am i correct to include increase inventory to CFO direct method calculation increase, question, include, understand, correct

hanvinh

Hi,

i have a question from qbank which i do not understand:

Financial information for Jefferson Corp. for the year ended December 31st, was as follows:

Sales: $3,000,000
Purchases: $1,800,000
Inventory at Beginning: $500,000
Inventory at Ending: $800,000
Accounts Receivable at Beginning: $300,000
Accounts Receivable at Ending: $200,000
Other Operating Expenses Paid: $400,000


Based upon this data and using the direct method, what was Jefferson Corp.’s cash flow from operations (CFO) for the year ended December 31st?

A) $1,200,000.

B) $800,000.

C) $900,000.

This is the Answer from Qbank which is C
CFO = sales $3,000,000 – purchases $1,800,000 – change in accounts receivable ($200,000 – $300,000) – other cash operating expenses $400,000 = $900,000.


My calculation is:
$3,000,000 (Sales)
$1,800,000 (Purchases )
$800,000 - $500,000= 300,000 (Increase in inventory which is use of cash)
$200,000 – $300,000 = -100,000 (Decrease in account receivables which is source of cash)

therfore $3,000,000 - $1,800,000 - 300,000 (use) + 100,000 (source) = $1,000,000

My question is why the increase in inventory is not include in the calculation? I thought an increase in assets is consider as use of cash.

Thanks

joemoran

Using the direct method: (left out three '000)

Step 1: Cash collected from customers

Sales $3,000
+ Decrease in A/R $100
Total = 3,100

Step 2: Cash paid to suppliers
COGS <$1,500>
Increase in Inventory <300>
Total = <1,800>

Step 3:
Cash collected from customers 3,100 - from step 1
Less: Cash paid to suppliers <1,800> - from step 2
Less: Other oper. expenses < 400> - from info in the question
CFO = 900

hope this helps a little...

thisisbrianly

Oh i see. So in direct method, i'm wrong to include purchases into the calculation bcos the purchases is to allow us to find the cogs (end inv = begin inv + purchase - cogs).

Am i right at this point?

Thanks for the help flo7002.
Greatly appreciate the guidance you have given me.

pacmandefense

I just broke it down and used the full formula, but yeah, in this example, they already gave you the cash paid to suppliers (purchases) number. But if you just had different pieces, you'd have to work that number out.