GB518 Unit 8 Cash Flow Statement Exercise Example

Profitable and Short of Cash: A Unit 8 Cash Flow Statement Exercise for a Fast-Growing Electronics Assembler

[Student Name]

Purdue University Global

GB518: Financial Accounting Principles and Analysis

Unit 8 Cash Flow Statement Exercise

[Instructor Name]

[Date]

The electronics assembler and every figure are composite and illustrative; the standards and sources cited are real.

The Given Data

Voltaic Assembly builds circuit boards and control modules for industrial equipment makers. Its comparative balance sheets and current income statement, in thousands of dollars, show net income of $4,200 for the year, depreciation of $2,600 and a $180 loss on the sale of old equipment. Between the two year-ends, accounts receivable rose from $11,200 to $15,800, inventory from $12,100 to $17,400, accounts payable from $7,300 to $9,600 and accrued liabilities from $1,900 to $2,100. The company bought $7,400 of new surface-mount equipment, sold old equipment with a book value of $600 for $420, borrowed $4,000 on a term loan and paid $1,200 in dividends.

The Statement of Cash Flows, Indirect Method

Operating activities. Net income $4,200. Add depreciation of $2,600 and the loss on the equipment sale of $180, both deducted in net income without using cash. Subtract the increase in receivables of $4,600 and the increase in inventory of $5,300, cash tied up in customers' unpaid bills and in stock. Add the increase in payables of $2,300 and in accrued liabilities of $200, costs recorded but not yet paid. Net cash used by operating activities: $420.

Investing activities. Purchase of equipment, $7,400 out. Proceeds from the equipment sale, $420 in. Net cash used by investing activities: $6,980.

Financing activities. Term loan proceeds, $4,000 in. Dividends paid, $1,200 out. Net cash provided by financing activities: $2,800.

Net change in cash: a decrease of $4,600, from $6,800 to $2,200, which ties to the balance sheets.

Beginning with net income and working back to cash is the indirect approach that ASC 230 allows and most companies choose (Kieso et al., 2022).

Free Cash Flow

Subtracting the $7,400 of equipment spending from operating cash flow of negative $420 leaves free cash flow of negative $7,820. The company spent far more than its operations generated.

Voltaic earned $4.2 million, but $9.9 million went into receivables and inventory, so operations used cash instead of producing it.

Reading the Three Sections Together

Each section tells part of the story. Operating activities show that the business is not yet turning its growth into cash, mainly because customers pay later and stock builds up. Investing activities show heavy spending on capacity, a sign management expects growth to continue. Financing activities show the company borrowing $4,000 while still paying $1,200 of dividends, so part of the dividend was effectively funded by the loan. Read together, the sections describe a company growing faster than its cash can support, which is a common and fixable condition, but one that cannot continue for long without either more borrowing or tighter control of working capital.

Checking the Statement

The statement ties to the balance sheets: beginning cash of $6,800 less the net decrease of $4,600 equals ending cash of $2,200. The equipment accounts also reconcile. Gross equipment rose by the $7,400 purchased less the original cost of the equipment sold, and the $180 loss is the difference between the $600 book value and the $420 received, so it is added back in operating activities while the full proceeds appear in investing.

Memo to the Chief Executive

To: Marisa Kent, Chief Executive. From: Controller. Subject: Why a profitable year ended with less cash.

Question 1: Are our earnings real? Yes, in the sense that the sales and costs were properly recorded. But their quality as cash is weak this year. K. R. Subramanyam describes earnings quality partly as how closely earnings are backed by operating cash flow (Subramanyam, 2014). This year, $4.2 million of earnings produced negative operating cash flow. Receivables grew faster than sales: up 41 percent against 30 percent sales growth, which suggests customers are paying more slowly. Inventory grew 44 percent, faster than sales, which suggests we are carrying more stock than growth requires.

Question 2: Why did cash fall? Three uses of cash exceeded what we earned: $9.9 million into receivables and inventory, $7.4 million into equipment and $1.2 million in dividends. Depreciation, the new loan and higher payables covered part of it, and the rest came from our cash balance.

Question 3: Can we fund next year's expansion internally? Not at current working capital levels. The planned second assembly line will cost about $6 million. Even if operating cash flow returns to the level of a typical year, around $6 to $7 million, it would barely cover the line, with nothing left for dividends or for working capital to support further growth. Robert Libby, Patricia Libby and Frank Hodge warn that rapid growth often consumes cash through working capital before it produces cash through profits (Libby et al., 2023).

What would change the answer. If we cut collection time back to last year's level and bring inventory in line with sales, about $3 million of cash would be released. That, with a normal year's operating cash flow, would fund the line without new borrowing. I recommend we set targets for days sales outstanding and inventory days before committing to the expansion.

References

Kieso, D. E., Weygandt, J. J., & Warfield, T. D. (2022). Intermediate accounting (18th ed.). Wiley.

Libby, R., Libby, P. A., & Hodge, F. (2023). Financial accounting (11th ed.). McGraw Hill.

Subramanyam, K. R. (2014). Financial statement analysis (11th ed.). McGraw-Hill Education.