Understanding cash flow terminology

‘MetroModa is getting to be as laid back as its clothes. Operating working capital soared by over A200 million in x1, absorbing cash needed for expansion and contributing to negative free cash flow that year.

The company has a great product line. If only its financial management were in the same league . . .’

MetroModa, a specialist designer and manufacturer of ‘smart casual’ clothes, is enjoying rapid growth, thanks to the movement towards less formal attire in the office. However, the company has attracted criticism among professional investors for its poor working capital management and high financial leverage.

This criticism attracts the notice of the company’s non-executive directors. One of them saw the above comment in the Green Eye Shade column of the Business News, a prominent weekly newspaper, shortly after the company released its x1 results. He contacts the chief financial officer of the company and asks some questions (see below). The CFO is busy negotiating several acquisitions at present and, knowing your financial analysis skills, she asks you to deal with them. Extracts from MetroModa’s x1 accounts are given in Exhibit 6.24.

Required Answer the following questions raised by the non-executive director, using information in MetroModa’s x1 accounts.

(a) ‘How can working capital have increased by over A200 million in x1? By my calculations, working capital was A150 million at the end of x0 and A322 million at the end of x1. That’s an increase of only a172 million – a big increase, to be sure, but less than the figure quoted in Business News.’

(b) ‘What is “free cash flow”? It’s not stated anywhere on the cash flow statement. Is it the same as

“net increase in cash”? If so, this is a positive, not a negative, figure.’

(c) ‘Is the figure for depreciation in the cash flow statement correct? According to the balance sheet, depreciation was A786 million in x1. I assume that’s the number that should be in the cash flow statement.

It can’t be the change in depreciation between end-x0 and end-x1. That’s only A136 million.’AppenedixLO1

Transcribed Image Text:

Exhibit 6.24 MetroModa SA Extracts from x1 accounts (amounts In million) Balance sheet at 31 December x1 x1 x0 Current assets Current Nabitles Cash and marketable securities 122 110 Accounts payable 211 170 Accounts receivable 243 140 Accrued expenses 51 56 Inventories Prepaid expenses 348 200 Taxes payable 33 25 67 50 Bank loans 153 100 770 500 448 350 Fixed assets Long-term loans 430 300 Property, plant and equipment 1,819 1,600 Less: Accumulated depreciation -786 -650 1,033 950 Shareholders' equity Contributed capital Retained profits 200 200 725 600 925 800 Total assets Total lablities 1,803 1,450 and shareholders' equity 1,803 1,450 Cash flow statement for x1 Operating activities Net profit 175 150 Depreciation Changes in operating working capital: Accounts receivable Inventories Prepaid expenses Accounts payable Accrued expenses Taxes payable -103 -148 Net cash inflow from operations Investing activities Purchase of plant and equipment -240 Sale of property 777 Net cash outflow on Investing activities -233 Financing activities Increase in bank loans Increase in long-term loans Dividends pald Net cash inflow from financing activities Net Increase In cash Cash and marketable securities, start-x1 Cash and marketable securities, end-x1 110 122