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.
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

1. Disparity between Net Income & Cash Flow

• Principle Difference: Net Income is calculated on the basis of Accrual Concept. Cash flows are calculated based on Cash system.
• Net Income is calculated by deducting expenses from the revenue, irrespective of their cash collection status
• Cash flows are calculated based on reciept and payment status, working capital changes, capital expenditure paid, sale of assets, funds raised, debts paid etc.
• In the current sceanrio, though the Company has achieved its net income of $100,000 the cash flows are low possibly due to following reasons:
  • Receivables piled up (affects Cash Flow from Operating activities)
  • Accelerated Payments to Suppliers (affects Cash Flow from Operating activities)
  • Excess Inventory (affects Cash Flow from Operating activities)
  • Huge Capex incurred (affects Cash Flow from Investing activities)
  • Repayment of debt (affects Cash Flow from Financing activities)

2. the importance of operating cash flow

Operating cash flow is the financial health barometer of the company. It is an important for creditors to understand the payment capacity of the business and for potential investors assessing the investment potential of the company. Operating Cash flow is a better tool to judge the company's financial health than Net Income. Operating Cash flow is harder to manipulate as compared to Net Income. Cash is king and if the company is not generating enough cash flows from its operations, their days are numbered.

3.  the renewable source(s) of cash flow

The Company's renewable source of cash flow is the cash generated from its operations. The other two sources being investing and financing activity are non recurring. It is the operations that keep on generating cash every year and replenish the company cash levels. Because of their continuos nature they are also referred as Sustainable cash flows

4. Suggestions to improve cash flows

• Budgeting the expenses and keeping a check on the same on regular basis
• Review of inventory cycle and accordingly strengthening the procurement procedure, production schedule
• Review of credit policy for customers and strengthening the collection team and procedure
• Negotiating better terms with Suppliers and creditors etc
• Appropriate planning to incur capex
• Proper systematic and cheapest route to raise funds in case of fund requirement
• Robust treasury policy to invest surplus cash (if any)