Question

Answer questions as directly as possible.

1.) Define internal and external sources of liquidity. What is a material deficiency in liquidity? If a firm has a material deficiency in liquidity what should be reported in the management discussion and analysis?

2.) Indicate whether each of the following items would result in net cash flow from operating activities being higher (H) or lower (L) than net income.

          a. Increase in inventory

          b. Increase in accounts payable

          c. Amortization expense

          d. Decrease in accrued liabilities

          e. Loss on sale of assets

          f. Decrease in accounts receivable

          g. Decrease in deferred tax assets

          h. Increase in deferred revenue

          i. Decrease in income taxes payable

          j. Decrease in prepaid expenses

3.) Prepare an income statement using the following information:

Gross profit margin                             40%

          Gross profit                                         $7,550

          Tax rate                                               35%

          Operating profit                                   $400

Answer 1

1)

Internal sources of liquidity

can be easily used to generate liquidity for the company. They are generally cash and other near-cash assets. More specifically, they include:

1. Cash Balances (generally in bank Account)

2. Short Term Funds

3. Cash Flow Management

External Source of Liquidity

Unlike the Internal sources of liquidity, the External sources usually cannot be converted into cash without an effect on the company’s operations. For example, it can be the case of a company that has run out of cash and near-cash assets and needs to liquidate assets, such as inventory, plants, and equipment, to pay its bills.

More specifically, a company’s secondary sources of liquidity include:

1. Negotiating its debt Obligations

2. Liquidating Assets

3. Bankruptcy Protection and Reorganisation

Material Deficiency in Liquidity:

Material Deficiency includes significant deficiency of liquidity in the company. It can be observed as a cash crunch in the company and may hamoer the going concern assumptions also.

Material Deficiency plays in vital role in understanding the cash management and opearting management of the company. It also entales the financial postiion of the company and its future prospects.

Reporting of Materia Deficiency:

A discussion of liquidity includes:
• the terms of and changes in credit facilities, debt covenants and debt
repayments, including the effects of any non-compliance or anticipated
non-compliance with terms
• risks associated with financial instruments and other sources of liquidity,
including any terms that could trigger an additional funding requirement
or early payment to counterparties; and circumstances that could impair
the company’s ability to undertake transactions considered essential
to operations
• any legal restrictions on the ability of subsidiaries to transfer funds
to the company and the impact on the company to meet obligations.

2)

a. Increase in inventory

          b. Increase in accounts payable - (H)

          c. Amortization expense - (H)

          d. Decrease in accrued liabilities - (L)

          e. Loss on sale of assets - (H)

          f. Decrease in accounts receivable - (H)

          g. Decrease in deferred tax assets - (H)

          h. Increase in deferred revenue - (L)

          i. Decrease in income taxes payable - (L)

          j. Decrease in prepaid expenses - (H)

3)

Gross Profit = 7550

Gross Profit Margin = 40%

Sales = 7550/40% = 18875

Cost of Goods Sold = Sales - Gross Profit = 18875-7550 = 11325

Opeating Profit = Gross Profit - OPerating Expense

400 = 7550 - OPerating Expense

Operating Exp = 7150

Income Statement
Particulars	Amount
Sales	18,875
Cost of Goods Sold	11,325
Gross Profit	7,550
Operating Expense	7150
Opearing Profit	400
Income Tax	140
Net Income	260