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:
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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:
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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:
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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:
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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:
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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:
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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:
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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)
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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:
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funds from operations
sale of fixed assets
issue of share capital
borrowings
 Uses of funds are:
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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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