Cash flow impact....

[nr]

Hi,

I was doing cash flows & got this doubt...do lemme know if any of you have come across similar questions.

If i were to analyze impact of 'goods are sold on credit', I would think the current ratio would increase for the following reason:

1. While we value inventory on LCM & in a normal situation, it would represent cost,
2. Accounts receivable would include profit margin on sales

Thus on an overall basis, Current Ratio (CR) would NOT remain constant but would increase....

Anybody agrees on my view??? Feedback please...

 

[Super I]

You seem to be mixing up 2 concepts. You start out asking about cash flow, and then you switch to working capital (current ratio).

Sale on Credit:

Increase Accounts receivable (current asset)
Increase Revenue (Inc Stmnt, closed into equity)

Decrease Inventory (current asset)
Increase Expense (Inc Stmnt, closed into equity)

Assuming you sell at a profit, you are correct current ratio will increase.

BUT, there is no cash in sight. An increase in current ratio does not mean an increase in cash.

Remember, when you calculate cash flow starting with the income statement you adjust for changes in current assets and liabilities to account for situations like, so you'll subtract out any net increase in accounts receivable to reflect revenues earned but not received as cash (and make a similar adjustment to all other working capital accounts to get cash from operations).

Does this help clarify things?

 

[nr]

Thanks Super I.....

I know, i shudn't have said this is related to cash flows....

My primary doubt was that, since the dec & inc happens in inventory & accounts receivable, the answer wouldn't be NO CHANGE because the amounts involved are different...