“Why can’t we pay our shareholders a dividend?” shouts your new boss at Polar Opposites. “This income statement you prepared for me says we earned $5 million in our first year!” You recently prepared the financial statements below.

           POLAR OPPOSITES
           Income Statement
For the year ended December 31, 2021

                                         ($ in millions)
Net sales ............................................... $65
Cost of goods sold ........................... (35)
Depreciation expense ....................... (4)
Operating expenses ......................... (21)
Net income .......................................... $ 5

POLAR OPPOSITES
Balance Sheet
December 31, 2021

                                                        ($ in millions)
Cash .......................................................................................... $ 1
Accounts receivable (net) ................................................. 16
Merchandise inventory ...................................................... 14
Machinery (net) .................................................................... 44
Total assets .......................................................................... $75
Accounts payable ............................................................... $ 7
Accrued expenses payable ................................................. 9
Notes payable ....................................................................... 29
Common stock ..................................................................... 25
Retained earnings ................................................................. 5
Total liabilities and stockholders’ equity ................... $75

Although net income was $5 million, cash flow from operating activities was a negative $5 million. This just didn’t make any sense to your boss.

Required:

Prepare a memo explaining how net income could be positive and operating cash flows negative. Include in your report a determination of operating cash flows of negative $5 million using the indirect method.