking cash receipts from sales, adding interest and dividends, and deducting cash payments for purchases, operating expenses, interest and income taxes.
Cash Collections Receipts from Sales
= Sales + Decrease (or - increase) in Accounts Receivable
Cash payments for purchases
= cost of goods sold + increase (or - decrease) in inventory + decrease (or - increase) in accounts payable
Cash payments for operating expenses
= operating expenses + increase (or - decrease) in prepaid expenses + decrease (or - decrease) in accrued liabilities
Cash interest = interest expense - increase (or + decrease) interest payable + amortization of bond premium (or - discount)
Cash interest is the interest paid to debt holders in cash.
Cash payments for income taxes
= income taxes + decrease (or - increase) in income taxes payable
Cash payment for incometaxes is the actual cash paid in the form of taxes.
Note:
· Cash flow from investing and financing are computed the same way it was calculated under the indirect method.
Free Cash Flow (FCF)
Cash flow that a company has left over after it has paid all of its expenses, including net capital expenditures. Net capital expenditures are what a company needs to spend annually to acquire or upgrade physical assets such as buildings and machinery to keep operating.
Free cash flow = cash flow from operating activities - net capital expenditures (total capital expenditure - after-tax proceeds from sale of assets)
The FCF measure gives investors an idea of a company's ability to pay down debt, increase savings and increase shareholder value, and FCF is used for valuation purposes.
Free cash flow to the firm (FCFF)
Cash flow available to all investors including stockholders and debt holders.
Calculated from net income
FCFF = NI + non-cash charges +[Interest expense x (1-tax rate)] – net capital investment – working capital investment
Calculated from operating cash flow
FCFF = CFO +[interest expense x(1-tax rate)] – net capital expenditure
Free cash flow to equity (FCFE)
Cash flow available for distribution to the common shareholders, i.e. after all obligations have been paid.
FCFE = CFP- net capital expenditures +net borrowings
Direct vs indirect methods
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