Management of Statement of Cash Flows, Ethical Issues  Fred Jackson, president a

Management of Statement of Cash Flows Ethical Issues Fred Jackson president and owner of Bailey Company is concerned about the companys ability to obtain a loan from a major bank. The loan is a key factor in the firms plan to expand its operations. Demand for the firms product is high”too high for the current production capacity to handle. Fred is convinced that a new plant is needed. Building the new plant however will require an infusion of new capital. Fred calls a meeting with Karla Jones financial vice president. Fred: Karla what is the status of our loan application? Do you think that the bank will approve? Karla: Perhaps but at this point there is a real risk. The loan officer has requested a complete set of financials for this year and the past 2 years. He has indicated that he is particularly interested in the statement of cash flows. As you know our income statement looks great for all 3 years but the statement of cash flows will show a significant increase in receivables especially for this year. It will also show a significant increase in inventory and Im sure that hell want to know why inventory is increasing if demand is so great that we need another plant. Both of these effects show decreasing cash flows from operating activities. Fred: Well it is certainly true that cash flows have been decreasing. One major problem is the lack of operating cash. This loan will solve that problem. Bill Lawson has agreed to build the plant for the amount of the loan but will actually charge me for only 95% of the stated cost. We get 5% of the loan for operating cash. Bill is willing to pay 5% to get the contract. Karla: The loan may help with operating cash flows but we cant get the loan without showing some evidence of cash strength. We need to do something about the increases in inventory and receivables that we expect for this year. Fred: The increased inventory is easy to explain. We had to work overtime and use subcontractors to take care of one of our biggest customers. That inventory will be gone by the first of next year.Karla:The problem isnt explaining the inventory. The problem is that the increase in inventory decreases our operating cash flows and this shows up on the statement of cash flows. This effect coupled with the increase in receivables depicts us as being cash poor. Itll definitely hurt our chances. Fred: I see. Well this can be solved. The inventory is for a customer that I know well. Shell do me a favor. Ill simply get her to take delivery of the inventory early before the end of our fiscal year. She can pay me next year as originally planned. Karla: Fred all that will do is shift the increase from inventory to receivables. Itll still report the same cash position. Fred: No problem. Well report the delivery as a cash sale and Ill have Bill Lawson advance me the cash as a temporary loan. Hell do that to get the contract to build our new plant. In fact we can do the same with some of our other receivables. Well report them as collected and Ill get Bill to cover. If he understands that this is what it takes to get the loan hell cooperate. He stands to make a lot of money on the deal. Karla: Fred this is getting complicated. The bank will have us audited each year if this loan is approved. If an audit were to reveal some of this manipulation we could be in big trouble particularly if the company has any trouble in repaying the loan. Fred: The company wont have any trouble. Sales are strong and the problem of collecting receivables can be solved especially given the extra time that the 5% of the loan proceeds will provide. e of ethics what would you do (supposing that Fred insists on implementing his plan)? Now answer the question assuming that Fred is willing to consider alternative ways to solve the companys problems.

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