Module I· Cash Flow Statement ConstructionIntermediate
Question
How do you build up OCF from net income — the standard reconciliation?
Answer
Standard build-up (indirect method)
net income (starting point) + D&A (non-cash add-back) + stock-based compensation + impairments / write-downs + Δ deferred taxes (DTA reduction / DTL increase as an add-back) + losses / − gains on asset sales (against the cash proceeds in investing) + equity-method loss / − equity-method income ± other non-cash items (e.g. the unwinding of the discount on a pension provision) − Δ AR (AR ↑ → OCF ↓) − Δ inventory (inventory ↑ → OCF ↓) + Δ AP (AP ↑ → OCF ↑) ± Δ other WC items = OCF.
Deep diveShow more details
Pitch tip
In the model the exact order isn't standardized (every company reports differently), but the logic is universal: add back non-cash items, then working-capital changes with the correct sign.