I have a question about finance?

Question

This question involves "uses of cash" and "sources of cash." Why is it that an increase in accounts receivable is considered a use of cash? Isn't accounts receivable the money that another company owes you?

Also, if an increase in accounts receivable is a use of cash, does that mean that a decrease in accounts receivable is also a use of cash?

Answer 1

I presume you're referring to the cash flow statement. If your AR increased from 1 period to another, you have more debtors who owe you than in the previous period. Think of it as you extending a loan to them. That's why it's a use of cash. You're financing your debtors.

A decrease in AR would mean more people have paid up than the last period, so if people pay up, that would be a source of cash.

Some students understand this better if they think of these as good or bad, from the cash flow point of view. If AR increases, that's BAD cos people are not paying you, they're holding on to their money. If it's bad, then it's a use of cash. If AR decreases, that's GOOD, cos people are paying you. If it's good, then it's a source of cash.

Let's apply this to Accounts Payable. If AP increases, it's good, cos you're not paying your creditors, now it's you who're holding on to your cash. Since that's good, it's a source of cash. If AP decreases, you've been paying your creditors, that's bad from a cash flow point of view. Since it's bad, it's a use of cash. Good = source of cash; Bad = use of cash.

Students will find their own ways to reason this out. The important thing is that they're comfortable with the rationale and can remember it without learning anythng by heart.

Answer 2

Think of accounts receivable as money someone owes you and hasn't paid back yet. In essence, they are using your money for a while. You allow that use of cash. If you want to 'use' less cash, then require shorter terms, cash up front, etc., that way the cash is no longer being used by your customer.

The same applies for A/P. It's money you owe someone, but haven't paid yet. That means you're using the money/goods/services without paying for it, so it's considered a source of cash. In personal terms, a credit card is a source of cash, but you still have to pay it back eventually. A/P isn't necessarily a loan, but it's the same concept.