Chemalite Solution

Topics: Income statement, Cash flow, Generally Accepted Accounting Principles Pages: 3 (611 words) Published: April 6, 2008

Chemalite had a promising first year and will likely continue to make profits for its shareholders over the next five years.

Problem Statement

The first year of business is important for predicting the future success of a company. The aim of the memo is to analyze the financial data from Chemalite and make a recommendation on the prospects of holding investments in Chemalite.

Key Points

Zero liabilities
Positive net income
Negative cash flow from operating activities
Cash invested in business
Falling bank account balance
Start up expenses already incurred
Net income understates potential of business
Lifetime of patent

Zero liabilities. Chemalite financed all of its start up costs through money contributed by the initial investors. Furthermore, it did not need any outside financing for operations during its first year. Therefore, the only claims on Chemalite’s assets are the investors.

Positive net income. It is common for a business to loose money during its first year because of startup costs. However, despite these costs and only selling products for half of its first year, Chemalite had a net income of 39,375.

Negative cash flow from operating activities. Although Chemalite had retained earnings, it had negative cash flow from operating activities because it sold on account. There is no reason to assume this account will not be paid, and therefore this negative cash flow is not concerning in terms of income.

Cash invested in business. The cash flow statement indicates that Chemalite used its cash to invest in the business. Chemalite spent $212,500 on equipment for producing Chemalites.

Falling bank account balance. Some investors were worried that Chemalite was loosing money (not making a profit) because the bank account balance was steadily falling. While a positive net income tells us this is not true, the falling bank account balance is still cause for some concern and needs to be...
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