Question

Cash flows case: (indirect method).

Messi Company has not yet prepared the statement of cash flows. The Balance sheet as of December 31, 2017 and January 1, 2017 and the additional information regarding the statement of income and retained earnings for the year are presented below.

Messi Company

Comparative Balance Sheet

(Dollars in Millions)

Assets                                                                  12/31/2107                              1/1/2017    

Current Assets:

            Cash                                                                $   98                                     $ 158

            Account Receivables                                      1,290                                      1,160

            Inventory                                                        1,320                                     1,230

Total Current Assets                                                   2,708                                       2,548

Property, Plant, and Equipment                      3,030                           2,932

Less Accumulated Depreciation                     1,530                          1,282

Net Property, Plant, and Equipment                             1,500                                     1,650

Total Assets                                                              $4,208                                 $4,198

Liability and Equity

Current Liability:

            Account payable                                             $500                                         $310

            Accrued Liability                                              380                                           330

            Income tax payable                                            152                                             140

Total current Liability                                                 $1,032                                        $780

Bonds payable                                                                  900                                         1,240

Total Liability                                                               1,932                                         2,020

Stockholders’ Equity:

            Common Stock                                                     322                                            322

            Retained earnings                                               1,954                                          1,856

Total Stockholders’ Equity                                             2,276                                         2,178

Total Liability and Stockholders’ Equity                      $4,208                                      $4,208

Messi Income statement ((Dollars in Millions)

Net Income                                                     $7,200

Cost of goods sold                                          5,100

Gross Margin                                                  2,100

Selling and administrative Expenses              1,750

Net Operating Income                                        350

Nonoperation items:

            Gain on sale of Equipment                        6

Income before Taxes                                             356

Income tax                                                            126

Net Income                                                        $ 230

Messi also provided the following information:

The company sold equipment that had an original cost of $26 million and accumulated depreciation of $16 million. The cash proceeds from the sale were $16 million. The gain on the sale was $6 million

The company did not issue any bonds during the year.

The company paid a cash dividend during the year

The company did not complete any common stock transactions during the year

Required:

Prepare a statement of cash flows for the year using the indirect method

Compute Messi’s free cash flow

Assume that Messi has sales of $7,600, Net income of $230, and net cash provided by operating activities of $300 in the prior year. Prepare a memo that summarizes your interpretations of Messi’s financial performance

Use the analysis of Messi Company to illustrate how information in the balance sheet and the statement of cash flows helps the users of the financial statements.

Answer 1

Messi Company
Statement of Cash Flows
For the year ended December 31, 2017
	$ in Millions	$ in Millions
Cash Flows from Operating Activities
Net Income		230
Adjustments to reconcile net income with net cash flows from operating activities
Depreciation Expense	264
Gain on Sale of Plant	(6)
Increase in accounts receivable	(130)
Increase in inventory	(90)
Increase in accounts payable	190
Increase in accrued liability	50
Increase in Income Tax Payable	12	290
Net Cash Flows from Operating Activities		520
Cash Flows from Investing Activities
Proceeds from Sale of Equipment	16
Cash paid for Purchase of Equipment	(124)
Net cash used in Investing Activities		(108)
Cash Flows from Financing Activities
Cash paid for dividends	(132)
Cash paid to retire bonds payable	(340)
Net cash used in Financing Activities		(472)
Net change in cash during the period		(60)
Beginning cash balance		158
Ending cash balance		98

Free cash flow = $ 520 million - $ 108 million = $ 412 million.

The net margin for the current year has improved from 3.03 % ( $ 230 / $ 7,600) in the prior year to 3.19 % ( $230 / $ 7,200) in the current year. Therefore though sales have decreased year on year, the profitability of the company has improved.

Net cash flows from operations for the current year is $ 520 million, as compared to $ 300 million in the prior year, which augurs well for the company. It indicates better working capital management in the current year, leading to more sound liquidity position for the company. As a result, the company could embark on major asset acquisition without resorting to borrowings. Moreover, it has retired long term debt during the current year, thereby increasing its financial flexibility.

Most notable is the fact that net income was only $ 230 million, while operating cash flows were more than double at $ 520 millions.

In spite of a decreased cash balance, the company has acheived balance sheet growth from $ 4,198 million to $ 4,208 million.