Financial Statements

Question 1 (12 marks)

(a) Line-by-line derivation (8 marks) — 1 mark each line + 1 for correct ordering.

• Revenue = 500,000 × ₹200 = ₹100,000,000 (revenue = units × price)
• COGS = direct materials + labour + operating depreciation attributable to production. Here COGS = ₹60,000,000 (dep is treated as operating below; if included in COGS same total flows). Take COGS = ₹60,000,000.
• Gross Profit = Revenue − COGS = 100,000,000 − 60,000,000 = ₹40,000,000 (measures product-level profitability)
• Operating Income (EBIT) = Gross Profit − SG&A − Depreciation = 40,000,000 − 12,000,000 − 5,000,000 = ₹23,000,000 (core operations, before financing/tax)
• Pre-tax Income (EBT) = EBIT − Interest = 23,000,000 − 3,000,000 = ₹20,000,000 (interest is a financing cost, sits below EBIT)
• Tax = 25% × 20,000,000 = ₹5,000,000
• Net Income = EBT − Tax = 20,000,000 − 5,000,000 = ₹15,000,000 (the bottom line)

(b) Margins (2 marks)

• Gross Margin = Gross Profit / Revenue = 40,000,000 / 100,000,000 = 40% (1)
• Net Margin = Net Income / Revenue = 15,000,000 / 100,000,000 = 15% (1)

(c) Explain (2 marks) — EBIT excludes interest (capital-structure choices) and tax (jurisdiction/timing), so it isolates how well the core operations generate profit and lets you compare firms regardless of how they are financed. (1 for excluding financing/tax; 1 for comparability)

Question 2 (10 marks)

(a) Classification (4 marks) — ½ mark each:

• Cash → Current Asset; Inventory → Current Asset; AR → Current Asset
• PP&E (net) → Non-current Asset
• Accounts Payable → Current Liability; Short-term borrowings → Current Liability
• Long-term debt → Non-current Liability
• Share Capital, Retained Earnings → Equity

(b) Derive Retained Earnings (4 marks) Accounting equation: Assets = Liabilities + Equity

• Total Assets = 40,000 + 80,000 + 60,000 + 300,000 = 480,000 (1)
• Total Liabilities = 50,000 + 30,000 + 200,000 = 280,000 (1)
• Equity = Assets − Liabilities = 480,000 − 280,000 = 200,000 (1)
• Retained Earnings = Equity − Share Capital = 200,000 − 150,000 = ₹50,000 (1)

(c) Explain (2 marks) — Every asset is funded by either a claim from creditors (liabilities) or from owners (equity); double-entry records both sides of each transaction, so total resources must always equal total claims on them. (1 funding identity; 1 double-entry)

Question 3 (12 marks)

(a) Indirect CFO template + computation (7 marks) Template (3 marks for correct template):

CFO = Net Income
    + Non-cash expenses (Depreciation/Amortization)
    − Increase in current assets (AR, Inventory)   [+ if decrease]
    + Increase in current liabilities (AP)          [− if decrease]

Computation (4 marks):

• Start: Net Income = 100,000
• • Depreciation = +20,000
• − Increase in AR = −15,000
• • Decrease in Inventory = +10,000
• • Increase in AP = +8,000
• CFO = 100,000 + 20,000 − 15,000 + 10,000 + 8,000 = ₹123,000

(b) Explain (3 marks) — Profit is recognised when a sale is earned (accrual basis), so a credit sale adds to revenue/net income immediately even though no cash has arrived. The unpaid amount sits in receivables; the rise in receivables represents earned-but-uncollected cash, so it is subtracted when converting profit to cash.

(c) Scenario (2 marks) — e.g., rapid growth where the firm sells on credit and stockpiles inventory: profit is booked but cash is tied up in AR and inventory, so cash can be exhausted (or a big loan repayment/capex outflow with slow collections).

Question 4 (8 marks)

(a) (6 marks) — 1 per section name + ½ per valid example (2 examples each):

• Operating (CFO): cash from customers, cash paid to suppliers/employees, taxes paid, interest paid.
• Investing (CFI): purchase/sale of PP&E (capex), purchase/sale of investments, acquisitions.
• Financing (CFF): issuing/repaying debt, issuing/buying back shares, dividends paid.

(b) (2 marks) — Positive CFO (core business generates cash), heavy negative CFI (investing/expanding via capex), positive CFF (raising debt to fund it): a growth / expansion stage company.

Question 5 (10 marks)

(a) NWC (2 marks) — Net Working Capital = Current Assets − Current Liabilities = 140,000 − 40,000 = ₹100,000.

(b) CCC derivation (6 marks) — 1½ each:

• DIO = (Inventory / COGS) × 365 = (90,000 / 730,000) × 365 = 45 days
• DSO = (AR / Revenue) × 365 = (50,000 / 1,000,000) × 365 = 18.25 days
• DPO = (AP / COGS) × 365 = (40,000 / 730,000) × 365 = 20 days
• CCC = DIO + DSO − DPO = 45 + 18.25 − 20 = 43.25 days

(c) (2 marks) — A negative CCC means the company collects cash from customers before it pays suppliers, effectively funding operations with suppliers' money — no cash is tied up in the operating cycle (a working-capital advantage).

Question 6 (8 marks) — 1 mark red-flag name + 1 mark reasoning each

(a) Possible earnings manipulation / low earnings quality. Reported profit isn't backing into cash, suggesting aggressive revenue recognition or non-cash accruals inflating income.

(b) Channel-stuffing / revenue recognition red flag. Sales may be booked without genuine collection, or credit terms loosened to inflate revenue — collection risk rising.

(c) Earnings management via estimates. Lengthening useful life lowers depreciation and boosts profit; frequent changes suggest tuning numbers to hit targets.

(d) "One-time" items aren't one-time. Recurring exceptional charges hide ongoing operating weakness by pushing costs "below the line" so headline/core profit looks better.

[
  {"claim":"Q1 Net Income = 15,000,000","code":"rev=500000*200; cogs=60000000; gp=rev-cogs; ebit=gp-12000000-5000000; ebt=ebit-3000000; tax=0.25*ebt; ni=ebt-tax; result = (ebit==23000000 and ebt==20000000 and ni==15000000)"},
  {"claim":"Q1 margins 40% and 15%","code":"rev=100000000; gp=40000000; ni=15000000; result = (gp/rev==Rational(2,5) and ni/rev==Rational(3,20))"},
  {"claim":"Q2 Retained Earnings = 50,000","code":"assets=40000+80000+60000+300000; liab=50000+30000+200000; equity=assets-liab; re=equity-150000; result = (assets==480000 and equity==200000 and re==50000)"},
  {"claim":"Q3 CFO = 123,000","code":"cfo=100000+20000-15000+10000+8000; result = (cfo==123000)"},
  {"claim":"Q5 CCC = 43.25 days","code":"dio=Rational(90000,730000)*365; dso=Rational(50000,1000000)*365; dpo=Rational(40000,730000)*365; ccc=dio+dso-dpo; result = (dio==45 and dpo==20 and float(dso)==18.25 and float(ccc)==43.25)"}
]