60 Minutes, Strong PROBLEM 13.

8A
MIRACLE TOOL, INC.
a.
MIRACLE TOOL, INC.
Worksheet for a Statement of Cash Flows
For the Year Ended December 31, 2015
Balance sheet effects:
Beginning Debit Credit Ending
Balance Changes Changes Balance
Assets
Cash and cash equivalents 10,000 (x) 50,000 60,000
Marketable securities 20,000 (8) 15,000 5,000
Accounts receivable 40,000 (4) 17,000 23,000
Inventories 120,000 (5) 2,000 122,000
Plant and equipment (net of
accumulated depreciation) 300,000 (9) 20,000 (3) 35,000 285,000
Totals 490,000 495,000

Liabilities & Owners' Equity

Accounts payable 50,000 (6) 23,000 73,000
Accrued expenses payable 17,000 (7) 3,000 14,000
Notes payable 245,000 (10) 10,000 (9) 18,000 253,000
Capital stock 120,000 (11) 15,000 135,000
Retained earnings 58,000 (1) 34,000 20,000
(2) 4,000
Totals 490,000 123,000 123,000 495,000

Cash effects: Sources Uses

Operating activities:
Net loss (1) 34,000
Depreciation expense (3) 35,000
Decrease in accounts
receivable (4) 17,000
 Increase in inventory (5) 2,000
Increase in accounts payable (6) 23,000
Decrease in accrued (7) 3,000
expenses payable
Loss on sale of marketable
securities (8) 1,000
Investing activities:
Proceeds from sale of
marketable securities (8) 14,000
Cash paid for plant assets (9) 2,000
Financing activities
Dividends paid (2) 4,000
Payment of note payable (10) 10,000
Issuance of capital stock (11) 15,000
Subtotals 105,000 55,000
Net increase in cash (x) 50,000
Totals 105,000 105,000

PROBLEM 13.8A
MIRACLE TOOL, INC. (continued)
b.
MIRACLE TOOL, INC.
Statement of Cash Flows
For the Year Ended December 31, 2015
Cash flows from operating activities:
Net loss $(34,000)
Add: Depreciation expense 35,000
Decrease in accounts receivable 17,000
Increase in accounts payable 23,000
Loss on sale of marketable securities 1,000
Subtotal $42,000
Less: Increase in inventory $2,000
Decrease in accrued expenses 3,000 5,000
Net cash provided by operating activities $37,000

Cash flows from investing activities:

Proceeds from sale of marketable securities $14,000
Cash paid to acquire plants assets (see supplementary schedule) (2,000)
Net cash used in investing activities 12,000

Cash flows from financing activities:

Dividends paid $(4,000)
Payment of note payable (10,000)
Issuance of capital stock 15,000
Net cash provided for financing activities 1,000

Net increase (decrease) in cash $50,000

Cash and cash equivalents, January 1, 2015 10,000
Cash and cash equivalents, Dec. 31, 2015 $60,000
 Supplementary Schedule: Noncash Investing and Financing Activities

Purchase of plant assets $20,000

Less: Portion financed through issuance of long-term debt 18,000
Cash paid to acquire plant assets $2,000

PROBLEM
13.8A
MIRACLE TOOL, INC.
(continued)
c. Miracle Tool, Inc. achieved its positive cash flow from operating activities basically by liquidating assets and by not paying its bills.
It has converted most of its accounts receivable into cash, which probably means that credit sales have declined substantially over
the past several months. A decrease in sales shows up in the income statement immediately, but may take months before its effects
appear in a statement of cash flows.
 Miracle Tool, Inc. is not replacing plant assets as quickly as these assets are being depreciated. In any given year, this may not be
significant. But on the other hand, this relationship certainly indicates that the business is not expanding, and it may indicate that
the company is deferring replacements of plant assets in an effort to conserve cash.

Miracle Tool, Inc. is allowing its accounts payable to rise much more quickly than it is increasing inventory. This indicates that the
company is not paying its bills as quickly as it used to. While this conserves cash, the “savings” are temporary. Also, if the
company’s credit rating is damaged, this strategy may reduce both earnings and cash flows in the near future.

d. Miracle Tool, Inc. has substantially more cash than it did a year ago. Nonetheless, the company’s financial position appears to be
deteriorating. Its marketable securities—a highly liquid asset—are almost gone. Its accounts payable are rising rapidly, and
substantially exceed the amount of cash on hand. Most importantly, sales and accounts receivable both are falling, which impairs
the company’s ability to generate cash from operating activities in the future. Also, the liquidity of the company’s inventory is
questionable in light of the declining sales.

e. This company is contracting its operations. Its investment in marketable securities, receivables, and plant assets all are declining.
Further, the income statement shows that operations are eroding the owners’ equity in the business. The decline in sales—already
apparent in the income statement—soon will reduce the cash collected from customers, which is the principal factor contributing to
a positive cash flow from operating activities.

In summary, this company appears to be in financial trouble.

f. The company’s principal revenue source—sales of tools—is declining. If nothing is done, it is likely that the annual net losses will
increase, and that operating cash flows will turn negative. Thus, management’s first decision is whether to attempt to revive the
company, or liquidate it.
If the company is to be liquidated, this should be done quickly to avoid future operating losses. Information should be gathered to
determine whether it would be best to sell the company as a going concern or whether management should sell the assets
individually. In either event, management should stop purchasing tools. Assuming that sales continue to decline, the company’s
current inventory appears to be approximately a one-year supply.
35 Minutes, Medium PROBLEM 14.5A
SWEET TOOTH, INC.

(Dollars in
Thousands)
a. (1) Quick assets:
($189,000 ($189,000
Cash
÷ .075) ÷ .075) $50,230
Marketable securities (short-
term) 55,926
Accounts receivable 23,553
Total quick assets $129,709

(2) Current assets:

($189,000 ($189,000
Cash
÷ .075) ÷ .075) $50,230
Marketable securities (short-
term) 55,926
Accounts receivable 23,553
Inventories 32,210
Prepaid expenses 5,736
Total current assets $167,655

(3) Current liabilities:

($189,000 ($189,000
Notes payable to banks (due within one year)
÷ .075) ÷ .075) $20,000
Accounts payable 5,912
Dividends payable 1,560
Accrued liabilities (short-term) 21,532
Income taxes payable 6,438
Total current liabilities $55,442
b. (1) Quick ratio:
($189,000
Quick assets (part a)
÷ .075) $129,709
Current liabilities 55,442
Quick ratio: ($129,709 ÷
$55,442) 2.3 to 1

(2) Current ratio:

Current assets (part a) $167,655
Current liabilities (part a) $55,442
Current ratio ($167,655 ÷
$55,442) 3.0 to 1

(3) Working capital:

($189,000 ($189,000
Current assets (part a)
÷ .075) ÷ .075) $167,655
Less: Current liabilities (part a) $55,442
Working capital $112,213

(4) Debt ratio:

Total liabilities (given) $81,630
Total assets (given) $353,816
Debt ratio ($81,630 ÷ $353,816) 23.1 %

PROBLEM 14.5A
 SWEET TOOTH, INC. (concluded)
c. (1 From the viewpoint of short-term creditors, Sweet Tooth appears highly liquid. Its quick and current
) ratios are well above normal rules of thumb, and the company’s cash and marketable securities alone
are almost twice its current liabilities.

(2 Long-term creditors should feel relatively secure. Not only is the company highly liquid, but
) creditors’ claims amount to only 23.1% of total assets. If Sweet Tooth were to go out of business and
liquidate its assets, it would have to raise only 23 cents from every dollar of assets for creditors to
emerge intact.

(3 From the viewpoint of stockholders, Sweet Tooth, Inc. appears overly liquid. Current assets generally
) do not generate high rates of return. The company’s relatively large holdings of current assets dilutes
its return on total assets. This should be of concern to stockholders. If Sweet Tooth is unable to invest
its highly liquid assets more productively in its business, stockholders probably may want to see the
money distributed as dividends.
 PROBLEM 13.8A
MIRACLE TOOL, INC. (concluded)
If management decides to continue business operations, it should consider taking the following actions:

• Expand the company’s product lines! The combination tool alone can no longer support profitable
operations. Also, dependency upon a single product—especially a faddish product with a limited
market potential—is not a sound long-term strategy.

• Stop buying the combination tool—at least until the current inventory is sold. This will not improve
profitability, but will help cash flows. (As explained above, the company’s current inventory appears
about equal to next year’s potential sales.)

• Look for ways to reduce operating expenses. In 2015, sales declined by 30%, but the company was able
to reduce operating expenses by only about 6.5% ($17,000 decline from a level of $260,000).

• Stop paying dividends. The company has no cash to spare. As sales continue to fall, the net cash flow
from operating activities is likely to turn negative. Collecting existing receivables and letting payables
go unpaid can only bolster net cash flow for a limited period of time.

• Develop forecasts of future operations and cash flows. If a turnaround does not appear realistic,
management should reconsider the option of liquidating the company.