Is Accounts Receivable Operating, Investing, or Financing?
Unravel how a common business asset related to sales fits into a company's financial activities and cash flow reporting.
Unravel how a common business asset related to sales fits into a company's financial activities and cash flow reporting.
The cash flow statement tracks the movement of money into and out of a business. This statement categorizes cash flows to provide insights into how a company generates and uses its cash resources.
Accounts receivable (AR) represents money owed to a business by its customers for goods or services that have already been delivered but not yet paid for. It arises when a company extends credit to its customers, allowing them to receive products or services immediately and pay at a later date. For instance, if a marketing agency completes a project for a client, but the client has 30 days to pay the invoice, that outstanding amount becomes an account receivable.
Accounts receivable is listed as a current asset on a company’s balance sheet. This classification signifies that the company expects to convert these amounts into cash within one year or one operating cycle, whichever is longer. They represent a legally enforceable claim for payment.
The cash flow statement reports three primary categories of business activities. These categories organize a company’s cash inflows and outflows.
Operating activities encompass the primary revenue-generating actions of a business. These include cash received from customers for sales of goods and services, as well as cash paid for day-to-day expenses such as employee salaries, rent, utilities, and inventory purchases.
Investing activities involve the purchase or sale of long-term assets. Examples include cash used to buy property, plant, and equipment, or investments in other companies’ stocks and bonds. Cash inflows from investing activities would typically come from selling such assets.
Financing activities relate to transactions that change the size and composition of a company’s equity and debt capital. This category includes cash received from issuing new stock or borrowing money, as well as cash paid out for repaying debt, repurchasing company stock, or paying dividends to shareholders. These activities reflect how a company raises and repays capital.
Accounts receivable is consistently classified as an operating activity on the cash flow statement. This classification directly stems from the nature of accounts receivable, as it arises from a company’s core, day-to-day business operations of selling goods or services to customers on credit. The collection of these receivables is an integral part of generating revenue from primary business activities.
Changes in accounts receivable directly impact a company’s operating cash flow. When accounts receivable increases, it means a company has made more sales on credit, but the cash for those sales has not yet been collected. In the context of the indirect method of preparing a cash flow statement, an increase in accounts receivable is subtracted from net income, reducing the reported operating cash flow. This adjustment reflects that while revenue was recognized, the corresponding cash has not yet been received, thereby tying up capital in unpaid invoices.
Conversely, a decrease in accounts receivable indicates that the company has successfully collected more cash from its customers for past credit sales. This collection of previously owed amounts leads to an increase in actual cash flow. On the cash flow statement, a decrease in accounts receivable is added back to net income, which boosts the reported operating cash flow. This demonstrates that cash is being efficiently converted from credit sales, improving the company’s liquidity.