Statements of cash flows
Analysis & Interpretation
Problems
Note: For text book problems, refer to the ACF 201 Problems.xlsx
Review questions
Review Questions – Ch 05
1. Explain the information that a user can obtain from a cash flow statement that cannot be obtained from the current or comparative statements of financial position.
2. Many people preferred the direct method for cash flow preparation, but IAS 7 did not require it. Discuss possible reasons for allowing choice and the effectiveness of the IASB’s encouragement to companies to use the direct method.
3. A negative free cash flow is always a sign of a company in trouble. Discuss.
Problems
1. Ch 05 – Question 1 – Direct plc p.123
2. China Trading Company has just completed its first year of trading, to 31 August 20X9. The financial statements have been completed for taxation purposes, but a statement of cash flows was not included. Xin Huang, owner of China Trading Company, has provided you with the following information and asked you to prepare the statement of cash flows for the year.
DetailsCash Book
$
To open bank account40,000
Payments to suppliers978,300
Interest received5,400
Payments to staff545,000
Receipts from customers1,850,000
Drawings22,000
Sale of surplus office equipment8,000
Rent paid25,000
Purchase of Ford van33,500
Loan from owner25,000
Advertising5,000
Taxes paid109,000
PAYE paid136,250
Telephone and tolls3,500
Office expenses14,600
3.Your friend Freddie, the owner of Freddie’s Fashions Ltd, tells you that profits from his first year of trading were $450,000, but the bank balance is just $7,800. He does not understand why there is such a large difference between the profits and bank balance, and has asked you to explain the reasons to him. What would you tell him?
- Ch 05 - Question 7 Maytix – p.129
Review Questions – Ch 27
1.Explain:
(i) Basic earnings per share
(ii) Fully diluted earnings per share
(iii) Potential ordinary shares and
(iv) Limitations of EPS as a performance measure.
2.Why are issues at full market value treated differently from rights issues?
- Income smoothing describes the management practice of maintaining a steady profit figure.Explain why managers might wish to smooth the earnings figure. Give three examples of how they might achieve this.
4.Explain the relationship between EPS and the price/earnings (P/E) ratio. Why may the P/E ratio be considered important as a stock market indicator?
Problem
- Ch27 Question 1 – Alpha plc – p.699
Review Questions – Ch 28
1. (a) Explain the uses and limitations of ratio analysis when used to interpret the published financial accounts of a company.
(b) State and express two ratios that can be used to analyse each of the following:
(i) profitability
(ii) liquidity
(iii) management control.
(c)Explain briefly points which are important when using ratios to interpret accounts under each of the headings in (b) above.
2.Discuss why a company might decide to report EBITDA in addition to operating profit.
3.Discuss why an increasing current ratio might not be an indicator of better working capital management.
Problems
1Ch 28 Question 4 – Saddam Ltd – p.734
2
2.The following are the accounts of Kaiyuan Gongchengxue, a company that manufactures playground equipment,for the year ended 30 November 20X6.
Statements of comprehensive income for years ended 30 November
20X6 20X5
$000 $000
Earnings before interest and tax (EBIT)4,4003,140
Interest expense340300
Profit before tax4,0602,840
Taxation1,4601,040
Profit after tax2,6001,800
Dividends paid500500
Retained profit2,1001,300
Statements of financial position as at 30 November 20X6
20X620X5
$000 $000
Non-current assets (written-down value)12,70011,200
Current assets
Inventories4,2004,140
Accounts Receivable 3,4203,080
Total assets20,32018,420
Current liabilities
Accounts payable2,0802,260
Taxation1,100900
Bank overdraft740960
Total assets less current liabilities16,40014,300
Non-current liabilities
10% debentures 20X7/20X83,0003,000
Net assets13,40011,300
Capital and reserves
Share capital: ordinary shares of 50cents fully paid6,0006,000
Share premium1,5001,500
Retained earnings5,9003,800
13,40011,300
The directors are consideringtwo schemesto raise $6,000,000 in orderto repaythe debentures andfinance expansion estimated to increase profit before interest and tax by $900,000. It is proposed tomake a dividend of 6 cents per share whether funds are raised by equity or loan. The two schemes are:
1.an issue of 13% debentures redeemable in 30 years;
2.a rights issue at $1.50 pershare. The current market price is $1.80 pershare (20X5: $1.50; 20X4: $1.20).
Required:
(a)Calculate the return on equity and any three investment ratios of interest to a potential shareholder.
(b)Calculate three ratios of interest to a potential long-term lender.
(c)Report briefly on the performance and state of the business from the viewpoint of a potentialshareholder and lender using the ratios calculated above and explain any weaknesses in theseratios.
(d)Advise management which scheme they should adopt on the basis of your analysis above andexplain what other information may need to be considered when making the decision.
Review Questions – Ch 29
- Explain what you would look for when examining a company’s common-sized statement of financial position.
- Discuss the difficulties when attempting to identify comparator companies for benchmarking as, for example, when comparing relative performance with competitors.
Problems
- Ch 29 Question 2 – Amalgamated Engineering – p.774
- Ch 10 Anal&Interp Handout Exercise 5 –Wholesale Distributors Ltd – p.320 of handout