Heather and Dan Holt met while both were employed in the interior trim and upholstery department of an auto manufacturer. After their marriage, they decided to earn some extra income by doing small jobs involving canvas, vinyl, and upholstered products. Their work was considered excellent, and at the urging of their customers, they decided to go into business for themselves, operating out of the basement of the house they owned. To do this, they invested $120,000 cash in their business. They spent $10,500 for a sewing machine (expected life 10 years) and $12,000 for other miscellaneous tools and equipment (expected life 5 years). They undertook only custom work, with the customers purchasing the required materials, to avoid stocking any inventory other than supplies. Generally, they required an advance deposit on all jobs. The business seemed successful from the start, as the Holts received orders from many customers. But they felt something was wrong. They worked hard and charged competitive prices. Yet there seemed to be barely enough cash available from the business to cover immediate personal needs. Summarized, the checkbook of the business for 2002, their second year of operations, showed:

Balance, January 1, 2002 $99,200

Cash received from customers:

For work done in 2001 $36,000

For work done in 2002 200,000

For work to be done in 2003 48,000 284,000

383,200

Cash paid out:

Two year insurance policy, dated 1/1/02 $19,200

Utilities 48,000

Supplies 104,000

Other expenses 72,000

Taxes, including sales taxes 26,400

Dividends 40,000 309,600

Balance, 12/31/02 $73,600

Considering how much they worked, the Holts were concerned that the cash balance decreased by $25,600 even though they only received dividends of $40,000. Their combined income from the auto manufacturer had been $65,000. They were seriously considering giving up their business and going back to work for the auto manufacturer. They turned to you for advice. You discovered the following:

Of the supplies purchased in 2002, $24,000 were used on jobs billed to customers in 2002; no supplies were used for any other work.

Work completed in 2002 and billed to customers for which cash had not yet been received by year-end amounted to $40,000.

First step in the analysis is to rough out an income statement for the Holts in 2002.