Module 3

Accounting & Business

Reporting
Entrepreneurship Training for CSC Academy
Financial statements
• We saw last time that three financial statements are used to record
and report a business’ transactions:
1. Balance sheet
2. Profit & loss (P&L) statement
3. Statement of cash flows
• We are going to understand the first two in greater detail this time.
Balance sheet
• The balance sheet represents the financial position of a business as of
a particular date, typically at the end of a quarter or financial year.
• It is divided into two parts:
1. Assets (“Use” of capital): Includes all goods and property owned by the
business as well as amounts due to the business.
2. Liabilities and Shareholders’ Equity (“Source” of capital): Includes all
amounts and debts owed by the business and the shareholders’ ownership
interest in the business.
• Remember, Total Assets = Total Liabilities + Shareholders’ Equity!
Current vs non-current items
• Both assets and liabilities are classified as current and non-current.
• Current refers to those items that are due in the upcoming financial year. That
is, they are due within the next one year.
• Non-current refers to those items that are due after one year.
• You could think of current as short-term vs non-current as long-term.
Assets
• Assets are classified as current and non-current assets.
• Current assets are those assets that are expected to be sold or
converted to cash or consumed within one year.
• Non-current assets include plant, property and equipment (PPE),
which typically last for more than one year.
Current assets
• Common types of current assets are:
• Cash: This is the amount held in bank accounts by the business at the end of
the financial period.
• Inventories: This is the value of raw materials held, work-in-process and
finished good held by the business.
• Receivables: These are the amounts due to the business from its clients or
customers to whom goods or services have already been provided. These are
typically sales made on credit.
• Short-term loans and advances: These are loans and advances given to other
entities like suppliers, which are due within one year.
Raju the Thelawala … revisited
• Going back to Raju the thelawala, remember, that he sold the
vegetables for ₹ 3,000.
• Last time, we assumed that he sold his entire stock of vegetables and
he received cash of ₹ 3,000 from his customers.
• Let’s change this to the following:
• He was able to sell only ₹ 1,500 worth of vegetables out of the ₹ 2,000 worth
of vegetables he bought.
• Also, he has an informal agreement with some of his customers who pay him
only once every fortnight. In other words, he offers credit to valuable
customers.
• He sold the vegetables for a total of ₹ 2,250, for which he received ₹ 1,500 in
cash and the balance ₹ 750 will be paid after two weeks.
Raju’s current assets
• Remember, Raju’s balance sheet looked like the following after he bought
his thela:
Equity + Liabilities 20,000 Assets 20,000
Equity 20,000 Cash 10,000
• Out of the ₹ 10,000 in0 cash, he paid
Liabilities Thela ₹ 2,000 to buy vegetables.
10,000
• He also receives ₹ 1,500 in cash from some of his customers when he sold
vegetables to them.
• So his cash balance is now 10,000 – 2,000 + 1,500 = ₹ 9,500.
• He has not sold ₹ 500 of his vegetables, which will now show up as
inventory on the asset side (specifically, a current asset).
• He has not received ₹ 750 from some customers, which will now be
entered as receivables on the asset side (specifically, a current asset).
Raju’s updated assets
Assets
Thela (1) 10,000
Current assets
Cash (2) 9,500
Inventory (3) 500
Receivables (4) 750
Total current assets (5)=(2)+(3)+(4)10,750
Total assets (1)+(5) 20,750
Non-current assets
• Common types of non-current assets are:
• Tangible assets: Includes fixed assets like machinery, building, land, etc. Also
commonly referred to plant, property and equipment (PPE).
• Intangible assets: Includes patents, trademarks, copyrights, goodwill, brand
recognition, etc. These are not common for small businesses and start-ups.
• Non-current investments: Investments that mature in more than one year.
• Long-term loans and advances: These are loans and advances given to other
entities like suppliers, which are due after one year.
Raju’s non-current assets
• Raju spent ₹ 10,000 to buy his thela.
• This is his business’ fixed asset.
• He does not have any other non-current asset.
Raju’s updated assets
Assets
Non-current assets
Thela 10,000
Total non-current assets(1) 10,000
Current assets
Cash (2) 9,500
Inventory (3) 500
Receivables (4) 750
Total current assets (5)=(2)+(3)+(4)10,750
Total assets (1)+(5) 20,750
Liabilities
• Like assets, liabilities are also classified as current and non-current
liabilities.
• Current liabilities are liabilities that become due within one year.
• Non-current liabilities are liabilities that are due after one year.
Current liabilities
• Common types of current liabilities are:
• Payables: Expenses that have been incurred but not been paid as yet but
need to be paid within one year.
• Short-term debt: Any loan that is due within the next one year.
• Current portion of long-term loans: Part of long-term loans that are due in the
next one year.
Non-current liabilities
• Non-current liabilities mainly include any form borrowing or debt or
loan that is due to be repaid after one year.
Equity
• Shareholders’ equity represents the total equity interest of all
shareholders in a business.
• It represents the net worth of the company, which is the difference
between the business’ assets and liabilities.
• This consists of two parts:
• Share capital: These are funds raised by issuing shares in return for cash. This
represents how much capital the owners have provided to the business.
• Surplus: This is a business’ profit, which comes from the profit and loss (P&L)
statement.
Raju the Thelawala … revisited
• Going back to Raju the thelawala, remember, that he paid ₹ 2,000 in
cash to buy vegetables.
• Let’s change this to the following:
• He paid ₹ 1,250 in cash to buy vegetables and he bought the balance ₹ 750
worth of vegetables on credit.
• He will pay his vegetable supplier the ₹ 750 after two weeks.
• After buying the thela, he had ₹ 10,000 in cash.
• He spent ₹ 1,250 to buy vegetables.
• He received ₹ 1,500 in cash from some customers.
• His new cash balance is 10,000 – 1,250 + 1,500 = ₹ 10,250.
Raju the Thelawala … contd.
• Raju owes ₹ 750 to his vegetable supplier, which means payable is ₹
750 under current liabilities.
• He was able to sell ₹ 1,500 worth of vegetables for a total of ₹ 2,250.
• His profit, which will get added to the surplus under equity, is 2,250 – 1,500 =
₹ 750.
• He has not borrowed any money and so his non-current liabilities are
zero.
Raju’s updated balance sheet
Shareholders’ Equity + Liabilities Assets
Shareholders’ equity Non-current assets
Equity (1) 20,000 Thela 10,000
Surplus (2) 750 Total non-current assets(1) 10,000
Total shareholders’ equity (3)=(1)+(2) 20,750 Current assets
Liabilities Cash (2) 10,250
Non-current liabilities (4) 0 Inventory (3) 500
Current liabilities Receivables (4) 750
Payables 750 Total current assets (5)=(2)+(3)+(4)11,500
Total current liabilities (5) 750 Total assets (1)+(5) 21,500
Total liabilities (6)=(4)+(5) 750
Total shareholders’ equity + total liabilities
(3)+(6) 21,500
Net worth of Raju’s business
• Net worth = Total assets – Total liabilities = 21,500 – 750 = ₹ 20,750.
• At the start of the business, the net worth was 20,000 – 0 = ₹ 20,000.
• So Raju has added a net worth of ₹ 750 from operating his thela,
which is the profit from his business.
P&L statement
• P&L stands for profit and loss statement.
• It is also called income statement.
• It shows the business’ operating results for the period (quarter,
• year, etc.).
• Net income (or profit and loss) = Revenue – Expenses.
Retained earnings and surplus
• Any income or profit not paid out to shareholders is called retained
earnings.
• Retained earnings are accumulated over time on the balance sheet
under Surplus on the Shareholders’ Equity part of the balance sheet.
• For Raju, the surplus was ₹ 750.
Inventory
• Inventory is the goods held for sale or items used in the manufacture of
products that will be sold.
• Cost of inventory held is reported under Inventory on the balance sheet.
• Once the inventory is sold, it is reported as cost of good sold (COGS) on the
P&L statement.
• Beginning-of-period inventory + purchases = COGS + End-of-period
inventory.
• For Raju, he started with zero inventory, bought inventory worth ₹ 2,000, sold ₹
1,500.
• So End-of-period inventory = 0 + 2,000 – 1,500 = ₹ 500, which is what entered under
Inventory in the balance sheet.
Expensing
• Notice that the cost of the thela (₹ 10,000), even though an outflow
and a cost to Raju, does not appear on the P&L statement; it appears
only on the balance sheet.
• It does not affect the profitability of Raju’s business.
• Why does this happen?
• Assets and expenses are two sides of the same coin.
• If the benefits of a cost are expected to accrue in the same period in
which the cost is incurred, then the cost is expensed in that period.
• In other words, the entire amount appears as an expense on the P&L
statement for that period.
Capitalising
• If the benefits of a cost are expected to accrue in future periods to
when the cost is incurred, then the cost is capitalized in that period.
• Capitalising means the entire amount of the cost is shown as an asset
in the balance sheet.
• Example of capitalised expenditures: property, plant and equipment
(PP&E).
Amortisation
• Capitalized costs are eventually charged as expenses to the P&L
statement.
• Amortization is the process of allocating an asset’s value to those
future periods when its benefits are expected to be earned, typically
over the asset’s useful life.
• For example, if an asset’s useful life is 5 years, then 1/5 of the asset’s
value will be charged as an expense during each of those five years in
the P&L statement.
• Most common example of amortization is depreciation, which is the
terminology used for amortizing PP&E.
Depreciating Raju’s thela
• The cost of Raju’s thela will be depreciated over its useful life.
• If we assume that its useful life is 10 years, then ₹ 10,000 ÷ 10 = ₹
1,000 will be the annual depreciation expense on the P&L statement
for each of the next ten years.
• At the end of the financial year, the ₹ 1,000 will be deducted from
Raju’s profits before taxes are computed.
Selling, general and administrative (SG&A)
expenses
• SG&A expenses include sales agents’ salaries and commissions;
advertising and promotion; travel and entertainment; executives’
salaries, office payroll; and office expenses.
• This usually includes depreciation expenses.
Different profit measures
• Here is how a P&L statement looks and the different profit
measures(in bold) after each expense is deducted:
Revenues
– Cost of Goods Sold (COGS)
Gross profit
– SG&A expenses
Earnings before interest, taxes, depreciation and amortization (EBITDA)
– Depreciation and amortization expenses
Operating profit or Earnings before interest, taxes (EBIT)
– Interest on any outstanding loans
Profit before tax (PBT)
– Taxes
Profit after tax (PAT) or Net income or “bottom line”
Key takeaways
• Define current assets, non-current assets, current liabilities, non-
current liabilities. Give examples of each.
• Explain how the different types of assets and liabilities tie into the
balance sheet.
• How do profits from P&L statement affect the balance sheet?
• What are the different items of a P&L statement?
• Distinguish between expensing and capitalising costs.
• Define the different types of profits on the P&L statement.