Changes in accrued liabilities absolutely affect cash flow, but not in the way you might expect. Accrued liabilities can temporarily affect cash flow by the amount saved in taxes from an increase in expenses on the income statement.

How an increase in accrued liabilities affects cash flow
Suppose that a company accrues a liability for rents and utilities for the current period in the amount of $1,000. This amount is expensed in the current period on the income statement and affects income statement as follows.

Income statement math:

  • Expenses: +$1,000
  • Gross profit: -$1,000
  • Taxes:-$350 (35% tax rate)
  • Net income: -$650

The cash flow statement begins with net income, which fell by $650 because of the increase in expenses. Here's how this affects the cash flow statement.

Cash flow statement math:

  • Net income: -$650
  • Increase in accrued liabilities: +$1,000
  • Change in cash: +$350

Notice that the change in cash is exactly equal to the $350 in taxes that are saved by a $1,000 increase in expenses. When an expense is matched with a liability that will be paid off at a later date, cash increases in the amount of the tax savings on the income statement.

The balance sheet would reflect the increase in cash, increase in accrued liabilities, and decrease in net income.

Balance sheet math:

  • Cash: +$350
  • Accrued liabilities: +$1,000
  • Retained earnings: -$650

What happens when accrued liabilities decrease?
We can now go in the other direction to see what happens when a company's accrued liabilities decrease. This happens when a company pays off an accrued liability by making cash payments for wages or utilities, for example.

Let's suppose the company will now use $1,000 in cash to pay off the previously accrued liabilities. This will not affect the income statement, as the expense that created the liability has already been recorded on the income statement in a prior period. We can start off at the cash flow statement.

Cash flow math:

  • Net income: No change
  • Decrease in accrued liabilities: -$1,000
  • Change in cash: -$1,000

The balance sheet would change to reflect the decrease in cash, and the decrease in accrued liabilities, and no change in retained earnings.

Balance sheet math:

  • Cash: -$1,000
  • Accrued liabilities: -$1,000
  • Retained earnings: No change

A temporary benefit
Though an increase in accrued liabilities will result in an increase in cash flow, the benefit is only temporary. In periods where expenses associated with an accrued liability exceed accrued liabilities paid off, a company will generate an abnormally high amount of cash. The opposite is also true -- when accrued liabilities paid off exceed amounts expensed on the income statement, a company will generate an abnormally low amount of cash flow.

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