EQUITY RESEARCH

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Understanding Financial Statements

Key sections of an annual report: Management discussion & analysis Auditors report Balance sheet Profit & loss account Cash flow statement Schedule & notes to account

1. Management discussion & analysis

This is a section used to understand the companys perspective of their performance. It outlines the managements view of the business. This section includes: 1. How the company sees the various sales segments growing for the next financial year and trends in sales. 2. Details about how the company is doing in terms of both product lines and geographies. 3. It gives an overview of the markets where it is present, as well as real data about its performance in these markets.

2. Auditors report
The auditors report is an independent verification of certain financial aspects, relating to the business. This report must be read, as it may highlight certain issues such as delay in servicing a loan etc. The auditors report also outlines any contingent liabilities and disputes that the company is involved in.

3. Profit & loss account

It summarizes all income and expenditure, pertaining to the relevant period. 1. The P&L statement is made for a particular period this might be a month, a quarter or an year. 2. It summarizes all income and expenditure, pertaining to the relevant period. 3. The items of income and expenditure are recorded based on the accrual concept. Accrual Concept: Income and expense are recognized/recorded when a transaction occurs, not when cash changes hands. Broad sections of a profit and loss account are: Operating Income:

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A QUALITY E-LEARNING PROGRAM BY WWW.LEARNWITHFLIP.COM This section considers revenues that the company generates through its operations. The simple rule is that the revenues should be recurring in nature and accrue from actual operations i.e. they will stop if the production/operation process is stopped. It also excludes an excise duty that we pay, as it is levied directly on production.

Cost of Goods Sold (COGS): The COGS takes into account only those costs that are related to the production of the goods sold by the company. It includes only direct costs, and is used to find out the gross profit. COGS covers: purchase of finished goods, consumption of raw materials, Other direct costs & increase/decrease in inventory

Gross profit: It is the profit made considering the Operating Income less the costs related to production i.e. COGS. Other operating expenses: It includes employee remuneration, lease payments on machinery used in operations & any operating expenses made for repairs & maintenance etc. EBITDA: It stands for Earnings before Interest, Taxation, and Depreciation & Amortization. Adjusted EBITDA: It excludes non-operating income. Depreciation: represents the wear and tear on the machinery that is used by the company. Amortization: It is the reduction in value for intangible assets. Net interest costs: It refers to the net capital cost of the company i.e. interest expense interest income. Other Income: It refers to the non operating income of the company. It could include items like profit on sale of assets, forex gains and other sources that will not necessarily recur year on year. Exceptional or extraordinary income/expense: It stands for any income or expense that is one-off in nature and not expected to recur. Profit Before Tax (PBT): As the name suggests, represents the profits of the company before paying off taxes. Tax: The company can pay two types of taxes: Current Taxes For the current financial year Deferred Taxes A company may pay taxes in advance due to difference in the accounting and tax periods.

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A QUALITY E-LEARNING PROGRAM BY WWW.LEARNWITHFLIP.COM PAT/ Net Profit: It is the final figure after all deductions. This is an important figure, as this reflects the actual return for the equity share holder.

4. Balance sheet
The Balance Sheet is the snapshot of a business as on a particular date (unlike the P&L and Cash Flow, which summarise transactions over a period). Balance sheet has two main sections: Liabilities & Assets Assets and liabilities are also known as uses of funds and sources of funds respectively. Liabilities section contains: 1. Capital and Reserves 2. Long Term Liabilities 3. Current Liabilities Assets section contains: 4. Fixed Assets 5. Current Assets 6. Noncurrent Assets 7. Intangible Assets & Miscellaneous Expenditure

1. Capital & Reserves Paid-up Capital - This represents the amount of equity that has been invested by owners/shareholders of the company. Preference Share Capital - This refers to any preference capital that has been invested into the company, and is not redeemable in the next financial year. General Reserves & Surplus - This refers to the reserves accumulated in the company over time. Revaluation Reserves - This represents any surplus amount that has been included in the balance sheet through revaluation of assets. Loss Brought Forward - Any cumulative losses that are brought forward from previous years are recorded here.

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A QUALITY E-LEARNING PROGRAM BY WWW.LEARNWITHFLIP.COM 2. Long Term Liabilities Long-term liabilities are liabilities which are due for repayment, after one year. 3. Current Liabilities Current Liabilities are liabilities that need to be repaid immediately, or within a year. It contains: Creditors for Purchases refers to the creditors to whom the business owes money for purchase of raw materials. Creditors for Expenses refers to creditors to whom the business owes money for expenses other than raw materials. Provision for Tax - Provision for any taxes is considered as a current liability. This provision is used, to indicate the position of the company after deducting taxes to arrive at the PAT. Long Term Debt due within One Year - This refers to the principal amount of long term debt that has to be repaid by the company in the current financial year. Outstanding Expenses - Any outstanding expenses are considered current liability, regardless of the purpose of the expense. Others (Current Liabilities/provisions) - Any other provisions or liabilities that are regarded as current by the credit manager would be included in this field. Creditors on Capital Account - These are creditors for purchase of machinery or any capital equipment that the company purchases, that are due within one year. 4. Fixed assets These are all those assets that are held by the company to generate revenues. 5. Current assets It refers to those assets that are short term in nature. Their value changes due to the increase/decrease in activity within the company. Inventories - Inventories refer to the stocks of raw materials (RM), finished goods (FG), spares and work in progress (WIP) within the company. Debtors - are those who owe money to the company. Other Current Assets - Other current assets include cash and bank balance, prepaid expenses (expenses that have been made in advance), loans and advances given by the company on a short term basis, advance taxes paid and others (deposits with sale tax authorities etc.). 6. Non-current assets These are assets that have a tenor longer than one year, but which cannot be classified into the fixed assets category. 7. Intangible Assets and Miscellaneous Expenditure

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A QUALITY E-LEARNING PROGRAM BY WWW.LEARNWITHFLIP.COM Intangible assets are assets that do not exist in physical form.

5. Cash flow statement

This determines the actual cash generated by the business from financing, investment and operating activities. Items on a P&L are recorded on accrual basis, not cash basis. Depreciation, for example, is merely that part of a lump-sum expense, allocated to this period not an actual outflow of cash. Cash flows for a business can be further sub-divided on the basis of broad activities of a business. 1. Cash Flow from Financing (CFF): The cash flow arrived at by financing activities such as borrowing money, getting capital from owners, and repaying both. 2. Cash Flow from Investing (CFI): The cash flow arrived at by investment activities such as purchasing or selling stocks and bonds or machinery. 3. Cash Flow from Operations (CFO): The cash flow arrived at by operating activities: sales and expenses. This cash flow is of prime importance for a lender as it ensures ongoing repayment capacity.

6. Schedule & notes to account

This section details the main numbers that have been stated in the summary financial statements. Notes to account section, details some underlying data relating to the statements & this section is where you will get, some drill down information to any financial statement.

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