PURPLE LIMITED

"Frankly, if we continue to grow, we will be out of business soon:'

This was the glum assessment of Kathy Lin, President and CEO of Purple Limited, a company that designs, manufactures, and retails women's fashion. Kathy has a 30-year his-

tory in the fashion business and has managed her own label for much of that time. In 20X0, she incorporated Purple, and the company grew rapidly. It was particularly known for its edgy fashion design, reasonable prices, and quick turnaround. Purple hires young design-

ers and has established a highly efficient manufacturing and distribution system to place trendy clothes in stores ahead of her competition. InitiaV designs had been sold only in Purple's own stores, but over the last two years, Purple began selling to larger chains. As a result, the scope of Purple has significantly increased as have revenues and profits. In fact, the company reported a loss of $1,345 in 20X0 but moved to earnings of $133 in 20X1, earnings of $2,580 in 20X2, and an impressive $6,245 in 20X3 (All figures in thousands.) Sales had more-than tripled over the past three years. Capital assets purchased over this period were $16,000 in 20X0, $9,500 in 20X2, and $8,000 in 20X3.

"We are pretty much out of cash, and I have bills to suppliers that are due. My banker will provide some cash, but not enough to keep up with this-and all that borrowing is getting

expensive. I'm not sure how we can post such high earnings and be so broke. Can you explain this to me and help me with a plan to get out of this mess? I need good advice, fast."

You are an accounting professional in public practice and have provided business advice to Kathy in the past. You agree to meet with her on this issue tomorrow and now are pre-

paring a draft report for discussion. You decide that calculating cash flows from operating activities is a good place to start (Exhibit I).

Required:

Prepare the draft report for discussion.

EXHIBIT 1

PURPLE LIMITED

Summarized Statement of Financial Position

At 31 December (in thousands)20X320X220X120X0

Cash$320$1,680$4,210$5,870

Accounts receivable29,24018,4503,0602,940

Inventory41,97032,97025,76022,800

Prepaid assets1,5661,2111,0871,004

Plant and equipment (net)22,72017,65011,29014,600

Other assets3,6501,5402,9701,340

Total$99,466$73,501$48,377$48,554

Liabilities

Accounts payable and

accrued liabilities32,11926,40418,81316,824

Short-term debt35,56624,92913,27614,675

Long-term debt20,15015,80012,50013,400

Equity

Common shares5,0005,0005,0005,000

Retained earnings (deficit)6,6311,368(1,212)(1,345)

Total$99,466$73,501$48,377$48,554