Chapter 1, Problem 1.1STP

Learning Goal 4

ST1-1 Emphasis on Cash Flows Worldwide Rugs is a rug importer located in the United States that resells its import products to local retailers. Last year, Worldwide Rugs imported $2.5 million worth of rugs from around the world, all of which were paid for prior to shipping. On receipt of the rugs, the importer immediately resold them to local retailers for $3 million. To allow its retail clients time to resell the rugs, Worldwide Rugs sells to retailers on credit. Prior to the end of its business year, Worldwide Rugs collected 85% of its outstanding accounts receivable.

1. a. What is the accounting profit that Worldwide Rugs generated for the year?
2. b. Did Worldwide Rugs have a successful year from an accounting perspective?
3. c. What is the financial cash flow that Worldwide Rugs generated for the year?
4. d. Did Worldwide Rugs have a successful year from a financial perspective?
5. e. If the current pattern persists, what is your expectation for the future success of Worldwide Rugs?

Summary Introduction

To determine: The accounting profit that the WR Company incurred during the year.

Introduction:

Monetary costs that a firm pays out and the revenue a firm generated during the year is termed as accounting profit. This is considered as the bookkeeping profit which is greater than the economic profit.

Answer to Problem 1.1STP

The accounting profit that the WR Company incurred during the year is $500,000.

Explanation of Solution

Given information:

The WR Company has imported $2,500,000 of rugs and sales revenue of rugs is $3,000,000.

The formula to compute accounting profit is as follows:

$\text{Accounting profit}=\text{Total monetary revenue}-\text{Total costs}$

Compute accounting profit:

$\begin{array}{c}\text{Accounting profit}=\text{Total monetary revenue}-\text{Total costs}\\ =\$3,000,0000-\$2,500,000\\ =\$500,000\end{array}$

Hence, the accounting profit that the WR Company incurred during the year is $500,000.

Summary Introduction

To discuss: Whether the WR Company had a successful year from an accounting perspective.

Explanation of Solution

The WR Company had a successful year from an accounting viewpoint. It is because the company was profitable and it has generated 20 percent profit $\left(\frac{\$500,000}{\$2,500,000}\right)$ on its investment.

Summary Introduction

To determine: The financial cash flow that the WR Company incurred during the year.

Answer to Problem 1.1STP

The financial cash flow that the WR Company generated during the year is $50,000.

Explanation of Solution

Given information:

The WR Company has imported $2,500,000 of rugs and sales revenue of rugs is $3,000,000.

Note: Refer Excel to determine the value of cash inflows.

The formula to compute financial cash flow is as follows:

$\text{Financial cash flow}=\text{Cash inflows}-\text{Cash outflows}$

Compute financial cash flow:

$\begin{array}{c}\text{Financial cash flow}=\text{Cash inflows}-\text{Cash outflows}\\ =\$2,550,000-\$2,500,000\\ =\$50,000\end{array}$

Hence, the financial cash flow that the WR Company incurred during the year is $50,000.

Summary Introduction

To discuss: Whether the WR Company had a successful year from a financial perspective.

Explanation of Solution

The WR Company has generated a positive cash flow. However, the Company has only 2 percent return on investment $\left(\frac{\$50,000}{\$2,500,000}\right)$. This is not sufficient to cover operating costs. Therefore, the WR Company is not a successful year from a financial perspective.

Summary Introduction

To discuss: The Person X expectation of the WR Company’s future success.

Explanation of Solution

The WR Company has a risk associated with the importing system and ability to collect on its accounts receivables. The Company has only 2 percent return on investment $\left(\frac{\$50,000}{\$2,500,000}\right)$ . This seems doubtful that the company can lead a long-term success.  It is because the company does not have adequate cash inflows to meet its obligations. As a result, the firm will not survive irrespective of its level of profits.