"Why can't we pay our shareholders a dividend?" shouted your new boss. "This income statement you prepared for me says we earned $5 million in our first half-year!"
You were hired last month as the chief accountant for Enigma Corporation, which was organized on July 1 of the year just ended. You recently prepared the financial statements below.
ENIGMA CORPORATION
Income Statement
For the Six Months Ended December 31, 2018
($ in millions)
Sales revenue ..........................................$ 75
Cost of goods sold ....................................(30)
Depreciation expense.................................. (5)
Remaining expenses ....................................(35)
Net income................................................ $ 5
ENIGMA CORPORATION
Balance Sheet
December 31, 2018
($ in millions)
Cash.......................................... $ 1
Accounts receivable (net) ..................20
Merchandise inventory..................... 15
Machinery (net) ..............................44
Total ..........................................$80
Accounts payable ...........................$ 2
Accrued expenses payable.................. 7
Notes payable................................. 36
Common stock ................................30
Retained earnings.............................. 5
Total ..........................................$80
You have just explained to your boss, Robert James, that although net income was $5 million, operating activities produced a net decrease in cash. Unable to understand your verbal explanation, he has asked you to prepare a written report.
Required:
Prepare a report explaining the apparent discrepancy between Enigma's profitability and its cash flows. To increase the chances of your boss's understanding the situation, include in your report a determination of net cash flows from operating activities by both the direct and indirect methods. Your report should also include a narrative explanation of how it is possible for operating activities to simultaneously produce a positive net income and negative net cash flows