The UCA Cash Flow Statement and the Traditional "Cash Flow" Proxy
Q: Why does positive sales growth lead to cash outflows?
A: Positive sales growth usually leads to a cash outflow because the increase in operating asset accounts on the balance sheet, such as accounts receivable and inventory, drain more cash than the increase in profit and operating liability accounts, such as accounts payable and accrued liabilities.
In other words, the net movements in the operating accounts on the balance sheet – the net result of changes in accounts receivable, inventory, account payable, and accrued liabilities – drain more cash from the company than provided by the increase in EBITDA and bottom-line profit.
However, for companies with a very thin balance sheet, i.e., few receivables, inventory, payables and accruals, a sales increase may well result in a cash inflow since the increase in cash from increased profit would dominate.
The key initial indicator in any case is the movement in the financing gap – receivables days plus inventory days less payable days (which may include accruals). If this gap increases by a few days, it usually signals an operating cash outflow. But actual cash results can only be identified by use of the UCA cash flow statement.
Course overview: The UCA Cash Flow Statement and the Traditional "Cash Flow" Proxy