Statement of Cash Flows, accounting homework help

John
Young is a new assistant controller at Richmond Electronics, a large
regional consumer electronics chain. Before John’s recruitment, he was
aware of Richmond’s long trend of moderate profitability. The reports on
his desk confirm the slight, but steady, improvements in net income in
recent years. The issue he is facing as he reviews the reports is the
decline and erratic trend in cash flows from operations.

John sketched the following comparison ($ in millions):

His
sketch shows increasing profits but an ominous trend in cash flow,
which is consistently lower than net income. Upon closer review, Ben
noticed three events in the last two years that, unfortunately, seemed
related:

1. Richmond loosened its credit policy. In other words, Richmond relaxed its credit terms and lengthened payment periods.
2. Accounts receivable balances increased dramatically.
3. Several of the company’s compensation
   arrangements, including that of the controller and the company
   president, were based on reported net income.

What is so ominous about the combination of events John sees? If you were John, what course of action will you take?