CA5-5 WRITING (Cash Flow Analysis) The partner in charge of the Kappeler Corpora

Question

CA5-5 WRITING (Cash Flow Analysis) The partner in charge of the Kappeler Corporation audit comes by your desk and leaves a letter he has started to the CEO and a copy of the cash flow statement for the year ended December 31, 2017. Because he must leave on an emergency, he asks you to finish the letter by explaining: (1) the disparity between net income and cash flow, (2) the importance of operating cash flow, (3) the renewable source(s) of cash flow, and (4) possible suggestions to improve the cash position KAPPELER CORPORATION STATEMENT OF CASH FLows FOR THE YEAR ENDED DEcEMBER 31, 2017 Cash flows from operating activities Net income Adjustments to reconcile net income to net cash provided by operating activities Depreciation expense Amortization expense Loss on sale of fixed assets Increase in accounts receivable (net) Increase in inventory Decrease in accounts payable Net cash provided by operating activities $100,000 $ 10,000 1,000 5,000 (40,000) (35,000) Cash flows from investing activities Sale of plant assets Purchase of equipment Purchase of land Net cash used by investing activities 25,000 (100,000) (20,o) (275,000) Cash flows from financing activities Payment of dividends Redemption of bonds Net cash used by financing activities (10,000) Net decrease in cash Cash balance, January 1, 2017 Cash balance, December 31, 2017 ,000) (385,000) 400.000 S 15,00o

Explanation / Answer

As clearly visible from the above cash flow statement that we have an absolute difference of $1,00,000 between net income and cash flow.

(A) Explaining disparity between Net Income and Cash Flow

In simple words, if I try to explain the reasons for the difference it will be the difference between actual cash inflows and outflows and various nominal deductions. The reasons are explained further as follows:

In simple words, the disparity has arisen and are visible because net income has been calculated based on accrual concept whereas cash flow records real outflows. Considering the impact of the same on the company, net income shows a positive result and growth. However, zero net operating cash flows are a matter of concern and require apt attention.

(B) Why Operating Cash Flows are important

Operating cash flows shows day to day operations and transaction of a company which is generated as a result of doing regular business. Operating Cash flows are critical from investors and creditors perspective because it shows the company's immediate health and its ability to generate cash to pay for its own expenses such as purchases, utility bills, employee payments etc. Basically, it covers all the renewable sources of cash flow.

(C) What are renewable sources of cash flow?

Renewable sources of cash flow, as the name suggests, are sources which generate regular and day to day cash flow which generally includes all the core business activities and revenue sources. Renewable sources of cash flow are really important to help a business grow and sustain its growth. Wherever, a company is facing a cash crunch or negative cash flows, the most obvious response would be to increase the renewable sources of cash flow.

(D) Possible suggestions to improve the cash situation

The following suggestions can help to the improve the cash situation:

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