Thanks Brian, super helpful videos. I understand that AR has a relation with Inventory. While AR does come into the picture on the second step, analyzing the effect of an increase in the AR cannot be independent of the sale of inventory. If we think of it as independent, AR should have nothing to do with revenue, because it is a mere delay in cash collection and a delay cannot increase revenue. On the other hand, a delay can happen after an increase in revenue. And revenue can increase only if a sale happens and for a sale to happen there must be inventory. Also, the Starting point of this analysis should be that the Inventory exists and not when the Inventory was purchased, otherwise we go even more steps back in the past to the cash balance when the inventory was purchased / produced. The amount of AR and revenue could be the same, if the customer doesn’t pay anything at the time of the sale but the these can not be equal to gross profit unless we assume there is no cost associated with the goods sold. My answer: An increase in AR by 100 means that I sold for 100 a product, which I produced for, say 10, and the transaction stipulated a later cash payment.
In chronological order, On Income Statement, Revenue increases by 100 and simultaneously, COGS increase by 10 and Inventory on the Balance Sheet decreases by 10. Gross Profit Increases by 90. Pretax Income increases by 90. Tax amount increases by 36. Net Income increases by 54. This is Step 1 Since the customer had agreed to pay later, AR on the Balance Sheet increases by 100. This is Step 2 On the Cash Flow Statement, Net Income increases by 54. Changes in Working Capital are increase of 10 and decrease of 100. Net change in WC is a decrease of 90. So, the net change in Cash Flow is a decrease of 36 Again, on the Balance Sheet, on the Asset side, changes in assets include a decrease in Inventory by 10, an increase in AR by 100 and a decrease in Cash by 36. Net change on the Asset side is: - 10 - 36 + 100 = increase of 54. On the Balance Sheet’s Liabilities and Equity side, Retained Earnings increase because of an increase in Net Income of 54 which balances the balance sheet. For a company with a 40% tax rate, an increase in AR by 100 should not increase Retained Earnings by 60 but anything less than that, depending on the Gross Profit Margin.
Yes, inventory would factor in in real life, but this is a simple/simplified interview question intended to test the very basics. They ask this type of question to verify that you know the bare minimum about how AR and the financial statements work. Your walkthrough is more accurate but also more complex and is more likely to be a follow-up question or part of a multi-step scenario.
For when we are collecting AR, I noticed on your 3-FS that on the balance sheet you still have AR as +100? Should that not be going to zero, now that we collected? Because based on your example, AR on the BS is not changing. Should it not?
This is a very old video using an older version of the accounting / interview question model on our site, so I would not read too much into this. All these accounting videos need to be updated and revised. However, if you're referring to the part at 7:55, the AR balance does decrease by $100 upon collection. Before any of these changes, AR was $100. Then it went up to $200 when the customer paid on credit. Now, we collect the $100 of AR that was owed, and it goes back to the original $100 level.
Mergers & Inquisitions / Breaking Into Wall Street Brian, 2 questions: is it fair to assume that an interviewer is unlikely to *only* ask what would happen if AR decreases? But rather that they would ask about it logically? In other words they would first ask you to explain the accrual (AR increase) and then the subsequent collection of cash (AR decrease)? Secondly, 8:17, I'm having a little bit of a tough time understanding why you wouldn't enter the change (in this case a reduction) in AR under Changes in Operating Assets & Liabilities. If the asset goes down, your cash benefits (which is exactly what is happening, as you are now collecting the cash you are owed). Is this just a specific instance of when not to show the change on the cash flow statement? It may just be my mental muscle memory wanting to kick in... 8:23 "because now that we've actually collected this in cash, the change here is not going to affect our cash balance because now we have it" is the sentence that is throwing me off, I think. EDIT: so I've been thinking about it - is another way to think about this that the AR line item on your BS is now back down to 100 (from the previous 200) so in other words even if I were to enter the change on the cash flow it would be 0 (100 minus 100)? Thank you for your help.
The interviewer could ask anything, so no, those are not fair assumptions. They could easily ask you to explain the accrual of AR and cash collection. If you have questions to this level of detail, you should ask within our courses. I'm confused over why you're leaving comments here (when UA-cam comments have been proven to cause mental damage) when you've already said you signed up for the Fundamentals course. Please take a look at the written quick reference guides in the course or the more complete videos there for explanations of these topics.
Yes, that's true, but for interview question purposes, no one will ask about that. The goal in these questions is to avoid over-thinking the scenario and prove you understand the main concept, i.e., that AR increasing typically represents sales without a cash payment received and that AR decreasing typically represents a cash collection. If they want to go beyond that and ask you about other scenarios and special cases, let them, but always focus on the core concept.
To the same effect as explained in the video, my intuition was to record the receipt of $100 cash as Change in AR, thereby increasing cash, and reducing AR by $100 on the balance sheet. The BS totals remain the same. I may be wrong but perhaps I'm sticking to what I have read in accounting, and in my CFA material that a decrease in a current asset would be treated as incoming cash and hence added in the Cash Flow from Operations.
When a company receives an owed payment from a customer, yes, the Change in AR increases and AR on the Balance Sheet decreases. Cash is up and AR is down so the Balance Sheet remains in balance. But for that to happen, the company must have already recorded revenue from this owed payment in some previous period.
I wish the ACCO professors could have used a spreadsheet to explain the concept like this. It was much more confusing to illustrate on a single statement.
Brian, these videos are amazing. I had a question question though if the AR is going up by 100 and then along with Revenue going up by 100 shouldn't the inventory go down and the COGS go up (depending on the margin) as well considering you would need inventory to sell?
If the company sells inventory and records revenue for it, revenue increases, COGS increases, and inventory decreases. But you should start that type of change by recording the initial purchase of inventory first. I'm not sure what AR has to do with this. AR only factors in if, in the second step, the company doesn't collect the cash for the sale right away. And then it would decrease once the cash is collected.
Thanks Brian, super helpful videos. I understand that AR has a relation with Inventory. While AR does come into the picture on the second step, analyzing the effect of an increase in the AR cannot be independent of the sale of inventory. If we think of it as independent, AR should have nothing to do with revenue, because it is a mere delay in cash collection and a delay cannot increase revenue. On the other hand, a delay can happen after an increase in revenue. And revenue can increase only if a sale happens and for a sale to happen there must be inventory. Also, the Starting point of this analysis should be that the Inventory exists and not when the Inventory was purchased, otherwise we go even more steps back in the past to the cash balance when the inventory was purchased / produced. The amount of AR and revenue could be the same, if the customer doesn’t pay anything at the time of the sale but the these can not be equal to gross profit unless we assume there is no cost associated with the goods sold. My answer: An increase in AR by 100 means that I sold for 100 a product, which I produced for, say 10, and the transaction stipulated a later cash payment.
In chronological order, On Income Statement, Revenue increases by 100 and simultaneously, COGS increase by 10 and Inventory on the Balance Sheet decreases by 10. Gross Profit Increases by 90. Pretax Income increases by 90. Tax amount increases by 36. Net Income increases by 54. This is Step 1 Since the customer had agreed to pay later, AR on the Balance Sheet increases by 100. This is Step 2 On the Cash Flow Statement, Net Income increases by 54. Changes in Working Capital are increase of 10 and decrease of 100. Net change in WC is a decrease of 90. So, the net change in Cash Flow is a decrease of 36 Again, on the Balance Sheet, on the Asset side, changes in assets include a decrease in Inventory by 10, an increase in AR by 100 and a decrease in Cash by 36. Net change on the Asset side is: - 10 - 36 + 100 = increase of 54. On the Balance Sheet’s Liabilities and Equity side, Retained Earnings increase because of an increase in Net Income of 54 which balances the balance sheet. For a company with a 40% tax rate, an increase in AR by 100 should not increase Retained Earnings by 60 but anything less than that, depending on the Gross Profit Margin.
Hi! How come CoGS doesn't go up at all as A/R goes up? If the transaction is recorded, shouldn't it apply both the revenue and the CoGS, and not just for the former? Thanks!
In real life, yes, COGS, Inventory, Revenue, and AR will all have some relationship and move together. In an artificial interview question setting, it's best to keep it simple and answer the specific question without trying to make it "more realistic" or introduce added complications.
Can someone please clear this doubt: when Accounts Receivable increases, why won't the cost of goods sold increase? Accounts Receivable increased due to "extra" sell of a product. So, shouldn't have the costs of goods sold also increased? I cant seem to understand why COGS wont increase!?
In real life, when AR goes up, it means the company has delivered a product/service to the customer, which almost always comes with associated COGS. So you would normally see at least a small increase in COGS. In this artificial example intended for interview questions, we do not walk through that scenario because this is intended to be used for a very simple interview question about AR. We do cover more real-world scenarios with added complexities in the courses and guides.
Brian, I have a question about the second scenario, when you collect $100 cash from customers. On the balance sheet, why does Accounts Receivables not go down by $100?
It does go down on the Balance Sheet: remember, AR went up from $100 to $200 initially. And now when you collect the cash, it goes back down to $100. So AR decreases from the state where you had not yet collected the cash.
Mergers & Inquisitions / Breaking Into Wall Street I think Xian Mo's question arose from the same thought I have, in that I thought on the Assets side of the BS, the net change should be -40 (increase in cash of 60 and a decrease in AR of 100 (+60-100 = -40)). Why is the second operation ignored? You are of course right that it goes down from $200 to $100 (this can clearly be seen in the Excel too) but I'm missing something in the math here I think. In this scenario I would always have done +60-100 on the Assets side of the BS.
AR is different from credit sales. Credit sales just refers to the portion of revenue that was paid on credit, not in cash. Accounts receivable represents the total cumulative balance of credit sales over time that are still owed at the end of the period. So they are related, but the Change in AR reflects both additional credit sales as well as the cash collection of credit sales from previous periods.
When AR is negative? That can't really happen. If you mean "the Change in AR," then it just means that AR is increasing, which reduces the company's cash flow (since it receives less cash upfront from customers and has to wait on it).
@@adarshmadhav2356 Depends on the company and what is in revenue and what COGS represents... this is just a simplified scenario intended to answer a common interview question testing the basics. But yes, in real life, COGS tends to increase when revenue and AR increase because the cost of goods corresponding to products must be recorded when the products are sold and delivered, even if the customers have not yet paid in cash.
@@financialmodelingIn any case if there is an increase in Revenue there must be corresponding increase in COGS, then how can we add back the entire increase. I m not arguing, it's just a doubt.
@@adarshmadhav2356 Yes, you're correct, but the point is that this is an artificial scenario designed to answer an equally artificial interview question. Also, keep in mind that not all companies necessarily have COGS that correspond directly to Revenue. Some companies don't even list COGS as an expense category (for example, many software/biotech companies).
Thanks Brian, super helpful videos.
I understand that AR has a relation with Inventory. While AR does come into the picture on the second step, analyzing the effect of an increase in the AR cannot be independent of the sale of inventory.
If we think of it as independent, AR should have nothing to do with revenue, because it is a mere delay in cash collection and a delay cannot increase revenue.
On the other hand, a delay can happen after an increase in revenue. And revenue can increase only if a sale happens and for a sale to happen there must be inventory.
Also, the Starting point of this analysis should be that the Inventory exists and not when the Inventory was purchased, otherwise we go even more steps back in the past to the cash balance when the inventory was purchased / produced.
The amount of AR and revenue could be the same, if the customer doesn’t pay anything at the time of the sale but the these can not be equal to gross profit unless we assume there is no cost associated with the goods sold.
My answer:
An increase in AR by 100 means that I sold for 100 a product, which I produced for, say 10, and the transaction stipulated a later cash payment.
In chronological order,
On Income Statement, Revenue increases by 100 and simultaneously, COGS increase by 10 and Inventory on the Balance Sheet decreases by 10. Gross Profit Increases by 90. Pretax Income increases by 90. Tax amount increases by 36. Net Income increases by 54. This is Step 1
Since the customer had agreed to pay later, AR on the Balance Sheet increases by 100. This is Step 2
On the Cash Flow Statement, Net Income increases by 54. Changes in Working Capital are increase of 10 and decrease of 100. Net change in WC is a decrease of 90. So, the net change in Cash Flow is a decrease of 36
Again, on the Balance Sheet, on the Asset side, changes in assets include a decrease in Inventory by 10, an increase in AR by 100 and a decrease in Cash by 36. Net change on the Asset side is: - 10 - 36 + 100 = increase of 54.
On the Balance Sheet’s Liabilities and Equity side, Retained Earnings increase because of an increase in Net Income of 54 which balances the balance sheet.
For a company with a 40% tax rate, an increase in AR by 100 should not increase Retained Earnings by 60 but anything less than that, depending on the Gross Profit Margin.
Yes, inventory would factor in in real life, but this is a simple/simplified interview question intended to test the very basics. They ask this type of question to verify that you know the bare minimum about how AR and the financial statements work. Your walkthrough is more accurate but also more complex and is more likely to be a follow-up question or part of a multi-step scenario.
Brian, these recent videos are so useful and explained everything so well / clear! Thanks so much!!
Thanks for watching!
For when we are collecting AR, I noticed on your 3-FS that on the balance sheet you still have AR as +100? Should that not be going to zero, now that we collected? Because based on your example, AR on the BS is not changing. Should it not?
This is a very old video using an older version of the accounting / interview question model on our site, so I would not read too much into this. All these accounting videos need to be updated and revised. However, if you're referring to the part at 7:55, the AR balance does decrease by $100 upon collection.
Before any of these changes, AR was $100. Then it went up to $200 when the customer paid on credit. Now, we collect the $100 of AR that was owed, and it goes back to the original $100 level.
Mergers & Inquisitions / Breaking Into Wall Street Brian, 2 questions: is it fair to assume that an interviewer is unlikely to *only* ask what would happen if AR decreases? But rather that they would ask about it logically? In other words they would first ask you to explain the accrual (AR increase) and then the subsequent collection of cash (AR decrease)?
Secondly, 8:17, I'm having a little bit of a tough time understanding why you wouldn't enter the change (in this case a reduction) in AR under Changes in Operating Assets & Liabilities. If the asset goes down, your cash benefits (which is exactly what is happening, as you are now collecting the cash you are owed). Is this just a specific instance of when not to show the change on the cash flow statement? It may just be my mental muscle memory wanting to kick in...
8:23 "because now that we've actually collected this in cash, the change here is not going to affect our cash balance because now we have it" is the sentence that is throwing me off, I think.
EDIT: so I've been thinking about it - is another way to think about this that the AR line item on your BS is now back down to 100 (from the previous 200) so in other words even if I were to enter the change on the cash flow it would be 0 (100 minus 100)?
Thank you for your help.
The interviewer could ask anything, so no, those are not fair assumptions. They could easily ask you to explain the accrual of AR and cash collection. If you have questions to this level of detail, you should ask within our courses. I'm confused over why you're leaving comments here (when UA-cam comments have been proven to cause mental damage) when you've already said you signed up for the Fundamentals course. Please take a look at the written quick reference guides in the course or the more complete videos there for explanations of these topics.
Hey Brian thanks for the video. I checked for the file and didn’t see it on the site. Kindly can you provide and updated link?
This one is not available because it uses an old version of the model. We may eventually create a new one.
Thanks Brian!
Thanks for watching!
Thanks a lot! Very informative video, I have learnt a lot🙏🙏🙏
Thanks for watching!
Brian, why it is assumed that AR can only increase due to new sales? It also can happen if you collected less cash having the same revenue.
Yes, that's true, but for interview question purposes, no one will ask about that. The goal in these questions is to avoid over-thinking the scenario and prove you understand the main concept, i.e., that AR increasing typically represents sales without a cash payment received and that AR decreasing typically represents a cash collection. If they want to go beyond that and ask you about other scenarios and special cases, let them, but always focus on the core concept.
To the same effect as explained in the video, my intuition was to record the receipt of $100 cash as Change in AR, thereby increasing cash, and reducing AR by $100 on the balance sheet. The BS totals remain the same. I may be wrong but perhaps I'm sticking to what I have read in accounting, and in my CFA material that a decrease in a current asset would be treated as incoming cash and hence added in the Cash Flow from Operations.
When a company receives an owed payment from a customer, yes, the Change in AR increases and AR on the Balance Sheet decreases. Cash is up and AR is down so the Balance Sheet remains in balance. But for that to happen, the company must have already recorded revenue from this owed payment in some previous period.
I wish the ACCO professors could have used a spreadsheet to explain the concept like this. It was much more confusing to illustrate on a single statement.
Thanks for watching!
Brian, these videos are amazing. I had a question question though if the AR is going up by 100 and then along with Revenue going up by 100 shouldn't the inventory go down and the COGS go up (depending on the margin) as well considering you would need inventory to sell?
If the company sells inventory and records revenue for it, revenue increases, COGS increases, and inventory decreases. But you should start that type of change by recording the initial purchase of inventory first. I'm not sure what AR has to do with this. AR only factors in if, in the second step, the company doesn't collect the cash for the sale right away. And then it would decrease once the cash is collected.
Thanks Brian, super helpful videos.
I understand that AR has a relation with Inventory. While AR does come into the picture on the second step, analyzing the effect of an increase in the AR cannot be independent of the sale of inventory.
If we think of it as independent, AR should have nothing to do with revenue, because it is a mere delay in cash collection and a delay cannot increase revenue.
On the other hand, a delay can happen after an increase in revenue. And revenue can increase only if a sale happens and for a sale to happen there must be inventory.
Also, the Starting point of this analysis should be that the Inventory exists and not when the Inventory was purchased, otherwise we go even more steps back in the past to the cash balance when the inventory was purchased / produced.
The amount of AR and revenue could be the same, if the customer doesn’t pay anything at the time of the sale but the these can not be equal to gross profit unless we assume there is no cost associated with the goods sold.
My answer:
An increase in AR by 100 means that I sold for 100 a product, which I produced for, say 10, and the transaction stipulated a later cash payment.
In chronological order,
On Income Statement, Revenue increases by 100 and simultaneously, COGS increase by 10 and Inventory on the Balance Sheet decreases by 10. Gross Profit Increases by 90. Pretax Income increases by 90. Tax amount increases by 36. Net Income increases by 54. This is Step 1
Since the customer had agreed to pay later, AR on the Balance Sheet increases by 100. This is Step 2
On the Cash Flow Statement, Net Income increases by 54. Changes in Working Capital are increase of 10 and decrease of 100. Net change in WC is a decrease of 90. So, the net change in Cash Flow is a decrease of 36
Again, on the Balance Sheet, on the Asset side, changes in assets include a decrease in Inventory by 10, an increase in AR by 100 and a decrease in Cash by 36. Net change on the Asset side is: - 10 - 36 + 100 = increase of 54.
On the Balance Sheet’s Liabilities and Equity side, Retained Earnings increase because of an increase in Net Income of 54 which balances the balance sheet.
For a company with a 40% tax rate, an increase in AR by 100 should not increase Retained Earnings by 60 but anything less than that, depending on the Gross Profit Margin.
@@prakharmahajan8124 hey! so do we indeed make changes to COGS as a result of increasing/decreasing accounts receivable?
Hi!
How come CoGS doesn't go up at all as A/R goes up?
If the transaction is recorded, shouldn't it apply both the revenue and the CoGS, and not just for the former?
Thanks!
In real life, yes, COGS, Inventory, Revenue, and AR will all have some relationship and move together. In an artificial interview question setting, it's best to keep it simple and answer the specific question without trying to make it "more realistic" or introduce added complications.
Can someone please clear this doubt:
when Accounts Receivable increases, why won't the cost of goods sold increase?
Accounts Receivable increased due to "extra" sell of a product.
So, shouldn't have the costs of goods sold also increased? I cant seem to understand why COGS wont increase!?
In real life, when AR goes up, it means the company has delivered a product/service to the customer, which almost always comes with associated COGS. So you would normally see at least a small increase in COGS.
In this artificial example intended for interview questions, we do not walk through that scenario because this is intended to be used for a very simple interview question about AR. We do cover more real-world scenarios with added complexities in the courses and guides.
@@financialmodeling perfect
Thanks!
Hi Brian, can you post a link with the files so I can practice and review over the financial statements.
This one is no longer available, sorry, but we may release a similar version in the future.
@@financialmodelinghope u can re upload it again soon
@@financialmodeling Hi, it would be great if you can repost the link for the excel document for practice. Thankyou
you are a god
Thanks, but these are fairly simple accounting question walk-throughs. Glad you find them useful, though.
Brian, I have a question about the second scenario, when you collect $100 cash from customers. On the balance sheet, why does Accounts Receivables not go down by $100?
It does go down on the Balance Sheet: remember, AR went up from $100 to $200 initially. And now when you collect the cash, it goes back down to $100. So AR decreases from the state where you had not yet collected the cash.
Mergers & Inquisitions / Breaking Into Wall Street I think Xian Mo's question arose from the same thought I have, in that I thought on the Assets side of the BS, the net change should be -40 (increase in cash of 60 and a decrease in AR of 100 (+60-100 = -40)). Why is the second operation ignored?
You are of course right that it goes down from $200 to $100 (this can clearly be seen in the Excel too) but I'm missing something in the math here I think. In this scenario I would always have done +60-100 on the Assets side of the BS.
In the first case, when there is increase in the A/R there should be proportionate increase in the COGS. Is it ?
Hi, do you have a similar spreadsheet like this one? Can be a newer version, I think the old one is deleted right?
There is a newer version, but only available in our courses currently. We may release a simplified version in the future.
does change in AR means outstanding credit sales at the end of period??
AR is different from credit sales. Credit sales just refers to the portion of revenue that was paid on credit, not in cash. Accounts receivable represents the total cumulative balance of credit sales over time that are still owed at the end of the period. So they are related, but the Change in AR reflects both additional credit sales as well as the cash collection of credit sales from previous periods.
Link below i could not able to find..
Sorry, this one is not available anymore.
@@kashik1725 Sorry, I am not sure what you're asking. We are not a placement agency; we just offer training for interviews and job preparation.
Hello, can you explain what does it mean when AR are negative? Thanks
When AR is negative? That can't really happen. If you mean "the Change in AR," then it just means that AR is increasing, which reduces the company's cash flow (since it receives less cash upfront from customers and has to wait on it).
@@financialmodeling A/R is increasing , then there should be proportionate increase in the COGS too. Is it?
@@adarshmadhav2356 Depends on the company and what is in revenue and what COGS represents... this is just a simplified scenario intended to answer a common interview question testing the basics. But yes, in real life, COGS tends to increase when revenue and AR increase because the cost of goods corresponding to products must be recorded when the products are sold and delivered, even if the customers have not yet paid in cash.
@@financialmodelingIn any case if there is an increase in Revenue there must be corresponding increase in COGS, then how can we add back the entire increase. I m not arguing, it's just a doubt.
@@adarshmadhav2356 Yes, you're correct, but the point is that this is an artificial scenario designed to answer an equally artificial interview question. Also, keep in mind that not all companies necessarily have COGS that correspond directly to Revenue. Some companies don't even list COGS as an expense category (for example, many software/biotech companies).
You are a beast
Thanks for watching!
It's very helpful. Could i receive Template Excel by email, pls?
Please see the free samples on our IB Interview Guide course description page.
Is the Excel document still available?
This one is not because it was from an older version of the Interview Guide, which we have since deleted.
where is excel link
We have removed this one, sorry.