Schweser says you “need to add interest to the receivables to both income and expense” as part of adjustments when sale of receivables occurs. “Hence, net income will not be affected, but the coverage ratios will bel ower than reported.” What is the concept here? Are they saying that if you actually were holding the receivables on your books, you would be earning “interest” on the receivables you had, and also, because you held less cash, you would not be earning interest on the cash, since that cash would not be on your balance sheet?
And further, Schweser says that adjusted ebit would be higher by the implicit interest rate applied to the receievables balance. how could that be? if you have to adjust for both the incremental interest income and the incremental interest expense, then how could ebit be higher by the full interest expense amount?
treat the sale of recievable as borrowing … you have to add back the recievables sold Account recievable; now as we are treating the sales proceeds of recievable sold as loan, we have to add interest on both income and expense. As we are adding additional interest to expenses, that will reduce EBIT and will also affect coverage ration negatively, but will have no impact on net income. Cash flows also needs to be adjusted, reduce CFO and increase CFF. Also note CFI and total cash flows are not affected. Run an example through your head, i suggest not to memorize it.