Cash Flow Statement: Alpha, Beta and Gamma Corporation - Assignment Example

Cash Flow ment Alpha, Beta and Gamma Corporation Part I Major Sources and Uses of Cash Alpha Corporation Major Sources of Cash: Cash from Operations, Cash from Loans (Short-Term and Long-term), Cash from Capital Investments (Proceeds from sales of fixed assets, Proceeds from sale of Class B common stock etc.) Major Uses of Cash: Investment in Depreciable Assets, Investment in Capitalized Software, Repayments of Short-Term Borrowings and Long-Term Debt. Beta Corporation Major Sources of Cash: Cash from Operations and Proceeds from the issuance of common stock. Major Uses of Cash: Investment Activities (Capital Expenditures and Purchase of Marketable Securities) and Payment of subordinated debt. Gamma Corporation Major Sources of Cash: Cash from Operations, Issuance of treasury shares (including tax benefits) and Proceeds from issuance of debt. Major Uses of Cash: Investing Activities (Purchase of Plant, Property and Equipment, Net Increase in other assets, and Purchase of Kienzie business), Payments to retire debt and Purchase of treasury shares. (2) 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? Alpha Corporation: In each of the three years, 1989, 1990 and 1991, Alpha’s cash flow from operations ($125.2 million) was a positive figure and was greater than the net loss ($377.9 million) which arose in each of the three years for Alpha Corporation. The major reasons for the difference between these two figures comprise of: Depreciation and Amortization: a huge amount of depreciation and a relatively lower amount of Amortization in each of the three years were added to the net loss which increased the cash flow from operations (these non-cash charges, among others are added to the net income or net loss to arrive at a Net Cash Flow figure so as to proceed with further cash transactions with this amount), Restructuring: the addition of net amount of restructuring and other unusual items in the net loss also elevated the cash flow from operations, and Working Capital: the decrease in Accounts Receivable due to collection of receivables and the reduction in Inventory (both only in the recent two years) were also reasons of a difference between the figure of cash flow from operations and the net loss. Beta Corporation 1989: In 1989, the cash flow from operations was greater than the net income of Beta Corporations. The main drivers for the elevated cash flow were; the addition of depreciation and amortization (apart from amortization of original issue discount) which comes out to be a huge amount of $2.23 million in 1989 followed by the reduction in inventory of $1.04 million and finally the increase in accounts payable and accrued expenses of $2.07 million. 1990: In the second year as well, the cash flow from operations ($7 million) was greater than the net income ($5.2 million), though the difference was relatively less than that in 1989. Once again the main reason for the increase was the addition of depreciation and amortization ($ 2.7 million). This was followed by amortization of original issue discount and a decrease in deposits and other assets. 1991: In this year, however, the picture is different as the cash flow from operations is less than the net income of Beta Corporation. A huge increase of around $10.84 million in accounts receivable was the major reason behind the difference of $2.04 million between the afore mentioned two items. This was followed by a rise in inventory and deposits and other assets both of which accumulated $1.62 million. Gamma Corporation In each of the three years, the cash flow from operating activities was greater than Gamma’s Net Income, however, the highest difference was found in 1991 (more than $1.6 million) when a net loss was experienced. Year Major reasons of change Amount of change(In Millions of $) 1989 Depreciation and Amortization 686.74 Increase in deferred revenues and customer advances 105.85 1990 Depreciation and Amortization 796.20 Increase in restructuring reserve 443.54 Increase in other liabilities 285.18 Increase in accounts payables 107.00 1991 Depreciation and Amortization 828.56 Increase in restructuring reserve 593.16 Other adjustments to income 189.08 Decrease in accounts receivable 105.98 (3) Was the firm able to generate enough cash from operations to pay for all of its capital expenditures? Alpha Corporation: In each of the three years, Alpha has not earned enough cash from operations to pay for all its capital investments that are namely, Investment in depreciable assets and Investment in capitalized software. Beta Corporation: In 1989 and 1990, Beta was able to cover all its capital expenditures with its cash flow from operations (almost barely in 1989) but the case was opposite in the final year when there was a deficit between the two. Gamma Corporation: In all of the three years, Gamma generated enough cash flows from operating activities to pay for all of its capital investments. (4) Did the cash flow from operations cover both the capital expenditures and the firm’s dividend payments, if any? Alpha Corporation: No, as Alpha’s cash flows from operating activities were not able to cover even its capital expenditures in all the three years, an incremental cost of dividend payments just increases the deficit. Beta Corporation: There were no dividend payments carried out by Beta in all three years so the situation remains the same as what was in part (3). Gamma Corporation: There were no dividend payments carried out by Gamma Corporation in all three years. (5) If it did, how did the firm invest its excess cash? Alpha: It wasn’t able to cover its capital expenditures through its cash flow from operations so there was a deficit balance of cash. Beta: Beta didn’t invest its excess cash in anything when it had so in 1989 and 1990, however, it did invest in the purchases of marketable securities in 1991 but this was not from the cash flow from operations but mainly from the proceeds from issuance of stock. Gamma: Gamma only invested its excess cash in 1991 to purchase Kienzle business. (6) If not, what were the sources of cash the firm used to pay for the capital expenditures and / or dividends? Alpha: In 1989, Alpha mainly used short-term borrowings and the proceeds from long-term debt to pay for the capital expenditures and dividends both. While in 1990, there were a number of sources of cash from which Alpha would have paid for capital expenditures and dividends such as proceeds from disposal of depreciable and other assets, proceeds from the sale of discontinued operations and proceeds from long-term debt. This same proposition was also experienced by Alpha in 1991. Beta: In 1991, Beta had only one source of cash which it used to pay for its capital expenditures and other expenses as well, the proceeds from the issuance of common stock that is it raised funding by issuing new shares that amounted to a huge $23.08 million. Gamma: Gamma was able to pay for its capital expenditures in all the three years. (7) Were the working capital (current assets and current liability) accounts other than cash and cash equivalents primarily sources of cash, or users of cash? Alpha 1989: All Current Asset Accounts including Accounts Receivable, Inventory and Other Current Assets were uses of cash as they increased in 1989 whereas in Current Liability Accounts, Accounts Payable were sources of cash as they increased and other current liabilities were uses of cash as they were paid off by Alpha in 1989. 1990: Accounts Receivable and Inventory were sources of cash as they decreased and generated cash through collection whereas other current assets increased so they ought to be uses of cash. In the case of Current Liabilities, Accounts Payable decreased therefore they were uses of cash whereas other current liabilities increased so they were sources of cash generation. 1991: The same case as of the year 1990 applies here as well just with the exception of other current assets being sources of cash in this year instead of uses of cash. Beta 1989: All current asset accounts except inventory were uses of cash as they increased in 1989 whereas there was an increase in accounts payable and accrued expenses depicting a source of cash; inventory was a source of cash which shows that it was sold in the year to generate cash. 1990: Accounts receivable and inventory were uses of cash whereas short-term deposits and other assets were sources of cash. Accounts payable and accrued expenses, the only current liability account decreased in 1990 depicting to be a use of cash. 1991: All three current asset accounts were uses of cash as they increased in 1991 whereas Accounts Payable and accrued expenses increased so they were sources of cash for Beta Corporation. Gamma 1989: Accounts receivable and inventories were uses of cash whereas prepaid expenses were sources of cash. In the case of current liability accounts, accounts payable increased so being a source of cash. 1990: Accounts receivable and prepaid expenses were uses of cash whereas inventories and accounts payable were sources of cash for Gamma Corporation in 1990. 1991: Accounts receivable and inventories were uses of cash while prepaid expenses and accounts payable were sources of cash in 1991. (8) What other major items affected cash flows? Alpha: Payments of long-term debt was a major factor affecting Alpha’s cash flows negatively in all the three years. Beta: Interest paid, income taxes paid, net payments under working capital line of credit, net payments under equipment line of credit and principal payment under capital lease obligations had adverse effects on cash flows. A new huge issue of common stock in 1991 also affected Beta’s cash flows but with a positive line of sight. Gamma: Increase in restructuring reserve had a positive impact on Gamma’s cash flows. Payments to retire or repay debt and purchase of treasury shares (though decreasing year by year) influenced Gamma’s cash flows negatively. Part II (9) What was the trend in: (i) Net Income? Alpha: A negative trend (net loss) throughout the three years with improvement seen in 1991 but still the figure has not passed the zero level. Beta: An increasing trend with huge acceleration in net income from 1989 to 1990 by more than 1100% and medium elevation in the final year as well. Gamma: A steep decreasing trend of net income with a healthy profit figure of more than a billion dollars in 1989 coming to around 74 million in 1990 and then into a negative form in 1991 that too more than $600 million. (ii) Cash Flow from continuing operations? Alpha: A clear increasing trend but at a decreasing rate as there was a 90.8% increase in 1990 and only 40.2% rise in 1991in the cash flow from continuing operations or operating activities. Beta: An increasing – cum – decreasing trend with an absolute increase of $3.33 million (90.7%) up to $7 million in the year 1990 but a sharp fall then to $3.919 million (-44.01%) in 1991. Gamma: A decreasing trend with a relatively slight fall in 1990 ($ 45.317 million, -3.06%) followed by a sharp fall in 1991 ($393.173 million, -27.42%). (iii) Capital Expenditures? Alpha: A decreasing trend of capital expenditures was seen for Alpha Corporation throughout the three years being analyzed with a sharp decline in the year 1990 followed by a relatively slighter fall in 1991. Beta: An increasing trend at an increasing rate with a 26.03% rise in 1990 and 31.11% increase in the final year. Gamma: A decreasing trend of capital expenditures; almost 16% decline in 1990 and 28.23% fall in 1991. (iv) Dividends? Only Alpha Corporation paid dividends that too in the first two years concerned only (1989 and 1990). A decreasing trend was experienced by Alpha with a sharp decline of 72.31% in 1990 and a reduction to zero dividend payments in 1991. (v) Net borrowing (proceeds less payments of short- and long-term debt)? Alpha’s Net Borrowing 1989: $353.1 million 1990: -$599.7 million 1991: -$84.7 million The above computations show a sharp decreasing – cum – increasing trend with a drastic decrease in the net borrowings in 1990 by $952.8 million and by $515 million in 1991. Beta’s Net Borrowing (excluding principal payments under capital lease obligations) 1989: $3.152 million 1990: -$2.126 million 1991: -$5.985 million The above calculations depict a decreasing trend from Net Proceeds to Net Borrowings. A sharp decline of $5.278 million in the year 1990 is followed by a fall of $3.859 million in 1991. Gamma’s Net Borrowing 1989: -$112.82 million 1990: - $3.235 million 1991:-$98.177 million Gamma Corporation paid much more than what it got as proceeds of long-term and short-term loans. Its net borrowings fell down to $98.18 million in 1991 from a huge figure of $112.82 million in 1989. (vi) Working capital accounts? Alpha Corporation 1989: Change in Current Assets = Increase of $61.2 million Change in Current Liabilities = Increase of (41 – 10.5) = $30.5 million 1990: Change in Current Assets = Decrease of (73.4+100.9-1.2) = $173.1 million Change in Current Liabilities = Decrease of (21.3 – 14.1) = $7.2 million 1991: Change in Current Assets = Decrease of $258 million Change in Current Liabilities = Decrease of $88.5 million The above working shows a decreasing trend in both current assets and current liabilities so overall working capital accounts depict a decreasing trend from 1989 to 1991. Beta Corporation 1989: A net increase in current assets of $1.27 million and an increase of $2.07 million. 1990: A net increase of $1.06 million in current assets and a decrease of $310,000 in current liabilities were experienced. 1991: An increase of $12.45 million in current assets and $5.66 million in current liabilities was seen. The above computations show an increasing trend in current assets with a slight decrease in 1990 followed by a jump in 1991 by $12.45 million. Current Liabilities depicted fluctuations with an initial increase followed by a slight decrease and finally a jump in 1991 by $5.66 million. Gamma Corporation 1989: A net increase of $417.23 million in current assets and a rise in current liabilities of $30.65 million. 1990: A net increase in current assets of $232.22 million and again a rise in current liabilities of $107.001 million. 1991: A net decrease of $77.35 million and $17.69 million was seen in both current assets and current liabilities. The trend for Gamma’s current assets was an increasing – cum – decreasing one with a reduction in 1991 whereas almost the same trend was experienced by Gamma’s current liabilities with a relatively lesser decrease in the final year. Part III Based on the evidence in the Statement of Cash Flows alone, what is your assessment of the financial strength of this business? Why? Alpha Corporation: Current Assets, on an overall basis, decreased throughout the three years reported which shows that Alpha’s ability to cover its short term obligations has reduced in these years; Current Liabilities including mainly accounts payable have reduced but relatively on a lower scale. The decrease in accounts receivable can be taken in a way that Alpha has become efficient in these years with tight credit policies for collections and in the case of inventory as well, it was turned over efficiently in the last two years to generate more cash. Short-term borrowings decreased by time but the payments for long-term debt remained in all the three years with the highest amount coming up in 1990 which is why the cash balance at year end is the lowest; this indicates a financial weakness or pending financial problems for Alpha Corporation. In short-term cash payments, Alpha is quite efficient but in the long-term case, it has financial weaknesses to be worked on. Beta Corporation: The main thing to be considered for Beta is its capital structure change in the year 1991from debt financing to equity financing with issuance of common stock. This shows a risky decision has been taken by Beta as it should have been balanced in its capital structure. The main reason for a huge incline in Beta’s cash balance was its issuance of common stock in 1991. Current Assets increased the highest in 1991 showing inefficiency in collecting receivables and blocking cash in inventories. Accounts Payable elevated hugely by $5.66 million. The main reason for a good cash balance was only Beta’s financing structure and not its operating or investing activities so this depicts that there is some financial weaknesses existing in Beta’s performance. Gamma Corporation: Gamma seems to be a relatively stable firm with its highest cash flows coming from its operating activities which depict its efficiency in handling operations. Gamma’s current assets reduced in 1991 showing efficiency in handling receivables and inventories. It had negative cash flows from investing activities in all three years which means it only invested in securities and assets and did not dispose of any of them. Financing activities included purchasing and issuing of treasury shares while retiring and paying for debt which concluded negative cash flows in 1989 and 1991 and a meager positive figure in 1990. Conclusion Overall, considering the financial strengths of all three companies, Gamma Corporations has performed well in these years and has not been dependent on financing needs like Alpha and Beta Corporation. Gamma’s operating activities were handled very efficiently and generated enough cash to cover its capital as well as financing needs. References Julie H. Hertenstein & William J. Bruns (1993). Statement of Cash Flows: Three Examples. Boston, MA 02613, Harvard Business School Publishing Read More