HI5020 Corporate Accounting Group Assignment
Assessment task:
Part A
Do the relevant research to critically examine the relative information content of income statement and statement of cash flows. Why do investors find both income statement and statement of cash flows useful?
Part B
Appendix A, B, and C contain cash-flow statements from three companies. Each cash-flow statement has Three years of data. Examine the contents of these cash-flow statements carefully. Answer the following questions about each of the three cash-flow statements.
1. For each of the three years on the Statement of Cash Flows:
a) What are the major sources of cash for each firm? What are the major uses of cash for each firm?
b) What was the trend in cash flow from (continuing) operations for each firm?
c) Was cash flow from operations greater than or less than net income? Explain in detail the major reasons for the difference between these two figures. (Answer this question using only Appendix B: Cash flow statement for BHP Limited).
d) Was the firm able to generate enough cash from operations to pay for all of its capital expenditures?
e) Did the cash flow from operations cover both the capital expenditures and the dividend payments made by the firm (if any)?
f) If the firm has generated excess cash from operations, how did the firm invest the excess cash? If not, what were the sources of cash the firm used to pay for the capital expenditures and/or dividends?
g) Did the firm use the working capital (current asset and current liability) accounts other than cash and cash equivalents as sources of cash, or uses of cash? (Answer this question using only Appendix B: Cash flow statement for BHP Limited).
h) What other major items affected cash flows?
i) What was the trend in capital expenditures for each firm?
j) What was the trend in dividends (if any) for each firm?
k) What was the trend in net borrowing (proceeds from borrowing less payments of shortand long-term debt) for each firm?
l) What was the trend in working capital accounts? (Answer this question using only Appendix B: Cash flow statement for BHP Limited).
2. Critically evaluate the financial strength of each of the three companies based on the evidence presented in the Statement of Cash Flows.
3. If you are asked to evaluate these three companies for lending purposes, which of the three companies you will select for lending? Explain Why.
Solution
Abstract
The report shows cash flow statements, and its in-depth analysis of the questions given. The relative content analysis of the income statement to the cash flow statement conducted in the first part has helped us understand the different purposes of each of the statements. The analysis of the cash flow statements of the three firms; fantastic Limited, BHP limited, and Santos limited help in understanding the use of the content of the cash flow statement inefficient manner. The trend analysis, comparisons, and evaluation of sources and consumption areas of cash indicated the real financial health of the operations of the company. The decision to lend to one of these three companies is made through cash flow statement analysis, which helped in choosing one for lending purposes.
Introduction
Financial statement analysis is a technique or method through which the financial information and accounting information of the company are reviewed and analyzed to analyze the past, present, and potential future company performance. The statement analysis is usually conducted to make the decisions more informed (Kusuma, 2014). The main aim of the statement analysis is to use the financial information on the past performance of a company to better forecast the potential outlook of this company. Another major use of the financial statement analysis is the identification of the trouble areas or problems of the company as evident from its financial information.
Part A
As per AASB, the information reported in the statement of cash flow combined with the information in other statements helps in the assessment of the company’s ability to produce any net cash flows in future (Nallareddy et al., 2018). A statement of cash flow is the report which explains the point of source of the cash for the company and how it spent it over the specific given period. The report does not consider any noncash items and further amends the net income to these non-cash items. This helps in the determining of the short-term financial position of the company. The company is going to be able to pay its bills or not is shown by this report. Cash management is crucial for any company which requires the analysts to go for cash flow statements for analysis of the company (Omag, 2016).
The statement of cash flow is not dissimilar to the statement of income in terms of the fact that it records the outlook of a firm for a given period. The similarity ends when the income statement also considers the non-cash accounting items of amortization, impairment costs, and depreciations while the cash flow statement does not (Esin, 2015). On the contrary, it always strips all of these accounts and shows the actual cash amount the company has generated in the given period. The cash flow is a good picture showing how the company has managed the outflows and inflows of the company. The statement shows the ability of the company in terms of its financial growth, its financing capabilities, and its ability to pay the creditors.
The income statement reflects the net loss or profit of the company operating activities for a given period. The statement of cash flow, on the other hand, records the changes in the cash and its equivalents for that period of the time(Mulenga & Bhatia, 2017). The income statement content includes the revenues, gains, losses, and expenses incurred by the company. The statement of cash flow shows the positive and negative cash flows of the company. The statement of income is accrual based, while the statement of cash flow is based on cash. The objective of the income statement is to show the profitability of the company operations while the statement of cash flow shows the solvency and liquidity of the company. The income statement also records any accounting transactions which has not yet been received or paid while the cash flow statement only records all the transactions which had been paid or received (Šteinberga & Millere, 2017). The income statement records the operating and non-operating activities, and the cash flow statement shows the investing, financing, and operating activities of the company.
Even with all the differences between these two statements, both are mandatory for all companies to be reported as these both serve different purposes and cannot replace each other. The stakeholders, suppliers, competitors, and customers, all use the two statements for evaluating the financial health of the company in terms of its solvency, profitability, and liquidity. Both statements offer different purposes, which are both needed to comprehend the actual health of the company better. Without knowing the actual profitability of the company, the reliance on the change in cash and its equivalents over time would be misleading for any investors. The cash flow statement cannot be developed without first making the income statement as the first account of the cash flow statement is the net income of the company (Jemâa et al., 2015). Similarly, only relying on the profitability of the company, even when the company has or has not increased its cash flows can be misleading as well.
Part B
Question 1.
a) Sources and Uses of Cash
Funtastic Limited
Sources of Cash
The major sources of cash for this company as shown in its cash flow statement is the receipts from the customers which are evidently the revenue of the company, the proceeds from the borrowings of the company, cash from the issuance of the shares and lastly from the income generated through the investment and interest received.
Uses of Cash:
The use of cash for this company are in the areas of payments made to the employees and suppliers. This represents the payments of the account’s payable and salaries payable; cash spent on the repayment of the commercial bills, payments for the plant and equipment, intangible assets, and on the interests and costs of the finance paid.
BHP Limited
Sources of Cash
For this company, the sources of cash are profit before taxation, and the adjustments made to its in terms of the depreciation, impairment, and amortization expenses. The interests and dividends received by the firm, and the proceeds from the interest-bearing liabilities.
Uses of Cash:
The cash was spent the most on the investing activities which included the purchase of PPE, the expenditure for exploration, the dividends paid to the shareholders, and non-controlling interests, on repayment of the interest-bearing liabilities and the purchase of shares by ESOP Trust.
Santos Limited
Sources of Cash
The receipts from the customers and the receipts from the issuance of the ordinary shares, and the disposal of the non-current assets, the drawdown of the borrowings and pipeline tariffs are the major cash sources.
Uses of Cash:
The cash is spent on the payments to the employees and suppliers, borrowing costs, exploration studies, oil and gas assets, repayment of the borrowings, dividend payments, and acquisition of the subsidiary.
b) The trend of Operating Activities
Funtastic Limited:
The trend of the continuing operations activities for Funtastic has been rather declining and negative. The company operations have not been generating enough cash flow and are following a declining trend in each year.
BHP Limited:
The trend of the continuing operations activities for BHP Limited has been positive. The company operations have been generating enough cash flow and are increasing each year as compared to the previous one.
Santos Limited:
The trend of the continuing operations activities for Santos has been rather positive. The company operations have been generating enough cash flow and are increasing each year as compared to the previous one.
c) Net Income and OCF
For BHP Limited, the Net Income would be less than the cash flow generated from the operations. This would be because cash flow also takes into account the adjustments for impairment, amortizations, and depreciations expenses, which are all deducted from the net income. The depreciation and amortization costs weigh down on the net income while these are not necessarily any cash outflows.
d) Operating Cash Flow
Funtastic Limited:
No. Fantastic Limited was not able to produce enough cash flow to compensate for its capital expenditure. The company has generated negative cash flow from operations in the three years, which, on the contrary, consumed the cash flows generated from the financing activities.
BHP Limited:
Yes. BHP Limited was able to generate enough cash flow from its operations to compensate for the capital expenditures of the company. This is evident from the net operating cash flow of $18,461, $16, 804, and $10, 525 thousand higher than the net investing cash outlay of $-5921, $-4161, $-7245 thousand in 2018, 2017 and 2016 respectively.
Santos Limited:
Santos Limited generated enough cash flow from its operations in 2016 to compensate for its investing cash outlays of $205 Million. The company also had higher cash flow from operations of $1248 million in 2017 than its capital expenditure of $534 million. However, in 2018, the cash generated by operations, $1578 million was less than the capital expenditure outlays of $2373 million.
e) OCF compensating Capital Expenditure and Dividends
For Funtastic Limited, it is not possible as the company did not generate even enough cash flow from its operations to compensate for its capital expenditures or dividends alone. BHP Limited had however generated enough operating cash flow in 2018 of $18461 thousand to compensate its all-capital expenditures of $5921 Thousand, and dividends paid to the shareholders of $ 5220 thousand and the noncontrolling interest of $1582 thousand and still have a remaining cash flow of $5738 thousand. Similarly, in 2017, it generated enough operating cash flow of $16804 thousand to compensate its all-capital expenditures of $4161 Thousand, and dividends paid to the shareholders of $ 2921 thousand and the non-controlling interest of $575 thousand and still have a remaining cash flow of $5657 thousand. In terms of Santos Limited, it is not possible in 2018 as the operating cash flow is less than the investing cash flow. In 2017, the net cash flow of operations was greater than the capital expenditures, and there are no dividends paid. And in 2016, the company operating cash flows is enough for capital expenditures and dividends payments of the company.
f) OCF use in Investing Activities
Funtastic Limited:
The company did not generate any excess cash to invest in its investments. For investments, the main sources of the cash had been the proceeds from the borrowings of the company, receipts from the issuance of the shares and lastly from the income generated through the investment and interest received. The company has used it in the investing activities of payments for the plant and equipment and the intangible assets.
BHP Limited:
The company has had enough of excess cash flow generated from its operation to compensate the capital expenditures and the dividend payments. The activities in investing included purchases for the property, plant, and equipment, exploration expenditures, the funding and investment for the equity accounted investments, and some other investments.
Santos Limited:
The company did not generate enough operating cash flow in 2018, but it did in 2017, and 2016. For 2018, the sources of cash had been receipts from the issuance of the ordinary shares, and the disposal of the noncurrent assets, drawdown of the borrowings. The investing activities included the exploration of the assets and their evaluations, the oil and gas assets investments, buildings, plants and equipment, acquisitions for the oil and gas assets, payment of the borrowing costs.
g) Working Capital Accounts
The working capital accounts for BHP Limited other than the cash, and its equivalents include the accounts of inventories, trade and other receivables, trade and other payables. The company has used the account of trade and other receivables as sources of cash in 2016 and 2017 and use of cash in 2018. The company has used the account of trade and other payables as sources of cash in 2017 and 2018 and use of cash in 2016. The company used the account of inventories as a source of cash in 2016 and consumer of the cash in 2017 and 2018 as well.
h) Other Major Accounts
Funtastic Limited:
For this company, the other major items which affected the cash flow include the costs from the issuance of the issues, income taxes paid or refunded, and interests and investment income received by the company.
BHP Limited:
For this company, the other major items which affected the cash flows include the accounts of provisions and other assets and liabilities which declined the operating cash flow in 2016, and in 2017, the payment of cash management related instruments which declined the operating cash flow, the net income tax refunded and paid, the royalty-related tax refunded and paid, proceeds of the assets sales, divestitures of the operations, subsidiaries, and joint operations, and from debt related instruments.
Santos Limited:
For this company, the other major items which affected the cash flows include the accounts of royalty and excise payments, income taxes, and cash flow from other operations. The costs linked with the subsidiary’s acquisitions, and proceeds from the disposal of the subsidiaries, purchase of the treasury shares, and proceeds from the ordinary share issuance are some other accounts which affected the cash flows
i) Capital Expenditure Accounts Trends:
The trend in the capital expenditure accounts of Funtastic shows that its investing activates has declined in the last three years. The company had 558 thousand of investing cash outlay I 2016, which inclined to $989 thousand in 2017 but then steeply declined to $298 thousand.
In terms of BHP Limited, the investing activities had used around 7245 thousand of cash in 2016, which declined in 2017 to 4164 thousand and then increased to $5921 thousand in 2018.
In terms of Santos Limited, the investing activities have been following a stable inclining trend with 205 million invested in 2016 and then increased to 534 million invested in 2016 and 2373 million invested in 2018.
j) Dividends Trend
Santos Limited shows that the company paid 43 million dividends in 2016 and then it paid no dividends in 2017. In 2018, it paid 73 million dividends. BHP Limited paid 4130 thousand of dividends in 2016, which declined to 2921 thousand of dividends in 2017 and then increased to 5220 thousand of dividends in 2018. Funtastic limited has paid no dividends in all three years.
k) Net Borrowings Trend
The net borrowings trend for Funtastic limited shows that the company has followed a declining trend starting from the net borrowings of $7457 thousand in 2016 and getting to $2630 thousand in 2018. The net borrowings trend of BHP Limited shows that the proceeds have been declining for the last three years. For Santos Limited the company as well has negative net borrowings in 2016 and 2017 and positive in 2018. Thus, Santos is following a positive net borrowing trend.
l) Working Capital Accounts Trend
The working capital accounts of BHP limited include the accounts of the cash and equivalents, inventories, trade, and other receivables, trade and other payables. The cash and cash equivalents have increased over the last three years for the company from $10276 thousand in 2016 to $15813 thousand in 2018. The trade and receivable accounts have declined in the three years, starting from $1387 thousand in 2016 to $-667 thousand in 2018. The trade and payables account are following a positive trend starting from $-1272 thousand in 2016 to $7 thousand in 2018. The inventories account has been $521 thousand in 2016, which declined to -687 thousand in 2017 and then moved somewhat upward but remained still negative at $-182 thousand.
Question 2. Financial Strength of the Three Companies
Funtastic Limited:
The company is generating not enough cash flow from its operations, as shown in the cash flow statement, which has become a constraint in its investing activities as well. Even though the cash and cash equivalents improved in 2018 as compared to in 2017, it has been following a declining trend altogether. The company is dependent on its financing cash flows for much of its investing, and operating cash outlays, which shows the weak position of the financial health of the company.
BHP Limited:
The company is not only generated enough cash flows from its operations to compensate the capital expenditure but also to pay dividends and purchase shares. The financing and investing outlays are majorly compensated from the operating cash flows, which are a big indicator of the financial health of the company. Furthermore, the net cash and its equivalents at the end of the year have been improving as well. Although the change in cash shows a declining trend, which shows that the company should raise more cash from financing activities as well.
Santos Limited:
Santos Limited has been generating good enough cash from its operations; however, it is only covering its capital expenditures in 2016 and 2017. In 2018, it was not enough to compensate for any investing activities majorly, which is why the net cash from financing activities has been helpful. The net change in the cash improved in 2018; however, the company can work more on improving its financial health.
Question 3. Selection of Company for lending purpose
For the lending purpose, the company that can be selected would be BHP limited. This is because of the good financial health of the company as it would then be able to pay back the borrowed amount easily. The company is not only producing enough cash flows from its operations to compensate the capital expenditures but also to pay dividends and purchase shares, which is a big indicator of the financial health of the company.
Conclusion:
The analysis of the cash flow statements of the three firms; fantastic Limited, BHP limited, and Santos limited help in understanding the use of the content of the cash flow statement inefficient manner. It showed how the minute details help in making better financial decisions for the investors. The trend analysis, comparisons, and evaluation of sources and consumption areas of cash indicated the real financial health of the operations of the company. The relative content analysis of the income statement and the cash flow statement helped understand the different purposes of each of the statements. The different financial health of the three companies helped in evaluating the decision of choosing one for lending purpose.
References:
Esin, F., 2015. Liquidity And Financial Flexibility Using the Cash Flow Statement. International Academic Conference Proceedings, 1(1), pp.109-13.
Jemâa, O.B., Toukabri, M. & Jilani, F., 2015. Accruals and the prediction of future operating cash-flows: Evidence from Tunisian companies. International Journal of Accounting and Economics Studies, 3(1), pp.1-6.
Kusuma, H., 2014. THE INFORMATION CONTENT OF THE CASH FLOW STATEMENT: AN EMPIRICAL INVESTIGATION. International Journal of Arts and Commerce, 3(4), pp.59-74.
Mulenga, M. & Bhatia, M., 2017. The Review of Literature on the Role of Earnings, Cash Flows and Accruals in Predicting of Future Cash Flows. Accounting and Finance Research, 6(2), pp.59-70.
Nallareddy, S., Sethuraman, M. & Venkatachalam, M., 2018. Earnings or Cash Flows: Which is a better predictor of future cash flows? Harvard Business School, 1(1), pp.1-54.
Omag, A., 2016. Cash Flows from Financing Activities. Evidence from the Automotive Industry. International Journal of Academic Research in Accounting, Finance and Management Sciences, 6(1), pp.115-22.
Šteinberga, D. & Millere, I., 2017. Solvency Evaluation, Comparing Traditional Financial Situation Assessment Methods with Information from Cash Flow Statements, Using Data from Insolvent Companies in the Republic of Latvia. European Research Studies Journal, 20(3A), pp.246-58.
