After graduating near the top of his class, Ben Naegle was hired by the local of

Question

After graduating near the top of his class, Ben Naegle was hired by the local office of a Big 4 CPA firm in his hometown. Two years later, impressed with his technical skills and experience, Park Electronics, a large regional consumer electronics chain, hired Ben as assistant controller. This was last week. Now Ben's initial excitement has turned to distress. The cause of Ben's distress is the set of financial statements he's stared at for the last four hours. For some time prior to his recruitment, he hd been aware of the long trend of moderate profitability of his new employer. The reports on his desk confirm the slight, but steady, improvements in net income in recent years. The trend he was just now becoming aware of, though, was the decline in cash flows from operations.

Ben had sketched out the following comparison ($ in millions):

  2011       2010       2009       2008

Income from operations $140.0 $132.0   $127.5 $127.0

Net income 38.5        35.0 34.5 29.5

Cash flow from operations 1.6         17.0 12.0 15.5

Profits? Yes. Increasing profits? Yes. The cause of his distress? The ominous trend in cash flow which consistently lowered than net income. Upon closer review, Ben noticed three events in the last two years that, unfortunately, seemed related:

a. Park's credit policy had been loosened; credit terms were relaxed and payment periods were lengthened.

b. Accounts receivable balances had increased dramatically.

c. Several of the company's compensation arrangements, including that of the controller and the company president, were based on reported net income.

Required:

1. What is so ominous about the combination of events Ben sees?

2. What course of acton, if any, should Ben take?

Explanation / Answer

The ominous is that the credit policy relaxation leads to increase in accounts receivable thus decreasing the cash , since the compensation is based on reported net income thus the controller and president are more concerned about increasing the same.

2) Ben should tighten the credit policy which will lead to increase in cash flow , and the compensation arrangements should be revised.

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