Financial Accounting
The four basic financial statements:
Balance Sheet
Income Statement
Statement of Cash Flows
Statement of Shareholders’ Equity
Most companies prepare financial statements
at the end of each year (called annual
reports), at the end of each quarter (called
quarterly reports), and following significant
events (called current reports).
Profit / Loss Account
Balance Sheet
Balance Sheet
March 31, 2008
March 31, 2007
Cash Flow
The Balance Sheet
Components of the Statement:
Assets
Economic benefits owned by the business as
a result of past transactions.
Liabilities
Debt and other obligations of the business
that result from past transactions. .
Shareholders’ Equity
Residual claim of and financing provided by
the owners of the business
BALANCE SHEET
ASSETS LIABILITIES
BALANCE SHEET
ASSETS All long term assets
1.Intangibles
FIXED ASSETS Goodwill, patents,
licenses etc.
2.Net fixed assets
Land and buildings,
plant and equipment,
transport, computers,
office equipments etc.
BALANCE SHEET
ASSETS
FIXED ASSETS
Long term investments
Often shares in
associated companies,
INVESTMENTS Shares in subsidiaries,
Investment in
Government bonds
Investment in shares of
other corporations.
BALANCE SHEET
All short term assets
1.Inventories (stock)
Raw materials, work in
ASSETS progress, finished goods,
maintenance spares.
FIXED ASSETS 2.Accounts Receivable
Trade debtors –
amounts due from customers
arising from normal business.
INVESTMENTS 3. Cash
Includes all cash
equivalents for example bank
short term deposits and other
CURRENT ASSETS liquid securities
4. Miscellaneous
All other short term assets
eg: Pre- payments to
suppliers, amounts due to the
company of a non trading
nature.
BALANCE SHEET
Liabilities
Owners’ Funds
1. Issued common stock
(OF)
2. Capital reserve
3. Revenue reserve
BALANCE SHEET
Liabilities
All long term loans
Owners’ Funds (more than a year)
(OF) • Mortgages
• Debentures
Long term • Term loans
• Foreign currency
Liabilities (LTL)
loans
• Bonds
BALANCE SHEET
Liabilities All short term liabilities (to be
paid within a year)
Owners’ Funds • Accounts Payable
Trade creditors - amounts
(OF) due to suppliers arising from
normal business
• Short term loans
Long term Includes bank overdrafts and
Liabilities (LTL) all other interest bearing
short term debt
• Miscellaneous
Current Liabilities All other short term liabilities
(CL) eg: accrued payments,
interest, current tax and
dividend due.
BALANCE SHEET
ASSETS LIABILITIES
FIXED ASSETS Owners’ Funds
(OF)
Long term
Liabilities (LTL)
INVESTMENTS Current Liabilities
(CL)
CURRENT ASSETS
BALANCE SHEET
ASSETS LIABILITIES
FIXED ASSETS Owners’ Funds
(OF)
INVESTMENTS Long term
Liabilities (LTL)
CURRENT ASSETS Current Liabilities
(CL)
Total Assets = Fixed Assets + Current Assets + Investments
Or Owners’ funds + Long term Liabilities + current liabilities
BALANCE SHEET
ASSETS LIABILITIES
FIXED ASSETS Owners’ Funds
(OF)
INVESTMENTS Long term
Liabilities (LTL)
CURRENT ASSETS Current Liabilities
(CL)
Capital Employed = Fixed Assets + Current Assets – Current
Liabilities
Or Owners’ funds + Long term Liabilities
BALANCE SHEET
ASSETS LIABILITIES
FIXED ASSETS Owners’ Funds-OF
(issued shares, capital
reserve, revenue reserve)
INVESTMENTS Long term
Liabilities (LTL)
CURRENT ASSETS Current Liabilities
(CL)
NET WORTH = Total assets – Current Liabilities – Long term
liabilities Or
Owners’ funds (Issued shares, Capital reserves, revenue reserves)
Profit and Loss Account
Three main groups:
Revenues
Sales Revenues
Expenses
Cost of Goods Sold (COGS)
Selling, General and Administrative (SG&A)
Research and Development (R&D)
Interest
Tax
Net Income
Profit and Loss Account
REVENUE - EXPENDITURE (revenue) = Profit / Loss
Profit before Interest and tax (PBIT)
(minus) Interest Lenders (short term + Long term loans)
Profit before tax
(minus) Tax Government
Profit after tax
Shareholders (paid in cash)
(minus) Dividends
Retained Earnings (RE)
Credited to shareholders account in
Balance Sheet - OWNERS’ FUNDS
Basic Accounting Equation
Assets = Liabilities + Shareholders’ Equity
Assets – Liabilities =
Owners’ Funds + Revenues - Expenditures
Statement of Cash Flows
Reports the changes to other accounts which
affect a change in the cash account on the
balance sheet.
The change in the cash account is usually not
equal to net income.
Revenues reported do not always equal cash
collected.
Expenses reported do not always equal cash paid.
Statement of Cash Flows
Cash flows from Operating Activities
Cash flows from Investing Activities
Cash flows from Financing Activities
Statement of Shareholders’ Equity
Three main components:
Capital Contributions
Common and preferred stock. .
Operating Transactions
Earnings generated from assets financed by
creditors and owners.
Distributions
Dividends and share repurchases.
The residual claim is either distributed to owners or
recognized under the Statement of Shareholders’
Equity shareholders’ equity account.
Statement of Retained Earnings
Income of the Enterprise:
Distributed to shareholders.
Dividends and share repurchases.
Retained by enterprise.
Retained earnings.
Clean Surplus Equation:
Beginning Retained Earnings + Net Income –
Dividends = ENDING RETAINED EARNINGS
Basic Measures of Performance
• Return on Equity (ROE)
PAT / OWNERS’ FUNDS
• Return on Total Assets (ROTA)
PBIT / TOTAL ASSETS
PROFIT MARGIN (Sales Margin) X ASSET TURNOVER
PBIT / SALES x SALES / TA
Basic Measures of Performance
DRIVERS OF MARGIN ON SALES (ON THE
BASIS OF COSTS)
MATERIALS / SALES
LABOR / SALES
FACTORY OVERHEADS / SALES
ADMIN & SELLING COSTS / SALES
Basic Measures of Performance
DRIVERS OF SALES TO TOTAL ASSETS
SALES / TOTAL ASSETS
SALES / FIXED ASSETS
SALES / INVENTORIES
SALES / ACCOUNTS RECEIVABLE
Basic Measures of Performance
• Sales to Fixed Assets Ratio
• Inventory Days (for non – service industry)
• Debtor days
Basic Measures of Performance
(Liquidity)
Current Ratio =
Current Assets (CA) / Current Liabilities (CL)
Quick Ratio
(C A – Inventory) / Current Liabilities
Working Capital to Sales Ratio
(CA-CL) / Sales
Working Capital Days
Inventory Days + Accounts Receivable – Accounts
Payable
Basic Measures of Performance
(Financial Strength)
Debt to Equity Ratio
Total Debt / Owners’ Funds
(Total Debt = Long term loans + short term loans + Accounts
Payable & Miscellaneous)
Interest Coverage Ratio
PBIT / Interest
Sources of Finance
• Equity share capital
• Preference capital
• Debentures
• Internal Accruals
• Term loans
• Working capital advances
• Miscellaneous sources
Some Terminologies
Market capitalization
Share values, Par Value, Book Value,
Market Value
Earnings per share
Dividends per share
Price to earnings ratio
Market to book ratio
Corporate valuation
DCF valuation
Some Terminologies
Initial Public Issue
Seasoned Offerings
ADRs
GDRs
Bonus Issue
Rights Issue
Stock Split
Merger & Demerger
Valuation
Financial Management of a Firm
• Capital Budgeting
• Capital Structure
• Working Capital Management
Terminologies
• Cost of Equity
• Cost of Debt
• Institutional Investors
• ESOP
• Private Placement
• Option
• Futures
