Chartered Financial Analyst (CFA) Practice Exam Level 2

What is the general structure of cash flow projection in a pro-forma company model?

1. OpCF = NI + Non Cash Expense + CHG WC

2. OpCF = NI - Non Cash Expense - CHG WC

3. OpCF = NI - Non Cash Expense + CHG WC

4. OpCF = NI + CHG WC - Non Cash Expense

The correct answer is: OpCF = NI - Non Cash Expense + CHG WC

In the context of a pro-forma company model, the proper structure of cash flow projection for operating cash flow (OpCF) is to start with net income (NI) and then adjust for non-cash expenses and changes in working capital (CHG WC). Starting with net income is fundamental because it reflects the company's profitability after accounting for all expenses, including non-cash elements like depreciation and amortization. These non-cash expenses need to be added back to net income to reflect the actual cash generated from operations since they reduce net income but do not affect cash flow. Next, changes in working capital represent the net investment in current assets and liabilities. An increase in working capital typically indicates that the company is using cash (for example, by increasing inventory or accounts receivable), which should subtract from cash flow, while a decrease in working capital suggests that the company is generating cash (for example, by decreasing inventory or accounts receivable), which should be added to cash flow. The established formula OpCF = NI - Non Cash Expense + CHG WC accurately reflects the necessary adjustments for calculating operating cash flow, making it essential for cash flow forecasting and analysis in financial modeling. This approach provides a reliable picture of how much cash a company is generating from