Financial Accounting (B/sheet & P& L)

SHIFT IN FOCUS

Use of Financial Information in Investing---

Primary Focus on Equity Valuation
Discounted cash flow approach to valuation
How are fundamental (intrinsic) values estimated?
Determination of P/E & Market to Book Ratios
Relevance of Dividends/Earnings/Book value

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Basics of Financial Accounting

Understand financial statements

Understand the methods of depreciation
Understand accounting standards

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Basics of Financial Accounting

Trial Balance

Is a list of closing balances in all accounts on a particular

date
Has the debit and credit balances written separately

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Basics of Financial Accounting

Trading and Profit and Loss Account

Trading Account
Is related to the trading activity that is primarily concerned with
buying and selling of goods by an entity
Is constructed for finding out the gross profit
Has the debit side, which consists of:
Opening stock
Purchases made during the year
Direct expenses related to the trading activity
Has the credit side, which consists of:
Sales effected during the year
Closing stock

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Basics of Financial Accounting

Trading and Profit and Loss Account (Contd.)

Profit and Loss Account

The balances in all the nominal accounts are transferred to the
Profit and Loss Account
The expenses are entered on the debit side and income on the
credit side
The net balance represents Profit or Loss
Does not carry forward the balances in the nominal accounts to
the next year

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Basics of Financial Accounting

Balance Sheet

Shows the financial position of a business entity

Represents the assets and liabilities of the business
Shows liabilities on the left side and assets on the right side

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Basics of Financial Accounting

Methods of Depreciation

Written Down Value Method

Writes off the book value of an asset, every year, during the
useful life of the asset
Fixed Installment Method
Provides a percentage on the original value of an asset as
depreciation year after year during the life of the asset
Is also known as straight-line method

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Basics of Financial Accounting

Accounting Standards

Were formulated under the National Advisory Committee on

Accounting Standards in 2001
Are mandatory for all Indian organisations listed on the
stock exchanges
Are applicable for entities whose annual turnover exceeds
Rs. 50 crores
Provide uniform disclosure norms
Issue directives, related to:
Accounting for depreciation
Enterprise and related party
Reporting requirements on economic activity controlled by
parent body and an outsider group
Introduce an element of uniformity in reporting numerous
issues

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Basics of Financial Accounting

All organisations, irrespective of their size, have to maintain a

record of their monetary transactions. A summary of these
records is known as the financial statements
The various financial statements prepared and used in an
organization are:
Trial Balance
Trading and Profit and Loss Account
Balance Sheet
Trial Balance is a list of closing balances in all accounts with
the debit and credit balances written separately
A trading account is related to the trading activity that is
primarily concerned with the buying and selling of goods by an
entity
The consolidated listing of all nominal accounts is called the
Profit and Loss account
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Basics of Financial Accounting

(Contd.)
The balance sheet gives out the financial position of the
business entity, in terms of what it owns and what it owes, as
on a given date
In a running account this does not happen and invariably there
will be some closing stock
The closing stock of one year becomes the opening stock of
the next year and has to be taken on the Debit side of the
Profit and Loss Account before Purchases
Under the commonly accepted “Accrual Method” of accounting,
all incomes and expenses relating to the period, whether paid
or not, have to be included in the Profit and Loss Account
The value of assets such as vehicles, equipments, and
machines depreciate over time

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Basics of Financial Accounting

(Contd.)
There are two methods of depreciation:
Written down value method
Fixed installment method or Straight line method
The emergence of accounting standards provides for uniform
disclosure norms

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Analysing Financial Statements

Analyse financial statements

Understand Profit and Loss account

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Analysing Financial Statements

Financial Statement Analysis

Financial Statement:
Gives a snapshot view of the:
Operations of an organisation
Financial position of an organisation
Financial status of the organisation
Provides valuable information about the organisation to all the
stakeholders
Acts as a tool in decision making
Has the following users:
Government
Creditors
Employees
Customers
Prospective investors

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Analysing Financial Statements

Financial Statement Analysis (Contd.)

Financial Statement (Contd.):

Suppliers
Credit analysts
Consists of the following reports and statements:
Director’s Report
Auditor’s Report
Notes on Accounts
Profit and Loss Account
Balance Sheet
Schedules to Balance Sheet and Profit and Loss Account
Cash Flow Statement

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Analysing Financial Statements

Profit and Loss Account

Is a revenue account
Shows the expenses and gains of an organisation
Transfers the balances related to expenses or incomes to
this account
Includes of the following items:
Sales
Cost of goods sold
Depreciation
Selling, general, and administrative expenses
Interest
Taxes

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Analysing Financial Statements

Profit and Loss Account (Contd.)

Operating Profit
Is the difference between the income and expenditure
excluding interest
Operating Loss
Is the difference between the income and expenditure, where
expenditure is more than the income
Represents the profit or loss made by the organization in
carrying out its core operations
Stages at which profit/loss can be looked at for purposes of
analysis:
EBDITA
PBIT
PBT
PAT

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Analysing Financial Statements

Analysing financial statements is useful for ascertaining the

financial position of the organization and helpful in making
investment decision
The financial statements consist of various statements and
reports. These are:
Director’s report
Auditor’s report
Notes on account
Profit and loss account
Balance sheet
Schedules to balance sheet and profit and loss account
Cash flow statement

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Analysing Financial Statements

The most common items in Trading and Profit and Loss

Account are:
Sales
Cost of goods sold
Depreciation
Selling, general, and administrative expenses
Interest
Taxes
The various stages at which profit/loss can be looked at for
purposes of analysis are:
EBDITA
PBIT
PBT
PAT

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Analysing Financial Statements

Objectives

In this session, you will learn to:

Understand balance sheet
Understand additional components of balance sheet

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Analysing Financial Statements

Balance Sheet

Has the following main components:

Shareholders’ funds
Long term loans/liabilities
Current liabilities
Fixed assets
Current assets
Other non-current assets

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Analysing Financial Statements

Balance Sheet (Contd.)

Contents of the Balance Sheet:

Shareholders’ Funds Fixed Assets

+
+ Other Non-Current
Assets
Long Term Liabilities

Current Assets
Current Liabilities

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Analysing Financial Statements

Balance Sheet (Contd.)

Fixed Assets
Are assets not intended for sale but are used for normal
working of the company
Are not consumed in the process of manufacturing but rather
assist in the manufacturing process
Are permanent or semi-permanent in nature
Remain with the organization for a long period
Are normally shown in the balance sheet as follows:
Net Block= Gross Block – Depreciation
Other Non-Current Assets
Are assets, other than fixed assets, that are of long term in
nature
Are not expected to be converted into cash within the next 12
months

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Analysing Financial Statements

Balance Sheet (Contd.)

Current Assets
Are assets that will turn into cash within a year from the
balance sheet date
Are assets, most of which are normally consumed in the
course of manufacturing
Keep changing from one form to another
Current Liabilities
Payment obligations and commitments of the organization that
are due and payable within twelve months from the date of the
balance sheet

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Analysing Financial Statements

Balance Sheet (Contd.)

Shareholders’ Funds and Term Liabilities

Represent total interest of shareholders and long term lenders
in the company
Are long term in nature
Are expected to remain in the business for a considerably long
period
Long Term Liabilities
Are long-term debt, which are due after one year

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Analysing Financial Statements

Additional Components of Balance Sheets

Inventory
Inventory Valuation
Depreciation Policy

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Analysing Financial Statements

Summary

In this session, you learned that:

The main components of balance sheet are:
Shareholders’ funds
Long term loans/liabilities
Current liabilities
Fixed assets
Current assets
Other non-current assets
The additional components of the balance sheet are:
Inventory
Inventory valuation
Depreciation policy

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