MINICASE- Cash Flows and Financial Statements at Sunset Boards, Inc.
Sunset Boards is a small company that manufactures and sells surfboards in Malibu. Tad Marks, the
founder of the company, is in charge of the design and sale of the surfboards, but his background is in surfi
ng, not business. As a result, the company’s fi nancial records are not well maintained.
The initial investment in Sunset Boards was provided by Tad and his friends and family. Because the initial
investment was relatively small, and the company has made surfboards only for its own store, the investors
haven’t required detailed fi nancial statements from Tad. But thanks to word of mouth among professional
surfers, sales have picked up recently, and Tad is considering a major expansion. His plans include opening
another surfboard store in Hawaii, as well as supplying his “sticks” (surfer lingo for boards) to other
sellers.
Tad’s expansion plans require a signifi cant investment, which he plans to fi nance with a combination of
additional funds from outsiders plus some money borrowed from banks. Naturally, the new investors and
creditors require more organized and detailed fi nancial statements than Tad has previously prepared. At
the urging of his investors, Tad has hired fi nancial analyst Christina Wolfe to evaluate the performance of
the company over the past year.
After rooting through old bank statements, sales receipts, tax returns, and other records, Christina has
assembled the following information:
Sunset Boards currently pays out 50 percent of net income as dividends to Tad and the other original
investors, and has a 20 percent tax rate. You are Christina’s assistant, and she has asked you to prepare the
following:
1. An income statement for 2008 and 2009.
2. A balance sheet for 2008 and 2009.
3. Operating cash fl ow for each year.
4. Cash flow from assets for 2009.
5. Cash flow to creditors for 2009.
6. Cash flow to stockholders for 2009.
Sol: (1) Income statement — 2008 and 2009
2008 2009
Sales $ 247,259 $ 301,392
Cost of goods sold 126,038 159,143
Selling & administrative 24,787 32,352
Depreciation 35,581 40,217
EBIT $ 60853 $ 69680
Interest expense 7,735 8,866
Taxable Income $ 53118 $ 60814
Tax (20%) 10624 12163
Net Income $ 42494 $ 48651
Dividend (50% of Net Income) 21247 24326
Addition to Retained Earnings 21247 24325
(2) Balance sheet — 2008 and 2009
Assets = Liabilities + Equity
Current assets = Cash + Accounts Receivable + Inventory
Current liabilities = Accounts payable + Notes payable
Assets 2008 2009 Liabilities & Equity 2008 2009
Current Assets Current Liabilities
Cash $ 18187 $ 27478 Accounts Payable $ 32143 $ 36403
Accounts Receivable 12887 16717 Notes Payable 14651 15997
Inventory 27119 37216 $ 46794 $ 52401
$ 58193 $ 81411 Long term debt 79235 91195
Net Fixed Assets 156975 191250 Total Liabilities $ 126,029 $ 143,596
Equity 89139 129065
Total Assets $ 215168 $ 272661 Total Liabilities & Equity $ 215168 $ 272661
Equity breakdown 2009: New equity issued = 15,600 →So retained earnings (end of 2009) = 129,065 − 15,600 = 113,465.
Note: retained earnings rose from 89,139 (2008) → 113,465 (2009) = increase of 24,326, which equals net income less
dividends for 2009
3) Operating cash flow (OCF) for each year
OCF = EBIT + Depreciation − Taxes
2008: OCF = 60,853 + 35,581 − 10,624 = 85,810
2009: OCF = 69,680 + 40,217 − 12,163 = 97,734
4) Cash flow from assets (for 2009)
CFA = OCF − Net capital spending − Changes in NWC
We know, Net capital spending (NCS) = (NFA_end − NFA_begin) + Depreciation
Changes in NWC = (CA_end − CL_end) − (CA_begin − CL_begin)
NCS2009 = (191,250 − 156,975) + 40,217 = 34,275 + 40,217 = 74,492
NWC2008 = 58,193 − 46,794 = 11,399
NWC2009 = 81,411 − 52,401 = 29,010
Changes in NWC = 29,010 − 11,399 = 17,611
Thus CFA2009 = 97,734 − 74,492 − 17,611 = 5,631
(positive $5,631 means the firm generated a small net cash flow from assets in 2009)
5) Cash flow to creditors (for 2009)
Cash flow to creditors = Interest paid − Net new borrowing (long-term debt change)
Long-term debt change = 91,195 − 79,235 = 11,960 (net new borrowing)
Cash flow to creditors = 8,866 − 11,960 = −3,094
(Negative means net cash from creditors — the firm borrowed more from creditors than it paid in interest; net
borrowing exceeded interest payments.)
6) Cash flow to stockholders (for 2009)
Cash flow to stockholders = Dividends paid − Net new equity issued
Dividends (50% payout) = 0.5 × Net income2009 = 0.5 × 48,651 = 24,326
Net new equity issued = 15,600
Cash flow to stockholders = 24,326 − 15,600 = 8,726
(positive = net cash paid to stockholders after accounting for new equity issued)
Page#43 (22)
Consider the following abbreviated financial statements for Parrothead Enterprises:
a. What is owners’ equity for 2008 and 2009?
b. What is the change in net working capital for 2009?
c. In 2009, Parrothead Enterprises purchased $1,350 in new fi xed assets. How much in fixed assets did
Parrothead Enterprises sell? What is the cash fl ow from assets for the year? (The tax rate is 35 percent.)
d. During 2009, Parrothead Enterprises raised $270 in new long-term debt. How much long-term debt must
Parrothead Enterprises have paid off during the year? What is the cash flow to creditors?
Solution:
Parrothead Enterprises
Balance sheet — 2008 and 2009
Assets 2008 2009 Liabilities & Equity 2008 2009
Current Assets $ 653 $ 707 Current Liabilities $ 261 $ 293
Net Fixed Assets 2691 3240 Long term debt 1422 1512
Total Liabilities $ 1683 $ 1805
Equity 1661 2142
Total Assets $ 3344 $ 3947 Total Liabilities & Equity $ 3344 $ 3947
Parrothead Enterprises
Income statement — 2009
2009
Sales $ 8280
Cost of goods sold 3861
Depreciation 738
EBIT $ 3681
Interest expense 211
Taxable Income $ 3470
Tax (35%) 1215
Net Income $ 2255
(a) Owners’ equity — 2008 and 2009
Assets = Liabilities + Equity
Equity = Assets − Liabilities
2008: $3,344 − 1,683 = $1,661
2009: $3,947 − 1,805 = $2,142
(b) Change in net working capital for 2009
Net working capital = Current assets − Current liabilities
NWC(2008) = 653 − 261 = $392
NWC(2009) = 707 − 293 = $414
Change in NWC = 414 − 392 = $22 (increase)
(c) Fixed assets sold in 2009 and cash flow from assets
Part 1 — Net capital spending (NCS) for 2009
NCS = (NFA_end − NFA_begin) + Depreciation= (3,240 − 2,691) + 738 = 549 + 738 = $1,287
They tell us gross purchases = $1,350.
Proceeds from sales = Purchases − NCS = 1,350 − 1,287 = $63
So Parrothead sold fixed assets for $63 (cash inflow from sale).
Part 2 —
Cash flow from assets (CFA) OCF = EBIT + Depreciation − Taxes
CFA = OCF − Net capital spending − Changes in NWC = 3,681 + 738 − 1,215 = $3,204
= 3,204 − 1,287 − 22 Net capital spending= $ 1287 (from part 1)
= $1,895 Change in NWC = $22 (from b)
d) Part 1-
Long-term debt (2008) = $1,422
Long-term debt (2009) = $1,512
Net change = $1,512 − 1,422 = + $90
They raised $270 in new long-term debt during 2009.
If net increase was only $90, the amount paid off (principal repaid) must be: $ 270 - 90 = $180.
So Parrothead paid off $180 of long-term debt in 2009.
Part 2 —
Now cash flow to creditors: CFC= Interest paid- Net new borrowing= $211- 90=$121
Interpretation: the firm paid $211 in interest but borrowed a net $90, so net cash paid to creditors was $121.
14. Jetson Spacecraft Corp. shows the following information on its 2009 income statement: sales $196,000; costs
$104,000; other expenses $6,800; depreciation expense $9,100; interest expense $14,800; taxes $21,455;
dividends $10,400. In addition, you’re told that the fi rm issued $5,700 in new equity during 2009 and redeemed
$7,300 in outstanding long-term debt.
a. What is the 2009 operating cash flow?
b. What is the 2009 cash flow to creditors?
c. What is the 2009 cash flow to stockholders?
d. If net fixed assets increased by $27,000 during the year, what was the addition to NWC?
Sol: Jetson Spacecraft Corp.
2009 Income statement
2009
Sales $ 196,000
Cost of goods sold 104,000
other expenses 6,800
Depreciation expense 9,100
EBIT $ 76,100
Interest expense 14,800
Taxable Income $ 61300
Taxes 21,455
Net Income $ 39,845
Dividend 10,400
Addition to Retained Earnings $ 29445
(a) Operating Cash Flow=EBIT+Depreciation-Taxes= $ 76,100+9,100-21455=$ 63745
(b) Cash Flow to Creditors= Interest paid- Net new borrowing= $ 14800-(-7300)=$ 22100
(c) Cash Flow to Stockholders= Dividends paid- Net new equity raised= $ 10400-5700=$ 4700
(d) We know that, CFA=CFC+CFS=$22100+4700=$26800
Cash Flow from Assets= Operating cash flow-Net capital spending-Change in NWC
Net capital spending= Increase in net fixed assets+Depreciation= $27000+9100=$36100
Cash Flow from Assets= Operating cash flow-Net capital spending-Change in NWC
=> $ 26800= $ 63745-36100- Change in NWC
=> Change in NWC=$ 63745-36100-26800=$ 845
21. Dahlia Industries had the following operating results for 2009: sales $22,800; cost of goods sold $16,050;
depreciation expense $4,050; interest expense $1,830; dividends paid $1,300. At the beginning of the year, net
fixed assets were $13,650, current assets were $4,800, and current liabilities were $2,700. At the end of the year,
net fixed assets were $16,800, current assets were $5,930, and current liabilities were $3,150. The tax rate for 2009
was 34 percent.
a. What is net income for 2009?
b. What is the operating cash flow for 2009?
c. What is the cash flow from assets for 2009? Is this possible? Explain.
d. If no new debt was issued during the year, what is the cash flow to creditors? What is the cash flow to
stockholders? Explain and interpret the positive and negative signs of your answers in (a) through (d).
Sol:(a) Dahlia Industries
2009 Income statement
2009
Sales $ 22,800
Cost of goods sold 16,050
Depreciation expense 4,050
EBIT $2700
Interest expense 1830
Taxable Income $ 870
Taxes (34%) 296
Net Income $ 574
Dividend paid 1300
Addition to Retained Earnings
(b) Operating Cash Flow=EBIT+Depreciation-Taxes= $ 2700+4050-296=$ 6454
(c) Cash Flow from Assets = Operating cash flow-Net capital spending-Change in NWC
= $ 6454- (Ending net fixed assets-Beginning net fixed assets+Depriciation)- ( Ending NWC-Beginning NWC)
= $ 6454-($16800-13650+4050)-{(CA_end-CL_end)-(CA_begin-CL_begin)}
= $6454-7200-{$5930-3150)-(4800-2700)}= $6454-7200-(2780-2100)=$6454-7200-680=-$1426
Note: CFA can be positive or negative, Since it represents whether the firm raised fund or distributed funds on a
net basis. In this problem, Even thogh net income & OCF are positive, the firm invested havily in both fixed
assets & Net Working Capital; It had to raise a net $ 1426 in funds from its stockholders and creditors to make
these investments.
(d) Cash Flow to Creditors= Interest paid- Net new long term debt= $ 1830-0= $1830
We know that, CFA=CFC+CFS
=> CFS= CFA- CFC= -$1426-1830=$ -3256
We also know that, Cash Flow to Stockholders (CFS)= Dividends paid- Net new equity
=>-$3256=$1300-Net new equity
=> Net new equity = $1300+$3256=$ 4556
The firm had positive earnings in an accounting sense
Net income>0 and had positive cash flow from operating. The firm invested $680 in new net WC & $ 7200 in
new fixed assets. The firm had to raise $ 1426 from its stockholders to support these new investment. It
accomplished this by raising $ 4556 in the form of new equity. After paying out $1300 of these in the form of
dividend to stockholders and $ 1830 in the form of interest creditors & $1426 was left to meet the firms cash flow
needs for investment.
* Cash Flow for Mara Corporation based on the following information, prepare an income statement for 2009
and balance sheets for 2008 and 2009. Next, calculate cash flow from assets, cash flow to creditors, and cash flow
to stockholders for Mara for 2009. Use a 35 percent tax rate throughout.
Sol: Mara Corporation
2008 & 2009 balance sheet
Mara Corporation
2009 income statement
2009
Sales $ 4507
Cost of goods sold 2633
Depreciation 952
EBIT $ 922
Interest expense 196
Taxable Income 726
Tax (35%) 254
Net Income $ 472
Dividend 250
Addition to Retained Earnings 222
Cash Flow from Assets= Operating cash flow-Net capital spending-Change in NWC
Operating Cash Flow=EBIT+Depreciation-Taxes= $ 922+952-254=$ 1620
Net capital spending= Ending net fixed assets-Beginning net fixed assets+Depreciation= $7650-7344+952= $ 1258
Change in NWC= Ending NWC-Beginning NWC= (CA_end-CL_end)-(CA_begin-CL_begin)
=($2429-1255)-($2205-1003)= $ 1174-1202=-$28
=>Cash Flow from Assets= $ 1620-1258-(-28)=$ 390
Cash Flow to Creditors= Interest paid- Net new borrowing= $ 196-(2085-3106)=$ 196-(-1021)=$ 1217
Cash Flow to Stockholders= Dividends paid- Net new equity raised= $ 250-1,077= $ 827
Formula
Cash flow from assets= Cash fl ow to creditors (bondholders)+Cash fl ow to stockholders (owners)
Cash flow from assets=Operating cash flow-Net capital spending-Change in net working capital (NWC)
Operating cash flow= Earnings before interest and taxes (EBIT)+Depreciation-Taxes
Net capital spending= Ending net fixed assets-Beginning net fixed assets+Depreciation
Change in NWC=Ending NWC-Beginning NWC=(CA_end-CL_end)-(CA_begin-CL_begin)
Cash flow to creditors= Interest paid- Net new borrowing (Long term debt change)
Cash fl ow to stockholders=Dividends paid-Net new equity raised
NWC=CA-CL
Proceeds from Sales=Purchases-Net capital spending
Increase in net fixed assets= Ending net fixed assets-Beginning net fixed assets