Question

A comparative balance sheet for Shabbona Corporation is presented below.

Particular	December 31
2017	2016
Assets
Cash	\(73,000	\)22,000
Accounts receivable	82,000	66,000
Inventory	180,000	189,000
Land	71,000	110,000
Equipment	260,000	200,000
Accumulated depreciation – Equipment	(69,000)	(42,000)
Total	\(597,000	\)545,000
Liabilities and stockholder’s equity
Account payable	\(34,000	\)47,000
Bonds payable	150,000	200,000
Common stock (\(1 par)	214,000	164,000
Retained earnings	199,000	134,000
Total	\)597,000	\(545,000

Additional information:

1. Net income for 2017 was \)125,000. No gains or losses were recorded in 2017.

2. Cash dividends of \(60,000 were declared and paid.

3. Bonds payable amounting to \)50,000 were retired through issuance of common stock.

Instructions

(a) Prepare a statement of cash flows for 2017 for Shabbona Corporation.

(b) Determine Shabbona Corporation’s current cash debt coverage, cash debt coverage, and free cash flow. Comment on its liquidity and financial flexibility.

Short answer

Net increase in the cash is equal to$51,000.

Step-by-step solution

Definition of Cash Debt Coverage

Cash debt coverage is the financial metric used to determine the ability of the company to pay off all the liabilities using the cash generated from the general business operations.

Statement of Cash Flow

Particular	Amount $	Amount $
Cash flow from operations:
Net income	$125,000
Add or less: Adjustments to net income
Depreciation expenses	27,000
Increase in accounts receivable	(16,000)
Decrease in inventory	9,000
Decrease in accounts payable	(13,000)
Cash flow from operation		132,000
Cash flow from investing activities:
Sale of land	39,000
Purchase of equipment	(60,000)
Cash flow used in investing activities		(21,000)
Cash flow from financing activities:
Cash Dividend	(60,000)
Cash flow used financing activities		(60,000)
Net increase or decrease in cash		51,000
Add: opening cash balance		22,000
Ending cash balance		$73,000

Cash Flow Ratios and Interpretation

Free cash flow:

Particular	Amount $
Cash flow from operations	$132,000
Less: Cash dividend	(60,000)
Less: Capital expenditure	(60,000)
Free Cash Flow	$12,000

Cash debt coverage:

$\begin{array}{rcl}\mathrm{Cash}\mathrm{Debt}\mathrm{Coverage}& =& \frac{\mathrm{Cash}\mathrm{flow}\mathrm{from}\mathrm{operating}\mathrm{activties}}{\mathrm{Total}\mathrm{liabilities}}\\ & =& \frac{\$132,000}{\$184,000}\\ & =& 0.72\end{array}$

Current cash debt coverage:

$\begin{array}{rcl}\mathrm{Current}\mathrm{Cash}\mathrm{Debt}\mathrm{Coverage}& =& \frac{\mathrm{Cash}\mathrm{flow}\mathrm{from}\mathrm{operating}\mathrm{activities}}{\mathrm{Average}\mathrm{current}\mathrm{liabilities}}\\ & =& \frac{\$132,000}{{\displaystyle \frac{\$47,000+\$34,000}{2}}}\\ & =& 3.26\end{array}$

Liquidity: Current cash debt coverage reflects the business’s liquidity, which is 3.26 times. That means the business entity can cover its current liabilities using the cash generated from operation.

Flexibility: Financial flexibility is reflected by cash debt coverage, and it is 0.72. It means the business entity cannot pay off all liabilities using the cash generated from operations.