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Chapter 5: Problem 15

In each of the following cases, indicate whether the amount of cash inflow (or outflow is greater or less than the related revenue (or expense): a. A firm's accounts receivable balance has increased during the period. b. A firm's salaries payable balance has increased during the period. c. A firm's accumulated depreciation balance has increased during the period. d. A firm's inventory balance has increased during the period, and the supplier accounts payable balance has also increased by a greater amount.

Short Answer

Expert verified
a. Revenue is more than cash inflow. b. Expense is more than cash outflow. c. Expense is greater than cash outflow. d. Expense is less than cash outflow.

Step by step solution

01

Analyzing accounts receivable

If a firm's accounts receivable balance has increased during the period, it means that the firm has made sales on credit, but those amounts are yet to be collected in cash. This would indicate that revenue is greater than the cash inflow.
02

Analyzing salaries payable

If a firm's salaries payable balance has increased, it means the firm has incurred salary expense but has not yet paid it in cash. Thus, the expense is greater than the cash outflow.
03

Reflecting on Accumulated Depreciation

The increase in the firm's accumulated depreciation balance signifies a recognition of depreciation expense. However, since depreciation is a non-cash expense, there is no direct cash outflow associated with it. Hence, the expense is greater than cash outflow.
04

Addressing inventory and supplier's accounts payable

If a firm's inventory balance has increased and the suppliers' accounts payable balance has also increased by a greater amount, it means the cost of inventory (an expense) is less than the cash outflow. The company has bought more inventory on credit than it has paid for in cash.

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Key Concepts

These are the key concepts you need to understand to accurately answer the question.

Cash Flow Analysis
Cash flow analysis is a critical component of financial statement analysis, focusing on how cash moves in and out of a business. Understanding cash flow helps businesses assess their liquidity, solvency, and financial flexibility.
For instance, an increase in accounts receivable may indicate higher sales, but it also means that cash hasn't been received yet. This is crucial when determining whether revenue (which is earned) is actually leading to a cash inflow (which is received).
  • Positive cash flow suggests a company can reinvest in its operations, manage expenses, and avoid financial stress.
  • Negative cash flow, on the other hand, could signal trouble, even if profits look good on paper.
Conducting a cash flow analysis allows businesses to make timely decisions and maintain a healthy cash position.
Accounts Receivable
Accounts receivable represents sales made on credit. When this balance increases, it signifies that a company has sold more products or services on credit without receiving immediate payment.
The increase in accounts receivable points to revenue being greater than cash inflow. This matters because while sales may appear healthy, the company's actual cash reserves may not reflect the surge in sales.
  • An effective accounts receivable management ensures quicker turnover and enhances cash flow.
  • Delays in collecting receivables can lead to liquidity issues.
Efficiently managing accounts receivable is vital for sustaining cash flow and ensuring that liquidity needs are consistently met through timely collections.
Salaries Payable
Salaries payable are wages that a company owes but has not yet paid out. An increase in this account suggests that a firm has incurred salary expenses without making corresponding cash payments.
This results in expenses being greater than cash outflow. In the short term, this might seem advantageous as it preserves cash, but prolonged periods can lead to employee dissatisfaction.
  • Ensuring timely salary payments strategy boosts employee morale and retention.
  • Monitoring payable balances aids in effective cash budgeting.
Effectively managing salaries payable ensures that employees are paid on time and helps maintain a positive image and workforce loyalty.
Accumulated Depreciation
Accumulated depreciation reflects the total depreciation expense charged against an asset over its useful life.
This is considered a non-cash expense as it has no immediate impact on cash flow, even though it reduces the book value of assets over time.
  • Understanding accumulated depreciation helps in assessing asset usage and future capital investment needs.
  • It indicates wear and tear, aiding in predicting future maintenance or replacement costs.
Although it presents no direct cash outflow, accumulated depreciation affects income statements and balance sheets, compelling firms to account for asset utilization in their financial strategies.
Inventory Management
Inventory management involves overseeing the quantities and qualities of products or materials held by a business, ensuring that stock levels meet demand without unnecessary overstocking.
An increase in inventory, coupled with a greater rise in supplier accounts payable, means that the company is acquiring more inventory on credit than paying cash. This situation points toward the cost of inventory being lower than cash outflow for their acquisition.
  • Effective inventory control avoids tying up valuable cash assets.
  • Strategic supplier payment negotiations can optimize cash flow.
By managing inventory levels tightly, firms can align stock availability with sales while preserving cash for other essential operations.

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Most popular questions from this chapter

Assume that you are the controller of a publicly held company called Spring Corporation.The CEO and the CFO are quite concerned about financial analysts assessments of Spring's prospects. Analysts have publicized their doubts about Spring's ability to generate cash from operating activities. As is common, Spring pays for all of its inventory purchases almost immediately upon receipt of the appropriate bills. Because finance charges in this industry are exorbitant, you, as controller, are careful to make all payments within the allowable interest-free period. At year end, the CFO orders you to suspend temporarily all payments to suppliers.The obvious reason for this suspension is to enhance, that is to "window dress," Spring's CFOA in its statement of cash flows. It is also obvious that this action will cost Spring substantial future inter est charges. Write a short response to the CFO's request.

Determine the amounts of cash flows associated with each of the following: 1\. Sales revenue was \(\$ 20\) million; accounts receivable decreased by \(\$ 2\) million. 2\. Salary expense was \(\$ 7.5\) million; salaries payable decreased by \(\$ 1\) million. 3\. cost of goods sold was \(\$ 9\) million; inventories decreased by \(\$ 1.2\) million. Supplier accounts payable increased by \(\$ 1.6\) million.

The Shifting Sands Company reported an increase in its property (land) account of \(\$ 4\) million during \(1999 .\) During 1999 , the firm sold land with an initial cost of \(\$ 12\) million for cash proceeds of \(\$ 9\) million and purchased additional land for \(\$ 16\) million. Determine the effects of these transactions on the following elements of the firm's 1999 financial statements: a. Net income (ignore income tax effects) b. Adjustments to net income to compute cash flows from operations (as in the indirect method) c. cash flows from investing activities

VaporWare II, Inc. (VWIII), had spectacularly good financial results in \(1999 .\) However, in 2000 , the millenium bug, other defects, and general customer dissatis faction resulted in returns of \(\$ 3\) million. These products had originally been expensed for \(\$ 1\) million. It cost \(\$ 5\) million to satisfy \(\mathrm{VW}\) III's irate customers. VWII chose not to report any returns in 2000 , while showing the \(\$ 5\) million as sales revenue in 2000 a. Show how the \(\$ 3\) million of returns should have been recorded. b. If the defects had been properly anticipated, what impact would this have had on VWIII's 1999 income statement? c. Show how the 1999 balance sheet would have changed if the returns had been recorded correctly. Why might VWIII's management be unhappy with these results? d. Discuss how the 2000 financial statements will be affected by VWIII's treat ment of these returns. e. Discuss the ethical problems inherent in this situation, for the company, for its financial managers, and for its auditors.

Contrast cash and cash equivalents? Why would managers want to include both when preparing a statement of cash flows?
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