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Hallo,
Studying the layout of CF from OA – inderect method, there are two sayings which contradict to me or I’m not understanding something. They relate to the begining and the end of the layout, citing from BPP ACCA book:
– Profit before interest and tax (income statement)* vs Take profit before tax and add back any interest expense
a) I see in the layout below that interest expense is subtracted – where it says “interest (paid)”, not added, what do they mean by saying – add the interest expense back?
b) Why the sentence “Take profit before tax and add back any interest expense”
talks about taking only the profit before tax and nothing about taking the profit as well before interest, when the first line of the layout below specifically says we take the amount before both interest and tax?Layout:
Profit before interest and tax (income statement)* X
Add depreciation X
Loss (profit) on sale of non-current assets X
(Increase)/decrease in inventories (X)/X
(Increase)/decrease in receivables (X)/X
Increase/(decrease) in payables X/(X)
Cash generated from operations X
Interest (paid)/received (X)
Income taxes paid (X)
Net cash flows from operating activities X
* Take profit before tax and add back any interest expenseThank you!
We always start with the profit before interest and tax (so we need to take the profit and add back the interest expense and the tax expense).
Obviously cash will have been paid during the year for interest and tax, but the amounts paid must be shown separately in the Statement of Cash Flows, as a deduction from the cash generated from operations (and, of course, the cash paid will not necessarily be the same as the expense in the SOPL).
I do suggest that you watch our free lectures on Statements of Cash Flows. Our lectures are a complete course for Paper F3 and cover everything needed to be able to pass the exam well.
Hallo,
I don’t understand your statement very well: “We always start with the profit before interest and tax (so we need to take the profit and add back the interest expense and the tax expense)” – if the profit doesn’t include the interest and tax expense, this means the profit hasn’t been reduced yet – as interest and expense reduce the profit, so, as long as the profit hasn’t been reduced yet and if we add further interest and tax expense, this would make the profit artificially higher, or?
I opened the lecture and I am not quite clear about the following in it, only the numbered ones:
1. Net profit before taxation x
1.1. Why doesn’t it say before interest as well, because in this case it has been deducted from the profit in (1) already and thus is subtracted in (2) below or what is the reason?1.2. When it says here only taxation, this would mean we don’t need to add back the taxation expense, as it has not been subtracted yet, is this the reason why below we don’t see tax expense added?
Adjustments for:
Depreciation x
Profit on sale of non-current assets (x)2. Interest expense x
2.1. Is this the same interest that you say we are adding back, as it has been deducted from the profit in (1) in comparison to the tax expense, which hasn’t been deducted?Op. profit before working cap. changes x
Increase in accounts receivable (x)
Increase in inventories (x)
Increase in accounts payable x
Cash generated from operations x3. Interest paid (x)
3.1. Is this the same or it is not the same as the interest expense in (2), probably it’s different?Dividends paid (x)
4. Taxation paid (x)
4.1. This also is different from the interest expense you’re talking about, correct?Net cash from operating activities x
I am going to watch the video and read the lecture, but these details are escaping my understanding.
Thank you!
If the profit is already before interest and tax, then obviously we don’t need to add it back again!!! One way or another we need to get the profit before interest and tax.
1.1 It is simply because it is copied from the accounting standard. Again, we should start with the profit before interest and tax, which is what I explain as I work through the example.
1.2 Profit before tax means it is the profit after tax with the tax added back.
2.1 See my answer to 1.1. Also the interest paid during the year will not always be the same as the interest expense (it depends whether there is any interest accrued or not).
3.1 See my answer to 2.1
4.1 Tax paid is certainly different than interest paid. I guess, however, that you are asking if the tax paid will be different from the tax expense. The answer to this is almost certainly yes, because the tax expense for the year will not normally be paid until the following year and so will be a liability in the SOFP.
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