Financial Reporting and Analysis – Session 1

Revision of Financial Statements Construction

(Chapter No 1)
Give this a suitable title
How would you judge the
health of any individual?
How would you judge the
health of any business?
 How would you judge the
health of any business?

PERFORMANCE POSITION LIQUIDITY

Income Balance Cash Flow

Statement Sheet Statement
 All entities can be divided into 5 elements

Liability
Assets
Future probable Future probable
economic benefits economic obligations

Income Expense
Revenue Stream
Cost Incurred to earn the
income
Owner’s Equity

Net benefit after meeting

all the obligations
 What goes where…
Adobe Acrobat
Document

Balance Income Cash Flow

Sheet Statement Statement

Asset, Liability Income and Focus only on cash

and Capital Expenses (O | I | F)
Focus only on
Accrual
As at… For the period ending …
 Manager’s Balance Sheet

Assets Liabilities and Equity

1. Property, Plant & Equipment 1. Share Capital
Long Term Risk
Long Term
2. Intangible Assets finances 2. Reserves
Capital

Non-
operational 3. Investments 3. Long term loan Borrowed
capital
4. Prepaid expenses Short Term
4. Short term loan
finances
5. Inventory (Stocks) 5. Accounts payable
Short Term 6. Accounts Receivables 6. Advanced received
Operational
7. Marketable Securities obligations
7. Unearned revenue
8. Cash & Bank 8. Accrued expenses
 Manager’s Profit and Loss Statement

Particulars
Revenue from Operations
Can you identify Investing /
Operating and Financing items?

trade
Basic
(Less) COGS (All direct expenses)
Operating

Gross Profit
(Less) Selling & Distribution Exp Where do you see maximum fixed
(Less) costs?

Business
expense
Administrative Exp
(Less) General Exp
EBITDA Which level of profit is most critical
(Less) Depreciation in M&A?
EBIT
(Less) Interest exp
Operating

Which profit does the Startup

Non-

(Add) Non Operating Inc/exp

struggle to establish?
EBT
(Less) Income Tax Expense
PAT or Net Income
 Manager’s Cash Flow Statement

 CFs classified into 3 categories: Which head is the most important

for any business?
1. Cash flow from operating activities (CFO)
How would you interpret the
following?
2. Cash flow from investing activities (CFI) • Net CF-
• -CFI and -CFO but CFF+
3. Cash flow from financing activities (CFF) • +CFI and -CFO but CFF-
 The Book Value of Equity from Statement of Owner’s Equity

1. Capital stock (initial capital issued)

2. Securities Premium

3. Retained earnings (previous years profits)

4. Accumulated other comprehensive incomes

5. Minority Interest

6. Less: Treasury stocks

Preference Share will always be shown along with Common Equity unless mandatorily
redeemable at a fixed price (then Financial Liability)
Annual Report JSW Steel Ltd. FY19 (#pg 3)
 Recap: Three different categories of business activity

1. Operating activity: transactions that involve the firm’s primary activities.

• This includes the main route by which any company intends to make profits
• It includes the day to day business functions of a company

2. Investing activity: activities associated with the acquisition and disposal of long term business
assets or any activity related to non-business assets

3. Financing activity: activities related to Capital Structure i.e. obtaining or repaying capital to be
used in the business.

This bifurcation is critical because the three ecosystems are different paradigms
 10 Min: Classification of Activities for both the entities involved
1. SBI gave a loan to Maruti for $100 Mn

2. DLF purchased a piece of land from Farmers near Bhiwadi

3. Maruti used that amount to buy a land from DLF for constructing a factory $80 Mn

4. A full-time investor opened a time deposit account with SBI for $1Mn

5. A non-full time investor got share in SBI’s IPO for $1Mn

6. DLF sold a commercial space to an investor as part of his real estate portfolio

7. Maruti sold scrap generated during the production process

8. Bharti Airtel made investments into mutual funds to park surplus funds

9. Apple Inc. announced a buyback of its shares $300mn, executed it for $100mn

10. Reliance paid the fees to the GOI for allocation of an oil exploration site in India
 Sequence of actions in business and its reporting

1 Business Transaction

2 Recording for future reference Accounting

(Journals, Ledgers, Memo)

3 Proper presentation Financial Reporting

(Balance sheet, P/L, Cash Flow St)

4 Use of information by stakeholder Financial Statement

Analysis
 Self Read
Basic Definitions
1. Accounts
 Records which contain history of transactions under taken for business
 Sequence of preparation is:
 Journal (date-wise)
 General Ledger (account-wise)
 Trial Balance

2. Accounting
“Accounting is the art of recording, classifying and summarizing in a significant manner and in terms
of money, transactions and events, which are, in part at least , of a financial character and
interpreting the results thereof.”
 Self Read
Basic Definitions (Contd.)
3. Accountancy
 Principles / techniques / rules which are used in accounting are collectively called as Accountancy
 These rules are necessary to be followed to promote standardization
 Formed by technical organizations but enforced by regulatory body
1. Technical bodies: Rule making agencies
2. Regulatory bodies: Rule enforcement agencies
 E.g. All listed companies will follow AS XX as formed by ICAI from 1st April, 20XX

The US UK India

Technical FASB IASB ICAI

Regulatory SEC FSA SEBI

 Self Read
Basic Definitions (Contd.)
4. Financial Reporting
The process of placing different ledger balances from Trial balance into different formats

5. Financial Statements
Are the different (medical) report which have been prescribed by the law (accountancy) to be used for the
purpose of financial reporting.

Each medical report communicates a separate aspect of the business

Different Financial Statements are:

1. Statements of Profit and Loss
2. Balance Sheet
3. Cash Flow Statement
4. Statement of Change in Owners’ Equity
 Basic Accounting Assumptions

1. Going Concern: Business is expected to continue forever

2. Accrual : Records transaction when these are done rather than when cash

flow associated take place

Income Expense
Accrual Earned Incurred

Cash Received Paid

 Accounting Principles

1. Materiality: cost of collecting the information should always be less than the benefit of
using that information

2. Conservatism: Recognize all expenses and losses immediately but don’t account for
profits and gains unless they actually accrue.

3. Substance over form: Giving weight to the true nature of an item instead of its legal
form
4. Fair presentation: no malafide intention while preparing the accounts
 Accounting Principles (Contd.)

5. Consistency: Stick to one policy after making a choice from various options available
6. No offsetting of assets against liabilities or income with expenses unless otherwise
specified
7. Comparability: Records of previous years also to be presented to facilitate comparison

8. Verifiability: All transaction to have source documents

 Cash Flow and The Timing of Basic Transaction do not coincide

1. Rent paid $400 out of which 180$ is for next year.

2. Salary for current year $1,200 out of which $200 is still not paid
 How do Shareholders Reduce Agency Cost and Trust Data Given by Management?

 Audit is an independent review of Financial

Statements
 To reasonably assure the stakeholders about the
fairness of FS Shareholders

 Watchdog versus Bloodhound

 Types of audit report
1. Standard / unqualified
2. Qualified
3. Adverse Management Auditor

4. Disclaimer of opinion
 Internal Auditor versus Statutory Auditor
The layers of Governance
1. Internal Auditor
2. Statutory Auditor
3. Audit Committee | Risk Management Committee
4. Board of Directors
5. Credit Rating Agency
6. Ministry of Corporate Affairs / Registrar of Companies
7. SEBI

29
Let us not forget who we are in this course – The Analyst / Manager

1. Determine
2. Gather
the Objective
Data
and Context

6. Update the 3. Process

Analysis the Data

5. Report the
4. Analyze and
Conclusions or
interpret the
Recommendation
data
s
 Different Stakeholders interested in FRA

Stakeholder Objective (Decision)

► Lender
► Investor
► Supplier

► Customer

► Capital Markets
► Government
► Employees
 Different Stakeholders interested in FRA

Stakeholder Objective (Decision)

► Lender ► Credit worthiness
► Investor ► Returns from the investment

► Supplier ► Liquidity Position

► Customer ► Sustainability of operations

► Capital Markets ► Corporate Governance

► Government ► Revenue generation ability
► Employees ► Impact on wages/salaries
 Journal Entry to Balance Sheet

1. Business borrowed Rs. 12,500 cash from the promoter. In addition she brought her laptop
whose market value on the date of joining business was Rs. 4,000

2. The business buys inventory worth Rs. 5,000 by paying cash.

3. Furniture was purchased for Rs. 5,000 in cash

4. It sells merchandise costing Rs. 3,500 for Rs. 4,750 for cash.

5. It purchased and received merchandise for inventory for Rs. 5,000, agreeing to pay within 30
days.

6. Dividend of Rs. 300 was paid in cash to the promoter

 Different Forms of Doing Business
Sole Prop Partnership Private Company Public Company

No. of members 1 2-10/100 2-200 7 or more

Amount of Capital

Regulations
applicable
Banker’s risk

Agency problem
(Owner vs Mgr)