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Accounting Principles
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Monetary transactions and Events enter the system Process Using an Accounting Mechanism Follow certain rules or principles of Accounting called as GAAP (Generally Accepted Accounting Principles) or Accounting standards Audit to lend credibility to the reports
The Balance sheet is a status report giving the Financial Position of the Company at a particular point of time
The profit and loss account or the Income statement, reports the companys revenues, expenses, and net income or net loss for the period. Revenues or Incomes arise from selling of goods or services to customers Expenses related to earnings are deducted from revenues
The statement of cash flows reports the companys cash inflows and Outflows from its various activities.
Balance Sheet
Balance Sheet
Gives the resources owned and their funding The assets owned and the claimants against the assets
Assets.
Liabilities
Owners equity
Resources owned by a firm Capable of giving future cash flows (by use or disposal value) Objectively verifiable arising from a past identifiable event
LIABILITIES
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Liabilities are Debts They are present obligations a firm owes. They are claims against the assets the firm. Liabilities may be to the owners or to outsiders
Uses of Funds
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Share Capital Reserves and Surplus Borrowings: Secured Unsecured Current Liabilities and Provision
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FIXED ASSETS
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Used for producing goods / services for renting out or for administrative uses Useful life of more than 1 year Not held for sale in the ordinary course of the business Disclosed : Gross book value As less: Accumulated Depreciation Net book value
FIXED ASSETS
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Depreciation is treated as Expenses and is charged to the profit and loss account Accumulated Depreciation its the sum of depreciation charged to the profit and loss account till the end of the current financial year
INVESTMENTS
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Are assets held as stores of value with a view to get interest, dividend or capital appreciation TYPES: Long Term/ Current (holding period) Quoted / Not Quoted Trade Investments
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Current assets are assets that form part of the operating cycle and take interrelated form Expected to be converted into cash in next 12 months Consists of :
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LIABILITIES
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They are present obligations a firm owes. They are claims against the assets the firm. Discharging the liability will result in the decline of the assets
Shareholders Funds
Share Capital { Amount contributed by owners towards the capital of the firm { They are divided into units called share { Have a face Value { RESERVES AND SURPLUS { They are the accumulated profits or retained earnings not distributed and owed by the business to the equity share holders Share Capital + R & S is called Net Worth
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LOANS
Are borrowing to be repaid as per agreed terms on which interest needs to be paid irrespective of availability of profits. TYPES:
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Arising on account of acquiring goods/services on credit or incurring expenses which are paid for later Normally they are to be settled within a period of 12 months
Deferred tax
Misc Expenditure and Losses (to the extent not written off)
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1579 100
Administration and Selling Exp PBIT (Operating Profit) INTEREST PBT INCOME TAX PROFIT AFTER TAX Padmini Srinivasan - iimb
Depreciation
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Some Myths about Depreciation It is a process of valuation It generates cash It helps in replacement to new machine
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Truths ..
Depreciation is the allocation of cost (depreciable value) of an asset to the periods that benefit from its use. Its a charge of the asset over the useful life of an asset
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Depreciation
Some Terms: { Original cost (OC) of the asset { Expected Useful life of the asset (This is not the physical life) { Residual Value (RV) at the end of the useful life { Depreciable Value of the asset (OCRV)
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Depreciation
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Which ever method you use the total depreciation to be charged over the useful life will be the same
Depreciation
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Formula:
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How is the financial condition of the company How investment activities have performed during the year How does the unit stand in comparison to the industry Preparation of Forecasts Evaluation of SBUs and departments Credit rating
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(An annual report and financials therein represents a snapshot at a given moment. { Directors Report - Working of the Company { Auditors Report { Management Discussion &Analysis { Profit and loss account { Balance Sheet { Cash Flow statements { Supplementary schedules and Notes { Accounting Policies { Subsidiary Company Information
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COMMON SIZE STATEMENTS HORIZONTAL ANALYSIS RATIO ANALYSIS CASH FLOW ANALYSIS
Expresses each income statement category as a percentage of net sales Expresses each item on balance sheet as a percentage of total assets or equities
HORIZONTAL ANALYSIS
Year to year changes { Changes in amounts and percentages { Reveals a trend & direction
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RATIO ANALYSIS
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GIVES THE LINK BETWEEN INVESTMENT, FINANCING AND OPERATING ACTIVITY i.e. how various items in the financial statements relate to one and another Analysis of Past performance helps in forecasting the future performance
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Note: Different authors take slightly different approach (formulas) for eg: PBIT instead of PAT etc., PBIT (NOPAT) is a good measure for inter divisions evaluation
FSA-Basic Structure
R Return on Equity E Leverage or Financial risk Return on Total Assets (ROI) Asset Turnover ratios Fixed Asset Turnover Current Ratio Current Asset TOR Inventory Turnover Debtors Turnover or Collection Period
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Profitability Ratios
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measure the overall performance of a firm and its efficiency in managing assets, liabilities and equity
Return Ratios
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Return on Equity
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Measure overall efficiency of the firm in managing investment in assets and generating return to stockholders
Return Ratios
Return on Total Assets (ROCE)
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PAT /Avg Total Assets or - PBIT/ AVG Total Assets* - NOPAT / Total Assets
The ratio measures the overall efficiency of the firm in managing investment in assets and generating return to stockholders
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Profitability Ratios
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Net Profit After Tax/Net Sales PBIT (Profit before interest and tax) /Net Sales Salary/Net Sales
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Sales / Avg Fixed Assets Assess the effectiveness of the fixed assets to generate sales Also reflects the investment strategies
Number of Days Stock Avg Inventory / Sales(COGS) per day (Measures efficiency of inventory management (not the inventory policy of the management)
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Accounts Receivable/Average Daily Sales (Avg daily sales = Credit sales/365) Another measure of efficiency of firms ability to collect fast Helps gauge liquidity of accounts receivable (ability to collect cash from customers)
Financial Leverage
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Financing Pattern
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Leverage Ratios
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measure the extent of a firms financing with debt relative to equity and its ability to cover interest and other fixed charges also called as the Solvency ratios Measures the firms ability to meet cash needs as they arise
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Liquidity Ratios
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Liquidity Ratios
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Current Ratio
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Current Assets/Current Liabilities Measures ability to meet short-term cash needs Current Assets-Inventory/Current Liabilities Measure ability to meet short-term cash needs more rigorously
Earnings
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per Share
PAT /Average Equity Shares z Indicates return on a per share basis Book Value of the Share Net worth / Number of shares
CASH IS CASH REST IS ACCOUNTING!!! Accounting profits do not help in assessing the firms ability to meet its debts
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As they are based on accrual concept As they are based on subjective judgements like depreciation
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Cash flow statement can be taken as a summary of the cash book Need for cash flow statement arises from the deficiencies in the profit and loss a/c and the balance sheet, as these numbers are influenced by the accounting policies etc Cash flow statement helps in forecasting future value.
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Objectives of a CFS
Provide information to the user on: - ability of the enterprise to generate cash and cash equivalents and the timing and certainty of their generation. - the manner in which the enterprise puts cash and cash equivalents to use. - financial structure, liquidity, solvency,net assets and adaptability of the enterprise Padmini Srinivasan - iimb -
Provides information on cash flow related to operation financing and investing activities Firms follow the accrual and matching principle to record transactions and hence the company's incomes/ expenses are not related to cash
CASH FLOWS ARE DIVIDED INTO 3 SEGMENTS AS : CASH FLOW FROM OPERATING ACTIVITY CASH FLOW FROM INVESTING ACTIVITY CASH FLOW FROM FINANCING ACTIVITY
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OPERATING ACTIVITIES
Includes the cash flows derived from principal revenue producing activities of enterprise. Cash receipts from main business of company. Cash receipts from royalties, fees, etc. Cash payment to supplier. Cash payment to and behalf of employees. Cash payments or refunds of income tax.
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INVESTMENT ACTIVITIES
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Shows the expenditure that have been made to generate future income and cash flows.
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Cash payment to acquire fixed assets. Cash receipts from disposal of fixed assets (including intangibles) Cash payment to acquire shares ,warrants or debt instrument of other firms. Cash receipts from disposal of shares Padmini Srinivasan - iimb etc
FINANCING ACTIVITIES
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proceeds from issuing shares or other similar instruments { Cash received from debentures,loans bonds and other borrowings { Cash repayments of amount borrowed. Padmini Srinivasan - iimb
A firm is defined as profitable if it has a positive net income A positive net income results from revenues exceeding expenses A firm may have a positive net income, but this does not guarantee that the firm has the CASH to meet its obligations!
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4. 5.
BS: Capital 50000 = Cash 50000 Capital 50000 + Crs 20000 = Inventory 50000 + Cash 20000 OE 50000+ Profit 60000+ Crs 20000 = Drs 100000 + Inv 10000 + Cash 20000 OE 50000+ Profit 60000+Crs 20000 = Eqpt 15000+DRs 100000+ Inv 10000+Cash 5000 OE 50000+ Profit 57000+Crs 20000 = Eqpt 12000+DRs 100000+ Inv 10000+Cash 5000
CFO: Paid Creditors CFF Capital CFI Equipment Ending Cash Balance
(30000)
CFO:PAT Add: Depreciation Cash flow before WC Changes Increase Creditors 20000 Increase in Drs - 100000 Increase in Inv - 10000 Net outflow CFF Capital CFI Equipment Ending Cash Balance
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Forward Contracts
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Used for hedging open positions Its contract to deliver or receive at a specified rate &date a certain amount of foreign currency. Open positions hedged like foreign currency assets/liabilities or commitments eg : Receivable /Payables / loans