Lisa Gish is preparing for a meeting with her banker. Her business is finishing

Question

Lisa Gish is preparing for a meeting with her banker. Her business is finishing its fourth year of operations. In the first year, it had negative cash flows from operations. In the second and third years, cash flows from operations were positive. However,inventory costs rose significantly in year 4, and cash flows from operations will probably be down 25%. Gish wants to secure a line of credit from her bankers as a financing buffer. From experience, she knows the banker will scrutinize operating cash flows for years 1 through 4 and will want a projected number for year 5. Gish knows that a steady progression upward in operating cash flows for years 1 through 4 will help her case. She decides to use her discretion as owner and considers several business actions that will turn her operating cash flow in year 4 from a decrease to an increase over year 3. <?XML:NAMESPACE PREFIX = O />

1. Identify two business actions Gish might take to improve cash flows from operations.

2. Comment on the ethics and possible consequences of Gish's decision to pursue these actions.

Explanation / Answer

Here's some things Gish might do.

She could cut her salary. If the business is very small she might take a pay cut an increase the operating cash flow. This is within her discretion but it is a bit misleading because it might not reflect the normal operation of the company.

Gish could change from a FIFO (first in first out) system of accounting for inventory to a LIFO (last in first out) system and then restate the prior years earnings. The change would cause the higher priced items to be expensed first and potentially reduce the inventory level on the balance sheet and cash flow statement. It would moderate the affect of the inventory cost increase on the latest results.

Banks expect financial statements to reflect the normal operation of a business. If Gish takes either of these actions just to get a loan, it might be considered unethical or illegal. In the extreme, if it could be proven that Gish is intentionally trying to deceive bank officials, it could be considered fraud.

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