Cash flows case:(indirect method).

Messi Company has not yet prepared the statement of cash flows.The Balance sheet as of December 31, 2017 and January 1, 2017 and the additional information regarding the statement of income and retained earnings for the year are presented below.

Messi Company

Comparative Balance Sheet

(Dollars in Millions)

Assets12/31/21071/1/2017

Current Assets:

Cash$ 98$158

Account Receivables 1,2901,160

Inventory1,3201,230

Total Current Assets2,7082,548

Property, Plant, and Equipment3,0302,932

Less Accumulated Depreciation 1,5301,282

Net Property, Plant, and Equipment1,500 1,650

Total Assets$4,208 $4,198

Liability and Equity

Current Liability:

Account payable$500$310

Accrued Liability 380330

Income tax payable152140

Total current Liability$1,032 $780

Bonds payable 9001,240

Total Liability1,9322,020

Stockholders' Equity:

Common Stock322322

Retained earnings1,9541,856

Total Stockholders' Equity2,2762,178

Total Liability and Stockholders' Equity$4,208$4,208

Messi Income statement ((Dollars in Millions)

Net Income$7,200

Cost of goods sold5,100

Gross Margin2,100

Selling and administrative Expenses1,750

Net Operating Income 350

Nonoperation items:

Gain on sale of Equipment6

Income before Taxes356

Income tax126

Net Income$230

Messi also provided the following information:

1.The company sold equipment that had an original cost of $26 million and accumulated depreciation of $16 million.The cash proceeds from the sale were $16 million.The gain on the sale was $6 million

2.The company did not issue any bonds during the year.

3.The company paid a cash dividend during the year

4.The company did not complete any common stock transactions during the year

Required:

1.Prepare a statement of cash flows for the year using the indirect method

2.Compute Messi's free cash flow

3.Assume that Messi has sales of $7,600, Net income of $230, and net cash provided by operating activities of $300 in the prior year.Prepare a memo that summarizes your interpretations of Messi's financial performance

4.Use the analysis of Messi Company to illustrate how information in the balance sheet and the statement of cash flows helps the users of the financial statements.

Messi Company

Statement of Cash Flows

For the period December 31, 2017

(Dollars in Millions)

Cash flows from operation activities

Net income $230

Adjustment for:

Depreciation expense $248

Gain on sale of equipment (6)

Increase in accounts receivables (130)Increase in inventory (90)Increase in accounts payable 190Total adjustments 212

Net cash provided by operating activity 442

Cash flows from investing activities

Sale of asset 150

Net cash provided by investing activity 150

Cash flows from financing activities

Principal payment on bonds(340)

Net cash provided by operating activity (340)

Net increase in cash and cash equivalent252

Cash and cash equivalents, January 1, 2017158

Cash and cash equivalents, December 31, 201798

Free cash flow = cash provided by operating activities - dividends - capital expenditure

Free cash flow = 442,000,000 -

1.Prepare a statement of cash flows for the year using the indirect method

Messi Company

Statement of Cash flows

For the year ended 31.12.2017

(Dollars in Millions)

(Dollars in Millions)

Cash flow from operating activities

Net Income

230

Adjustments for:

Depreciation (1530-1282)

248

Gain on sale of equipment

(6)

242

Increase in Accounts Receivables(1290-1160)

(130)

Increase in inventory(1320-1230)

(90)

Increase in accounts payable(500-310)

190

(30)

Cash generated from operations

442

Cash flows from investing activities

Disposal of asset (1650-1500)

150

Net Cash generated from investing activities

150

Cash flows from financing activities

Payment of bonds(1240-900)

(340)

Net Cash used in financing activities

(340)

Net increase in cash and cash equivalents

252

Cash and cash equivalents at beginning of period

158

Cash and cash equivalents at end of period

98

2.Assume that Messi has sales of $7,600, Net income of $230, and net cash provided by operating activities of $300 in the prior year.Prepare a memo that summarizes your interpretations of Messi's financial performance

Memorandum

To:

From:

Date:

Subject: Interpretation of Messi's Profitability and liquidity

2016

2017

(Dollars in Millions)

(Dollars in Millions)

Sales

7600

7200

Net Income

230

230

Net cash from operating activities

300

442

Net profit margin

2016

=230/7600

=0.030

2017

=230/7200

=0.032

Comparison between the two years shows that the company has increased its profitability as it has been able to maintain the same level of net income with lesser sales than in 2016.

Cash generated from operating activities has also increased from 2016 to 2017

3.Use the analysis of Messi Company to illustrate how information in the balance sheet and the statement of cash flows helps the users of the financial statements.

Shareholders and Investors

Shareholders are interested in getting a return from the company and also growing their wealth. Investors provide funds which are used to purchase assets are therefore interested in the return on assets (ROA) to measure the efficiency of the company in utilizing its assets.

ROA=Net Income/Total Assets

Messi company shows a decline in profitability of use of its assets as it is able to come up with the same net income with more assets 2017 than in had in 2016

Shareholders also look at the cash flow statement to determine whether they will be able to earn dividends on their shares.

Lenders and Suppliers

These users of financial information are interested in the ability to pay their liabilities as and when they fall due.

The liquidity ratios such the current ratio calculated from the balance sheet provide information about the companies liquidity e.g

Current Ratio=current assets/current liabilities

=2708/1032

=2.6

This shows that the company is able to meet its obligations such as of paying suppliers and interest and principal for lenders

Government

The government is interested in the amount of tax it collects from Messi Company and therefore will be interested in both the cash flow statement and the balance sheet of the company. The balance sheet shows that the income tax liability of the company which at the end of 2017 stands at $152 million. The cash flow statement in particular the operating activities shows the ability of the company to meet its tax liability.

Managers and Employees

Although managers regularly make operating and financial decisions based on information that is more detailed and timely management accounting they also require analysis of the financial statements. This is in order to satisfy the other user groups.

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