Using the indirect method to prepare the statement of cash flows, which of the following statements is true?Increase in current assets means an increase in cashDecrease in current assets means a decrease in cashDecrease in current liabilities means an increase in cashIncrease in current liabilities means an increase in cash
Question
Using the indirect method to prepare the statement of cash flows, which of the following statements is true?Increase in current assets means an increase in cashDecrease in current assets means a decrease in cashDecrease in current liabilities means an increase in cashIncrease in current liabilities means an increase in cash
Solution
The statement that is true when using the indirect method to prepare the statement of cash flows is:
- "Increase in current liabilities means an increase in cash."
When using the indirect method, an increase in current liabilities (like accounts payable) means that the company has delayed paying its bills, which conserves cash, thus increasing the cash balance.
Here's why the other statements are not true:
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Increase in current assets means an increase in cash: This is not necessarily true. For example, if accounts receivable (a current asset) increases, it means that the company has made sales on credit and has not yet collected the cash, which does not increase the cash balance.
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Decrease in current assets means a decrease in cash: This is not necessarily true. For example, if accounts receivable decreases, it means that the company has collected cash from its customers, which increases the cash balance.
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Decrease in current liabilities means an increase in cash: This is not true. If current liabilities decrease, it means the company has paid off some of its short-term debts, which would decrease the cash balance.
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