The Comprehensive Guide on How to Read a Financial Report: Wringing Vital Signs Out of the Numbers, + Website

CHAPTER 9

INVENTORY AND ACCOUNTS PAYABLE

Examining Our Third Link, with a Twist

In Chapters 7 and 8, the primary link or connection examined was between the balance sheet and income statement (i.e., accounts receivable to sales and inventory to costs of goods sold expense). In this chapter, our attention turns to discussing a connection, which is of critical importance but only deals with the balance sheet. That is, the link between inventory and accounts payable. But before we delve into the more technical aspects of the connection, one key concept needs to be understood as to why this connection is so important—cash!

Anyone who has managed a business understands that when operating conditions get tight and cash balances come under stress, one of the most common and easy areas to target to improve cash levels is to take it out on your vendors. Whether these vendors supply just inventory or extend terms to pay for professional services, companies of all shapes, sizes, and forms will look to “leverage” their vendors as much as possible to increase the time they have to pay the outstanding invoices, thus holding onto cash longer (which can be utilized in other areas of the business). And by the way, this strategy is not limited to just companies that are experiencing a rough patch as some of the biggest and baddest global businesses have taken this strategy to an entirely new level.

Pay particular close attention to any section titled “Seller Beware” as this section spells out that ...