CFA Level IFinancial Statement AnalysisHard
A company reports revenue of $600,000 and cost of goods sold of $400,000. Accounts receivable increased from $80,000 to $100,000, inventory increased from $50,000 to $70,000, and accounts payable increased from $40,000 to $55,000 during the year. Cash operating expenses paid were $50,000. Using the direct method, what is cash flow from operations (CFO)?
- A$150,000
- B$115,000
- C$125,000
- D$105,000
Show answer & explanationAnswer & explanation
Correct answer: C. $125,000
Cash collected from customers = Revenue − Increase in AR = $600,000 − $20,000 = $580,000. Cash paid to suppliers = COGS + Increase in inventory − Increase in AP = $400,000 + $20,000 − $15,000 = $405,000. CFO = Cash collections − Cash paid to suppliers − Cash operating expenses = $580,000 − $405,000 − $50,000 = $125,000.
Why the other options are wrong
- A. This ignores the increase in inventory when calculating cash paid to suppliers.
- B. This results from a minor miscalculation in the inventory or payable adjustment.
- D. This results from omitting the accounts payable adjustment in cash paid to suppliers.
Direct Method Cash Flow from Operations
The direct method calculates CFO by directly computing cash collected from customers and cash paid to suppliers and for operating expenses, using accrual figures adjusted for changes in working capital accounts.
- Cash collections = Revenue − Increase in AR (or + decrease)
- Cash paid to suppliers = COGS + Increase in inventory − Increase in AP
- CFO = Cash collections − Cash paid to suppliers − Cash operating expenses
Memory trick: Adjust each accrual line for its matching balance sheet change to get real cash.