ProblemHarish Company Formed On January 1, 20x1
Problemharish Company Was Formed On January 1 20x1 The Companys Ac
Harish Company was formed on January 1, 20X1. The company's accountant prepared the following income statement, statement of retained earnings, and balance sheet at the conclusion of the first full year of operations. Mr. Harish desires for the company to declare and pay a dividend equivalent to the company's net income for the year.
Income Statement for the Year Ending December 31, 20X1
- Revenues: Services to customers $70,000
- Expenses: Wages $30,000, Rent $12,000
- Net income: $28,000
Statement of Retained Earnings for the Year Ending December 31, 20X1
- Beginning retained earnings: $0
- Plus: Net income: $28,000
- Less: Dividends: $28,000
- Ending retained earnings: $0
Balance Sheet as of December 31, 20X1
| Assets | Amount |
|---|---|
| Cash | $4,000 |
| Accounts receivable | $15,000 |
| Equipment | $50,000 |
| Total assets | $69,000 |
| Liabilities | Amount |
|---|---|
| Rent payable | $1,000 |
| Notes payable | $30,000 |
| Total liabilities | $31,000 |
| Stockholders' equity | Amount |
|---|---|
| Capital stock | $10,000 |
| Retained earnings | $28,000 |
| Total stockholders' equity | $38,000 |
Based on this information, answer the following questions:
- Is the company currently able to declare and pay the dividend? Why or why not?
- Explain why net income can differ from cash provided by operations.
- In addition to operating activities, what other "categories" of business activity can generate or expend cash? Provide examples for each category.
- Prepare a statement of cash flows for Harish Company for the year ending December 31, 20X1.
Paper For Above instruction
The financial health and operational performance of a company are critically assessed through its financial statements and cash flow analysis. Harish Company, established on January 1, 20X1, has presented its initial financial statements, setting a foundation for evaluating its liquidity, profitability, and cash management. This comprehensive analysis addresses whether the company can declare dividends, the divergence between net income and cash flows, the different categories of cash activities, and a step-by-step preparation of its cash flow statement for the first year.
Assessment of Dividend Declaration Capability
Harish Company's ability to declare and pay dividends hinges heavily on its available cash and retained earnings. According to the balance sheet, the company ended its first year with $4,000 in cash and total assets of $69,000, with liabilities totaling $31,000 and stockholders' equity at $38,000.
Importantly, the accumulated retained earnings are $28,000, indicating that the company generated a net income of the same amount during its first year. However, the company’s cash reserves ($4,000) are a critical factor in determining dividend payment capability. Since dividends are typically paid from retained earnings and cash, here, the company has a sufficient amount of $4,000 in cash to potentially pay dividends. Furthermore, the net income of $28,000 signifies that the overall retained earnings are positive, strengthening the argument that the company is financially positioned to distribute dividends, assuming no other significant liabilities or cash flow constraints.
Nevertheless, the decision to declare dividends should consider cash flow specifics, not just net income. Because net income includes non-cash items like depreciation, and other operational cash flow realities, a mere examination of net income may not fully reflect cash availability. Given the company's positive net income, and available cash, it appears capable of declaring dividends, but detailed cash flow analysis is required to confirm liquidity sufficiency.
Net Income vs. Cash Provided by Operations
Net income, calculated on an accrual basis, differs from cash provided by operations due to timing differences and non-cash expenses. Accrual accounting recognizes revenues when earned and expenses when incurred, regardless of actual cash receipt or disbursement. As a result, net income includes income that may not have yet been received in cash and expenses that may not involve cash payments during the period.
For instance, accounts receivable increase causes revenue recognition without immediate cash inflow, and accrued expenses or depreciation expenses reduce net income without cash outflows. Similarly, cash might be received before earning the revenue (accounts receivable decreases) or expenses paid in advance (prepaid expenses), leading to discrepancies between net income and actual cash flows from operating activities. These timing differences explain why a profitable company might have limited or negative cash flow from operations.
Categories of Business Activities that Generate or Expend Cash
Beyond operating activities, business cash flows are also influenced by investing and financing activities. These categories reflect the core transactions affecting company assets and capital structure.
- Investing activities: These involve the acquisition or disposal of long-term assets and investments. Examples include purchasing equipment, selling property, or acquiring securities.
- Financing activities: These involve transactions with the company's owners or creditors. Examples include issuing stock, borrowing funds, or repaying debt and paying dividends.
For example, purchasing equipment is an investing cash outflow, while issuing new stock or borrowing money results in inflows in financing. Conversely, repaying loans or paying dividends are cash outflows from financing activities. These categories are essential for understanding changes in the company's capital and investment strategies over time.
Preparation of the Statement of Cash Flows
Constructing the statement of cash flows involves analyzing changes in balance sheet accounts and income statement data to classify cash movements into operating, investing, and financing activities.
For Harish Company, initial step entails determining cash received from customers and cash paid for expenses, then adjusting for non-cash items and changes in working capital. Given the data, the following assumptions and calculations are necessary:
- Cash received from customers: Since accounts receivable increased from $0 to $15,000, cash collected is net of this change. In the absence of prior data, an approximation is that cash collected equals revenue minus receivables increase, i.e., $70,000 minus $15,000 equals $55,000.
- Cash paid for wages and rent: Known expense amounts ($30,000 wages and $12,000 rent) suggest cash disbursements; assuming all expenses are paid in cash, total cash outflows are $42,000.
- Investing activities: The equipment worth $50,000 was acquired; thus, cash outflow is $50,000.
- Financing activities: Changes in notes payable or stock issued are needed; assuming the company issued no new stock or took additional loans besides what is known, net changes in liabilities and stock are minimal.
Precise calculations could vary based on further data but, for this illustration, these assumptions guide the cash flow statement preparation.
The resulting cash flows from operating, investing, and financing activities culminate in the net increase or decrease of cash over the period, aligning with the change from $0 to $4,000 in cash balance, as per the balance sheet.
Conclusion
Harish Company's first-year financial statements indicate a profitable and solvent startup capable of distributing dividends, provided cash flow supports such payments. The divergence between net income and cash flow underscores the importance of cash flow analysis in assessing liquidity. Operational, investing, and financing activities collectively shape the company's cash position and strategic growth. Constructing an accurate statement of cash flows offers vital insights into the firm's cash management and overall financial health, guiding stakeholders' decisions.
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