Recently, Galaxy Corporation lowered its allowance for doubtful accounts by reducing bad debt expense from 2 percent of sales to 1 percent of sales. Ignoring taxes, what are the immediate effects on Galaxy’s operating income and operating cash flow? Operating income Operating cash flow A) Higher No effect B) No effect No effect C) Higher Lower The correct answer was A. Lower bad debt expense will result in higher operating income. Operating cash flow is not affected until Galaxy actually collects the receivables. Can some please tell me why Operating CF does not decrease? Why wouldn’t a change in allowance for doubtful accounts INCREASE Net A/R and thus lower Operating CF?
because it is a non-cash event. Its not money actually doing anything, its more of a placeholder the way I look at it.
its a non-cash charge such as depreciation. no physical cash is entering or leaving the statements.
alright. i was kind of thinking that, but thought when we calc. CF the doubtful accounts is figured into NWC. Thanks for your responses. ALWAYS HELPFUL.
“Woogie? Don Wooginowsky?”
More than being a non-cash event, as called, I though of it as a nullifying transaction on the change(WC). As AR will now increase as the firm has confidently reduced the bad debt expense say from 2%*Sales to 1%*Sales, but at the same time the contra account (bad-debt allowance account) will reduce by the same (2-1)%*sales differential. Making it to cancel out the effects. Do you think it’s the right way to look at things? (CP?)