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

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

" Wiley's prep material was a huge part of my success." - Lindsey G., USA

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.

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..

"We're talking about a man who's satisfied Maris - something that's still on my 'to do' list."

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.

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.

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

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?

RobRoy wrote:

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?

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

^^

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

RobRoy wrote:

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?

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. 

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

edited