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Jeet R.Shah 1

Financial Statements: Introduction

Learning Objectives

After studying this chapter, you should be able to understand

Balance sheet

Income Statement

Cash Flow Statement




Jeet R.Shah 2

Introduction:The end product of the financial accounting is a set of financial statements. Some of these

statements are statutory and some are not. These financial statements relate to a specific date or

covers a specific period viz. month, quarter, annual. In the Indian context, he balance sheet, the

profit& loss account, and cash flow statement are considered to be the statutory statements,

though many companies have started including other statements in their annual reports.

In this chapter we will concentrate on the two basis statutory statements viz. balance sheet and the

profit & loss account. To examine the content of these financial statements and how to read

them, let’s look at the financial statements of Wipro Limited for the year ending 31st

march 2000

and 2001.

At this point, we will focus our attention on the larger picture and not get into the nitty-gritty of

the financial statements. Our goal is an overall understanding of the basic financial statements.

At this stage we will ignore the details on each statement. However, as we progress through the

text, we will examine these details to enable you to undertake an in-depth analysis of the financial

statements.

Balance sheetLet us begin with the balance sheet of Wipro Limited. The exhibit 2.1 displays the condensed

balance sheet for two years.

The balance sheet represents the financial picture of an organisation as it stood on a particular

date. It can be prepared every day, on the last day of the week, last day of the month, last day of

the year, or any other day. The balance sheet for the previous year is also presented along with the

current one to facilitate comparison. Balance sheet is prepared on the basis of certain basic

concepts and conventions of accounting (which will be discussed in the next chapter) and

presented in the format prescribed by the Companies Act 1956.

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 inthe 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. eithercollected 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 3

machinery, equipment, buildings, inventories, etc., or, things that have immediate purchasingpower, like, cash and short-term marketable securities; or claims that can be converted into cash

such as accounts receivable; inventory of finished goods etc., are of value to the enterprise. If an

item is valuable to the enterprise, the acid test of whether a particular item is an asset of an

enterprise or not is the ownership of the item. If an enterprise does not hold title of a particular

item though it may have physical possession (e.g., rental building), it is not represented among

the list of assets. The various categories of assets are discussed as follows:

Fixed Assets

Fixed assets are tangible valuable things owned by the enterprise with the intention of carrying onbusiness operations over a long time horizon. Thus, fixed assets are of a tangible nature and are

durable. The usefulness of an asset to an enterprise is always either on grounds of technology or

economic benefits. When the term “fixed asset” is used without qualification, the reference is

generally to tangible assets and specifically to plant and machinery, buildings and land.

Generally, all the fixed assets are grouped together at the original cost value to represent the gross

block, from this accumulated depreciation on all the assets till the date is subtracted to arrive at

the net block. Usually, this information is substantiated by a schedule containing details on

original cost, accumulated depreciation till the date of previous balance sheet, and depreciationfor the current accounting period for each fixed assets component.

Current Assets, Loans and Advances

Current assets include cash and all “cash-like” items which can be converted into cash in the near

future (i.e., in a year) or during a normal operating cycle. The operating cycle, here, is defined as

the time span between the cash injected into operating processes through purchase of raw

materials and the cash received from the sale of goods. So, current assets are cash and bank

balance, stock of raw materials, work-in-process, finished goods and account receivables. The

current assets are as could be observed from the above explanati9on, asset items of current nature.

Here the word current means that the assets change from (say raw materials into work-in-process,

or work-in-process into finished goods, or finished goods into accounts receivables or receivableinto cash) frequently during the operating period. On the other hand, fixed assets are more

permanent in nature. The various components of current assets are discussed as follows:

i. Cash and bank balance: Cash consists of funds that are immediately available for

disbursement. Usually, most of the organisations do not keep a lot of cash on hand as

most dealings are done through banks.

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 netamount 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




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representing the amount outstanding for more than six months but considered doubtful.Sometimes under the head of debtors, certain amounts arising out of non-regular

operational transactions e.g., amount yet to be received from sale of an asset, are also

included.

iv. Marketable securities: These are the firm’s investment in shares and debentures of

corporations, and other securities for a relatively short period of time. The wordmarketable indicates that these securities can be sold and bought on a stock exchange.

v. Prepaid expenses: These are expenses that have been paid in advance for example

advance income tax or insurance premium paid in advance. If insurance premium is paidon 25th December for the next accounting year, then it will be indicated as prepaid

insurance, because it has been paid for future coverage. Similarly rent paid in advance

for future use of equipment or buildings will be indicated as prepaid rent.

vi. Interest receivable: If interest has been earned but not received in cash as on the date of

balance sheet, it is represented as interest receivable. For example if an enterprise has

deposits in a bank and the bank pays interest half-yearly, then on 31st December it has

earned interest but has not received it. We will represent this information on the balancesheet as interest receivable.

Investments

An enterprise may decide to invest in long-term securities of other institutions. For example a

firm may periodically set aside certain cash and invest this cash in long-term securities, so as to

ensure availability of cash for any repayment at a future date. An enterprise may also buy shares

of another firm with a view to diversify its operations.

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 5

• Taxes owed to government authorities

• Rent owed to owners of land and buildings

• Money owed to the shareholders

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 businessentity 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 dividendequalization 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 development-

oriented institutions.

Long-Term Liabilities




Jeet R.Shah 6

Current liabilities represent the obligations maturing within a relatively short period notexceeding 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.

In general, long-term liabilities are theenterprise’s obligations for moneyobtained for a relatively long period,generally more than year. Theseliabilities are incurred to finance the

operations of the business. This,therefore, represents claim againstassets. These liabilities are more oftenagainst the securities by hypothecationor pledge of the assets.

Concept of Time

In accounting, time is divided onthe 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 (Short-Term)

Distinguish between ‘Expenses Accrued’ and

‘Expenses Due’




Jeet R.Shah 7

iv. Rent received in advance: if an enterprise owns a building and rents it to a tenant and thetenant has paid the rental charges in advance, then this amount will be indicated as rent

received in advance, on the liability side of the balance sheet.




Jeet R.Shah 8

Now let us see the balance sheet of Wipro limited and understand the terms.

Exhibit 4.1

WIPRO LIMITED

BALANCE SHEET AS AT MARCH 31 2001

(All figures in rupees million)

SOURCES OF FUNDS As on March 31 APPLICATION OF FUNDS As on March 31

2001 2000 2001 2000

Share capital 466 708 Gross block 9020 6757

Less Depreciation -3793 -2928

Reserves and surplus 19184 6994Net Block 5227 3829

Shareholders' Funds 19650 7702Capital Work in progress 797 708

Fixed Assets 6024 4537Secured Loans 400 492

Unsecured Loans 47 86 Investments 1636 462

Loan Funds 447 578 Inventories 1152 1340

Sundry creditors 4813 4057Sundry Debtors 6176 4469

Provisions 532 428 Cash and Bank balances 4463 747

Current Liabilities 5345 4485Loans and advances 5992 1210

Current Assets 17783 7766

Total 25442 12765 Total 25443 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.

Simplified Version of Balance Sheet

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.




Jeet R.Shah 9

Let us now further demystify the balance sheet by further reducing the number of items and themunderstand the interrelationship. In the process you will get introduced to some more accounting

terms which will be taken up for further discussion in the subsequent chapters.

Exhibit 4.2

WIPRO LIMITEDBALANCE SHEET AS AT MARCH 31 2001


Liabilities As on March 31 Assets As on March 31

2001 2001

Shareholders' Funds 19650 Fixed Assets 7660

Long Term Loan 447

Current Assets 17783

Current Liabilities 5345

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)

Some interesting relationships

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 10

Preparing Balance sheet: Common Sense Approach

Even without understanding the technicalities of accounting, one can prepare a balance sheet. The

assumption on which the balance sheet is prepared is quite basic and commonsensical: Every

application (i.e. purchase of asset, or increase in asset) should have a corresponding source. So

based on this assumption the total applications at any point of time will be equal to the source.Let us try to understand this with the following transactions of an hypothetical company.

1. A ltd. is company formed on 1st

April 2001 to buy and sell computers. The promoters

collected Rs. 1000 as share capital from their friends and relatives. The balance sheet will beas follows:

Compusales Ltd.

BALANCE SHEET AS on 2001

(All figures in rupees 000)

SOURCES OF FUNDS APPLICATION OF FUNDS

Capital 1000 Cash 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.



SOURCES OF FUNDS As on March 31

APPLICATION OF

FUNDS As on March 31

2001 2001

Capital 1000 Cash 900Furniture 100


n.b. No change in capital and on the sources side.




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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.




APPLICATION OF


2001 2001


IDBI Loan 1500 Bank 1500

Furniture 100

Total2500

Total2500

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.




APPLICATION OFFUNDS As on March 31

2001 2001Capital 1000 Cash 900


Furniture 100

AC 25


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.




APPLICATION OF


2001 2001




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XY Ltd. (Creditors) 2000 Stock of Computers 2000

Furniture 100


You can see from the balance sheet that the increase in the assets is being funded by the increasein 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.




APPLICATION OF


2001 2001



SBI Loan 500


Furniture 100


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.




APPLICATION OF


2001 2001Capital 2000 Cash 1450


SBI Loan 500


Profit 10 Furniture 100





Jeet R.Shah 13

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.




APPLICATION OF


2001 2001



SBI Loan 500



Loss 6


Now let us summarise the Learnings from the above transactions:


a) Increase in asset will have the following effects Increase in liabilities, or Decrease in cash/other asset

b) Increase in liability will have the following effect

Increase in cash, or Increase in other asset Decrease in any other liability

c) If Source side is greater than application, the difference is treatedas ‘Profit’.

d) If Source side is lesser than the application side, the difference istreated as ‘Loss’




Jeet R.Shah 14

10. The company sold another 20 computers @ of Rs. 25000 to a local organisation (ABC ltd.).

10% of the sales collected immediately and the balance to be collected in twelve equal

installments.

Cash increases by Rs. 50,000

Debtors (Receivables) increases by 450,000 Stock decreases by Rs. 400,000

Difference is treated as profit: Rs. 100,000

Comp sales Ltd.

BALANCE SHEET AS on


SOURCES OF FUNDS As on

APPLICATION OF

FUNDS As on

2001 2001



SBI Loan 500 Debtors 450



Profit 100 Loss 6


Instead of showing the profits and losses separately, they can be netted off as follows:

Comp sales Ltd.

BALANCE SHEET AS on


SOURCES OF FUNDS As on

APPLICATION OFFUNDS As on

2001 2001



SBI Loan 500 Debtors 450




Profit = 100 + 10 – 6 = 104




Jeet R.Shah 15

Now let us present the above balance sheet in the format shown in exhibit 2.2

Comp sales Ltd.

BALANCE SHEET AS on


Liabilities As on March 31 Assets As on March 31

2001 2001

Shareholders' Funds 2104 Fixed Assets 100

Long Term Loan 1500

Current Assets 6004

Current Liabilities 2500


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 particularperiod of time then it is better to prepare the Income Statement or Profit & Loss Account.

To do: Compare the balance sheet of a manufacturing company with that of a service

company and a banking company.




Jeet R.Shah 16

Income Statement

Learning Objectives


Income Statement Relationship between Income Statement and Balance Sheet




Jeet R.Shah 17

Profit and Loss Account/Income Statement

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 –howsuccessful 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. Thisprofit 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

SalesThe 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 item’s 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 IncomesThe 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.

Why is it necessary to show sales and other

incomes as separate items?




Jeet R.Shah 18

Expenditure Side

The expenditure side of a P & L account gives the details of all the revenue expenses whether

accrued or paid for during a year.

Cost of goods Consumed

The cost of goods consumed is arrived at after making suitable adjustments for opening andclosing stocks as shown below: (Rs in Lakhs).

Opening Stock 250

Add: Purchases 12001450

Less: Closing Stock 400

Goods Consumed 1050

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.


OpeningStock/Purchase Rate (Rs.)

1.5.2001 3000 4.5

2.5.2001 1000 5

4.5.2001 2000 6

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%

Profit changesbecause of thechange in themethod ofvaluation




Jeet R.Shah 19

It is important to note that the profit changes by 31% not because of the change in the operatingefficiency, 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 ExpensesThese 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 thefactory.

Salaries and WagesSalaries 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 ExpensesAdministrative expenses include head office expenditure, secretarial costs, postage and

telephones, directors’ remuneration and other administrative expenses.

Selling ExpensesSelling expenses include freight, advertising and sales promotion, commissions and discounts and

other selling and distribution costs.

InterestThe interest cost consists of interest on long-term loans, debentures, bank loans for working

capital, interest on public deposits and other loans.

DepreciationDepreciation 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 ExpensesThe other expenses include auditors’ remuneration, petty expenses, small donations, if any etc.




Jeet R.Shah 20

Presentation of Income Statement:

At this juncture we will see the general format of presenting the incomes and expenses. Generally

the income statement is known as ‘Trading and Profit and Loss Account’ and consists of three

sections as illustrated in the following exhibit

Trading Account Sales

Less Cost of Goods Sold

GROSS PROFIT

Profit and Loss Account GROSS PROFIT

Add Other Incomes

Less All other Expenses

Repairs

Depreciation

Interest

OthersNET PROFIT

Appropriation Account NET PROFIT

Less Income Tax

Transfer to Dividend

Transfer to SpecificReserves

RETAINED PROFIT

Gross Profit: shows the ability of the business to generate profitNet Profit: Money available for distribution among the various stakeholders

Retained Profit: Profit available for re-investing in the business.

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

Distinguish between

Profit Before Interest and Tax(PBIT), and

Profit After Tax (PAT)




Jeet R.Shah 21

sale value i.e. Rs. 500,000 was shown as the income. Similarly, when an item bought on credit, itis recognized as an expense immediately, though the cash is yet to flow out of the business.

Now let us see the profit and loss account of Wipro Ltd.

WIPRO LIMITEDProfit and Loss Account for the year ending Mar 31


2001 2000

IncomeSales and Services 30539 22735

Other Income 692 257

31231 22992Expenditure

Cost of goods sold 18103 15203

Selling, general and administrative expenses interest 5404 3995

Interest 68 286

23575 19484

Profit before taxation and non

Recurring / extraordinary items 7656 3508

Provision for taxation 992 501

Profit after tax before non-recurring/ 6664 3007

Extraordinary items

Non recurring / extraordinary items 16 -523

Profit for the period 6648 2484

AppropriationsInterim Dividend on Preference Shares 18 26

Interim Dividend on Equity Shares 69

Proposed Dividend on Equity Shares 116

Corporate tax on dividend 13 10

Transfer to Capital Redemption Reserve 250

Transfer to general reserve 6251 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 22

Important financial items and financial statements

• Sources (liabilities)

• Uses (assets)

• Expenses

• Incomes

Balance sheet

Owner's Fund Fixed Assets

Long Term Funds Investments

Short Term Funds Current Assets

Income Statement

Sales

Less

Cost of goods consumed

ExpensesDepreciation

Profit before Interest (PBIT)

Interest

Profit after Interest

Tax

Profit after Tax (PAT)

Balance Sheet

Income Statement




Jeet R.Shah 23

Financial Statements: Cash Flow Statement

Learning Objectives


Cash Flow Statement Inter-relationship between BS, IS, and CFS




Jeet R.Shah 24

Cash Flow Reporting

The basic objective of a cash flow statement is to provide relevant information as regards cash

receipts and cash payments of an enterprise during the accounting period. CFS shows the

movement of cash of an enterprise. It records all cash flows occurred during a particular period.

It is believed that cash flow information together with other traditional accrual basis financialstatements help investors creditors and others to –

• Assess the enterprise’s ability to generate positive cash flow from operations

in future;

• Assess the enterprise’s ability to meet its obligations, its need for external

financing and ability to pay dividend;

• Assess the reasons for difference between net profit and net cash flow from

operations;

• Assess the effects on an enterprise’s financial position of both its cash and

non-cash investing and financing transactions during the period.

• Shows the balance in hand or at bank,

• Helps in understanding the composition of cash flows, and

• It facilitates financing, investment and dividend decisions.

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 termadvances. 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 CFSCash 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:




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• Cash receipts from the sale of goods and the rendering of services;

• Cash receipts from royalties, fees, commissions and other revenue;

• Cash receipts and payments from contracts held for dealing or trading

purposes;

• Cash payments to suppliers for goods and services;

• Cash payment to and on behalf of employees;

• Cash payments for income tax and refunds of income tax unless

specifically identified with financing or investment activities.

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.




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Financing activities are activities that result in changes in the size and composition of the

equity capital and borrowing of the enterprise.

Cash inflows from financing activities include –

• Proceeds from issuing equity instruments;

• Proceeds from issuing bonds, mortgages, notes and from other short or long termborrowing.

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.

Situation 1

Situation

2

Situation

3

Situation

4

Situation

5

Cash from Operation Negative Positive Negative Positive Negative

Cash from Financing Positive Negative Positive Positive Negative

Cash from Investing Positive Positive Positive Positive Negative

Which is the best combination and why?

Cash Flows of some Indian companies:

India Cements ACC Madras Cements

Cash from Operation 85.74 84.22 66.77

Cash from Financing 419.17 -83.04 -64.54

Cash from Investing -584.13 -15.61 -44.09

Give your comments.




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

Documents

Acconting Notes