How can an increase in accounts receivable affect liquidity?

An increase in accounts receivable can signify that a company has made sales on credit, which means they are expecting to collect cash in the future from customers. However, this can negatively impact liquidity if those collections are delayed. When accounts receivable rise, it indicates that more funds are tied up in receivables rather than being available as cash on hand. If the payments from customers are not received promptly, the company's ability to meet short-term obligations may be compromised.

In contrast, if sales are collected promptly, liquidity would not be affected adversely. Therefore, the timing of the collections from accounts receivable is crucial. When there's a substantial increase without timely collections, it can create a cash flow crunch, making it harder for the business to navigate its immediate financial responsibilities. This understanding highlights the importance of managing accounts receivable efficiently to maintain good liquidity.