Why are increases in accounts receivable a cash reduction on the cash flow statement?
Since our cash flow statement starts with net income, an increase in accounts receivable is an adjustment to net income to reflect the fact that the company never actually received those funds.
When business buys raw materials for manufacturing / ready goods for trading, it pays the supplier cash - Cash Outflow. The raw material is converted into finished goods. At this point, there is an increase in stock (finished goods). Hence, increase in stock is assumed to be cash reduction in cash flow statement. On the other hand, if a good is sold, and there is immediate receipt of cash, then there is cash inflow and it negates the cash outflow that happened initially. If goods are sold on credit, there is no immediate cash inflow. In other words, the cash that was used to buy the goods initially has not returned to the business. Hence, increase in accounts receivables is cash reduction in cash flow statement.
This is another brainteaser question, where one needs to stop and think about the relationship between accounts receivable and net income (increasing AR) , and the receiving of the actual cash which impacts the cash flow statement (increases the CFS when cash is received, but decreases the CFS when AR is increased on the income statement).
Community answers are written by other candidates practicing this set. Reading how others frame the same question is one of the fastest ways to sharpen your own.
Anonymous Answer
A/R shows credit sales, a non-cash item in the Income statement which increases profit. An increase in AR balance means sales with no cash activity i.e on credit and hence needs to be netted out of Net profit on the cash flow statement, which shows only cash-related activity.
Marcie's Feedback
Good explanation! You've done a good job answering this question. To strengthen your answer, consider including a real-life example so the interviewer knows that you fully understand this concept.
Unlock all 32 Finance questions
Unlock expert responses to technical and behavioral questions that financial firms prioritize.
Get Started