You are on page 1of 33

CHAPTE R 24

FINANCIAL STATEMENTS AND CASH FLOW ANALYSIS

LEARNING OBJECTIVES
2

Introduce financial statementsbalance sheet and profit and loss account Distinguish between accounting profit and economic profit Discuss the meaning of funds flow and working capital flow Highlight the need for analyzing the changes in a firm's funds and cash flow position Explain the mechanism of preparing funds flow and cash flow statements Emphasize the need and utility of preparing a comprehensive statements of financial position that explains changes in cash flow from operations, investment activities and financing activities

Financial Statements
3

Financial

statements provide information about the financial activities and position of a firm. are:

Important financial statements Balance sheet Profit & Loss statement Cash flow statement

Balance Sheet
4

Balance

sheet indicates the financial condition of a firm at a specific point of time. It contains information about the firms: assets, liabilities and equity. Assets are always equal to equity and liabilities: Assets = Equity + Liabilities

Assets
5

Assets

are economic resources or properties owned by the firm. There are two types of assets:

Fixed assets Current assets

Current Assets
6

Current

assets (liquid assets) are those which can be converted into cash within a year in the normal course of business. Current assets include:

Cash Tradable (marketable) securities Debtors (account receivables) Stock of raw material Work-in-process Finished goods

Fixed Assets
7

Fixed assets are long-term assets. Tangible fixed assets are physical assets like land, machinery, building, equipment. Intangible fixed assets are the firms rights and claims, such as patents, copyrights, goodwill etc. Gross block represent all tangible assets at acquisition costs. Net block is gross block net of depreciation.

Liabilities
8

Liability

is a firms obligation to pay cash or provide goods or services in the future. types of liabilities are:

Two

Current liabilities Long-term liabilities

Current Liabilities
9

Current

liabilities are payable within a year in the normal course of business. They include:

Accounts payable (creditors) Outstanding expenses Advances from customers Provision for tax Provision for dividend

Long-term Liabilities
10

Long-term

liabilities are the obligations or debts payable in a period of time greater than the accounting period. They include - Debentures, bonds, and secured long-term loans from financial institutions.

11

Shareholders Funds or Equity


Share

capital is owners contribution divided into

shares. A share is a certificate acknowledging the amount of capital contributed by the shareholder. Shareholders equity has two parts:

(i) paid-up share capital, and (ii) reserves and surplus (retained representing undistributed profits.

earnings)

Paid-up

share capital and reserve and surplus together are called net worth.

12

Gujarat Narmada Valley Fertilizers Company Balance Sheet as on 31 March

Balance Sheet Relationship


13

Total

assets (TA) equal net fixed assets (NFA) plus current assets (CA):
TA = NFA + CA

Net

current assets (NCA) is the difference between current assets (CA) and current liabilities (CL):
NCA = CA CL

Balance Sheet Relationship


14

Net

assets (NA) equal net fixed assets (NFA) plus net current assets (NCA):
NA = NFA + NCA

Capital

employed (CE) is the sum of net worth or equity (E) and borrowing/debt (D) and it is equivalent of net assets:
CE = Net Worth + Borrowing = E + D Capital Employed = Net Assets

Profit & Loss Statement


15

Profit &

Loss statement provides information about a firms:


revenues, expenses, and profit or loss.

Nature of Revenues
16

Revenue

is the amount received or receivable within the accounting period from the sale of the firms goods or services. Operating revenue is the one that arises from main operations of the firm, and the revenue arising from other activities is called non-operating revenue.

Nature of Expenses
17

Expense

is the amount paid or payable within the accounting period for generating revenue.
Examples: raw material consumed, salary and wages, power and fuel, repairs and maintenance, rent, selling and marketing expenses, administrative expenses.

Expenses

are expired costs and capital expenditures represent un-expired costs and appear as assets in balance sheet.

Concepts of Profit
18

Gross profit = sales cost of goods sold (CGS) CGS = raw material consumed + manufacturing expenses of goods that have been sold PBDIT = Profit before dep., interest and tax = sales expenses, except dep., interest and tax Operating profit (OP), OP = GP OEXP DEP PBIT= Profit before interest and tax= PBDIT DEP PBT= Profit before tax = PBIT Interest PAT = Profit after tax = PBT Tax Net operating profit after tax (NOPAT)=PBIT (1 Tax rate)

19

Gujarat Narmada Valley Fertilizers Company Ltd Profit & Loss Account for the year ended on 31 March

20

Economic Vs. Accounting Profit


Accounting profit is a result of the arbitrary allocation of expenditures between expenses (revenue expenditure) and assets (capital expenditure). Economic profit is the net increase in the wealth of the firm, and it is measured in cash flow.

21

CHANGES IN FINANCIAL POSITION

The

statement of changes in financial position summarizes: Changes in assets and liabilities resulting from financial and investment transactions during the period, as well as those changes which resulted due to change in owners equity; and the way in which the firm used its financial resources during the period

The

most commonly used forms of the statement of changes in financial position are called the funds flow statement and the cash flow statement.

Definition of Funds
22

Funds

may mean change in financial resources, arising from changes in working capital items and from financing and investing activities of the enterprise, which may involve only non-current items.

23

Concept of Working Capital Flow


The

net working capital increases or decreases when a transaction involves a current account and a non-current account. It remains unaffected when a transaction involves only current accounts. It remains unaffected when a transaction involves only non-current accounts.

24

Effect of Changes in Accounts on Working Capital

Sources of Working Capital


25

1. 2.

3.

Funds from operations (adjusted net income) Sale of non-current assets: sale of long-term investments (shares, bonds/debentures, etc.) sale of tangible fixed assets like land, building, plant or equipments sale of intangible fixed assets like goodwill, patents or copyrights Long-term financing:

long-term borrowings (institutional loans, debentures, bonds, etc.)

4.

issuance of equity and preference shares Short-term financing such as bank borrowings

Uses of Working Capital


26

Adjusted net loss from operations 2. Purchase of non-current assets:


1.

purchase of long-term investments like shares, bonds/debentures, etc. purchase of tangible fixed assets like land, building, plant, machinery, equipment, etc. purchase of intangible fixed assets like goodwill, patents, copyrights, etc.

3. 4. 5.

Repayment of long-term debt (debentures or bonds) and short-term debt (bank borrowing) Redemption of redeemable preference shares Payment of cash dividend

27

Forms of Funds Flow Statement


XY Company Statement of Changes in Working Capital for the year ended 31 December 20X1

Comprehensive Funds Flow Statement: Financial Resources Basis ACME Company


28

CASH FLOW STATEMENT


29

statement of changes in financial position on cash basis, commonly known as the cash flow statement, summarizes the causes of changes in cash position between dates of the two balance sheets.

It indicates the sources and uses of cash.


statement analyzes changes in noncurrent accounts as well as current accounts (other than cash) to determine the flow of cash.

This

Sources of Cash
30

The

profitable operations of the firm, Decrease in assets (except cash), Increase in liabilities (including debentures or bonds), and Sale proceeds from an ordinary or preference share issue.

Uses of Cash
31

The

loss from operations Increase in assets (except cash) Decrease in liabilities Redemption of redeemable preference shares Cash dividends

32

Comprehensive Cash Flow Statement: Financial Resources Basis ACME Company

USES OF THE STATEMENT OF CHANGES IN FINANCIAL POSITION It helps to answer the following questions:
33

1. 2. 3. 4.

What is the liquidity position of the firm? What are the causes of changes in the firms working capital or cash position? What fixed assets are acquired by the firm? Did the firm pay dividends to its shareholders or not? If not, was it due to shortage of funds?

5.

How much of the firms working capital needs were met by the funds generated from current operations?
Did the firm use external sources of finances to meet its needs of funds? If the external financing was used, what ratio of debt and equity was maintained?

6. 7.

8.

Did the firm sell any of its non-current assets? If so, what were the proceeds from such sales?
Could the firm pay its long-term debt as per the schedules? What were the significant investment and financing activities of the firm that did not involve working capital?

9. 10.