Financial Statements

Question 1

(a) Income Statement (8 marks)

COGS $=$ purchases $+$ opening inv $-$ closing inv $= 7{,}200 + 900 - 1{,}500 = 6{,}600$. (cash purchases are the "purchases" figure; inventory build reduces COGS) (2)

• Gross profit $=12{,}000-6{,}600=5{,}400$ (2)
• EBIT $=5{,}400-1{,}800-600=3{,}000$ (2)
• EBT $=3{,}000-400=2{,}600$; Tax $=650$; NI $=1{,}950$ (2)

(b) Cash Flow Statement (9 marks)

CFO (indirect): (5) $\text{CFO}=1{,}950 + 600 \;(\text{D\&A})\; - 900\;(\Delta\text{AR})\; - 600\;(\Delta\text{Inv})\; + 300\;(\Delta\text{AP})$ $= 1{,}950+600-900-600+300 = 1{,}350$

• Add back non-cash D&A; AR↑ and Inv↑ consume cash (subtract); AP↑ provides cash (add).

CFI $= -2{,}000$ (capex). (1) CFF $= +1{,}500 - 300 = +1{,}200$ (borrowing less dividends). (1) Net change in cash $= 1{,}350 - 2{,}000 + 1{,}200 = 550$. (1) Closing cash $= 500 + 550 = 1{,}050$. (1)

(c) Proof & Interpretation (7 marks)

Cash generated by operations = cash-basis revenue − cash-basis operating costs − cash tax. Starting from accrual NI and converting each accrual item to cash: (3)

• Revenue collected in cash $=$ Revenue $-\Delta\text{AR}$.
• Cash COGS $=$ COGS $+\Delta\text{Inv} - \Delta\text{AP}$ (buying more inventory uses cash; paying suppliers later saves cash).
• D&A is a non-cash charge inside NI, so add it back.

Rearranging: $\text{CFO}= \text{NI} + \text{D\&A} - \Delta\text{AR} - \Delta\text{Inv} + \Delta\text{AP} = 1{,}950+600-900-600+300 = 1{,}350\ \checkmark$ (2)

Most damaging item: the $\Delta\text{AR}=900$ jump — revenue was booked but not collected. (1) A profitable firm can run out of cash because profit recognises sales on accrual (delivery) while cash arrives later; rapid growth ties up cash in receivables and inventory faster than profit replenishes it. (1)

Question 2

(a) Ratios (6 marks) — using COGS $=6{,}600$

• DIO $= \dfrac{1{,}500}{6{,}600}\times365 = 82.95 \approx \mathbf{83.0}$ days (1.5)
• DSO $= \dfrac{1{,}900}{12{,}000}\times365 = 57.79 \approx \mathbf{57.8}$ days (1.5)
• DPO $= \dfrac{1{,}100}{6{,}600}\times365 = 60.83 \approx \mathbf{60.8}$ days (1.5)
• CCC $= 83.0+57.8-60.8 = \mathbf{80.0}$ days (≈79.9 unrounded). (1) Interpretation: cash is locked up ~80 days between paying suppliers and collecting from customers → positive working-capital funding need; growth will consume cash. (0.5)

(b) Code & Incremental Need (9 marks)

def ccc(rev, cogs, inv, ar, ap):
    dio = inv / cogs * 365
    dso = ar / rev * 365
    dpo = ap / cogs * 365
    return dio + dso - dpo
 
# base year
rev, cogs = 12000, 6600
inv, ar, ap = 1500, 1900, 1100
NWC_0 = (ar + inv) - ap          # non-cash working capital = 2300
 
# 20% growth, ratios constant -> all WC items scale with their driver (rev/cogs), i.e. x1.2
g = 0.20
NWC_1 = NWC_0 * (1 + g)          # 2760
incremental_need = NWC_1 - NWC_0 # = NWC_0 * g
print(incremental_need)          # 460

(5 for correct function + driver logic)

Formula: since inventory & payables scale with COGS and receivables with revenue — all growing at 20% — net working capital $\text{NWC}=(\text{AR}+\text{Inv}-\text{AP})$ scales by the same factor. Base NWC $=1{,}900+1{,}500-1{,}100=2{,}300$. (2) Incremental financing need $= \text{NWC}_0\times g = 2{,}300\times0.20 = \mathbf{460}$ ₹ lakh. (2)

(c) Negative CCC proof (5 marks)

Cash tied in operations $\approx \text{NWC} = \text{NWC-per-unit-sales}\times\text{Sales}$. If CCC $<0$ then NWC per unit sales $<0$ (payables + collections outrun inventory + receivables). (2) Then $\Delta\text{NWC}=(\text{NWC/Sales})\times\Delta\text{Sales}<0$ for $\Delta\text{Sales}>0$: growing sales releases cash rather than absorbing it. (2) Example: Amazon/retail-e-commerce & subscription models (customers pay upfront/instantly, suppliers paid on 60–90 day terms, low inventory). (1)

Question 3

(a) Table (6 marks)

Accruals ratios: $20/5000=0.4\%$; $270/6000=4.5\%$; $560/7200=7.78\%$. (3) Rev growth $6000/5000-1=20\%$, $7200/6000-1=20\%$. Receivables $1100/600-1=83.3\%$, $2000/1100-1=81.8\%$. (3)

(b) Red flags (6 marks) — any three:

1. Widening NI–CFO gap / rising accruals ratio: profit growing while CFO collapses (380→250→90) — earnings not backed by cash. (2)
2. Receivables growing far faster than revenue (~82% vs 20%): suggests channel-stuffing or booking sales that aren't converting to cash — possible aggressive/premature revenue recognition. (2)
3. Inventory growing faster than revenue (500→900→1600, +80%/+78% vs +20% sales): demand overstated or obsolescence/write-down risk; also inflates gross profit if not written down. (1) Mechanism: recognising revenue before collection inflates NI and AR simultaneously while no cash arrives → NI rises, CFO falls, AR balloons — exactly this pattern. (1)

(c) Footnotes to inspect (4 marks) — any two:

• Revenue recognition policy note: check timing/point of recognition and any change; expect vague "on shipment"/bill-and-hold language if aggressive. (2)
• Receivables ageing / allowance for doubtful debts note: expect rising overdue buckets and inadequate provisioning if red flag is real. (2)
• (Alt) Inventory valuation & write-down note; related-party sales disclosures.

[
  {"claim":"COGS = 7200 + 900 - 1500 = 6600","code":"result = (7200+900-1500)==6600"},
  {"claim":"Net income = 1950","code":"rev=12000; cogs=6600; gp=rev-cogs; ebit=gp-1800-600; ebt=ebit-400; ni=ebt-0.25*ebt; result = ni==1950"},
  {"claim":"CFO = 1350 and closing cash = 1050","code":"ni=1950; cfo=ni+600-900-600+300; cfi=-2000; cff=1500-300; close=500+cfo+cfi+cff; result = (cfo==1350) and (close==1050)"},
  {"claim":"CCC approx 79.9 days","code":"dio=1500/6600*365; dso=1900/12000*365; dpo=1100/6600*365; ccc=dio+dso-dpo; result = abs(ccc-79.9)<0.2"},
  {"claim":"Incremental WC need on 20% growth = 460","code":"nwc0=1900+1500-1100; inc=nwc0*0.20; result = inc==460"},
  {"claim":"Y3 accruals ratio approx 7.78%","code":"result = abs((650-90)/7200-0.0778)<0.001"}
]