What is PIK interest, and how does $10 of it flow through the three statements?

PIK stands for payment in kind. The interest isn't paid in cash. It's added to the loan balance each period, and the lender collects it all when the debt matures. For the $10, I'll use a 25% tax rate and assume the interest is tax deductible. On the income statement it's still interest expense, cash or not. Pre-tax income is $10 lower, the tax charge is $2.50 lower, and net income is $7.50 lower. The cash flow statement starts from that $7.50 drop. Since the $10 was never paid, it gets added back in cash flow from operations as a non-cash item. Cash flow from operations is $2.50 higher, and cash ends $2.50 higher. The balance sheet has cash $2.50 higher on the assets side. On the other side, the debt balance is $10 higher because the interest accrued to it, and retained earnings are $7.50 lower. Ten minus $7.50 is $2.50, so liabilities and equity match assets.

PIK stands for payment in kind. The interest isn't paid in cash. It's added to the loan balance each period, and the lender collects it all when the debt matures. Borrowers use it to keep cash in the business, often in a buyout that carries a lot of debt, and lenders charge a higher rate for waiting. For the $10, I'll use a 25% tax rate and assume the interest is tax deductible. On the income statement it's still interest expense, cash or not. Pre-tax income is $10 lower, the tax charge is $2.50 lower, and net income is $7.50 lower. The cash flow statement starts from that $7.50 drop. Since the $10 was never paid, it gets added back in cash flow from operations as a non-cash item. Cash flow from operations is $2.50 higher, and cash ends $2.50 higher. The balance sheet has cash $2.50 higher on the assets side. On the other side, the debt balance is $10 higher because the interest accrued to it, and retained earnings are $7.50 lower. Ten minus $7.50 is $2.50, so liabilities and equity match assets. In the period it looks like any non-cash expense that saves tax. The difference is that this one comes due. The $10 is now principal, and it earns interest too. On a $100 PIK note at 10%, the balance is $110 after one year, so the second year's interest is $11, not $10. In a model I'd check that the debt balance rolls the PIK interest forward and that the full amount is repaid at maturity. The tax deduction is an assumption as well, since interest deductions can be capped.