An increase in accounts receivable is deducted from net income to obtain operating cash flows because a. cash collections from customers were less than the revenues reported. b. cash collections increased due to increasing sales. c. cash collections decreased due to declining sales. d. cash collections from customers were greater than the revenues reported. e. None of these.

The answer is a.cash collections from customers were less than the revenues reported.

Explanation: Usually, the total revenue comprises cash and a receivable component, based on the accrual method or matching principle of accounting. When a sales transaction is made, if it is accrual (no cash receipt yet), you debit accounts receivable and credit revenue. Then, when cash is received, debit cash and credit the accounts receivable. At times, cash settlement is made within a very short period of time or deferred depending on the contract terms with the purchaser. To derive the actual cash from operating activities, we therefore need to back out the non-cash component (accounts receivable) from the accrued revenue.

A) cash collections from customers were less than the revenues reported.

Explanation:

Cash flows do not match net income unless the company uses the cash basis system of accounting, sometimes the company might be losing money while the cash flows are increasing. On the other hand, a company can be economically healthy but financially broke.

Finances rely on cash flows, because it deals with the value and use of money in time. Sales are either collected in cash or given out as credit to customers, but until the credit is paid, cash flows do not record the sales.

A company might be selling a lot on credit, but unless it can collect the money, then it will not be able to pay its expenses, or will be forced get a loan itself which costs money and is not immediate.

E.g. when GMC went bankrupt during the last recession, its balance sheet wasn't that bad, it had tons of assets including inventory and accounts receivables (sky high accounts receivables), and their expenses were nothing compared to them. It was the car company that sold the most cars in the world for decades, so how could a little bump in sales make it go bankrupt? Because it had no cash, and without cash a company cannot function. Employees are not paid with IOUs to be collected in 90 days, components and parts suppliers will hand out credit until they go bankrupt themselves, the government doesn't accept IOUs either as payment for taxes. On the other hand, Ford was selling much fewer cars, millions of cars less actually, and both had similar cost structures. The difference was that Ford had billions of dollars in cash, and not other types of assets. So one year of low sales was something they could deal with, because even if they lost money they could pay their bills.

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