22 13 Financial Statements

8/3/2019 22 13 Financial Statements

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Financial Statements andCash Flow Analysis


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Financial Statements

Financial statements provide informationabout the financial activities and position of afirm.

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 firms: 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 firms rights andclaims, such as patents, copyrights, goodwill etc.

Gross block represent all tangible assets atacquisition costs.

Net block is gross block net of depreciation.


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Liabilities

Liability is a firms 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 inthe 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 orEquity

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 orretained earnings

are undistributed profits.

Shareholders funds orequity is the sum ofshare 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 networth 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 ofBalance Sheet

Stewardship role

Measurement of liquidity

Measurement of solvency


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Profit & Loss Statement

Profit & Loss statement provides information

about a firms:

revenues,

expenses, and

profit or loss.


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Nature ofRevenues

Revenue is the amount received or receivable

within the accounting period from the sale of

the firms goods or services.

Operating revenue is the one that arises frommain operations of the firm, and the revenue

arising from other activities is called non-

operating revenue.


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Nature ofExpenses

Expense is the amount paid or payable withinthe accounting period for generating revenue.

Examples: raw material consumed, salary andwages, power and fuel, repairs and maintenance,rent, selling and marketing expenses, administrativeexpenses.

Expenses are expired costs and capitalexpenditures represent un-expired costs andappear 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 incurredon 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 ofDepreciation

Depreciation may be provided on

straight line basis or

written down value basis (DWV). DWV basisis allowed for taxation in India.


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Concepts ofProfit

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 andtax

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&LA/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 ofFinancial 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 availablewith the firm. It is reflected by the funds or cashflows rather than the stockof current assets

and liabilities. Funds flow is a change in a firms net current

assets while cash flow is a change in the firmscash position. Funds or cash flows occur due to

changes in items in the balance sheet andprofit & loss statement. Thus liquidity analysisinvolves measurement of changes in assets,liabilities and equity.


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Sources and Uses ofFunds 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 ofFunds and Cash Flow

Statements Liquidity position

Capital expenditures

Dividends paid

Retained earnings

External financing

Repayment of loans

Non-performing assets

22 13 Financial Statements

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