Professional Documents
Culture Documents
com
Learning Objectives
After studying this chapter, you should be able to understand Balance sheet Income Statement Cash Flow Statement
Jeet R.Shah
Balance Sheet, also known as the statement of financial position, reports a company's financial status at a set date noted on the statement. The statement is like a snapshot because it shows what the company is worth as on a particular date . The statement shows: what the company owns (Assets)? what the company owes (Liabilities)? what belongs to the owners (Shareholders fund)?
In the standard accounting model, the balance sheet can be represented by using the accounting equation i.e. Assets = Shareholders Funds + Liabilities (More about the accounting equation in the subsequent chapters). As such, both sides of the balance sheet should be same. They are in balance because, each rupee of asset acquired will have a corresponding source i.e. either collected from the share holders or the creditors Assets A thing that is valuable to the business is an asset. The value may be defined in terms of its capacity to be instrumental in production of goods or services. For example, plant and
Jeet R.Shah
ii. Stocks: Stocks, also known as inventories, consist of raw materials goods, half-the-way through the process (work-in-process) and finished goods awaiting sales. The conservatism concept of accounting is followed in valuing the inventory and is done either at cost or market value, whichever is lower. iii. Debtors: Debtors represent the amount owed to an enterprise by the customers. This shows the claims of the company for the goods and services rendered with an agreement to receive payment for it at a later date. The amount shown under this head is the net amount which means that out of the total debtors, the amount not likely to be collected (called, doubtful debts or bad debts), is deducted to get a clear picture of the amount receivable. Debtors are also termed as accounts receivables. Most of enterprises, in their schedule of debtors in the balance sheet, segregate the item into two categories: one
Jeet R.Shah
Intangible Assets These are the assets that do not have physical existence, therefore, we cannot see or touch them, for example goodwill is an intangible asset. Such assets may have a fixed term of existence by law, regulation or agreement, for example patents, copyrights and leases. Difficulties may arise in ascertaining the existence and quantum of future benefits from such assets. Therefore, it is usually recommended that expenditures made by the enterprise in developing these assets should not be recognized as asset. Only if an intangible asset is acquired through purchase from other entities, should it be recognized as an asset. LIABILITIES Liabilities On the statement of financial position, debts are called liabilities. Liabilities represent what a business as a distinct entity owes to various parties either against some specific securities or otherwise either for relatively a longer period of time or for a short duration.. Examples of liabilities include: Money owed to banks and other lenders Money owed to suppliers of goods and services (sundry creditors/accounts payable)
Jeet R.Shah
Liabilities represent what a business as a distinct entity owes to various parties namely to shareholders, for share capital and retained earnings, and to other parties, for loans to the business entity either against some specific securities or otherwise either for relatively a longer period of time or for a short duration. Although liabilities are a necessary part of doing business, companies must manage their liabilities carefully. If a company cannot make interest payments on time and repay the principal when due, the company can be forced to declare bankruptcy and either reorganize or disband. So it is necessary to understand the liabilities in details. Generally liabilities can be differentiated on the basis of the following: Insider and outsider Term (period) Secured or unsecured Mode of repayment Rate of interest Broadly the total liabilities can be studied under three heads viz. owners equity, long-term liabilities, and current liabilities, which are discussed as follows: Shareholders(Owners) Equity Stockholders' equity is the amount owners invested in new stock plus the earnings the company retained since it started. (Retained earnings is the amount of profit kept after dividends are paid). On the statement of financial position the amount of stockholders' equity always equals the value of all the assets minus all the liabilities.
This section is subdivided into the following subsections. i. Share capital: This category of owners equity shows the stated value of share certificates issued (Issued share capital) and the value contributed by the shareholders to the share pool of the company (paid-up share capital).
ii. Reserve funds and other funds: This section of owners equity represents the earnings foregone by the shareholders in the previous year(s) and retained with the business or ploughed back into the business. The net profit is apportioned to various reserves. Some of these are: investment allowance reserve rehabilitation reserve and dividend equalization reserve. Sometimes, provision for certain reserves have to be made in compliance with various regulatory requirements. The other funds represent funds received from other agencies such as World Food Programmes, and International Development Agency etc. this item can be seen in the balance sheet of developmentoriented institutions. Long-Term Liabilities
Jeet R.Shah
In accounting, time is divided on the basis of the accounting year i.e. twelve months. So we have the long and short-term liabilities. Where as in economics, time is divided on the basis of the time taken for supply to change.
Current liabilities represent the obligations maturing within a relatively short period not exceeding one year or the normal operating cycle of the business. Current liabilities include sundry creditors, tax liability, unpaid dividend, outstanding expenses and advances from customers. These dues are honored using current assets. The explanation for these terms is given below: i. Sundry creditors: Sundry creditors show the amount due to suppliers, by the enterprise. These claims are generally not secured against any asset.
ii. Liability for taxation: The amount of taxes as shown in the balance sheet represent the provisions made on the basis of estimates. Since the actual tax liability is assessed based on the taxable income of the year, payment is adjusted against the provisions made.
iii. Outstanding expenses: The expenses that relate to the current accounting period and, therefore, have accrued but have not been paid at the end of the accounting period, are referred to as accrued expenses. For example, wages for the month of March will remain unpaid on 31st March and, therefore, it will be represented as wages payable on the balance sheet as on 31st March.
Jeet R.Shah
Jeet R.Shah
Total
25442
12765
Some observations: The balance sheet is true as on the 31st March 2001 and 2000. The shareholders fund has increased by two and half times. A large component of the shareholders fund is reserves and surplus. The share capital has decreased. Loans have decreased during this period Current liabilities have increased marginally. Fixed assets have increased by one and half times The company has huge cash and bank balance and has given huge money in the form of loans and advances to various parties.
To do: Take the balance sheet of any company of your choice and compare it with the above and write a note on your observations.
Simplified Version of Balance Sheet
Jeet R.Shah
Total
25442
Total
25443
So five important items of the balance sheet are as follows: Shareholders Funds (SF or OF) Long Term Loans (LTF) Current Liabilities (CL) Fixed Assets (FA) Current Assets (CA)
SF+ LTF = Capital Employed CA-CL = Working Capital (WC) SF = (FA +CA)-(LTF+CL) Capital Employed = FA+WC Total Assets = Capital Employed + CL Total Liabilities = FA+CA
Jeet R.Shah
SOURCES OF FUNDS
Total
1000
Total
1000
2. Purchased furniture Rs. 100 for cash. This transaction will reduce cash and increase another form of asset i.e. furniture. The balance sheet will be as follows: Compusales Ltd. BALANCE SHEET AS on 2001 (All figures in rupees 000) APPLICATION OF SOURCES OF FUNDS As on March 31 FUNDS As on March 31 2001 2001 Capital 1000 Cash 900 Furniture 100 Total 1000 Total 1000
Jeet R.Shah
10
3. Took 12% loan from IDBI: Rs.1500. Deposited the same with UTI bank. In this case the sources increase and since they have not used that money for acquiring any asset it will be shown as cash at bank.
Compusales Ltd. BALANCE SHEET AS on 2001 (All figures in rupees 000) APPLICATION OF SOURCES OF FUNDS As on March 31 FUNDS As on March 31 2001 2001 Capital 1000 Cash 900 IDBI Loan 1500 Bank 1500 Furniture 100 2500 2500 Total Total
4. Purchased air conditioner and paid by cheque: Rs.25000. This transaction will reduce the bank balance and increase another form of asset i.e. AC. No change in the sources. Comp sales Ltd. BALANCE SHEET AS on 2001 (All figures in rupees 000) APPLICATION OF SOURCES OF FUNDS As on March 31 FUNDS As on March 31 2001 2001 Capital 1000 Cash 900 IDBI Loan 1500 Bank 1475 Furniture 100 25 AC 2500 2500 Total Total 5. Entered into agreement to buy 1000 computers from a local manufacturers XY Ltd. This transaction will not affect the balance sheet. 6. Received 100 computers at the rate of Rs. 20,000. Money to be payable on a later date. So this a credit transaction. Comp sales Ltd. BALANCE SHEET AS on 2001 (All figures in rupees 000) APPLICATION OF SOURCES OF FUNDS As on March 31 FUNDS 2001
As on March 31 2001
Jeet R.Shah
11
You can see from the balance sheet that the increase in the assets is being funded by the increase in sources i.e. a new liability has been created.
7. Issued one lakh shares of Rs. 10 to the public and collected money through bank and also raised further loan of Rs. 50000 from SBI to meet the short term expenses. Comp sales Ltd. BALANCE SHEET AS on 2001 (All figures in rupees 000) APPLICATION OF SOURCES OF FUNDS As on March 31 FUNDS As on March 31 2001 2001 Capital 2000 Cash 1400 IDBI Loan 1500 Bank 2500 SBI Loan 500 XY Ltd. (Creditors) 2000 Stock of Computers 2000 Furniture 100 7000 6000 Total Total
8. 2 computers were sold @ Rs. 25000 for cash over the counter. You may aware that the computers were purchased for Rs.20000. Let us see the impact on the balance sheet. Cash increases by Rs. 50,000 Computers decrease by Rs. 40,000 The balance is treated as Profit: Rs. 10,000
Comp sales Ltd. BALANCE SHEET AS on 2001 (All figures in rupees 000) APPLICATION OF SOURCES OF FUNDS As on March 31 FUNDS As on March 31 2001 2001 Capital 2000 Cash 1450 IDBI Loan 1500 Bank 2500 SBI Loan 500 XY Ltd. (Creditors) 2000 Stock of Computers 1960 Furniture 100 Profit 10 6010 6010 Total Total
Jeet R.Shah
12
9. Suppose the company sold 3 computers @ Rs. 18000 to a local school. In this case it has incurred a loss of Rs. 6000. Cash increases by Rs. 54,000 Stock decreases by Rs. 60,000 Balance is treated as loss: Rs. 6,000
Comp sales Ltd. BALANCE SHEET AS on 2001 (All figures in rupees 000) APPLICATION OF SOURCES OF FUNDS As on March 31 FUNDS As on March 31 2001 2001 Capital 2000 Cash 1504 IDBI Loan 1500 Bank 2500 SBI Loan 500 XY Ltd. (Creditors) 2000 Stock of Computers 1900 Furniture 100 Profit 10 Loss 6 6010 6010 Total Total
a) b)
c) d)
Increase in asset will have the following effects Increase in liabilities, or Decrease in cash/other asset Increase in liability will have the following effect Increase in cash, or Increase in other asset Decrease in any other liability If Source side is greater than application, the difference is treated as Profit. If Source side is lesser than the application side, the difference is treated as Loss
Jeet R.Shah
13
SOURCES OF FUNDS Capital IDBI Loan SBI Loan XY Ltd. (Creditors) Profit Profit Total
As on
Instead of showing the profits and losses separately, they can be netted off as follows: Comp sales Ltd. BALANCE SHEET AS on (All figures in rupees 000) APPLICATION OF FUNDS 2001 2000 1500 500 2000 104 6104 Cash Bank Debtors Stock of Computers Furniture Total
SOURCES OF FUNDS Capital IDBI Loan SBI Loan XY Ltd. (Creditors) Profit Total Profit = 100 + 10 6 = 104
As on
Jeet R.Shah
14
Total
6104
Total
6104
Shareholders Fund = Capital + Profit Loss Current Liabilities = Creditors + SBI Loan Current Assets = Cash + Debtors + Stock So profit or loss of an organisation can be determined by preparing the balance. However, if the expenses and incomes are many and the net result has to be determined at the end of a particular period of time then it is better to prepare the Income Statement or Profit & Loss Account.
service
Jeet R.Shah
15
Learning Objectives After studying this chapter, you should be able to understand Income Statement Relationship between Income Statement and Balance Sheet
Jeet R.Shah
16
The income statement of an organisation shows the net operating result of the activities undertaken during a particular period of time. The income statement is also known as the Profit and Loss Account (P/L Account). It tells us the financial results of business activity how successful the operation of the business is. If income exceeds expenses during the period, it is profit and if the expenses exceeds the income it will be treated as loss. It is important to note that the transactions recorded in the profit and loss account flow through to the balance sheet. For example in the previous section we have sent that the balance sheet shows the profit or loss. This profit or loss can also be determined by preparing the profit and loss account. We discuss the interrelationship in some details in the later part of the chapter. Some of the important items that find place in the income statement are as follows: Income Side Sales The sale of products and services is the main source of income for companies. These are usually recorded at gross value, including excise duty if any. The excise duty is then separately recorded on the expenditure side. However, for the purpose of financial analysis, it is better to arrive at the net sales figure (net of excise duty) because the rates of excise duty may change from year to year depending upon the policy of the government. The sales figure is also net of discounts and returns. In other words, if an items price is Rs. 50, but is sold at a discount of 10%, the sales shown in the income statement will be Rs. 45. The net sales values provide a more dependable basis for calculating the profitability ratios. Other Incomes The income received by a company from sources other than sales of its main products and services is mentioned separately. In many companies the other income constitutes a significant portion of the profit before tax.
Jeet R.Shah
17
It is important to note that the cost of goods consumed depends of the principles of valuation of inventory. Inventory valuation in detail will be discussed in chapter: However, we will see a very simple example to show the impact of the inventory valuation. There are different methods of valuing inventory. However, we see the impact of only two of them LIFO and FIFO. LIFO: Last-in-first-out. Under this method the goods purchased last will be used first. So the unsold stock is generally from the past purchases. FIFO: First-in-first-out. Under this method, the oldest purchase is used first. So the unsold stock is from the latest purchases.
10.5.2001 2500 units are sold at 10 per unit COGS Sales G.Profit FIFO Cost of Goods Sold 11250 25000 13750 (2500*4.5) LIFO Cost of Goods Sold 2000*6 14500 25000 10500 500*5
Change in profit
31%
Jeet R.Shah
It is important to note that the profit changes by 31% not because of the change in the operating efficiency, but just because of the change in the valuation method. FIFO results in higher profits because of lower cost of goods sold and a higher, whereas LIFO results in lower profits because of higher cost of goods sold.
Manufacturing Expenses These include all expenses related to plant and manufacturing operations like power and fuel, repairs and maintenance, stores consumed, water treatment, pollution treatment, etc.
Excise Duty This is the amount paid to the government as a tax, before the goods are dispatched from the factory. Salaries and Wages Salaries and wages and all other employee benefits and amenities are included in this expenditure. They include provident fund, ESI (Employees State Insurance) contributions, medical benefits, leave travel benefits, bonus, gratuity, pension, other super-annuation benefits etc. Administrative Expenses Administrative expenses include head office expenditure, secretarial costs, postage and telephones, directors remuneration and other administrative expenses. Selling Expenses Selling expenses include freight, advertising and sales promotion, commissions and discounts and other selling and distribution costs. Interest The interest cost consists of interest on long-term loans, debentures, bank loans for working capital, interest on public deposits and other loans. Depreciation Depreciation is the charge for using the assets. It can be described as the cost of the assets used during the year. This amount need not be paid to any outside party. Refer to chapter: XX for details Other Expenses The other expenses include auditors remuneration, petty expenses, small donations, if any etc.
Jeet R.Shah
19
Trading Account
Profit and Loss Account GROSS PROFIT Add Other Incomes Less All other Expenses Repairs Depreciation Interest Others NET PROFIT Appropriation Account NET PROFIT Less Income Tax Transfer to Dividend Transfer to Specific Reserves RETAINED PROFIT
Gross Profit: shows the ability of the business to generate profit Net Profit: Money available for distribution among the various stakeholders Retained Profit: Profit available for re-investing in the business.
Distinguish between
Profit Before Interest and Tax (PBIT), and Profit After Tax (PAT)
Though, the income statement is an important statement, it has the limitation of no being able to show the cash position. This limitation can be attributed to one of the important concepts of accounting i.e. Accrual Concept. The Income statement does not tell us how much cash has been received and how cash has been paid during the period. All it does is to summarise the incomes and expenses. While preparing the balance sheet we have seen that when the company has sold 20 computers @ Rs.25000, of which only 10% was received immediately. For the purpose of determining the profit or loss, the entire
Jeet R.Shah
20
Now let us see the profit and loss account of Wipro Ltd. WIPRO LIMITED Profit and Loss Account for the year ending Mar 31 (All figures in rupees million) 2001 Income Sales and Services Other Income Expenditure Cost of goods sold Selling, general and administrative expenses interest Interest Profit before taxation and non Recurring / extraordinary items Provision for taxation Profit after tax before non-recurring/ Extraordinary items Non recurring / extraordinary items Profit for the period Appropriations Interim Dividend on Preference Shares Interim Dividend on Equity Shares Proposed Dividend on Equity Shares Corporate tax on dividend Transfer to Capital Redemption Reserve Transfer to general reserve 16 6648 -523 2484
2000
30539 22735 692 257 31231 22992 18103 15203 5404 3995 68 286 23575 19484 7656 992 6664 3508 501 3007
26 69 10 2379
To do: Study the change in the income statements over the two years and explain how
profit for the period has increased by 168% .
Jeet R.Shah
21
Balance Sheet
Expenses Incomes
Income Statement
Balance sheet Owner's Fund Long Term Funds Short Term Funds Fixed Assets Investments Current Assets
Income Statement Sales Less Cost of goods consumed Expenses Depreciation Profit before Interest (PBIT) Interest Profit after Interest Tax Profit after Tax (PAT)
Jeet R.Shah
22
Learning Objectives After studying this chapter, you should be able to understand Cash Flow Statement Inter-relationship between BS, IS, and CFS
Jeet R.Shah
23
Cash and Cash Equivalents: However, the term cash and cash flow are not uniquely defined. Thus cash equivalents are risk-free short term investments, either in reporting currency or in foreign currency, having a maturity period of not exceeding three months, net of short term advances. Other definitions may mislead the users by understating the investment cash flows. What it records? It captures all the cash transactions undertaken during a particular period. In other words it records the following: It records both revenue and capital items: Profit and loss account shows only the revenue incomes and revenue expenses, balance sheet shows the capital receipts and expenditures, whereas the cash flow statement shows all types of cash flows. The distinction between capital and revenue is not relevant while preparing CFS. For example: Salary paid (revenue expense), Purchased Plant (capital expense), Advertisement for launching a new product (deferred revenue expense) It records all cash flows even if it previous years, or future years. For example: Advance premium paid (relating to the next year), Arrear salary paid (relating to the previous year) Components of CFS Cash flow statement explains the reasons for changes in cash and cash equivalents detailing out cash flow on various heads. Important among these heads are: Cash flow from operating activities; Cash flow from investing activities; Cash flow from financing activities. Operating activities are principal revenue producing activities of the enterprise and other activities that are not investing or financing activities. Some example of cash flow from operating activities:
Jeet R.Shah
24
Direct approach Under direct approach operating cash flow information is obtained from the cash book- cash receipts and payments can be classified and aggregated under the usual heads of accounts. Indirect Approach Under indirect cash approach cash flow form operating activities can be derived as follows: Net profit or loss Add : Non-cash charge such as depreciation, provisions, deferred taxes, unrealized foreign exchange losses; Add: Charges which are classified as part of investment or financing activities; Less : Non-cash income such as depreciation and other write backs; Less : Income which are classified as part of investment or financing activities. Add/Less : Changes in inventories, operating receivables and payables. Direct method is most appropriate for deriving operating cash flow because major heads of cash receipts and payments are disclosed. However, the SEBI has recently notified to follow indirect method only. Investing activities relate to the acquisition and disposal of long term assets and other investments not included in cash equivalents. As per Para 21 of IAS 7 and Para 21 of AS-3 separate disclosure of cash flows from investing activities is necessary. Cash inflows from investing activities include Receipts from collections of loans made by the enterprise and sale of debt instruments of other entities (other than cash equivalents) that were purchased by the enterprise; Receipts from sale of equity instruments of other enter prises and from return of investment of those enterprises; Receipts from sale of property, plant equipment and other productive assets; Receipts from derivative transactions
Cash outflows from investing activities include Disbursement of loan made by the enterprise and payments to acquire debt instruments of other entities (other than cash equivalents); Payments to acquire equity instruments of other enterprises; Payments for acquisition of property, plant and equipment. Payments for derivative transactions.
Jeet R.Shah
25
Cash outflows from financing activities include Repayment of amount borrowed; Capital element of finance lease payments; Buyback of shares; Payment of expenses or commissions on any issue of shares, debentures, loans, notes, bonds and other financing.
Which is the best combination and why? Cash Flows of some Indian companies: India Cements ACC 85.74 419.17 -584.13 Madras Cements 84.22 66.77 -83.04 -64.54 -15.61 -44.09
Jeet R.Shah
26
Cash Flow Statement Opening cash in hand Add: Cash Receipts Cash Sales Collection from customers Issue of share Issue of Debentures Loan Raised Sale of Assets Sale of Investments Dividend Received Intererets Received Less: Cash Payments Cash Purchases Payment to the suppliers loan repaid buy back of shares purchase of fixed assets Interest paid Divident distributed Closing Cash in hand
Cash Flow Statement Opening Cash in hand Add Cash from Operations Add Cash from Investments Add Cash from Financing Closing Cash in hand
Jeet R.Shah
27