The Effect of Accounts Receivable on the Statement of Cash Flows
As you’ll recall from our last video, we had left our hero struggling because the balance sheet didn’t balance. This was because one client, to whom we had charged $1,000 of sales, had not paid us. So $1,500 of sales had only translated into $500 in cash.
The statement of cash flows can help us. Let me just write out a little narrative so we can see what the story looks like.
So here’s the narrative that we need the cash flow statement to tell us. We know that cash should have increased by $1,500 from net income. However, we agreed to let a customer pay us $1,000 next month. By the way, we know when we allow a customer to pay us a month or two from now, that is an accounts receivable. The cash flow statement is already telling us where the money went. The money went up here, in accounts receivable, which increased by $1,000. That means that our assets total now goes from $500 to $1,500. This immediately shows us that our balance sheet is now in balance. So the cash flow statement has already solved our particular problem.
Let me keep going and rewrite the cash flow statement in a way that’s more formal. And here’s how the cash flow statement actually looks. The chapter heading: cash from operations. Net income should increase to $1,500 but it decreased because it went to accounts receivable (minus $1,000). Therefore, the net cash from operations is $500.
We take a look at the cash at the start of the month, which was zero. Then you add the $500 that came in during the month, which leaves cash at the end of the month of $500. And that exactly matches the balance sheet account.
This leads me to my next point, which is that the statement of cash flows fits perfectly between the income statement and the balance sheet:
• the last line of the income statement becomes the first line of the statement of cash flows and
• the last line of the statement of cash flows becomes the first line of the balance sheet.
It’s just perfect.
You’re doing a great job. Just a couple of more videos and then we’re done.