Accounting for Regulation PS

7/30/2019 Accounting for Regulation PS

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Financial statement analysis

Dr. Padmini Srinivasan

Indian Institute of ManagementBangalore



Accounting Principles

{ Monetary transactions and Events enter

the system

{ Process Using an Accounting Mechanism

{ Follow certain rules or principles of Accounting called as ‘GAAP’ (GenerallyAccepted Accounting Principles) orAccounting standards

{ Audit to lend credibility to the reports



Primary Financial Statements

Balance Sheet

Statement of FinancialPosition

Profit and LossA/c

(IncomeStatement) Cash FlowStatement

The financial statements reports on status &

performance of the company in financial terms



The Balance sheet

The Balance sheet is a status report

giving the Financial Positionof the Company at a particularpoint of time

Resourcesowned and

amounts owed



The Profit and Loss AccountMeasures Operating Performance

The profit and loss account or theIncome statement, reports the company’srevenues, expenses, and net income

or net loss for the period.

Revenues or Incomes arise from selling of

goods or services to customersExpenses related to earnings are deductedfrom revenues



The Statement of Cash Flows

Thestatement of cash flowsreportsthe company’s cash inflows and

Outflows from its various activities.



Balance Sheet



Balance Sheet

Assets.

Liabilities

Owners’ equity

•Gives the resources owned and their funding

•The “assets” owned and the claimants against the assets



© Padmini Srinivasan - iimb

Balance Sheet: ASSETS

{ Resources owned by a firm

{ Capable of giving future cash flows

(by use or disposal value){ Objectively verifiable arising from a

past identifiable event




LIABILITIES

{

Liabilities are Debts{ They are present obligations a firm

owes.

{ They are claims against the assets thefirm.

{ Liabilities may be to the owners or to

outsiders




Balance Sheet of ABC LTD as on31ST MARCH, 2005

Uses of Funds{ Fixed Assets

{ Investments

• Current Assets,Loans andAdvances

{ Sources of Funds(Liabilities)

z Share Capital

z Reserves and

Surplusz Borrowings:

Secured

Unsecured

z CurrentLiabilities andProvision




FIXED ASSETS

{ Used for producing goods / services for renting

out or for administrative uses{ Useful life of more than 1 year

{ Not held for sale in the ordinary course of thebusiness

{ Disclosed : Gross book value

As less: AccumulatedDepreciation

Net book value




FIXED ASSETS

z Depreciation is treated as Expensesand is charged to the profit and lossaccount

z Accumulated Depreciation it’s the sumof depreciation charged to the profitand loss account till the end of the

current financial year




INVESTMENTS

{ Are assets held as stores of value with a

view to get interest, dividend or capitalappreciation

{ TYPES: Long Term/ Current (holdingperiod)

Quoted / Not QuotedTrade Investments




CURRENT ASSETS, LOANS ANDADVANCE

{ Current assets are assets that form part of the

operating cycle and take interrelated form

{ Expected to be converted into cash in next 12months

{ Consists of :z Cash

z Sundry Debtors

z Inventory

z Others




LIABILITIES

{ They are present obligations a firmowes.

{ They are claims against the assets

the firm.{ Discharging the liability will result in

the decline of the assets




Shareholders Funds

{ Share Capital

{ Amount contributed by owners towardsthe capital of the firm

{ They are divided into units called share

{ Have a face Value{ RESERVES AND SURPLUS

{ They are the accumulated profits orretained earnings not distributed andowed by the business to the equity shareholders

Share Capital + R & S is called Net Worth




LOANS

{ Are borrowing to be repaid as peragreed terms on which interestneeds to be paid irrespective of availability of profits.

TYPES:

{ SECURED LOAN OR UNSECURED LOANS

{

LONG TERM OR SHORT TERM




Current liabilities and Provisions

{ Arising on account of acquiringgoods/services on credit orincurring expenses which are paid

for later{ Normally they are to be settled

within a period of 12 months



Two other items

{ Deferred tax

{ Misc Expenditure and Losses

(to the extent not written off)



Profit and Loss Account




PROFIT AND LOSS ACCOUNT FOR THE YEAR ENDED 31/3/2006

SALES 1579

Other Income 100Total income

ExpensesRAW MATERIALS 700

WAGES & SALARIES 374

OTHER Overheads 100

Depreciation 100

Administration and Selling Exp 100

PBIT (Operating Profit) 305

INTEREST 38

PBT 267

INCOME TAX 59

PROFIT AFTER TAX 108




Depreciation

{ Some Myths about Depreciation

{ It is a process of valuation

{ It generates cash

{ It helps in replacement to new machine

z Truths ..{ Depreciation is the allocation of cost

(depreciable value) of an asset to theperiods that benefit from its use.

{ It’s a charge of the asset over the usefullife of an asset




Depreciation

Some Terms:

{ Original cost (OC) of the asset

{ Expected Useful life of the asset

(This is not the physical life){ Residual Value (RV) at the end of

the useful life

{ Depreciable Value of the asset (OC-RV)




Depreciation

{ Methods of Charging Depreciation

z Straight Line Method

z Reducing Balance Method

{

Which ever method you use thetotal depreciation to be chargedover the useful life will be the same




Depreciation

{ Straight Line Method

z Formula: Cost -Residual Value

z Useful life

{

Reducing Balance MethodFormula for computation of rate

1 - Residual value

Costn= useful life in years

n




Straight Line MethodCompute Depreciation

{

Cost of asset Rs. 650,000{ Salvage value Rs. 50,000

{ Depreciable Value = 6,50,000 – 50,000

= 600,000

{ Depreciation = 600,000 / 3 Rs.200,000p.a.

{ =200,000/650,000 * 100 30.6 %




Straight line method

Year GrossBlock

Depr Acc. Depr NetBlock

1 650000 200000 200000 450000

2 650000 200000 400000 250000

3 650000 200000 600000 50000




Reducing Balance method

Year GrossBlock

Depr Acc.Depr

NetBlock

1 650000 373,750 373,750 276250

2 650000 158,843 532,593 117,407

3 650000 67,507 600000 50000



Financial Statement Analysis(Analysis of Financial Performance)




Need for Financial statement analysis

•How has the business performed during the year

•How is the financial condition of the company

•How investment activities have performed during the year

•How does the unit stand in comparison to the industry•Preparation of Forecasts

•Evaluation of SBU’s and departments

•Credit rating




Where to look for data

{ The Annual reports

( An annual report and financials therein represents asnapshot at a given moment.

{ Directors Report - Working of the Company

{ Auditors Report

{ Management Discussion &Analysis

{ Profit and loss account

{ Balance Sheet

{

Cash Flow statements{ Supplementary schedules and Notes

{ Accounting Policies

{ Subsidiary Company Information




TOOLS FOR EVALUATION

{ COMMON SIZE STATEMENTS

{ HORIZONTAL ANALYSIS

{ RATIO ANALYSIS

{ CASH FLOW ANALYSIS’




Common Size Statements

{ Common size income statement

z Expresses each income statementcategory as a percentage of net sales

{ Common size balance sheet

z Expresses each item on balance sheetas a percentage of total assets orequities

{ Both statements facilitate structuralanalysis of the firm




HORIZONTAL ANALYSISYear to year changes

{ Changes in amounts and percentages

{ Reveals a trend & direction

z For long term trends prepare a indexnumber trend series




RATIO ANALYSIS

{ GIVES THE LINK BETWEENINVESTMENT, FINANCING ANDOPERATING ACTIVITY

i.e. how various items in thefinancial statements relate to oneand another

{

Analysis of Past performance helpsin forecasting the futureperformance




Financial Statement Analysis

{ PROFITABILITY

{ LIQUIDITY

{ SOLVENCY

Note: Different authors take slightly different approach(formulas) for eg: PBIT instead of PAT etc.,

PBIT (NOPAT) is a good measure for inter divisionsevaluation




FSA-Basic Structure

Leverage orFinancial risk

Fixed Asset Turnover

Debtors Turnover orCollection Period

Inventory Turnover

Current Asset TOR

Asset Turnover ratios

Interest / Sales

Other expenses / Sales

Raw material/Sales

Profit Margins

Return on Total Assets

(ROI)

R Return on EquityE

Current Ratio




Financial Ratio Analysis

{ Profitability Ratios

z measure the overall performance of afirm and its efficiency in managingassets, liabilities and equity




Return Ratios

{ Return on Equity

z PAT/ AVG Stockholders’ Equity

{ Measure overall efficiency of the firm in

managing investment in assets and generatingreturn to stockholders




Return Ratios

Return on Total Assets (ROCE)

z PAT /Avg Total Assets or- PBIT/ AVG Total Assets*- NOPAT / Total Assets

{ The ratio measures the overall efficiencyof the firm in managing investment in

assets and generating return tostockholders




Profitability Ratios

{ Net Profit Marginz Net Profit After Tax/Net Sales

{ Operating Profit Marginz PBIT (Profit before interest and tax) /Net

Sales

{ Various Expenses to Salesz Salary/Net Sales

{ All measure firm’s ability totranslate sales into profits




Turn Over Ratios(ResourceUtilization)

The Ability of different assets like FixedAssets, current assets and both togenerate sales (turnover)

Total Asset Turn over Ratio

Sales / average Total Assets




Fixed Assets Turn Over Ratio

Sales / Avg Fixed Assets

Assess the effectiveness of the fixed assetsto generate sales

Also reflects the investment strategies




Inventory Turnover Ratio (Not

Relevant)

{ Cost of Goods Sold (Sales) / AVG

Inventory

{ Number of Days Stock

Avg Inventory / Sales(COGS) per day

(Measures efficiency of inventory

management (not the inventory policyof the management)




Debtors Turnover Ratio

{ Debtors Turnover Ratio

z Net Sales/ Average Debtors

{ Average Collection Period

z Accounts Receivable/Average Daily Sales

(Avg daily sales = Credit sales/365)

Another measure of efficiency of firm’s ability tocollect fast

Helps gauge liquidity of accounts receivable (ability

to collect cash from customers)




Financial Leverage

{

It Pays to have Debt in your CapitalStructure




Financing Pattern

{ Leverage Ratios

z measure the extent of a firm’sfinancing with debt relative to equityand its ability to cover interest and

other fixed charges also called as theSolvency ratios

{ Liquidity Ratios

z Measures the firms ability to meet cashneeds as they arise




Leverage: Debt Ratios (!!)

{ Debt to Equity Ratio

z Long Term Debt/Equity{ Debt Asset Ratio

Total Outside Liability / Total Assets

Interest Cover Ratio

{ Operating Profit/Interest Expense

z Indicates how well operating earnings coverfixed interest charges

{ They measure the extent of firm’s financing withdebt and the financial risk




Liquidity Ratios

{ Current Ratioz Current Assets/Current Liabilities

z Measures ability to meet short-term cashneeds

{ Quick or Acid Test Ratioz Current Assets-Inventory/Current Liabilities

z Measure ability to meet short-term cash needsmore rigorously




Other Ratios : For the Investor

{ Earnings per Share

z PAT /Average Equity Shares

z Indicates return on a per share basis

Book Value of the Share

Net worth / Number of shares




CASH FLOW STATEMENT

{ CASH IS CASH REST IS

ACCOUNTING!!!

{

Accounting profits do not help inassessing the firms ability to meetits debts

z As they are based on accrual concept

z As they are based on subjective judgements like depreciation




CASH FLOW STATEMENT

{ Cash flow statement can be taken as a summary

of the cash book

{ Need for cash flow statement arises from the

deficiencies in the profit and loss a/c and thebalance sheet, as these numbers are influencedby the accounting policies etc

{ Cash flow statement helps in forecasting futurevalue.




Objectives of a CFS

Provide information to the user on: -

- ability of the enterprise togenerate cash and cash equivalentsand the timing and certainty of their

generation.- the manner in which the

enterprise puts cash and cash

equivalents to use.- financial structure, liquidity,solvency,net assets and adaptabilityof the enterprise

-




CASH FLOW STATEMENTS

{ Provides information on cash flowrelated to operation financing andinvesting activities

{ Firms follow the accrual and matchingprinciple to record transactions andhence the company's incomes/expenses are not related to cash






{ CASH FLOWS ARE DIVIDED INTO 3SEGMENTS AS :

{ CASH FLOW FROM OPERATING ACTIVITY

{ CASH FLOW FROM INVESTING ACTIVITY

{ CASH FLOW FROM FINANCING ACTIVITY




OPERATING ACTIVITIES

{ Includes the cash flows derived from

principal revenue –producing activities of enterprise.

{ Cash receipts from main business of

company.{ Cash receipts from royalties, fees, etc.

{ Cash payment to supplier.

{

Cash payment to and behalf of employees.

{ Cash payments or refunds of income tax.




INVESTMENT ACTIVITIES

{ Shows the expenditure that have

been made to generate futureincome and cash flows.

z Cash payment to acquire fixed assets.

z Cash receipts from disposal of fixedassets (including intangibles)

z Cash payment to acquire shares

,warrants or debt instrument of otherfirms.

z Cash receipts from disposal of sharesetc




FINANCING ACTIVITIES

{Cash proceeds from issuingshares or other similarinstruments

{Cash received fromdebentures,loans bonds and

other borrowings{Cash repayments of amount

borrowed.




Profitable, yet in Trouble?

{ A firm is defined as “profitable if it

has a positive net income

{ A positive net income results fromrevenues exceeding expenses

{ A firm may have a positive netincome, but this does not guaranteethat the firm has the CASH to meetits obligations!




Cash Flow from operations

1.Started business with share capital of Rs.50000

2. Purchased goods for Rs. 50000 paid 60 % incash, balance payable

3. Sold goods costing Rs. 40000 for Rs. 100000

on one month credit.4. Purchased equipment for Rs. 15000

5. Depreciation of Eqpt. Rs. 3000

The month end. Prepare the FinancialStatements

The company wants to declare dividends of Rs.40000 ?

Operating Results: Transaction




p g

analysis

1. BS: Capital 50000 = Cash 50000

2. Capital 50000 + Crs 20000 = Inventory 50000 +Cash 20000

3. OE 50000+ Profit 60000+ Crs 20000

= Drs 100000 + Inv 10000 + Cash 20000

4. OE 50000+ Profit 60000+Crs 20000 =Eqpt 15000+DRs 100000+ Inv 10000+Cash 5000

5. OE 50000+ Profit 57000+Crs 20000 =Eqpt 12000+DRs 100000+ Inv 10000+Cash 5000

There is profit of 57000 after depreciation but nocash ?




Cash Flow (Direct Method)

1. CFO:

Paid Creditors (30000)

2 CFF

Capital +50000CFI

Equipment (15000)

Ending Cash Balance 5000

Cash Flow (Indirect Method)




1. CFO:PAT 57000

Add: Depreciation 3000

Cash flow before WC Changes 60000

Increase Creditors 20000Increase in Drs - 100000

Increase in Inv - 10000 -90000

Net outflow -30000

2 CFFCapital +50000

3 CFIEquipment (15000)

Ending Cash Balance 5000



Forward Contracts

{ Used for hedging open positions

{ Its contract to deliver or receive ata specified rate &date a certainamount of foreign currency.

{ Open positions hedged like foreigncurrency assets/liabilities orcommitments eg : Receivable /Payables / loans

Accounting for Regulation PS

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