Engineering Economics & Finance

Niladri Das
Associate Professor
Department of Management Studies
 Financial Statements
 Financial statements provide information about the financial
activities and position of a firm.

 Important financial statements are:

 Balance sheet
 Profit & Loss statement
 Cash flow statement

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

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

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 Current Assets
 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

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 Fixed Assets
 Fixed assets are long-term assets.
 Tangible fixed assets are physical assets like land, machinery,
building, equipment.
 Intangible fixed assets are the firm’s 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.

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 Liabilities
 Liability is a firm’s obligation to pay cash or provide goods or
services in the future.

 Two types of liabilities are:

 Current liabilities
 Long-term liabilities

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 Current Liabilities
 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

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 Long-term Liabilities
 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.

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 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 earnings)—representing
undistributed profits.
 Paid-up share capital and reserve and surplus
together are called net worth.

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 Gujarat Narmada Valley Fertilizers Company
Balance Sheet as on 31 March

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 Balance Sheet Relationship
 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

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 Balance Sheet Relationship
 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

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 Profit & Loss Statement
 Profit & Loss statement provides information about a firm’s:
 revenues,
 expenses, and
 profit or loss.

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 Nature of Revenues
 Revenue is the amount received or receivable within the
accounting period from the sale of the firm’s 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.

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 Nature of Expenses
 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.

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 Concepts of Profit
 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)

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

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 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.

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 Definition of Funds
 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.

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 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.

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 Effect of Changes in Accounts on
Working Capital

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 Sources of Working Capital
1. Funds from operations (adjusted net income)
2. 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
3. Long-term financing:
 long-term borrowings (institutional loans, debentures, bonds, etc.)
issuance of equity and preference shares
4. Short-term financing such as bank borrowings

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 Uses of Working Capital
1. Adjusted net loss from operations
2. Purchase of non-current assets:
 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. Repayment of long-term debt (debentures or bonds) and short-
term debt (bank borrowing)
4. Redemption of redeemable preference shares
5. Payment of cash dividend

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

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Comprehensive Funds Flow Statement:
Financial Resources Basis
ACME Company

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 CASH FLOW STATEMENT
 A 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.

 This statement analyzes changes in noncurrent accounts as well as

current accounts (other than cash) to determine the flow of cash.

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 Sources of Cash
 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.

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

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Comprehensive Cash Flow Statement:
Financial Resources Basis
ACME Company

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 USES OF THE STATEMENT OF CHANGES
IN FINANCIAL POSITION
It helps to answer the following questions:
1. What is the liquidity position of the firm?
2. What are the causes of changes in the firm’s working capital or cash position?
3. What fixed assets are acquired by the firm?
4. Did the firm pay dividends to its shareholders or not? If not, was it due to shortage of funds?
5. How much of the firm’s working capital needs were met by the funds generated from current
operations?
6. Did the firm use external sources of finances to meet its needs of funds?
7. If the external financing was used, what ratio of debt and equity was maintained?
8. Did the firm sell any of its non-current assets? If so, what were the proceeds from such sales?
9. Could the firm pay its long-term debt as per the schedules?
10. What were the significant investment and financing activities of the firm that did
not involve working capital?

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References
 Financial Management- I M Pandey, Vikas Publishing
 Finance Sense - Prasanna Chandra, Tata Mc Graw Hill (CFM-
TMH Professional Series in Finance)