Question

(Cash Flow Reporting)

Brockman Guitar Company is in the business of manufacturing top-quality, steel-string folk guitars. In recent years, the company has experienced working capital problems resulting from the procurement of factory equipment, the unanticipated buildup of receivables and inventories, and the payoff of a balloon mortgage on a new manufacturing facility. The founder and president of the company, Barbara Brockman, has attempted to raise cash from various financial institutions, but to no avail because of the company's poor performance in recent years. In particular, the company's lead bank, First Financial, is especially concerned about Brockman's inability to maintain a positive cash position. The commercial loan officer from First Financial told Barbara, “I can't even consider your request for capital financing unless I see that your company is able to generate positive cash flows from operations.”

Thinking about the banker's comment, Barbara came up with what she believes is a good plan: With a more attractive statement of cash flows, the bank might be willing to provide long-term financing. To “window dress” cash flows, the company can sell its accounts receivables to factors and liquidate its raw materials inventories. These rather costly transactions would generate lots of cash. As the chief accountant for Brockman Guitar, it is your job to tell Barbara what you think of her plan.

Instructions

Answer the following questions.

(a)	What are the ethical issues related to Barbara Brockman's idea?

(b)	What would you tell Barbara Brockman?

Answer 1

a) the Window dressing is an action taken in order to strengthen financial position of the company. Selling the accounts receivables to factors & liquidating the raw materials inventory can generate cash flows for the company in the short term to generate enough cash flow from operations in order to raise more cash from various the financial institutions. Ethical implication is the showcase of misleading financial statements that can negatively affect the stakeholders (Financial institutions in this case). Also, it is an un-professional behaviour to perform such actions.

(b) Suggestions to Barbara Brockman:

1. Such idea is unethical and it will only be a short-term solution for cash problems that the the business is facing.

2. Taking advantage by " window dressing " and getting finance can lead to prolems in future when they won't be able to generate enough cash to repay debts.

3. Financial startements won't give a true and fair view of the organisation's postition and the auditor can report such misleading statements in the audit report.

4. This will have huge dent on the credibility and goodwill of the business.

5.the Better idea would be to solve issues, say reducing account receivables by giving instant cash discounts to customers or reducing the credit period, finding out ways to reduce bad debts,etc. These solutions will be helpful in the long-run and the business will be able to generate more cash for a longer duration.