Q: What defines short-term debt vs long-term debt?
A: In general, short-term debt is payable within one year or less. Long-term debt has a repayment period in excess of one year.
Short-term debt is used to fund short-term needs or business activities that generate cash during the coming year. One example is a line of credit (LOC) to finance inventory and accounts receivable until they convert to cash (generally within a year) with draws made on a recurring basis as the line pays down. Current maturities or current portion of long-term debt (CMLTD) is that portion of long-term debt due and payable in the coming year. Despite being a component of long-term debt, the due date(s) for this portion of the total debt overrides the long-term nature of the total debt to be classified as short-term debt.
Long-term debt usually provides financing for long-term events or business activities that require more than a year to convert to cash. For example the acquisition of fixed assets with a useful life of multiple years is properly supported by long-term debt.
Q: In Step I in the Exercise, we discussed how a decrease in gross margin (GM) is a cash outflow. If accounts payable (A/P) increases in conjunction with a decrease in GM, would that increase in A/P be a source of cash rather than a cash outflow despite the GM decrease?
A: Yes. You are correct in saying that an increase in accounts payable is a source of cash.
In constructing a cash flow statement, the cash flow impact of A/P, a source of cash flow for this discussion, is integrated with the cash flow impact of Cost of Goods Sold (COGS), a use of cash since it represents production costs. The positive cash flow impact of an increase in A/P offsets the negative cash flow impact of an increase in COGS and may, on occasion, exceed it. If the increase in A/P exceeds the increase in COGS, the result of the two changes is a cash inflow.
In Step 1, we referred to a decrease in A/P days – not A/P – as a cash outflow, which may be a source of confusion. Even though A/P did increase and did represent a source of cash in 2015, A/P days decreased from 47 to 43 days, which is a use of cash since the level of A/P relative to COGS decreased.
We have two offsetting events occurring with respect to the movement in A/P in 2015. The $24,111 increase in A/P was a cash inflow in 2015. But the four-day decrease in A/P days was a cash outflow that drained $39,709 in cash from the company. That is, if Tampa Bay Leisure had maintained A/P days at 47 days in 2015, instead of paying more rapidly by four days, the ending 2015 A/P balance would have been $446,967. Since the ending A/P balance in 2015 was $407,258, the company gave up $39,709 in cash by paying four days more rapidly. Therefore, we commented that the four-day decrease in A/P days was a cash outflow.
To take a more fundamental look at your question, note that the GM is calculated by dividing Gross Profit (excluding non-cash charges) by sales. A declining GM such as we saw in Tampa Bay Leisure’s performance, indicates that the company was less efficient in managing its production costs relative to sales for the period. It’s that fundamental inefficiency that makes a decrease in the gross margin a use of cash when constructing a cash flow statement. That is, COGS, which is a use of cash, has increased relative to sales, which is a source of cash.
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