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, 2010.
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.

Kappeler Corporation
Statement of Cash Flows
For the Year Ended December 31, 21010

Cash flows from operating activities

Net income 100,000
Adjustments to reconcile net income to net cash
provided by
operating activities:
Depreciation expense 10,000
Amortization expense 1,000
Loss on Sale of fixed assets 5,000
Increase in accounts receivable (net) (40,000)
Increase in inventory (35,000)
Decrease in accounts payable (41,000) (100,000)
-
Net cash provided by operating activities
Cash flows from investing activities
Sales of plant assets 25,000
Purchase of equipment (100,000)
Purchase of Land (200,000)
(275,000)
Net cash used by investing activities
Cash flows from financing activities
Payment of dividends (10,000)
Redemption of bonds (100,000)

Net Cash used by financing activities (110,000)

Net decrease in cash (385,000)

Cash balance, January 1, 2010 400,000
Cash balance, December 31, 2010 15,000

Instructions:
Complete the letter to the CEO, including the four components requested by your boss.
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, 2010. The good news is that the 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. Net cash from operating activities equals
our net income which means that that the operating activities did not bring enough cash into
the business. The net income is the balance between our revenues earned minus the expenses
incurred in order to earn those revenues. Our accounts receivable, even though they represent
revenue for the company, does not increase our cash flow until the payments have been
received, therefore even though our accounts receivable increased our net income, it does not
increase our cash flow.

The cash flow is the cash our company generates through the operations of our business.
Because operating cash flow adjusts for liabilities, depreciation, and receivables, it is viewed as
a more accurate measure of how much cash a company generates than more traditional
measures of profitability, such as net income. Through normal business operations, cash comes
into the business as income and goes out as expenses. This cash flow is core to any business
and directly impacts its ability to remain solvent and generate profits. The amount of cash the
company generates is an important measure of its overall financial health.

Our renewable cash is derived from the company’s profitable operations. To keep the
company’s financial health profitable operations are a must. Following are some suggestions to
improve our cash position:

 Tighten inventory: Keeping too much product on hand can tie up a great deal of cash.
We must make sure our inventory turns over at a regular pace.
 Bill early and often: Bill a project when it's complete, and invoice products as soon as
they ship. Keep a detailed receivables report and act immediately on overdue
accounts.
 Don't expand until you have the cash to support growth. Figure out what our
projected expansion will cost and make sure there is enough cash to cover it.
 Stretch out payables. Don't pay every bill as soon as it arrives — wait 30 or 60 days
and keep the cash on hand. If suppliers want their money more quickly, ask about
discounts for early payment.
 Consider raising our prices. Check out what the competition's doing and make sure
our prices or rates aren't too low.