Prepare and Interpret a Statement of Cash Flows; Free Cash Flow [LO1, LO2, LO3]

Sharon Feldman, president of Allied Company, considers $20,000 to be a minimum cash balance for operating purposes. As can be seen from the following statements, only $15,000 in cash was available at the end of 2011. Because the company reported a large net income for the year, and also issued bonds and sold some long-term investments, the sharp decline in cash is puzzling to Ms. Feldman.

Allied Company Comparative Balance Sheet December 31, 2011, and 2010 2011 2010 Assets Current assets:
Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 15,000 $ 33,000 Accounts receivable . . . . . . . . . . . . . . . . . 200,000 210,000 Inventory . . . . . . . . . . . . . . . . . . . . . . . . . 250,000 196,000 Prepaid expenses . . . . . . . . . . . . . . . . . . 7,000 15,000 Total current assets . . . . . . . . . . . . . . . . . . . 472,000 454,000 Long-term investments . . . . . . . . . . . . . . . . 90,000 120,000 Plant and equipment . . . . . . . . . . . . . . . . . . 860,000 750,000 Less accumulated depreciation . . . . . . . . 210,000 190,000 Net plant and equipment . . . . . . . . . . . . . . . 650,000 560,000 Total assets . . . . . . . . . . . . . . . . . . . . . . . . . $1,212,000 $1,134,000 Liabilities and Stockholders’ Equity Current liabilities:
Accounts payable . . . . . . . . . . . . . . . . . . . $ 175,000 $ 230,000 Accrued liabilities . . . . . . . . . . . . . . . . . . . 8,000 15,000 Income taxes payable . . . . . . . . . . . . . . . 42,000 39,000 Total current liabilities . . . . . . . . . . . . . . . . . 225,000 284,000 Bonds payable . . . . . . . . . . . . . . . . . . . . . . . 200,000 100,000 Total liabilities . . . . . . . . . . . . . . . . . . . . . . . 425,000 384,000 Stockholders’ equity:
Common stock . . . . . . . . . . . . . . . . . . . . . 595,000 600,000 Retained earnings . . . . . . . . . . . . . . . . . . 192,000 150,000 Total stockholders’ equity . . . . . . . . . . . . . . . 787,000 750,000 Total liabilities and stockholders’ equity . . . . $1,212,000 $1,134,000 Allied Company Income Statement For the Year Ended December 31, 2011 Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $800,000 Cost of goods sold . . . . . . . . . . . . . . . . . . . . 500,000 Gross margin . . . . . . . . . . . . . . . . . . . . . . . . 300,000 Selling and administrative expenses . . . . . . 214,000 Net operating income . . . . . . . . . . . . . . . . . 86,000 Nonoperating items:
Gain on sale of investments . . . . . . . . . . . $20,000 Loss on sale of equipment . . . . . . . . . . . . (6,000) 14,000 Income before taxes . . . . . . . . . . . . . . . . . . 100,000 Income taxes . . . . . . . . . . . . . . . . . . . . . . . . 30,000 Net income . . . . . . . . . . . . . . . . . . . . . . . . . $ 70,000 The following additional information is available for the year 2011:

a. The company sold long-term investments with an original cost of $30,000 for $50,000 during the year.

b. Equipment that had cost $90,000 and on which there was $40,000 in accumulated depreciation was sold during the year for $44,000.

c. The company declared and paid a cash dividend during the year.

d. The stock of a dissident stockholder was repurchased for cash and retired during the year. No issues of stock were made.

e. The company did not retire any bonds during the year.
Required:
1. Using the indirect method, compute the net cash provided by operating activities for 2011.
2. Prepare a statement of cash flows for 2011.
3. Compute free cash flow for 2011.
4. Explain the major reasons for the decline in the company’s cash balance.