Page 111 - Finance for Non-Financial Managers

Siciliano06.qxd 2/8/2003 7:05 AM Page 92
Finance for Non-Financial Managers
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Inventory up, Sales Not:
Another Red Flag for Cash!
A company will add inventory when it anticipates grow-
ing sales.Toy companies add inventory all year long for their big holi-
day selling season. But that costs cash—and inventory doesn’t return
to cash for a long time. It must first become sales and accounts receiv-
able before it becomes cash again. If inventory is going up and sales
forecasts aren’t growing accordingly, the company may be investing too
much in goods that might never become cash. Liquidating old invento-
ry is a very poor way to raise cash—and it almost always results in a
loss on the income statement and in cash flow.
or sold inventory it didn’t have to purchase that month. As a
formula, it would look like this:
beginning inventory + cost of goods purchased and not yet sold – cost
of goods sold that were purchased previously = ending inventory
Or, if we rearrange the pieces a bit:
(cost of goods purchased and not yet sold – cost of goods sold that
were purchased previously) = (beginning inventory – ending inventory)
So, the cash flow adjustment must deduct the cash cost of
any inventory added to beginning inventory balances (meaning
that inventory went up during the month, costing cash).
Conversely, the cash flow adjustment would be positive if the
inventory balance were reduced during the month, indicating
the company sold some goods out of beginning inventories and
did not have to spend cash to replace them.

Increase in Accounts Payable
The last operating item in this report is accounts payable,
amounts owed to creditors of all kinds. Since payment of liabili-
ties requires use of cash, any change in a company’s accounts
payable means it has either used cash to pay off some trade
obligations not included in the income statement or increased
the amount owed to creditors, thus borrowing money from cred-
itors for use in the company.
If a company uses cash to pay down its creditor balances,