Ratios and Messages about Profitability and Cash Flow
Q: Regarding Poll Question 5, please explain how the increase in accounts receivable would have allowed them to meet all operating expenses?
A: Poll Question 5 is as follows:
“If accounts receivable had remained at 20 days in 2018, the increase in the balance would have been $48,688, which means that:
- The company’s 2018 business cash flow would have improved by $107,510.
- The company would have been able to meet all operating expenses, including interest expense from business cash flow.
- The company would still fall short of meeting all interest-bearing debt service.
- All of the above.
- None of the above.”
The correct answer is “All of the above”.
If accounts receivable had remained at 20 days in 2018, the accounts receivable balance for Buckeye Beverages, Inc. would have increased by $48,688 rather than by $156,198. This $107,510 reduction in the accounts receivable would a) improve the company’s business cash flow by $107,510, which would b) result in a $21,980 surplus at Business Cash Income, but c) fail to generate sufficient business cash flow to pay down $164,223 of long-term debt as scheduled.
Positive Business Cash Income of $21,980 means that the company enjoyed a $21,980 cash flow surplus of $21,980 after paying all cash operating expenses, including interest expense but not scheduled long-term debt repayment. Since scheduled long-term debt repayment in 2018 was $164,223, the $21,980 cash flow surplus available to meet this payment fell short of doing so by $142,243.
In other words, if the company allowed accounts receivable to increase by only $48,688 – the increase that would take place if accounts receivable days remained at the 2017 level of 20 days – Buckeye Beverages, Inc. would be able to meet all its operating expenses, including interest expense. But it would fall short of fully paying its interest-bearing debt service by $142,243.
Course overview: Ratios and Messages about Profitability and Cash Flow