how+to+read+balance+sheet

8/4/2019 How+to+Read+Balance+Sheet

http://slidepdf.com/reader/full/howtoreadbalancesheet 1/26

Professor .V.RAMACHANDRAN.SIESCOMS, NERUL,

NAVI MUMBAI.

HowHow Read Financial StatementsRead Financial Statements



Three Categories of Statements

� Each shareholder gets an ³Annual Report´

� Statement from Chairman/President/MD

�

Firm¶s operating results for the last financialyear in qualitative terms, future outlook

� Quantitative statements

Balance Sheet

Profit and Loss Statement (Income Statement)Cash Flow Statement



Balance Sheet

� It is actually a snap shot at the instant it isprepared

� Shows the company¶s financial position whatthe company owns and owes

� Shows the sources and applications of funds

� It is not duration specific like P&L statement .

� Can be prepared even every day;

� Companies in India usually Prepare on a

Quarterly/Annual basis.� Numbers by themselves are not important; ratios

are.



Balance Sheet continued«

� As per Double entry accounting system: The Assetsand Liabilities must balance

� Every transaction gets entered at two places under different heads so that accounts are ³balanced´.

� Credit / Debit or Assets / Liabilities

� Compare the movement across the quarters or years

� Scope for manipulation: Asset valuation, paymentrealization (GAAP)



Balance Sheet Structure & Financial Management

Decisions

Liabilities Assets

Long Term Liabilities Fixed Assets

Equity,TermLoans,Debentures

Land,Buildings,Vehicles,Equipments

Current Liabilities Current Assets

Accounts payables Cash, Account

receivables

Short Term Loans Inventory,WIP,Finished

Goods

Capital Structure

Decisions

Capital

budgeting

Decisions

Operating policy Decisions



Assets

� You pay for them to acquire them and so you

³own´ them

� They can be tangible or intangible (goodwill,

monopoly)

� They generate revenues in short or long term

� Liquidity of an asset: Length of the time it takes

to generate revenue

� Their value generally depreciates over time

� They can be revalued on some events



Examples of Assets

Current Assets

� Cash in bank and in hand (bank balance, physical cash)

� Marketable Securities (parked funds)

� Accounts Receivables

�

Inventory (Raw Materials, Work In Progress Finishedgoods)

Fixed Assets

� Land, Building, Plants, Offices, Vehicles

�

Equipment (PCs, Office equipment, Test jigs)� Patents, Copyrights, Trademarks

� Goodwill, Brand Position



Liabilities

� Money received from outside sources that

has been made available to the firm

� The firm owes them to outside agents

including the shareholders

� Liabilities can be with short term, longterm, or no term repayment schedules



Examples of Liabilities

Current Liabilities� Accounts payable (supplier credit)

� Accrued corporate tax

�

Short term loansLong Term Liabilities

� Debentures

� Long term loans

� Equity (common stock + preferred stock)

� Retained earnings



A Typical Manufacturing Company Starts

Operation

Liabilities Assets

Equity 5,00,000 Cash 5,00,000

Total 5,00,000 Total 5,00,000

Two promoters deposit Rs 5 lakhs in the company account as

equity

XYZ Private Limited

Balance Sheet at April 1, 2001



A lathe is bought on cash basis

Liabilities Assets

Equity 5,00,000 Cash 2,00,000

Plant 3,00,000

Total 5,00,000 Total 5,00,000

Owner pays Rs 3 lakhs from the bank acount



Raw material worth Rs 80,000 bought on a 60 day

credit basis

Liabilities Assets

Equity 5,00,000 Cash 2,00,000

Account

Payable80,000 Plant 3,00,000

Inventory 80,000

Total 5,80,000 Total 5,80,000

No payment is done so cash position does not change



Raw material worth Rs 40,000 processed and sold for Rs 50,000 with

a 30 day credit

Liabilities Assets

Equity 5,00,000 Cash 2,00,000

Accounts Payable 80,000 Plant 3,00,000

Retained

Earnings

10,000 Inventory 40,000

Accounts Receivable 50,000

Total 5,90,000 Total 5,90,000

No payment is done so cash position does not change, but inventory is reduced



Customer pays up after 20 days

Liabilities Assets

Equity 5,00,000 Cash 2,50,000


Retained Earnings 10,000 Inventory 40,000


Total 5,90,000 Total 5,90,000

Payment deposited in bank so cash position changes



Supplier credit period is over and raw material is paid

for after 60 days

Liabilities Assets

Equity 5,00,000 Cash 1,70,000


Retained

Earnings

10,000 Inventory 40,000


Total 5,10,000 Total 5,10,000

Payment done from bank so cash balance reduces



Profit & Loss Account (Income Statement)

Sales Revenues 4,00,000Other Revenues 1,00,000

Total Revenues 5,00,000 100 %

Cost of Goods Sold 2,00,000 40 %Gross Profit 3,00,000 60 %

Operating Expenses 1,50,000 30 %PBITD

1,50,000 30 %Interest + Tax + Depreciation 25,000 5 %

Net Profit 1,25,000 25 %



Cash Flow / Funds Flow Statement

� Differences in successive balance sheets

� Sources of Funds Net profit

Issue of new share capital

Sale of fixed assets

New loans

� Use of Funds Payment of dividends

Purchase of fixed assets

Repayment of loans



Ratio Analysis

� Compare the performance of the company for three/five successive years

� The absolute numbers change so compare

ratios

� Compare two companies of differing size butfrom the same industry, e.g, Infosys and Mastek

� Calculate industry-wide numbers (net profitmargins for automobile companies)



Liquidity Ratios

� Measure a firm¶s ability to meet its short term obligations� Show trends early and so corrective actions can be taken

in the working capital management

� Current Ratio: Current Assets / Current Liabilities

� Acid Test Ratio or Quick Ratio:

(Current Assets ± Inventory) / Current Liability

(Cash or cash equivalent) / Current Liability

A firm is ³solvent´ if its assets are greater than outsideliabilities. A firm is ³liquid´ if its current assets aregreater than its current liabilities



Gearing Ratios

� Leverage of a firm: Proportion of its longterm liabilities that are debts

� Long term liabilities = Debts + Equity� Debt/Equity ratio

Loan Capital / Share holder¶s funds

Gears, Leverage: Mechanical Engg terms



Asset Utilization Ratios

� Return on Total Investment: management¶s

skill in exploiting the funds made available

ROI =

PBT / (Shareholders¶ funds + Long term loans)

� Return on Shareholders¶ Equity

ROE =

PAT / (Shareholders¶ funds)Sales / Total Capital Employed



Profitability Ratios

� Net Profit Margin = NP / Sales

� Gross Profit Margin = GP / Sales



Market Value related Ratios

� EPS (Earning Per Share) :

NP / Total outstanding shares

� P/E : Market Price / Earning Per Share

� Revenue Multiple: Revenues / Assets

� Market to Book: Market Value / Book Value



Limitations of Financial Statements

� They are backward looking: Accrued resultsof the past year / quarter

� Company¶s value depends on its futureprofitability which depends on many factorsnot reflected in the balance sheet, which are

non-monetary

Nature and innovativeness of it products

Technology landscape (product obsolescence)

Competitors

Economic conditions (recession / boom), governmentpolicies

Staff and management morale



THANK YOU

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