Question

Fred Gowen opened Gowen Retail Sales as a sole proprietorship and recorded the following transactions during his first month in business:

1. Purchased $50,000 of fixed assets, putting 15% down and borrowing the remainder.

2. Sold 1,000 units of product at an average price of $45 each. Half of the sales were on credit, none of which had been collected as of the end of the month.

3. Recorded cost of goods sold of $21,000 related to the above sales.

4. Purchased $35,000 worth of inventory and paid cash.

5. Incurred other expenses (including the interest from the loan) of $5,000, all of which were paid in cash.

6. Fred's tax rate is 32%. (Taxes will be paid in a subsequent period.)

A.) What will the business report as net income for its first month of business? (Hint: Write out an income statement and enter revenue, cost, and expense. Then calculate tax and net income.) $_________

B.) List the flows of cash in and out of the business during the month. Show inflows as positives and outflows as negatives (using sign "-"). Sum to arrive at a "Net Cash Flow" figure.

Cash Flows
Purchase of Assets	$
Proceeds from Loan	$
Cash from Sales	$
Purchase of Inventory	$
Other Expenses	$
Net Cash Flow	$

1. Should Fred pay more attention to net income or cash flow?
   

Answer 1

A) Income Statement

Particulars Amount Working Sales Cost of goods sold Gross margin Other expense 45000 (1000*45) 21000 24000 (Sales-COGS) 5000 19000 Tax Earnings after tax 6080(19000*32%) 12920 (EBT-taxes

Net income is $12,920

B) List the flows of cash in and out of the business during the month

c) Should Fred pay more attention to net income or cash flow?

Net income and net cash flow are 2 different measure of a firm's profitability, while Net income is more used to gauge the long term profitability, cash flow is used to measure the short term profitability.

Fred has to pay attention to both net income and cash flow.

It is the first month of Fred's business so it's expected that cash flows will be negative but it is also a good thing that net income is positive, it implies that Fred can at least from the current perspective, can continue his business in the long run. Cash flows will automatically generate in future months as one-time expenses will not incur again.