Why subtract Asset buildup
Philip Morris is very excited because sales for his clothing company was expected to double from $500,000 to $1,000,000 next year. Philip notes that net assets (assets – liabilities) will remain at 50 percent of sales. His clothing firm will enjoy a 9 percent return on total sales. He will start the year with $100,000 in the bank and is bragging about the two Mercedes he will buy and the European vacation he will take. Does his optimistic outlook for his cash position appear to be correct? Compute his likely cash balance or deficit for the end of the year. Start with beginning cash and subtract the asset buildup (equal to 50 percent of the sales increase) and add profit.
This is the answer:
Beginning cash $100,000
Asset buildup (250,000) (1/2 × $500,000)
Profit 90,000 (9% × $1,000,000)
Ending cash ($60,000) Deficit
No. Cash will be in a deficit.
What I don't get is... why subtract asset buildup. What is that. It's not related to cash! It probably is really simple but I don't understand. Thanks