Question

The partner in charge of the Kappeler Corporation audit comes by your desk and leaves a letter he has started to the CEO and a copy of the cash flow statement for the year ended December 31, 2017. Because he must leave on an emergency, he asks you to finish the letter by explaining: (1) the disparity between net income and cash flow, (2) the importance of operating cash flow, (3) the renewable source(s) of cash flow, and (4) possible suggestions to improve the cash position.

Date

President Kappeler, CEO

Kappeler Corporation

125 Wall Street

Middleton, Kansas 67458

Dear Mr. Kappeler:

I have good news and bad news about the financial statements for the year ended December 31, 2017. The good news is that net income of $100,000 is close to what we predicted in the strategic plan last year, indicating strong performance this year. The bad news is that the cash balance is seriously low. Enclosed is the Statement of Cash Flows, which best illustrates how both of these situations occurred simultaneously . . .

Instructions

Complete the letter to the CEO, including the four components requested by your boss.

Short answer

Date

President Kappeler, CEO

Kappeler Corporation

125 Wall Street

Middleton, Kansas 67458

Dear Mr Kappeler:

I have good news and bad news about the financial statements for the year ended December 31, 2017. The good news is that net income of $100,000 is close to what we predicted last year's strategic plan, indicating strong performance this year. The bad news is that the cash balance is seriously low. Enclosed is the Statement of Cash Flows, which best illustrates how these situations occurred simultaneously.

• There exists a difference between the net income and cash flow because of the accrual concept of accounting.
• Operating cash determines the financial performance of the business entity, and it is considered a renewable source of cash flow.
• Cash recovery must be fastened, and cash payment must be slowed down.

Regards,

Step-by-step solution

Definition of Cash from Operations

Any cash generated by the business entity from daily activities or recurring activities is known as cash from the operation.

The Disparity in Net Income and Cash Flow

There is a difference between the amount reported as cash flow and the amount of net income because the net income is calculated using the accrual accounting that includes all income and expenses incurred or earned even if the payment and receipts are due. While under cash flow, only those income and expenses are recorded, including cash payment and receipts.

The Importance of Operating Cash Flow

Operating cash flow proves to be important because the financial success of the business entity can be determined using the operating cash flow. Operating cash flow provides information regarding the cash generated through the normal course of business.

The Renewable Sources of Cash Flow

Renewable sources of the cash flow include the sources of cash flow that provide recurring cash flow. It includes all operating activities because these activities are recurring in nature. At the same time, the activities such as financing and investing activities that do not occur frequently are not included in the renewable sources.

Suggestions to Improve Cash Flow

Following are some suggestions to improve the cash flow of the business entity:

1. Recovery of payment from receivables must be quicker.

2. The business entity must take more time to make accounts payable payments.

3. Purchase of fixed assets must be reduced, and repayment of bonds must be made partially.