Both CFAI and Schweser say: Sale of receivables are recorded as a sale, thereby decreasing accounts receivable and increasing CFO. For analysis purposes, CFO should be adjusted by classifying the sale of receivables as cash from financing instead of cash from operations. Why do we do such a change in cash flows?
Because the OBS receivables securitization is effectively a financing activity – monetizing the receivables through a conduit rather than actually selling them to the open market. Think of it as a situation where the seller of receivables is actually taking out a cash loan that is collateralized by the receivables.
mino, the rationale for this analytical treatment stems from the nature of this transaction. The company selling its receivables is borrowing money from the purchaser, using the accounts receivable as collateral for the loan. An important detail here is that a liability is generated for the company selling its receivables. My understanding is that receivables are typically sold “with recourse,” meaning the company selling its receivables is still accountable for actually collecting on the accounts and likely would have to make up for any losses over some agreed upon level of doubtful accounts. In summary, the transaction is just a more elaborate form of borrowing money, justifying treatment as CFF. Moreover, consider the impact of neglecting to reclassify this transaction. A few examples: - overstatement of CFO - overstatement of receivables turnover (and the cash conversion cycle) - understatement of current liabilities (i.e. collecting on the receivables that collateralize the loan) - overstatement of the current ratio (CA/CL) Hopefully others can clarify or correct anything I’ve misstated, thanks.
Another way to think of it is… cash flow is not generated by an operational activity such as customer payments for the goods or services sold to them… instead cash is generated by selling the Receivables to a third-party. The third-party loans the amount to the seller of A/R. The third-party recovers payment on a later date. Thus, the sale of an A/R can be treated as a CFF rather than CFO. Hope I was clear enough…
Thank you very much for your answers… I can understand now why it should be CFF activity, but then why do we record it as CFO at the beginning? Just to complicate things ??
When we say it is a CFO at the beginning, it is because Accounts Receivable is an operational activity. A/R is treated as a “Use of Cash” (decreases cash flow from operations)… just like how we treat A/P as a “Source of Cash”… Only when the sale of A/R to a third-party takes place, it becomes CFF although there is a recourse (increases cash flow - source).
Ok, I see it now… Thank you very much for the explanation…