Inventory and expenses

Inventory is often the largest current asset of the business that sells products. If the inventory account is larger at the end of the period than at the start of the reporting period, the quantity the business actually paid in cash for that inventory is more than what the business recorded as its cost of good sold expense.  When that occurs, the accountant deducts the inventory increase from net income for determining cash flow from profit.

the prepaid expenses asset account works in exactly the same as the change in inventory and a / r accounts. However, adjustments to prepaid expenses are usually much smaller than changes in those other two asset accounts.

The first moment balance of prepaid expenses is charged to expense in this year, but the cash was actually paid out last year. this period, the business pays cash for next period's prepaid expenses, which affects this period's earnings, but doesn't affect net income until the next period. Simple, right?

As a business grows, it needs to increase its prepaid expenses for such things as fire premiums, which have to be paid in advance of the insurance coverage, and its stocks of office supplies. Increases in accounts receivable, inventory and prepaid expenses are the cash flow price a business has to pay for growth. Rarely do you find a business that can increase its sales revenue without increasing any assets you have.

The lagging behind effect some money flow is the price of business growth. Managers and investors need to understand that increasing sales without increasing a / r isn't a realistic scenario for growth. In the real business world, you generally can't enjoy rise in revenue without incurring additional expenses.