Solutions to Homework Questions - Topic 8

Question 1, FINAL EXAM Session 2, 2010

(a) Using the indirect method of estimating cash flows from operations what are the
permanent differences?
Blackwolf Ltd.
Reconciliation of Net Profit and Cash from Operations
For Year Ended 30 June 2010
$000s
Net Profit

$000s
67

Adjustments for permanent difference:

Add:

Depreciation expense buildings

Depreciation expense equipment
Loss on sale of equipment

Less: Gain on disposal of building

5
4
5
(5)

9
76

(b) Using the indirect method of estimating cash flows from operations what are the
timing differences?
Adjustments for timing differences (changes in operating
Assets & liabilities):
$000s
- Increase in accounts receivable
- Increase in inventory
+ Increase in accounts payable
- Decrease in accrued expenses
+ Increase in income tax payable
+ Increase in interest payable
Net Cash Flows from Operations

(94)
(53)
45
(1)
6
3

$000s

(94)
(18)

WORKINGS on other cash flows:

$000s
Cash flows from Investing activities
Proceeds on sale of building
Proceeds on sale of equipment

20
5

Cash inflows from investing activities

25

Buildings

Equipment

DR
o/b

CR

DR

51

51

o/b
20
31
51

55

30
55

c/b

DR 20,000
DR 5,000
CR
CR

5,000
20,000

Cash
Acc. Depreciation
Loss on Sale of Equipment
Equipment

DR 5,000
DR 15,000
DR 5,000
CR

25,000

Cash flows from Financing activities

Repayment of borrowings
Proceeds on share issue
Payment of final dividends (2009)
Payment of interim dividends (2010)

CR
Sale
c/b

$000s
(2)
10
(3)
(6)

Cash outflows from financing activities

(1)

Short-term loan

Share Capital

DR

CR
5
2
3
5

25

Sale

Cash
Acc. Depreciation
Gain on Sale of Buildings
Buildings

CASH
c/b

55

DR

CR
88 o/b
10 Share issue

o/b
c/b

98
98

98

Retained Earnings
DR
Dividend
payable
Interim
dividend
c/b

CR
15

70

o/b

6
116

67

profit

137

137

QUESTION 1 Final Exam semester 2, 2011

Sheppard Ltd Ltd is a start-up company

Because it burns cash from operations, needs to invest significantly, and has to
finance its operations and investments.

McKay Ltd is a mature company

Because it generates significant operating cashflow, has much less worthwhile
investments to make, and is returning cash to shareholders/ lenders.

Additional Question - One.Tel (adapted from TGC)

(A) Outline three (3) red flags you can identify from One.Tels Cash Flow Statement:
Red flag 1: There are two consecutive years of negative cash flows from operations. With a
sizable increase in payments to suppliers and employees not matched by receipts from
customers.
Red flag 2: The companys borrowings are increasing significantly from 1999 to 2000 and
are not matched by increases in cash flows from operations.
Red flag 3: The dividends paid in 2000 have dropped compared to 1999 this sends a bad
signal to the market the company is struggling to pay dividends. This is also concerning at
the proceeds from share issue is large new shareholders will expect future cash flows either
through dividends or capital gains.
DO NOT WRITE OUTSIDE THE BOX
(B) From the red flags identified above one (1) most strongly indicates that the company will
fail within one year.
The negative cash flows from operations for two consecutive periods and of a magnitude of
outflow greater than borrowing inflows.
DO NOT WRITE OUTSIDE THE BOX
(C) Identify at least three (3) signs from the cash flow statement that indicate the company
may survive long-term. Note: below are some suggested answers, there could be others.
1: There is a significant amount of cash proceeds from share issue this could indicate that
the market is confident enough to invest into the company.
2: The company is investing into productive assets, with the balance of investing cash flows
being an outflow. These productive assets could help the company to produce future cash
flows is they are profitable (NPV positive) investments.
3: There is a significant positive cash balance at the end of 2000, suggesting that the cash can
be used in the investing and financing activities.
DO NOT WRITE OUTSIDE THE BOX
3