Why Gains and Losses are Non-Cash Charges (11:20)
In this tutorial, you’ll learn why Gains and Losses on Asset Sales are considered non-cash charges and why you subtract them out or add them back within the Cash Flow from Operations section of the Cash Flow Statement – including two ways you can think about this point.
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What Gains and Losses Are
Put simply, you record a Gain or Loss when you sell an Asset for a price that’s *different* from its Book Value.
In other words, it’s listed on the Balance Sheet as a $100 Asset, but you sell it for $80 or $120.
You would have to record a Loss of $20 in the first case, or a Gain of $20 in the second case.
Many companies will have a line item for Gains and Losses on the CFS, usually right below or near Depreciation & Amortization.
But why? Why do these items count as non-cash adjustments, given that the entire transaction – selling an Asset – takes place in cash?
Why Gains and Losses Are Non-Cash Adjustments – Method #1 (Timing Differences)
Gains and Losses are non-cash adjustments because they correspond to long-term Assets purchased in PRIOR periods.
In other words, if you sell a $100 asset for $80, you need to record a Loss of $20 on the Income Statement… but you are NOT literally losing $20 in cash in THIS period!
It’s only a cash loss relative to what you paid for the asset a long time ago.
But the Income Statement and Cash Flow Statement show us ONLY what is happening in THIS year, so we count this as a non-cash adjustment.
Net Income on the CFS will be lower as a result of this, so we add back the Loss (or subtract the Gain), and then show the Net Proceeds Received in Cash Flow from Investing.
So… we add back the Loss of $20 in CFO, and then in CFI, we subtract out the $20 again, and also show the book value of $100 for the Assets we just sold, so that $80 shows up in CFI.
The logic is very similar for Gains: if we sell a $100 Asset for $120, that doesn’t count as a real $20 “cash gain” IN THIS period.
It is a gain over what the company has spent previously, but all that matters is what’s on the financial statements in this period.
So you subtract the Gain in the CFO section, and then add the Gain and show the book value of the Assets sold in the CFI section, so $120 appears there.
Why Gains and Losses Are Non-Cash Adjustments – Method #2 (Re-classifications)
Another way to think about this point is that you’re really “re-classifying” Gains and Losses from Cash Flow from Operations into Cash Flow from Investing instead.
Since they don’t relate to a company’s core business operations – but rather long-term investing activities – they belong in the CFI section instead.
The Cash Flow Statement is often used to “re-classify” items into other sections; one good example is Excess Tax Benefits from Stock-Based Compensation, which are often subtracted out from Cash Flow from Operations and then put into Cash Flow from Financing.
The same idea applies here, but it’s with Gains and Losses on Asset Sales instead.