The following topics and concepts were covered in this session:

● The basic structure of the income statement

● The key metrics to look for in an income statement
● The basic structure of the balance sheet
● Dividends
● The basic structure of a cash flow statement
● Interpreting a cash flow profile
● Cash flow from operations and total cash generated
● The link between the financial statements

Income Statement
The income statement, also known as the profit and loss statement, tells you about the income
and expenses that your firm has incurred over a period of one financial year.

The principles of accounting mentioned in the image below must be followed while preparing an
income statement.

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An income statement typically consists of the line items listed in the following table.

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While the cost of goods sold, marketing, legal, HR, R&D, and depreciation and amortisation are
grouped under operating expenses, interest and taxes make up the non-operating expenses of
a company.

The following metrics can be used to analyse an income statement:

● Variable margin: It is often computed as a %age of sales revenue to enable comparison

between companies and benchmarking with the industry average. It can be computed
using the following formula:

● Earnings before interest and tax: Shortened to EBIT, it shows the profit from the core,
primary revenue-generating activities of a business. It can be computed using the
following formula:

● Earnings before interest, tax, depreciation and amortisation: Shortened to EBITDA,

it shows the cash operating income of a company. It can be computed using the
following formula:

EBITDA is a better indicator of cash-operating performance as compared to EBIT because of

the following reasons:

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 Balance Sheet

A balance sheet gives a snapshot of the financial position of a company at a particular point of
time. It has two sides: the ‘assets’ side and the ‘liabilities and equity side’.

● The assets side of the balance sheet consists of the line items listed in the table below.

The value of inventory must be the lowest of the purchase price or estimated market value as
per the ‘prudence principle’.

● The liabilities and equity side of the balance sheet consist of the line items listed in the
following table.

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 Dividends

When a company declares no dividend for a period, then,

When a company declares dividend for a period, then,

After paying the dividend, the balance sheet of the company is still balanced.

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 Cash Flow Statement –Basic Structure

A cash flow statement is a financial statement that identifies the actual movement of cash due to
any financial transaction in a company:

● A cash flow statement starts with the ‘cash at the beginning of the period’, and the
bottom line mentions the ‘cash at the end of the period’. Between these two line items is
‘the total cash flow generated’, which can be calculated as follows:

The image below explains the different entities in the calculation of the total cash flow
generated.

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The excess cash from operations, which remains after investment in the company’s growth is
called the free cash flow. The free cash flow is what the company uses as a means to reward
the bankers and its shareholders for their investment in it.

Cash Flow Profile

The graphical presentation of a cash flow statement is known as the cash flow profile of a
company. Interpretation and analysis of the cash flow profile of a company reveals its cash flow
position, which can then be used to draw meaningful conclusions about the company.

Here’s how it looks.

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 Cash Flow Statement – Detailed Structure

The table below lists the different elements in the ‘cash flow from financing activities’ and ‘cash
from investment activities’.

Category Element

Financing ● Issue of new loan or repayment of existing loan

activities ● Issue of new shares for buyback of old shares
● Dividend distribution/interest payment

Investing activities ● Purchase of property, plant and equipment

● Sale of fixed assets

The following points are key while accounting for the cash flow from operating activities:

● It starts with the EBIT as it is closely linked to cash.

● The depreciation expense is an accounting non-cash expense; hence, it must be added
back to the EBIT to determine the true cash flow of the company.
● While accounting for the working capital, the key points include the ones shown in the
following table.

Element Increase Decrease

Accounts receivable Customers owe more Collection from the past

money to the company; year’s accounts
cash outflow receivable > Newly
generated accounts
receivable; cash inflow

Inability to sell; cash

Inventory Sales increased; cash
outflow
inflow

Accounts payable Company owes more Company has paid

money to its suppliers; its suppliers; cash
cash inflow outflow

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 ● The interest expense and taxes are deducted from the EBIT to arrive at the cash flow
from operating activities.

Analysing the cash flow statement reveals the difference between the profit made by the
company and the actual cash generated by it.

Financial Triangle

The three financial statements are linked similar to the three ends of a triangle, and the resulting
structure is known as the financial triangle. This is because of the following reasons:

● The bottom line of the cash flow statement, ‘Cash at end’, is transferred to the asset side
in the balance sheet.
● The bottom line of the income statement, ‘Net profit’, is transferred to the owners’ equity
side of the balance sheet.

In order to have a comprehensive view of the financial health of a company in any period, it is
important to analyse all three statements.

Finance Framework of Businesses

Typically, a business can be summarised as having the framework shown in the following
image.

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