Accounts Receivable and Cash Flow

• Some items create differences between a company's cash flow and net income.

Accounts Receivable (A/R)

• Accounts receivable represents the future benefit of cash.
• It occurs when a company delivers a good or service but doesn't immediately receive cash payment.
• Initially, A/R has a negative impact because cash isn't received upfront.
• A/R creates a temporary difference between net income and cash flow as revenue is recorded without immediate cash inflow.
• When a product or service is delivered, revenue must be recorded.
• Instead of cash, the A/R line item increases in the "Assets" section of the balance sheet.
• Example: A/R increases by $100.
  • Revenue increases by $100 (e.g., from $1,000 to $1,100).
  • Assuming a 25% tax rate, net income increases by $75 (e.g., to $225).
  • Since cash hasn't been received, $100 is deducted on the cash flow statement.
  • Cash decreases by $25 due to paying taxes on the recognized revenue.
  • On the balance sheet: A/R increases by $100, cash increases by $125, and net income increases total equity by $225.
• When the $100 is received:
  • The income statement remains unchanged.
  • The $100 deduction on the cash flow statement is reversed, resulting in a +$100 cash flow from operations (CFO).
  • Cash increases by $100, and A/R decreases by $100.
• Changes in A/R create a discrepancy between net income and cash flow.

Accounts Payable (A/P) and Accrued Expenses

• A/P arises when a company receives a service but doesn't pay for it immediately.
• The payable creates a temporary difference between net income and cash flow.
• An expense is recorded when a product or service is received from a vendor, and A/P is recorded when payment isn't made immediately.
• A/P isn't always linked to an income statement line item, depending on the nature of the product or service.
• Example: Receiving a service from Google for $20.
  • Income Statement: Sales and marketing (operating expenses) increases by $20.
  • Assuming a 25% tax rate, net income decreases by $15.
  • Cash Flow Statement: Net income is the top line with $135. CFO (changes in working capital) increases by $20 since no cash was exchanged. Change in Cash is +$155
  • There's a $5 tax benefit because the expense decreases taxable income.
  • This $5 represents the tax savings due to the expense reducing taxable income.
  • Balance Sheet: Cash increases by $155 on the assets side. On the liabilities and equity side, A/P increases by $20, and shareholder's equity increases by $135.
• Paying the $20 expense:
  • Income Statement: No change, as the service was already delivered and the expense incurred in the previous period.
  • Cash Flow Statement: CFO (changes in NWC) decreases by $20, as cash flows out to pay the expense, and the change in cash is a decrease of ($15).
  • Net income of $15 was initially down, the AP was added back so its now up by $5, then reversed back to being down $15
  • Balance Sheet: Under assets cash decreases by $15 changing it from $155 to $135. Under Liabilities and Owner's Equity - A/P decreases by $20, and total equity remains down by $15.
  • No change in equity, because the income statement remains the exact same as before
• Accrued expenses are similar to A/P but are used for recurring expenses like utilities, rent, and wages.

Accounts receivable (A/R) represents future cash benefit when goods/services are delivered without immediate payment. Initially, A/R negatively impacts cash flow, creating a temporary difference between net income and cash flow. Revenue is recorded, increasing the A/R line item on the balance sheet.