Shah Fabrics, Inc.’s comparative balance sheets for December 31, 2014 and 2013, follow — Additional information about operations during follows net income 112 000 building

Shah Fabrics, Inc.’s comparative balance sheets for December 31, 2014 and 2013, follow.

.:.

Additional information about Shah Fabrics’ operations during 2014 is as follows: (a) net income, $112,000; (b) building and equipment depreciation expense amounts, $60,000 and $12,000, respectively; (c) equipment that cost $54,000 with accumulated depreciation of $50,000 sold at a gain of $21,200; (d) equipment purchases, $50,000; (e) patent amortization, $12,000; purchase of patent, $4,000; (f) funds borrowed by issuing notes payable, $100,000; notes payable repaid, $60,000; (g) land and building purchased for $648,000 by signing a mortgage for the total cost; (h) 6,000 shares of $40 par value common stock issued for a total of $200,000; and (i) paid cash dividend, $36,000.

Required

1. Using the indirect method, prepare a statement of cash flows for Shah Fabrics.

2. Why did Shah Fabrics have an increase in cash of $268,800 when it recorded net income of only $112,000? Discuss and interpret.

🔒

Unlock the complete assignment

You are viewing the free preview. Purchase this assignment once to reveal the complete resource.

$9.99 USD

Secure checkout is completed by Stripe.

3. Compute and assess cash flow yield and free cash flow for 2014. (Round to one decimal place.) What is your assessment of Shah Fabrics’ cash-generating ability?

SOLUTION:

			Shah Fabrics, Inc.	Shah Fabrics, Inc.
			Statement of Cash Flows	Statement of Cash Flows
			For the Year Ended December 31, 2014	For the Year Ended December 31, 2014	For the Year Ended December 31, 2014
Cash flows from operating activities:	Cash flows from operating activities:	Cash flows from operating activities:	Cash flows from operating activities:
	Net income	Net income	Net income					$	$	$	112,000
	Adjustments to reconcile net income to net	Adjustments to reconcile net income to net	Adjustments to reconcile net income to net
	cash flows from operating activities:	cash flows from operating activities:	cash flows from operating activities:
		Depreciation, building	Depreciation, building		$	60,000
		Depreciation, equipment	Depreciation, equipment			12,000
		Amortization, patent	Amortization, patent			12,000
		Gain on sale of equipment	Gain on sale of equipment			(21,200)	(21,200)
		Changes in current assets and current liabilities:	Changes in current assets and current liabilities:
			Increase in accounts receivable		(108,000)	(108,000)	(108,000)
			Decrease in inventory			100,000
			Decrease in prepaid expenses			80,000
			Decrease in accounts payable		(104,000)	(104,000)	(104,000)
			Decrease in accrued liabilities			(49,200)	(49,200)				(18,400)	(18,400)
Net cash flows from operating activities	Net cash flows from operating activities	Net cash flows from operating activities	Net cash flows from operating activities					$	$	$	93,600
Cash flows from investing activities:	Cash flows from investing activities:	Cash flows from investing activities:	Cash flows from investing activities:
	Purchase of equipment	Purchase of equipment	Purchase of equipment		$	(50,000)	(50,000)
	Sale of equipment	Sale of equipment	Sale of equipment			25,200
	Purchase of patent	Purchase of patent	Purchase of patent			(4,000)	(4,000)
Net cash flows from investing activities	Net cash flows from investing activities	Net cash flows from investing activities	Net cash flows from investing activities								(28,800)	(28,800)
Cash flows from financing activities:	Cash flows from financing activities:	Cash flows from financing activities:	Cash flows from financing activities:
	Issue of notes payable	Issue of notes payable	Issue of notes payable		$	100,000
	Repayment of notes payable	Repayment of notes payable	Repayment of notes payable			(60,000)	(60,000)
	Issue of common stock	Issue of common stock	Issue of common stock			200,000
	Payment of dividends	Payment of dividends	Payment of dividends			(36,000)	(36,000)
Net cash flows from financing activities	Net cash flows from financing activities	Net cash flows from financing activities	Net cash flows from financing activities								204,000
Net increase (decrease) in cash	Net increase (decrease) in cash	Net increase (decrease) in cash	Net increase (decrease) in cash					$	$	$	268,800
Cash at beginning of year	Cash at beginning of year	Cash at beginning of year	Cash at beginning of year								109,440
Cash at end of year	Cash at end of year	Cash at end of year	Cash at end of year					$	$	$	378,240
			Schedule of Noncash Investing and Financing Transactions	Schedule of Noncash Investing and Financing Transactions	Schedule of Noncash Investing and Financing Transactions	Schedule of Noncash Investing and Financing Transactions	Schedule of Noncash Investing and Financing Transactions	Schedule of Noncash Investing and Financing Transactions	Schedule of Noncash Investing and Financing Transactions	Schedule of Noncash Investing and Financing Transactions
Issue of mortgage for land	Issue of mortgage for land	Issue of mortgage for land	Issue of mortgage for land	Issue of mortgage for land				$	$	$	100,000
Issue of mortgage for building	Issue of mortgage for building	Issue of mortgage for building	Issue of mortgage for building	Issue of mortgage for building							548,000
								$	$	$	648,000

Although net income of $112,000 generated only $93,600 of cash flows from operating activities, and $28,800 was used by investing activities, Shah Fabrics managed to in-crease cash by $268,800. Net cash flows (or increases) from financing activities were $204,000. Shah Fabrics has increased its cash balance through these financing activities by borrowing from the bank and issuing common stock. Its investing activities were relatively small. Next year's statement of cash flows will reveal what management did with the cash.

Cash Flow Yield	=	Net Cash Flows from Operating Activities	Net Cash Flows from Operating Activities	Net Cash Flows from Operating Activities	Net Cash Flows from Operating Activities	Net Cash Flows from Operating Activities	Net Cash Flows from Operating Activities	Net Cash Flows from Operating Activities
Cash Flow Yield	=
Cash Flow Yield	=			Net Income	Net Income	Net Income	Net Income	Net Income
				Net Income	Net Income	Net Income	Net Income	Net Income
	=	$93,600	=	0.8	times*	times*	times*	times*	times*	times*	times*
	=		=	0.8	times*	times*	times*	times*	times*	times*	times*
	=	$112,000	=	0.8	times*	times*	times*	times*	times*	times*	times*
		$112,000
Free Cash Flow	=	Net Cash Flows from Operating Activities ‒ Dividends ‒	Net Cash Flows from Operating Activities ‒ Dividends ‒	Net Cash Flows from Operating Activities ‒ Dividends ‒	Net Cash Flows from Operating Activities ‒ Dividends ‒	Net Cash Flows from Operating Activities ‒ Dividends ‒	Net Cash Flows from Operating Activities ‒ Dividends ‒	Net Cash Flows from Operating Activities ‒ Dividends ‒	Net Cash Flows from Operating Activities ‒ Dividends ‒	Net Cash Flows from Operating Activities ‒ Dividends ‒
		Purchases of Plant Assets + Sales of Plant Assets	Purchases of Plant Assets + Sales of Plant Assets	Purchases of Plant Assets + Sales of Plant Assets	Purchases of Plant Assets + Sales of Plant Assets	Purchases of Plant Assets + Sales of Plant Assets	Purchases of Plant Assets + Sales of Plant Assets	Purchases of Plant Assets + Sales of Plant Assets	Purchases of Plant Assets + Sales of Plant Assets	Purchases of Plant Assets + Sales of Plant Assets	Purchases of Plant Assets + Sales of Plant Assets
	=	$93,600	‒	$36,000	$36,000	‒	$50,000	+	$25,200
	=	$32,800

Shah Fabrics does not generate sufficient cash from operating activities; nor does it have strong free cash flow. Most companies should have net cash flows from operating activities that exceed net income. Also, if free cash flow is low, growth must be financed by borrowing or issuing stock. As was seen in requirement 2, the company has raised cash through debt and stock issuance, which may enable the company to invest and improve its performance.