How do changes in prepaid expenses impact cash flow?
When the prepaid expense balance increases, that means the company has a cash outflow for expenses that have not yet been recognized in the income statement. An example that you might see on the CPA exam might indicate that if the company prepays rent for 12 months, the prepaid rent balance will increase for the 12 months of rent prepaid. However, on the expense side, the 12 months of expenses will not be recognized until the end of the year. Overall, an increase in prepaid expenses results in a cash outflow while a decrease results in a cash inflow. We feel that it’s important to see this with a visual in order to better understand the intuition. Check out our breakout below:
What Does an Increase Mean?
An increase in prepaid expenses indicates that more cash is being spent today for future expenses incurred. This will lead to a decrease in net cash flows.
What Does a Decrease Mean?
A decrease in prepaid expenses indicates that less cash is being spent today for expenses incurred, which will lead to an increase in net cash flows.
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