Calculation of CFO, CFF and CFI

Some points to remember

  • CFO is calculated differently but the result is the same under both methods
  • CFI and CFF is identical under both methods
  • Inverse relationship between asset and cash
    • An asset account increase = use of cash 
    • An asset decrease = source of cash
  • Direct relationship between liability and cash flow 
    • Increase of liability account = source of cash 
    • Decrease in liability = use of cash
  • Source of cash are positive number (cash inflows) and use of cash are negative numbers (Cash outflows)

Direct method 

  • Provide information about where cash comes from and went out
  • CFO ‘s common components
  • CFI is calculated by examining the change in the gross asset accounts that result from investing activities
    • Fixed asset (48)
      • It is necessary to consider if old assets are sold:
        • It is necessary to consider any gain or loss from the sale
    • Intangible asset (49)
    • Investment securities (50)
  • CFF measures CF occuring between the firm and its suppliers of capital
    • Between the firm and its creditor
      • Positive CFF: new borrowing, negative CFF: debt principal repayments
    • Between the firm and its shareholders
      • Positive CFF: equity issued, negative CFF: shares are repurchased, dividends are paid
  • Total cash flow = CFO + CFI + CFF

Indirect method 

  • CFO
    • Begin with net income 
    • Adjust for differences between accounting items and actual cash receipts and cash disbursements
      • Add/subtract non-cash components of revenue: depreciation 
      • Subtract gains/plus loss on the disposal of assets
        • Proceeds from sales of fixed assets are investing cash flow
      • Accounts receivable increased → need to subtract this in net income (not received yet)
      • Accounts payable increased → Need to add this in net income (not paid yet)
    • Calculate CFO under indirect method
      • Step 1: begin with net income
      • Step 2: Subtract gain or loss that resulted from financing or investing 
      • Step 3: Add back all noncash charges to income and subtract all noncash components of revenue
      • Step 4: Add or subtract changes to balance sheet operating accounts