The Zaro Company’s balance sheet for December 31, 2002, income statement for the year ended December 31, 2002, and the statement of cash flows for the year ended December 31, 2002, are shown below and on the following page.

ZARO COMPANY Balance Sheet December 31, 2002 and 2001 2002 2001 Assets Cash $ 30,000 $ 15,000 Accounts receivable, net 75,000 87,000 Inventory 90,000 105,000 Prepaid expenses 3,000 2,000 Land 25,000 25,000 Building and equipment 122,000 120,000 Accumulated depreciation (92,000) (80,000)

Total assets $253,000 $274,000 Liabilities and Stockholders’ Equity Accounts payable $ 25,500 $ 32,000 Income taxes payable 2,500 3,000 Accrued liabilities 5,000 5,000 Bonds payable (current $20,000 at 12/31/02) 90,000 95,000 Common stock 85,000 85,000 Retained earnings 45,000 54,000 Total liabilities and stockholders’ equity $253,000 $274,000 ZARO COMPANY Income Statement For Year Ended December 31, 2002 Sales $400,000 Less expense:
Cost of goods sold (includes depreciation of $5,000) $280,000 Selling and administrative expenses (includes depreciation expenses of $7,000) 78,000 Interest expense 8,000 Total expenses $366,000 Income before taxes 34,000 Income tax expense 14,000 Net income $ 20,000 ZARO COMPANY Statement of Cash Flows For Year Ended December 31, 2002 Net cash flow from operating activities:
Net income $ 20,000 Noncash expenses, revenues, losses, and gains included in income:
Depreciation 12,000 Decrease in accounts receivable 12,000 Decrease in inventory 15,000 Increase in prepaid expenses (1,000)
Decrease in accounts payable (6,500)
Decrease in income taxes payable (500)
Net cash flow from operating activities $ 51,000 Cash flows from investing activities:
Increase in buildings and equipment $ (2,000)
Net cash used by investing activities (2,000)
Cash flows from financing activities:
Decrease in bonds payable $ (5,000)
Cash dividends paid (29,000)
Net cash used for financing activities: (34,000)
Net increase in cash $ 15,000 The president of the Zaro Company cannot understand how the company was able to pay cash dividends that were greater than net income and at the same time increase the cash balance. He notes that business was down slightly in 2002.
Required

a. Comment on the statement of cash flows.

b. Compute the following liquidity ratios for 2002:
1. Current ratio 2. Acid-test ratio 3. Operating cash flow/current maturities of long-term debt and current notes payable 4. Cash ratio

c. Compute the following debt ratios for 2002:
1. Times interest earned 2. Debt ratio

d. Compute the following profitability ratios for 2002:
1. Return on assets (using average assets)
2. Return on common equity (using average common equity)

e. Give your opinion as to the liquidity of Zaro.

f. Give your opinion as to the debt position of Zaro.
g. Give your opinion as to the profitability of Zaro.
h. Explain to the president how Zaro was able to pay cash dividends that were greater than net income and at the same time increase the cash balance.