The Use of Net Income and Cash Flow to Evaluate a Company
After you have gained five years of experience with a large CPA firm, one of your clients, Duke Inc., asks you to take over as chief financial officer for the business. Duke advises its clients on the purchase of software products and assists them in installing the programs on their computer sys- tems. Because the business is relatively new (it began servicing clients in January 2014), its accounting records are somewhat limited. In fact, the only statement available is the following income statement for the first year:
Duke Inc.
Statement of Income
For the Year Ended December 31, 2014
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Revenues
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$1,250,000
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Expenses:
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Salaries and wages
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$480,000
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Supplies
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65,000
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Utilities
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30,000
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Rent
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120,000
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Depreciation
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345,000
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Interest
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138,000
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Total expenses
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1,178,000
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Net income
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$72,000
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Based on its relatively modest profit margin of 5.76% (net income of $72,000 divided by revenues of $1,250,000), you are concerned about joining the new business. To alleviate your concerns, the president of the company is able to give you the following additional information:
a. Clients are given 90 days to pay their bills for consulting services provided by Duke. On December 31, 2014, $230,000 of the revenues is yet to be collected in cash.
b. Employees are paid on a monthly basis. Salaries and wages of $480,000 include the December payroll of $40,000, which will be paid on January 5, 2015.
c. The company purchased $100,000 of operating supplies when it began operations in January. The balance of supplies on hand at December 31 amounts to $35,000.
d. Office space is rented in a downtown high-rise building at a monthly cost of $10,000. When the company moved into the office in January, it prepaid its rent for the next 18 months be- ginning January 1, 2014.
e. On January 1, 2014, Duke purchased a computer system and related accessories at a cost of $1,725,000. The estimated useful life of the system is five years.
f. The computer system was purchased by signing a three-year, 8% note payable for $1,725,000 on the date of purchase. The principal amount of the note and interest for the three years are due on January 1, 2017.
Required
1. Based on the income statement and the additional information given, prepare a statement of cash flows for Duke for 2014. (Hint: Simply list all of the cash inflows and outflows that relate to operations.)
2. On the basis of the income statement given and the statement of cash flows prepared in part (1), do you think it would be a wise decision to join the company as its chief financial officer? Include in your response any additional questions that you believe are appropriate to ask before joining the company.