Say $10 of interest accrues (PIK) to the principal. In the cash flow statement: for operations, we have a decrease in net income from the PIK interest expense but we add-back the expense as it is non-cash. Do we also adjust the cash flow from financing under issuance / (payment) of debt? Since the PIK interest accrues to the principal and causes the liabilities to increase on balance sheet, should we also adjust cash flow from financing on the cash flow statement?
My intuition is no because for cash flow statement we are essentially looking at if an item is a source or use of cash. Since regular interest expense does not appear under CFF we should not include the PIK interest in issuance/(payment) of debt for CFF. Can someone please confirm or provide counterargument? thanks.
It’s noncash, also you already account for it on your income statement in net income
Thanks, this is what I thought. My one point of confusion is that our principal for that piece of mezz-debt is now higher and that is shown in the balance sheet liabilities. Is the reason why we don't account for this in CFF that the PIK accretion is not considered a source of cash but rather a result of operations? Normally when we issue a follow-on or do a recapitalization we would increase principal of debt and adjust CFF upwards.
The other commenter is right. If you include in CFF you’re double counting. PIK is non-cash so you add it back on CFO to account for cash tax savings. If you included the increase of CFF (to your point on follow ons) you’re acting as if the bank gave you more cash since the PIK note has a larger principal balance. But, you’re not actually receiving more cash, the interest expense is just accruing and eventually you’ll make that larger bullet payment at maturity.
Let's really simplify this by going back to journal entries, A = L+E style.
Normal interest you have E -10 (interest exp.) and A -10, and specifically that A is cash.
PIK interest you have E - 10 and L +10 (the principal growing). A, and thus cash, are unchanged.
Bringing this to the CFS, you have NI -10, add back the non-cash in CFO and then are done. CFI and CFF only generally deal with actual cash raises / outlays as opposed to the indirect format of CFO. Think of those sections as much more direct rather than as deltas of balances.
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