An increase in a current asset uses cash; an increase in a current liability provides it; two exclusions

Reason from the account, not from a rule

After the non-cash items, Haliburton’s operating section stands at 108,000. The remaining differences between net income and operating cash are timing differences in working capital: sales made but not yet collected, purchases made but not yet paid, expenses paid ahead or behind. Each one is read from the change in a current asset or current liability between the two balance sheets, and each is easiest to get right by asking what the account did.

Accounts receivable rose 6,000 (46,000 → 52,000). Sales of 640,000 are in net income, but 6,000 more was sold than collected — customers still hold it. Cash from operations is 6,000 less than net income implies: subtract 6,000.

Inventory fell 7,000 (70,000 → 63,000). Cost of goods sold charged 384,000 to net income, but 7,000 of that was stock bought and paid for in earlier years — this year Haliburton sold more than it bought. Less cash left than the expense implies: add 7,000.

Prepaid insurance rose 1,000 (3,000 → 4,000). Haliburton paid for more coverage than it expensed: subtract 1,000.

Accounts payable rose 5,000 (33,000 → 38,000). Purchases went into cost of goods sold, but 5,000 of them are still unpaid — suppliers financed them: add 5,000.

Salaries payable fell 2,000 (8,000 → 6,000). Haliburton paid 2,000 more in salaries than the 98,000 it expensed, clearing part of last year’s accrual: subtract 2,000.

Income tax payable rose 1,000 (4,000 → 5,000). Tax expense 18,000; tax paid 17,000: add 1,000.

The sign rule

Read from the account, the rule writes itself. A current asset that increases absorbed cash (subtract); one that decreases released it (add). A current liability that increases means someone else is funding the business (add); one that decreases means the business paid them down (subtract). The grid in the figure places every Haliburton line.

$$\text{Operating}=\text{NI}+\text{non-cash items}-\Delta \text{CA}+\Delta \text{CL}$$

The section, complete

Net income                                          72,000
Add: amortization                                   34,000
Add: loss on disposal of equipment                   2,000
Increase in accounts receivable                     (6,000)
Decrease in inventory                                7,000
Increase in prepaid insurance                       (1,000)
Increase in accounts payable                         5,000
Decrease in salaries payable                        (2,000)
Increase in income tax payable                       1,000
Net cash provided by operating activities          112,000

108,000 − 6,000 + 7,000 − 1,000 + 5,000 − 2,000 + 1,000 = 112,000. Operating cash exceeds net income by 40,000 — mostly the amortization add-back — which is the normal shape for a company with a large equipment base.

Two current items that are never operating

Haliburton’s balance sheet has two more current liabilities, and both stay out of this section. The current portion of the bank loan (20,000 both years) is a reclassification of long-term debt; the cash that repays it is a financing outflow, and moving a slice of the loan from long-term to current is not a cash flow at all. Dividends payable (0 → 3,000) belongs to dividends, which are financing: the 3,000 increase is used in L13.5 to convert dividends declared into dividends paid, never here. The test is not “is it current?” but “does it belong to an operating account?” — payables to suppliers, staff and the tax authority do; the bank and the shareholders do not.