PROFITABILITY DECLINES AND THE STATEMENT OF CASH FLOWS The Bookbarn, Inc., is a retail seller of new books in a moderate-sized city. Although initially very successful, The Bookbarn’s sales volume has declined since the opening of two competing bookstores two years ago. The accountant for The Bookbarn prepared the following statement of cash flows at the end of the current year:
The Bookbarn, Inc.
Statement of Cash Flows For the Year Ended December 31, 2009 Cash flows from operating activities Net income $ 26,500 Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation expense $ 38,500 Loss on sale of equipment 2,100 Increase in accounts receivable (1,200)
Increase in inventory (3,800)
Increase in accounts payable 6,700 Decrease in wages payable (1,200)
Total adjustments 41,100 Net cash provided by operating activities $ 67,600 Cash flows from investing activities Equipment purchase $(12,000)
Proceeds from sale of equipment 2,300 Net cash used by investing activities $ (9,700)
Cash flows from financing activities Payment of dividends $ (4,000)
Repayment of mortgage (10,000)
Net cash used by financing activities (14,000)
Net increase in cash $ 43,900 Your analysis suggests that The Bookbarn’s net income will continue to decline by $8,000 per year to $18,500 as sales continue to fall. Thereafter, you expect sales to stabilize.
Required:
. What will happen to the amount of cash provided by operations as net income decreases?
. Assume that equipment is nearly fully depreciated but that it will be fully serviceable for several years. What will happen to cash flows from operations as depreciation declines?
. Do the operations of businesses experiencing declining sales volumes always consume cash? Explain your answer.
. Can current assets and current liabilities buffer operating cash flows against the impact of declines in sales volume in the short run? In the long run? Explain your answer.
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