Management Science-II Prof. R.

Madumathi

MODULE 2

Business Enterprise

Business Enterprise
• The business enterprise during its existence, over a period of time,
accumulates certain real properties termed as assets of the
business enterprise.

• These assets are acquired by the business through funds that are
made available through borrowings or through owners' contribution.

Financial Statements

• Financial Statements present the financial activities of the business.

The accounting premise in the formulation of financial statements
can be stated as:

• Assets = Liabilities + Owners' Contribution

Types Of Financial Statements

• Balance Sheet

• Income Statement

• Cash Flow Statement

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Management Science-II Prof. R.Madumathi

Balance Sheet

The balance sheet consolidates the asset value and capital and liability
value of a business enterprise as on a specific day of the accounting year.
In order to acquire the assets, the business enterprise has to use its own
capital or has to borrow the required funds. The matching of assets
(application of funds) with the sources of funds is shown in the balance
sheet statement.

Balance Sheet Components

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Management Science-II Prof. R.Madumathi

Owner’s Contribution / Capital

Share Capital
• Owners' contribution is the fund that has been provided by
the promoters and shareholders of the business enterprise.
Their contribution is termed as capital. The capital of a
business enterprise that has many public/private owners in
units called shares is referred to as share capital.

• The shares may be issued as ordinary share capital or

preference share capital. Ordinary share capital is the
shares that are usually issued by business enterprises,
which carries with them a voting right. They are entitled to a
share in the profits of the business enterprise too. The profits
may either be distributed among the shareholders as
dividend or retained with the business enterprise itself as
reserves.

Owner’s Contribution / Capital

Share Capital

• Certain type of shareholders may have special preference

with respect to the dividend payments or the capital amount
according to the terms of issue. They are referred to as
Preferential shareholders

Reserves
• The capital reserves (profits) may arise from revaluation of
assets, the purchase of shares of other business enterprises
or due to the payback of its own shares.

• Revenue reserves (profits) represent profits that are retained

in the business enterprise to be used latter. Both the capital

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reserves and the revenue reserves belong to owners and

hence they are owners' funds.

Liabilities

• Debentures are long term loans issued to the public with a

face value (usually Rs.100) at specific contractual interest
rates and repayable at the designated time.

• Long-term loans are mostly from financial institutions.

Long-term loans are also availed from other sources such as
company subsidiaries.

• Convertible debt is a long-term financing instrument with

the option of being converted into any other type of financial
instrument especially shares at the time of conversion.

Fixed Assets
• Fixed assets can be defined as those assets that are bought for
use in the business and not for resale such as
• equipment,
• plant,
• land,
• buildings,
• furniture,
• vehicles etc.
• In addition to the physical assets, a business may also acquire
certain non-physical assets called intangible assets such as
• patents,
• copyrights,
• trade marks,
• brand names,
• goodwill etc.

Investments

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Management Science-II Prof. R.Madumathi

A business may also buy other businesses in the form of their shares or
other instruments such as deposits. They are referred as investments.

Net Working Capital

• Net working capital is the difference arrived at by comparing current

assets with current liabilities and provisions.

• A positive net working capital position indicates a surplus current

assets position, while a negative net working capital indicates an
excess current liabilities position.

Components Of Net Working Capital

Current Assets:

Current assets hardly exist in the business for more

than a year. They are the assets that keep rotating in the business.
Current assets arise because of the operational cycle of business. A
simple illustration of an operational cycle is when cash is used to buy
inventory and inventory is sold and cash is got back into the business.

Certain important components of current assets are:

– Inventory,
– Debtors,
– Accounts receivable,
– Bank balance,
– Cash balance, and
– Pre-payments.

Components Of Networking Capital

Current Liabilities:

Current liabilities are due for repayment by the

business within the accounting year. The components of current liabilities
may be:

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– Creditors,
– Accounts Payable,
– Bank overdraft,
– Accrued expenses etc.

Components Of Net Working Capital

Provisions:

Provisions are profits set aside for specific future purpose.

Provisions are created usually in terms of

– Bad debts
– Accounts Receivables
– Tax payable
– Dividend payable etc.

Balance Sheet (Rs. crores)

Mar Mar Mar Mar Mar
1998 1999 2000 2001 2002
12 12 12 12 12
months months months months months
Sources Of Funds
Total Share Capital 40.12 40.12 40.12 64.19 64.19
Equity Share Capital 40.12 40.12 40.12 64.19 64.19
Preference Share
0.00 0.00 0.00 0.00 0.00
Capital
Reserves 220.38 264.39 317.29 347.01 346.37
Revaluation Reserves 0.00 0.00 0.00 0.00 0.00
Networth 260.50 304.51 357.41 411.20 410.56
Secured Loans 145.42 168.94 123.36 163.46 76.29
Unsecured Loans 47.43 47.92 51.08 63.36 34.48
Total Debt 192.85 216.86 174.44 226.82 110.77

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Total Liabilities 453.35 521.37 531.85 638.02 521.33

Balance Sheet (Rs. crores)

Mar 1998 1999 2000 Mar 2001 Mar 2002

Application Of Funds
Gross Block 303.92 410.60 468.17 544.83 595.88

Less: Accumulated Depreciation 94.18 116.29 141.29 172.42 213.96

Net Block 209.74 294.31 326.88 372.41 381.92

Capital Work in Progress 21.72 6.80 2.46 3.95 2.43
Investments 46.07 49.78 40.54 44.07 63.34
Inventories 165.97 160.89 186.12 198.91 155.95
Sundry Debtors 80.74 79.95 86.66 121.65 118.96
Cash and Bank Balance 19.59 22.34 18.98 11.84 22.13
Total Current Assets 266.30 263.18 291.76 332.40 297.04
Loans and Advances 103.73 69.60 103.54 125.27 142.92
Total Current Assets, Loans &
370.03 332.78 395.30 457.67 439.96
Advances
Deferred Credit 0.00 0.00 0.00 0.00 0.00
Fixed Deposits 23.70 15.96 12.07 8.83 2.02
Current Liabilities 100.60 80.48 141.04 105.54 209.63
Provisions 93.72 81.82 98.20 138.64 161.83

Total Current Liabilities & Provisions 194.32 162.30 239.24 244.18 371.46

Net Current Assets 175.71 170.48 156.06 213.49 68.50

Miscellaneous Expenses 0.11 0.00 5.91 4.10 5.14
Total Assets 453.35 521.37 531.85 638.02 521.33
Contingent Liabilities 28.62 24.43 28.14 29.11 52.57

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Management Science-II Prof. R.Madumathi

Income Statement

• The revenues and costs incurred during an accounting period are

reported in the income statement.

• The income statement shows a profit when revenues exceed costs.

• The income statement shows a loss when revenues are lesser than
the
• costs.

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Management Science-II Prof. R.Madumathi

Revenue

• Revenue is the gross inflow of cash, receivables or other

consideration arising in the course of the ordinary activities of a
business.

• from the sale of goods,

• from the rendering of services, and

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Management Science-II Prof. R.Madumathi

• from the use by others of enterprise resources yielding interest,

royalties and dividends.

• Revenue is measured by the charges made to customers or clients

for goods supplied and services rendered to them and by the
charges and rewards arising from the use of resources by them.

• In an agency relationship, the revenue is the amount of commission

and not the gross inflow of cash, receivables or other consideration.

Cost Of Goods Sold

• Cost of goods sold is the business’s expenses directly associated

with the product. Cost of goods sold includes the money the
business spent to buy the raw materials needed to produce its
products, the money it spent on manufacturing its products and
labor costs associated with this manufacture.
• Gross profit on sales (also called gross margin) is the difference
between all the revenue the business earns and the sales of its
products minus the cost of what it took to produce them.

• Gross Profit on Sales = Net Sales - Cost of Goods Sold

• When all expenses incurred in the production of the goods and

services (cost of goods sold) is reduced from the money made from
selling them (net sales), the gross profit on sales is arrived at.

Operating Expenses

• Operating expenses are normal expenses incurred in the day-to-

day operation of running a business. Typical items in this category
include sales or marketing expenses, salaries, rent, and
administration costs.

• Depreciation is the gradual loss in value of equipment and other

tangible assets over the course of its useful life.

Indian Institute of Technology Madras

Management Science-II Prof. R.Madumathi

Earnings Before Interest And Taxes

• Earnings before interest and taxes (EBIT) is the sum of operating
and non-operating income. This includes besides operating income
what is referred to as "other income“ (or other loss) and
"extraordinary income" (or extraordinary loss). As its name
indicates, it is a business's income excluding interest expenses and
income tax expenses. EBIT is calculated as follows:

• EBIT = Operating Income +(-) Other Income (Loss)

ƒ + (-) Extraordinary Income (Loss

Extraordinary Income(Loss)

• Extraordinary income (or loss) occurs when money is gained (or

lost) resulting from an event that is deemed both unusual and
infrequent in nature. Examples of such extraordinary happenings
could include damages from a natural disaster or the early
repayment of debt.

• Many businesses may not have either other income or

extraordinary income in a given year. If this is the case, then
earnings before income and taxes is the same as its operating
income.

Net Earnings

• Net earnings or net income is often referred to as the bottom

line of the business. It measures the amount of profit a business
makes after all of its income and all of its expenses. It also
represents the total net profit that may be distributed to its
shareholders. The computation of net earnings is arrived at by
subtracting the interest and tax expenses from EBIT.

• Net Earnings = Earnings Before Interest and Taxes

• Interest Expense - Income Taxes

Profit & Loss Account

(Rs. in Crores)

Indian Institute of Technology Madras

Management Science-II Prof. R.Madumathi

Mar Mar Mar Mar Mar

1998 1999 2000 2001 2002
Income
Sales
1,021.17 1,127.93 1,341.60 1,498.99 1,639.93
Turnover
Excise Duty 149.23 161.17 174.60 189.98 198.11
Net Sales 871.94 966.76 1,167.00 1,309.01 1,441.82
Other Income 17.05 22.05 13.62 18.50 31.24
Stock
12.52 2.34 20.35 10.77 -38.15
Adjustments
Total Income 901.51 991.15 1,200.97 1,338.28 1,434.91
Expenditure
Raw Materials 404.00 449.49 538.34 590.40 591.64
Power & Fuel
16.88 18.02 20.59 22.13 24.40
Cost
Employee
42.81 48.41 57.22 71.82 90.86
Cost
Other
Manufacturing 146.97 157.43 176.56 193.98 207.53
Expenses
Selling and
Admin 129.14 143.03 185.10 208.60 245.18
Expenses
Miscellaneous
24.63 28.87 31.94 41.76 37.52
Expenses
Preoperative
Exp 0.00 0.00 0.00 0.00 0.00
Capitalised
Total
764.43 845.25 1,009.75 1,128.69 1,197.13
Expenses
Operating
120.03 123.85 177.60 191.09 206.54
Profit

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Management Science-II Prof. R.Madumathi

Profit & Loss Account

(Rs. in Crores)
Mar 1998 Mar Mar Mar Mar
1999 2000 2001 2002
12 12 12 12 12
months months months months months
Total Value
360.43 395.76 471.41 538.29 605.49
Addition
Preference
0.00 0.00 0.00 0.00 0.00
Dividend
Equity Dividend 30.09 32.09 40.12 44.93 57.77
Corporate Dividend
3.01 3.39 4.41 6.86 2.29
Tax

Per share data (annualised)

Shares in issue
401.20 401.20 401.20 641.90 641.90
(lakhs)
Earning Per Share
16.07 18.32 23.16 15.51 17.61
(Rs)
Equity Dividend (%) 75.00 80.00 100.00 70.00 90.00
Book Value (Rs) 64.93 75.90 89.09 64.06 63.96

Cash Flow Statement

The flow of funds for a business may be looked at as a continuous
process, in a way linking every use of fund with a source. The cash
flow statement is a method by which we express the increase or
decrease of cash flows into the business over a specified duration.
This is derived from the balance sheets of the business. In a typical
cash flow statement, changes are expressed in three categories

– operating activities,
– investing activities and
– financing activities

Indian Institute of Technology Madras

Management Science-II Prof. R.Madumathi

Cash Flow Components

Indian Institute of Technology Madras

Management Science-II Prof. R.Madumathi

Types Of Cash Flows

• Cash flows from operating activities indicate the net cash

accruing to a business from its trading / manufacturing /

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Management Science-II Prof. R.Madumathi

business activity. This cash flow is adjusted with respect to

changes in current assets and liabilities of the business.
• Cash flows from investing activities show purchase or sale of
fixed assets and other cash flows from investments made by the
business.
• Cash flows from financing activities indicate the increase or
decrease in cash through sources such as equity, debt or any
other related flow such as dividend.
• Cash flow statement gives the net inflow / outflow of cash from
operating activities, financing activities & investment activities.

Indian Institute of Technology Madras

Management Science-II Prof. R.Madumathi

Indian Institute of Technology Madras

Management Science-II Prof. R.Madumathi

Amount Amount
Particulars
(Rs.) (Rs.)
Cash flows from Operating Activities
Cash generated from operations 84,000
Income tax paid (15,000)
Cash flow from extraordinary item
3,000
(Earthquake insurance claim)
Net Cash provided by Operating
72,000
Activities
Cash Flows from Investing Activities
Purchase of Plant and Machinery (1,73,000)
Sale of Plant and Machinery 22,000
Purchase of Investments (26,000)
Sale of Investments 42,000
Interest received 7,000
Net cash used in Investing Activities (1,28,000)
Cash Flows from Financing Activities
Issuance of share capital 1,00,000
Repayment of unsecured loan (1,000)
Repayment of secured loan (27,000)
Dividend paid (25,000)
Interest paid (22,000)
Net cash provided by financing activities 25,000
Net Decrease in Cash and Cash
(31,000)
Equivalents
Cash and cash equivalents at the
51,000
beginning
Cash and cash equivalents at the end 20,000

Uses Of Financial Statements

• Financial statements of business are audited statements and hence
are reliable subject to the limitations of audit.

• Financial statements are relied upon by investors, lenders and

other stakeholders to evaluate the business.

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Management Science-II Prof. R.Madumathi

• Financial statements being quantitative data can be used for

projecting future performance.

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