An analyst gathered the following information for a company for the year ending 31 December 2000: Debt $1,000,000 Equity $500,000 Debt-to-equity ratio 2.0 EBIT $200,000 Interest expense $50,000 Coverage ratio 4.0 The amount of receivables sold during this period was $150,000 and was not used to retire debt. Also, the sale has not transferred the risk of the receivables. The analyst is trying to make adjustments to the financial statements to reflect off balance sheet activities. To adjust the effects of off balance sheet financing on cash flows, the analyst should: A) increase the cash flows from operations. B) increase the cash flows from financing. C) increase the cash flows from investing. D) decrease the cash flows from investing
I would say B
I opt for B. Since the A/R sales is with recourse, this is a kind of “temporary” financing and hence an increase in C.F from Financing. Correct me, if I am wrong. Thanks.
Answer is B. florinpop and maparam nailed it.
the money received appears on CFO but what really happened is that the company that bought the receivables is financing the company that sold since there is no transfer of risk.In case something happens then the company assumes responsbility so it has a liability This means that cfo is overstated and needs to be decreased and cfi is understated and need to be increased
But it is not clear why the sales has not transferred the risk! I am reading this to mean that when they sold their A/R, they got cash, and they no longer have to worry about customers paying them. The risk the company has with its A/R is completely gone (at least for the portion sold). It is corect to say that the cash received is a form of financing and should be added to CFF, but other questions linger: 1) What if they used it to retire debt? Do you still add the casfh flow to CFF and also add it to CFI? 2) How would this problem be solved if they’d sold their inventory at a loss? Dreary
Dreary, I think that what they did is called factoring if I remember correctly. Depending if you guarantee the recevailability of your receivables, there will bea different discount rate applied, that is you will get more or less money for selling your receivables. If the money would have been used to retire debt then there is a financing cash outflow, but I think that shouldn’t change the fact that the financing is understated.(cash flow is smaller but still understaed ) They sell their receivables at a lower price than the amount to be received because the factoring company needs to make money. How would you record it?I really don’t know maybe the difference as interest charged or as a loss from debt that needs to be written off I am just making assumptions here, wait on inputs