Question

QUESTION 12 a). Why are cash flow statements sometimes considered more useful than profit statements? b). The income statement below is for Aboagye Ltd for the year ended December 31, 2010 GHCm 9,000 (7,710) Revenue Cost (except depreciation and interest) Depreciation Interest expense, net Income taxes Net income Aboagye Ltd: balance sheet as at December 31, 2010 (181) (215) 800 Non-current assets Current assets Total assets GHC m 5,500 4.500 10,000 Capital and reserves Ordinary share capital (1,600 million shares) Retained earnings 1,600 1020 2,620 3,000 4.380 Long term liability Current liabilities

QUESTION 12 a). Why are cash flow statements sometimes considered more useful than profit statements? b). The income statement below is for Aboagye Ltd for the year ended December 31, 2010 GHCm 9,000 (7,710) Revenue Cost (except depreciation and interest) Depreciation Interest expense, net Income taxes Net income Aboagye Ltd: balance sheet as at December 31, 2010 (181) (215) 800 Non-current assets Current assets Total assets GHC m 5,500 4.500 10,000 Capital and reserves Ordinary share capital (1,600 million shares) Retained earnings 1,600 1020 2,620 3,000 4.380 Long term liability Current liabilities

Answer 1

A. Importance of cash flow statement

The cash flow report is important because it informs the reader of the business cash position. It needs cash to pay its expenses, to pay bank loans, to pay taxes and to purchase new assets. A cash flow report determines whether a business has enough cash to do exactly this.

A cash flow statement tells you where the money went.  A profit and loss statement says nothing about principal payments you make to the bank. You could have reasonably good profits, but the amount of money you pay your bank every month could be putting you out of business.

A cash flow statement can help you focus on creating excess cash.  Having profits is important. Profits are one of the things that help create cash. There are other things that can also help you create cash.

Cash flow statements often provide better KPI’s (Key Performance Indicators) than profit and loss statements.  I believe developing excess cash is a great KPI. This is an activity that literally every area of your company can get involved in through individual drivers.

Cash flow statements help with financing decisions.  Buying capital equipment uses cash. Growing capacity in your company uses cash. Adding inventory uses cash. Adding customers uses cash.

Part -B

a. Five key ratios relevant to Z' Score

Key Ratios	Dec, 2010
Working capital/ Total assets	1%
Retained earnings/ Total Assets	10%
Profit before interest and tax/ Total assets	11%
Market value of equity/ Book value of debts	107%
Sales/ Total assets (times)	0.90

b. Calculation of Z' Score value

Z Score = 0.012* 1.2% + 0.014* 10.2% + 0.033* 11.09% + 0.006* 106.66% + 0.999* 0.9 = 0.91

Since Z' Score of the company is below 1.8, therefore it will be classified as potential failure.

C. Benefit of Z score

The Z Score provides a quantitative measurement into a company's financial health.

Business managers use the Z Score to raise capital and secure credit.

The Z Score is an effective tool to demonstrate credit worthiness to bankers and soundness of business model to investors.