Paper discussion series- is an account receivables increase a cash outflows

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Paper Discussion Series: Is an Account
Receivables Increase a Cash Outflows?
Sukarnen Feb 10-2015
Increase in AR is not cash outflows......so many authors make incorrect sentences about this....
Sukarnen Feb 10
AR increase is not CASH OUTflows. There is no cash outflow at all to the customer. The
company just sends the invoice to the customer.
AR increase is an adjustment to the Net Income (under Operating Activities of the Cash Flow
Statements if we use indirect method), since there is a Sales recognized fully though the
collection might not happen in the same year of the sales transpired. So AR Increase is an
adjustment and not CASH OUTflows.
Sukarnen
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Inventory increase, yes, it is a CASH OUTflow, since the company has PAID the materials and
all overheads or stock (if this is a trading company).
This is why as well, that the company doesn't need to have Current Ratio more than 1, since the
current assets are not all as we see in their respective book/carrying value. AR might be less
collected. Inventory, we could sell more than its book value.
Joe Tham Feb 12
Consider the following.
Company A has a policy of zero AR. Only cash basis.
Company B has a policy of AR of two months. In other words, customers can pay their bills
within 60 days.
In every respect, both companies are identical, except for the AR policy.
From a cash flow point of view, is there any difference between the two companies or are they
the same?
Sukarnen Feb 12
Thanks for the "riddle".
First, the "riddle" doesn't really relate to my comments below since I am talking about one
company (=increase in AR between two dates) and your question is about comparing two
companies (AR in one date).
Second, answering your question: I need to be clear about whether you mean "cash flow" or
"cash", as you know they are different. The first is dynamic concept and the latter is static (or
stock) concept.
The question itself is conflicting. AR in one date as you put below (between two companies)
which is a static concept, and "cash flows" (as you put below" is a dynamic concept.
Hope you could see my point above.

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Nonetheless, if what you meant is a dynamic one, "cash flows"....both will be the same, it is just
the different as to WHEN the company will receive the collection of AR. But if you meant is a
static one, then (as a finance person always says) "it depends". It depends on the date that you
are talking about. If the date of sales, then, it is different, but it is the date after collection, they
both are the same.
Having said above, still I am thinking they are both different. Why? Risk (and inflation if we
make it a bit complicated).
Ignacio Feb 13
Perhaps this working paper will clarify our position in CFV book and Joe's question
http://papers.ssrn.com/abstract=718741
Why We Subtract the Change in Working Capital When Defining Cash Flows? A Pedagogical
Note
Sukarnen Feb 13
Thanks for the paper, yet upon reading that...this is again as I said, Increase in AR (between
two dates) IS NOT CASH OUTflowing....No CASH INVOLVED AT ALL.
It is an ADJUSTMENT to SALES figures, since we need to reconcile the change in CASH
BALANCE between TWO DATES. As simple as that.....No complication.
This is why I said before, so many authors make incorrect statement and impression, that the
increase in AR between two dates is Cash Outflows...
AR is coming from sales, and all the company does, is just send the invoice out to recognize the
AR and Sales (hope I don't bore you with this stuff as I am pretty sure, you are quite aware of
that.....)

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Sukarnen Feb 13
One more...this is why in the DIRECT METHOD used for the presentation of the Net Cash
Flows from the Operating Activities, we only see "collections from the customers" reflecting all
cash INFLOWS from customers. Only Cash Inflows.....There is no such Cash Outflowing as
long as we are talking about AR.
As the INDIRECT METHOD is as confusing as it mixes up Earnings, Working Capital
adjustments and Cash Flows, accountants cleverly drop this method off from the Statement of
Cash Flows for publicly listed companies or for privately-owned companies, it is still a
preference.
Sukarnen Feb 13
Not intending to drag this discussion off too long, but as I know you, the logic that an "increase
of AR means LESS cash from the corresponding sales" is not correct. Sales has nothing to do
at all with CASH, unless the company sales everything on cash term. If it is on credit (and that's
why we have AR) then it is not CASH-related. The only thing we see cash is COLLECTION
transaction.... This is why I said many times, there is so much confusion in the working capital
adjustment shown in the Cash Flow Statement. It gives incorrect impression, that the increase
in AR is CASH Outflows..........As long as we are talking about sales and AR, the one and only
thing as far as it relates to cash, is COLLECTION, and that meant CASH INFLOWS. There is no
such thing called MORE or LESS Cash...It is the CASH INFLOWS and OUTFLOWS that we
see in the Cash Flow Statements (separated into Operating, Investing and Financing). That's
all, full stop.
This is as clear as crystal to me. I don't know why so many authors get confused with this and
keep explaining to the reader, that the increase in AR is Cash Outflows....Very strange....
AR stuff is only collection matter, and that's cash inflows.
Ignacio Feb 13
All you say is ok. AR is postponed cash.

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Joe Feb 13
Suppose you have purchased equipment worth $1000.
Assume that the expected inflation rate is zero so there is no inflation risk.
You have two options.
Option A: Pay for the equipment with cash.
Option B: Pay for the equipment in two months.
Which option would you prefer?
From a cash flow point of view, are these options the same or different?
Look forward to your answer.
Sukarnen Feb 14
Option A: From "wealth" perspective, the net assets (book value) stay the same....it is just a
move from Cash to Equipment account. No change to the total assets, though in terms of risk of
individual asset, it has changed. Cash is considered carrying lower risk compared to
equipment, though in terms of "expected" return, it will be lower as well.
Option B: From "wealth" perspective, the net assets (book value) stays the same...We have
more assets but at the same time, more liability. In terms of risk, then, in fact, it has
changed....AP is a commitment anyway. Equipment is a not a commitment and the company
could realize either higher or lower return on the use of equipment.
In terms of cash flows, "this depends"...if the company could use the equipment to generate the
cash inflows higher within 60 days, then having bought the equipment on credit is better.
One thing to note down. AR and AP is not the same. In AR, the company has a margin on top of
its cost. So though the company delivers the goods to customer, the company actually just paid
the "cost" of the goods.

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Having thrown away above stuffs, assuming the value of liquidity of cash is not considered, then
both options might end up the same.
As you asked about "in terms of cash flow point of view"...they might end up the same,
yet...again, the risk is different. By paying cash, the company has turned down the opportunity
to leverage up the AP as a "free funding" (assuming the supplier does not factor the interest
cost into its selling price of goods to the company).
Joe Feb 14
I would PREFER to delay and pay for the equipment in two months RATHER than pay for it
now.
Joe Feb 14
I am pleased that we agree on the answer to the simple question.
i know that questions in finance can be complicated. But in this simple case, most people would
agree that we prefer to delay the payments for the purchases that we make. To make progress,
we have to start with simple cases and then move to complicated ones.
What is the reasoning behind this logic for the accounts payable?
We have purchased equipment, it has been delivered but with credit, we do not have to pay for
it until two months later.
From a cash flow point of view, we are delaying the payment.
So the delay in the payment is a cash flow benefit to the buyer (the company) because the cash
flow is expenditure.
Now suppose the credit is extended from 2 months to 6 months.
As a buyer what would be our reaction?
We would say GREAT. Now we can delay the payment for 6 months, to OUR benefit.

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In this simple case, without additional complications, do you agree with the logic that I have
outlined above?
Look forward to your opinion. I hope that you will agree so that the conversation can move
forward.
And if you do not, please give me reason.
Sukarnen Feb 15
In general, I agree with you. Just one note, since you mention about benefit, which really
depends on whether the market is perfect competition. If yes, no players can take full benefit.
Either it is zero sum game or we need to share the benefits.
Joe Feb 15
Comment on Accounts Receivable
Suppose, at the end of month one, I sell equipment $1,000 on credit, and give people one
month to pay.
What is the cash flow profile if I sell on cash basis with no credit?
Cash flow profile with no credit
End of month convention Month One Month Two
Revenues (cash) $1,000 $0
At the end of month one, the company receives $1,000. And that is it. End of story.
What is the cash flow profile if I sell on credit for one month?
Cash flow profile with credit
End of month convention Month One Month Two
Revenues (cash) $0 $1,000

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At the end of month one, the company receives nothing. At the end of month two, the company
receives $1,000.
Joe Feb 15
I am happy that we more or less agree on the payables.
To summarize, we said that from a cash perspective, the impact of payables is positive.
Now, the case of receivables is JUST the reverse of payables. What are payables for us are
receivables for the supplier of the equipment.
This means, that by logic, from a cash perspective, the impact of receivables must be negative.
I hope that we continue to find common ground and agreement.
Sukarnen Feb 15
This is where many people get confused. I have put that in my previous email. Logic for AP is
not the same with AR.
AP is going straight to inventory (assuming trading company). AP is at cost. No margin is in AP.
AR is cost of stock + margin. When we ship the goods + send invoice, actually in terms of
money, we only incur cost of stock, which cost will be covered when we collect the AR. Where is
the cost of stock going to profit loss statement when we recognize AR and Sales? Cost of goods
sold....unfortunately AR increase (or decrease) is always linked to sales account. This is not
wrong BUT this gives impression that AR increase is cash INFLOWS.
Hope you now are able to see my point.

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Sukarnen Feb 15
My last effort to convince you. This is based on my real experience in corporate life. No
accounting magic.
Cash INfllows ONLY come from AR DECREASE and cash sales. Also AP Increase since we
receive goods (cash equivalent).
AR increase doesn't give rise to cash outflows though we send goods to customer. WHY?
Because cash outflows for that stock has happened when we paid the supplier.
Joe Feb 15
I think you will agree with the following.
From a cash flow perspective, an increase in AR means that MORE cash is postponed to the
future.
This means that an increase in AR has a negative impact on the PV of the cash flow profile.
Agree?
Joe Feb 15
After some thinking, perhaps we are agreeing but our disagreement is due to misunderstanding
from the language.
Let me restate the issue.
If the AR increases, then it means that the CF is postponed into the future. Do you agree with
this statement?
Sukarnen Feb 16
Yes...I agree with that statement.

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I don't think this is about misunderstanding due to language. Probably I guess, I start everything
from CASH FLOW STATEMENT, specifically, the Cash Flows from Operating Activities using
Indirect Method.
If possible, please please take a look on that statement again. It is about reconciling the net
income to the cash flows from operating activities. It is NOTHING to do with postponing cash to
the future or even the PV of the cash inflows. Cash Flow Statement is about NOW. Explaining
the movement of the CASH BALANCE in the balance sheet.
Under the Cash Flows from Operating Activities, normally, you will see the increase/decrease of
all working capital accounts, including AR. AR increase is reducing the net income (or indirectly
SALES account) but this DOES NOT MEAN in anyway, cash INFLOWS. It is an adjustment.
If you don't start from CASH FLOW STATEMENT, then, we need to agree to disagree.
I do believe, Ignacio understands very well about what I said that we need to start from CASH
FLOW STATEMENT, because movement of working capital accounts is only reflected in this
statement (and not in the Balance Sheet or Income Statement, or even CB. I need to mention
CB since that's Ignacio's favorite).
Joe Feb 16
To bring closure to our interesting discussion, I would like to summarize the key points.
Accounts payable:
This means that we delay cash payments for goods that we have purchased from our suppliers.
Because we postpone the payment, from a cash flow point of view, we gain, and the in present
value terms, there is a positive impact. We like to delay payments because it is good for us.
Accounts receivable:
This means that our customers postpone the cash payments for the goods that we have sold to
them. From a cash flow point of view, our customers gain, and we lose because there is a delay
in the payment that we should have received earlier. And in present value terms, there is a
negative impact. Customers like to delay payments as much as possible they it is good for
them.

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I hope that this correctly summarizes the discussion, and then we move forward and discuss
other interesting issues.
Sukarnen Feb 17
A simple fact that I concur with.
Let's move on!
Note:
Ignacio Velez-Pareja a financial consultant (Columbia-based), corporate finance lecturer,
(US-based)Joseph (“Joe”) Tham
Mathematics background
Visiting Associate Professor
Duke Center for International Development (DCID)
Sanford School of Public Policy
Duke University
Rubenstein Hall, Room 272
302 Towerview Drive
Box 90237, Durham, NC 27708-0237
Sukarnen (Indonesia-based)
A corporate finance student
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