Page 109 - Finance for Non-Financial Managers

Siciliano06.qxd 2/8/2003 7:05 AM Page 90
Finance for Non-Financial Managers
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A Negative Adjustment for Accounts
Receivable Is a Red Flag
This small gem of information is of huge importance if
cash management is important to the company, because the amount of
accounts receivable means cash that has to come from somewhere—
cash that will stay out of the company’s reach until those balances are
collected. If this happens every month, the balance sheet could be
growing, sales could be growing, but the company could be slowly slip-
ping into insolvency, as Wonder Widget was in Chapter 5.
Now, that may be OK if their sales grew as much or more, because
a growing company that sells on credit—and does reasonable cash
flow planning—should normally expect its accounts receivable to grow
as its sales grow. But if sales were flat or down from the prior month,
and the company still loaned money to its customers, that would mean
its collection effort was not adequate and its customers are using up
the company’s working capital by delaying payment to them.
Remember: any increase in receivable balances greater than the monthly
increase in sales is an interest-free loan to your customers.And that sinks
companies.

for them wasn’t actually received. Now the formula might look
like this:
sales + (beginning accounts receivable – ending accounts receivable) =
cash collections
Notice that the calculation in parentheses effectively con-
verts sales to cash collections by comparing the balances of
accounts receivable from the beginning of the month and the
end of the month. If the company sold more to its customers
during the month than it collected, this adjustment would be a
negative or bracketed amount, showing less cash inflow than
what was presumed by net income. In other words, in our
example the company loaned its customers $125,600 out of
cash, so cash was reduced as a result.
Decrease in Prepaid Expenses
In our Chapter 3 discussion of prepaid expenses, we talked
about the up-front payment for things that have an extended
period of value, like insurance. And we noted that such pay-