20. What is the difference between the Direct Method and Indirect Method for cal
ID: 2675756 • Letter: 2
Question
20. What is the difference between the Direct Method and Indirect Method for calculating Cash Flow? Explain how the two methods are reconciled and also provide a brief description of each method.1-List 3 reasons for diversifying a portfolio via international investing
2. What is the risk factor associated with international investing that potentially can also be viewed as a benefit [and hence, a 4th reason to invest internationally -- see question #1]. IF this factor is trending favorably for your investment portfolio, briefly explain why it is a benefit
Explanation / Answer
There are no differences for the investing and financing sections. The differences exist only in the operating section, which looks like this under the direct and indirect method:
DIRECT METHOD:-
Cash flows from operating activities
Cash receipts from customers
Cash paid to suppliers and employees
Cash generated from operations
Interest paid
Income taxes paid
Net cash from operating activities xxx
INDIRECT METHOD :-
Cash flows from operating activities
Profit before taxation
Adjustments for:
Depreciation
Foreign exchange loss
Investment income
Interest expense
Increase in trade and other receivables
Decrease in inventories
Decrease in trade payables
Cash generated from operations
Interest paid
Income taxes paid
Net cash from operating activities......
EXPLANATION:-
With the Direct Method, the cash flow from operations is calculated directly (from scratch). With the Indirect Method, however, the cash flow from operations is calculated by taking the net income of the company and then making adjustments. These adjustments are required because net income is calculated using the accrual method, and we are interested only in cash receipts reduced by cash disbursements (the cash method). These adjustments include:
· Adding back expenses that were deducted from net income but did not cost anything (e.g., depreciation expense, amortization expense, and depletion expense);
· Taking out capital gains and losses that do not relate to operations (e.g., sale of plant assets);
· Taking out expenses that were accrued but not yet paid (e.g. income taxes accrued but not paid in the current year)
· Taking out expenditures that cost cash but were not expensed this year (e.g., the purchase of inventory that was not sold or supplies that were not used up, and the payment of prepaid expenses still outstanding at the end of the year);
· Taking out income that was accrued but not yet received (e.g., credit sales where the account receivable is still outstanding, accrued interest not yet received); and
· Adding back cash receipts that were not treated as income (e.g. customers payments of accounts receivable that were generated in a prior year)
1)3 reasons for diversifying a portfolio via international investing:
1) International investing provides diversification :– spreading your investment risk among foreign companies and markets that are different than your home economy.
2)international investment provides more opportunity for growth: taking advantage of the potential for growth in some foreign economies, particularly in emerging markets.
3)your own market may be highly concentrated : economies such as Canada or New Zealand have highly concentrated markets (i.e. energy in Canada) which limits diversification.
2)Investing in international securities involves various risks which may be greater than when investing in U.S. securities markets. These risks include changes in currency exchange rates; political, economic and social events; potential for illiquid markets; less information; reliance on foreign legal remedies; and different market structures and operations. You should be sure to understand these risks before investing in foreign securities. As always, if you have any questions or concerns regarding any of your investments, please discuss with your account representative.
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