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FINANCIAL STATEMENTS AND CASH FLOWANALYSIS

CHAPTE

R 24

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LEARNING OBJECTIVES

Introduce financial statementsbalance sheet and profit and loss

account

Distinguish between accounting profit and economic profit

Discuss the meaning of funds flow and working capital flow

Highlight the need for analyzing the changes in a firm's funds and cash

flow position

Explain the mechanism of preparing funds flow and cash flow

statements

Emphasize the need and utility of preparing a comprehensive

statements of financial position that explains changes in cash flow from

operations, investment activities and financing activities

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Financial Statements

Financial statements provide information aboutthe financial activities and position of a firm.

Important financial statements are: Balance sheet

Profit & Loss statement

Cash flow statement

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Balance Sheet

Balance sheet indicates the financial condition of

a firm at a specific point of time. It contains

information about the firms: assets, liabilities

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

Assets = Equity + Liabilities

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Assets

Assetsare economic resources or properties

owned by the firm.

There are two types of assets:

Fixed assets

Current assets

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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

Tradable (marketable) securities

Debtors (account receivables) Stock of raw material

Work-in-process

Finished goods

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Fixed Assets

Fixed assets are long-term assets. Tangible fixed assets are physical assets like land,

machinery, building, equipment.

Intangible fixed assets are the firms rights and claims,such as patents, copyrights, goodwill etc.

Gross block represent all tangible assets at acquisitioncosts.

Net block is gross block net of depreciation.

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Liabilities

Liability is a firms obligation to pay cash or

provide goods or services in the future.

Two types of liabilities are:

Current liabilities

Long-term liabilities

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Current Liabilities

Current liabilities are payable within a year inthe normal course of business.

They include:

Accounts payable (creditors) Outstanding expenses

Advances from customers

Provision for tax

Provision for dividend

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Long-term Liabilities

Long-term liabilities are the obligations or

debts payable in a period of time greater than the

accounting period.

They include - Debentures, bonds, and securedlong-term loans from financial institutions.

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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.

Shareholdersequity has two parts:

(i) paid-up share capital, and

(ii) reserves and surplus (retained earnings)representing undistributed profits.

Paid-up share capital and reserve and surplus

together are called net worth.

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Gujarat Narmada Valley Fertilizers

Company Balance Sheet as on 31 March

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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 current assets (CA) and current

liabilities (CL):

NCA = CACL

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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 worthor equity (E) and borrowing/debt (D) and it isequivalent of net assets:

CE = Net Worth + Borrowing = E + D

Capital Employed = Net Assets

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Profit & Loss Statement

Profit & Loss statement provides information

about a firms:

revenues,

expenses, and

profit or loss.

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Nature of Revenues

Revenue is the amount received or receivable

within the accounting period from the sale of the

firmsgoods or services.

Operating revenue is the one that arises from mainoperations of the firm, and the revenue arising

from other activities is called non-operating

revenue.

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Nature of Expenses

Expenseis the amount paid or payable within theaccounting period for generating revenue.

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

Expenses are expired costs and capitalexpenditures represent un-expired costs andappear as assets in balance sheet.

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Concepts of Profit

Gross profit = salescost of goods sold (CGS)

CGS= raw material consumed + manufacturing expenses of goodsthat have been sold

PBDIT = Profit before dep., interest and tax = salesexpenses, except

dep., interest and tax Operating profit (OP), OP = GPOEXPDEP

PBIT= Profit before interest and tax= PBDITDEP

PBT= Profit before tax = PBITInterest

PAT= Profit after tax = PBTTax Net operating profit after tax (NOPAT)=PBIT (1Tax rate)

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Gujarat Narmada Valley Fertilizers Company Ltd

Prof i t & Lo ss Acco un t for the year ended on 31 March

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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 firm, and it is measured in cash flow.

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CHANGES IN FINANCIAL

POSITION The statement of changes in financial position summarizes:

Changes in assets and liabilities resulting from financial and

investment transactions during the period, as well as those

changes which resulted due to change in ownersequity; and

the way in which the firm used its financial resources during the

period

The most commonly used forms of the statement of changes in

financial position are called the funds flow statement and the cash

flow statement.

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Definition of FundsFunds may mean change in financial resources,

arising from changes in working capital items and

from financing and investing activities of the

enterprise, which may involve only non-currentitems.

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Concept of Working Capital

FlowThe net working capital increases or decreases

when a transaction involves a current account and a

non-current account.

It remains unaffected when a transaction involvesonly current accounts.

It remains unaffected when a transaction involves

only non-current accounts.

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Effect of Changes in

Accounts on Working Capital24

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Sources of Working Capital1. Funds from operations (adjusted net income)

2. Sale of non-current assets:

sale of long-term investments (shares, bonds/debentures, etc.)

sale of tangible fixed assets like land, building, plant orequipments

sale of intangible fixed assets like goodwill, patents or

copyrights

3. Long-term financing: long-term borrowings (institutional loans, debentures, bonds, etc.)

issuance of equity and preference shares

4. Short-term financing such as bank borrowings

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Uses of Working Capital1. Adjusted net loss from operations

2. Purchase of non-current assets:

purchase of long-term investments like shares, bonds/debentures,

etc.

purchase of tangible fixed assets like land, building, plant,

machinery, equipment, etc.

purchase of intangible fixed assets like goodwill, patents,

copyrights, etc.

3. Repayment of long-term debt (debentures or bonds) andshort-term debt (bank borrowing)

4. Redemption of redeemable preference shares

5. Payment of cash dividend

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F f F d Fl

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Forms of Funds Flow

Statement27

XY CompanyStatement of Changes in Working Capital for the year

ended 31 December 20X1

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ompre ens ve un s ow

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ompre ens ve un s owStatement:

Financial Resources BasisACME Company

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CASH FLOW STATEMENTA statement of changes in financial position on cash basis,

commonly known as the cash flow statement, summarizes the

causes of changes in cash position between dates of the two

balance sheets.

It indicates the sources and uses of cash.

This statement analyzes changes in noncurrent accounts aswell as current accounts (other than cash) to determine the

flow of cash.

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Sources of Cash The profitable operations of the firm,

Decrease in assets (except cash),

Increase in liabilities (including debentures or bonds), and

Sale proceeds from an ordinary or preference share issue.

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Uses of Cash

The loss from operations

Increase in assets (except cash)

Decrease in liabilities

Redemption of redeemable preference shares

Cash dividends

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Statement:

Financial Resources Basis32ACME Company

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OF CHANGES IN FINANCIAL

POSITIONIt helps to answer the following questions:1. What is the liquidity position of the firm?

2. What are the causes of changes in the firms working capital or cash position?

3. What fixed assets are acquired by the firm?

4. Did the firm pay dividends to its shareholders or not? If not, was it due to shortage of

funds?

5. How much of the firms working capital needs were met by the funds generated from

current operations?

6. Did the firm use external sources of finances to meet its needs of funds?

7.If the external financing was used, what ratio of debt and equity was maintained?

8. Did the firm sell any of its non-current assets? If so, what were the proceeds from such

sales?

9. Could the firm pay its long-term debt as per the schedules?

10. What were the significant investment and financing activities of the firm that did

not involve working capital?

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