MBA604_Financial Reporting and Analysis

Financial Statement Analysis III 245 (d) Sundry Creditors Creditors Turnover Ratio Credit Purchases = Closing Creditors Bills Payables 24,30,000 6 = Closing Creditors 10,000 Closing Creditors = ` 3,95,000 Note: Creditors velocity of 2 months implies that Creditors turnover ratio will be 6 (12/2). Credit Purchases have been calculated as follows: Cost of Goods Sold = Opening Stock + Purchases (assumed all on credit basis) — Closing Stock 24,00,000 = 15,85,000 + Purchases – 16,15,000 Purchases = ` 24,30,000 Problem 9. The capital of Era Co. Ltd is as follows: Equity Share capital (1,60,000 @ ` 10 each) 16,00,000 9% Preference Share capital (6,000 @ ` 100 each) 6,00,000 22,00,000 The accountant has ascertained following information: Profit (after tax at 30%) ` 5,40,000 Depreciation ` 12,000 Equity Dividend Paid 30% Market Price of equity share ` 80 You are required to calculate: (a) Dividend Yield on equity shares (b) Cover for the preference and equity dividends (c) Earnings for Equity Shares (d) Price-earnings ratio Solution: Dividend per share 3(30% of 10) Dividend Yield on equity shares = Market price per share = 80 = 3.75 CU IDOL SELF LEARNING MATERIAL (SLM)

246 Financial Reporting and Analysis Cover for preference dividends Pr ofit after tax Cover for equity dividends = Dividend payable to preference shareholders 5, 40, 000 = 54,000 = 10 times Pr ofit after tax – Pr eference Dividends = Dividend Payable to equity shareholders 5,40,000 – 54,000 = 1,60,000 3 = 1.1025 times Earnings for equity shares Earnings available to equity shareholders = Number of equity shares outs tanding 4, 86, 000 = 1,60,000 = ` 3.04 per share Price-earnings ratio Market price per share 80 = Earnings per share = 3.04 = 26.32 times Problem 10. With the help of the following ratios of Indu Films, calculate current liabilities, inventories, trade receivables, cash, fixed assets and current assets. Current Ratio 2.5 Liquidity Ratio 1.5 Net Working Capital ` 3,00,000 Stock Turnover Ratio (cost of sales/ closing stock) 6 times Gross Profit Ratio 20 percent Fixed Assets Turnover Ratio (on cost of sales) 2 times Debt Collection Period 2 months Fixed Assets to Shareholders’ Net Worth 0.80 Solution: Net Working Capital = Current Assets – Current Liabilities Current assets Current Ratio Current Assets = Current Liabilities = 2.5 Hence, = 2.5 Current Liabilities Net Working Capital = 2.5 Current Liabilities – Current Liabilities 3,00,000 = 1.5 Current Liabilities CU IDOL SELF LEARNING MATERIAL (SLM)

Financial Statement Analysis III 247 Current Assets = 2.5 Current Liabilities = 5,00,000 Liquid assets ratio Liquid assets Liquid Assets = Current Liabilities = 1.5 = 3,00,000 Inventories = Current Assets – Liquid Assets Stock turnover ratio = 5,00,000 – 3,00,000 = ` 2,00,000 Cost of sales = 6 times (cost of sales/closing stock) = 6 × 2,00,000 = ` 12,00,000 Sales = 12,00,000 + (12,00,000 × 20/80) = ` 15,00,000 Debtors Turnover = Sales/Closing Debtors 12/12 (Debt Collection Period) = 15,00,000/Closing Debtors Closing Debtors = ` 2,50,000 Cash = Current Assets – Stock – Debtors = ` 50,000 Fixed Assets Turnover Ratio (on cost of sales) = 2 times Cost of Sales/Fixed Assets =2 Fixed Assets = 12,00,000/2 = ` 6,00,000 Problem 11. Calculate current assets, liquid assets, current liabilities and stock from the followim information: Current Ratio 2.6 Liquidity Ratio 1.4 Net Working Capital ` 3,30,000 Solution: Calculation of Current Assets and Current Liabilities: Working Capital = Current Assets – Current Liabilities Current Assets Current Ratio = Current Liabilities = 2.6 : 1 Working Capital = Current Assets – Current Liabilities Working Capital = 2.6 Current Liabilities – Current Liabilities = 1.6 Current Liabilities CU IDOL SELF LEARNING MATERIAL (SLM)

248 Financial Reporting and Analysis Working Capital (Given) = 3,30,000 1.6 Current Liabilities = 3,30,000 Current Liabilities = ` 2,06,250 Current Assets = 2.6 × ` 2,06,250 = ` 5,36,250 Calculation of Liquid Assets: Liquid Ratio (Given) = 1.4 Liquid Assets Liquid Ratio = Current Liabilities Liquid Assets = 2,06,250 × 1.4 = ` 2,88,750 Liquid Assets = Current Assets – (Stock + Prepaid Expenses) Stock = Current Assets – Liquid Assets (Assuming nil prepaid expenses) = ` 2,47,500 Problem 12. From the following information given below, you are required to calculate Operating Profit Ratio: Gross Sales ` Sales Return 11,70,000 Opening Stock Closing Stock 90,000 Purchases 45,000 Office and Administrative Expenses 54,000 Selling and Distribution Expenses 7,38,000 90,000 72,000 Solution: Operating Pr ofit Operating Profit Ratio = Net Sales × 100 Operating Profit = Net Sales – Total Operating Cost Net Sales = Gross Sales – Sales Return Total Operating Cost = 11,70,000 – 90,000 = ` 10,80,000 = Cost of Goods Sold + Office and Administrative Expenses + Selling and Distribution Expenses CU IDOL SELF LEARNING MATERIAL (SLM)

Financial Statement Analysis III 249 Cost of Goods Sold = Opening Stock + Purchase – Closing Stock = 45,000 + 7,38,000 – 54,000 = ` 7,29,000 Total Operating Expenses = 7,29,000 + 90,000 + 72,000 = ` 8,91,000 Operating Profit = Net Sales – Total Operating Expenses = 10,80,000 – 8,91,000 = ` 1,89,000 Operating Profit Ratio 1, 89, 000 = 10,80,000 × 100 = 17.5% Problem 13. Calculate Return on Shareholders’ Investment Ratio from the following information : 5,000 Equity shares @ of ` 100 each ` 20,000, 15% preference share @ of ` 50 each 5,00,000 Reserves and Surplus 10,00,000 Net Profit before Interest and Tax 2,50,000 Interest on Loan 5,00,000 Taxes 1,00,000 15,000 Solution: = Profit after int erest and tax × 100 Return on Shareholders’ Investment Shareholders’ Investment Capital Employed Net Profit after Interest and Taxes = Equity Share Capital + Preference Share Capital + Reserves and Surplus – Return on Shareholders' Investment Accumulated Losses = 5,00,000 + 10,00,000 + 2,50,000 = ` 17,50,000 = Net Profit before Interest and Tax – Interest on Loan – Taxes = 5,00,000 – 1,00,000 – 15,000 = 2,50,000 2, 50, 000 = 17,50,000 × 100 = 14.28% CU IDOL SELF LEARNING MATERIAL (SLM)

250 Financial Reporting and Analysis Problem 14. Compute: (a) Earnings per share (b) Dividend Yield Ratio (when dividend payout is not given) (c) Price Earnings Ratio from the following information: ` 9,00,000 Net profit before tax ` 95 Market Price Per Equity Share Number of Equity Shares 90,000 Provision for Tax ` 1,50,000 Preference Dividend ` 90,000 Solution: Earnings available to equity shareholders Earnings for equity shares = Number of equity shares outs tanding 6, 60, 000 = 90,000 = ` 7.33 per share Dividend yield on equity shares Earnings per share 7.33 Price-earnings ratio = Market price per share = 95 = 7.716% Market price per share 95 = Earnings per share = 7.33 × 100 = 12.96 times 8.4 Concept A cash flow statement discloses net increase (or decrease) in cash during an accounting period. As per AS-3 (Revised), the objective of cash flow statement is to provide information about cash flows of an enterprise which is useful in providing the users of financial statements a basis to assess the ability of an enterprise to generate cash and cash equivalents to utilise those cash flows. The statement deals with the provisions of information about the changes in cash and cash equivalents during the accounting year. It classifies cash flows into operating, investing and financing activities. It is significant to note that AS-3 is titled ‘Cash Flow Statement’ whereas Ind AS-7, issued in February 2015, is titled ‘Statement of Cash Flows’. However, contents of both the standards are almost identical. CU IDOL SELF LEARNING MATERIAL (SLM)

Financial Statement Analysis III 251 8.5 Definitions in Ind AS-7 ‘Statement of Cash Flow’ The following terms are used in this Statement with the meanings specified: Cash comprises cash on hand and demand deposits with banks. Cash equivalents are short-term, highly liquid investments that are readily convertible into known amounts of cash and which are subject to an insignificant risk of changes in value. Cash flows are inflows and outflows of cash and cash equivalents. Operating activities are the principal revenue-producing activities of the enterprise and other activities that are not investing or financing activities. Investing activities are the acquisition and disposal of long-term assets and other investments not included in cash equivalents. Financing activities are activities that result in changes in the size and composition of the owners’ capital (including preference share capital in the case of a company) and borrowings of the enterprise. Cash and Cash Equivalents 1. Cash equivalents are held for the purpose of meeting short-term cash commitments rather than for investment or other purposes. For an investment to qualify as a cash equivalent, it must be readily convertible to a known amount of cash and be subject to an insignificant risk of changes in value. Therefore, an investment normally qualifies as a cash equivalent only when it has a short maturity of, say, three months or less from the date of acquisition. Investments in shares are excluded from cash equivalents unless they are, in substance, cash equivalents; for example, preference shares of a company acquired shortly before their specified redemption date (provided there is only an insignificant risk of failure of the company to repay the amount at maturity) 2. Cash flows exclude movements between items that constitute cash or cash equivalents because these components are part of the cash management of an enterprise rather than part of its operating, investing and financing activities. Cash management includes the investment of excess cash in cash equivalents. Classification of Cash Inflows and Outflows A cash flow statement focuses on various activities and items which bring about changes in the cash balance between two balance sheet dates. This statement covers all items which increase or decrease the cash of a business enterprise. For example, this statement includes items like receipts from debtors and payments to creditors. On the contrary, this statement will not cover items which have no immediate effect on cash increase or decrease. For instance, goods purchased on credit and goods sold on credit will not be included in this statement as these transactions have no effect on inflow and outflow of cash. CU IDOL SELF LEARNING MATERIAL (SLM)

252 Financial Reporting and Analysis A cash flow statement aims to determine the effects on cash of different types of cash inflows and outflows. In this process, all cash flows, i.e., activities resulting into cash flows are classified into different categories. The ICAI’s AS-3 ‘Cash Flow Statement’ has classified cash flows into three categories: I. Operating Activities (or Flows) II. Investing Activities (or Flows) III. Financial Activities (or Flows) Figure 8.1 displays the classification of cash inflows and cash outflows relating to operating activities, investing activities and financing activities. Cash Inflows Activities Cash Outflows Cash payments for goods and services, Cash received from debtors for goods and Operating merchandise services Activities Cash payments for wages Interest and dividends on loans and investment Cash payments for interest to creditors Cash sales of property, plant, equipment, Investing Payments to government for taxes other long-term assets, and intangibles Activities Payments to others for expenses Cash sales of investments in shares, debentures and other securities Purchase of shares, debentures and securities of other enterprises Cash collection (loan repayments) from borrowers Purchase of property, plant, equipment and other long-term assets Loans given to other firms Proceeds from issue of shares Financing Repayment of loans Proceeds from short-term and long-term debt Activities Payment to owners, including cash dividend Reacquiring preference or equity shares Figure 8.1: Classification of Cash Inflows and Outflows Relating to Operating Activities, Investing Activities and Financing Activities CU IDOL SELF LEARNING MATERIAL (SLM)

Financial Statement Analysis III 253 I. Operating Activities: Operating activities are those transactions which are considered in the determination of net income. Examples of cash inflows in this category are cash received from debtors for goods and services, interest and dividend received on loans and investment. Examples of cash outflows in this category are cash payments for goods and services, merchandise, wages, interest, taxes, supplies and others. Classification of Cash Inflows and Cash Outflows: AS-3 Cash Flow Statement states: (i) The amount of cash flows arising from operating activities is a key indicator of the extent to which the operations of the enterprise have generated sufficient cash flows to maintain the operating capability of the enterprise, pay dividends, repay loans and make new investments without recourse to external source of financing. Information about the specific components of historical operating cash flows is useful, in conjunction with other information, in forecasting future operating cash flows. (ii) Cash flows from operating activities are primarily derived from the principal revenue producing activities of the enterprise. Therefore, they generally result from the transactions and other events that enter into the determination of net profit or loss. Examples of cash flows from operating activities are: (a) cash receipts from the sale of goods and the rendering of services; (b) cash receipts from royalties, fees, commissions and other revenue; (c) cash payments to suppliers for goods and services; (d) cash payments to and on behalf of employees; (e) cash receipts and cash payments of an insurance enterprise for premiums and claims, annuities and other policy benefits; (f) cash payments or refunds of income taxes, unless they can be specifically identified with financing and investing activities; and (g) cash receipts and payments relating to future contracts, forward contracts, option contracts and swap contracts when the contracts are held for dealing or trading purposes. (iii) Some transactions, such as the sale of an item of plant, may give rise to a gain or loss which is included in the determination of net profit or loss. However, the cash flows relating to such transactions are cash flows from investing activities. (iv) Cash flows from operating activities are determined according to the activities relating to the business in which the enterprise deals in, e.g., interest and dividend received by financial institutions will be treated as operating cash flow. CU IDOL SELF LEARNING MATERIAL (SLM)

254 Financial Reporting and Analysis Similarly, an enterprise may hold securities and loans for dealing or trading purposes, in which case they are similar to inventory acquired specifically for resale. Therefore, cash flows arising from the purchase and sale of dealing or trading securities are classified as operating activities. In the same manner, cash advances and loans made by finance enterprises are usually classified as operating activities since they relate to the main revenue-producing activity of that enterprise. Operating ActiviteisInd AS-7 provides the following on reporting cash flows from operating activities: 1. An entity shall report cash flows from operating activities using either: (a) the direct method, whereby major classes of gross cash receipts and gross cash payments are disclosed; or (b) the indirect method, whereby profit or loss is adjusted for the effects of transactions of a non-cash nature, any deferrals or accruals of past or future operating cash receipts or payments, and items of income or expense associated with investing or financing cash flows. 2. Entities are encouraged to report cash flows from operating activities using the direct method. The direct method provides information which may be useful in estimating future cash flows and which is not available under the indirect method. Under the direct method, information about major classes of gross cash receipts and gross cash payments may be obtained either: (a) from the accounting records of the entity; or (b) by adjusting sales, cost of sales (interest and similar income and interest expense and similar charges for a financial institution) and other items in the statement of profit and loss for: (i) changes during the period in inventories and operating receivables and payables; (ii) other non-cash items; and (iii) other items for which the cash effects are investing or financing cash flows. 3. Under the indirect method, the net cash flow from operating activities is determined by adjusting profit or loss for the effects of: (a) changes during the period in inventories and operating receivables and payables; (b) non-cash items such as depreciation, provisions, deferred taxes, unrealised foreign currency gains and losses, and undistributed profits of associates; and (c) all other items for which the cash effects are investing or financing cash flows. CU IDOL SELF LEARNING MATERIAL (SLM)

Financial Statement Analysis III 255 Alternatively, the net cash flow from operating activities may be presented under the indirect method by showing the revenues and expenses disclosed in the statement of profit and loss and the changes during the period in inventories and operating receivables and payables. II. Investing Activities: Investing activities include acquisition of long-term or fixed assets; disposal of long-term or fixed assets; acquisition and disposal of intangible assets; purchase and sale of shares, debentures and other securities; lending of money and its subsequent collection. Cash inflows from investing activities generally include cash sales of property, plant, equipment and intangible assets, cash sales of investments in shares, debentures and other securities, cash collection (loan repayments) from borrowers. Cash outflows are purchase of shares, debentures and securities of other enterprises, purchase of property, plant, equipment and other long-term assets, loan given to other firms. According to AS-3 Cash Flow Statement: (i) The separate disclosure of cash flows arising from investing activities is important because the cash flows represent the extent to which expenditures have been made for resources intended to generate future income and cash flows. Examples of cash flows arising from investing activities are: (a) Cash payments to acquire fixed assets (including intangibles). These payments include those relating to capitalised research and development costs and self constructed fixed assets; (b) Cash receipts from disposal of fixed assets (including intangibles); (c) Cash payments to acquire shares warrants or debt instruments of other enterprises and interests in joint ventures (other than payments for those instruments considered to be cash equivalents and those held for dealing or trading purposes); (d) Cash receipts from disposal of shares, warrants or debt instruments of other enterprises and interests in joint ventures (other than receipts from those instruments considered to be cash equivalents and those held for dealing or trading purposes); (e) Cash advances and loans made to third parties (other than advances and loans made by a financial enterprise); (f) Cash receipts from the repayment of advances and loans made to third parties (other than advances and loans of a financial enterprise); (g) Cash payments from future contracts, forward contracts, option contracts and swap contracts except when the contracts are held for dealing or trading purposes, or the payments are classified as financing activities; and CU IDOL SELF LEARNING MATERIAL (SLM)

256 Financial Reporting and Analysis (h) Cash receipts from future contracts, forward contracts, option contracts and swap contracts except when the contracts are held for dealing or trading purposes, or the receipts are classified as financing activities. (ii) When a contract is accounted for as a hedge of an identifiable position, the cash flows of the contract are classified in the same manner as the cash flow of the position being hedged. III. Financing Activities: Financing activities relate to long-term liability and equity capital. A firm engages in financing activities when it obtains resources from owners, returns resources to owners, borrows resources from creditors and repays amounts borrowed. Cash inflows include proceeds from issue of shares and short-term and long-term borrowings. Cash outflows include repayment of loans and payments to owners, including cash dividends. Repayments of accounts payable or accrued liabilities are not considered repayment of loans under financing activities but are classified as cash outflows under operating activities. AS-3 Cash Flow Statement observes: The separate disclosure of cash flows arising from financing activities is important because it is useful in predicting claims on future cash flows by providers of funds (both capital and borrowings) to the enterprise. Examples of cash flows arising from financing activities are: (a) cash proceeds from issuing shares or other similar instruments; (b) cash proceeds from issuing debentures, loans, notes, bonds, and other short- or long-term borrowings; and (c) cash repayments of amounts borrowed. Provisions of AS-3 on Treatment of Certain Items 1. Interest and Dividend Cash flows from interest and dividends received and paid should be disclosed separately and classified on the basis of nature of the enterprise as shown below: For Financial Enterprises • Interest paid and received, dividend received as operating activities. • Dividend paid as financing activities. For Other Enterprises • Interest and dividend received as investing activities. • Interest and dividend paid as financing activities. CU IDOL SELF LEARNING MATERIAL (SLM)

Financial Statement Analysis III 257 2. Extraordinary items The cash flows associated with extraordinary items should be classified as arising from operating, investing or financing activities as appropriate. It should be disclosed separately. Few examples of such items are: (i) Claim for loss of Stock — Operating activity (ii) Claims for loss of assets — Investing activity (iii) Recovery of bad debts — Operating activity (iv) Damages paid/received for breach of contract — Operating activity (v) Winnings from lotteries — Investing activity (vi) Cost of legal action to protect property title — Investing activity. 3. Taxes on Income Cash flows arising from taxes on income should be separately disclosed and should be classified as cash flows from operating activities unless they can be specifically identified with financing and investing activities. For instance: (i) Provision for taxation for the current year — Non-cash charge under operating activity (ii) Tax paid — Operating cash outflow (iii) Income tax refund — Cash inflow from operating activity (iv) Capital gains tax — Cash outflow from investing activity (v) Corporate dividend tax — Cash outflow from financing activity. 4. Foreign Currency Cash Flows Foreign currency cash flows should be converted at the exchange rate of the date of cash flow. Exchange gain/loss on cash and cash equivalents held in foreign currency will be reported as part of reconciliation of change in cash and cash equivalents for the period and hence, not reported in cash flow statement. 5. Non-cash Transactions Investing and financing transactions that do not require the use of cash or cash equivalents are not shown in the cash flow statement. Examples of such non cash transactions are: (i) Issue of shares or debentures for a consideration other than cash, i.e., against building, machinery, etc. (ii) Conversion of debentures into equity shares. (iii) Purchase of business by issue of shares. CU IDOL SELF LEARNING MATERIAL (SLM)

258 Financial Reporting and Analysis AS-3 (Revised) recommends that such transactions may be disclosed under footnote to cash flow statement. 6. Investments in Subsidiaries, Associates and Joint Venture Acquisition of interest in any subsidiary, associates or in any joint venture is treated as ‘Investing Activity”. Similarly, sale or disposal of such interest and receipt of interest or dividends on such investments is treated as “Investing Activity”. 8.6 Presentation of Cash Flow Statement A cash flow statement can be presented in either the direct or indirect format. The investing and financing sections will be the same under either format. However, the operating section will be different. ABC Company for the Year Ended 31st December, 2016 Particulars `` (A) Cash Flow from Operating Activities Cash Receipts from: Sales Interest Received Cash Payments for: Purchases Operating Expenses Interest Payments Income Taxes Net Cash Flow from Operating Activities (B) Cash Flows from Investing Activities: Sale of Plant Assets Sale of Investments Purchase of Plant Assets Purchase of Investments Net Cash Flows Used by Investing Activities (C) Cash Flows from Financing Activities: Repayment of Bonds and Debentures Issue of Common Shares Dividends Paid Net Cash Flows from Financing Activities Net Increase (Decrease) in Cash Figure 8.3: Cash Flow Statement (Direct Method) CU IDOL SELF LEARNING MATERIAL (SLM)

Financial Statement Analysis III 259 ABC Company for the Year Ended 31st December, 2016 Particulars ` ` (A) Cash Flow from Operating Activities Net Income Adjustments to Reconcile Net Income to Net Cash provided by Operating Activities: Depreciation Gain on Sale of Investments Loss on Sale of Plant Asset Decrease in Accounts Receivable Increase in Inventory Decrease in Prepaid Expenses Increase in Accounts Payable Increase in Accrued Liabilities Decrease in Income Taxes Payable Net Cash Flow from Operating Activities (B) Cash Flows from Investing Activities: Sale of Plant Assets Sale of Investments Purchase of Plant Assets Purchase of Investments Net Cash Flows Used by Investing Activities (C) Cash Flows from Financing Activities: Repayment of Bonds and Debentures Issue of Common Shares Dividends Paid Net Cash Flows from Financing Activities Net Increase (Decrease) in Cash Figure 8.4: Cash Flow Statement (Indirect Method) 8.7 Steps in Preparing the Cash Flow Statement The preparation of the cash flow statement uses data from both the income statement and the comparative balance sheets. As noted earlier, companies often only disclose indirect operating cash flow information, whereas analysts prefer direct—format information. Understanding how cash flow information is put together will enable you to take an indirect statement apart and reconfigure it in a more useful manner. The result is an approximation of a direct cash flow statement, which—while not perfectly accurate— can be helpful to an analyst. The following demonstrates how direct cash flow statement is prepared using the income statement and the comparative balance sheets for ABC Company, a fictitious company, shown here in Fig. 8.5 and Fig. 8.6. CU IDOL SELF LEARNING MATERIAL (SLM)

260 Financial Reporting and Analysis ABC Company Income Statement for the Year Ended 31 December 2016 Particulars ` ` ` 23,598 Revenue ` 4,123 Cost of goods sold 1,052 11,456 Gross profit 3,577 12,142 Salary and wage expense Depreciation expense 205 8,752 Other operating expenses (246) 3,390 Total operating expenses Operating profit (41) Other revenues (expenses): 3,349 Gain on sale of equipment 1,139 Interest expense ` 2,210 Income before tax Income tax expense Net Change Net income ` (152) Figure 8.5 55 707 ABC Company Comparative Balance Sheets (23) 31 December 2016 and 2015 587 Particulars 2016 2015 _ _ Cash ` 1,011 ` 1,163 243 Accounts receivable 1,012 957 (552) Inventory 3,984 (309) Prepaid expenses 155 3,277 ` 278 178 ` 263 Total current assets 6,162 10 Land 510 5,575 Buildings 510 Equipment* 3,680 Less: Accumulated depreciation 8,798 3,680 (3,443) 8,555 Total long-term assets (2,891) Total assets 9,545 ` 15,707 9,854 Accounts payable ` 15,429 Salary and wage payable ` 3,588 85 ` 3,325 75 CU IDOL SELF LEARNING MATERIAL (SLM)

Financial Statement Analysis III 261 Interest payable 62 74 (12) Income tax payable 55 50 5 Other accrued liabilities 1,126 1,104 22 Total current liabilities 4,916 4,628 288 Long-term debt 3,075 3,575 (500) Common equity 3,750 4,350 (600) Retained earnings 3,966 2,876 1,090 Total liabilities and equity ` 15,707 ` 15,429 ` 278 Figure 8.6 *During 2016 the company purchased new equipment for a total cost of ` 1,300. No Items impacted retained earnings other than net income and dividends. Solution: The first step in preparing the cash flow statement is to determine the total cash flows from operating activities. The direct method of presenting cash from operating activities is illustrated below. Further is given the indirect method of presenting cash flows from operating activities. Cash flows from investing activities and from financing activities are identical under either method. Operating Activities: Direct Method We first determine how much cash ABC received from its customers, followed by how much cash was paid to suppliers and to employees as well as how much cash was paid for other operating expenses, interest, and income taxes. Cash Received from Customers: The income statement reported revenue of ` 23,598 for the year ended 31st December, 2016. To determine the approximate cash receipts from its customers, it is necessary to adjust this revenue amount by the net change in accounts receivable for the year. If accounts receivable increase during the year, revenue on an accrual basis is higher than cash receipts from customers, and vice versa. For ABC Company, accounts receivable increased by ` 55, so cash received from customers was ` 23,543, as follows: Revenue ` 23,598 Less: Increase in accounts receivable (55) Cash received from customers ` 23,543 CU IDOL SELF LEARNING MATERIAL (SLM)

262 Financial Reporting and Analysis Cash received from customers affects the accounts receivable account as follows: Beginning accounts receivable ` 957 Plus revenue 23,598 Minus cash collected from customers (23,543) Ending accounts receivable ` 1,012 The accounts receivable account information can also be presented as follows: Beginning accounts receivable ` 957 Plus revenue 23,598 Minus ending accounts receivable (1,012) Cash collected from customers ` 23,543 Cash received from customers” is sometimes referred to as “cash collections front customers” or “cash collections.” Cash Paid to Suppliers: For ABC Co., the cash paid to suppliers was ` 11,900, determined as follows: Cost of goods sold ` 11,456 Plus: Increase in inventory 707 Equals purchases from suppliers ` 12,163 Less: Increase in accounts payable (263) Cash paid to suppliers ` 11,900 There are two pieces to this calculation: the amount of inventory purchased and the amount paid for it. To determine purchases from suppliers, cost of goods sold is adjusted for the change in inventory. If inventory increased during the year, then purchases during the year exceeded cost of goods sold, and vice versa. The company reported cost of goods sold of ` 11,456 for the year ended 31st December 2016. Inventory increased by ` 707. So, purchases from suppliers was ` 12,163. Purchases from suppliers affect the inventory account, as shown below: Beginning inventory ` 3,277 Plus purchases 12,163 Minus cost of goods sold (11,456) Ending inventory ` 3,984 CU IDOL SELF LEARNING MATERIAL (SLM)

Financial Statement Analysis III 263 The company purchased ` 12,163 of inventory from suppliers in 2016 but is this the amount of cash that was paid to its suppliers during the year? Not necessarily. The company may not have yet paid for all of these purchases and may yet owe for some of the purchases made this year. In other words, the company may have paid less cash to its suppliers than the amount of this year’s purchases, in which case liability (accounts payable) will have increased by the difference. Alternatively, the company may have paid even more to its suppliers than the amount of this year’s purchases, in which case accounts payable will have decreased. Therefore, once purchases have been determined, cash paid to suppliers can be calculated by adjusting purchases for the change in accounts payable. If the company made all purchases with cash, then accounts payable would not change and cash outflows would equal purchases. If accounts payable increased during the year, then purchases on an accrual basis would be higher than they would be on a cash basis, and vice versa. In this example, the company made more purchases than it paid in cash. So, the balance in accounts payable increased. The cash paid to suppliers was ` 11,900, determined as follows: Purchases from suppliers ` 12,163 Less: Increase in accounts payable (263) Cash paid to suppliers ` 11,900 The amount of cash paid to suppliers is reflected in the accounts payable account, as shown below: Beginning accounts payable ` 3,325 Plus purchases 12,163 Minus cash paid to suppliers (11,900) Ending accounts payable ` 3,588 Cash Paid to Employees: To determine the cash paid to employees, it is necessary to adjust salary and wages expense by the net change in salary and wages payable for the year. If salary and wages payable increased during the year, then salary and wages expense on an accrual basis would be higher than the amount of cash paid for this expense, and vice versa. Salary and wages payable increased by ` 10, so cash paid for salary and wages was ` 4,113, as follows: Salary and wage expense ` 4,123 Less: Increase, in salary and wage payable (10) Cash paid to employees ` 4,113 CU IDOL SELF LEARNING MATERIAL (SLM)

264 Financial Reporting and Analysis The amount of cash paid to employees is reflected in the salary and wages payable account, as shown below: Beginning salary and wages payable ` 75 Plus salary and wage expense 4,123 Minus cash paid to employees (4,113) Ending salary and wages payable ` 85 Cash Paid for Other Operating Expenses: To determine the cash paid for other operating expenses, it is necessary to adjust the other operating expenses amount on the income statement by the net changes in prepaid expenses and accrued expense liabilities for the year. If prepaid expenses increased during the year, other operating expenses on a cash basis would be higher than on an accrual basis, and vice versa. Likewise, if accrued expense liabilities increased during the year, other operating expenses on a cash basis would be lower than on an accrual basis, and vice versa. For ABC Co., the amount of cash paid for operating expenses in 2016 was ` 3,532, as follows: Other operating expenses ` 3,577 Less: Decrease in prepaid expenses (23) Less: Increase in other accrued liabilities (22) Cash paid for other operating expenses ` 3,532 Cash Paid for Interest: To determine the cash paid for interest, it is necessary to adjust interest expense by the net change in interest payable for the year. If interest payable increases during the year, then interest expense on an accrual basis will be higher than the amount of cash paid for interest, and vice versa. For ABC Co., interest payable decreased by ` 12, and cash paid for interest was ` 258, as follows: Interest expense ` 246 Plus: Decrease in interest payable 12 Cash paid for interest ` 258 Alternatively, cash paid for interest may also be determined by an analysis of the interest payable account, as shown below: Beginning interest payable ` 74 Plus interest expense 246 Minus cash paid for interest (258) Ending interest payable ` 62 CU IDOL SELF LEARNING MATERIAL (SLM)

Financial Statement Analysis III 265 Cash Paid for Income Taxes: To determine the cash paid for income taxes, it is necessary to adjust the income tax expense amount on the income statement by the net changes in taxes receivable, taxes payable, and deferred income taxes for the year. If taxes receivable or deferred tax assets increase during the year, income taxes on a cash basis will be higher than on an accrual basis, and vice versa. Likewise, if taxes payable or deferred tax liabilities increase during the year, income tax expense on a cash basis will be lower than on an accrual basis, and vice versa. For ABC Co., the amount of cash paid for income taxes in 2016 was ` 1,134, as follows: Income tax expense ` 1,139 Less: Increase in income tax payable (5) Cash paid for income taxes ` 1,134 Investing Activities The second and third steps in preparing the cash flow statement are to determine the total cash flows from investing activities and from financing activities. The presentation of this information is identical, regardless of whether the direct or indirect method is used for operating cash flows. Purchases and sales of equipment were the only investing activities undertaken by ABC Co. in 2016, as evidenced by the fact that the amounts reported for land and buildings were unchanged during the year. An informational note tells us that ABC Co. purchased new equipment in 2016 for a total cost of ` 1,300. However, the amount of equipment shown on balance sheet increased by only ` 243 (ending balance of ` 8,798 minus beginning balance of ` 8,555); therefore, ABC Co. must have also sold or otherwise disposed of some equipment during the year. To determine the cash inflow from the sale of equipment, we analyse the equipment and accumulated depreciation accounts as well as the gain on the sale of equipment. Assuming that the entire accumulated depreciation is related to equipment, the cash received from sale of equipment is determined as follows: The historical cost of the equipment sold was ` 1,057. This amount is determined as follows: Beginning balance equipment (from balance sheet) ` 8,555 Plus: Equipment purchased (from informational note) 1,300 Minus: Ending balance equipment (from balance sheet) (8,798) Equals: Historical cost of equipment sold ` 1,057 The accumulated depreciation on the equipment sold was ` 500, determined as follows: Beginning balance accumulated depreciation (from balance sheet) ` 2,891 Plus: Depreciation expense (from income statement) 1,052 Minus: Ending balance accumulated depreciation (from balance sheet) (3,443) Equals: Accumulated depreciation on equipment sold ` 500 CU IDOL SELF LEARNING MATERIAL (SLM)

266 Financial Reporting and Analysis The historical cost information, accumulated depreciation information, and information from the income statement about the gain on the sale of equipment can be used to determine the cash received from the sale. Historical cost of equipment sold (calculated above) ` 1,057 Less: Accumulated depreciation on equipment sold (calculated above) (500) Equals: Book value of equipment sold ` 557 Plus: Gain on sale of equipment (from the income statement) 205 Equals: Cash received from sale of equipment ` 762 Financing Activities As with investing activities, the presentation of financing activities is identical, regardless of whether the direct or indirect method is used for operating cash flows. Long-term Debt and Common Equity: The change in long-term debt, based on the beginning 2016 (ending 2015) and ending 2016 balances was a decrease of ` 500. Absent other information, this indicates that the Company retired ` 500 of long-term debt. Retiring long-term debt is a cash outflow relating to financing activities. Similarly, the change in common stock during 2016 was a decrease of ` 600. Absent other information, this indicates that the Company repurchased ` 600 of its common stock. Repurchase of common stock is also a cash outflow related to financing activity. Dividends Recall the following relationship: Beginning retained earnings + Net income – Dividends = Ending retained earnings Based on this relationship, the amount of cash dividends paid in 2016 can be determined from an analysis of retained earnings, as follows: Beginning balance of retained earnings (from the balance sheet) ` 2,876 Plus: Net income (from the income statement) 2,210 Minus: Ending balance of retained earnings (from the balance sheet) (3,966) Equals: Dividends paid ` 1,120 Note that dividends paid are presented in the statement of changes in equity. Overall Statement of Cash Flows Direct Method Figure 8.7 summarises the information about ABC Co.’s operating, investing, and financing cash flows in the statement of cash flows. At the bottom of the statement, the total net change in cash is shown to be a decrease of ` 152 (from ` 1,163 to ` 1,011). This decrease can also be seen on the comparative balance sheet in Figure 25.8. The cash provided by operating activities of CU IDOL SELF LEARNING MATERIAL (SLM)

Financial Statement Analysis III 267 ` 2,606 was adequate to cover the net cash used in investing activities of ` 538; however, the company’s debt repayments, cash payments for dividends, and repurchase of common stock (i.e., its financing activities) of ` 2,220 resulted in an overall decrease in cash of ` 152. Particulars `` Cash flow from operating activities: Cash received from customers ` 23,543 Cash paid to suppliers (11,900) Cash paid to employees (4,113) Cash paid for other operating expenses (3,532) Cash paid for interest Cash paid for income tax (258) Net cash provided by operating activities (1,134) Cash flow from investing activities: Cash received from sale of equipment 2,606 Cash paid for purchase of equipment Net cash used for investing activities 762 Cash flow from financing activities: (1,300) Cash paid to retire long-term debt Cash paid to retire common stock (538) Cash paid for dividends Net cash used for financing activities (500) Net increase (decrease) in cash (600) Cash balance, 31st December, 2015 (1,120) Cash balance, 31st December, 2016 (2,220) (152) 1,163 ` 1,011 Figure 8.7: ABC Co.’s Cash Flow Statement (Direct Method) for Year Ended 31st December, 2016 Overall Statement of Cash Flows: Indirect Method Using the alternative approach to reporting cash from operating activities, the indirect method, we will present the same amount of cash provided by operating activities. Under this approach, we reconcile ABC Company’s net income of ` 2,210 to its operating cash flow of ` 2606. To perform this reconciliation, net income is adjusted for the following: (a) any non-operating activities, (b) any non-cash expenses, and (c) changes in operating working capital items. CU IDOL SELF LEARNING MATERIAL (SLM)

268 Financial Reporting and Analysis The only non-operating activity in ABC Co.’s income statement, the sale of equipment, resulted in a gain of ` 205. This amount is removed from the operating cash flow section; the cash effects of the sale are shown in the investing section. The Company’s only non-cash expense was depreciation expense of ` 1,052. Under the indirect method, depreciation expense must be added back to net income because it was a non-cash deduction in the calculation of net income. Changes in working capital accounts include increases and decreases in the current operating asset and liability accounts. The changes in these accounts arise from applying accrual accounting; i.e., recognising revenues when they are earned and expenses when they are incurred instead of when the cash is received or paid. To make the working capital adjustments under the indirect method, any increase in a current operating asset account is subtracted from net income and a net decrease is added to net income. As described above, the increase in accounts receivable, for example, resulted from recording income statement revenue higher than the amount of cash received from customers; therefore, to reconcile back to operating cash flow, that increase in accounts receivable must be deducted from net income. For current operating liabilities, a net increase is added to net income and a net decrease is subtracted from net income. As described above, the increase in wages payable, for example, resulted from recording income statement expenses higher than the amount of cash paid to employees. Figure 8.8 presents a tabulation of the most common types of adjustments that are made to net income when using the indirect method to determine net cash flow from operating activities. Additions  Non-cash items — Depreciation expense of tangible assets — Amortisation expense of intangible assets — Depletion expense of natural resources — Amortisation of bond discount  Non-operating losses — Loss on sale or write-down of assets — Loss on retirement of debt — Loss on investments accounted for under the equity method  Increase in deferred income tax liability  Changes in working capital resulting from accruing higher amounts for expenses than the amounts of cash payments or lower amounts for revenues than the amounts of cash receipts — Decrease in current operating assets (e.g., accounts receivable, inventory and prepaid expenses) — Increase in current operating liabilities (e.g., accounts payable and accrued expense liabilities) CU IDOL SELF LEARNING MATERIAL (SLM)

Financial Statement Analysis III 269 Subtractions  Non-cash items (e.g., amortisation of bond premium)  Non-operating items — Gain on sale of assets — Gain on retirement of debt — Income on investments accounted for under the equity method  Decrease in deferred income tax liability  Changes in working capital resulting from accruing lower amounts for expenses than for cash payments or higher amounts for revenues than for cash receipts — Increase in current operating assets (e.g., accounts receivable, inventory, and prepaid expenses) — Decrease in current operating liabilities (e.g., accounts payable and accrued expense liabilities) Figure 8.8: Adjustments to Net Income using the Indirect Method Accordingly, the ` 55 increase in accounts receivable and the ` 707 increase in inventory are subtracted from net income and the ` 23 decrease in prepaid expenses is added to net income. For current liabilities, the increases in accounts payable, salary and wage payable, income tax payable, and other accrued liabilities ` 263, ` 10, ` 5, and ` 22, respectively) are added to net income and the ` 12 decrease in interest payable is subtracted from net income. Figure 8.9 presents the cash flow statement for under the indirect method by using the information that we have determined from our analysis of the income statement and the comparative balance sheets. Note that the investing and financing sections are identical to the statement of cash flows prepared using the direct method. Cash flow from operating activities: ` 2,210 Net income 1,052 Depreciation expense (205) Gain on sale of equipment (55) Increase in accounts receivable (707) Increase in inventory 23 Decrease in prepaid expenses 263 Increase in accounts payable 10 (12) Increase in salary and wage payable 5 Decrease in interest payable 22 Increase in income tax payable Increase in other accrued liabilities 2,606 Net cash provided by operating activities CU IDOL SELF LEARNING MATERIAL (SLM)

270 Financial Reporting and Analysis Cash flow from investing activities: 762 Cash received from sale of equipment (1,300) Cash paid for purchase of equipment (538) Net cash used for investing activities Cash flow from financing activities: (500) (600) Cash paid to retire long-term debt (1,120) Cash paid to retire common stock (2,220) Cash paid for dividends (152) 1,163 Net cash used for financing activities ` 1,011 Net decrease in cash Cash balance, 31st December, 2015 Cash balance, 31st December, 2016 Figure 8.9: ABC Co.’s Cash Flow Statement (Indirect Method) Year Ended 31st December, 2016 Illustrative Problems Illustrative Problem 1. From the following Profit and Loss Account and additional information of M/s Anurag Enterprises, compute cash flow from operations. Profit and Loss Account for the Year Ended 31st March, 2017 Particulars ` Particulars ` To Opening Stock 2,00,000 1,60,000 By Sale 6,00,000 To Purchases 6,00,000 Cash 10,00,000 8,00,000 Credit 2,08,000 Cash 48,000 1,12,000 Credit By Closing Stock To Wages 1,76,000 By Commission 80,000 To Office Expenses 96,000 By Royalties 40,000 To Selling Expenses 16,000 By Discount Received To Bad debts 32,000 To Discount Allowed To Depreciation 1,20,000 To Provision for Tax 2,40,000 To Net Profit 3,52,000 20,40,000 20,40,000 CU IDOL SELF LEARNING MATERIAL (SLM)

Financial Statement Analysis III 271 Additional Information: March 31, 2016 March 31, 2017 Particulars `` Debtors 1,20,000 1,44,000 Creditors 1,12,000 80,000 O/s Selling Expenses 32,000 Prepaid Office Expenses 24,000 24,000 Accrued Royalties 16,000 88,000 Advance Commission 96,000 64,000 Provision for Tax 72,000 3,20,000 4,80,000 Solution: ` ` Cash Flow from Operations 6,00,000 9,76,000 Particulars 88,000 (A) Receipts from Operations: 1,04,000 17,68,000 Cash Sales Cash Received from Debtors*1 11,12,000 Cash from Royalties*2 6,56,000 Cash from Commission*3 80,000 Less: 2,00,000 5,76,000 6,32,000 (B) Operating Cash Payments 88,000 Cash Purchases 1,92,000 Cash paid to Creditors*4 Cash Selling Expenses Cash Office Expenses Cash inflow from operations before tax Less: Income Tax paid (on operating incomes) Net Cash flow from operations *1. Cash Received from debtors (Prepare Debtors A/c) Particulars Debtors A/c ` ` Particulars 9,76,000 To Balance b/d 1,44,000 To Sales (Credit) 1,20,000 By Cash Received (Bal. (Fig.) 10,00,000 By Balance c/d 11,20,000 11,20,000 CU IDOL SELF LEARNING MATERIAL (SLM)

272 Financial Reporting and Analysis *2 Cash from Royalties Opening Balance + Royalties as per P & L A/c — Closing Balance = Cash from Royalties 96,000 + 80,000 – 88,000 = ` 88,000 *3 Cash from Commission Closing Balance + Commission as per P & L A/c — Opening Balance = Cash from Commission 64,000 + 1,12,000 – 72,000 = ` 1,04,000 *4 Cash Opening Balance + Purchases – Cl. Balance = Cash Paid to Creditors 80,000 + 6,00,000 – 1,12,000 = ` 6,32,000 Illustrative Problem 2. The net income reported on the income statement for the year was ` 1,10,000 and depreciation of fixed assets for the year was ` 44,000. The balances of the current asset and current liability accounts at the beginning and end of the year are as follows: End of the Year Beginning of the year ` ` Cash 1,30,000 1,40,000 Debtors 2,00,000 1,80,000 Inventories 2,90,000 3,00,000 Prepaid Expenses Accounts Payable 15,000 16,000 Calculate total cash from operating activities. 1,02,000 1,16,000 Solution: Cash from Operating Activities Particulars ` ` Net Income 10,000 1,10,000 Add: Depreciation 1,000 44,000 Operating Profit before working capital changes Add: Decrease in Inventories 20,000 1,54,000 14,000 Decrease in prepaid expenses 11,000 1,65,000 Deduct: Increase in Debtors Decrease in Accounts Payable 34,000 1,31,000 Net Cash Flow from Operating Activities CU IDOL SELF LEARNING MATERIAL (SLM)

Financial Statement Analysis III 273 Illustrative Problem 3. From the following, calculate cash from operation by Indirect Method. Profit and Loss Account for the Year Ended 31st March, 2016 Particulars ` ` Particulars ` To Opening Stock 2,25,000 2,00,000 By Sales 45,00,000 To Purchases 25,000 36,40,000 By Closing Stock 2,40,000 To Wages To Outstanding 2,50,000 47,40,000 To Manufacturing Expenses 75,000 5,75,000 To Gross Profit c/d 37,500 5,75,000 17,500 To Salaries 1,37,500 47,40,000 55,000 Add: Outstanding 62,500 By Gross Profit b/d 6,85,000 To Insurance 30,000 2,00,000 By Rent Received Less: Prepaid 7,500 To Office Expenses By Commission Accrued To Selling Expenses 22,500 By Net Loss 1,17,500 To Depreciation 1,45,000 To Share Issue Expenses w/o 1,25,000 75,000 6,85,000 Solution: Calculation of Cash from Operating Activities (Indirect Method) Particulars` ` Net Loss as per Profit and Loss Account (Before tax and extraordinary item) 1,25,000 (55,000) Adjustments for Non-cash Charges and Non-operating Items 75,000 Add: Depreciation 2,00,000 Add: Share Issue Expenses w/o 1,45,000 (37,500) Less: Rent Received (Non-operating) 25,000 1,07,500 Operating Profit before Working Capital Charges 62,500 87,500 Adjustment for Current Assets/Liabilities: 1,95,000 Add: Increase in Current liabilities Wages O/s Salaries CU IDOL SELF LEARNING MATERIAL (SLM)

274 Financial Reporting and Analysis Less: Increase in Current Assets 7,5000 40,000 Stock 17,500 Prepaid Insurance (65,000) Accrued Commission 1,30,000 Net Cash from operating Activities Illustrative Problem 4. X Ltd. has the following balance on 1st January, 2016: `` Fixed Assets 15,00,000 10,00,000 Less: Depreciation (5,00,000) 87,500 Bank Other Current Assets 6,25,000 Current Liabilities 2,50,000 Net year’s estimate are: (i) The company will acquire fixed assets costing ` 2,50,000 after selling one machine for ` 70,000, costing ` 1,50,000 on which depreciation provided will amount to ` 90,000. (ii) The net profits will be ` 1,75,000 after providing for depreciation of ` 1,50,000. (iii) Current assets and current liabilities (other than bank balance) at 31.12.2016 are estimated to be ` 7,50,000 and ` 4,00,000 respectively. At the end of the accounting year, the company deposits all the cash into the bank. Calculate the cash flows from operations and investing activities for the year 2016. Solution: Cash Flow from Operating Activities Particulars ` ` 3,40,000 Net Profit after depreciation 1,75,000 Add: Depreciation provided 1,50,000 Less: Profit on sale of machinery (10,000) Operating profit before working capital changes 3,15,000 Less: Increase in assets (1,25,000) Add: Increase in current liabilities 1,50,000 Net cash from operating activities CU IDOL SELF LEARNING MATERIAL (SLM)

Financial Statement Analysis III 275 Cash Flow from Investing Activities Particulars `` Purchase of Machine 70,000 Purchase of Machine (2,50,000) Net cash used in investing activities (1,80,000) Working Note: Calculation of Profit on sale of machinery: 70,000 – (1,50,000 – 90,000) = ` 10,000. Illustrative Problem 5. From the following information, calculate cash from operations. Profit and Loss Account for the year ended 31st March ,2016 Particulars ` Particulars ` To Opening Stock 1,50,000 By Sales 32,75,000 To Purchases 14,50,000 By Closing Stock 3,25,000 To Wages To Gross Profit c/d 70,000 By Gross Profit b/d 36,00,000 19,30,000 By Interest on Investments 19,30,000 To Operating Expenses By Dividend Received To Interest on Debentures 36,00,000 By Profit on Sale of Land 15,000 To Depreciation By Rent Received 18,000 To Loss on Sale on Plant 11,10,000 By Refund of Tax 20,000 To Discount on Issue of Shares 18,000 By Insurance Claims for 12,000 To Goodwill w/o Loss of Stock 8,000 To Provision for Tax 1,20,000 To General Reserve 40,000 1,25,000 To Proposed, Dividend 10,000 To Interim Dividend 15,000 21,28,000 To Net Profit 30,000 25,000 1,80,000 70,000 5,10,000 21,28,000 Additional Information: 31.03.15 31.03.16 ` ` Stock Debtors 1,40,000 1,00,000 Creditors 25,000 1,00,000 Provision for Tax 15,000 50,000 50,000 60,000 CU IDOL SELF LEARNING MATERIAL (SLM)

276 Financial Reporting and Analysis Outstanding Salaries 20,000 25,000 Accrued Commission 15,000 15,000 Prepaid Expenses 18,000 20,000 Solution: Cash Flow from Operating Activities Particulars `` Net Profit before Tax and Extraordinary items (1) 6,82,000 Adjustment for: Non-cash Charges and Non-operating Items Add: Depreciation 1,20,000 2,03,000 15,000 8,85,000 Goodwill 10,000 Discount on Issue of Shares 40,000 (53,000) Loss on Sale of Plant 18,000 8,32,000 Interest on Debentures (2) 20,000 Less: Profit on Sale of Land (3) 15,000 Interest Received (3) 18,000 Dividend Received (3) 40,000 80,000 Operating Profit before Working Capital Changes 35,000 9,12,000 5,000 Adjustment for Working Capital: Add: Decrease in Current Assets and Increase in Current Liabilities: Stock Debtors O/s Salaries Less: Increase in Current Assets and Decrease in Current Liabilities: 75,000 (92,000) Debtors 15,000 8,20,000 Accrued Commission 2,000 (12,000) Prepaid Expenses 8,08,000 Less: Tax Paid 1,25,000 9,33,000 Cash flow before Extraordinary Items Add: Cash from Extraordinary Items (Insurance Claims for Loss of Stock (4)) Net Cash Flow from Operations CU IDOL SELF LEARNING MATERIAL (SLM)

Financial Statement Analysis III 277 Working Notes: `` (1) Net Profit as per P and L A/c 30,000 5,10,000 Add: Tax and Appropriations: 1,80,000 Provision for Tax 3,05,000 Proposed Dividend 70,000 8,15,000 Interim Dividend 25,000 1,33,000 General Reserve 6,82,000 Less: Tax Refund and Extra Ordinary Receipts (8,000 + 1,25,000) (2) Interest on Debentures to be adjusted against Financing Activities. (3) Interest Received, Dividend Received, Profit on sale of Fixed Assets are covered by Investing Activities. (4) Insurance claims for loss of Stock is treated under Operating Activities while loss of assets under “Investing Activities’. Illustrative Problem 6. The following data are provided for ABC Ltd.: Income Statement Data for 2016 Particulars ` Revenues 84,000 Cost of goods sold (48,000) Depreciation expense (4,000) Interest expense (6,000) Other expenses (22,000) Net Income 4,000 Comparative Balance Sheets Data 2016 2015 Particulars `` Assets 20,000 16,000 Current Assets 12,000 7,000 Cash 16,000 14,000 Debtors (Net) Stock in Hand CU IDOL SELF LEARNING MATERIAL (SLM)

278 Financial Reporting and Analysis Non-current Assets 24,000 20,000 Plant and Machinery (8,000) (4,000) Less: Accumulated Depreciation 64,000 63,000 Total Assets Liabilities 12,000 14,000 Creditors 20,000 20,000 Non-current Note Payable (1,600) (2,000) Less: Discount on Note 30,400 32,000 Owner’s Equity 24,000 14,000 Equity Share Capital 9,600 7,000 Retained Earnings 33,600 21,000 64,000 63,000 Total Liabilities Required: Prepare statement of cash flows using the Indirect Method as per [AS-3 (Revised)] Solution: ABC Ltd. Cash Flow Statement for the year Ended 31st December, 2016 [AS-3 (Revised)] (Indirect Method) Particulars ` ` (A) Cash Flows from Operating Activities 4,000 5,400 Net Income before tax (4,000) Adjustments for: 4,000 Depreciation 400 Amortisation of discount on note payable Interest expenses 6,000 Operating Profit before Working Capital Changes 14,400 Increase in Debtors (5,000) Increase in Inventories (2,000) Decrease in Creditors (2,000) Net Cash Provided by Operating Activities (4,000) (B) Cash Flows from Investing Activities Purchase of Plant and Machinery Net Cash Used in Investing Activities CU IDOL SELF LEARNING MATERIAL (SLM)

Financial Statement Analysis III 279 (C) Cash Flows from Financing Activities 10,000 Issues of Share Capital (6,000) Interest Paid (1,400) Dividends Paid Net cash from financing activities 2,600 Net increase in cash and cash equivalent (A + B + C) 4,000 Cash and cash equivalents at the beginning of the period 16,000 Cash and cash equivalents at the end of the period 20,000 Note: ` Dividends paid have been calculated as under: 7,000 4,000 Retained earnings at the beginning 11,000 Add: Net Income 9,600 1,400 Less: Retained earnings at the end Dividend paid Illustrative Problem 7. From the following particulars, prepare Cash Flow Statement for the year ended 31st March, 2016 using: (a) Direct Method (b) Indirect Method Income Statement for the year ended 31st March, 2016 Particulars ` ` Turnover 3,16,000 12,80,000 Less: Cost of Goods sold 6,000 8,00,000 Add: Other Receipts: 84,000 4,80,000 Insurance Claims for loss of Stock due to fire 400 20,000 Less: Operating Expenses 5,00,000 Interest on Debentures Depreciation 4,06,400 Discount on Debentures w/o 93,600 Profit before Tax 36,800 Less: Provision for Tax 56,800 Profit after Tax CU IDOL SELF LEARNING MATERIAL (SLM)

280 Financial Reporting and Analysis The assets and liabilities as on 31st March, 2015 and 31st March, 2016 were as under: Particulars 31.03.2015 31.03.2016 ` ` Stock 16,000 72,000 88,000 12,000 Debtors 44,800 15,200 Bills Receivable 31,200 22,000 Cash and Bank Balance 8,000 99,200 Creditors 12,400 38,000 Bills Payable 6,000 O/s Expenses 17,600 Additional Information: (i) Fully paid Equity shares of the face value of ` 80,000 were allotted at a premium of @ 20%. (ii) Fired assets were acquired for ` 60,000 and the payment was made in 6% convertible debentures at par. (iii) Income Tax paid during the year amounted to ` 38,000. (iv) Company paid a dividend and corporate dividend tax thereon for the year ended 31st March, 2006 amounting to ` 44,000. (v) 9% Debentures for ` 1,20,000 were redeemed at a premium of 2%. Solution: (a) Cash Flow Statement (Direct Method) Particulars ` ` 1,30,800 Cash Flow from Operating Activities: 12,70,800 (a) Operating Cash Receipts: 11,22,000 Cash from Customers (1) (b) Operating Cash Payments (2) Cash Flow from Operations (a – b) 1,48,800 Income Tax Paid (38,000) Cash Flow from Extraordinary Items: 1,10,800 Add: Claims Received 20,000 Net Cash Flow from Operating Activities CU IDOL SELF LEARNING MATERIAL (SLM)

Financial Statement Analysis III 281 Cash Flow from Financing Activities: 96,000 • Issue of Shares at Premium (3) (1,22,400) • Redemption of Debentures • Interest on Debentures (6,000) • Dividend and Corporate Dividend Tax (44,000) Net Cash Used in Financing Activities Net Increase in Cash and Cash Equivalents (76,400) Cash and Cash Equivalents in the Beginning 54,400 44,800 Cash and Cash Equivalents at the End 99,200 Financing and Investing Activities not affecting cash flow 60,000 — Issue of debentures against acquisition of land Working Notes: (1) Receivables A/c (Debtors + Bills Receivables) Particulars ` Particulars ` To Balance b/d 28,000 By Cash Received (B.F.) 12,70,800 To Sales (credit) 12,80,000 By Balance c/d 37,200 13,08,000 13,08,000 (2) Payables A/c (Creditors + Bills Payable) Particulars ` Particulars ` To Cash Paid 8,11,200 By Balance b/d 39,200 To Balance c/d By Purchases* 8,16,000 44,000 8,55,200 8,55,000 Operating Expenses A/c Particulars ` Particulars ` To Cash Paid (Bal. Figure) 3,10,800 By Balance b/d 12,400 To Balance c/d By Profit and Loss A/c 3,16,000 17,600 3,28,400 3,28,400 *Purchases = Closing Stock + Cost of Goods Sold – Opening Stock Purchases = 88,000 + 8,00,000 – 72,000 = 8,16,000 This operating cash payment = 8,11,200 (To creditors) and operating expenses paid 3,10,800 11,22,000 CU IDOL SELF LEARNING MATERIAL (SLM)

282 Financial Reporting and Analysis (3) Face Value of Shares issued ` Add: Premium @ 20% 80,000 16,000 96,000 (b) Cash Flow Statement as per AS-3 (Revised) (Indirect Method) Particulars ` ` I. Cash Flow from Operating Activities: 73,600 1,30,.800 Net Profit before Tax and Extraordinary Item 84,000 — Adjustment for Non-cash and Non-operating items: Depreciation — Discount on Issue of Debentures 400 Interest on Debentures 6,000 (76,400) 1,64,000 54,400 Operating Profit before Working Capital Changes 44,800 Adjustment for current items: (16,000) 99,200 Less: Increase in Stock (10,000) Less: Increase in Bills Receivable (2,000) Less: Decrease in Bills Payable Add: Decrease in Debtors 800 Add: Increase in Creditors 6,800 Add: Increase in O/s Expenses 5,200 1,48,800 Cash Generated from Operation 38,000 Less: Income Tax paid 1,10,800 Cash Flow from Operation before Extraordinary Item 20,000 Add:Insurance Claim for Loss of Stock Net Cash Generated from Operation — II. Cash Flow from Investing Activities 96,000 III. Cash flow from Financing Activities (1,22,400) Issue of Shares at Premium (6,000) Redemption of Debentures (44,000) Interest on Debentures Dividend and Corporate Dividend Tax Net Cash Used in Financing Activities Net Increase in Cash and Cash Equivalents Cash and Cash Equivalents in the Beginning Cash and Cash Equivalents at the End CU IDOL SELF LEARNING MATERIAL (SLM)

Financial Statement Analysis III 283 Illustrative Problem 9. Presented below is the comparative balance sheets for Jyoti Ltd. at 31st March: Particulars 2016 2015 ` ` Cash Accounts Receivable 40,000 57,000 Inventory 77,000 64,000 Prepaid expenses 1,32,000 1,40,000 Land 12,140 16,540 Equipment 1,25,000 1,50,000 Accumulated Depreciation-Equipment 2,00,000 1,75,000 Building (60,000) (42,000) Accumulated Depreciation-Building 2,50,000 2,50,000 (75,000) (50,000) Accounts Payable 7,01,140 7,60,540 Bonds Payable 33,000 45,000 Equity Share Capital (` 10 per share) 2,35,000 2,65,000 Retained Earnings 2,80,000 2,50,000 1,53,140 2,00,540 Additional information: 7,01,140 7,60,540 (i) Operating expenses include depreciation expense of ` 70,000 and amortisation of prepaid expenses of ` 4,400. (ii) Land was sold for cash at book value. (iii) Cash dividends of ` 74,290 were paid. (iv) Net income for 2007 was ` 26,890. (v) Equipment was purchased for ` 65,000 cash. In addition equipment costing ` 40,000 with a book value of ` 13,000 was sold for ` 15,000 cash. (vi) Bonds were redeemed at face value by issuing 3,000 equity shares of ` 10 at par. Prepare a statement of cash flow for 2016 using the indirect method [AS-3 (Revised)]. CU IDOL SELF LEARNING MATERIAL (SLM)

284 Financial Reporting and Analysis Solution: Jyoti Ltd. Cash Flows Statement for the Year Ended 31st December, 2016 [AS-3 (Revised)] (Indirect Method) Particulars ` ` (A) Cash Flows from Operating Activities 26,890 82,290 Net Income Adjustments for: 70,000 (25,000) Depreciation 4,400 (74,290) Amortisation of Prepaid Expenses (2,000) (17,000) Gain on Sale of Equipment 99,290 Operating Profit before Working Capital Changes 57,000 40,000 Increase in Accounts Receivable (13,000) Decrease in Inventories 8,000 ` Decrease in Accounts Payable 2,50,000 Net Cash from Operating Activities (12,000) (B) Cash Flow from Investing Activities: 30,000 Sale of Land 25,000 2,80,000 Sale of Equipment 15,000 Purchase of Equipment (65,000) Net Cash Used in Investing Activities (C) Cash Flows from Financing Activities (74,290) Dividends Paid Net Cash Used in Financing Activities Net Decrease in Cash and Cash Equivalents (A + B + C) Cash and Cash Equivalents at the Beginning of the Period Cash and Cash Equivalents at the End of the Period Significant Non-cash Transaction Redemption of Bonds in exchange for Equity Share Capital ` 30,000 Working Notes: Equity Share Capital Account Particulars ` Particulars To Balance c/d 2,80,000 By Balance b/d 2,80,000 By Bond Payable A/c CU IDOL SELF LEARNING MATERIAL (SLM)

Financial Statement Analysis III 285 Particulars Bonds Payable Account ` ` Particulars 2,65,000 To Equity Share Capital Account 2,35,000 By Balance b/d 2,65,000 To Balance c/d 30,000 2,65,000 Illustrative Problem 10. ABC Limited has collected the following information for the preparation of cash flow statement for the year ended 31st March, 2016. Net Profit (` in lakhs) Dividend (including dividend tax) paid Provision for income tax 25,000 Income tax paid during the year 8,535 Loss on sale of assets (net) 5,000 Book value of the assets sold 4,248 Depreciation charged to Profit and Loss Account Amortisation of capital grant 40 Profit on sale of investments 185 Carrying amount of investment sold 20,000 Interest income received on investments Interest expenses 6 Interest paid during the year 100 Increase in working capital (excluding cash and bank balance) 27,765 Purchase of fixed assets 2,506 Investment in joint venture 10,000 Expenditure on construction work-in-progress 10,520 Proceeds from calls in arrear 56,075 Receipt of grant for capital projects 14,560 Proceeds from long-term borrowings 3,850 Proceeds from short-term borrowings 34,740 Opening cash and bank balance Closing cash and bank balance 2 12 25,980 20,575 5,003 6,988 Prepare the Cash Flow Statement for the year ended 31st March, 2016 in accordance with AS- 3 ‘Cash Flow Statement’. CU IDOL SELF LEARNING MATERIAL (SLM)

286 Financial Reporting and Analysis Solution: ABC Limited Cash Flow Statement for the Year Ended 31st March, 2016 Particulars ` in lakhs Cash Flows from Operating Activities 30,000 Net profit before taxation (25,000 + 5,000) Adjustments for: 20,000 Depreciation 40 Loss on sale of assets (Net) (6) Amortisation of capital grant Profit on sale of investments (100) Interest income on investments (2,506) Interest expenses 10,000 57,428 Operating profit before working capital changes (56,075) Changes in working capital (Excluding cash and bank balance) 1,353 Cash generated from operations (4,248) Income taxes paid (2,895) Net cash used in operating activities 145 Cash Flows from Investing Activities 27,865 Sale of assets (185 – 40) 2,506 Sale of investments (27,765 + 100) (14,560) Interest income on investments (3,850) Purchase of fixed assets (34,740) Investment in joint venture (22,634) Expenditure on construction work-in progress 2 Net cash used in investing activities 12 Cash Flows from Financing Activities 25,980 Proceeds from calls in arrear 20,575 Receipts of grant for capital projects (10,520) Proceeds from long-term borrowings (8,535) Proceed from short-term borrowings 27,514 Interest paid 1,985 Dividend (including dividend tax) paid 5,003 6,988 Net increase in cash and cash equivalents (27,514 – 22,634 – 2,895) Cash and cash equivalents at the beginning of the period Cash and cash equivalents at the end of the period CU IDOL SELF LEARNING MATERIAL (SLM)

Financial Statement Analysis III 287 Illustrative Problem 11. The summarised Balance Sheet of XYZ Ltd. for the years ended 31st March, 2015 and 2016 are as follows: Liabilities 31.3.2015 31.3.2016 Assets 31.3.2015 31.3.2016 (`) (`) (`) (`) Equity share capital 11,20,000 15,60,000 Fixed Assets 32,00,000 38,00,000 9,20,000 11,60,000 10% Preference share capital 4,00,000 2,80,000 Less: Depreciation 26,40,000 3,20,000 Capital Reserve — 40,000 22,80,000 General Reserve 6,80,000 8,00,000 Investment 4,00,000 10,000 Profit and Loss A/c 2,40,000 3,00,000 Cash 10,000 13,10,000 9% Debentures 4,00,000 2,80,000 Other Current Assets 11,10,000 Current liabilities 4,80,000 5,36,000 42,80,000 Proposed dividend 1,20,000 1,44,000 Provision for tax 3,60,000 3,40,000 38,00,000 42,80, 000 38,00,000 Additional information: (i) The company sold one fixed asset for ` 1,00,000, the cost of which was ` 2,00,000 and the depreciation provided on it was ` 80, 000. (ii) The company also decided to write off another fixed asset costing ` 56, 000 on which depreciation amounting to ` 40, 000 has been provided. (iii) Depreciation on fixed assets provided ` 3,60,000. (iv) Company sold some investment at a profit of ` 40, 000, which was credited to capital reserve. (v) Debentures and preference share capital redeemed at 5% premium. (vi) Company decided to value inventory at cost, whereas previously the practice was to value inventory at cost less 10%. The inventory according to books on 31.3.2015 was ` 2,16,000. The inventory on 31.3.2016 was correctly valued at ` 3,00,000. Prepare Cash Flow Statement as per revised AS-3 by indirect method. CU IDOL SELF LEARNING MATERIAL (SLM)

288 Financial Reporting and Analysis Solution: Cash Flow Statement for the year ended 31st March, 2016 Particulars ` ` A. Cash Flow from Operating Activities 36,000 5,68,000 Profit after appropriation 1,20,000 (6,36,000) Increase in Profit & Loss A/c after inventory adjustment 1,44,000 [` 3,00,000 – (` 2,40,000 + ` 24,000)] 3,40,000 68,000 Transfer to general reserve Nil Proposed dividend Provision for tax 10,000 10,000 Net profit before taxation and extraordinary item 6,40,000 Adjustments for: Depreciation 3,60,000 Loss on sale of fixed assets 20,000 Decrease in value of fixed assets 16,000 Premium on redemption of preference share capital 6,000 Premium on redemption of debentures 6,000 Operating profit before working capital changes 10,48,000 Increase in current liabilities (` 5,36,000 – ` 4,80,000) 56,000 Increase in other current assets [` 13,10,000 – (` 11,10,000 + ` 24,000)] (W.N.1) (1,76,000) 9,28,000 Cash generated from operations Income taxes paid (3,60,000) Net cash from operating activities B. Cash Flow from Investing Activities (8,56,000) Purchase of fixed assets (W.N.3) 1,00,000 Proceeds from sale of fixed assets 1,20,000 Proceeds from sale of investments (W.N.2) Net cash from investing activities 4,40,000 C. Cash Flow from Financing Activities (1,26,000) Proceeds from issuance of share capital (1,26,000) Redemption of preference share capital (` 1,20,000 + ` 6,000) (1,20,000) Redemption of debentures (` 1,20,000 + ` 6,000) Dividend paid Net Cash from financing activities Net increase/decrease in cash and cash equivalent during the year Cash and cash equivalent at the beginning of the year Cash and cash equivalent at the end of the year CU IDOL SELF LEARNING MATERIAL (SLM)

Financial Statement Analysis III 289 Working Notes: 1. Revaluation of inventory will increase opening inventory by ` 24,000. 2,16, 000  10 = ` 24,000 90 Therefore, opening balance of other current assets would be as follows: ` 11,10,000 + ` 24,000 = ` 11,34,000 Due to under valuation of inventory, the opening balance of profit and loss account be increased by ` 24,000. The opening balance of profit and loss account after revaluation of inventory will be ` 2,40,000 + ` 24,000 = ` 2,64,000. 2. Investment Account Particulars ` Particulars ` To Balance b/d 4,00,000 By Bank A/c 1,20,000 To Capital reserve A/c 40,000 (balancing figure being 3,20,000 (Profit on sale of investment) investment sold) By Balance c/d 4,40000 4,40,000 3. Fixed Assets Account ` Particulars `` Particulars 32,00,000 By Bank A/c (sale of assets) 1,00,000 8,56,000 To Balance b/d ByAccumulated Depreciation A/c 80,000 To Bank A/c (Balancing figure being assets By Profit and loss A/c 20,000 2,00,000 purchased) (Loss on sale of assets) 56,000 38,00,000 ByAccumulated Depreciation A/c 40,000 By Profit and loss A/c (Assets written off) 16,000 By Balance c/d 40,56,000 40,56,000 4. Accumulated Depreciation Account Particulars ` Particulars ` 9,20,000 To Fixed Assets A/c 80,000 By Balance b/d To Fixed Assets A/c 40,000 By Profit and loss A/c 3,60,000 To Balance c/d 11,60,000 (Depreciation for the period) 12,80,000 12,80,000 CU IDOL SELF LEARNING MATERIAL (SLM)

290 Financial Reporting and Analysis 8.8 Summary The analysis of a ratio gives the relationship between two variables at a point of time and over a period of time. Ratio analysis offers following advantages: (1) It aids financial statement analysis. (2) It facilitates intra-firm comparison and help chart trends. (3) Ratios are relative concepts and therefore support inter-firm comparison. (4) Ratios help in simplifying accounting terms by providing answers in percentages and times. (5) It checks and highlights the performance of an enterprise on key parameters of liquidity, profitability and growth. (6) It identifies the points of concern for management and aids in decision making. (7) It can be used as a forecasting tool. There are mainly four types of ratios profitability, liquidity, turnover and solvency ratios. Liquidity ratio measures the short-term liquidity of the firm with the help of ratios like current ratios, quick ratios, etc. Profitability ratios measure the operational efficiency of the firm. They give the details of how efficient the firm is in applying its resources to get the maximum returns. Current Ratio (page no. 5) Acid Test Ratio (page no. 6) Cash Ratio (page no. 7) Capital Turnover Ratio (page no. 8) Fixed Assets Turnover Ratio (page no. 9) Net Working Capital Turnover Ratio (page no. 10) Inventory Turnover Ratio (page no. 10) Receivables Turnover (page no. 11) Return on Capital Employed/ROI (page no. 13) Return Equity (page no. 14) Return on Total Assets (page no. 15) Gross Profit Ratio (page no. 16) Net Profit Ratio (page no. 17) Operating Profit Ratio (page no. 18) Operating Ratio (page no. 19) Debt-equity Ratio (page no. 20) Interest Coverage Ratio (page no. 22) CU IDOL SELF LEARNING MATERIAL (SLM)

Financial Statement Analysis III 291 Proprietary Ratio (page no. 22) Earning per Share (page no. 23) Net Dividend Per Share (page no. 25) Gross Dividend Per Share (page no. 25) Gross Dividend Yield (page no. 25) Dividend Yield Ratio (page no. 25) Dividend Cover (page no. 26) Payout Ratio (page no. 26) Dividend to Cash Flow (page no. 27) Price Earnings (P/E) Ratio (page no. 27) Net Asset Value Per Share (page no. 28) Limitations of ratio: (1) False results, (2) qualitative factors are ignored, (3) lack of standard ratio, (4) may not be comparable, (5) price level changes are not considered, (6) window dressing and (7) personal bias. The cash flow statement reflects a firm’s liquidity. The balance sheet is a snapshot of the firm’s financial resources. The cash flow statement includes only inflows and outflows of cash and cash equivalents; it excludes transactions that do not directly affect cash receipts and payments. These non-cash transactions include depreciation or write-offs on bad debts or credit losses to name a few. The CFS is a cash basis report on three types of activities these are operating activity, investing activity and financing activity. Operating activities are those transactions which are considered in the determination of net income. Examples of cash inflows in this category are cash received from debtors for goods and services, interest and dividend received on loans and investment. Examples of cash outflows in this category are cash payments for goods and services; merchandise; wages; interest; taxes; supplies and others. Investing activities include acquisition of long-term or fixed assets; disposal of long-term or fixed assets; acquisition and disposal of intangible assets; purchase and sale of shares, debentures and other securities; lending of money and its subsequent collection. Cash inflows from investing activities generally include cash sales of property, plant, equipment and intangible assets, cash sales of investments in shares, debentures and other securities, cash collection (loan repayments) from borrowers. Cash outflows are purchase of shares, debentures and securities of other enterprises, purchase of property, plant, equipment and other long-term assets, loan given to other firms. CU IDOL SELF LEARNING MATERIAL (SLM)

292 Financial Reporting and Analysis Financing activities relate to long-term liability and equity capital. A firm engages in financing activities when it obtains resources from owners, returns resources to owners, borrows resources from creditors and repays amounts borrowed. Cash inflows include proceeds from issue of shares and short-term and long-term borrowings. Cash outflows include repayment of loans and payments to owners, including cash dividends. Repayments of accounts payable or accrued liabilities are not considered repayment of loans under financing activities but are classified as cash outflows under operating activities. Provisions of AS-3 on Treatment of Certain Items: (1) Interest and Dividend (For Financial enterprises): interest paid and received, dividend received as operating activities; and dividend paid as financing activities and (For Other Enterprises): interest and dividend received as investing activities; and interest and dividend paid as financing activities. (2) Extraordinary items: The cash flows associated with extraordinary items should be classified as arising from operating, investing or financing activities as appropriate. It should be disclosed separately. Few examples of such items are: (i) Claim for loss of stock – Operating activity, (ii) Claims for loss of assets – Investing activity, (iii) Recovery of bad debts – Operating activity, (iv) Damages paid/received for breach of contract – Operating activity, (v) Winnings from lotteries – Investing activity and (vi) Cost of legal action to protect property title – Investing activity. (3) Taxes on Income: Cash flows arising from taxes on income should be separately disclosed and should be classified as cash flows from operating activities unless they can be specifically identified with financing and investing activities. For instance, Provision for taxation for the current year – Non-cash charge under operating activity, (ii) Tax paid – Operating cash outflow, (iii) Income tax refund – Cash inflow from operating activity, (iv) Capital gains tax – Cash outflow from investing activity and (v) Corporate dividend tax – Cash outflow from financing activity. 8.9 Key Words/Abbreviations  LIFO: Last in First Out.  FIFO: First in First Out.  P/E Ratio: Price earning ratio.  EPS: Earning per share.  EBIT: Earning before interest and tax.  PAT: Profit after tax.  CFS: Cash Flow Statement.  IFRS: International Financial Reporting Standard.  GAAP: Generally Accepted Accounting Principles.  ICAI: The Institute of Chartered Accountants of India. CU IDOL SELF LEARNING MATERIAL (SLM)

Financial Statement Analysis III 293 8.10 Learning Activity 1. Calculate Current and Quick Ratio: Amount S. No. Items 40,000 5,000 1 Current Investments 2,000 2 Inventories 20,000 3 Trade Receivables 2,500 4 Short-term Borrowings 2,000 5 Trade Payables 3,000 6 Prepaid Expenses 5,000 7 Short-term Provisions 4,000 8 Other Current Liabilities 1,00,000 9 Short-term Loans and Advances 10,000 10 Tangible FixedAssets 8,000 11 Cash and Cash Equivalents 12 Advance Tax _________________________________________________________________ _________________________________________________________________ 2. Calculate following ratios from the above particulars: (i) Debt-Equity ratio (ii) Total Assets to Debt ratio (iii) Proprietary ratio Particulars Amount Equity Share Capital 3,00,000 Preference Share Capital 1,00,000 General Reserve Profit & Loss Balance 60,000 12% Mortgage Loan 40,000 Current Liabilities 1,80,000 Non-current Assets 1,20,000 Current Assets 4,50,000 3,50,000 CU IDOL SELF LEARNING MATERIAL (SLM)

294 Financial Reporting and Analysis What conclusions do you draw from the above ratios? _________________________________________________________________ _________________________________________________________________ 8.11 Unit End Questions (MCQ and Descriptive) A. Descriptive Type Questions 1. What is ratio analysis? 2. What is liquid ratio? 3. What is Inventory turnover ratio? 4. What are operating expenses? 5. What is operating profit? How is it calculated? What is its significance? 6. What are non-operating expenses? 7. What are the items included in Shareholders’ Fund? 8. What does too low ‘Trade Receivables Turnover Ratio’ indicate? 9. What does too high ‘Trade Receivables Turnover Ratio’ indicate? 10. Discuss the computation and significance of the following financial ratios: (a) Current Ratio (b) Quick Ratio (c) Inventory Turnover Ratio (d) Debt-equity Ratio (e) Accounts Receivables Ratio (e) Earnings Margin (f) Earnings per Share CU IDOL SELF LEARNING MATERIAL (SLM)