MBA-IB 2021-23

PRE-READ
MATERIAL
FINANCE

Compiled by
Prep Comm, IIFT
Indian Institute of Foreign Trade Pre-Read Material – Finance Prep Comm, IIFT

Table of Contents

S. No. Topic Pg. No.

1 Introduction 1

2 Finance Society at IIFT Delhi 1

3 Financial Accounting 2

4 Financial Statements 6

5 Income Statement 6

6 Balance Sheet 7

7 Cash Flow Statement 9

8 Financial Ratios 12

*Note: Please click on the topic links to directly go to the topic page

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Indian Institute of Foreign Trade Pre-Read Material – Finance Prep Comm, IIFT

1. INTRODUCTION

The Indian Institute of Foreign Trade (IIFT) was set up in 1963 by the Government of India as an
autonomous organization to help professionalize the country's foreign trade management and
increase exports by developing human resources, analyzing and disseminating data and
conducting research. The Institute visualizes its future role as: The primary provider of training
and research-based consultancy in the areas of international business, both for the corporate
sector, Government and the students’ community.

2. FINANCE SOCIETY, IIFT DELHI

The Finance Society at IIFT Delhi acts as a bridge between the finance industry and IIFTians to constantly
improve learning and meet industry expectations in the finance space in-order to polish industry ready
finance and investment professionals. The Society aims to help fellow IIFTians develop an interest in
Finance; get exposure and information about the domain; and discover, learn, assimilate, and take the
plunge to the Finance and Investment domain roles

Key Events:
• The National Finance Summit during Trade Winds
• Vriddhan during Quo Vadis
• Fusion Deal Challenge hosted by Capital
• Stockathon Valuation Challenge hosted by the ERC

Capital Club
Capital is the Finance and Investments Club at the Indian Institute
of Foreign Trade (IIFT), Delhi. The objectives of the club include
providing a platform for all the Finance enthusiasts to be a part of
the club initiatives and promoting finance as a career option in the
student community. Capital is one of the oldest clubs at IIFT and
enjoys tremendous support from Alumni and Administration alike.
It has played an integral part in instilling and honing the Financial
acumen of IIFT students.

Equity Research Cell (ERC)

Equity Research Cell at IIFT strives to bring a culture of critical
analysis and thorough research of investment avenues. At Equity
Research Cell, we help those students who want to pursue their
career in finance, more specifically in equity research, by floating
various competitions such as stock pitch report preparation, virtual
trading etc, and by conducting various knowledge sessions on
topics of relevance.
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Indian Institute of Foreign Trade Pre-Read Material – Finance Prep Comm, IIFT

3. FINANCIAL ACCOUNTING

Hi, I’m here to guide you all in the domain of FINANCE.

Here’s a summary of few important topics which shall help in your summer internship
process.

What is Financial Accounting?

Financial accounting is the branch of accounting which involves the
process of recording, summarizing, and reporting the transactions
arising from business operations over a period of time. Such
transactions are outlined in the preparation of the balance sheet,
income statement, and cash flow statement.

Need for Financial Accounting

To keep a record of all transactions so that:
1. Financial position of the business at the end of given period can be determined,
2. Financial information required by the management and stakeholders such as lenders, investors,
employees, etc. can be provided.
E.g., investors may be interested in knowing the extent of profit or loss earned by the company during a
given period and compare it with the performance of other similar enterprises.

Generally Accepted Accounting Principles

• In order to maintain uniformity and consistency in accounting
records, certain rules or principles have been developed which are
generally accepted by the accounting profession. These are called
Generally Accepted Accounting Principles (GAAP)
• The Institute of Chartered Accountants of India (ICAI), the
regulatory body issues Accounting Standards to bring consistency
in the practices. It helps in proper recording of transactions and
makes it more acceptable to users.
https://corporatefinanceinstitute.com/resources/knowledge/accounti
ng/gaap/
The Accounting Process

Economic Event- Occurrence of Communicating Accounting

the Transaction Information

Decision Makers (Internal and

External users)
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Indian Institute of Foreign Trade Pre-Read Material – Finance Prep Comm, IIFT

Basic Accounting Principles

1. Business Entity: It states that every business entity should be treated as an

entity that is separate from its owners.

2. Accounting Period: Accounting process should be completed within a certain

time period which is usually a financial or calendar year.

3. Monetary Unit: All the financial transactions of a business should be capable

of being expressed in a monetary unit.

4. Consistency: A company should use same accounting policies and methods

for recording transactions in every financial period.

5. Going Concern: The business entity is assumed to continue it operate for an

indefinite period and shall not liquidate soon.

6. Matching Concept: This revenue for a particular period to be matched with its
corresponding expenditure to ascertain the true profit.

7. Historical Cost: The assets should be valued at their historical cost irrespective
of the current realizable or liquidation value.

8. Materiality: Details can be ignored if its net impact has a small impact on the
financial statements that a reader would not be misled.

9. Conservatism: All anticipated expenses or losses should be accounted for, but

all potential income or gains should not be recorded until earned/received

10. Accrual Basis: All revenue and expenditure to be recorded in the period it is
actually incurred and not when it has been received/spent.

Accounting Process

Identifying
Recording in Posting to Financial
& Analysing Trial Balance
the Journals the ledger Statements
Transactions

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Indian Institute of Foreign Trade Pre-Read Material – Finance Prep Comm, IIFT

Identifying Transactions

• The accounting process starts with identifying and analyzing business

transactions and events. Not all transactions and events are entered into
the accounting system.
• Only those that pertain to the business entity are included in the process.
For example, a personal loan made by the owner that does not have
anything to do with the business entity is not accounted for.

Recording in the Journals

• A journal is a book – paper or electronic, in which transactions are

recorded. Business transactions are recorded using the double-entry
bookkeeping system.
• They are recorded in journal entries containing two accounts (one
debited and one credited).
• There are both Modern and Traditional rules for recording a transaction.

Modern Rules of Accounting

CAPITAL ASSETS LIABILITY EXPENSE INCOME

Debit Decrease Increase Decrease Increase Decrease

Credit Increase Decrease Increase Decrease Increase

Traditional Rules of Accounting

• Real Account: Ledger accounts which

DEBIT CREDIT contain transactions related to Assets and
Liabilities. They are not closed at year-end
and carried forward. Eg- Bank a/c.
Real a/c What Comes in What Goes out
• Personal account: Connected to all
persons like individuals, firms and
Personal a/c The Receiver The Giver associations. Eg-Creditor a/c
• Nominal account: Pertaining to all
Expenses & Incomes & income, expenses, losses and gains. Eg-
Nominal a/c Interest a/c.
Losses Gains
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Ledger Posting

• After journal entries are made, the next step is to post these entries into their ledger accounts.
• After the posting all transactions to the ledger, the Closing Balances of each account can be
determined.

Let’s take a transaction:

Now, go to the ledger and post the

Date Particulars Debit Credit
amounts in debit & credit to the
appropriate side. DR go to the left and CR
Dec 1 Cash 10,000
to the right. After posting the accounts
would look like ` Mr. Gray Capital 10,000
https://www.accountingnotes.net/posting/posting
-from-journal-to-ledger-
Cash Mr. Gray Capital
10,000 10,000

Trial Balance

• To prepare a trial balance, you will Particulars Debit Credit

need the closing balances of the ($) ($)
ledger accounts. Cash Balance 1,352
• If both columns of the trial balance
Capital 2,000
tally, we can be reasonably assured
of the accuracy of the accounts. Sales 2,125
Purchases 1,600
https://cleartax.in/s/trial-balance Advertisement 73
Salaries 600
Drawings 500
4,125 4,125

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Indian Institute of Foreign Trade Pre-Read Material – Finance Prep Comm, IIFT

4. FINANCIAL STATEMENTS

What are Financial Statements?

• Financial Statements are written records that convey how is the business carrying out its activities and
the financial performance of the company to both external and internal shareholders.
• Internal Shareholders like management use the financial statements to plan and control the business
operations. External Shareholders include creditors, shareholders and employees of the enterprise.

Types of Financial Statements:

There are mainly three types of financial statements that are of utmost importance:
1. The Income Statement: Focuses on a company’s revenues and expenses during a particular period.
Revenue less Expenses produces the Profit figure called Net Income.
2. The Balance Sheet: Provides an overview of Assets, Liabilities and Equity at a specific point of time.
3. The Cash Flow Statement: Measures the generation of cash to pay for Operating Activities, Investing
Activities and Financing Activities

5. INCOME STATEMENT
Particulars Amount
Net Sales (Top Line)
xxx
(Company’s revenue from sales or services. A company may have a single or multiple revenue streams)
Cost of Sales
(xxx)
(Direct costs associated with selling products. It is also known as Cost of Goods Sold. Example: labor, parts)
Gross Profit xxx
Selling, General & Administrative Expenses
(Indirect Costs associated with running the business and selling goods and/or services. Example: (xxx)
advertising, salaries, rent, etc.)
Earnings Before Interest, Tax, Depreciation and Amortization xxx
Depreciation & Amortization
(xxx)
(Non-Cash expenses that arise due to regular obsolescence due to usage in case of tangible / intangible)
Earnings Before Interest and Tax (Operating Profit) xxx
Interest
(xxx)
(Expense in relation to debt issued by the company)
Other Revenue
xxx
(Non-Operating Revenue arising from non-core operations of the business)
Other Expenses
(xxx)
(Non-Operating Expense arising from non-core operations of the business)
Profit Before Tax xxx
Taxes
(xxx)
(Regulatory Requirement to be paid to the government)
Profit After Tax (Net Income/Bottom Line) xxx
Dividends
(xxx)
(Portion paid out to the shareholders of the company)
Retained Earnings (Carried Forward to the Balance Sheet) xxx
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5. INCOME STATEMENT

• Income Statement covers the operations of a business over a range of time

• This range of time is termed as an accounting period and usually covers a year (in case of annual
statements)
• It shows the profitability of a company during the specified accounting period by covering Revenues &
Expenses for that period which may be both Operating and Non-Operating in nature.
• Operating Activities are those activities that contribute to generating revenue from the business’s
core operations. This could be manufacturing, marketing and selling of goods.
• Non-Operating Activities, on the other hand, are those activities that are not a part of business’s core
operations. Example: Interest Income, Dividend Income, etc. This is the reason that Earnings Before
Interest and Tax is also known as Operating Profit as it accounts only for operating revenues fewer
operating expenses.

6. BALANCE SHEET

• As opposed to the Income Statement, Balance Sheet provides information about the company’s
Assets, Liabilities and Equity at a certain point of time. It can also be referred to as a statement of net
worth or financial position.
• It is based on the fundamental equation:

Assets = Liabilities + Equity

• A simple Balance Sheet is divided into two sections. The left side displays all a company’s assets while
the right side displays the company’s liabilities and shareholders’ equity. In this case, the balance of
both the sides should match.
A. Assets: Anything of value that can be converted into cash
B. Liabilities: Company’s legal debts or obligations that arise during business operations. The
amount is owed to outside parties and therefore known as external liability.
C. Equity: It represents the equity stake held in the books by equity investors. It is referred to as
the amount that the company owed to its owners or internal liability.

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6. BALANCE SHEET
Assets Amount Liabilities & Equity Amount
CURRENT ASSETS: CURRENT LIABILITIES:
(Assets that are expected to be converted into cash (These are debts payable within one year)
within one year in the normal course of business. A
company funds the day-to-day business using current
assets.)
Cash and Cash Equivalents xxx Accounts Payable xxx
(Represents cash in hand and all other (Represents the accounts yet to be
highly convertible investments) debited in near future for supplies utilized for
operating purposes)
Accounts Receivables xxx Short-Term Note Payable xxx
(Represents the accounts yet to be (Written promise that the borrower
credited in near future for goods or services sold) makes to the lender to repay its borrowings)
Inventory xxx Current Portion LTD xxx
(Stock of goods with a company, (Amount of unpaid principal from long-
including raw material and finished goods) term debt that has accrued in a company’s normal
operating cycle)
Prepaid Expenses xxx
(Expenses not due but paid, the benefit
of which will accrue in the future)
TOTAL CURRENT ASSETS xxx TOTAL CURRENT LIABILITIES xxx

NON-CURRENT ASSETS: NON-CURRENT LIABILITIES:

(Assets that are expected to be converted into cash in a (Debts that are payable over a period longer than a
time frame greater than a year) year)
Property, Plant and Equipment xxx Long-term Debt xxx
(Also called fixed assets including (Debt to be repaid in a long-term
property, machinery and other equipment that the horizon that is more than the company’s operating
company cannot easily liquidate) cycle)
Goodwill xxx Deferred Tax Liabilities xxx
(Intangible asset associated with a (Tax expenses to be paid in long-term
company’s brand name and customer relation when horizon deferred in the current period)
one company purchases another company)
TOTAL NON-CURRENT ASSETS xxx TOTAL NON-CURRENT LIABILITIES xxx

NET WORTH
Common Stock xxx
(Value that shareholders have invested
in the company initially as well as additional amount
raised through issue of shares)
Retained Earnings xxx
(Total amount of net income that the
company decides to keep from its net income. The
rest is given out as dividends. This retained earnings is
accumulated over time through its operations.)

TOTAL NET WORTH xxx

TOTAL ASSETS xxx TOTAL LIABILITIES & EQUITY xxx

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7. CASH FLOW STATEMENT

The cash flow statement explains cash inflows and outflows in a company and will ultimately reveal the
amount of cash the company has in hand at the end of the year. It tries to explain how the company has
been earning and spending its cash throughout the year. It is designed to convert the accrual basis of
accounting used in the income statement and balance sheet back to a cash basis.
The cash flow statement reveals the following information:
o How the company obtains and spends cash
o Why there may be differences between net income and cash flows
o If the company generates enough cash from operation to sustain the business
o If the company generates enough cash to pay off existing debts as they mature
o If the company has enough cash to take advantage of new investment opportunities

Some of the terms used below:

o Cash: Comprises cash on hand and demand deposits with banks
o Cash Equivalents: Short term, highly liquid investments that are readily convertible into known
amounts of cash and which are subject to an insignificant risk of changes in value
o Cash Inflows: Any cash/cash equivalent receipts by the company
o Cash Outflow: Any cash/cash equivalent disbursal by the company

Basic Premise of a Cash Flow Statement:

Cash at the Cash at the

Cash from Cash from Cash from
start of the end of the
Operations Investing Financing
year year

Methods:
There are 2 methods to build a cash flow statement, the basic difference is in the format for cashflow
from operating activities:

Direct method: Indirect method:

Starts with Net Income from income
Shows all cash inflows (revenue, other
statement, from which non-cash and
income) that the company has received,
irrelevant expenditure/income are
from which are then subtracted all the
added/subtracted
cash outflows (COGS, Salaries, etc.)
Preferred since it shows a reconciliation
Usually not followed
from net income to operating cash

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Cashflows from Operating Activities (Indirect Method):

It refers to cash inflows and outflows related to a company’s core business operations. It starts with Net
Income, which is then adjusted for non-cash expenditure like depreciation (since actual cash isn’t going
out), interest and dividend expenses (since these expenses are related to company’s financing) followed
by changes in working capital.
Working capital:
Working capital refers to the difference between the current assets and current liabilities. A change in
working capital affects the cash available with the company and since these items are related to core
business operations, we deduct the change in working in Cashflows from operating activities.
o Increase in Current Assets: If current liabilities increase, more cash is tied up in non-cash assets (e.g.,
inventories), leading to a reduction in cash balance
o Decrease in Current Assets: If current assets decrease, it means that the company has sold/realized
some asset and received cash in return. This increases the cash balance
o Increase in Current Liabilities: Increase in current liabilities means that the company has taken up
some liability/borrowed in the short-term, resulting in an increase in cash balance
o Decrease in Current Liabilities: A decrease in current liabilities means that the company has paid off
some liabilities, resulting in a decrease in the cash balance
Particulars Amount
Net profit before taxation, and extraordinary item xxx
Adjustments for:
o Depreciation (Non-cash expense) xxx
o Interest Earned (Not related to core operations) (xxx)
o Dividend income (Not related to core operations) (xxx)
o Interest expense (Not related to core operations) xxx
o Operating profit before working capital changes xxx

o Increase in debtors (xxx)

o Decrease in inventories xxx
o Decrease in creditors (xxx)
o Cash generated from operations xxx

Income taxes paid (xxx)

Net Cashflow from Operations xxx

Cashflows from Investing Activities:

Refers to any investments and/or sale of investments made by the company (Purchase/sale of an asset,
etc.). It also includes any other income that company earned by making that investment. (E.g. Interest
received by providing a loan, dividend earned by making an equity investment, etc.)

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Cashflows from Investing Activities:

Particulars Amount
o Purchase of fixed assets (xxx)
o Proceeds from sale of equipment xxx
o Interest/Dividends received xxx
o Purchase of Equity shares/Debt instruments xxx

Net cash from investing activities xxx

Cashflows from Financing Activities:

Refers to any fundraising activities of the company like raising debt or equity. Also includes repayment of
debt, buyback of shares, dividends/interest paid, etc.
Particulars Amount
o Proceeds from issuance of share capital xxx
o Proceeds from long-term borrowings xxx
o Repayment of long-term borrowings (xxx)
o Interest paid (xxx)
o Dividends paid (xxx)

Net cash used in financing activities xxx

Net Cash:
Net increase in cash and cash equivalents: This refers to the net increase/decrease in the cash due to
operating, investing, and financing activities.
Cash and cash equivalents at beginning of period: Closing cash balance for last year.
Cash and cash equivalents at end of period: Closing cash balance for this year = Opening balance + Net
increase/(Decrease) in cash throughout the year.
Particulars Amount
Cash/Cash Equivalents at the beginning of year xxx
Add: Net increase/(Decrease) in cash throughout the year xxx

Cash/Cash Equivalents at the end of year: xxx

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8. FINANCIAL RATIOS
• Financial Ratios are used to evaluate financial health of the firm which helps in taking better
investment decisions by understanding the business performance of the company. They can also be
used to compare 2 companies.
• Based on the kind of financial metrics used we can classify financial ratios into 4 major categories:

Liquidity Ratios:
Measures a firm’s ability to meet its short-term obligations without raising external capital.
• Current Ratio: Indicates the company’s ability to pay off its short-term obligations using its current
assets only. A general rule of thumb is 2:1 for it but it varies according to industry in which the firm is
operating.
Current Ratio = Current Assets
Current Liabilities
• Quick Ratio: The quick ratio evaluates a company’s ability to pay its short-term liabilities with only
assets that can quickly be converted into cash. Therefore, the quick ratio excludes accounts such as
inventories and prepaid expenses.
Quick Ratio = (Cash + Quick Assets + Accounts Receivables)
Current Liabilities

Solvency Ratios:
Measures a firm’s ability to meet its long-term obligations.
• Debt to Assets: Indicates the percentage of assets that are being financed with debt. The higher the ratio,
the greater the degree of leverage and financial risk.

Debt to Assets = Total Debt

Total Assets

• Debt to Equity: Indicates whether a company’s capital structure utilizes more debt or equity financing. A
higher debt-equity ratio indicates a levered firm – a firm that is financed with debt. Leverage has benefits
such as tax deductions on interest expenses but also the risks associated with these expenses.

Debt to Equity = Total Debt

Total Shareholder’s Equity

• Financial Leverage: Also called Equity Multiplier. measures the portion of the company’s assets that are
financed by equity. It is also used to indicate the level of debt financing that a firm has used to acquire
assets and maintain operations.

Financial Leverage = Total Assets

Total Equity

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Profitability Ratios:
Measures the ability of a firm to generate a return on its assets.
• Gross Profit Margin: It shows how much profit a company makes after paying off its cost of goods sold.

Gross Profit Margin = Gross Profit

Revenue
• Return on Assets: Indicates how well a company is performing by comparing the profit it is generating
to the total capital it has invested in assets. The higher the return, the more productive and efficient
the management is in utilizing economic resources.

Return on Assets (ROA) = Net Income

Total Assets
• Return on Equity: measure of a company’s annual return (net income) divided by the value of its total
shareholders’ equity. Return on equity is a product of asset efficiency, profitability, and financial
leverage.
Return on Equity (ROE) = Net Income
Total Equity

Activity Ratios:
Determines the efficiency of the firm in utilizing its assets to generate revenue.
• Accounts Receivable Turnover: Measures the number of times over a specific period that a company
collects its average accounts receivable.
Accounts Receivable Turnover = Total Net Sales
Average Accounts Receivable
• Accounts Payable Turnover: Shows how many times in one accounting period the company turns over
(repays) its accounts payable to creditors.

Accounts Payable Turnover = Cost of Goods Sold

Average Accounts Payable
• Inventory Turnover: Measures how many times a business sells and replaces its stock of goods in each
period. It indicates how efficient a business is at clearing its inventories.
Inventory Turnover = Cost of Goods Sold
Average Inventory
• Debt Coverage: Indicates company’s ability to satisfy its debt obligations, and its capacity to take on
additional debt without impairing its survival.

Debt Coverage = (Net Profit + Any non-cash expense)

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DuPont Analysis:
• The DuPont analysis is a framework for analyzing fundamental performance.
• DuPont analysis is a useful technique used to decompose the different drivers of return on equity
• Breakdown of ROE is done to analyze the impact of Liquidity, Profit margins, and turnover on equity.
• An investor can use analysis like this to compare the operational efficiency of two similar firms.
Managers can use DuPont analysis to identify strengths or weaknesses that should be addressed.

Three-Step DuPont Five-Step DuPont

The three-step equation breaks up ROE into The five-step DuPont equation breaks down net profit
three very important components: margin further showing that that increases in
leverage don't always indicate an increase in ROE.
ROE = EBT × S × A × (1-TR)
ROE = NPM × Asset Turnover × Equity Multiplier
S A E
where: where:
• NPM = • EBT = Earnings before tax
Net profit margin, the measure of operating • S = Sales
efficiency • A = Assets
• Asset Turnover = Measure of asset use efficiency • E = Equity
• Equity Multiplier = Measure of financial leverage​ • TR = Tax rate

• Both the three- and five-step equations provide a deeper understanding of a company's ROE by
examining what is changing in a company rather than looking at one simple ratio. As always with
financial statement ratios, they should be examined against the company's history and its competitors

Limitations of Financial Ratios:

• Financial ratios are not useful when viewed in isolation. They are only valid when compared to those
of other firms or to the company’s historical performance.
• Comparisons with other companies are made more difficult because of different accounting
treatments. This is particularly important when analyzing non-US firms.
• It is difficult to find comparable industry ratios when analyzing companies that operate in multiple
industries.
• Conclusions cannot be made from viewing one set of ratios. All ratios must be viewed relative to one
another.
• Determining the target or comparison value for a ratio is difficult, requiring some range of acceptable
values.

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Useful Resources:
• https://www.youtube.com/watch?v=7-y9ZCbMUlo&feature=youtu.be
• https://youtu.be/lRq58tmMpJc
• https://youtu.be/vuetn_PQOvM
• https://www.coursera.otg/learn/wharton-accounting
• https://www.coursera.org/learn/wharton-finance
• https://www.coursera.org/specializations/wharton-business-financial-modeling
• https://www.coursera.org/specializations/financial-management

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