1 Financial Statements and Cash Flow Analysis

Financial Statements and

Cash Flow AnalysisCash Flow Analysis

Financial Statements

• Financial statements provide information about the financial activities and position of a firm.

• Important financial statements are:

– Balance sheet

– Profit & Loss statement– Profit & Loss statement

– Funds flow statement

– Cash flow statement

Balance Sheet

• Balance sheet indicates the financial condition of a

firm at a specific point of time. It contains information

about the firm’s: assets, liabilities and equity.

• Assets are always equal to equity and liabilities:• Assets are always equal to equity and liabilities:

Assets = Equity + Liabilities

Assets

• Assets are economic resources or properties owned

by the firm.

• There are two types of assets:

– Fixed assets– Fixed assets

– Current assets

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)– Accounts receivable (debtors)

– Inventory (stocks)

– Advances to suppliers

– Prepaid expenses

Fixed Assets

• Fixed assets are long-term assets.

– Tangible fixed assets are physical assets like plant.

– Intangible fixed assets are the firm’s rights and claims, such as patents, copyrights, goodwill etc.

– Gross block represent all tangible assets at – Gross block represent all tangible assets at acquisition costs.

– Net block is gross block net of depreciation.

Liabilities

• Liability is a firm’s obligation to pay cash or provide

goods or services in the future. Two types of liabilities

are:

– Current liabilities

– Long-term liabilities

Current Liabilities

• Current liabilities are payable within a year in the normal course of business. They include:

– Accounts payable (creditors)

– Outstanding expenses

– Advances from customers

– Provision for tax– Provision for tax

– Provision for dividend

Long-term Liabilities

• Long-term liabilities are payable after a year. They

include:

– Borrowings from financial institutions and banks

etc.

– Debentures/bonds:– Debentures/bonds:

�Non-convertible

�Fully convertible

�Partly convertible

Shareholders’ Funds or Equity

• 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 or retained earnings are • Reserves and surplus or retained earnings are

undistributed profits.

• Shareholders’ funds or equity is the sum of share

capital plus reserves & surplus. It is also called net

worth.

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 • Net current assets (NCA) is the difference between

current assets (CA) and current liabilities (CL):

NCA = CA – CL

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 net worth or equity (E) and borrowing/debt (D) and it is equivalent equity (E) and borrowing/debt (D) and it is equivalent of net assets:

CE = Net Worth + Borrowing = E + D

Capital Employed = Net Assets

Functions of Balance Sheet

• Stewardship role

• Measurement of liquidity

• Measurement of solvency• Measurement of solvency

Profit & Loss Statement

• Profit & Loss statement provides information about a

firm’s:

– revenues,

– expenses, and

– profit or loss.

Nature of Revenues

• Revenue is the amount received or receivable within

the accounting period from the sale of the firm’s goods

or services.

• Operating revenue is the one that arises from main • Operating revenue is the one that arises from main

operations of the firm, and the revenue arising from

other activities is called non-operating revenue.

Nature of Expenses

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

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

• Expenses are expired costs and capital expenditures represent un-expired costs and appear as assets in balance sheet.

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 incurred on acquiring assets are called

capital expenditures. Depreciation is allocation of

these expenditures over the life of assets that have these expenditures over the life of assets that have

helped in generating revenue.

Methods of Depreciation

• Depreciation may be provided on

• straight line basis or

• written down value basis (DWV). DWV basis is

allowed for taxation in India.

Concepts of Profit

• 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 and tax = sales – expenses, except dep., interest and tax

• PBIT= Profit before interest and tax

= PBDIT – DEP

• PBT= Profit before tax = PBIT – Interest

• PAT = Profit after tax = PBT – Tax

Functions of Income Statement

• Summary of revenues and expenses

• Measurement of profitability

Relationships: B/S and P&L A/C

• Net profit = Equity (end) – Equity (begin)

• Equity (end) = Equity (begin) + Net profit + Equity issued – Dividend

• Net profit = [Equity (end) – Equity (begin)] – [Equity • Net profit = [Equity (end) – Equity (begin)] – [Equity issued – Dividend]

• Change in equity = Equity (end) – Equity (begin) = Net profit + Equity issued – Dividend

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 Economic profit is the net increase in the wealth of the

firm, and it is measured in cash flow.

Standards of Financial Reporting

• Full disclosure

• Materiality

• Consistency

• Conservatism

• Fairness

Accounting Principles and Concepts

• Business entity concept

• Money measurement concept

• Going concern concept

• Cost concept• Cost concept

• Duality concept

• Accounting period concept

• Matching concept

Balance Sheeet as at M arch 31

Rs. Crore2006 2005 2004

SOURCES OF FUNDS

SHAREHOLDERS FUNDSShare capital 33.09 33.08 33.08

Reserves and surplus 2047.22 1,356.56 800.23Net Worth 2080.31 1389.6392 833.30

BORROWINGS 0.00 0.00 0.00Capital Employed 2080.31 1389.64 833.30

APPLICATION OF FUNDS

FIXED ASSETSFIXED ASSETSOriginal cost 960.6 631.14 284.03

Less: Depreciation 393.03 244.13 133.65Net book value 567.57 387.01 150.38

Add: Capital work-in-progress 150.67 170.65 56.96718.24 557.66 207.34

INVESTM ENTS 44.44 34.12 13.83DEFFERED TAX ASSET 24.22 0.00 0.00

CURRENT ASSETS, LOANS & ADVANCESSundry debtors 336.73 302.37 136.18Cash and bank balances 772.22 385.06 431.79

Loans and advances 643.87 430.28 210.131752.82 1,117.71 778.10

Less: Current liabilities 126.11 134.92 67.15 P rovisions 333.3 184.93 98.82

NET CURRENT ASSETS 1293.41 797.86 612.13Net Assets 2080.31 1,389.64 833.30

Profit and Loss Account for the year ended M arch 31 Rs crore2006 2005

INCOM E

Software development services and productsOverseas 2,552.47 1,874.03

Domestic 51.12 26.542,603.59 1,900.57

EXPENDITURE

Software development expenses 1,224.82 870.83GROSS PROFIT 1,378.77 1,029.74

Selling and M arketing Expenses 129.79 92.07Administrative and other expenses 211.35 172.82

341.14 264.89Operating profit (PBIDT) 1,037.63 764.85Operating profit (PBIDT) 1,037.63 764.85

Interest 0.00 0.00Depreciation 160.65 112.89

OPERATING PROFIT AFTER INTEREST & DEPRECIAION 876.98 651.96Other income 66.41 59.37

Provision for investment 0.00 15.29PROFIT BEFORE TAX & EXTRA ORDINARY ITEM 943.39 696.04

Provision for taxation 135.43 72.71PROFIT AFTER TAX BEFORE EXTRA ORDNARY ITEM 807.96 623.33

Extraordinary item -- transfer of intellectual property right (net of tax) 0.00 5.49Net profit after tax and extraordinary item 807.96 628.82

AM OUNT AVAILABLE FOR APPROPRIATION 807.96 628.82

Dividend 132.36 66.16

Interim 49.63 16.54 Final (P roposed) 82.73 49.62

Dividend Tax 5.06 8.70Amount transferred - general reserve 670.54 553.96

807.96 628.82

Financial Ratios

2006 2005

Activity Ratios

Income/Assets 1.25 1.37

Income/Debtors 7.73 6.29

Current Ratios

CA/CL 3.82 3.49

CA/Assets 0.84 0.80CA/Assets 0.84 0.80

NCA/Assets 0.62 0.57

Profitability Ratios

Margin

PBDIT/Income 39.85% 40.24%

PBIT/Income 33.68% 34.30%

PAT/Income 31.03% 32.80%

Return on Investment

PBDIT/Assets 49.88% 55.04%

PBIT/Assets 42.16% 46.92%

PAT/NW 38.84% 44.86%

XYZ Company Ltd.

BALANCE SHEET

AS AT 31ST MARCH, 2006 Rs crore

2006 2005

SOURCES OF FUNDS

1. Shareholders' Funds

Share Capital 978.07 901.55

Advances against Share Capital 244.3 96.46

Reserves & Surplus 746.77 874.08

1969.14 1872.09

2. Loan Funds

Secured Loans 4989.26 3582.6

Unsecured Loans 630.09 1088.29

5619.35 4670.89

TOTAL 7588.49 6542.98

APPLICATION OF FUNDS

1. Fixed Assets

Gross Block 3470.36 1640.28

Less: Depreciation 704.01 498.14

Net Block 2766.35 1142.14 Net Block 2766.35 1142.14

Capital Work -in-Progress 2093.31 2740.66

Pre-operative exp. etc. 1715.74 2231.85

6575.4 6114.65

2. Investments 130.87 135.79

3. Current Assets, Loans & Advances

Inventories 257.37 259.48

Sundry Debtors 389.69 250.4

Cash & Bank Balances 53.9 77.7

Loans, Advances & Deposits 1018.31 907.61

1719.27 1495.19

Less: Current Liabilities & Provisions

Liabilities 1150.7 1185.39

Provisions 18.86 18.61

1169.56 1204

Net Current Assets 549.71 291.19

4. Miscellaneous Expenditure 134.37 1.35

(To the extent not written off or adjusted)

5. Profit and Loss Account Debit balance 198.14 _

TOTAL 7588.49 6542.98

XYZ Company Ltd.

PROFIT AND LOSS ACCOUNT

FOR THE YEAR ENDED 31ST MARCH

2006 2005

INCOME

Sales & Job Work (Net) 2238.89 1425.48

Other Income 25.18 11.65

TOTAL (A) 2264.07 1437.13

EXPENDITURE 3.95 33.7

Decrease in stocks 3.95 33.7

Raw Materials Consumed 823.04 778.15

Purchases of Finished Goods 7.77 9.32

Payments to & Provisions for Employees 43.99 21.79

Excise Duty 269.94 118.83

Mfg., Dist., Sell. & Admin. Expenses 890.84 306.72

Interest & Finance Charges 345.96 100.13

Depreciation 206.33 79.89

(Rs. crores)

Depreciation 206.33 79.89

Less: Transfer from Revaluation Reserve 15.32 15.32

TOTAL (B) 2576.5 1433.21

Profit/(Loss) before Taxation (A+B) 312.43 3.92

Less: Provision for Taxation 0.03 0.32

Add: Provision for Taxation written back 0.07

Profit/(Loss) after taxation 312.46 3.67

Less: Balance brought forward from Previous Year 100.52 106.59

Transfer from Debenture Redemption Reserve 8.09

Transfer from Taxation Reserve 0.73

Transfer from General Reserve 13.07 _

Profit/(Loss) available for appropriation -198.14 118.35

APPROPRIATIONS:

Transfer to Debenture Redemption Reserve _ 17.83

Balance carried to Balance Sheet -198.14 100.52

TOTAL -198.14 118.35

Cash Flow

• Liquidity refers to resources currently available with the

firm. It is reflected by the cash flows rather than the

stock of current assets and liabilities.

• Cash flow is a change in the firm’s cash position. Cash • Cash flow is a change in the firm’s cash position. Cash

flows occur due to changes in items in the balance

sheet and profit & loss statement. Thus liquidity

analysis involves measurement of changes in assets,

liabilities and equity.

(Rs ‘000)

2005 2006 Change

ASSETS

Cash 54 135 81

Debtors 6,750 8,235 1,485

Stock (inventory) 10,125 22,680 12,555

Total current assets 16,929 31,050 14,121

Fixed assets (net) 2,970 6,075 3,105

Other assets 945 1,890 945

TABLE 1. ABC Co.: Balance Sheet Changes,

March 31, 2005-March 31, 2006

Other assets 945 1,890 945

Total Assets 20,844 39,015 18,171

LIABILITIES & NET WORTH

Bank borrowing 3,510 8,664 5,154

Creditors 2,835 6,615 3,780

Provision for taxes 270 972 702

Accrued expenses 810 2,700 1,890

Total current liabilities 7,425 18.951 11,526

Long-term debt 1,944 1,404 -540

Total liabilities 9,369 20,355 10,986

Paid-up share capital 8.37 8,370

Reserves and surplus 3,105 10,290 7,185

Total Liabilities 20,844 39,015 18,171

Sources and Uses of Funds

and Cash Flows

• Sources of funds or cash flows:

• Cash from operations

• sale of fixed assets

• issue of share capital

• Borrowings• Borrowings

• Uses of funds are:

• losses

• purchase of fixed assets

• repayment of borrowings

• payment of dividends

Cash from Operations

• Cash flow from operations

+ PAT (– loss)

+ Depreciation

+ Other non-cash expenses

– Non-cash incomes

+ Loss from the sale of fixed assets+ Loss from the sale of fixed assets

– Gain from the sale of fixed assets

+ Increases in net working capital

– Decreases in net working capital

Uses of Funds and Cash Flow Statements

• Liquidity position

• Capital expenditures

• Dividends paid

• Retained earnings• Retained earnings

• External financing

• Repayment of loans

• Non-performing assets