Cash flow usually refers to the movement of money in and out of a business due to business activities. It is affected by operating costs, liabilities, sales, investments, etc. Poor cash flow is the primary reason why 82 percent of businesses fail.
When money moves into your business, you can describe that as cash inflow (positive change). But when it moves out of a business, it is referred to as cash outflow (negative change). When your business’s cash inflow is greater than your cash outflow, then you can consider the company performance as healthy.
Your statement of cash flows, or cash flow statement book, will show how money moves in and out of business. The figures in it will impact your income statement values. And everything will be related to what appears on the balance sheet.
What you owe your creditors, such as suppliers, in the near future, plays a role in your cash flow. And so do the sales you generate by selling goods and services on credit. Both of these payments must be accounted for, which is where accounts receivable and accounts payable come in.
Read More: How to Prepare a Cash Flow Statement
Accounts Payable vs. Accounts Receivable
Accounts payable refers to the financial obligations you have toward your suppliers or vendors. These represent amounts yet to be paid. You can find them in the current liabilities section of your company’s balance sheet.
On the other hand, accounts receivable represents the financial obligations your customers have towards you. They represent the money customers owe you for products and services you have already sold to them.
You can find the account receivables amount within the current asset section of the balance sheet. But if you have given goods on credit for a period of over a year, the accounts receivable values will be found in the long-term asset section.
Generally, an increase in accounts receivable is a cash flow out of the business, or cash outflow, but a negative change in accounts receivable, which decreases its value, represents a cash inflow. On the other hand, an increase in accounts payable represents a cash inflow, while a decrease means money has flowed out of your business.
The increase in accounts receivable will be subtracted from the net profit in a cash flow statement and the corresponding amount recorded as sales in the income statement. However, the decrease in accounts receivable will be added to the net profit in the cash flow statement.
Basics of Inventory
Inventory represents the products that have not been sold yet or raw materials in the process of being manufactured. However, they are valuable since they will eventually generate revenue. Inventory is usually included in the balance sheet within the current asset category.
Generally, inventory helps to improve cash inflow. However, if the net change in inventory is positive, and it has increased, it causes a cash outflow since money has been spent on purchasing production materials and yet fewer products have been sold. On the other hand, if the inventory has decreased, it represents a cash inflow.
On the statement of cash flows, inventory is represented by both operating activities and changes in working capital
Calculate Cash Inflow
Below are the steps for calculating cash inflow using accounts receivable, inventory and accounts payable.
- Find the balance sheet of the company whose cash inflow you want to determine. Get the balance sheets for the current accounting period and the previous one. You can find company balance sheets on the investor relations section of their website or via the SEC’s EDGAR search tool. The 10-K report shows annual information, while the 10-Q report shows quarterly information.
- Take a look at the current assets section as well as the current liabilities section of the previous period’s balance sheet, as well as the balance sheet of the current accounting period.
- Note down the accounts receivable and inventory in the assets section and the accounts payable in the liabilities section for both accounting periods.
- Subtract the accounts receivable of the past period from the current period. Repeat the process for the inventory and accounts payable.
- If there is an outflow, assign a negative value. All cash inflows have a positive value. And then, add them up.
- The result is the total cash inflow from accounts receivable, inventory and accounts payable.
Cash Inflow Calculation Example
Suppose the furniture maker Royal Scarlet Inc. had accounts receivable, inventory and accounts payable balances of $15 million, $5 million and $8 million respectively for the previous accounting period. Also, suppose that during the accounting period, the company had accounts receivable, inventory and accounts payable balances of $10 million, $3 million and $10 million.
When you subtract the current period's balances from the previous period’s balance, you end up with a $5 million decrease from accounts receivable, $2 decrease million from inventory and $2 million increase from accounts payable.
A decrease in cash receivables and inventory implies a cash inflow, while an increase in accounts payable also means the same thing. So, your total cash inflow from accounts receivable, accounts payable and inventory is $9 million.
Read More: What Is Included on a Balance Sheet?
- Score.Org: The #1 Reason Small Businesses Fail - And How to Avoid It
- Corporate Finance Institute: Cash Flow
- Wall Street Prep: Understand the Differences Between Accounts Payable and Accounts Receivable
- Indeed: Accounts Payable and Income Statements: Definitions and How They Differ
- Corporate Finance Institute: Accounts Payable
- Corporate Finance Institute: Inventory
- SEC: Gov: EDGAR | Company Filings
- Cash inflows only represent one part of cash management. The combination of cash inflows and outflows determine the total increase or decrease in the company's cash balance.
- Changes in accounts receivable, inventory or accounts payable can also result in cash outflows. This occurs when accounts receivable or inventory increases or when accounts payable decreases from one year to the next.
- Do not rely on these calculations to determine the total amount of cash inflows. a company also experience cash inflows when it sells investments, when it sells stock or when it borrows money.
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