FINANCIAL ACCOUNTING CLASS 6 HOMEWORK
Cash without Profit versus Profit without Cash
This assignment is based on an example from a popular management book called “Financial
Intelligence: A Manager’s Guide to Knowing What the Numbers Really Mean”, Chapter 16,
Profit ≠Cash (and You Need Both). This problem illustrates the difference between profit and
cash by comparing two simple companies with dramatically different profit and cash positions.
NOTE: Your study group needs only to complete one of the scenarios below. We will discuss
both in class. I anticipate that once you complete one scenario you will be able to extrapolate
to the other, but you are certainly encouraged to complete both scenarios for practice.
Consider the following two scenarios:
Scenario A: Cash without profit (required only for even numbered study groups)
Sweet Dreams Bakery is a new cookies-and-cakes manufacturer that supplies specialty grocery
stores. The founder has lined up orders based on her unique home-style recipes, and she is
ready to launch on January 1. We will assume she has $10,000 cash in the bank, and we will
also assume that in the first three months her sales are $20,000, $30,000, and $45,000. Cost
of goods sold is 60 percent of sales, and her monthly operating expenses are $10,000.
Sweet Dreams Bakery has an agreement with its vendors to pay for the ingredients and other
supplies it buys in thirty days. The specialty grocers that Sweet Dreams Bakery sells to are
kind of precarious, and they take sixty days to pay their bills.
Scenario B: Profit without cash (required only for odd numbered study groups)
Fine Apparel is a start-up retailer that sells expensive men’s clothing. It is in a part of town
frequented by businessmen and well-to-do tourists. We will assume that Fine Apparel begins
on January 1 with $10,000 in the bank. Its sales for the first three months are $50,000,
$75,000, and $95,000. This is a healthy growing trend. Its cost of goods sold are 70 percent
of sales, and its monthly operating expenses are $30,000 because rent is very high.
As a retailer, Fine Apparel collects the money on each sale immediately. Fine Apparel was able
to negotiate good terms with its vendors, paying them in sixty days.
Professor Leslie Robinson
Financial Accounting
2
Required (before class)
Complete the following steps to demonstrate that you can express the financial outcome of
these scenarios using the structure and language of a set of financial statements. Focus on
what is happening to the monthly cash position.
For EACH of the first three months (i.e., you should have 3 sets of financial statements):
Step 1 – Prepare an income statement
Step 2 – Prepare a comparative balance sheet
Step 3 – Prepare a cash flow statement (use the indirect method to calculate cash flow
from operations)
Step 4A – For scenario A ONLY, complete steps 1 through 3 again but adjust all three
statements to reflect Sweet Dreams maintaining a constant cash balance of $10,000 by
funding any cash deficiencies with debt
Step 4B – For scenario B ONLY, complete steps 1 through 3 again but adjust all three
statements to reflect Fine Apparel maintaining a constant cash balance of $10,000 by using
any excess cash and investing it in Property, plant and equipment
Assumptions:
• Assume the beginning cash is financed with $5,000 debt and $5,000 contributed capital
• Unless otherwise stated, assume debt and contributed capital do not change over time
• Ignore interest on debt
• Ignore taxes on income
• Ignore depreciation on property, plant and equipment
Upload your group’s financial statements with the required scenario completed.
Consider your answers to the discussion questions below (you do not need to hand in answers
to the questions).
Discussion Questions (during class)
1. What is happening to the cash position? What is happening to profitability?
2. What business risks can you identify by examining the difference between cash and profit?
3. How would you explain these risks using the financial statements?
4. What sort of expertise do you think you would need to run this company?
Professor Leslie Robinson
Financial Accounting