Financial Statements

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Objective of the session

To understand the income statement
B/S and cash Flow
To analyse the statements
The aim of the session is to
understand the basics of financial
statements and the interrelation
between the statement

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Income Statement
Income Statement is a financial
statement which shows the profit
earned by a firm in a particular year.
In income statement we have
revenue and expenses. Revenue by
definition means amount earned in a
particular accounting year as a result
of sales. Income from sales of fixed
assets is also recorded in the book as
revenue.

Income Statement
Earned refers to amount that is due
hence we consider the total amount
we deem pertains to an accounting
period received or receivable.
Expenses refer to the amount of
money paid or payables for
services/goods which goes into
operating and financing a business
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Income Statement/P&L a/c

Performa:
Net Sales (consists of credit and cash sales)
Less: COGS (Cost of Goods Sold includes direct labour and direct
expenses)
Gross Profit (Shows the efficiency in managing cost of raw materials
and direct labour)
Less: Operating Expenses (Expenses incurred in running
operations)
EBIDTA (Earning Before Interest Depreciation and Amortization)
Less: Depreciation (estimated monetary value for usage of fixed
assets)
EBIT (Earning Before Interest and Tax represents operating profit)
Less: Interest (Cost of servicing debt)
EBT (Earning Before Tax)
Less: Tax
PAT (Profit After Tax)

Income Statement/P&L a/c

Income statement is a tool to assess and analyse
the profitability of the company:
1. Once upon a time the company sold bottles (for
cash and credit) which was called net sales
after he had accounted for defective bottles
returned to him and excise duty he paid.
2. There were some cost directly related to the
cost of bottles sold, which included direct labor
which went into manufacturing the bottles, raw
material such as glass and bottle caps and
expenses pertaining to transportation of raw
materials. The businessman termed this cost
of goods sold.
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Income Statement

1.

2.

He then wore his analyst hat and found the

difference between sales and cost of goods. This
helped him analyse his efficiency in managing his
direct cost and his ability to pass on the cost of goods
sold to the consumer. Difference between sales and
cost of goods sold and called it gross profit
He incurred some expenses on running the day to day
business which included paying out salaries,
stationery for office, selling and general expenses. He
clubbed these expenses
together and called it
operating expenses.

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Income
Statement

He then found the difference

between gross profit and operating
expenses and called it EBIDTA.
This helped him analyse his ability
to control the operating expenses.
He compared this with previous
year and used the industry bench
mark to gauge his performance.
He then estimated the monetary
value of usage of fixed assets
in the particular period which he
called depreciation.

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Income
Statement

Impairment which was fall in the value of the

reputation of the company (goodwill) was also
accounted for.
He subtracted Depreciation and Amortization from
EBITDA and he had EBIT.
He then realized he had been servicing his loans on a
regular basis with interest. This he knew was a
financial expense. Once he subtracted the financial
expense he got what is known as Earning Before tax
(EBT).

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Income
Statement

He had an old business of manufacturing

bottle caps which he sold as he was
running on loss and added income from a
business he had discontinued and called
it
income
from
discontinued
business.

He also sold some old furniture in his

office and showed the profit that he
earned he showed in his income
separately.

He had to pay some amount to the

government (TAX). What was left, the
net
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Valley profit 10 was all the money that he

Balance Sheet
1. Balance Sheet is a financial statement
which sums up the financial benefits and
obligations of the company as on a
particular date.
2. Future benefits which can be measured in
terms of money are known as assets. In
other words, if Tata Steel has an asset
worth Rs. Xxxxxxx in its balance sheet as
on 31st March 2011 it means Tata Steel
expects a monetary benefit of Rs.
Xxxxxxxxx from the assets.

Balance Sheet
1.

2.
3.
4.

Future obligations which can be measured in terms of money are

known as liability. In other words, if Tata Steel has a liability worth
Rs. Xxxxxxx in its balance sheet as on 31st March 2011 it means
Tata Steel is carrying an obligation of worth Rs. Xxxxxxxxx to the
next period.
Shareholders capital and reserve refers to the amount of money the
owners have invested in business. Current liabilities are obligations
which need to be paid off in the next year.
Accounting equation states that Assets is the sum of Liability and
Owners Equity.
It should also be noted that income increase amount owed to
shareholders and expenses decreases the same.

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Balance
Sheet
Assets
Current Assets
Cash
Accounts receivable
Inventory
Prepaid expenses
Short-term investments
Total current assets
Fixed (Long-Term) Assets
Long-term investments
Property, plant, and equipment
Intangible assets
Goodwill
Patents
Total fixed assets

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Assets
1. Once upon a time a businessman ran a bottle manufacturing
plant. He was told by his accountant that anything which had
a future benefit on the date on which the balance sheet was
prepared was called assets .
2. He had a plant located in Delhi. He had some machinery
which could manufacture the bottles. He had an office where
his white collared officers sat.
3. He clubbed them together and he decided to call it Property
Plant and Equipment (PP&E).
4. He also pointed that these assets were tangible in nature.
5. The businessman then made some long term investments on
behalf of the company he was running.
6. Last year, the businessman had bought his brothers
business for Rs. 500000 while his brothers accounting books
showed the value as Rs. 300000. He assumed that he had to
pay the extra Rs. 200000 because of the reputation his
brothers firm enjoyed. He called it goodwill.

Assets

1.He had chanced upon a new method

of manufacturing bottles and he
patented the knowhow and
showed it in his books as patents
and copyrights. He realized that
though patents and goodwill had
monetary value he could not see
these assets.

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Assets

1.To attract clients, in a highly

competitive environment he often
had to provide credit facilities to his
clients he called this accounts
receivable or debtors.
2.He was unable to sell particular
bottles last year which appeared in
his book as stock in trade or
inventory. He also had made some
short term investments.
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Assets

1.He decided he would call the above

two category of assets intangible
assets.
2.He realised that PP&E and intangible
assets had a life of more than one year
thus he called them long term assets

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Liabilities
Liabilities and Owner's Equity

Current Liabilities
Accounts payable
Short-term loans
Accrued salaries and wages
Current portion of long-term debt
Total current liabilities
Long-Term Liabilities
Long-term debt
Deferred income tax
Other
Total long-term liabilities
Owner's Equity
Owner's investment
Retained earnings
Total owner's equity
Total Liabilities and Owner's Equity

Liabilities

The businessman had to finance his purchase of assets

In the beginning he used his own funds
He had two options: he could either borrow money or
could accept money from individuals and investors in lieu
of share of the profit the business earns
The money that the businessman borrowed was called
long term debt. It included syndicated debt and
convertible debentures.
Convertible Debentures are financial instruments
which are issued to lenders and borrowers for a cost.
He borrowed long term debt by issuing debentures .

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He also used his own funds called Owners Funds. On the other hand the
shareholder also had an option Owners Fund comprised shareholders equity
and reserves.
Retained Earning was a part of the profits he transferred to reserves. The part
of profit that he gave to the shareholders was known as dividends.
He also had obligations which had a life of less than one year. He called them
current liability
To attract suppliers, in a highly competitive environment he often had to
provide credit facilities to his suppliers which he called accounts payable or
creditors.
There were other short term liabilities which included current portion of long
term debt and unpaid expenses for the given period.

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Cash Flow from

Following
is how a cash flow from operations looks:
Operations
Profit after taxation
Adjustments for:
Depreciation (Non Cash Expense)(Hence add back)
Interest expense (Non Operating expense)(Hence add
back)
Profit on the sale of property, plant & equipment (Increase
in profits, not in cash flow)Note: total cash from sales has
been recorded as a separate item under cash flow from
investment
Working capital changes:
Add Decrease in trade and other receivables
Add Decrease in inventories
Add Increase in trade payable
Cash generated from operations

Cash Flow from Operations

Hence, the increase in A/R is credit

sales in the year. As always, the
bottler wants to know the cash
position and hates anything that does
not involve cash. Thus, he subtracts
increase in A/R. He goes on to
subtract all increases in non cash
current assets and adds all decreases
in the same.
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Cash Flow from Operations

He notices accounts payable in the

given year has increased by Rs. 5000.
He has been told accounts payable
represents total amount of money due
from bottlers who buy goods on credit.
Hence, the increase in A/P is credit
purchase in the year. He adds back
accounts payable. He goes on to
subtract all decreases in h current
liabilities and adds all decreases in the
same.
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Cash Flow from

Operations

He notices accounts receivables in

the given year has increased by Rs.
5000. He has been told accounts
receivable represents total amount of
money due from bottlers who buy
goods on credit.

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Non cash expenses are added

Decrease in current assets are
added
Increase in current Liabilities are
added
Interest expenses which is
financial and not operasting in
nature is added
Profit from sales of assets are
operating in nature but do not
involve cash, hence subtract
Increases in current assets are
subtracted
Decrease in current Liabilities
are added

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Cash Flow from Investing

Activities

Cash flows from investing activities (CFI)

Less: Business acquisitions, net of cash acquired (purchases
of business leads to cash outflow ; hence negative)
Less: Purchase of property, plant and equipment(PP&E)
(purchases of PP&E leads to cash outflow ; hence negative)
Proceeds from sale of equipment (leads to cash inflow ;
hence positive)
Less: Acquisition of portfolio investments (leads to cash
outflow ; hence negative)

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Cash Flow from Investing

Activities

Add: Investment income (leads to cash inflow ; hence

positive)
Net cash used in investing activities Cash flows from
financing activities (CFF)
Add: Proceeds from issue of share capital (Cash inflow)
Add: Proceeds from long-term borrowings (Cash inflow)
Less: Payment of interest on long term borrowings (Cash
Outflow)
Less: Payment of Dividend on preference and Equity share
capital (Cash Outflow)
Redemption of shares and debentures (Debts)(Cash
Outflow)
Net increase in cash and cash equivalents (CFO+CFI+CFF)
Cash and cash equivalents at beginning of period
Cash and cash equivalents at end of period (Should match
with the cash and cash equivalent in the balance sheet)

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Cash Flow Investing and Financing

Activities
Next he had to find cash flow from investing activities. For the
purpose of cash flow from investing activities he was told he
had to look at:
1. The long term asset which he bought or sold
2. Determine whether cash is involved.

Cash Flow Investing and Financing

Activities

He had bought land for Rs.

5000000. Hence the cash had
decreased by Rs 5000000. Thus,
he recorded this as negative
item
He had invested Rs.15,0000 in
shares. This also increased his
investment.

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Cash Flow Investing and Financing

Activities

He had sold a car and some securities for cash which lead
to increase in cash.
At the end of the period he realized he had a negative
figure and he got perturbed. However, he realized any
growing firm should always spend more on buying assets
than by selling the same.
Now he wanted to find the cash flow from financing
activities. He was told that financing activities refers to the
process of funding the investments and operation of a
business. Following are the sources he had utilized for
long term financing of operations

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Cash Flow Investing and Financing

Activities
Long Term loans(Debts) He had borrowed money from bank. This lead to
increase in cash flow.
2. Preference Shares (Internal Sources with fixed rate of dividends) He
issued preference shares on behalf of his company. When he felt he
could not borrow more. This lead to increase in money at the disposal of
the company
3. Equity Share capital He invited investors to invest in his shares. This
lead to increase in share capital. (Internal Sources with dividend rates not
fixed)
A. The important fact to be remembered is issue of debts/equity share
capital/preference capital leads to cash inflow.
B. He had to pay interest which was the cost of external borrowing/debt
and dividends to share capital
C. He Redeemed debentures (Debt) and Preference shares which meant
he repaid the money. This lead to increase in cash flow.

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