The company made 10% more profit in Year 2 than Year 1 - $15.4 versus 14.0, whic
ID: 2618675 • Letter: T
Question
The company made 10% more profit in Year 2 than Year 1 - $15.4 versus 14.0, which increased shareholders’ equity from $36.0 to $51.4. But total cash went from $1.0 to $12.9.
Why did cash go up faster than sales? Why didn’t cash increase by the amount of profits?
Assumed Growth Rate
10.0%
Income Statement
Year 1
Year 2
Sales
$100.0
$110.0
Cost of Goods Sold
$60.0
$66.0
Gross Margin
$40.0
$44.0
Selling, General and Administrative
$20.0
$22.0
Operating Profits
$20.0
$22.0
Tax [corporate tax rate times Operating Profits]
$6.0
$6.6
After-Tax Operating Profits
$14.0
$15.4
Balance Sheet
Assets
Year 1
Year 2
Transactions Cash
$1.0
$1.1
Excess Cash
$0.0
$11.8
Inventory
$12.0
$13.2
Accounts Receivable
$15.0
$16.5
Net Property, Plant & Equipment (NPPE)
$20.0
$22.0
Total Assets
$48.0
$64.6
Liabilities
Accounts Payable
$12.0
$13.2
Shareholders' Equity
$36.0
$51.4
Total Liabilities
$48.0
$64.6
Assumed Growth Rate
10.0%
Income Statement
Year 1
Year 2
Sales
$100.0
$110.0
Cost of Goods Sold
$60.0
$66.0
Gross Margin
$40.0
$44.0
Selling, General and Administrative
$20.0
$22.0
Operating Profits
$20.0
$22.0
Tax [corporate tax rate times Operating Profits]
$6.0
$6.6
After-Tax Operating Profits
$14.0
$15.4
Balance Sheet
Assets
Year 1
Year 2
Transactions Cash
$1.0
$1.1
Excess Cash
$0.0
$11.8
Inventory
$12.0
$13.2
Accounts Receivable
$15.0
$16.5
Net Property, Plant & Equipment (NPPE)
$20.0
$22.0
Total Assets
$48.0
$64.6
Liabilities
Accounts Payable
$12.0
$13.2
Shareholders' Equity
$36.0
$51.4
Total Liabilities
$48.0
$64.6
Explanation / Answer
Solution:
Why did cash go up faster than sales? Why didn’t cash increase by the amount of profits?
Because the shareholder's equity consists of retained earnings and common stock. Retained earning gets increased by the net profit that is remained after paying dividends
Here $15.4 is the net profit that goes to retained earnings that is why shareholder's equity increased by $15.4
Now cash is only increased by $11.9 (1.0 to 12.9)
So remaining cash that is $15.4 - $11.9 = $3.5