How to Calculate Change in Accounts Receivable for Cash Flow

Accounts receivable represents money owed to a business by its customers for goods or services delivered on credit. Businesses often sell on credit, providing products or services now and allowing customers to pay later. This practice is common across many industries, forming a significant part of a company’s financial operations.

A cash flow statement tracks the actual cash movements into and out of a company over a specific period. It shows how a company generates and uses cash, which differs from profitability shown on an income statement. Understanding how accounts receivable changes affect this statement is important for assessing a company’s financial health. This article explains how its change is calculated and integrated into the cash flow statement.

Understanding Accounts Receivable

Accounts receivable (AR) refers to money customers owe a company for goods or services already received but not yet paid for. It is recorded as a current asset on a company’s balance sheet, expected to be converted into cash within one year. These amounts arise from sales made on credit, where a company extends a payment period, often ranging from a few days to several months, to its customers.

The balance of accounts receivable fluctuates constantly due to new credit sales being made and customer payments being collected. While sales increase a company’s revenue under accrual accounting, they do not always immediately increase its cash balance. This distinction is important because accrual accounting recognizes revenue when it is earned, regardless of when cash is received. Therefore, a significant portion of a company’s reported sales might initially be in the form of accounts receivable, highlighting why its management is relevant to a company’s cash flow.

Connecting Accounts Receivable to the Cash Flow Statement

The cash flow statement provides insights into how cash is generated and utilized by a business over a period. Unlike an income statement, which reports revenues and expenses based on accrual accounting, the cash flow statement focuses solely on actual cash inflows and outflows. It serves as a bridge, reconciling a company’s net income, which includes non-cash transactions like credit sales, with its actual cash position.

The cash flow statement is divided into three main sections: operating, investing, and financing activities. The operating activities section begins with net income and adjusts for non-cash items and changes in working capital accounts, including accounts receivable. An increase in accounts receivable indicates sales made on credit for which cash has not yet been received, reducing cash flow from operations. Conversely, a decrease means cash has been collected from customers for prior credit sales, which increases cash flow from operations.

Step-by-Step Calculation of the Change

Calculating the change in accounts receivable requires comparing its balance at two different points in time. You will need the accounts receivable balances from two consecutive balance sheets, typically the current year-end and the prior year-end. A balance sheet provides a snapshot of a company’s assets, liabilities, and equity at a specific date.

The formula for calculating the change in accounts receivable is:

Change in Accounts Receivable = Ending Accounts Receivable - Beginning Accounts Receivable

For example, if a company’s accounts receivable balance was $50,000 at the end of the prior year and $65,000 at the end of the current year, the calculation is: Change in Accounts Receivable = $65,000 – $50,000 = $15,000. A positive result indicates an increase in accounts receivable, meaning more money is owed. A negative result indicates a decrease, signifying more cash collected.

Applying the Change to the Cash Flow Statement

The calculated change in accounts receivable is integrated into the operating activities section of the cash flow statement, specifically when using the indirect method. The indirect method starts with net income and adjusts it for non-cash items and changes in working capital accounts to arrive at net cash flow from operating activities. The adjustment for accounts receivable reflects the difference between sales recognized on an accrual basis and the actual cash collected from customers.

There is an inverse relationship between the change in accounts receivable and its impact on cash flow. If the accounts receivable balance increased during the period, meaning the calculated change is positive, this amount is subtracted from net income. This subtraction is necessary because the increase in accounts receivable represents sales revenue that has been earned but not yet received in cash. For instance, if net income was $100,000 and accounts receivable increased by $15,000, $15,000 would be subtracted from the net income in the operating activities section. Conversely, if accounts receivable decreased, indicating a negative change, this amount is added back to net income. A decrease signifies that cash has been collected from customers for sales made in prior periods, thus increasing the cash available to the company.