Changes in Accounts Receivable
Recall that net income (the last line on the income statement and the first line on the cash flow statement) captures revenues and expenses based on the accrual method of accounting. As such, credit sales, in addition to cash sales, may be recorded as revenues.
The sales generated on credit are recorded on the balance sheet as accounts receivable, while cash revenues are recorded on the balance sheet as cash.
If accounts receivable increased from one year to the next, the implication is that more people paid on credit during the year, which represents a drain on cash for the company, as some of the revenues that came in during the year increased the accounts receivable balance instead of cash.
Conversely, if accounts receivable decreased from one year to the next, the implication is that those old accounts receivable were collected (i.e., credit sales were eventually converted into cash sales), representing cash inflow for the company.
Accounts Receivable and the Cash Flow ImplicationsCompany ABC has an accounts receivable balance of $200m in 2005. That means that Company ABC expects to receive $200m that it is owed by customers. What if the following year (2006), accounts receivable declined to a balance of $150m? (Assume no new purchases on credit for now.) Essentially, it means that ABC collected $50m of the $200m it was owed from customers. That means that ABC’s cash balance will go up by $50m (remember, since the accounts receivable balance declines, that implies that ABC is receiving money from the customers who originally purchased its goods or services on credit). This represents cash inflow. |
Bottom LineWhen accounts receivable increase, the cash impact is negative. Conversely, when accounts receivable decrease, the cash impact is positive. |