How do Assets and Liabilities affect Cash Flow

Assets: An increase causes a decrease in cash

Liabilities: An increase causes an increase in cash

Let’s use two examples. Accounts Receivable, an Asset and Accounts Payable, a Liability.

Accounts Receivable (AR)

AR represents money that a company is owed as services have been rendered, but the money is not yet paid for. It’s an Asset because it represents future cash.

So if we think about an AR balance of $200, that’s $200 worth of future cash that will be converted into real cash soon.

Now if our future cash goes down, that means it was converted into actual cash! So if AR increases, it means that we’re owed more future cash.

This makes our actual cash go down since we’ve spent the money to service the customer, but haven’t been paid yet. So if we think about the specific margin of this customer, it’s currently negative since we haven’t been paid, and that makes our cash balance go down.

In other words, we’re “spending money” (negative margin in this case). This is the key to why an increase in Assets causes a decrease in cash.

Think about Prepaid Expenses, where we paid cash for expenses that have not yet accrued.

Accounts Payable (AP)

AP is the flipside of AR. Let’s use the same logic as we did above. AP represents amounts owed to suppliers that have been received but not yet paid.

So let’s say that we resell flowers. We make one sale for $100. We owe our suppliers $50 for the flowers that we then sold to our customers. Now since we haven’t paid our suppliers, we’re making 100% cash margin.

In other words, our actual cash is overstated and our future cash is negative, since we’ll have to pay the supplier.

So, an increase in liabilities causes an increase in cash because they represent money that a company receives without immediately spending its own cash.