EXERCISE 7–1 Dax Corporation’s genetically engineered flowers have rapidly gained market acceptance and shipments to customers have increased dramatically. The company is preparing for significant increases in production. Management notes that despite increasing profits the cash balance has declined, and it is forced to nearly double its debt financing in the current year. You are hired to advise management as to specific causes of the cash deficiency and how to remedy the situation. You are given the following balance sheets of Dax Corporation for Years 1 and 2

($ thousands):

DAX CORPORATION Balance Sheets December 31, Year 2 and Year 1 ($ thousands) Year 2 Year 1 Assets Cash ................................................. $ 500 $ 640 Accounts receivable, net ................... 860 550 Inventories ........................................ 935 790 Prepaid expenses .............................. 25 —
Total current assets .......................... $2,320 $1,980 Patents ............................................. $ 140 Less accumulated amortization ........ (10) 130 —
Plant and equipment ........................ 2,650 $1,950 Less accumulated depreciation ........ (600) 2,050 (510) 1,440 Other assets ..................................... 200 175 Less accumulated depreciation ........ (30) 170 (25) 150 Total assets ...................................... $4,670 $3,570 Liabilities and Equity Accounts payable.............................. $ 630 $ 600 Deferred income tax .......................... 57 45 Other current liabilities..................... 85 78 Total current liabilities...................... 772 723 Long-term debt ................................. 1,650 850 Common stock, $1 par ...................... 2,000 1,800 Retained earnings ............................ 248 197 Total liabilities and equity ................ $4,670 $3,570 CHECK

(a) Year 2 CFO, $(166,000)
In addition, the following information is available:
1. Net income for Year 2 is $160,000 and for Year 1 it is $130,000.
2. Cash dividends paid during Year 2 are $109,000 and during Year 1 they are $100,000.
3. Depreciation expense charged to income during Year 2 is $95,000, and the provision for bad debts (expense) is $40,000. Expenses include cash payments of $28,000 in interest costs and $70,000 in income taxes.
4. During Year 2 the company purchases patents for $140,000 in cash. Amortization of patents during the year amounts to $10,000.
5. Deferred income tax for Year 2 amounts to $12,000 and for Year 1 it amounts to $15,000.
Required:

a. Prepare a statement of cash flows (indirect method) for Year 2.

b. Explain the discrepancy between net income and cash flows from operations.

c. Describe options available to management to remedy the cash deficiency.