"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, 2012

............................................................($ in millions)

Sales revenue ......................................................$65

Cost of goods sold ...............................................(35)

Depreciation expense .............................................(4)

Operating expenses ..............................................(21)

Net income .........................................................$ 5

POLAR OPPOSITES

Balance Sheet

December 31, 2012

................................................................($ in millions)

Cash...................................................................... $ 1

Accounts receivable (net) ..............................................16

Merchandise inventory .................................................14

Machinery (net) .........................................................44

Total .....................................................................$75

Accounts payable .......................................................$ 7

Accrued expenses payable ...............................................9

Notes payable .............................................................29

Common stock ...........................................................25

Retained earnings .........................................................5

Total .....................................................................$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:

Explain how net income could be positive and operating cash flows negative. Include a determination of operating cash flows of negative $5 million using the indirect method.