You are a loan officer for First Benevolent Bank. You have an uneasy feeling as

ID: 2488217 • Letter: Y

Question

You are a loan officer for First Benevolent Bank. You have an uneasy feeling as you examine a loan application from Daring Corporation. The application included the following financial statements.

DARING CORPORATION Income Statement For the Year Ended December 31, 2011
Sales revenue $100,000

Cost of goods sold (50,000)

Depreciation expense (5,000)

Remaining expenses (25,000)

Net income $20,000
DARING CORPORATION Balance Sheet December 31, 2011

Cash $5,000 Accounts receivable 25,000 Inventory 20,000 Depreciable assets 55,000 Accumulated depreciation (5,000) Total $100,000
Accounts payable $10,000 Interest payable 5,000 Note payable 45,000 Common stock 20,000 Retained earnings 20,000 Total $100,000

It is not Daring's profitability that worries you. The income statement submitted with the application shows net income of $20,000 in Daring's first year of operations. By referring to the balance sheet, you see that this net income represents a 20% rate of return on assets of $100,000. Your concern stems from the recollection that the note payable reported on Daring's balance sheet is a two-year loan you approved earlier in the year.
You also recall another promising new company that, just last year, defaulted on another of your bank's loans when it failed due to its inability to generate sufficient cash flows to meet its obligations. Before requesting additional information from Daring, you decide to test your memory of the intermediate accounting class you took in night school by attempting to prepare a statement of cash flows from the information available in the loan application.

Explanation / Answer

Statement of cash flow

Net income 20,000

Add:

Depreciation expense 5,000

Increase in accounts payable 10,000

Interest payable 5,000

Less:

Increase in account receivable -25,000

Increase in inventory -20,000 -25,000

Net cash used by operating activities -5,000

Cash provided by investing activities

Asset purchase -55,000

Net cash used by investing activities -55,000

Cash provided by financing activities

Common stock issued 20,000

Cash from notes payable 45,000

Net cash provided by financing activities 65,000

Net cash increase 5,000