Question

Vincent Fairfield, CEO of MetroAir, sat at his desk, examining the company's latest financial statements. “This just doesn't make sense to me,” Vincent thought. “We're reporting $1,662,015 in net income, yet our Cash balance decreased by over $350,000. With these results, I would think the Cash balance should go up by at least $1,000,000.”

MetroAir Income Statement For the Year Ended December 31, 2016
Sales	$78,555,000
Cost of goods sold	58,146,480
Gross profit	20,408,520
Selling expense	5,168,505
Administrative expense	3,814,660
Salaries expense	7,408,490
Depreciation expense	1,016,835
Interest expense	625,725
Income before taxes	2,374,305
Tax expense	712,290
Net income	$ 1,662,015

MetroAir Balance Sheets As of December 31
	2016	2015
Cash	$   266,280	$   631,710
Accounts receivable, net	9,355,695	8,751,435
Inventories	9,605,580	8,206,635
Other assets	691,380	359,640
Total current assets	19,918,935	17,949,420
Machinery and equipment, net	8,142,870	9,009,705
Total assets	$28,061,805	$26,959,125
Accounts payable	$ 6,624,030	$ 6,675,210
Accrued expenses	563,371	1,023,738
Salaries payable	615,940	595,380
Interest payable	58,143	55,412
Income taxes payable	63,781	59,860
Short-term debt	2,175,000	1,950,000
Total current liabilities	10,100,265	10,359,600
Long-term debt	4,200,000	4,500,000
Total liabilities	14,300,265	14,859,600
Common stock	3,150,000	3,150,000
Retained earnings	10,611,540	8,949,525
Total stockholders' equity	13,761,540	12,099,525
Total liabilities and stockholders' equity	$28,061,805	$26,959,125

Required

(a)  Prepare MetroAir's statement of cash flows using the direct method. During the year, the company purchased equipment, issued short-term debt, and retired long-term debt.

(b)  Prepare a memo to Vincent explaining why he should not necessarily expect an increase in cash when the company reports net income. Be specific and include any issues that should cause Vincent concern.

Answer 1

Cash flow Statement using Direct Method
Cash Flow from Operating Activities
Cash collected from customers	$    77,950,740.00		Opening Receivables + Sales - Closing receivables
Cash paid to suppliers	$ (59,596,605.00)		-(Opening Accounts Payable + COGS - Closing Accounts Payable + Closing Inventory - Opening Inventory)
Cash paid for Expenses	$    (9,775,272.00)		-(Opening Acrrued Expenses + Selling Expenses + Administrative Expenses - Closing accrued expenses + Closing other assets - Opening other assets)
Cash paid for salaries	$    (7,387,930.00)		-(Opening Salaries Payable + Salaries - Closing payable)
Cash paid for Interest	$       (622,994.00)		-(Opening Interest Payable + Interest - Closing payable)
Cash paid for Income Tax	$       (708,369.00)		-(Opening tax Payable + Income Tax - Closing payable)
Net cash used in operating activities		$ (140,430.00)
Cash flow from Investing activities
Purchase of Equipment	$       (150,000.00)		Opening value - Closing Value - Depreciation
Net cash used in Investing Activities		$ (150,000.00)
Cash flow from Financing Activities
Raised short term debt	$          225,000.00		Closing Value - Opening Value
Repayment of long term debt	$       (300,000.00)		Closing Value - Opening Value
Dividend Paid	$                           -		Opening Retained Earnings + Net Income - Closing Retained Earnings
Net cash used in financing Activities		$    (75,000.00)
Total decrease in cash		$ (365,430.00)
Opening cash		$    631,710.00
Closing Cash		$    266,280.00

2. Net income cant necessarily lead to increase in cash balance as shown above. It can be due to various reasons as mentioned below :
a) Cash may be used for purchasing of machinery, plant etc i.e. investing activities, but in income statement only depreciation is reflected.

b) Cash may be used to repay the debt, pay the dividends etc.

c) There might be more receivables than last year, that sales value is not fully collected in cash.
Less payables than last year, i.e. balance of last years also paid in current year and goes same for expenses as well.

There is not much concern for the company as cash has been decreased for increase in value of assets only.