Question

Cash Flow and Financial Statements at Sunset Boards, Inc.

Sunset Boards is a small company that manufactures and sells surfboards in Malibu. Tad Marks, the founder of the company, is in charge of the design and sale of the surfboards, but his background is in surfing, not business. As a result, the company's financial records are not well maintained.

The initial investment in Sunset Boards was provided by Tad and his friends and family. Because the initial investment was relatively small, and the company has made surf-boards only for its own store, the investors haven't required detailed financial statements from Tad. But thanks to word of mouth among professional surfers, sales have picked up recently, and Tad is considering a major expansion. His plans include opening another surfboard store in Hawaii, as well as supplying his "sticks" (surfer lingo for boards) to other sellers.

Tad's expansion plans require a significant investment, which he plans to finance with a combination of additional funds from outsiders plus some money borrowed from banks. Naturally, the new investors and creditors require more organized and detailed financial statements than Tad has previously prepared. At the urging of his investors, Tad has hired financial analyst Christina Wolfe to evaluate the performance of the company over the past year.

After rooting through old bank returns, and other records, Christina has assembled the following information:

Sunset Boards currently pays out 40 percent of net income as dividends to Tad and the other original investors, and it has a 30 percent tax rate. You are Christina's assistant, and she has asked you to prepare the following:

1. An income statement for 2014 and 2015.

2. A balance sheet for 2014 and 2015.

3. Operating cash flow for each year.

4. Cash flow from assets for 2015.

5. Cash flow to creditors for 2015.

6. Cash flow to stockholders for 2015.

QUESTIONS

In light of your discussion in the previous question, what do you think about Tad's expansion plans?

Answer 1

Income Statement:

This is the financial statement of a company which shows all the revenues earned and expenses incurred by the company over a period of time. Income statement is prepared to find out the operational performance of the company.

Balance Sheet:

Balance sheet is the synopsis of the financial position of the company on a particular date, and it is a method of organizing and summarizing the organizations’ assets, liabilities and owners equity (what is due to the owners) of the firm on a particular date.

The following formula is used to calculate the operating cash flow of the company:

Cash flow to the creditors:

Cash flow to creditors denotes the net payments made to the lenders or suppliers. The excess amount of interest paid over the net new borrowings during a particular period is referred to as cash flow to the creditors.

The following formula is used to calculate the cash flow to creditors:

Cash flow to the stockholders:

Cash flow to stockholders denotes the net payments made to the owners for a particular period of time. The excess amount of dividend paid over the net new equity raised is referred to as cash flow to the stockholder

The following formula is used to calculate the cash flow to stockholders:

Prepare the following Statements:

1. Prepare an income statement for S Incorporation for the year 2014 and 2015 as follows:

Calculate the amount of additions to retained earnings for S Incorporation for the year 2014 and 2015 as follows:

For the year 2014:

For the year 2015:

2. Prepare balance sheet for S Incorporation for the year 2014 and 2015 as follows:

For the year 2014:

Working note:

Calculate owners’ equity for S Incorporation for the year 2014 as follows:

For the year 2015:

Working note:

Calculate owners’ equity for S Incorporation for the year 2015 as follows:

3. Calculate operating cash flow for S Incorporation for the year 2014 and 2015 as follows:

For the year 2014:

Hence, the operating cash flow for S Incorporation for the year 2014 is .

For the year 2015:

Hence, the operating cash flow for S Incorporation for the year 2015 is .

4. Calculate cash flow from assets for S Incorporation for the year 2015 as follows:

Calculate net capital spending as follows:

Calculate the amount of changes in net working capital as follows:

Calculate cash flow from assets as follows:

Hence, the cash flow from assets for S Incorporation for the year 2015 is .

5. Calculate cash flow to creditors for S Incorporation for the year 2015 as follows:

Hence, the cash flow to creditors for S Incorporation for the year 2015 is .

6. Calculate cash flow to stockholders for S Incorporation for the year 2015 as follows:

Hence, the cash flow to stockholders for S Incorporation for the year 2015 is .

Brief discussion:

The expansion plan for the business may not be safe as the company earns enough profits to run the business successfully, however huge amount of operating cash flows is used in capital spending for existing business.

If company wants to enter in the new project, then it needs to raise more funds from the external financing sources like creditors, banks, or new stockholders. But, it is would so aggressive strategy for the company.

So, it is not advisable to the company to take up a new project in the present scenarios. And company might need additional investments for its growth and sustainability before investing in the expansion plan.

The company should identify the scope of current capital spending and it needs to gather the reasons for such a huge investment in current business.