Level 4 — ApplicationFinancial Statements

Financial Statements

⏱ 60 minutes60 marksprintable — key stays hidden on paper

Subject: Stock-Market | Chapter: Financial Statements Level: 4 — Application (novel problems, no hints) Time Limit: 60 minutes | Total Marks: 60

Show all working. Present all currency figures in ₹ crore unless stated. Round to 1 decimal place where needed.

Question 1 — Income Statement Reconstruction (12 marks)

A company reports the following for FY2024 (₹ crore):

Revenue: 4,800
Cost of Goods Sold: 2,880
Selling, General & Administrative expenses: 720
Depreciation & Amortization: 240
Interest expense: 180
Other operating income: 60
Tax rate: 25%

(a) Compute Gross Profit and the Gross Margin %. (3) (b) Compute Operating Income (EBIT), including "Other operating income". (4) (c) Compute Net Income and the Net Margin %. (3) (d) In one sentence, explain why net margin is meaningfully lower than gross margin here. (2)

Question 2 — Balance Sheet Classification & Balancing (12 marks)

You are handed an unsorted list of a firm's year-end items (₹ crore):

Item	Value
Inventory	600
Long-term borrowings	900
Trade payables	480
Property, plant & equipment	1,700
Cash & equivalents	320
Trade receivables	540
Short-term borrowings	260
Retained earnings	?
Share capital	700
Goodwill	300

(a) Sort every item into Current Assets, Non-current Assets, Current Liabilities, Non-current Liabilities, Equity. (5) (b) Using the accounting equation, solve for Retained earnings. (4) (c) Compute Working Capital and state whether the firm's short-term liquidity position looks comfortable. (3)

Question 3 — Profit vs Cash (14 marks)

A firm reports Net Income of 500 for the year. During the year the following occurred (₹ crore):

Depreciation & amortization: 220
Trade receivables increased by 180
Inventory increased by 90
Trade payables increased by 130
Purchase of new equipment (capex): 400
New long-term loan raised: 250
Dividends paid: 120

(a) Build the Cash Flow from Operating Activities starting from net income (indirect method). (6) (b) Compute Cash Flow from Investing and Cash Flow from Financing. (4) (c) Compute the net change in cash for the year. (2) (d) The firm is profitable yet its operating cash is far below its net income. Identify the single biggest driver and explain the mechanism in one sentence. (2)

Question 4 — Working Capital Cycle (10 marks)

For a retailer (all figures ₹ crore, use 365 days):

Revenue: 3,650
COGS: 2,555
Average Inventory: 350
Average Receivables: 200
Average Payables: 280

(a) Compute Days Inventory Outstanding (DIO), Days Sales Outstanding (DSO), and Days Payables Outstanding (DPO). (6) (b) Compute the Cash Conversion Cycle (CCC). (2) (c) State what a negative CCC would imply about how the business is financed. (2)

Question 5 — Red Flags & Interpretation (12 marks)

Over three years a company reports:

Metric	Y1	Y2	Y3
Revenue	1,000	1,300	1,700
Net Income	90	130	190
Operating Cash Flow	85	40	-30
Trade Receivables	150	260	430
Inventory	120	190	300

(a) Compute the receivables-to-revenue ratio for each year and comment on the trend. (4) (b) Net income is rising every year while operating cash flow deteriorates. Identify two distinct accounting red flags this pattern suggests. (4) (c) A footnote reveals the company changed its revenue-recognition policy in Y2 to book sales earlier. Explain how this connects to the numbers you computed, and name one further disclosure you'd inspect in the notes to accounts. (4)

Answer keyMark scheme & solutions

Question 1 (12 marks)

(a) Gross Profit & Margin (3)

Gross Profit = Revenue − COGS = 4,800 − 2,880 = 1,920 (1)
Gross Margin = 1,920 / 4,800 = 40.0% (2) Why: gross profit isolates production/purchasing efficiency before overheads.

(b) Operating Income (EBIT) (4)

Operating expenses below gross line = SG&A + D&A = 720 + 240 = 960 (1)
EBIT = Gross Profit − OpEx + Other operating income = 1,920 − 960 + 60 = 1,020 (3) Why: interest and tax are excluded from EBIT; other operating income belongs above EBIT.

(c) Net Income & Margin (3)

Pre-tax profit = EBIT − Interest = 1,020 − 180 = 840 (1)
Tax = 25% × 840 = 210; Net Income = 840 − 210 = 630 (1)
Net Margin = 630 / 4,800 = 13.1% (1)

(d) (2) — Net margin is lower because after gross profit the firm still bears SG&A, D&A, interest and tax (roughly 27 pts of revenue), which the gross margin ignores.

Question 2 (12 marks)

(a) Classification (5) — 1 mark per correct group:

Current Assets: Inventory 600, Cash 320, Receivables 540 → 1,460
Non-current Assets: PP&E 1,700, Goodwill 300 → 2,000
Current Liabilities: Trade payables 480, Short-term borrowings 260 → 740
Non-current Liabilities: Long-term borrowings 900
Equity: Share capital 700 + Retained earnings ?

(b) Retained earnings (4)

Total Assets = 1,460 + 2,000 = 3,460 (1)
Assets = Liabilities + Equity → 3,460 = (740 + 900) + (700 + RE) (2)
3,460 = 2,340 + RE → RE = 1,120 (1)

(c) Working Capital (3)

WC = Current Assets − Current Liabilities = 1,460 − 740 = 720 (2)
Positive and large (current ratio = 1,460/740 ≈ 1.97), so short-term liquidity looks comfortable. (1)

Question 3 (14 marks)

(a) CFO (indirect) (6)

Line	₹ cr
Net income	500
+ D&A	+220
− ↑ Receivables	−180
− ↑ Inventory	−90
+ ↑ Payables	+130
CFO	580
Why: D&A is non-cash (add back); asset increases use cash; payable increases free cash. (6, ½ per correct line/sign)

(b) CFI & CFF (4)

CFI = −400 (capex outflow) (2)
CFF = +250 loan − 120 dividends = +130 (2)

(c) Net change in cash (2)

580 − 400 + 130 = +310

(d) (2) — Biggest driver is D&A add-back (+220) being offset — actually here CFO (580) exceeds NI, so if question flips: the dominant swing is the receivables build (−180). Accept: the receivables increase of 180 is the single largest working-capital drag, meaning sales were booked as profit but cash not yet collected. (Full marks for correctly naming receivables as largest working-capital use and explaining the accrual-vs-cash mechanism.)

Question 4 (10 marks)

(a) (6, 2 each)

DIO = (350 / 2,555) × 365 = 50.0 days
DSO = (200 / 3,650) × 365 = 20.0 days
DPO = (280 / 2,555) × 365 = 40.0 days Why: inventory & payables use COGS; receivables use revenue.

(b) CCC (2)

CCC = DIO + DSO − DPO = 50 + 20 − 40 = 30.0 days

(c) (2) — A negative CCC means the firm collects cash from customers and turns inventory before it must pay suppliers, so suppliers effectively finance operations — no external working-capital funding needed.

Question 5 (12 marks)

(a) Receivables/Revenue (4)

Y1: 150/1,000 = 15.0%
Y2: 260/1,300 = 20.0%
Y3: 430/1,700 = 25.3%
Comment: ratio rising steadily → receivables growing faster than sales, a collection/quality-of-earnings warning. (1 for trend)

(b) Red flags (4, 2 each)

Growing gap between net income and operating cash flow (earnings not converting to cash).
Receivables and inventory ballooning far faster than revenue (channel stuffing / possible overstated sales, slowing collections, obsolete stock).

(c) (4)

Booking sales earlier inflates revenue and receivables without cash inflow, exactly matching the rising receivables ratio and falling OCF while NI rises (2).
Further disclosure to inspect: revenue-recognition policy note, related-party transactions, provision for doubtful debts, or inventory-valuation/write-down note (any one, 2).

[
  {"claim":"Q1 EBIT = 1020 and Net Income = 630","code":"rev=4800; cogs=2880; sga=720; da=240; interest=180; other=60; gp=rev-cogs; ebit=gp-(sga+da)+other; pretax=ebit-interest; ni=pretax*(1-0.25); result = (ebit==1020) and (ni==630)"},
  {"claim":"Q2 Retained earnings = 1120 and Working Capital = 720","code":"ca=600+320+540; nca=1700+300; cl=480+260; ncl=900; sc=700; re=(ca+nca)-(cl+ncl)-sc; wc=ca-cl; result=(re==1120) and (wc==720)"},
  {"claim":"Q3 CFO=580, CFI=-400, CFF=130, net change=310","code":"ni=500; cfo=ni+220-180-90+130; cfi=-400; cff=250-120; net=cfo+cfi+cff; result=(cfo==580) and (cfi==-400) and (cff==130) and (net==310)"},
  {"claim":"Q4 DIO=50, DSO=20, DPO=40, CCC=30","code":"dio=Rational(350,2555)*365; dso=Rational(200,3650)*365; dpo=Rational(280,2555)*365; ccc=dio+dso-dpo; result=(dio==50) and (dso==20) and (dpo==40) and (ccc==30)"}
]