Hey guys, I used to just ‘eyesdrop’ on this forum, but I signed in because I have a question, and this forum looked really helpful. I would be grateful of the help.
I’m using the Schweser for studying, and there’s something I don’t get regarding investing cash flows using the indirect method(but the calculation is same for CFI and CFF either direct or indirect, right? just checking).
It says that in order to calculate cash paid for a new asset, you have to determine whether old assets were sold, and then gives the formula
cash paid for new asset = ending gross assets + gross cost of old assets sold - beginning gross assets,
which is derived from the formula the same as the one I just wrote, just solving for ending gross assets instead.
What I don’t get is WHY you have to use the formula. Is it because you don’t know how much cash was paid for every asset acquired because you can’t keep record of every cash flow, so you’re trying to use the ending BS to derive the cash flow?
It may be a stupid question, but I’m really stuck here. Thanks!
If what I said was true about the second-to-last sentence(“Is it because you don’t know how much cash was paid for every asset acquired because you can’t keep record of every cash flow, so you’re trying to use the ending BS to derive the cash flow?”), then how do you know the gross cost of old assets sold??
Direct method and indirect method apply only to CFO; CFI and CFF are calculated the same way no matter what method you use to calculate CFO.
The reason that you have to use that formula is that they may not give you the amount you paid for the new assets; they may give you only ending gross assets, beginning gross assets, and gross cost of assets sold.
It’s not typical of what you’d encounter in the real world – where you would normally have all of the records on purchases – but might be a situation you’d encounter if the company kept horrible records.