Corporate Financial

Reporting and Analysis

Objectives

 Understand how financial statements are prepared

 Develop skills to analyse financial statements for decision making
 Identifying red flags
 Assessing the impact of various regulations
Text Books
Evaluation

 Group Assignment 20%

 AOL Exam 10%
 Quiz 20%
 Mid Term 20%
 End Term 30%
 Businesses…

Manufacture and sell Manufacture and Provide IT Retail

cars sell adhesives/ Services
chemicals

What’s common ?
Language…How much sales? How much profits? Whats the ROI?

Accounting
Accounting
 Language of business
 Helps to tell the story of the company
 It is the information system that
 Measures business activities
 Process the information into reports, and,
 Communicates the result to the decision makers
 The better you understand the language of business, the better you can manage
your own business, be a valuable employee, or make wise investments
Accounting

 Helps you to answer:

 How well the business is performing?
 How financially sound the business is?
 How much money comes in and goes out?
 Will I be able to pay my loans on time?
 How do my departments/ units perform?
 Is serving a particular customer profitable?
 How does my forthcoming year looks like?
 What are the improvement areas?
 ….and so on.
Accounting

 Who are the users of accounting information?

 Owners
 Investors • Summarized information Financial Accounting
 Lenders External • Useful of everyone who needs and Reporting
Decision it
 Customers Makers
 Govt. • Detailed decision specific Management
 Managers Internal information Accounting
Decision • Many a times confidential in
Makers nature
• Available to only managers
Financial Vs. Management Accounting
Financial Accounting and Reporting

 Accounting is an information system that measures and records business

activities, processes data, and reports the results to decision-makers.
 Financial statements are the reports that companies use to convey the financial
results of their business activities to various groups, which may include managers,
investors, lenders, and regulatory bodies.
 Important financial statements include:
 Balance Sheet
 Income statement
 Cash Flow Statement
 Statement of changes in Equity
 INCOME

IMPORTANT STATEMENT
Reports company’s
performance over a period of

FINANCIAL
time
Revenues – Expenses = Profits

STATEMENTS
BALANCE
• Reports SHEET
financial position at
a point in time
• Satisfies the equation: CASH FLOW
Assets = Liabilities + Equity STATEMENT
Important financials reported in the annual Reports changes in cash over a
report of the company. period of time
Segments into:
CF Operating Act
CF Investing Act
STATEMENT OF CF Financing Act
CHANGES IN
EQUITY
Reports changes in equity over
a period of time
Economic Entity

 An organization that stands apart as a separate economic unit.

 It is separate from its owners.
 It may take the form of sole proprietorship, partnership or a company.
 However, for accounting purposes business is separate from its owners.
Forms of Business Entities

 Sole Proprietorship
 Partnerships
 Limited Liability Partnerships (LLP)
 Companies
Balance Sheet

 Balance Sheet is a quantitative summary of a company’s financial position at a

specific point in time,
 Presents what is owned by the company (Assets) and what it owes (Equity and
Liabilities)
 Conveys the information of company’s health.
 Investments

Owner’s money (Business

Entity)

Outside
Financing
Understanding balance sheet

 Assets = Liabilities + Owner’s Equity

Dual Aspect or Double Entry Principle
 Every economic transaction has two aspects.
 It means every transaction effects two different accounts.
 For example, you borrow Rs. 5,000 from a friend to take your girlfriend out on a date.
 What happens??

 The economic transaction has two parts:

 Cash comes in Rs.5,000
 A obligation is created to pay back Rs. 5,000 to your friend in future
 After a week you repay Rs.3,000 to your friend with a promise to repay balance Rs.2,000 in
another week.
 Cash goes out Rs.3,000
 Future obligation reduces by Rs.3,000
Understanding balance sheet

 Assets = Liabilities + Owner’s Equity

Assets

 An asset is an economic resource that is expected to benefit the business in the

future.
 Assets are something of value that the business owns or has control of.
 Cash, Merchandise, Inventory, Furniture, and Land are examples of assets.
Assets
 Balance Sheet lists the assets in the order of liquidity.
 Liquidity implies the length of time required for converting them into cash.
 Assets that are held primarily for the purpose of trading or that are expected to be
sold, used up, or otherwise realized in cash within one year or one operating cycle
of the business, whichever is greater, after the reporting period are classified as
current assets.
 A company’s operating cycle is the average amount of time that elapses between
acquiring inventory and collecting the cash from sales to customers.
 Assets not expected to be sold or used up within one year or one operating cycle
of the business, whichever is greater, are classified as non-current assets.
 In India, non-current assets are presented first followed by current assets.
Accounting Policy at MRF
Assets

 Non-current Assets (Long term): Expected to generate cash in long term

 Property, Plant and Equipment
 Intangibles etc.
 Current Assets (Short Term) : Expected to generate cash in near term
 Cash
 Inventory
 Debtors etc.
 Proportion of Non-current to Current Assets is determined by company’s business
model and industry
Balance Sheet excerpt -MRF
Assets
Notes to Accounts - MRF
Notes to Accounts - MRF
Assets

Non-Current to Current Assets

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Maruti - in last decade

Chart Title
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2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

Non-current assets Current assets (incl. short term investments, loans & advances)
Liabilities

 Liabilities indicate the amount of financing provided by creditors.

 They are the company’s debts or obligations.
 Example, loans, accounts payables, tax payable etc.
 Liabilities expected to be settled within one year or within one operating cycle of
the business, whichever is greater, after the reporting period are classified as
current liabilities.
 All other liabilities are classified as Non-Current Liabilities
Balance Sheet excerpt -MRF
Notes to Accounts - MRF
Notes to Accounts - MRF
Notes to Accounts - MRF
Notes to Accounts - MRF
Owner’s Equity

 Stockholders’ equity indicates the amount of financing provided by owners of the

business and reinvested earnings
 Also known as Shareholders’ capital, Owner’s capital, Net worth etc.
 It also represents the residual interest in the assets of the entity after deducting all
its liabilities.
Equity
Financing activities
 Equity – Owner’s financing
 Money contributed by the owners (paid up capital)
 Retained earnings (profits retained in the business over a period)
 No repayment required
 Liabilities –Non-Owner’s financing
 Long term
 Short term
 Repayment is mandatory
 Proportion of Equity and Liabilities in overall financing is determined by company’s
business model and industry
Equity Vs. Liabilities

Equity Vs. Liabilities

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Maruti – In last decade

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Equity Liabilities
Accounting Equation

Investments Funding

or

RESOURCES CLAIMS ON RESOURCES

Understanding balance sheet

 Assets = Liabilities + Owner’s Equity

Or,
Assets = Liabilities + (Owner’s Investment + Retained Profits)
 Understanding balance sheet

 Sheldon Cooper started a business of trading in electronics products such as earphones,

speakers etc. He names his firm ‘HearWell’ and he invested Rs.10 lakhs from his account.
 HearWell purchased a store for Rs. 40 Lakhs by paying Rs. 6 Lakhs in cash and taking
mortgage loan of Rs.34 lakhs from HDFC Bank.
 HearWell purchased stock worth Rs.5 Lakhs by paying 2 lakhs in cash and balance on
credit of one month from A Ltd.
Understanding balance sheet - Principles

 Economic Entity Principle

 Dual Aspect Principle /Double entry system
 Monetary Unit Assumption
 Cost Principle
 Going Concern
 Consistency Principle
Monetary Unit Assumption

 Monetary unit assumption suggest that all economic transactions are valued and
recorded in monetary terms
Understanding balance sheet - Principles

 Economic Entity Principle

 Dual Aspect Principle /Double entry system
 Monetary Unit Assumption
 Cost Principle
 Going Concern
 Consistency Principle
Cost Principle

 The cost principle states that acquired assets and services should be recorded at
their actual cost (also called historical cost)
 The cost principle means we record a transaction at the amount shown on the
invoice and not any expected value.
 For example, if you buy a diamond earrings for your girlfriend for Rs.50,000,
although the value of the gold and diamond may increase later, for accounting
purposes it will be recorded at Rs.50,000.
Understanding balance sheet - Principles

 Economic Entity Principle

 Dual Aspect Principle /Double entry system
 Monetary Unit Assumption
 Cost Principle
 Going Concern
 Consistency Principle
Going Concern Assumption

 It is assumed that the business entity has neither the necessity nor an intention to
wind up in the foreseeable future.
 This means that the business will remain in operation long enough to use the
existing resources for their intended purpose.
Understanding balance sheet - Principles

 Economic Entity Principle

 Dual Aspect Principle /Double entry system
 Monetary Unit Assumption
 Cost Principle
 Going Concern
 Consistency Principle
Consistency principle

 Consistency principle states that accounting policies, practices or assumptions

should be followed consistently throughout the current as well as the future
period.
 This helps make financial statements comparable across periods.
 For example you consider a gift of upto Rs.1,000 as an immediate expense but a
gift of higher amount as an investment to your relation.
 The policies or practices may change if required by law or if the changed policy/
practice presents the information better
Accounting Equation Revisited

 Assets = Liabilities + Owner’s Equity

Accounting Equation Revisited

 Point out which accounts will be effected on the accounting equation by the
following transactions:
i. Owner contributed Rs. 15 Lakhs to start the business
ii. A bank was taken for Rs. 10 Lakhs
iii. A building worth Rs. 12 Lakhs is purchased for Rs. 11 lakhs due to better
bargain
iv. A machinery is purchased for Rs.4 lakhs
v. A vehicle is purchased for Rs. 6 lakhs
vi. Furniture purchased for office Rs. 2 Lakhs
vii. After a year, market value of building increased to Rs.14 lakhs
Income Statement

 The income statement presents information on the financial performance of a

company’s business activities over a period of time.
 The income statement communicates how much revenue the company generated
during a period and what costs it incurred in connection with generating that
revenue.
 The basic equation it satisfies:
Revenues – Expenses = Income
Elements of Income Statement

 Top Line – Revenue

 Revenue generally refers to the amount charged for the delivery of goods or
services in the ordinary activities of a business
 Also called ‘Sales’ or ‘Turnover’ or ‘Top Line’
Elements of Income Statement
Notes to Accounts-MRF
Expanding Accounting Equation

Assets = Liabilities + Equity

Ist year of operations

Assets = Liabilities + Equity + (Revenue – Expenses - Dividends)
Assets = Liabilities + Equity + Retained Earnings

Subsequent Years of operations

Assets = Liabilities + Equity + Previous Retained Earnings + (Revenue – Expenses – Dividends)
 Expanded Accounting Eqaution

 Sheldon Cooper started a business of trading in electronics products such as earphones,

speakers etc. He names his firm ‘HearWell’ and he invested Rs.10 lakhs from his account.
 HearWell purchased a store for Rs. 40 Lakhs by paying Rs. 6 Lakhs in cash and taking
mortgage loan of Rs.34 lakhs from HDFC Bank.
 HearWell purchased stock worth Rs.5 Lakhs by paying 2 lakhs in cash and balance on
credit of one month from A Ltd.
 HearWell sold half of its stock for Rs.4 Lakhs
 Hearwell paid salaries to staff amounting to Rs.50,000
Concepts

 Periodicity concept
 Accrual Concept
 Matching concept
 Realization concept
 Conservatism
Periodicity Concept

 Periodicity concept states that although the business is expected to continue for
the foreseeable future, the accounting information needs to reported on a shorter
basis for various decision making purposes.
 Companies report on annual basis, quarterly basis and monthly basis
(interanally).
 It helps to decide how revenues are booked on long term contracts and how
expenses are measured.
 In India companies follow April to March as the financial year.
Accrual Concept

 Accrual concept states that revenues are recorded in the period in which they are
earned and not based on the receipt of cash.

 Similarly, expenses are recorded in the period in which they are incurred and not
based on the disbursal of cash.
 For example, if a company makes a sale (deliver the product to customer) of Rs.5
lakhs in March’22 (FY 2021-22) but receives the payment in May ’22 (FY (2022-23),
then sales will be recorded in the FY 2021-22.
 Similarly, if the company has paid for some services in March’22 but received the
services in May’22, the expenses will be recorded in the FY 2022-23.
 Sec.128 of the Companies Act, 2013 mandates companies to follow Accrual basis of
accounting
Accrual Accounting

 Recognizes revenues when a business performs services or sells goods regardless

of when it receives cash.
 Recognizes expenses when it incurs them, that is when it consumes services or
uses goods, no matter when it pays for them.
Expenses that are
Income Revenue earned in
matched with
(Profit or loss) that period
revenue

 The period’s revenues generally not same as the period’s cash receipt
 The period’s expenses generally not same as the period’s cash payout
 Cash vs Accrual Accounting (Example)
Cash Accounting Accrual Accounting

2021 2022 2021 2022 2021 2022

3
Matching Concept

 Matching concept states that revenues and expenses should be MATCHED or

recorded in the same period.
 It requires recording expenses in the same accounting period in which the revenue
were earned as a result of the expenses.
 Two categories of expenses:
 Product cost: Traceable to the final product such as raw material, labour etc. matched
based on units
 Period cost: Not traceable to final product and therefore matched based on the period
to which the revenue belong e.g. rent, salaries etc.
Realization Concept

 Realization concept determines the point of time when revenue can be recognized
objectively, unbiased, and with certainty.
 Revenue can be said to have been earned when the ownership of goods has been
passed on to the buyer.
 E.g. A company receives an order to supply goods worth Rs.8 Lakhs on March
15, 2022. it delivers those goods on April 5, 2022. The revenue is said to be
earned only on April, 2022.
 Why managers insist on recording revenue as early as possible?
 Incentives structure
 Career Growth
Conservatism
 Conservatism principle state that one should recognize all expected losses but not
expected gains.
 This means the any gains should be recognized only when they are actually
realized, however, losses should be recognized as and when there is sufficient
possibility of them occurring.
 E.g. A company has made sales of Rs.8 crores in 2021-22 out of which Rs.1 crore
is still to be received from customers. Based on past data, it estimates that 2% of
the customers usually default in payment. Considering this information, it will
book an expected loss of Rs.2 lakhs.
Appropriation of profits

 Dividends
 Retained earnings
Appropriation of profits

Revenue for
the period

Expenses for
the period

Previous retained Profit for the Dividends paid Final balance of

earnings for the period retained earnings
period
Accounting Equation

Assets = Liabilities + Equity + Previous Retained Earnings + (Revenue – Expenses –

Dividends)
Example

 Assume that a company has the financial position as at March 31, 2022 as
presented in the excel file
 Account for the following transactions for April 2022 and present an Income
Statement for the month of April 2022 and Balance Sheet as at Apr 30, 2022.
Example
 Purchased inventory worth Rs. 4 lakhs, paid cash Rs. 2 lakhs balance payable to
the supplier in May 2022.
 Sold inventory worth Rs.2 Lakhs for Rs. 5 lakhs to FG Ltd. on credit
 Paid rent for the month of April 2022, Rs.1 lakh
 Paid Insurance premium on stock Rs.3 lakh for the period April to Jun 2022
 Sold inventory worth Rs. 3 lakhs for Rs.7 lakhs on credit to X Ltd on credit.
 Sold inventory worth Rs.5 lakhs for Rs.11 lakhs to ABC Ltd. on credit
 Received money from FG Ltd.
 Paid salaries Rs.3 lakhs
 Received money form ABC Ltd.
Treating Inventory in Accounting Equation

 It can become significantly cumbersome to