22

nd
July 2010
Kanu Doshi
Dean - Finance

• Interpretation of Financial Statements
And
• SATYAM
And
• Innovative Financial Instruments

Foundation Fortnight
Interpretation of financial
Statements:
Comparison is Cardinal:
We announce:
• On 01.04.2010 ABC Ltd. had Capital of Rs. 100
crore and net profit for 31.03.2010 was Rs. 55 crore.
• To Rahul, the engineer in Computer Science, these
figures make little sense except Rs. 100 crore and Rs.
55 crore are tolerably decent amounts.
But if we were to add:
• For 31.03.2009, its net profit was Rs. 110 crore,
then Pooja, the Commerce Graduate, would react
“What a lousy Company!”
Why? Because now we are comparing Rs. 110 crore of
2009 with Rs. 55 crore of 2010.
Then further we say:
• XYZ Ltd., in identical business, had a net loss of Rs.
5 crore for 31.03.2010.
• Now, Pooja, is sympathetic to ABC Ltd. & tells
Rahul, it is not so bad. Perhaps the industry had a
downturn.
Yet another look:

Let us assume that Net Profit amounts of two
companies for year ended 31st March 2010 are as
under:

A Ltd. = Rs. 7 Crore and B Ltd. = Rs.10 Crore.

On first impression, B Ltd. appears to be better than A
Ltd. because its profit amount of Rs. 10 crore is more
than Rs. 7 crore.

Accordingly A Ltd. becomes a better company than
B Ltd. because B’s operating profit is only Rs. 5 cr.
compared to Rs. 7 cr. of A Ltd.
But when Profit and Loss Account of B Ltd. is closely
looked into, it is noticed that B Ltd. had Rs. 5 crore
profit on sale of land (asset) as part of its net profit
while A Ltd. has only operating profit of Rs. 7 crore.
Ideally, a company’s profit should come from its
operations, e.g. manufacturing or from services.
Now B becomes better because a company with rising
profit is better than a company with falling profits.
Trend is a useful friend in understanding financial
statements
“Quality” of earnings is more important than the
“Quantity” of its earnings.
But we further find that A’s operating profit for earlier
year (2009) was Rs. 9 crore. While B’s operating profit
was Rs. 4 crore.
Satyam Asatyam…
i. Company takes out one year FD of Rs. 100 cr. With
BOI (say) on 7
th
January, 2010.
ii. Raju puts the receipt in his safe custody.
iii. On 15
th
January, Raju requests BOI to issue a
duplicate receipt saying the original is lost/misplaced.
iv. On 30
th
January, Raju surrenders the duplicate FD
receipt, duly discharged, and requests redemption
proceeds and requests a cheque for the same.
Satyam Asatyam…
v. On 1
st
February, Raju opens a bank a/c with Reddy
Co-op Bank ltd. And deposits the BOI cheque of Rs.
100 cr and gets a cheque book from Co-operative
Bank.
vi. Raju starts withdrawing funds from the Co-op Bank
a/c from 2
nd
February.
vii. Raju repeats the process with FDs of Rs.100 cr each
now with SBI/BOB/ Canara/ UCO/ Union
Satyam Asatyam…
viii. On 7
th
April, Auditors come for verification of bank
FD & Raju produces all the original receipts.
ix. Auditors are fully satisfied that everything is
perfectly in order and go home with a fat audit fee
cheque, laughing all the way to the bank.
Profit & Loss Account - Satyam
for year ended 31-03-2009
Inflated by bogus invoices
Income: (+)
Sales
Expenditure: (-)
Salaries
Operating Margin:
Interest (-)
Tax (-)
PAT
Inflated
Inflated by bogus staff members
All cash generated to meet lavish lifestyle, keeping politicians &
beaucrats on his side, to purchase real estate (MYTAS), larger than life
image!
Innovative Financial
Instruments:
Capital for a Co.
Shares
Equity
Variable
Dividend
Highest Risk
Preference
Fixed Dividend
Medium Risk
Debt
Debentures
Fixed Interest
Lowest Risk
Sample Share Certificates
Companies also issue Debentures.
Debentures unlike shares are a debt, a loan to the
company.
Therefore, carry interest and need to be repaid.
Interest on debentures is payable even if co. has a
loss while on shares, dividend is payable only if there
is profit.
7500
Profit & Loss Account
for year ended 31-03-2001
To Expenditure 6000
Interest (10% of 1200) 120
960
Tax @30% of 1380
By Sales 7500
(5 times fixed assets)
7500 Rs. Rs.
Net Profit (PAT)
420
1800
Balance Sheet
as on 31-03-2001
Debt – Equity Ratio: 2:1
Capital (EQ) 100
Reserves 500
Debentures
600
1200
Assets
Fixed
Current
1500
300
1800 Rs. Rs.
1800
1800
Balance Sheet
as on 31-03-2002
Post conversion of Debt on 1.4.2001 into
Equity at a PREMIUM of Rs. 90 per share
Capital (EQ) 100
Reserves 500
1580
Assets 1800
1800
120 220
1080
Share premium
(1200 – 120)
Rs. Rs.
New 10% of 120 (EQ)
9000
Profit & Loss Account
for year ended 31-03-2002
To Expenditure 7000
Interest (No Debt) -
600
1400 Net Profit (PAT)
Tax @ 30% of 2000
By Sales 9000
9000 Rs. Rs.
• Higher efficiency
• Finer variety
5400
Balance Sheet
as on 31-03-2003
Capital (EQ)
(100 + 120)
220
Reserves
1800
Loans 3600
Assets (Old) 1800
1580
5400
Plant (New) 3600
Rs.
Rs.
Debt Equity Ratio: 2:1
Profit & Loss Account
for year ended 31-03-2003
To Expenditure 17,280
Interest (10% of 3600) 360
190
2,770 Net Profit (PAT)
Tax @ 35% of 3960
By Sales 21,600
(5400x4)
21,600 Rs. Rs. 21,600
Thank You For Your Patience !!