Interest Added Back to Cash Flow from Operations?
I want some clarity regarding the treatment of Interest expense in the Cash Flow statement. I'm not able to get a satisfactory understanding on the same.
Let me just break down my doubt into two parts-
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Why is interest expense added back to PBT in Cash flow from operations?
My Understanding- Since we have adjusted interest expense which is a non-operating expense in P&L, therefore we need to add back to PAT in the cash flow from operations to get the real operating cash flow. Simultaneously, deduct interest expense from Cash flow from financing. -
Can Interest expense be operating in some cases?
My understanding- If fund is borrowed to met operating expenses then interest expense can be an operating expense. In this case, in will be adjusted in P&L with other operating expenses and there will be no treatment in the cash flow statement.
To add some more context: I'm valuing a company and therefore stuck up with this doubt.
Please clarify my doubt as per GAAP/Ind AS/ IFRS.
Not sure what you mean by this. What I've seen companies do is add back interest expense and deduct actual interest paid. For example, if a company's FYE is in December, and it issued a bond in July that pays interests in October and March, its interest expense will recognize the period from July-December, but it only paid interests for the July-October period so far. Hence Interest Expense > Interest paid.
Under US GAAP interest expense is always operating. Under IFRS it can be reported as either operating or financing.
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So like PIKs?
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Here's another example.
FY End: 12.31 50mn Bond Issued on June 30th. 100 face value @ 10% annual rate. Pays interest in October 31st and March 31st.
At Dec 31st, you'll have an interest expense of 2.5mn (10%x6/12x50mn) but paid only 1.66mn (10%x4/12x50mn). Hence you'll see Interest Expense added back for 2.5mn and Interes Paid substracted for 1.66mn
Interest is added back to operating cashflow just to reclassify it into investing activity. There may be a difference in the amount due to what has been paid vs what has been accrued as per income statement - this is since we are trying to arrive at the final cash levels in the company in the cash flow statement.
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