Cash Flow Statement and Analysis - Assignment Example

Cash Flow ment Amount in $ Net Income 50,000 Adjustment for non-cash items Depreciation 60,000 Loss on sale of asset 10,000 (Increase Decrease in operating assets Accounts Receivable (41,000) Prepaid Insurance (9,000) (Increase) / Decrease in operating liabilities Accounts Payable 5,000 Salaries Payable 5,000 Income taxed Payable (10,000) Bank loan payable (75,000) Net cash flow from operating activities (5,000) Cash flow from investing activities Property, Plant and equipment (125,000) Sale proceed from sale of land 90,000 Sale proceed from sale of equipment 20,000 (15,000) Cash flow from financing activities Dividend paid (5,000) (5,000) (Decrease) / Increase in cash and cash equivalent (25,000) Opening cash 40,000 Closing cash 15,000 2. (a) The cash flows from operating activities are showing a negative $ 5,000 which shows that the company has invested heavily in its working capital and also paying off its major liabilities. The cash flow statement starts from the net income taken from the income statement of the company. No figure of tax is mentioned in the profit and loss statement of the company so it is assumed that the net income is profit before tax and the tax paid is incorporated in the tax payable figure. From the net income non cash adjustments have been made such depreciation and loss recorded on sale of fixed asset. Since these items were charged to the profit and loss account, these are added back to the net income. In addition the net increase decrease is calculated in the current assets and liabilities. If the asset has decreased from the previous year it would be taken as cash inflow. This can be understood by considering accounts receivable for example. If the account receivable has decreased this means that the debtor has paid cash (the company would have made the entry Cash: Debit and Accounts receivable: credit) and thus it is taken as cash inflow. The situation is contrast when it comes to liabilities where increase in liability is taken as cash inflow and vice versa. The company has made a portion one of its major liabilities, bank loan, and the amount of payment was about $75,000. This major payment is one of the major cash outflows during the current year. When it comes to investing activities, the company purchased property, plant and equipment amounting to $ 125,000 whereas it received cash from the disposal of some of its property, plant and equipment amounting to $110,000. All in all, the cash flow is showing a net decrease of $25,000 as compared to the previous year. (b) The board of directors of the company needs to decide whether the funding should be equity based or debt based. Both modes of financing i.e. equity and debt have their own advantages and disadvantages. There are several factors which need to be considered before taking such decisions. For example statutory rules and requirements, terms and conditions imposed by the counter party and general economic conditions are analyzed before selecting one of the options. One of the major drawbacks of raising finance equity through issuance of equity is the fact that a lot of secretarial procedure is involved in raising such finance in contrast to acquiring financing directly from any bank. Most of the time, financing from any bank or financial institution is acquired by just filing an application with the bank or financial institution. The banks usually have their own procedure of screening where they evaluate the credit history, financial outlook, liquidity and other aspects of the company. Most importantly, the bank’s analyze the fact and ability of the company pertaining to the ability of the company to repay the amount of loan in the future. When it comes to raising finances through issuance of equity shares, the company is liable to fulfill several requirements such as making sure that a certain number of shares are issued in accordance with the listing regulations of the stock exchange, submitting a due diligence report to the share holder and issuing share to the current shareholder in accordance with their current share holding. These statutory rules and requirements are implemented by the authorities responsible in order to safeguard the interest of the organization and general public, complying with them can be require a great deal of time and effort. Another difficulty in raising finances through issuance of equity is the fact an uncertainty always remains that the share issued by the company might not be completely subscribed by the public at the time these are floated in the market. If such is the condition, the company would not be able to raise the necessary funds required for the capital expenditure. In contrast when a loan is acquired from any bank or financial institution, there is certainty about the sanctioning of the funds because in either case (whether the loan is sanctioned or not) the bank promptly communicates the decision to the board of director. In addition to the above, the cost of raising funds in the form of loan acquired from the bank or financial institutions is substantially less as compared to the cost of raising financing through shares or bonds. The cost of raising equity comprises of printing of shares, cost of listing the equity shares on the stock market and the legal and professional charges paid to the consultants for the due diligence of floating the new shares in the market. When it comes to raising finance through debt, very little or minimal cost is involved for the sanctioning of the loan whether it is long term or short term. However, with so many disadvantages for raising fund through issuance of equity, the biggest advantage of raising funds through issuance of shares is that no subsequent cost arises in such respect. For raising funds through debt financing, the company has to pay interest charges to the financial institution based on a predetermined rate. The interest rate is usually depended upon the tenure of the loan. The longer the period the higher the interest rate is expected to be. Moreover, there can be a situation where the company is not able to discharge its liabilities, for example the case where the company is short of liquid assets. No payment of interest charge can label the company as defaulter by the bank or the financial institution and it would not be able to secure financing from the very same financial institution in future. The debt financing can also increases the gearing of the company which cause adverse effect of the financial outlook of the company. (c) The debt to equity ratio is calculated by dividing the total liabilities of the company with the shareholder equity.   2012 2011 Liabilities 275,000 350,000 Equity 252,000 227,000 Debt to Equity Ratio 1.091 1.542 As apparent from the above table, the company is highly geared but it has managed to reduce its gearing through the payment of its bank loan. If the company obtain equity financing its debt to equity ratio will decrease but if it obtains debt financing its debt to equity ratio will further increase and it will cause an adverse impact on the financial outlook of the company. (d) The involvement of Anoop’s mother-in-law can raise concerns among the external shareholder who might consider it“non arms length” transactions. In the terms of finance, Anoop’s mother-in-law is a related party to the company and it would specific and separate disclosures in the financial statement regarding the nature and substance of the transactions. In order to reduce the shareholder’s concern about the nature and substance of transactions, the company should explicitly mention in its financial statement the details of the transaction and have it audited by any external auditor. Read More