Eastern Platinum Limited’s 2009 financial statements can be

Eastern Platinum Limited’s 2009 financial statements can be found at the end of this volume. The company is involved in the mining, exploration, and development of platinum products in South Africa.

Instructions

Review the financial statements and notes of Eastern Platinum Limited (Eastplats) and answer the following questions.

(a) How does Eastplats define cash and cash equivalents? Do the cash and cash equivalents reported on the statement of cash flows reconcile to the statement of financial position amounts that are reported? Provide details of the reconciliation.

(b) Prepare a summary analysis of Eastplats’s sources and uses of cash at the level of operating, investing, and financing subtotals only, for 2009 and 2008. Based on this, comment on the similarities and differences in the company’s needs for cash and how they were met over the past three years.

(c) What method of reporting operating cash flows does Eastplats use in the statement of cash flows? Do you think this approach provides useful information to a potential investor?

(d) Using the information provided in the statement of cash flows, determine the balances of the Trade Receivables, Inventories, and Accounts Payable and Accrued Liabilities that would have been reported on the January 1, 2008 statement of financial position. Compare this with the actual balance at January 1, 2008, provided in the notes and explain any differences.

(e) From the statement of cash flows, it appears that share-based payments provided U.S. $582 thousand of cash from operations and that environmental expense provided an additional U.S. $301 thousand. Explain.

(f) Explain why interest income has been deducted and finance costs have been added on the statement of cash flows. Companies have a choice in classifying interest income and finance costs. What choice did Eastplats make with respect to this?

(g) Based only on the information in the Financing Activities section of the statement of cash flows, can you tell whether the debt-to-equity ratio increased or decreased during the years ended December 31, 2009, and 2008? Explain.

(h) Is Eastplats’s operating capability expanding or contracting? What type of assets is the company investing in? What is the likely effect of these investments on Eastplats’s future operating and financing cash flows?

(i) Comment briefly on the company’s solvency and financial flexibility.

(a)  Eastplats defines cash and cash equivalents (in note 3 (o) as follows:

“Cash and cash equivalents consist of cash on hand, deposits in banks and highly liquid investments with an original maturity of three months or less.” Yes, the cash and cash equivalents reported on the Statement of Cash Flows tie into the statement of financial position amounts reported. (US$7,249 thousand and US$25,806 thousand at the end of 2009 and 2008, respectively)  In 2009, this amount represented cash on hand only.  In 2008, this amount was represented by cash of US$9,123 thousand and cash equivalents of US$16,683 thousand.

(b) A comparison of the major categories of sources and uses of cash for 2009 and 2008 is provided below.

(US$ in thousands)	2009	2008
CF from operating activities	(9,287)	53,512
CF from investing activities	(5,685)	(63,644)
CF from financing activities	(4,256)	17,695
Effect of foreign exchange on cash and cash equivalents	671	(575)
Net increase (decrease)	(18,557)	6,988
Cash and cash equivalents, beginning of the year	25,806	18,818
Cash and cash equivalents, of the year	$7,249	$25,806

The cash flows from operations have been very volatile over the past two years.  In 2008, the company had a positive cash flow and in 2009, this is now negative.  The main reasons for this is a significant reduction in interest income in 2009, an increase in the receivables and a reduction in the accounts payable.

Cash flows for investing activities were negative in both years. In 2008, in particular, the net cash flow from investing activities was more than US$63.6 million compared to only US$5.6 million.  The main reason for this difference is a business acquisition made in 2008, along with more invested in property, plant and equipment.  At the same time, there were short term investments that were liquidated in 2008. In both years, it appears that the company has financed the business acquisitions and capital expenditures by liquidating short term investments. 

In 2008, the company also issued common shares for proceeds totaling US$22 million.  In 2008 and 2009, financing cash flows were paid out to repay loans and finance leases.

In 2008, with strong positive operating cash flows and financing cash flows due to the issuance of equity, the company was able to increase net cash and cash equivalents by US$7 million.  However, in 2009, the company had negative operating, investing and financing cash flows, resulting in an overall decrease in cash and cash equivalents of US$18.6 million, causing the cash equivalents to be all liquidated.

(c)  Eastplats uses the indirect method to report operating cash flows in the statement of cash flows. The indirect approach is useful in giving the user information about how the net earnings of the company translate into cash. 

The indirect method provides adjustments to net income and arrives at a single cash flow from operations line. It does provide a useful link between the statement of cash flows and the income statement and balance sheet. However, its advantage of being less costly is challenged by the recent technological development in accounting information system, as it is expected to gather information for the direct method at a low cost.  In contrast, the direct approach would provide more detailed information on the various sources of cash flows in operations and provide more predictive value and more transparency to a user.

(d) The January 1, 2008, balances are calculated below using the December 31, 2008 balances from the balance sheet and the change information provided in the statement of cash flows.

(US$ in thousands)	December 31, 2008 balances		2008 change	January 1, 2008 Balances Calculated		January 1, 2008 Balances Actual
			Cash inflow (outflow)
Trade receivable	9,431	DR	14,031	23,462	DR	32,560
Inventories	3,881	DR	1,391	5,272	DR	6,888
Accounts payable and accrued liabilities	36,729	CR	12,962	23,767	CR	22,967

There are significant differences between the calculated amounts and the actual balances at January 1, 2008, as follows:

·         The actual balance of trade receivables is higher by US$9,098;

·         The actual balance of inventories is higher by US$1,616;

·         The actual balance of accounts payable and accrued liabilities is lower by US$800. 

The main reason for these differences is that the company’s functional currencies are the Canadian dollar and the South African Rand, as explained in Note 3 (c) and (d).   However, its presentation currency is the US dollar and therefore, on translation, there will be changes in the balances due to these rate changes, which represent non-cash transactions.

(e)      From the statement of cash flows, it appears that share-based payments provided US$582 thousand of cash from operations and that environmental expense provided an additional cash of US$301 thousand. However, this is not true as these expenses and provisions were “added” back to net income as ”items not affecting cash”. In other words, the company recognized the expenses regarding share based payments and environmental costs but did not pay cash for these items. Therefore, the impact of these items on net income should be eliminated to calculate the cash flow from operating activities by adding the amounts to the net income.

(f)      The interest income must be deducted and the finance cost must be added back to net income because the statement of financial position must disclose the actual interest received and the finance costs paid.  As seen in Eastplats’ statement of cash flow, the interest received and the finance costs paid have been classified as operating cash flows.

(g)      Based only on the information provided in the financing section of the cash flow statement, it is not possible to be sure whether the debt-to-equity ratio increased or decreased in 2009 or 2008.  This is because, although the increase or decrease in debt from cash transactions can be determined from this information, the net increase or decrease in equity involves other amounts such as net income.  Also, because the statement of cash flows does not show non-cash financing transactions, this information is not sufficient on its own to determine whether the debt to equity ratio increased or decreased.

(h)      Eastplats’ operating capability was expanding in 2008 in two ways: by acquiring businesses and by purchasing property and equipment. These acquisitions were made to expand their business as a mining and processing company of platinum. However, in 2009, the amount of capital expenditures on property, plant and equipment was significantly reduced, resulting in little expansion of operating capabilities. 

These investments are likely to increase the company’s future operating cash flows as the company can mine and process more platinum.  However, since platinum is a commodity, the selling price may fluctuate significantly, which will impact the amount of future operating cash flows that the company can generate as the operating costs are relatively fixed.  .

(i)      It is not easy to assess Eastplats financial solvency and financial flexibility as the financial performance and cash flows have fluctuated in recent years. In 2009, the cash flow from operations was negative which didn’t cover the capital expenditures. The company had to use cash equivalents to help provide cash flows from poor operating results and minimal investment in plant and equipment.  Due to negative operating cash flows, it might appear that the company’s liquidity has worsened over 2009.  However, the current ratio has actually improved from 1.83 in 2008 to 2.33 in 2009.  This is primarily due to a large reduction in accounts payable and accrued liabilities also.  

We know from the statement of cash flows that debt was repaid in 2009.  From the statement of financial position, we see that the debt to equity ratio in 2008 and 2009 is very low, and was 0.17 in 2008 and 0.12 in 2009.  The company has no long term debt and only a small amount (US$2.8 million) of finance leases, and therefore, solvency risk is very low.  Likely due to the volatile nature of its operations, and the company’s dependence on the commodity price of platinum, it keeps very low debt levels to reduce financial risk for the investors.