Balance Sheet

The financial performance of a company is assessed for a period of a year. Similar to

your classroom study, the Company is to bring out a report card of its (1)
performance during the year and the 92) status of the Company at the end of the
year. Continuing with the example of the classroom, at the end of the year your
performance is set out as marks in various subjects and a final grade. For an
enterprise it is the net profit it earned during the year. The grade is determined by
the stock market reflecting in the price of the share.
However , in addition to the Profits ( many a time losses as well) generated ( or
losses incurred) during the year, in the case of the enterprise , it has also to report
the financial condition at the end of the year as of 31 st March typically. This is an
accumulation of all the yearly earnings (or losses), ever since the beginning of the
enterprise. It is like having the student value the body of knowledge accumulated
over the years as of a particular date, not just what he learnt during the single year.
The performance during the year is prepared in a statement (like your report card)
and referred to as Profit and Loss (Profit and Loss?). The financial status as at the
end of the year is referred to as the Balance Sheet.
The Balance Sheet has various components across two broad sections- The Assets
Section and the Liabilities Section.

Assets as in English grammar refer to what the enterprise owns. Some of

these assets are used to run the business of the enterprise.
Assets are
further sub classified.

The Liabilities refer to the source of funds for acquiring the assets. Here too
there are sub classifications.

After you have familiarized with the various sub classifications of both assets and
liabilities, turn to the next page which is the Balance Sheet of Reliance Industries as
of 31st March 2011. We shall discuss this statement in the class.
Case: Please attempt at answers to the questions raised at the end of the case.

Profit & Loss

The Balance Sheet reflects the financial health of an Organization. IT reflects the
assets of the Organization which are used to run the Organization. In the first
session we have discussed and arrived at a consensus as to the purpose of a
commercial entity. The excess of the Income generated from the utilization of the
assets over the expenditure to earn that Income is the Profit. In the event of the
expenditure being more than the income generated, then there is a loss situation.
The statement that reflects the surplus generated or the loss incurred is called the
Profit & Loss Statement .As in the case of the balance Sheet, a P&L Statement has
certain standard components, details of which are highlighted in the text.
After

reading the text one should be familiar with terms like

Variable expenses
Fixed costs
Non cash expenditure
Apportionment of expenditure
Amortization of expenditure
Etc etc

After you have familiarized with the various sub classifications of assets and
liabilities, turn to the next page which is the Profit & Loss Statement of Reliance
Industries for the year ending 31st March 2011. We shall discuss this statement in
the class.

The Balance Sheet

By now we now appreciate that the Balance Sheet represents the financial health
of a Corporation as of a particular day . It comprises of two sections the
Liabilities section and the Assets section.
Liabilities
The Liabilities Section lists all the moneys owed as of a date This Section is also
called Sources of Funds. Note that the liabilities include the shareholders equity and

reserves. This is on the principle that the Corporation is a separate entity from the
Owner.
The broad heads of account in the Liabilities Section are:
A Own Funds
Equity
Reserves
B. Loan Funds
Secured
Unsecured
C Current Liabilities and Provisions
Assets
The Assets Section lists the utilization of every rupee of the Liabilities. This Section
is also called Utilization of funds .
Since every rupee owed needs to be accounted with its utilization, the combined
statement is called a Balance Sheet. A balance Sheet balances the Sources of
funds with its Utilization.

The broad heads of account in the Assets Section are:

D. Fixed Assets
Gross Assets
Less Accumulated depreciation
E Investment
F Current Assets
Cash and bank balances
Receivables
Loans and Advances
Inventory

Profit &Loss
A Profit and Loss Statement (often referred as the P&L Statement) on the other hand
, records the income generated from the operations of the Corporation during a
period ( typically a year) . At the end of the period the surplus generated accrues
to the Owners.
The broad heads of Account in a P&L Statement are :
A. Sales
B. Expenditure
Raw materials
Processing
Promotion
Administration
C EBIDTA
Interest
Depreciation
D PBT
E
Taxes
F PAT
G
Dividends
I Surplus

The surplus generated (after declaration of dividend) is added to the Reserves on

the liabilities side of the Balance Sheet.
Where is the corresponding entry on
Sheet?

the Assets Section of the Balance

Ideally the surplus generated should be added to the cash side of the assets Section
. In reality not all the surplus is in the form of cash. For instance some of the Sales
made may not be paid for as yet . It is due as receivables and it is shown in that sub
section of the Balance Sheet. Likewise payments may not have been made for some
of the expenses shown in the P&L Statement, like raw materials or processing .
These payments yet to be made is reflected in the Balance Sheet as Current
Liabilities.

By this time we should appreciate why the reserves on the liabilities side does not
equal the cash and bank balance on the Assets side.

Enter Cash Flow

As we discussed in an earlier session the accounting Principle of Accrual stipulates
that a Corporation must recognize ( i.e report) a sale even if the payment is not
received , as long as the sale is genuine and the buyer intends to pay. Likewise as
long as an expense has been incurred in the consumption of a raw material ,the use
of labour, the use of power , transportation of goods, etc, such expenses need to be
recorded as expenses even though payments may not have been made for these
inputs.
In the circumstances there is a difference between the P&L and the actual cash
generated . There is a need to assess the actual cash flow from the Operations
of the Corporation .
Likewise cash is generated from Financing activities . These transactions are not
in the P&L Statement but emanate from the Balance Sheet. For example availing of
a secured long term loan would increase the liability under Secured Loans and
increase cash on the assets side. Another example is when cash is invested in
Mutual Funds or other avenues. Here the cash is reduced and a corresponding
increase in Investments take place.
A third source of cash generation or utilization is from Investing Activities. These
transactions relate to investments/divestments , sale/purchase of assets.
Thus cash flows comprise of three components (1) Cash flows from operations ,(2)
Cash flows from financing activities and (3) cash flow from investing activities .
Tracking these flows help generate the cash flow statement.
Let us track these three flows from a Balance sheet and a P&L Statement Both
statements are in the last page of this handout- Fairway Corporation .
Cash Flow from Operations
Operations We start by first by examining the cash flows from Operating activities .
For this we need to study the P&L Statement
Q1
What is the Profit after Tax for the year 2006 ?

Q2
5

To whom does surplus belong ?

Q3
Where should it get reflected in the Balance Sheet ?

Q4
Has this amount been been reflected in the Balance Sheet , or a lesser amount ? If a
lesser amount why is this so?

Q5
The next step is to identify the movements in the balance Sheet of the operational
heads of account .The movement to be examined is from the earlier year closing
( 2005) to the current year (2006) closing. For instance the receivables as of
December 31st 2005 was $586,000. It is $673,000 as of end 2006.There has been an
increase of USD 87000.Does this mean, that there has been a inflow of cash from
receivables during the period, or has there been an outflow ?
Q6
Study each of the operating entries in balance sheet and fill up the following
table
USD000
No Entry
Outflow
Inflow
1
Receivables
2
Inventories
3
Payables
4
Taxes payable
5
Deferred Taxes
6
Depreciation
Total
Cash Flow from Financing Activities
We now turn our focus to Financing activities. For this, similar to the earlier exercise
with operational Heads of accounts in the Balance Sheet we study the financing
heads of accounts and categorise the movement during the year ( i.e closing
balance of 2006 Vs closing balance of 2005) as cash inflows or outflows.

No
1

Entry
Short term
debt

Outflow

USD000
Inflow

2
3
4

Long Term
debt
Equity
Dividend
Total

Cash Flow from Investment Activities

We finally turn our focus to Investment activities .For each of the Investment head
of account from the balance sheet categorise the movement during the year (i.e
closing balance of 2006 Vs closing balance of 2005) as cash inflows or outflows.

No
1
2

Entry
Equipment
Investment
Total

Outflow

USD000
Inflow

Finally sum up the three netcash flows from the three activities.
Cash Flows
$000
From Operations
From Financing Activities
From Investment Activities
__________________________________
Net increase/decrease
Opening Balance
Closing Balance
+++

Fairway Corporation1
Balanced Sheet as of December 31st 2005 and 2006
Unit 000$
No
A
A.1

A.2

Liabilities
200
2006
5
Owners Funds
Equity
183
227
Reserves
164
1780
0
Sub Total A.1
182
2007
3
Liabilities

A.4
A

Current
Liabilities
:Payables

500

835

140
150

Assets
Fixed Assets
Gross

44

Loan Funds
Long term
Debts

A.3

Diff

Acc Depr

Taxes
payables
Short Term
Borr.
Sub Total A.3

Deferred Taxes

388
10

2000

200
6

Diff

235
0
970
138
0

350
*
30

B.
1

Net FA

1000
1000

B.
2

Investment

450

400

-50

230

326

96

586

673

87

Receivables
Inventories

610

657

47

Sub Total CA

1426

165
6

230

34
36

56
0

380

335
Current
Assets
Cash
&Bank

332

Assets
2995

56
1

147

126

-21

488

524

36

65

70

B.
3

Total A 287 343

56
B
6
6
0
*Value of new Equipment purchased USD 500,000

Total B 2876

Profit & Loss For the Year ended 31Dec 2006 (000$)
No
Sales
3190
Cost Of Sales
2290
1
Contribution
900
Expenses
Other
477
1

Extract from Accounting by Anthony Hawkins and Merchant 12th edition pages 314 and 316
: Tata Mc Graw Hill

2
3

Expenses
Depreciation
PBT
Income Taxes
PAT

120
303
103
200