Sagnik B.

asked • 03/11/15

Accounting Net Income Question Need Assistance Will Give Best Answer

I need detailed help with steps on how to find answer, and reason why answer is what it is :
 
Carpon Lumber sells lumber and general building supplies to building contractors in a medium sized town in Montana. Data regarding the store's operations follow :
 
Sales are budgeted at $340,000 for November, $350,000 for December , and $370,000 for January.
Collections are expected to be 55% in the month of sale, 44% in month following sale, and 1% uncollectible.
The cost of goods sold is 75% of sales.
The company desires to have ending merchandise inventory equal to 60% of the next month's cost of goods sold. Payment for merchandise is made in the month following the purchase.
Other monthly expenses to be paid in cash are $21,100.
Monthly depreciation is $19,000.
Ignore Taxes.
 
Statement of Financial Position : October 31
 
Assets:
Cash : $13,000
Accounts Receivable (net of allowance for uncollectible accounts) : $82,000
Inventory : $153,000
Property , Plant , and Equipment (net of $598,000 accumulated depreciation) : $1,138,000
Total Assets : $1,386,000
 
Liabilities and Stockholders Equity :
Accounts Payable : $257,000
Common Stock : $600,000
Retained Earnings : $529,000
Total Liabilities and Stockholders Equity : $1,386,000
 
Question : The net income for December would be ?
A) 66,400 B) 43,900 C) 47,400 D) 61,500 E) None
 
Answer was given as C) in the solution manual but I am so confused as to how and why.

1 Expert Answer

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Joe C. answered • 03/11/15

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This question is much easier than it seems. Because it is looking for net income and not operating cash flow we focus only on revenue and expenses accrued in that month. So we take 350,000 subtract 75% of that to get gross profit of 87,500. Then subtract the opex and depreciation for a net income of 47400.
 
 
 
 
December
Revenue 350000
COGS 262500
GM 87500

Dep 19000
Opex 21100
Net Income 47400
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Sagnik B.

Wow that was simple, can you walk me through how to calculate the Cash Balance at end of December, answer was 65,400 but I can't get this answer. Your simplicity really helps, please write back :)
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03/11/15

Joe C.

This question is a little bit more complicated. If you want to see what is going on here it is best to build all three financial statements: the income statement, balance sheet and statement of Cash Flow. We can ignore PPE and Equity (Common Stock and Retained Earnings) because there are no Investment Cash flows (Capex) or Finance Cash Flows (raising/paying off debt or raising/buying back equity or issuing a dividend), but everything else is important.
 
It would be best to work this out in excel if you have it. I unfortunately don't think I can attach a worksheet to this comment, so I'll try to walk you through it. There is another way to do this where you calculate the cash sales etc.. But as an analyst I can tell you that this is what statements look like in real life. First we calculate the net income the same way as before except we've added a provision field that adjusts for the 1% of sales that are uncollectible. The first step to getting to cash flow is adding back non cash expenses to net income which in this case is only depreciation. Next we adjust for the change in working capital: an increase in accounts receivable or inventory will be a negative affect on cash while an increase in accounts payable will have a positive affect on cash. We have the balance sheet for the end of october so how do we find it for the end of november?
 
Accounts Receivable will be 44% of sales in that month because that is the amount we will collect the following month.
Inventory will be 60% of next months cost of goods sold based on company policy.
Accounts Payable will be equal to the amount of inventory purchased, because that is the amount we will be paying our supplier the following month. This is an important point. Three things make up this number. We need to buy enough inventory to a) meet this months COGS and b)have 60% of next months COGS, but we already have some ie the inventory as of Oct 31. So Accounts Payable is 255+157.5-153 = 259.5.
 
So if we take the net income, add back deprecation, subtract the change in AR and inventory and add the change in AP, we get the cash balance at the end of the month. Do the same for December and we end up with 65,400
 
Let me know if you have any questions
 
IS         October     November         December     January
Sales                       340.0            350.0             370.0
Provision                   3.4                3.5                3.7
Net Sales                   336.6           346.5           366.3

COGS                        255.0          262.5            277.5
Gross Margin               81.6           84.0             88.8

OpEx                          21.1           21.1             21.1

Depreciation               19.0            19.0             19.0

Net Income                41.5            43.9             48.7

BS
Assets
Cash               13.0          3.9             65.4
AR Net            82.0         149.6          154.0  
Inv                153.0         157.5        166.5

Liabilities
AP                  257.0        259.5         271.5  


CF
Net Income -            41.5           43.9          48.7
Depreication -           19.0          19.0         19.0

Change in WC:
AR                          (67.6)       (4.4)
Inv                          (4.5)        (9.0)
AP                            2.5          12.0

Net Cash Flow (Use)   (9.1)         61.5

Cash Beginning           13.0          3.9
Cash End                      3.9         65.4
 
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03/12/15

Joe C.

Is there a way for me to send or attach a spreadsheet on here?
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03/12/15

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