Why do we add back some non cash items when calculating ratios? - ProProfs Discuss
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Why do we add back some non-cash items when calculating ratios?

Asked by Bradon, Last updated: Sep 30, 2021

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John Smith

John Smith

John Smith
John Smith

Answered Sep 08, 2016

Most non-cash entries reduced the income that the company was showing on their earnings statement. In order to get a more accurate picture of how much cash the company has on hand, you would need to reverse these deductions by adding them back. However, equity income is a non-cash item that actually increased the total income the company was showing on its earnings statement. To reverse the non-cash effect of equity income, you would have to subtract it. Nexample: your company earns $100 in cash revenue. But you had an amortization expense of $20 and you had equity income of $5. Your earnings in this simplified example would be: $100 - $20 amortization + $5 equity income = $85 but if i wanted to know how much cash you actually had on hand, i could start with your income figure of $85 and reverse all the non-cash items. for non-cash items that reduced your income (i.e., amortization), i would add the amount back. For non-cash items that increased your income, i would subtract the amount. following this logic, i would discover the following about the amount of cash you have on hand: $85 income + $20 amortization - $5 equity income = $100 cash.

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