Why does cash decrease by $40 when accounts receivable goes up $100?
Hey guys,
I'm in the very early phases of learning and was reading through some guides where if the accounts receivable increases by $100, then the cash decreases by $40, net income increases by $60, assets increase by $60, and shareholder's equity increases by $60.
I'm a little confused as I thought accounts receivable is a current asset so the assets in the balance sheet would increase by $100 and the retained earnings would also increase by $100. I then thought maybe the revenue would increase by $100 and depending on the tax rate and maybe the COGS net income would increase by $60? which would result in a $60 increase in cash with the cash flow statement?
However, I don't think my thinking balances out and I am a little confused.
In a lot of the breaking into wall street guides, when other items like inventory or prepaid expenses change, the split is also always 60/40. Why is that?
Appreciate any help!
Increase in AR decreases cash as it is an increase in NWC
I apologize as I am still a little confused. So the AR increase means current assets increase which already means an increase in NWC. Why does cash have to decrease and why by specifically $40? I thought you haven't received the cash yet.
Cash up 60 from NI, down 100 from AR, nets out to be down 40
Your question works with the assumption CIT=40%. It obviously can be different depending on assumption, or more concretely, jurisdiction.
If I were to secure a contract worth 100$, my pre tax income would increase by 100, and post tax income by 60. (Since tax rate = 40%, I have to pay 40$ in tax and keep the rest for myself.)
Shareholders equity is (partially) a function of net income. If net income increases by 60, shareholders equity must too.
Given the fact that AR is not cash, but taxes paid is cash, our cash position goes down by 40 (to reiterate, we ignore the the 100 increase in AR).
Check, does the balance sheet reconciliate? AR +100; Cash -40 = net +60 effect. On the other side, shareholders equity increases by 60 as well.
Thank you! I forgot to think about the taxes :)
Perhaps good to point out that if tax rate = 10%, cash goes down by 10, net income by 90, etc.
Increase in AR coincides with an increase in revenue in this case. After expenses and taxes, net income is 60. Starting on cash flow from operations, you have the same net income of 60, but now because you have an increase of an operating asset of 100, you must subtract it out, as it is a “use” of cash. Another way to think about it is that you have recorded the revenue but not actually received cash, so the lack of having the cash itself means the 100 must be subtracted. No other changes on CFS so change in cash is down 40. On BS, cash down 40 AR up 100 so assets up 60. NI flows to RE so shareholders’ equity is up 60 so BS balances.
Thank you so much for the detailed explanation that helped a lot!
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