Maybe stupid question, but I can't figure it out

CFA Level I
#1

Stuck on Financial Reporting, my weakest link.

If we have an increase in for example accounts reciavables between two years, all else equal that means that we record a negative cash flow on the income statement if I have understood it correctly?

Simillary then if Inventory increase we will have an negative cash flow, since we bind up cash.

But if we have a write-down on Inventory, shouldn’t that then mean a positive cash flow following the same logic, but it doesn’t right, its a negative cash flow as well?

Can someone make this a bit more clear for me, what are all the effects on BS, I/S, Cash Flow Statement?

Thanks,

Rob

#2

Yes they are negative when calculating the CFO thru the indirect method, but that’s due to adjustments for cash flow calculation purpose.

Secondly, write down on inventory can be comprehend as impairments have occured to the inventory, and now they don’t worth as much as before. In general, US GAAP doesn’t allow “write-up” in inventories and long-live assets. Thou there’s an exception, but you are not likely to see it in the exam. When you see a “write up” question, that must be referring to the IFRS. For IFRS, the amount of revaluation or “write-up” only limits up to the original value of the inventories, any excess gain will go to the income statement. Similar treatments for impairment in long-live assets.

Hope this is helpful.

#3

I think it’s like this:

You use money to buy inventory so naturally cash flow goes down. Equivalently you gain money from the sale of it so cash flow up.

In the case of impairment, the inventory went down but you didn’t gain any money - you in fact lost some cash from the fact that there is less inventory to be converted into cash. Cash flow down.

I’m not 100% but that’s what it looks like to me… damn accounting…

#4

For AR, this come from sales. When you sell, its on credit (AR) or on cash. If AR increased then you didn’t collect cash from the sale. Sales or revenues is the top line when calculating Net Income. If all sales went to AR then you would still have a positive Net Income but you must subtract the increase in AR from the NI to calculate the CF. AP uses the same logic, AP is increased when you buy inventory on credit. The purchase is expensed on the I/S therefore reducing the NI. But since it’s on credit, you add back the increase to NI. Generally, an increase in asset is a reduction of cash. An increase in liability is an increase in cash.

#5

An inventory write down is a non-cash expense. It is a made up accounting number, no cash left your organization. The cash left your organization when you bought the inventory, your inability to sell it in a timely manner is an operational inefficiency. Inventory valuation can be done a number of ways, write downs reduce the value of the inventory and asset and must be reflected on the other side the write down a liability.

A = SE + L

Never say you lost cash for an inventory write down. This is a non-cash transaction. Unless you physically reach into your pocket to pay someone, it probably isn’t a cash expense.

Think of a lemon aid stand if you have do. You buy lemons. 20 dollars worth. You sell lemon aid all week and still have lemons left over, they are no longer as fresh so they are not worth what you paid. Fruit going bad is possibly accounted for as some sort of spoilage allowance, but it is similar to a more elaborate business writing down the inventory, that is no longer worth what they paid for it on the open market.

#6

Ok think it this way:

1, income statement and cf statement = not the same thing : one diffrence on the(CFO side) is that you only count cash ins and cash outs!

When you do adjustements for current account in balance sheet (receivables, inventory and payables) you are adjusting for cash ins and cash out.

==> when you buy inventory = you pay for it (cash or on credit, but it doesn’t matter) = meaning you used money (use of cash. so whenever inventory increases, meaning you bought more = it reduces your cash = reduces CFO

==> same for receivable, you converted your inventory into sales but on credit = use of cash

==> on the other hand payable is a source of cash. whenever you delay paying your suppliers you have more cash in your accounts = better for your operations.

==> the same idea comes back with current ratio, WC or cash conversion cycle. just know that the higher the payable compared to receivable and inventory, the better your CFO son add increases in payables and subtract increases in receivables and inventory!

As for write downs = non cash, not accounted for in cash flow statement

Hope it helps

#7

So if we go back to lemons:

Inventory = Lemons worth 20, Debt = 10, Equity = 10, A=L+E holds

I sell lemon aid during a period of time and my balance sheet looks like this afterwards:

Inventory = 5, Cash = 20 ($5 profit on $15 lemons), Debt = 10, Equity = 15 (Retained Earnings 5), A=L+E holds

So my Income statement shows:

Income 20

COGS -15

Net Income = 5

That my Cash Flow From Operations right?

Now in the next period the rest of my lemons are rotten and written down to zero:

Inventory = 0, Cash = 20 ($5 profit on $15 lemons), Debt = 10, Equity = 10 (Retained Earnings 5), A=L+E holds

My question to you is, what does the Income Statement show now and what is Cash Flow From Operations?

#8

Oh seriously? go back and do some serious reading!

Why do you match inventory with debt and equity? (inventory is with COGS and purchases)

  • net income is NOT CFO

  • you don’t always get cash when you sell inventory, hence increase in receivables

  • WRITE DOWNS ARE NON CASH!!! You don’t even read what people waste their time explaining to you!

This just pisses me off!!

have studied anything at all??? frown

#9

^^

Easy mate! I believe he’s only using a simplified example to understand better.

#10

I think what you are trying to figure out is how the transmission mechanism works so that writedowns in Recievables/ Inventory affect your Equity.

Before you write down your Inventory, you would have created a loss in your income statement. If the amount of Inventory write down is very small, this loss will be created as an expense along with Cost of Good sold. If the amount of Inventory write down is huge, you will have to report this separately as a Loss under unusual/infrequent items …but you will note that these losses will reduce your Net Income…and then reduce your retained earnings…and then reduce your Equity.

Your actual cash flows from operations is however not affected, since you haven’t actually sold them at a loss. They are still technically your lemons, just that they are now worth very little or nothing. So if you are calculating your cash flows from operations, you will have to add these Losses that were previously recorded as expenses back to your net income.

You should take care not to confuse Operating Income, Revenue, Expenses or Net Income with Cash Flows.

Operating Income contain things like change in recievables, change in Inventory, unrealized losses and gains etc that are actually not cash flows.

#11

Thanks for all the comments!

I think I got a better grip on FRA now, struggling to get it up to 70%, I think I’m almost there now. Feels quite good since I never studied any accounting or this type of economics before.

Cixi87 thanks for your efforts too, but dude, your attitude is more like Cixi97

#12

edited

#13

Not overly convinced by any of these answers, so I’ll just post a quick one here for anyone who finds this questions. I hope that the OP has long achieved his CFA charter by this point!

Inventory write down is a non-cash change. Yu are required to show that the “value” of your inventory has fallen, as it is presented on the balance sheet, but it doesn’t cost you any cash. You don’t have to go to the bank and issue a check to anyone when you change the value of your inventory.

In addition, you need to go to the income statement and post an expense which flows through net income, to retained earnings and to shareholders’ equity… which balances your balance sheet.

When it gets to the CFO calculation, you need to reflect the non-cash changes affecting Net Income. If you didn’t do anything, the net income figure would be too LOW, because of the expense you posted to the income statement, so we ADD back the write down to account for this “non-cash” change and the result is that CFO is unaffected by the write down.

To answer your question directly,Yes, if you see an increase in inventory, you’ll likely see a negative impact to cash, with the most obvious scenario being cash spent on inventory. And using that same logic, if you DECREASE inventory, you’ll likely see a POSITIVE impact to cash, which you do, but only after you’ve put the same amount as a negative impact to net income, which affects the starting point of calculating the change in cash for the period.

#14

Hi Rob,

Let’s break down the scenarios you’ve mentioned and their effects on the Balance Sheet (BS), Income Statement (I/S), and Cash Flow Statement.

  1. Increase in Accounts Receivable:

    • Balance Sheet (BS): Accounts Receivable (an asset) increases.
    • Income Statement (I/S): Revenue is recognized, contributing to an increase in net income.
    • Cash Flow Statement (CFS): No direct impact on cash flow from operating activities. However, if revenue recognition precedes cash collection, it can result in a negative cash flow from operating activities due to the increase in accounts receivable.

  2. Increase in Inventory:

    • Balance Sheet (BS): Inventory (an asset) increases.
    • Income Statement (I/S): Cost of Goods Sold (COGS) increases, which may reduce net income.
    • Cash Flow Statement (CFS): Negative cash flow from operating activities since cash is tied up in the increased inventory.

  3. Write-down on Inventory:

    • Balance Sheet (BS): Inventory decreases due to the write-down.
    • Income Statement (I/S): Recognizes a loss, reducing net income.
    • Cash Flow Statement (CFS): Negative cash flow from operating activities. The write-down is a non-cash charge, meaning it affects net income but not cash flow.

It’s essential to note that accounting rules often treat certain items differently on the Income Statement and Cash Flow Statement. Non-cash expenses, like inventory write-downs, affect net income but don’t impact cash flow in the same way.

To summarize:

  • Accounts Receivable Increase: No direct impact on cash flow, but it may indirectly affect cash flow from operating activities.
  • Inventory Increase: Negative cash flow from operating activities.
  • Inventory Write-down: Negative cash flow from operating activities, even though it’s a non-cash charge.

Understanding these dynamics will help you interpret financial statements more accurately. If you have further questions or need clarification on specific points, feel free to ask! And if you’re stressed, you can watch phim sex việt nam

#15

You are correct there are many reasons why something could have changed and we mark some assumptions to we can can produce some numbers.

I always though that financial analysys gives me questions that I need to answer not solutions

Think of this link

Opening Inventory + Purchases = COGS + Closing inventory

When we are trying to get to cash flow we trying to get Purchases from suppliers. As analaysts we don’t know this (the company does but we don’t tell us) we we use this assumption to help us.

But this assumption may not be correct. Maybe the company toook a huge writedown to inventory that was disclosed a seperate line item and not part of COGS and this does not really work. What about items stolen.
The compay have this detail but we don’t, so we have to make assumpions.

So when trying to calculate cash flow we assume
Opening Inventory + Purchases = COGS + Closing inventory

Purchases = Closing Inventory + COGS - Opening inventory
Purchases = COGS + Change in Inventory
We are making the assumption that any change in inventory can be exaplained by the different in COGS and Purchases. In the normal run of things small amounts of stoken goods, small w/downs breakages will appear in the accounts under COGS so that is ok but there could be issues we need to think about.

The CFA view/approach is simified to what the real world accounting is like. It does though give you the knowledge you need to analysis companies.
.

But if we have a write-down on Inventory, shouldn’t that then mean a positive cash flow following the same logic, but it doesn’t right, its a negative cash flow as well?

Remeber if we are think of a w/down is isolation in has no effect on cash it just reduces equity via the income statement, Think were it is most likely to appear in the income statement (assuming it is not large) as part of COGS.

Example

Opening Inv = 100
COGS = 1000
Closing Inv = 50
Purchases = 1000 + 50 - 100 = 950

But what if we realise inventory has a writedown on 20.
But that would have (probably) appeared as part of COGS

Purchases = (980 + 20) + (70 -20) -100 = 950
If the writedown had never happened
Purchases = 980 + 70 - 100 = 950

We make the simplify assumptions when use chnage in inventory to adjust from net income to CFO that the income statement has all the balancing transactions that mean it still makes sense.