Start with beginning cash and subtract the asset buildup (equal to 50 percent of the sales increase) and add in profit. In problem 1 if there had been no increase in sales and all other facts were the same, what would Else’s ending cash balance be? What lesson do the examples in problems 1 and 2 illustrate? (I) The calculation starts with the beginning cash which Is subtracted the asset buildup and then added In profit. As to why subtract the asset buildup? This Is because the calculation should be working with net assets (assets and liableness), which Is short for “assets not financed with debt”.
Because any asset not financed with debt In reality must be funded either with fresh equity or with retained earnings, the total $300,000 increase in assets needs to be supported by an increase in debt Oneness, 2006). Beginning cash $120,000 Asset buildup (300,000) Profit 96,000 $1 Ending cash ($84,000) Deficit Therefore, his optimistic outlook for his cash position Is wrong. Cash will be In a deficit. (ii) In problem 1 if there had been no increase in sales and all other facts, the new calculation is shown below.
Asset buildup (O) 48,000 Ending cash $168,000 Balance Therefore, even though no Increase in sales, Ell Lilly would end up with cash balance but not deflect. From the examples In problem 1 and 2, we can learn the lessons that higher sales may not translate into higher cash flow. The more sales obtain, the more financing building up inventories, which may depreciate in value or even become obsolete if the inventories are not sold in a timely manner. Inventories are valued as assets since they tie up capital; hence they are expected to be sold as soon as possible so hat realizing investment return.
The expenses of building up inventories are not recorded until products are actually sold. Inventories become liabilities when life cycle ends either because of expiry or by becoming discounted/ obsolete (Boycott & Ghana, 2004). In problem 1 even though the company’s sales are expected to double, the assets remain 50% of the increased sales, which leads to significant cash reduction even for a potential profitable firm. In order to ensure cash balance, Eli Lilly should try to sell the liquid assets such as inventories as soon as possible.