KEY CONCEPTS OF FINANCE

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Financial Statements
Income Statement or Profit & Loss (P&L) account
This statement gives the income earned and expenses, and therefore the profit, for a particular period. Components of P&L are: Revenues: All income earned, by the business of the company. Hence if the business is selling chocolates or cars, this is the income from chocolates/cars sold during the period. Direct expenses: These are expenses which vary directly with units produced. Direct expenses include raw material and labour, and appear only in the P&L of a manufacturing company. Operating expenses: It refers to the day to dayrunning expenses of the business. E.g.: Stationery items, electricity, salaries, telephone bills, travel, promotional activities, etc. Operating profit: Calculated by [Revenues (direct+operating expenses)], it is an important indicator of the health of the business: it shows whether the core business is profitable! Depreciation/amortization: It is that portion of large costs/lump-sum expense, which you are considering in this accounting period. Other Expenses: These are non-operating expenses.For example, if you have hired a lawyer to provide a legal opinion, the lawyers fee would come under this. Of course, if you have a lawyer as an employee, then her salary is part of operational expenses. Other income: It is non-operating income, such as interest income on deposits Extra ordinary income and expense are large, unusual sums which occur rarely. For example, when a business unit is sold off or bought. Operating Profit (Depreciation & Amortisation)+Other Income Other expenses + Extra-ordinary income Extraordinary expense = Profit or Earnings Before Interest & Tax, called PBIT or EBIT. After deducting interest expenses on any borrowings, the profit left is called Profit Before Tax or PBT; tax is then applied as a percentage of PBT, resulting in Profit After Tax or PAT. PAT is what the share-holders or owners have a claim on. If any of the profits are distributed back to the owners, thats called dividend. The remainder gets reinvested back into the business and appears under the heading Retained Earnings, under the Owners Equity part of the balance sheet.

Cash Flow Statement

The cash flow statement fulfills the requirement of tracking the cash of a business. It is divided in to three sections: Cash Flow from Financing: The cash flow arrived at by financing activities such as borrowing money, getting capital from owners, and repaying both

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KEY CONCEPTS OF FINANCE

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Cash Flow from Investing: The cash flow arrived at by investment activities such as purchasing or selling stocks and bonds or machinery. Cash Flow from Operations: The cash flow arrived at by operating activities: sales and expenses. This cash flow is of prime importance for a lender as it ensures ongoing repayment capacity

Balance Sheet:
The balance sheet is the position of a business as on a particular date. (Unlike the P&L and cash flow, which are over a period of time). The main components of a balance sheet are Assets, Liabilities and Owners Equity. Assets: Assets are divided into Current Assets (CA) & Long Term Assets. Current assets: These are assets which can be converted into cash within the accounting period. Receivables Inventories Prepaid expenses Other Current Assets Long-term Assets: It includes fixed assets, long term receivables & Intangible assets. Liabilities: It includes both current liabilities and long-term liabilities. Current Liabilities: These are items which have to be paid within the accounting period: Short term loans Account/Trade payables Accrued expenses Customer advances taxes payable Current portion of long term debt Other Current Liabilities Long Term Liabilities: It is the summation of long term debt, deferred liabilities/provisions & other liabilities. Net Worth or Owners Equity: It includes share capital, retained earnings & reserves. Contingent Assets & Contingent Liabilities: They are not assets or liabilities as on balance sheet date. But they may become assets/liabilities based on, or contingent upon some external occurrence.

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KEY CONCEPTS OF FINANCE

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Concept of Sources and Uses of Funds: In a business, there are certain components of the balance sheet which bring in funds into the business: such as loans, owners capital, customer advances. Hence, all liabilities and owners equity are described as a source of funds for a business; and all assets (except cash) as a use of funds.

Exercises: 1. Which of the following items belong to the Balance Sheet dated 31st December 2010? Note that salaries and telephone bills are paid in the month after they are incurred. Salaries for the month of Jan 2011 b. Salaries for the month of Nov 2010 c. Telephone bill of Dec 2010 d. Sales for Dec 2010, payment yet not received DCB Ltd purchased a machine for INR 10 crore in the year 2009. The terms of the payment were: down payment of INR 1 crore and nine equated yearly instalment of INR 1.1 crore starting from the next year. What will be the effect of this transaction on DCB Ltd cash flow statement for 2009? What type of cash flow would you classify this cash flow under?

a.

2.

Answers: 1. Items b & d. 2. The cash flow would show the down payment of INR 1 crore. It would affect cash flow from investments, as one is purchasing an asset.

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