Question

CA5-5 WRITING (Cash Flow Analysis) The partner in charge of the Kappeler Corporation audit comes by your desk and leaves
a letter he has started to the CEO and a copy of the cash flow statement for the year ended December 31, 2017. Because he must leave
on an emergency, he asks you to finish the letter by explaining: (1) the disparity between net income and cash flow, (2) the importance
of operating cash flow, (3) the renewable source(s) of cash flow, and (4) possible suggestions to improve the cash position.

KAPPELER CORPORATION Statement of Cash Flows For the Year Ended December 31, 2017
Cash flows from operating activities
Net income		$ 100,000
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation expense	$ 10,000
Amortization expense	1,000
Loss on sale of fixed assets	5,000
Increase in accounts receivable (net)	(40,000)
Increase in inventory	(35,000)
Decrease in accounts payable	(41,000)	(100,000)
Net cash provided by operating activities		–0–
Cash flows from investing activities
Sale of plant assets	25,000
Purchase of equipment	(100,000)
Purchase of land	(200,000)
Net cash used by investing activities		(275,000)
Cash flows from financing activities
Payment of dividends	(10,000)
Redemption of bonds	(100,000)
Net cash used by financing activities		(110,000)
Net decrease in cash		(385,000)
Cash balance, January 1, 2017		400,000
Cash balance, December 31, 2017		$  15,000

Date
President Kappeler, CEO
Kappeler Corporation
125 Wall Street
Middleton, Kansas 67458
Dear Mr. Kappeler:
I have good news and bad news about the financial statements for the year ended December 31, 2017. The good news is that net
income of $100,000 is close to what we predicted in the strategic plan last year, indicating strong performance this year. The bad
news is that the cash balance is seriously low. Enclosed is the Statement of Cash Flows, which best illustrates how both of these
situations occurred simultaneously . . .
Instructions
Complete the letter to the CEO, including the four components requested by your boss.

Answer 1

Date
President Kappeler, CEO
Kappeler Corporation
125 Wall Street
Middleton, Kansas 67458
Dear Mr. Kappeler:
I have good news and bad news about the financial statements for the year ended December 31, 2017. The good news is that net
income of $100,000 is close to what we predicted in the strategic plan last year, indicating strong performance this year. The bad
news is that the cash balance is seriously low. Enclosed is the Statement of Cash Flows, which best illustrates how both of these
situations occurred simultaneously . The reason we could achieve the targeted income but failed to generate adequate cash flows is a variety of factors. If you observe the cash flow from operating activities, even though the accounts receivable balance has increased, it hs not brought in cash for the company as the collections have been low. Similary, a lot of the company's cash is stuck in the inventory. Further, the purchase of equipment and land has further diminished the cash flow though this would benefit the company in the long term.As far as the financing activities are concerned, the company has paid dividend and redeemed its debt which has caused a further cash outflow. Owing to these factors, there is a wide gap between the net income and the cash flow.

Operating cash flow is basically the cash flows which the company brings in though its day to day operations. These are extremely important as it keeps the company's liquidity position sound. It is a good measure of the company's profitability and thus there should be a focus on generating a positive cash flow from operating activities.

Financing and investing activities are non recurring actvities. It is the operating activity which is a renewable source of cash flow as the cash which comes in keeps getting reinvested in the business and renews itself periodically.

I would strongly suggest the following measures to improve the company's cash position:

-The amount invested in inventory needs to be reduced to release working capital.

-Reduce the collection time for accounts receivable . The lesser the collection time, the better shall be the cash flow.

- Try to stretch out the account payables. The company needs to manage its funds and thus bills should be paid according to payment terms and not as soon as they arrive.

Yours sincerely,

Partner-in-charge