A general contractor is experiencing cash flow problems despite showing profit on the income statement. What is the most likely cause of this situation?
Correct Answer
B) Accounts receivable are collecting too slowly
Slow collection of accounts receivable is the most common cause of cash flow problems in profitable construction companies. Revenue is recognized when earned, but cash isn't received until customers pay their invoices.
Why This Is the Correct Answer
Accounts receivable collecting too slowly is the primary cause of cash flow problems in profitable construction companies. When revenue is recognized on the income statement upon completion of work or reaching milestones, but customers delay payment, the company shows profit on paper while lacking actual cash. This timing difference between earned revenue and collected cash creates a cash flow gap that can severely impact operations despite apparent profitability.
Why the Other Options Are Wrong
Option A: Equipment depreciation is too high
Equipment depreciation is a non-cash expense that reduces reported profit but doesn't affect actual cash flow. Higher depreciation would actually make the income statement look worse while preserving cash, which is the opposite of the described situation.
Option C: Workers' compensation rates increased
Increased workers' compensation rates would affect both the income statement (reducing profit) and cash flow simultaneously. This wouldn't create a situation where the company shows profit but lacks cash flow.
Option D: FICA taxes were miscalculated
Miscalculated FICA taxes would impact both profit and cash flow in the same direction. If understated, both profit and cash would be overstated; if overstated, both would be understated, not creating the described disconnect.
Memory Technique
Think 'PAPER vs POCKET' - you can have profit on paper but no cash in your pocket if customers don't pay promptly.
Reference Hint
Business and Finance for Contractors - Chapter on Cash Flow Management and Accounts Receivable
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