A significant increase in days payables above historical levels is most likely associated with:
A) an increase in net working capital. B) an unsustainable increase in reported earnings. C) low quality of the cash flow statement.
I said A) Increase in net working capital.
My reasoning was that if days payable increases, that means you are paying at a later date, therefore holding more cash now.
If working capital is CA-CL and cash is a CA, then surely your working capital increases as a result of retaining more cash from delaying payments???
Your answer: A was incorrect. The correct answer was C) low quality of the cash flow statement.
A significant increase in days payables may indicate that payables have been “stretched” (not paid or paid more slowly), which increases operating cash flow in an unsustainable manner and calls the quality of the reported cash flow values into question. An increase in days payables will decrease net working capital, other things equal. Please can someone enlighten me on this answer?
But if you don’t pay your payables, you’re retaining an equal amount of current liabilities. Net working capital doesn’t change when you pay current liabilities with cash.
This makes sense: “A significant increase in days payables may indicate that payables have been “stretched” (not paid or paid more slowly), which increases operating cash flow in an unsustainable manner and calls the quality of the reported cash flow values into question.”
This makes no sense: “An increase in days payables will decrease net working capital, other things equal.”