Why does i expense show up on the IS but not the CFS?
I'm a little confused because I read and understand that: -principal shows up in CF from financing -BUT interest paid back on loans shows up in CF from operations So then why is it that when there's, say, a $10 interest expense it shows up in the IS but not the CFS? Or maybe (beginner here) I'm just not understanding the terms properly? I mean I understand that i expense is an expense which would logically show up as an expense on the IS (duh). But why not the CFS as well..
I don't mean to be rude, but all of these questions that you are asking are answered in just about every interview guide. I would highly suggest purchasing one since you will need it for interview preparation as well.
To answer your question, for an expense to show up on the IS, it must be tax-deductible and in the current period. Many tax-deductible expenses are non-cash expenses (e.g. depreciation or amortization). Because of this, we need to add them back on the CFS to get a true sense of the cash flow of our firm. If we did not, the ending cash balance on our CFS would treat non-cash expenses as if we paid cash for them, which is not true. Hopefully that helps.
Thanks Sil! I actually have the M&I interview guide. The questions that I'm asking are about the answers M&I gives because some of their explanations are unclear for beginners. For example, this question that I asked here was for clarification on an answer explanation that they gave where they stated what happens to i expense, but they didn't say why. Maybe I should look around for clearer guides-- but thanks again for all your help.
I understand that non-cash expenses are added back in to the CFS. But I still don't understand why i expense wouldn't be accounted for in the CFS. My intuition was that i expenses are paid for in cash, so subtract the i expense from the CFS. But the M&I guide only accounts for it in the IS and not in the CFS which is throwing me off
Because it is already reflected in Net Income, which is the beginning line item on an indirect statement of cash flows. It is a cash outlay, but it lowers Net Income, which lowers your beginning cash flow from period by default.
Right okay, but my confusion is that you would count d&a twice (in IS and then add it back in CFS) so I don't get why you wouldn't count i expense twice as well. Maybe because i expense isn't a non cash expense and d&a is?
There you go. Think of it this way: your starting point is Net Income, then you adjust for all the non-cash items that affected Net Income (D&A being one of them).
You might want to read up on the indirect method for accounting for cash flows. It's the type you're describing. There's also a direct method, but almost no one uses it in the real world.
D&A isn't accounted for "twice", I think what you're confused about is how the financial statements flow into one another.
IS
Revenue
Less:COGS
Gross income
Less:S&GA expense Less: D&A expense Income from Operations Less:Interest expense Less: Taxes Net income------------>
CFS: Cash flow from operations: Net income Add:D&A etc etc
You add back D&A in cash flow statement because its a non-cash expense and therefore if you don't add it back, it'll be misrepresenting the true cash flows of the company. You don't add back interest expense because its lready accounted for in the net income figure, which is your first line for cash flow from operations on your CFS. A really watered down way of describing it but hope it makes sense.
Thanks so much guys.
Silver bananas all around. Thanks for helping out guys! :-)
And this is why WSO is awesome.
This is what helped me when first going over CFS in accounting: When recording depreciation/amortization you aren't physically paying out cash to anyone(i.e non-cash expense from above), so you add back that expense amount in CFS. When recording interest, you are physically paying out interest on a bond/note, so you do not add that expense back.
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