Moss Exports is struggling this year with a net income of only $60,000. The company has decided to apply for a loan and is aware that the bank will closely examine the cash flow from their operating activities. In order to present themselves in the best possible light for the loan it is suggested that they remove $80,000 from their accounts receivable that the customers have been slow in paying to a long term receivable. If the company moves the $80,000 from their current accounts receivable to the long term receivable account it will show an $80,000 positive increase in their operating activities. The company will now show $140,000 in their operating activities. The $80,000 would be reflected in the Investing Activities.
This would be unethical for several points:
a) Operating Activities cash inflow is from customers for the sale of merchandise inventory and services, and for interest and dividend income. (Account receivables is money customers owe the company for merchandise inventory and services.)
b) The Cash outflow for operating activities is for the purchase of merchandise inventory, payment of operating expense and for interest expense and income tax expense. (If the customer’s paid their invoices this is how the money would be used.)
c) Investing Activities cash inflows from the sale of property, plant, equipment and investments and from the collection of long term note receivables. (The outstanding money is none of these.)
d) Investing Activities cash outflow is for the purchase of property, plant, equipment, and investments, and for loans made to borrowers. (This is not what the outstanding money would be used for.)
It may not be illegal to move the outstanding accounts receivable funds on the cash flow statement, however it is unethical.
With the information provided, the net cash provided by operations would be calculated as $60,000 – $80,000 = ($20,000) while the accounts receivable are still included. If Moss Exports were to remove the accounts receivable, their net cash provided by operations would simply be $60,000 since there wouldn’t be any other current non-cash assets to adjust the net income. With an $80,000 swing, moving accounts receivable to long-term assets would definitely improve the picture in regard to the company’s cash flow. Theoretically, the $60,000 in cash provided by operations would increase the likelihood that a bank would issue the company a loan. In reality, however, this would not actually change the company’s financial performance, only hiding a major problem the company is facing. Furthermore, a negative cash flow from operating activities can signify trouble for a business, and can indicate the liquidity (or lack thereof) of a company’s income.
As is generally the case, manipulating financial statements to appear better than they really are is not ethical. I do think there is an opportunity for the company to reach out to their overseas customers to see if there is a way to expedite at least a portion of the payments owed. Even the generation of an additional $20,000 in cash would go a long way in improving the company’s cash flow. If Moss Exports is able to reexamine these accounts, there’s also a possibility that they could rightfully move these accounts receivable to long-term assets. Ultimately, changing financial statements without making legitimate financial transactions is wrong. It may not be noticeable at first look, but if an auditor or anyone else begins to look at income statements, balance sheets, and so forth, this issue could easily be identified. And in the end, that’s not going to do Moss Exports any more good.