Question

As the accountant for Awesome Foods Incorporated, you are responsible for preparing the cash flow statement. You have decided to prepare the statement using the indirect method and have gathered the following data from the accounting records:

Principal payments on non-current debt     $ 50,000

Collections on accounts receivable         287,500

Increase in accounts payable 25,300

Acquisition of equipment by issuing non-current note payable         70,000

Depreciation expense 71,500

Collection of loan principal      58,000

Proceeds from sale of investments, not including $5,100 gain            49,100

Increase in accounts receivable    7,200

Cash payments to purchase capital assets           62,000

Decrease in accrued liabilities               30,600

Payment of cash dividends         43,500

Income tax expense and payment 39,300

Proceeds from sale of capital assets, not including $7,400 loss            22,600

Net income                    143,100

Cash sales             217,400

Proceeds from issuance of common shares                 300,000

Increase 41,700

Loan to another company                            50,000

Bonds payable converted into common shares                       130,000

Payments to suppliers                               283,100

Decrease in prepaid expenses          12,800

Cash balance: December 31, 2016       62,500

Cash balance: December 31, 2017                462,200

Prepare the cash flow statement for the year ended December 31, 2017, using the indirect method.

Awesome Foods Inc. Statement of Cash Flows For Year Ended December 31, 2017
Cash Flow from Operating Activities:
Cash Flow from Investing Activities:
Cash Flow from Financing Activities:
Net Increase/(Decrease) in Cash:
Cash Balance: January 1, 2016
Cash Balance: December 31, 2017

Your best friend just lost his job because the company he was working for went bankrupt. He was complaining to you that even though the company had been profitable for three years in a row, it still went out of business. He asks you how this can happen.

Explain the most likely reason for the company declaring bankruptcy. Could your best friend have seen it coming? How?

Answer 1

Answer-

AWESOME FOODS INCORPORATED
STATEMENT OF CASH FLOWS (USING INDIRECT METHOD)
FOR THE YEAR ENDED 31 DECEMBER,2017
Particulars		Amount
		$
Cash flow from operating activities
Net Income		143100
Adjustments to reconcile net income to net cash provided by operating activities
Adjustment for non cash effects
Depreciation expense		71500
Loss on sale of equipment		7400
Gain on sale of investments		-5100
Change in operating assets & liabilities
Increase in accounts receivable		-7200
Incresae in inventory		-41700
Decrease in prepaid expenses		12800
Decrease in accrued liabilities		-30600
Increase in accounts payable		25300
Net cash flow from operating activities (a)		175500
Cash Flow from Investing activities
New capital assets purchased		-62000
Old capital assets sold		22600
Proceeds from sale of investments		49100
Net cash Flow from Investing activities (b)		9700
Cash Flow from Financing activities
Cash dividends paid		-43500
Principal payments of non-current debt		-50000
Collection of loan principal		58000
Proceeds from issuance of common shares		300000
Loan to another company		-50000
Net cash Flow from Financing activities (c)		214500
Net Change in cash c=a+b+c		399700
Beginning cash balance		62500
Closing cash balance		462200
Schedule of non cash investing & financing activities
Acquisition of equipment by issuing non-current note payable	$70000
Bonds payable converted into common shares		$130000

The reason for bankruptcy is the cash flows of the firm. A Higher profitable firm need not be solvent if its cash flows are not well managed. For example if it has higher inventory and receivables the cash flows can be lower than the net profit reported. The net income and expense is reported based on the accrual concept in Income statement and hence it ignores the cash flows of the firm. The cash flows of the firm is the key to remain solvent and net profit is not the indicator of solvency

Yes, my best friend could have seen it coming by reading the cash flow statement which is part of the financial statements published. Cash flow statement gives details of movement in cash and cash equivalent during the year. Hence it is made mandatory to be given as part of financial statements. Cash flow statement shows sources of cash and how it is used in the business. It classifies activities into operating, investing and financing.