How is Paid in Kind (PIK) interest handled in financial statements?

Paid in Kind (PIK) interest represents interest that is not paid in cash but instead is added to the principal balance of the debt. This method is often used in leveraged finance to conserve cash, particularly for companies that are cash-strapped.

When analyzing financial statements, PIK interest is recorded as an expense on the income statement, which increases the net interest expense. However, since no cash is actually exchanged at that moment, this interest needs to be managed carefully in cash flow analyses.

In the cash flow statement, PIK interest is considered an add-back because it doesn't use any cash in the period in question; therefore, to accurately reflect the cash available for operations, it must be added back to net income. This ensures that the cash flow from operations is not understated, providing a clearer picture of the company's cash position.

Thus, adding back PIK interest on the cash flow statement helps represent the true cash flows of the business, making option C the correct approach.