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Warf Computers, Inc., was founded 15 years ago by Nick Warf, a computer

programmer. The small initial investment to start the company was made by Nick and his

friends. Over the years, this same group has supplied the limited additional investment

needed by the company in the form of both equity and short- and long-term debt. Recently

the company has developed a virtual keyboard (VK). The VK uses sophisticated artificial

intelligence algorithms that allow the user to speak naturally and have the computer input

the text, correct spelling and grammatical errors, and format the document according to

preset user guidelines. The VK even suggests alternative phrasing and sentence structure,

and it provides detailed stylistic diagnostics. Based on a proprietary, very advanced

software/hardware hybrid technology, the system is a full generation beyond what is

currently on the market. To introduce the VK, the company will require significant outside

investment. Nick has made the decision to seek this outside financing in the form of new

equity investments and bank loans. Naturally, new investors and the banks will require a

detailed financial analysis. Your employer, Angus Jones & Partners, LLC, has asked you to

examine the financial statements provided by Nick. Here are the balance sheets for the two

most recent years and the most recent income statement:

Financial Statements and Cash Flow

WARF COMPUTERS
Balance Sheets (S in thousands)
2018 2019 2018 2019
Current assets Current liabilities
$ $ $

Cash and equivalents 516 596 Accounts payable 645 $ 685

Accounts receivable 883 945 Accrued expenses 529 329
Inventories 875 846 Total current liabilities $ $ 1,014

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1,174
Other 103 121
$ $

Total current assets 2,377 2,508 Long-term liabilities

$

Deferred taxes 210 $ 282

Fixed assets Long-term debt 1,517 1,557
Property, plant, and $ $ $

equipment 4,197 5,476 Total long-term liabilities 1,727 $ 1,839

Less accumulated

depreciation 1,441 1,777

Net property, plant, and $ $

equipment 2,756 3,699 Stockholders' equity

$

Intangible assets and others 936 1,047 Preferred stock 25 $ 25

$ $

Total fixed assets 3,962 4,746 Common stock 166 171

Capital surplus 1,027 1,044

Accumulated retained earnings 2,116 3,414

Less treasury stock 166 253
$

Total equity 3,168 $ 4,401

$ $ Total liabilities and shareholders $

Total assets 6,069 7,254 equity 6,069 $ 7,254

WARF COMPUTERS
Income Statement ($ in thousands)
Sales $ 9,975

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Cost of goods sold 5,882

Selling, general, and administrative expense 933
Depreciation 336
Operating income $ 2,824
Other income 98
EBIT $ 2,922
Interest expense 180
Pretax income $ 2,742
Taxes 687
Current: $615
Deferred: $72
Net income $ 2,055
Dividends $757
Retained earnings $1,298

Nick also has provided the following information: During the year the company raised

$301,000 in new long-term debt and retired $261,000 in long-term debt. The company also

sold $22,000 in new stock and repurchased $87,000 in stock. The company purchased

$1,955,000 in fixed assets and sold $565,000 in fixed assets. Angus has asked you to prepare

the financial statement of cash flows and the accounting statement of cash flows. He also

has asked you to answer the following questions:

ANSWER:

FINANCIAL CASH FLOW STATEMENT:

Operating Cash Flow:

Earnings before Income and taxes $2,922

Add: Depreciation $ 336

Less: Current taxes $ (615)

Operating Cash Flow $2,643

Net Capital Spending:

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Ending Fixed Assets $ 4,746

Less: Beginning Fixed Assets $(3,962)

Add: Depreciation $ 336

Net Capital Spending $ 1,120

Changes in Net Working Capital:

Ending Net Working Capital ($2,508 – $1,014) $1,494

Less: Beginning Net Working Capital ($2,377 - $1,174) $1,203

Changes in Net Working Capital $ 291

Free Cash Flow or Cash flow from assets:

Operating Cash flow $ 2,643

Less: Net Capital Spending $(1,120)

Less: Changes in Net Working Capital $ (291)

Free Cash flow or Cash flow from assets $ 1,232

FREE CASH FLOW USES:

Cash flow to Debt holders:

Beginning Long-term debt $ 1,517

Less: Ending Long-term debt $(1,557)

Add: Interest $ 180

Cash flow to Debt holders $ 140

Cash flow to Common Stockholders:

Beginning total stock ($25+$166+$1,027-$166) $ 1,052

Less: Ending total stock ($25+$171+$1,044-$253) $ (987)

Add: Dividends $ 757

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Cash flow to Common Stockholders $ 822

ACCOUNTING STATEMENT OF CASH FLOW:

Operating Activities:

Net Income as per Income Statement $2,055

Add back: Depreciation $ 336

Add back: Deferred tax liability (282-210) $ 72

Adjusted Net Income $2,463

Changes in Working Capital:

Less: Increase in Accounts Receivable (945 - 883) $ (62)

Add: Decrease in Inventory (846 – 875) $ 29

Less: Increase in Other Assets (121 – 103) $ (18)

Add: Increase in Accounts Payable (685 – 645) $ 40

Less: Decrease in Accrued Expenses (329 – 529) $ (200)

Net changes to working capital $ (211)

Cash flow generated from Operating Activities $2,252

Investing Activities:

Purchase of Fixed Assets $ (1,955)

Sale of Assets $ 565

Cash used in Investing Activities $(1,390)

Financing Activities:

Sale proceeds of new stock $ 22

Stock Repurchase $(87)

Proceeds of new debt $301

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Retirement of debt $(261)

Less: Dividends Paid $(757)

Cash used in Financing Activities $(782)

Net Cash generated $ 80

Add: Beginning cash balance $ 516

Ending cash balance $ 596

1. How would you describe Warf Computers’ cash flows?

Cash flow for Warf Computers is considered good and has an excellent ability to

continue generating cash in the future. We can see from the Financial Cash flow

statement; the company has a positive free cash flow of $1,232,000. This surplus allows

the company to spend $1,120,000 on fixed assets and $291,000 on changes in Net

Working Capital. The company can also return $822,000 to Common Stockholders and

$140,000 to Debt holders. Moreover, we can also see from the accounting statement of

cash flow that the company is generating positive Net earnings of $2,055,000 and a

positive cash flow from Operating Activities of $2,252,000.

In conclusion, investors would consider Warf Computers a good investment

opportunity as it generates positive cash flow and has fewer chances of bankruptcy.

2. Which cash flow statement more accurately describes the cash flows at the

company?

Investors need to be able to look at the performance of each activity, and the amount

of cash generated/used for each activity; therefore, the accounting statement of cash flow

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is a better statement that accurately describes the company's cash flow. Furthermore, this

statement also details the company's year-to-date expenses and revenue, as well as the

company's financial position. The investor will be able to make an intelligent investment

decision based on this statement.

3. In light of your previous answers, comment on Nick’s expansion plans

Nick’s expansion plan works well as even though the company raises new debt,

increases equity, and invests in fixed assets; it still generates positive cash flow.

Additionally, the company has a positive financial cash flow and is able to distribute a

significant amount to its investors. Therefore, as long as the plan continues, the company

will continue to generate revenue.

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