Transcript Chapter
Financial Statements and
Cash Flow Analysis
Financial Statements
Financial statements provide information
about the financial activities and position of a
firm.
Important financial statements are:
Balance sheet
Profit & Loss statement
Funds flow statement
Cash flow statement
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Balance Sheet
Balance sheet indicates the financial
condition of a firm at a specific point of time. It
contains information about the firm’s: assets,
liabilities and equity.
Assets are always equal to equity and
liabilities:
Assets = Equity + Liabilities
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Assets
Assets are economic resources or properties
owned by the firm.
There are two types of assets:
Fixed assets
Current assets
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Current Assets
Current assets (liquid assets) are those which
can be converted into cash within a year in
the normal course of business. Current
assets include:
Cash and bank balance
Accounts receivable (debtors)
Inventory (stocks)
Advances to suppliers
Prepaid expenses
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Fixed Assets
Fixed assets are long-term assets.
Tangible fixed assets are physical assets like
plant.
Intangible fixed assets are the firm’s rights and
claims, such as patents, copyrights, goodwill etc.
Gross block represent all tangible assets at
acquisition costs.
Net block is gross block net of depreciation.
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Liabilities
Liability is a firm’s obligation to pay cash or
provide goods or services in the future. Two
types of liabilities are:
Current liabilities
Long-term liabilities
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Current Liabilities
Current liabilities are payable within a year in
the normal course of business. They include:
Accounts payable (creditors)
Outstanding expenses
Advances from customers
Provision for tax
Provision for dividend
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Long-term Liabilities
Long-term liabilities are payable after a year.
They include:
Borrowings from financial institutions and banks
etc.
Debentures/bonds:
Non-convertible
Fully convertible
Partly convertible
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Shareholders’ Funds or Equity
Share capital is owners’ contribution divided
into shares. A share is a certificate
acknowledging the amount of capital
contributed by the shareholder.
Reserves and surplus or retained earnings
are undistributed profits.
Shareholders’ funds or equity is the sum of
share capital plus reserves & surplus. It is
also called net worth.
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Balance Sheet Relationship
Total assets (TA) equal net fixed assets
(NFA) plus current assets (CA):
TA = NFA + CA
Net current assets (NCA) is the difference
between current assets (CA) and current
liabilities (CL):
NCA = CA – CL
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Balance Sheet Relationship
Net assets (NA) equal net fixed assets (NFA)
plus net current assets (NCA):
NA = NFA + NCA
Capital employed (CE) is the sum of net
worth or equity (E) and borrowing/debt (D)
and it is equivalent of net assets:
CE = Net Worth + Borrowing = E + D
Capital Employed = Net Assets
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Functions of Balance Sheet
Stewardship role
Measurement of liquidity
Measurement of solvency
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Profit & Loss Statement
Profit & Loss statement provides information
about a firm’s:
revenues,
expenses, and
profit or loss.
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Nature of Revenues
Revenue is the amount received or receivable
within the accounting period from the sale of
the firm’s goods or services.
Operating revenue is the one that arises from
main operations of the firm, and the revenue
arising from other activities is called nonoperating revenue.
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Nature of Expenses
Expense is the amount paid or payable within
the accounting period for generating revenue.
Examples: raw material consumed, salary and
wages, power and fuel, repairs and maintenance,
rent, selling and marketing expenses, administrative
expenses.
Expenses are expired costs and capital
expenditures represent un-expired costs and
appear as assets in balance sheet.
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Depreciation
Depreciation is a charge for the use of fixed
assets; it is an expense. It is a non-cash
expense since cash was paid at the time fixed
assets were acquired. Expenditures incurred
on acquiring assets are called capital
expenditures. Depreciation is allocation of
these expenditures over the life of assets that
have helped in generating revenue.
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Methods of Depreciation
Depreciation may be provided on
straight line basis or
written down value basis (DWV). DWV basis
is allowed for taxation in India.
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Concepts of Profit
Gross profit = sales – cost of goods sold (CGS)
CGS = raw material consumed + manufacturing expenses of
goods that have been sold
PBDIT = Profit before dep., interest and tax
= sales – expenses, except dep., interest and
tax
PBIT= Profit before interest and tax
= PBDIT – DEP
PBT= Profit before tax = PBIT – Interest
PAT = Profit after tax = PBT – Tax
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Functions of Income Statement
Summary of revenues and expenses
Measurement of profitability
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Relationships: B/S and P&L A/C
Net profit = Equity (end) – Equity (begin)
Equity (end) = Equity (begin) + Net profit +
Equity issued – Dividend
Net profit = [Equity (end) – Equity (begin)] –
[Equity issued – Dividend]
Change in equity = Equity (end) – Equity
(begin) = Net profit + Equity issued – Dividend
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Economic Vs. Accounting Profit
Accounting profit is a result of the arbitrary
allocation of expenditures between expenses
(revenue expenditure) and assets (capital
expenditure).
Economic profit is the net increase in the wealth
of the firm, and it is measured in cash flow.
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Standards of Financial Reporting
Full disclosure
Materiality
Consistency
Conservatism
Fairness
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Accounting Principles and Concepts
Business entity concept
Money measurement concept
Going concern concept
Cost concept
Duality concept
Accounting period concept
Realisation concept
Matching concept
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Funds and Cash Flow
Liquidity refers to resources currently available
with the firm. It is reflected by the funds or cash
flows rather than the stock of current assets
and liabilities.
Funds flow is a change in a firm’s net current
assets while cash flow is a change in the firm’s
cash position. Funds or cash flows occur due to
changes in items in the balance sheet and
profit & loss statement. Thus liquidity analysis
involves measurement of changes in assets,
liabilities and equity.
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Sources and Uses of Funds and
Cash Flows
Sources of funds or cash flows:
funds from operations
sale of fixed assets
issue of share capital
borrowings
Uses of funds are:
losses
purchase of fixed assets
repayment of borrowings
payment of dividends
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Funds from Operations
Funds flow from operations
+ PAT (– loss)
+ Depreciation
+ Other non-cash expenses
– Non-cash incomes
+ Loss from the sale of fixed assets
– Gain from the sale of fixed assets
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Cash from Operations
Cash flow from operations
+ PAT (– loss)
+ Depreciation
+ Other non-cash expenses
– Non-cash incomes
+ Loss from the sale of fixed assets
– Gain from the sale of fixed assets
+ Increases in net working capital
– Decreases in net working capital
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Uses of Funds and Cash Flow
Statements
Liquidity position
Capital expenditures
Dividends paid
Retained earnings
External financing
Repayment of loans
Non-performing assets
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