Reconciling Net Income to CFO using the Indirect Method

1
Reconciling Net Income to CFO using the Indirect
Method

• Start with Net Income
• Add-back non-cash charges
  (depreciation, amortization, non-cash
  restructuring charges)
• Adjust for changes in operating accounts
  (non-financial and usually current accounts)
• Add-back (Subtract) Losses (Gains) from investing
  transactions
  (the cash proceeds will be in the investing
  section)

2
Indirect Cash Flow Statement 1. Cash from
Operations Cash Collections - Cash
Payments (Reflects day-to-day cash flows) 2.
Cash from Investing (Reflects assets cash flows
that are
not day-to-day) 3. Cash from Financing
(Reflects liability and equity cash
flows that are not
day-to-day)
3
Developing the Operating Portion of the Cash
Flow Statement
Converting Income to Operating Cash Flows
1. Convert income to Cash Revenues - Cash
Expenses 2. Convert Cash Revenues - Cash
Expenses to Cash Collections - Cash Payments
from Operations
4
Income Revenues - Expenses
1a. Income Cash revenues non-cash revenues
- cash expenses - non-cash
expenses Solve 1a for Cash revenues - cash
expenses 1b. Cash revenues - cash expenses
Income non-cash
expenses - non-cash revenues
5
Two typical non-cash expenses are
depreciation expense and
purchases on credit (increases in A/P) One
typical non-cash revenue is sales on credit
(increases in A/R)
6
Insert examples for non-cash revenues and
non-cash expenses 1. Depreciation expense is an
example of a non cash expense (Non cash
revenues would be subtractions). 2.
Accounts/Receivable is an example of an operating
asset. 3. Accounts/Payable is an example of an
operating liability. (Not all short-term
accounts are operating accounts. Some
long-term accounts occasionally are operating
accounts.)
7
With examples Cash Revenues - Cash Expenses
Income non-cash
expenses -
non-cash revenues
becomes Cash Revenues - Cash Expenses Income
depreciation
expense increases in A/P
- increases in A/R
8
Recognize that Cash Collections Cash Revenues

decreases in A/R or Cash Revenues Cash
Collections - decreases in A/R and
Recognize that Cash Payments Cash Expenses

decreases in A/P Cash Expenses Cash Payments
- decreases in A/P
9
Substitute for Cash Revenues - Cash Expenses
Basic Relationship Cash Revenues - Cash Expenses
Income
depreciation expense increases in A/P
- increases in
A/R Equations to be substituted Cash Revenues
Cash Collections - decreases in A/R Cash Expenses
Cash Payments - decreases in A/P Relationship
Becomes Cash Collections - decreases in A/R -
Cash Payments - decreases in A/P Income
depreciation
expense increases in A/P
- increases in A/R
10
Rearrange to focus on Cash from Operations (CFO)
Cash Collections - decreases in A/R - Cash
Payments - decreases in A/P Income
depreciation
expense increases in A/P
- increases in A/R
becomes CFO or Cash Collections - Cash
Payments Income
depreciation expense
decreases in A/R - increases in A/R
increases in A/P
- decreases in A/P or CFO or Cash
Collections - Cash Payments Income
depreciation expense
- ? in A/R ? in A/P