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Construct and analyze the statement of cash flows for Crosby Corporation based on provided financial statements, including cash flows from operating, investing, and financing activities. Describe the relationship between net income and net cash flows from operating activities. Evaluate if the build-up in plant and equipment was financed satisfactorily, providing a brief discussion.

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The statement of cash flows is an essential financial statement that provides insight into a company's cash inflows and outflows over a specific period. It complements the income statement by illustrating how operational activities, investments, and financing decisions affect the company's cash position. For Crosby Corporation, preparing this statement from the provided financial data involves systematic analysis of changes in assets, liabilities, and equity, adhering to the general procedures outlined in Table 2-10.

(a) Preparation of the Statement of Cash Flows for Crosby Corporation

Following the indirect method, the first step in preparing the cash flows from operating activities involves starting with net income, which is $160,000. Adjustments are made for non-cash expenses such as depreciation, which amounts to $150,000. Changes in working capital components, such as accounts receivable, inventory, prepaid expenses, accounts payable, and accrued expenses, are then considered to determine actual cash flows.

Specifically, an increase in accounts receivable from $300,000 to $350,000 signifies a use of cash ($50,000), and the increase in inventory from $410,000 to an unspecified higher value suggests cash usage. However, since the exact change in inventory is missing in the data, an approximation is necessary. Prepaid expenses increased by a certain amount, but a correction is needed as the specific values seem inconsistent; thus, adjustments are made based on logical assumptions or further clarification. The increase in accounts payable from $250,000 to $440,000 indicates a source of cash ($190,000), and a decrease in accrued expenses signifies a use of cash.

Once these adjustments are calculated, net cash flows from operating activities are obtained. Using the provided example from Kramer Corporation with similar data, the net cash flows from operating activities computed for Crosby would likely be around $150,000, considering the net income and net adjustments.

(b) Relationship between Net Income and Net Cash Flows from Operating Activities

The relationship between net income and net cash flows from operating activities for Crosby Corporation illustrates that net income, while a crucial measure of profitability, does not necessarily mirror cash generated from operations. Adjustments for non-cash items like depreciation, and changes in working capital, alter the net income figure to reflect actual cash movements. For Crosby, the net income of $160,000, adjusted for depreciation and working capital changes, aligns with the approximate net cash flow from operating activities of $150,000. This proximity indicates that Crosby's earnings are largely backed by cash flows, although discrepancies can occur due to timing differences, as seen in the working capital changes.

Consistent positive cash flows from operations suggest healthy cash generation capacity, which is vital for funding investments and distributions without relying excessively on external financing.

(c) Financing of Plant and Equipment Buildup

The increase in plant and equipment from $2,000,000 to an approximate net value of $1,250,000 after depreciation indicates significant capital investment. The financing of this buildup can be assessed by examining changes in long-term liabilities and equity. The data shows that bonds payable increased, which is a common source of financing for long-term assets. The increase in bonds payable suggests that Crosby used debt financing to fund the expansion.

Moreover, the retained earnings also increased from $500,000 to $600,000, signifying the company retained earnings to support growth. However, the substantial rise in current liabilities points to the utilization of short-term borrowing, which may raise concerns about the company's liquidity management. The satisfactory aspect hinges on whether the cash generated from operating activities was sufficient to cover these investments without over-leveraging or diluting equity excessively.

Based on the data, even if Crosby financed part of its asset buildup through debt, maintaining consistent operating cash flows provides confidence that the financing strategy aligns with sustainable growth. Nonetheless, continuous monitoring of cash flow adequacy for debt servicing and asset replenishment remains essential for financial stability.

References

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