Changes in Accounts Receivable
Do you use the accrual method of
accounting, but want to compute
your cash flow profit? If so, any increase in accounts receivable must be
subtracted from your accrual net profit because it represents sales included in
the net profit, but not yet collected in cash. Similarly, to determine your cash
flow profit, any decrease in accounts receivable must be added to your accrual
net profit because it represents cash collections that are not included in the
net profit for the current accounting period.
These adjustments are fairly simple if you think about the
reasoning behind the adjustments.
In terms of accounts receivable, when a sale is made to a
customer, the sale is recorded and the customer's credit account
is increased by the amount of the sale. When the sale is
recorded, your accrual income is increased by the amount of the
sale, but no cash is collected until the customer pays his bill.
To convert your accrual net profit to cash, you must subtract an
increase in accounts receivable. The increase represents income
that has been recorded but not yet collected in cash.
A decrease in accounts receivable has the opposite effect —
the decrease represents cash collected, but not included in