Question three

You are among the finance and accounting experts who have been invited to an investors workshop. In attendance are a group of investors who are shareholders in companies that are listed on the Lusaka Securities exchange. As a starting point, the following case study has been distributed to the investors and thereafter, you the experts will explain any concerns that may be raised by the investors.

Case study of W T. Grants and IBM

Investors usually focus on net income. However, information on cash flows can be important for assessing a company's liquidity, financial flexibility, and overall financial performance. Although W. T. Grant showed consistent profits and even some periods of earnings growth, its cash flow began to go down starting in about year three. The company filed for bankruptcy shortly after year seven. Financial statement readers who studied the company's cash flows would have found early warnings of its problems. The Grant experience is a classic case, illustrating the importance of cash flows as an early-warning signal of financial problems.

The recent picture at IBM (USA) is similar and raises some red flags as to the company's financial flexibility. IBM's earnings per share (EPS) growth has held steady, but growth in free cash flow is on the decline.

After reading this case study, investors are concerned and they seek clarification on the flowing.

i.)One of the investors Mr. Bwalya said what we know is that if the company is profitable then its a good investment choice how is it that Grant showed consistent profits and even some periods of earnings growth, while its cash flow began to go down.

Bearing in mind the underling concepts on which the income statement and the cash flow statement preparation is based, explain to Mr. bwalya how the company would show consistent profits and even some periods of earnings growth, while its cash flow began to go down.

ii) Another investors Mr Banda asked how it is that IBM's earnings per share (EPS) growth has held steady, but growth in free cash flow was on the decline.

Explain to Mr Banda what free cash flows is and how possible it is that IBM's earnings per share (EPS) growth was held steady, but growth in free cash flow was on the decline