Companies experience a variety of financial transactions throughout their business. Financial transactions impact various account balances, cash flows and financial reporting. Businesses rely on their cash flows to meet financial obligations and provide a return to the owner. Managers need to understand how each transaction impacts the company’s cash flows. Transactions involving accrued liabilities can increase or decrease company cash flows.
Accrued liabilities can affect cash flow by the very fact that the presence of these liabilities typically generate a short-term positive cash flow. Consequently, less funds are finding their way out of the business in question.
Understanding Cash Flows
Cash flows represent money entering or leaving the business. The company receives cash inflows and pays cash outflows. Cash inflows include customer payments or vendor refunds. Cash outflows include paying invoices or purchasing equipment. The company reports its cash flows on the Statement of Cash Flows, one of the primary financial statements reported by public companies to investors and the Securities and Exchange Commission . The total of all cash inflows and outflows determines the total change in the company’s cash balance and appears on the Statement of Cash Flows.
Documenting Accrued Liabilities
Accrued liabilities refer to money the company owes, but has not received formal notice of. The company records accrued liabilities when it incurs the liability, even if it receives no bill from the vendor. For example, when the company purchases materials from a vendor, it may not receive an invoice until the following month, though it knows that it owes the money. The company records an accrued liability when it receives the shipment. At the end of each period, the company reviews the accrued liabilities and bills it has received and pays. Then, it calculates the change in this balance.
Increase in Accrued Liabilities
When the company receives products or services without paying any cash, its accrued liabilities increase. The company compares this level of accrued liabilities to those from the previous period. An increase communicates that the company is recognizing its accrued liabilities, but paying less on them. The higher balance indicates that each liability remains outstanding for a longer time frame. This creates an increase in cash flows, since less cash is leaving the company.
Decrease in Accrued Liabilities
When accrued liabilities decrease, the company pays for the products or services it receives sooner, eliminating these accounts from the financial records. A decrease from the prior period level of accrued liabilities communicates that the company is recognizing its accrued liabilities, and paying more on them. The lower balance in this account indicates that each liability remains outstanding for a shorter time frame, creating a decrease in cash flows, since more cash is now leaving the company to pay these liabilities.