[ocboa]

Have a friend taking a finance class, and he was asked to calculate Operating Cash Flow (OCF). The formula he has is EBIT + Depreciation – Taxes. I have seen this formula elsewhere but I’m having trouble understanding why interest expense is not shown as a deduction.

When we do a statement of cash flows, using the indirect method, we start with net income which has included in it a deduction for interest expense.

Can anyone explain why in the finance formula for OCF interest expense is not a deduction, but for calculating cash flows from operating activities on the statement of cash flows, we do have interest expense as a deduction bc it’s included in net income.

[excel monkey]

Interest expense, along with tax expense, is added back to net income to calculate EBIT (Earnings Before Interest and Taxes).

FAR - 91
AUD - 88
BEC - 86
REG - 79

[ocboa]

I was confused as to why with respect to interest expense. HIs finance book calls it OCF, and our accounting books call it cash flows from operating activities. Yet in finance, interest expense is not deducted out, but in accounting it is.

[excel monkey]

Sorry, my reading comprehension failed me in the wee hours of the morning. The reason, as I understand it, is finance people add interest expense back to net income to eliminate differences that may arise from different capital structures when comparing companies. For accounting purposes, two companies could have the exact same operations and the one with a higher debt load will report lower cashflows from operating activities simply because one used debt and the other used stock to finance its activities. GAAP sees interest expense as an operating cash outflow, while most of the rest of the world would say it's a finance cashoutflow (You have the option to put it there under IFRS).

FAR - 91
AUD - 88
BEC - 86
REG - 79

[Author]

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