I know this is a small part of the FSA, but this saved me a lot of time, and I hope it will do the same for you. If using the Indirect Method, just start w/ Net Income, then if something is an economic benefit (i.e. decrease in Accounts Payable ((paying less is good right?), then you subtract. If it’s NOT an economic benefit (i.e. accounts receivable decreases) ((receiving less is bad right?)), then you add. The direct method is just the opposite, but you start with sales. To summarize, w/ Indirect…if economic benefit, subtract if non economic benefit, add Just the opposite w/ Direct Method, but you start w/ Sales, instead of NI (as w/ the Indirect Method). I hope this helps and makes sence. Let me know if anyone has questions.
Actually I have to disagree with you. Your comments about receiving less is bad and paying less is good are not quite right in this example. I am in banking, and even if you receive more (increase in AR according to your post) that is not good if credit terms are loose as AR past 60 has little value as an asset. And increasing AP is actually good for most companies as it allows them to use the credit of their suppliers vs. their own cash or our bank lines. If you have 2 companies making 1MM each, all things equal, the one with the lower ARs is more liquid, and the one with higher APs will probably have more cash on hand.
Agree with BizBanker. You have to rationalize it by cash inflow and outflow. When accounts receivable decreases, (without a write-off) it means customers paid off = cash inflow (add.) When accounts payable decreases, it means you paid off your AP = cash outflow (subtract.) When inventory increases, it means cash outflow to purchase this inventory = subtract. etc.
you guys have no idea. I’m not trying to be a d*ck. I’m just saying, what I said is correct. Read the material. You can’t necessarily “rationalize” it, but it does make logical sense. It’s cash flows starting from either Net income (which has already subtracted things out like depreciation etc…) so you have to ‘‘add’’ things that are ‘‘bad’’. like less AR, or more AP If you start from Revenue, then it’s “logical” b/c you subtract the bad and add the good, b/c nothing has been taken out yet (i.e. "“NET”.)
Ok Ill go with you telling me I have no idea. Its only something I do every day, and when you use terms like “good” and “bad”, I doubt you work in finance. Try running a business with no AP, like you say a decrease is “good” right? See how far you get paying cash for everything and running an AR schedule. The key is to balance all the ratios and terms, not to label them as good and bad.