Katie Murphy Is Preparing For A Meeting With Her Banker

Katie Murphy Is Preparing For A Meeting With Her Banker Her Business

Katie Murphy is preparing for a meeting with her banker. Her business is finishing its fourth year of operations. In the first year, it had negative cash flows from operations. In the second and third years, cash flows from operations were positive. However, inventory costs rose significantly in year 4, and cash flows from operations will probably be down 25%. Murph does not want her banker to see a declining trend in her cash flows, as this might hinder her chances of securing a line of credit. Therefore, she considers taking specific actions to improve her operating cash flows in year 4.

Murphy's goal is to present a more favorable cash flow situation to her banker by demonstrating an upward or stable trend in her business's financial health. To accomplish this, she considers two possible business actions:

1. Accelerating Revenue Recognition: Murphy could expedite the collection of receivables or delay the recognition of expenses not yet incurred. For example, she might offer discounts to customers willing to pay early, boosting incoming cash flows. Additionally, she might delay payments to suppliers or push back certain expenses to the next fiscal period, thereby presenting a higher cash inflow relative to outflows during year 4.
2. Inventory Liquidation or Deferment of Inventory Build-Up: She could sell off excess or slower-moving inventory at a discount, converting inventory into cash more quickly. Alternatively, she might defer new inventory purchases until after the reporting period to prevent the inventory increase from impacting year 4 cash flows.

Ethical Considerations and Potential Consequences of These Actions

While these actions could effectively improve year 4 cash flows temporarily, they raise significant ethical concerns. Accelerating revenue recognition by offering early payment discounts or delaying expenses could be viewed as manipulating financial results. Such practices may mislead the banker by presenting a distorted picture of the company's genuine operational performance, which breaches accounting ethics and transparency principles (Ketz, 2021).

Likewise, liquidating inventory at discounted prices might temporarily inflate cash flows but could harm the company's profitability and reputation if it appears to be a desperation move rather than a sound strategic decision (Healy & Wahlen, 1999). If the banker perceives these actions as manipulative or unsustainable, it could damage trust and credibility, potentially leading to denial of the credit line or increased scrutiny of the company's financial statements.

Furthermore, such moves may have long-term repercussions. For example, delaying expenses could lead to unpaid bills or strained supplier relationships. Selling inventory at discounts might reduce profit margins and devalue the company's products or brand integrity. Engaging in aggressive financial practices to portray a positive cash flow trend could also attract regulatory scrutiny or legal risks if deemed misleading or fraudulent (Laux & Leuz, 2009).

In conclusion, while Murphy's strategies might serve her immediate goal of securing a line of credit, they must be balanced against ethical standards and potential negative consequences. Transparent, sustainable practices—such as improving operational efficiency, increasing sales, or managing inventory prudently—are more likely to foster long-term success and trust with her banker. Ultimately, maintaining integrity and transparency in financial reporting is crucial for sustaining credible business relationships and avoiding legal or reputational damage (Porter et al., 2020).

References

• Healy, P. M., & Wahlen, J. M. (1999). A review of the earnings management literature and its implications for standard setting. Accounting Horizons, 13(4), 365-383.
• Ketz, J. E. (2021). Advanced Financial Accounting. McGraw-Hill Education.
• Laux, C., & Leuz, C. (2009). The crisis of fair value accounting: Making sense of the recent debate. Accounting, Organizations and Society, 34(6-7), 826-834.
• Porter, G., Parker, L., & Oswald, D. (2020). The importance of ethical financial management. Financial Review, 55(2), 341-359.