Question

Explain why an increase in the balance of liability causes a positive cash flow. briefly, please.

thank you

Answer 1

Companies generate cash in several ways, one of it being changes in working capital.

Working capital is the difference between a firm's current assets and current liabilities. Positive working capital is when a company has more current assets than current liabilities, and vice versa.

A positive cash flow i.e. the amount of cash and cash-equivalents being transferred to the firm, indicates that the firm's liquid assets are increasing, enabling it to settle debts, reinvest in business, return money to shareholders, pay expenses and provide a buffer against future financial challenges.

Any change in the balance of items of the working capital will lead to a change in the firm's cash flow - either positively or negatively.

For example. An increase in the firm's accounts receivable indicates that the firm collected less money from its customers than it recorded in sales during the same year on its income statement. Thus, it leads to a negative cash outflow.

Thus, as a rule of thumb, if the balance of a liability increases, cash flow from operations will increase; and if the balance of a liability decreases, cash flow from operations will decrease.

Similarly, an increase in the balance of an asset leads to a decrease in the cash flow of operations, and vice versa.