Chapter 1

ACCOUNTING IN ACTION
Definition of Accounting:

“Accounting is a services activity. Its function is to provide quantitative information,

primarily financial in nature, about economic entities that is to be useful in making economic
decisions, in making reasoned choices among alternative courses of action.” ---- AICPA
(1970).
Accounting is defined as “the process of identifying, measuring, and communicating
economic information to permit informed judgments and decisions by users of the
information.” --- AAA (1966).

Objectives of Accounting:
1. Making decisions concerning the use of limited resources, including the identification
of crucial decision areas and determination of objectives and goals.
2. Effectively directing and controlling an organization’s human and material resources.
3. Maintaining and reporting on the custodianship of resources.
4. Facilitating social functions and controls (with respect to taxation, detection and
protection of frauds, government control on public utility services, government
incentives for encouraging trade and commerce, statistics on economic activities, et.).
Scope of Accounting:

1. Data Creation and Collection: Historic and Predictive

2. Data Recording using Accounting Methods (GAAP) and Data Processing (Manual,
Mechanical and Electronic)
3. Data Evaluation that includes:
(a) Budgetary Control including Standard Costing and Variance Analysis
(b) Performance Analysis
(c) Cash Flow Analysis
(d) Analysis and Interpretation of Accounting Information (for external and internal
decision makers)
(e) Auditing
4. Data Reporting to internal management (according to their demand) and external
stakeholders (financial statements and notes accompanying those statements)
5. Accounting Theory in the heart of the above.
Information Needs of the Users of Financial Statements

According to paragraph 9 of the Framework for the Preparation and Presentation of

Financial Statements of the IASB (International Accounting Standards Board), the users of
financial statements include present and potential investors, employees, lenders, suppliers and
other trade creditors, customers, governments and their agencies and the public. They use
financial statements in order to satisfy some of their different needs of information. These
needs include the following:
(a) Investors: The providers of risk capital and their advisers are concerned with the risk
inherent in, and return provided by, their investments. They need information to help
them determine whether they should buy, hold or sell. Shareholders are also interested
in information which enables them to assess the ability of the enterprise to pay
dividends.
(b) Employees: Employees and their representative groups are interested in information
about the stability and profitability of their employers. They are also interested in
information which enables them to assess the ability of the enterprise to provide
remuneration, retirement benefits and employment opportunities.
(c) Lenders: Lenders are interested in information that enables them to determine whether
their loans, and the interest attaching to them, will be paid when due.
(d) Suppliers and other trade creditors: Suppliers and other creditors are interested in
information that enables them to determine whether amounts owing to them will be paid
when due. Trade creditors are likely to be interested in an enterprise over a shorter
period than lenders unless they are dependent upon the continuation of the enterprise as
a major customer.
(e) Customers: Customers have an interest in information about the continuance of an
enterprise, especially when they have a long-term involvement with, or are dependent
on, the enterprise.
(f) Governments and their agencies: Governments and their agencies are interested in the
allocation of resources and, therefore, the activities of enterprises. They also require
information in order to regulate the activities of enterprises, determine taxation policies
and as the basis for national income and similar statistics.
(g) Public: Enterprises affect members of the public in a variety of ways. For example,
enterprises may make a substantial contribution to the local economy in many ways
including the number of people they employ and their patronage of local suppliers.
Financial statements may assist the public by providing information about the trends
and recent developments in the prosperity of the enterprise and the range of its
activities.

1
Role of Accounting:

 Role as watchdogs – scorekeeping function (recording data for a later evaluation of

performance)
 Role as helpers – (1) attention directing function (reporting and interpretation of
information for the purpose of focusing on inefficiencies of operation or opportunities
for improvement); and (2) problem solving function (presenting a concise analysis of
alternative courses of action)
 Role as decision maker – regarding information decision for choosing needed
information for action choice
 Role as an associate with business world – maintaining records and documents of
organizations, preparation and presentation of financial statements through which
capital investments are invited, credit-worthiness is verified and basis for income tax
determination is found
 Role as a professional – doing auditing, tax consultancy, other professional services as
a ‘person of trust’
 Role as technicians – being skilled in business management techniques working as a
part of management and as an external consultant on different issues such as
accounting system design, short- and long-term planning, etc.
Functions of Accounting:

Types of Accountants Areas of Accounting

Financial Accounting Management Tax Accounting
Accounting
Private Accountants Preparation of General accounting, Preparation of
(accountants employed in financial statements Cost accounting, tax return, Tax
private firms) Preparation of budgets, planning
Internal audit
Public Accountants Audit of financial Advisory services to Preparation of
(independent professional statements management tax return, Tax
accountants for public planning
services)
Government Preparation of General accounting, Review of tax
Accountants financial statements, Cost accounting, return, Help to
(accountants employed Review of financial Preparation of budgets, taxpayers,
in government units) statements, Writing Internal audit Writing
regulation, regulation,
Investigation of Investigation of
violation of laws violation of laws
Forensic Accountants 1. Detection of:
(accountants hired by  Preparators of theft and frauds in corporate entities;
both private and  money-laundering;
government units)  identity-theft;
 tax evasion;
 insurance frauds such as arson;
2. Identification of materials assets in divorces

2
Parties involved with Accounting and Users of Accounting Information:

Generally
Accounting Accepted
Standards- Accounting
Setters Principles
(GAAP)

Preparers of
Financial
Statements Financial
Statements Users of
Accounting
Information
Audit
Reports
Auditors

Generally Internal Users: External Users:

Management - Investors (owners)
Auditing Accepted - Employees
Standards- Auditing - Lenders
Setters Standards - Suppliers and other
(GAAS) trade creditors
- Customers
- Government and its
representatives
- Public
- Regulatory agencies

3
Accounting as an Information System:

An accounting system consists of the personnel, procedures, devices, and records used by an
organization (1) to develop accounting information and (2) to communicate this information
to decision makers. The basic purpose of the accounting is to meet the organization’s needs
for accounting information as efficiently as possible.

Many factors affect the structure of the accounting information system (AIS) within a
particular organization. Among the most important are (1) the organization’s needs for
accounting information and (2) the resources available for operation of the system.

Viewing accounting as an information system focuses attention on the information

accounting provides, the users of the information, and the support for financial decisions that
is provided by the information. These relationships are depicted below:

ACCOUNTING AS AN INFORMATION SYSTEM

Information Users: Decisions

- Managers Supported:
- Investors (owners) Financial Information - Performance
- Employees evaluations
Provided:
- Lenders - Stock investments
- Suppliers and other - Profitability
- Tax strategies
trade creditors - Financial Position
- Labour relations
- Customers - Cash Flows - Resource allocations
- Government and its - Lending decisions
representatives - Borrowing
- Public
- Regulatory agencies

Output of Accounting – Financial Statements:

The output of accounting process is called ‘financial statements.’ In the general sense of the
word, a statement is simply a declaration of something believed to be true. A financial
statement is simply a monetary declaration of what is believed to be true about an enterprise.
When accountants prepare financial statements, they are describing in financial terms certain
attributes of the enterprise that they believe fairly represent its financial activities.

According to paragraph 7 of International Accounting Standard (IAS) 1, a complete set of

financial statements includes: (a) balance sheet; (b) income statement; (c) statement of
changes in equity; or statement of changes in retained earnings; (d) cash flow statement; and
(e) accounting policies and explanatory notes.

4
Accounting Process/Cycle:

The sequence of accounting procedures used to record, classify and summarize accounting
information is often termed as accounting cycle. In another way, the procedures established
by every business unit to provide the data to be reported on the financial statements are
collectively referred to as the accounting process or accounting cycle. The term ‘cycle’
indicates that these procedures must be repeated continuously to enable the business to
prepare new up-to-date financial statements at reasonable intervals. In a broader coverage, the
accounting cycle includes the following steps:

1. Identification of transactions: Occurrence of transactions explicitly (affecting the

concerned business unit for an involvement with an external party) or implicitly
(such as depreciation occurring as the result of ownership of a fixed asset,
consumption of office supplies purchased earlier and recorded as asset), where the
financial effect is measurable in definite monetary terms and then preparation or
collection of source documents of those transactions to ensure their objectivity of
occurrence.
2. Journalizing (Journalize or record transactions): Enter all transactions in the
journal by analyzing them into debit(s) and credit(s) accounts, thus creating a
chronological record of events.
3. Posting to the ledger (Posting to ledger accounts): Post debits and credits from
the journal to the proper ledger accounts with a running balance, thus creating a
record classified by accounts.
4. Preparation of a trial balance: Prove the equality of debits and credits in the
ledger.
5. Adjusting entries (Make end-of-period adjustments): Make adjusting entries in
the general journal and post to ledger accounts. The purpose is to assign to each
accounting period appropriate amounts of revenue and expenses Adjusting entries
are made to: (i) convert assets to expenses result from cash being paid prior to an
expense being incurred, (ii) convert liabilities to revenues result from cash being
received prior to revenue being earned, (iii) accrue unpaid expenses result from
expenses being incurred before cash is paid, and (iv) accrue uncollected revenue
result from revenue being earned before cash is received.
6. Preparation of an adjusted trial balance: Prove again the equality of debits and
credits in the ledger. Note that the figures mentioned in the adjusted trial balance are
the amounts used in the preparation of financial statements.
7. Preparation of financial statements and appropriate disclosures: Financial
statements prepared include: income statement (showing the results of operations of
the concerned enterprise for the period concerned), statement of changes in retained
earnings (showing the changes in the retained earnings during the period), balance
sheet (showing the financial position of the enterprise at the end of the period), and
cash flow statement (showing the results of cash activities for the period). Financial
statements should be accompanied by notes disclosing facts and accounting
policies necessary for the proper interpretation of those statements.
8. Closing entries (Journalize and post the closing entries): The closing entries
“zero” the revenue, expense, and dividends accounts, making them ready for
recording the events of the next accounting period. These entries also bring the
balance in th Retained Earnings account up-to-date.

5
9. Preparation of a post-closing trial balance: This step ensures that ledger remains
in balance after posting of the closing entries.
10. Reversing entries: Reversing entries eliminate those accounts originated at the time
of giving adjusting entries, which are not listed in the chart of accounts (the
complete list of all ledger accounts). This step ensures that ledger remains with the
accounts listed in the chart of accounts.

6
Financial Statements

According to paragraph 7 of IAS 1 (revised 1997), Presentation of Financial Statements, a

complete set of financial statements includes the following components:
(a) balance sheet;
(b) income statement;
(c) a statement showing either:
(i) all changes in equity [i.e., statement of changes in equity]; or
(ii) changes in equity other than those arising from capital transactions with owners
and distributions to owners [i.e., statement of changes in retained earnings];
(d) cash flow statement; and
(e) accounting policies and explanatory notes.

Balance Sheet:
It refers to the list of an entity’s (enterprise’s) assets, liabilities and owner’s equity as of a
specific date. It is also called a statement of financial position. Asset means a resource
controlled by the enterprise as a result of past events and from which future economic
benefits are expected to flow to the enterprise. Liability means a present obligation of the
enterprise arising from past events, the settlement of which is expected to result in an outflow
from the enterprise of resources embodying economic benefits. Equity means the residual
interest in the assets of an enterprise after deducting all its liabilities.

Income Statement:
It refers to the list of an entity’s (enterprise’s) revenues, expenses and net income or loss for a
specific period. It is also called a operating statement or a statement of operation. Income is
defined as the increases in economic benefits during the accounting period in the form of
inflows or enhancements of assets or decreases of liabilities that result in increases in equity,
other than those relating to contributions from equity participants. The term revenue means
the gross inflow of economic benefits during the period arising in the course of the ordinary
activities of an enterprise when those inflows result in increases in equity, other than
increases relating to contributions from equity participants. Expenses means the decreases in
economic benefits during the accounting period in the form of outflows or depletions of
assets or incurrence of liabilities that result in decreases in equity, other than those relating to
distributions to equity participants.

Statement Changes in Retained Earnings:

It refers to the financial statement showing summary of changes in the retained earnings
during a specific period. Retained earnings is the portion of owners’ (shareholders’) equity
created by earning net income and retaining the related resources in the business.
Statement Changes in Equity:
It refers to the financial statement showing summary of changes in owners’/shareholders’
equity (i.e., the capital and retained earnings) during a specific period.

Cash Flow Statement (CFS):

It is the financial statement that reports the impact of a firm’s operating, investing, and
financing activities on cash flows during a specific period (between two balance sheet dates).

7
Operating activities are the principal revenue-producing activities of the enterprise and other
activities that are not investing or financing activities. Investing activities are the acquisition
and disposal of long-term assets and other investments not included in cash equivalents.
Financing activities are activities that result in changes in the size and composition of the
equity capital and borrowings of the enterprise. The main purpose of a CFS is to provide
information to decision makers about a company’s cash inflows and outflows during the
period.
Accounting Policies and Explanatory Notes:
According to paragraph 21 of IAS 1, “Accounting policies are the specific principles, bases,
conventions, rules and practices adopted by an enterprise in preparing and presenting
financial statements.” Explanatory Notes are the important accompanying part of the basic
financial statements. According to the principle of adequate disclosure (the most important
accounting policy to the users of accounting information), the financial statements should be
accompanied by any information necessary information for the statements to be interpreted
properly. Since the basic components of the financial statements are always a summary
presentation, most disclosures appear within the several pages of notes that accompany the
financial statements. The explanatory notes to the financial statements of an enterprise
should (i) present information about the basis of preparation of the financial statements and
the specific accounting policies selected and applied for significant transactions and events;
(ii) disclose the information required by regulatory provisions that is not presented elsewhere
in the financial statements; and (iii) provide additional information which is not presented on
the face of the financial statements but that is necessary for a fair presentation.

Relationships among Financial Statements:

All the financial statements are related to an accounting period, which is usually a year. At
the beginning and ending points in time of that accounting period, an enterprise prepares the
balance sheet that gives a static look in financial terms of where the enterprise stands. The
other financial statements (income statement, statement of changes in equity/retained
earnings, and cash flows statement) cover the intervening period of time between the two
balance sheets and help explain important changes that occurred during the period.
From balance sheet, we understand where an enterprise stands financially at two points in
time. From income statement, we understand the changes that occurred during the intervening
period in terms of the enterprise’s profit-seeking activities. From statement of changes in
retained earnings, we understand the changes that occurred during the intervening period in
terms of the enterprise’s earnings and distribution/appropriation of those earnings. From
statement of changes in equity, we understand the changes that occurred during the
intervening period in terms of the enterprise’s earnings and distribution/appropriation of
those earnings and in addition the changes in terms of capital transactions of the owners.
From cash flows statement, we understand the changes that occurred during the intervening
period in terms of the enterprise’s cash activities.

8
Specimen Financial Statements of BEXIMCO INFUSIONS LTD.:
Below is the presentation of two-year comparative financial statements of Beximco Infusions Ltd.
INCOME STATEMENT STATEMENT OF CHANGES IN RETAINED EARNINGS
For the Year Ended 31 December For the Year Ended 31 December
2002 2001 2002 2001
Taka Taka Taka Taka
Revenue from Sales 328,288,005 314,977,227 Retained Earnings at
Cost of Goods Sold (192,857,430) (172,353,390) beginning of the year 117,600,234 80,411,015
Gross Profit 135,430,575 142,623,837 Add: Net Profit after Tax 35,003,485 51,168,724
Operating Expenses (76,119,117) (66,464,723) Less: Appropriation for
Profit from Operation 59,311,458 76,159,114 Tax-holiday Reserve (12,180,260) (13,979,505)
Finance Cost (20,509,022) (19,847,934) Less: Appropriation for
Net Profit before Dividend of Previous Year (10,000,000) -
Contribution to WPPF 38,802,436 56,311,180 Retained Earnings at
Contribution to WPPF (1,847,735) (2,681,485) end of the year 130,423,459 117,600,234
Net Profit before Tax 36,954,701 53,629,695
Income Tax Expense (1,951,216) (2,460,971)
Net Profit after Tax 35,003,485 51,168,724

BALANCE SHEET CASH FLOWS STATEMENT

As on 31 December For the Year Ended 31 December
2002 2001 2002 2001
ASSETS: Taka Taka Taka Taka
Non-Current Assets 322,788,211 328,278,824 Cash Flows from
Property, Plant and Operating Activities 24,878,144 50,141,380
Equipment - Carrying Value 322,189,061 327,679,674 Cash Flows from
Long-term Security Deposit 599,150 599,150 Investing Activities (6,368,182) (249,754)
Current Assets 232,219,916 189,808,694 Cash Flows from
Inventories 84,028,954 65,958,351 Financing Activities (24,057,003) (46,287,461)
Accounts Receivable 105,971,668 81,833,340 Net Increase/(Decrease)
Advances and Deposits 41,624,542 35,875,210 in Cash & Cash Equivalents (5,547,041) 3,604,165
Cash and Cash Equivalent 594,752 6,141,793 Cash & Cash Equivalents
Total Assets 555,008,127 518,087,518 at beginning of the Year 6,141,793 2,537,628
EQUITY & LIABILITIES Cash & Cash Equivalents
Shareholders' Equity 341,666,665 316,663,180 at end of the Year 594,752 6,141,793
Issued Share Capital 100,000,000 100,000,000
Tax-holiday Reserve 111,243,206 99,062,946
Retained Earnings 130,423,459 117,600,234
Non-Current Liabilities 16,342,110 34,629,164
Long-term Borrowing 12,790,437 31,561,454
Deferred Liability -
Provision for Gratuity 3,551,673 3,067,710
Current Liabilities 196,999,352 166,795,174
Short-term Borrowings 103,616,455 81,156,940
Long-term Borrowing -
Current Maturity 38,371,311 31,561,454
Loan from Associated
Undertaking - 10,775,000
17% Debenture -
Current Maturity 1,363,964 3,222,673
Creditors and Other
Payables 35,472,186 22,428,730
Accrued Expenses 10,965,723 10,502,897
Dividend Payable 415,000 1,145,350
Provision for Income Tax 6,794,713 6,002,130
Total Liabilities 213,341,462 201,424,338
Total Liabilities and
Shareholders' Equity 555,008,127 518,087,518

9
Profit versus Cash Flow:
There is a misconception that a profitable enterprise has no liquidity (cash availability)
problem. Under conventional accrual basis accounting, in measuring periodic profit, periodic
revenue is offset by all the expenses incurred in producing that revenue. Revenue is the
price of goods and services rendered during a given accounting period. Expenses are the
costs of the goods and services used up in the process of earning revenue. Here the
accounting principle followed is called the matching principle which ascertains the
relationship between revenues and expenses. Here timing is an important factor in matching
(offsetting) revenue with related expenses. In case of preparing annual income statement, one
year’s expenses are offset against only that year’s revenues. Thus it is often required at year-
end to provide adjusting entries to calculate the periodic revenues and expenses. Adjusting
entries are made to: (i) convert assets to expenses result from cash being paid prior to an
expense being incurred, (ii) convert liabilities to revenues result from cash being received
prior to revenue being earned, (iii) accrue unpaid expenses result from expenses being
incurred before cash is paid, and (iv) accrue uncollected revenue result from revenue being
earned before cash is received. Due to this type of adjusting entries, profit and cash flows are
not an alternative to other. In case of full cash transactions (that means, there is no credit
transactions), profit will be fully realized in cash, but this is only cash inflow from operating
activities (in case of loss, this will be an operating outflow of cash). Here, cash flow from
operating activities can be shown as follows:

Cash flow from Net Noncash Noncash Non-operating Non-operating

operating activities
= Profit
– Income
+ Expense
– Income
+ Expense

Cash flows (inflow or outflow) may be generated by financing activities and also by investing
activities. Thus, due to cash flows from other activities (financing or investing), an enterprise
may have adequate liquidity but that does not mean that it is a profitable enterprise. It is noted
here that the wealth of the owners of an enterprise (shareholders in case of corporate entities)
is based upon the movement of cash and accounting policies and conventions should have no
effect upon the value of the enterprise. This means that pure accounting or book entries
(noncash items) should be excluded in case of financial management decisions.

10
 Analysis of Financial Statements
Financial Statement Analysis
Financial statement analysis involves the application of analytical tools to financial
statements and supplemental data included with the financial statements to enhance the
ability of decision makers to make optimal decisions.

How can we determine:

The ability of an organization to pay loans?
Whether we are earning a fair return on our investment?
The adequacy of cash flow to pay operating expenses?
How to improve the overall performance of the company?
The best answer is: Financial Statement Analysis.
Limitations of Financial Statement Analysis
 When comparing companies and interpreting financial statement analysis, differences in
accounting methods and cost flow assumptions need to be considered.
 Ratios of a company should be compared with industry standards.
 Rather than focus on a single ratio, decision makers need to evaluate a company by
comparing ratios to those of previous years, budgeted amounts, and industry standards.
 Financial statements, and thus financial ratios, are prepared using historical costs and are
not adjusted for the effects of increasing prices.
Horizontal analysis
Horizontal analysis is used to analyze changes in accounts occurring between years.
Example
BEXIMCO INFUSIONS LIMITED
INCOME STATEMENT for the Year Ended December 31, 2001 and 2002
2002 2001 Increase Increase
(Decrease) (Decrease)
Taka Taka Taka %
Revenue from Sales 328,288,005 314,977,227 13,310,778 4.2
Cost of Goods Sold (192,857,430) (172,353,390) (20,504,040) 11.9
Gross Profit 135,430,575 142,623,837 (7,193,262) (5.0)
Operating Expenses (76,119,117) (66,464,723) (9,654,394) 14.5
Administrative Expenses (2,829,105) (2,534,032) (295,073) 11.6
Selling & Distribution Expenses (73,290,012) (63,930,691) (9,359,321) 14.6
Profit from Operation 59,311,458 76,159,114 (16,847,656) (22.1)
Finance Cost (20,509,022) (19,847,934) (661,088) 3.3
Net Profit before Contribution to WPPF 38,802,436 56,311,180 (17,508,744) (31.1)
Contribution to WPPF (1,847,735) (2,681,485) 833,750 (31.1)
Net Profit before Tax 36,954,701 53,629,695 (16,674,994) (31.1)
Income Tax Expense (1,951,216) (2,460,971) 509,755 (20.7)
Net Profit after Tax 35,003,485 51,168,724 (16,165,239) (31.6)

Changes in the Income Statement are analyzed above using the horizontal analysis.

A few results with respect to the income statement items of Beximco Infusions Ltd. have
been given below to show the changes from 2001 to 2002:

11
Sales increased by 04.2%
Cost of goods sold increased by 11.9%
Total operating expenses increased by 14.5%
Operating income decreased by 22.1%
Net income decreased by 31.6%

Note that focusing on net income without looking at other changes in income statement items
would definitely be a mistake in this case. From 2001 to 2002, although sales revenue has
been increased by an small amount (4.2%), the gross profit has been decreased by higher
figure (5.0%) and operating income decreased by over 22%. Net after-tax income has been
decreased by a greater amount (31.6%).

Changes in the other financial statements are analyzed below using the horizontal
analysis.

BEXIMCO INFUSIONS LIMITED

STATEMENT OF CHANGES IN RETAINED EARNINGS
For the Year Ended December 31, 2001 and 2002
2002 2001 Increase Increase
(Decrease) (Decrease)
Taka Taka Taka %
Retained Earnings at beginning of the year 117,600,234 80,411,015 37,189,219 46.2
Add: Net Profit after Tax 35,003,485 51,168,724 (16,165,239) (31.6)
Less: Appropriation for Tax-holiday Reserve (12,180,260) (13,979,505) 1,799,245 (12.9)
Less: Appropriation for Dividend of Previous Year (10,000,000) - (10,000,000) -
Retained Earnings at end of the year 130,423,459 117,600,234 12,823,225 10.9

BEXIMCO INFUSIONS LIMITED

BALANCE SHEET as on December 31, 2001 and 2002
2002 2001 Increase Increase
(Decrease) (Decrease)
ASSETS: Taka Taka Taka %
Non-Current Assets 322,788,211 328,278,824 (5,490,613) (1.7)
Property, Plant and Equipment - Carrying Value 322,189,061 327,679,674 (5,490,613) (1.7)
Long-term Security Deposit 599,150 599,150 0 0.0
Current Assets 232,219,916 189,808,694 42,411,222 22.3
Inventories 84,028,954 65,958,351 18,070,603 27.4
Accounts Receivable 105,971,668 81,833,340 24,138,328 29.5
Advances and Deposits 41,624,542 35,875,210 5,749,332 16.0
Cash and Cash Equivalent 594,752 6,141,793 (5,547,041) (90.3)
Total Assets 555,008,127 518,087,518 36,920,609 7.1

12
EQUITY AND LIABILITIES 2002 2001 Increase Increase
(Decrease) (Decrease)
Taka Taka Taka %
Shareholders' Equity 341,666,665 316,663,180 25,003,485 7.9
Issued Share Capital 100,000,000 100,000,000 0 0.0
Tax-holiday Reserve 111,243,206 99,062,946 12,180,260 12.3
Retained Earnings 130,423,459 117,600,234 12,823,225 10.9
Non-Current Liabilities 16,342,110 34,629,164 (18,287,054) (52.8)
Long-term Borrowing - Net of Current Maturity (Secured) 12,790,437 31,561,454 (18,771,017) (59.5)
Deferred Liability - Provision for Gratuity 3,551,673 3,067,710 483,963 15.8
Current Liabilities 196,999,352 166,795,174 30,204,178 18.1
Short-term Borrowings (Secured) 103,616,455 81,156,940 22,459,515 27.7
Long-term Borrowing - Current Maturity (Secured) 38,371,311 31,561,454 6,809,857 21.6
Loan from Associated Undertaking (Unsecured) - 10,775,000 (10,775,000) (100.0)
17% Debenture - Current Maturity (Secured) 1,363,964 3,222,673 (1,858,709) (57.7)
Creditors and Other Payables 35,472,186 22,428,730 13,043,456 58.2
Accrued Expenses 10,965,723 10,502,897 462,826 4.4
Dividend Payable 415,000 1,145,350 (730,350) (63.8)
Provision for Income Tax 6,794,713 6,002,130 792,583 13.2
Total Liabilities and Shareholders' Equity 555,008,127 518,087,518 36,920,609 7.1

Trend Analysis:

It is also a horizontal analysis of financial statements over several years.

It can be used to build prediction models to forecast financial performance in the future and
to identify problem areas by looking for sudden or abnormal changes in accounts.

Vertical Analysis

Vertical analysis compares financial statements of different companies and financial

statements of the same enterprise across time after controlling for differences in size.
Common size financial statements are statements in which all items have been restated as a
percentage of a selected item on the statement. Vertical analysis uses common size financial
statements to remove size as a relevant variable in ratio analysis.

Comparative Balance Sheet

Individual asset accounts are stated as a percentage (%) of total assets.

Individual liability and stockholder’s equity are stated as a percentage (%) of total liabilities
and shareholders’ equity (L & SE).

13
 BEXIMCO INFUSIONS LIMITED
COMMON SIZE BALANCE SHEETS
As on December 31, 2001 and 2002
2002 2001 2002 2001

Common Size Common Size

ASSETS: Taka Taka % %
Non-Current Assets 322,788,211 328,278,824 58.2 63.4
Property, Plant and Equipment - Carrying Value 322,189,061 327,679,674 58.1 63.2
Long-term Security Deposit 599,150 599,150 0.1 0.1
Current Assets 232,219,916 189,808,694 41.8 36.6
Inventories 84,028,954 65,958,351 15.1 12.7
Accounts Receivable 105,971,668 81,833,340 19.1 15.8
Advances and Deposits 41,624,542 35,875,210 7.5 6.9
Cash and Cash Equivalent 594,752 6,141,793 0.1 1.2
Total Assets 555,008,127 518,087,518 100.0 100.0
EQUITY AND LIABILITIES
Shareholders' Equity 341,666,665 316,663,180 61.6 61.1
Issued Share Capital 100,000,000 100,000,000 18.0 19.3
Tax-holiday Reserve 111,243,206 99,062,946 20.0 19.1
Retained Earnings 130,423,459 117,600,234 23.5 22.7
Non-Current Liabilities 16,342,110 34,629,164 2.9 6.7
Long-term Borrowing - Net of Current Maturity (Secured) 12,790,437 31,561,454 2.3 6.1
Deferred Liability - Provision for Gratuity 3,551,673 3,067,710 0.6 0.6
Current Liabilities 196,999,352 166,795,174 35.5 32.2
Short-term Borrowings (Secured) 103,616,455 81,156,940 18.7 15.7
Long-term Borrowing - Current Maturity (Secured) 38,371,311 31,561,454 6.9 6.1
Loan from Associated Undertaking (Unsecured) - 10,775,000 - 2.1
17% Debenture - Current Maturity (Secured) 1,363,964 3,222,673 0.2 0.6
Creditors and Other Payables 35,472,186 22,428,730 6.4 4.3
Accrued Expenses 10,965,723 10,502,897 2.0 2.0
Dividend Payable 415,000 1,145,350 0.1 0.2
Provision for Income Tax 6,794,713 6,002,130 1.2 1.2
Total Liabilities and Shareholders' Equity 555,008,127 518,087,518 100.0 100.0

14
Common Size Comparative Income Statements
Percentages are based on net sales.
The gross profit percentage is usually closely watched.

BEXIMCO INFUSIONS LIMITED

COMMON SIZE INCOME STATEMENTS
For the Year Ended December 31, 2001 and 2002
2002 2001 2002 2001
Common Size Common Size
Taka Taka % %
Revenue from Sales 328,288,005 314,977,227 100.0 100.0
Cost of Goods Sold (192,857,430) (172,353,390) (58.7) (54.7)
Gross Profit 135,430,575 142,623,837 41.3 45.3
Operating Expenses (76,119,117) (66,464,723) (23.2) (21.1)
Administrative Expenses (2,829,105) (2,534,032) (0.9) (0.8)
Selling & Distribution Expenses (73,290,012) (63,930,691) (22.3) (20.3)
Profit from Operation 59,311,458 76,159,114 18.1 24.2
Finance Cost (20,509,022) (19,847,934) (6.2) (6.3)
Net Profit before Contribution to WPPF 38,802,436 56,311,180 11.8 17.9
Contribution to WPPF (1,847,735) (2,681,485) (0.6) (0.9)
Net Profit before Tax 36,954,701 53,629,695 11.3 17.0
Income Tax Expense (1,951,216) (2,460,971) (0.6) (0.8)
Net Profit after Tax 35,003,485 51,168,724 10.7 16.2

Beximco Pharmaceutical Ltd. (BPL) & Beximco Infusions Ltd. (BIL)

COMMON SIZE INCOME STATEMENTS
For the Year Ended December 31, 2002
BPL BIL BPL BIL
Common Size Common Size
Taka Taka % %
Revenue from Sales 2,522,942,523 328,288,005 100.0 100.0
Cost of Goods Sold (1,620,493,149) (192,857,430) (64.2) (58.7)
Gross Profit 902,449,374 135,430,575 35.8 41.3
Operating Expenses (357,339,989) (76,119,117) (14.2) (23.2)
Administrative Expenses (79,926,759) (2,829,105) (3.2) (0.9)
Selling & Distribution Expenses (277,413,230) (73,290,012) (11.0) (22.3)
Profit from Operation 545,109,385 59,311,458 21.6 18.1
Other Income 7,266,435 0 0.3 0.0
Finance Cost (170,994,495) (20,509,022) (6.8) (6.2)
Net Profit before Contribution to WPPF 381,381,325 38,802,436 15.1 11.8
Contribution to WPPF (19,148,862) (1,847,735) (0.8) (0.6)
Net Profit before Tax 362,232,463 36,954,701 14.4 11.3
Income Tax Expense (20,552,415) (1,951,216) (0.8) (0.6)
Net Profit after Tax 341,680,048 35,003,485 13.5 10.7

15
 Beximco Pharmaceutical Ltd. (BPL) & Beximco Infusions Ltd. (BIL)
COMMON SIZE BALANCE SHEETS
As on December 31, 2002
BPL BIL BPL BIL
Common
Common Size Size
Taka

ASSETS: Taka % %
Non-Current Assets 4,780,464,825 322,788,211 70.7 58.2
Current Assets 1,982,226,375 232,219,916 29.3 41.8
Total Assets 6,762,691,200 555,008,127 100.0 100.0
EQUITY AND LIABILITIES
Shareholders' Equity 4,441,096,192 341,666,665 65.7 61.6
Non-Current Liabilities 812,591,999 16,342,110 12.0 2.9
Current Liabilities 1,509,003,009 196,999,352 22.3 35.5
Total Liabilities and Shareholders' Equity 6,762,691,200 555,008,127 100.0 100.0

Ratio Analysis

Ratio analysis is useful in assessing the impact of transactions on ROI, residual income,
EVA, and other key measures of performance.

Ratio analysis provides additional information necessary to enhance the decision-making

ability of the users of the information.

Ratios Formula What the ratio measures

Liqu- Current Ratio Current Assets ÷ Current Measures the entity’s liquidity.
idity (CR) Liabilities This ratio tells us the amount of current assets for
Ratios every Taka of current liabilities.
2.0 is considered to be a good CR.
Quick Ratio Quick Assets ÷ Current This ratio is a stricter test of a company’s ability to
Liabilities pay its current debts with highly liquid current
assets.
This ratio removes inventories and prepaid assets
from the CA amount used in the calculation.
A quick ratio of less than 1.0 should be of concern.
Cash Flow from Net Cash Provided by Cash flow from operations is sometimes used as the
Operations to Operating Activities ÷ numerator because all debt is paid with cash.
Current Average Current The ratio is indication of whether enough cash is
Liabilities Ratio Liabilities being generated from operations to pay current
obligations.
Working (Working Capital – Cash) This gives an indication of the additional finance
Capital per ÷ Sales necessary upon an expansion of sales.
Taka of Sales

16
Ratios Formula What the ratio measures
Activity Accounts Net Credit Sales ÷ This ratio tells that on average, how much was sold
Ratios Receivables Average Accounts on account and subsequently collected accounts
Turnover Receivable receivable.
Number of Number of Days in the This number is the average number of days to collect
Days Sales Are Period ÷ Accounts a credit sale.
in Receivables Receivable Turnover This may vary according to the credit policy of the
particular business and the industry standards.
This ratio has an impact on ROI as part of the
turnover of assets.
Inventory Cost of Goods Sold ÷ Determines how many times during the time period
Turnover Ratio Average Inventory that the value of the inventory was sold.
Determining what is good is dependent on the
industry and company standards.
Grocery stores would have a much higher expected
turnover than car dealerships.
Number of Number of Days in the Another way to look at inventory turnover is to
Days Inventory Period ÷ Inventory calculate the number of days inventory is held before
Is Held Before Turnover it is sold.
Sale This may vary according to the particular business
and industry standards.
This ratio has an impact on ROI as part of the
turnover of assets.
Cash-to-Cash Number of Days in Measures the length of time between the purchase of
Operating Inventory + Number of inventory and the collection of cash from sales.
Cycle Ratio Days in Receivables
Solve- Debt to Equity Total Liabilities ÷ Total A solvency ratio which measures the ability to stay
ncy Ratio Stockholders’ Equity financially healthy over the long-run.
Ratios Indicates the preference of debt or equity financing
of the entity.
Times Interest (Net Income + Interest Measures a company’s ability to meet current
Earned Expense + Income Tax) ÷ interest payments to creditors by specifically
Interest Expense measuring its ability to meet current-year interest
payments out of current-year earnings.
Especially important to bankers and other lenders.
Debt Service Cash Flow from Measures the amount of cash generated from
Coverage Ratio Operations Before Interest operating activities that is available to repay
and Taxes ÷ Interest and principal and interest in the upcoming year.
Principle Payments The ratio indicates the amount of cash generated for
every Taka 1 interest and principal paid.
Cash Flow from (Cash Flow from Measures a company’s ability to use cash flow from
Operations to Operations – Total operations to finance its acquisitions of property,
Capital Dividends Paid) ÷ Cash plant, and equipment.
Expenditures Paid for Acquisitions The ability to use cash from operations diminishes
Ratio the need to acquire outside financing such as debt.
Degree of (Net Income + Interest Measures the impact of a change in operating income
Financial Expense + Income Tax) ÷ on change in earning on equity capital.
Leverage1 (Net Income + Income Employed to plan the ratio between debt and equity
Tax) so that earning per share (EPS) is improved.

1
The term leverage is used in financial management to describe an enterprise’s ability to use fixed cost assets
or funds to increase the returns to its owners (equity shareholders in case of a company). The leverage
associated with the employment of fixed cost assets is referred to as operating leverage, while the leverage
resulting from the use of fixed cost sources of funds is known to as financial leverage. The degree of
operating leverage is calculated by dividing contribution margin (i.e., sales revenue minus variable costs)
with earning before interest and income tax.

17
Ratios Formula What the ratio measures
Profit- Return on [Net Income + Interest Considers the return to investors on all assets
ability Assets Expense (net of tax)] ÷ invested in the company.
Ratios Average Total Assets Interpretation is based on the company’s required
return on assets, industry standards, and trends.
Return on (Net Income – Preferred Measures the return to common stockholders as a
Common Dividends) ÷ Average percentage of stockholders’ equity.
Stockholders’ Common Stockholders’ Adequacy of return is dependent on a number of
Equity Equity factors including the risk of the investment.
Earnings Per (Net Income – Preferred Used to measure performance.
Share (EPS) Dividends) ÷ Average Used to compare the performance of companies
Number of Common across different industries.
Shares Outstanding
Price Earnings Current Market Price ÷ Important for investors as it is the relationship of
Ratio EPS earnings to dividends and the market price of a
company’s stock.
P/E is very dependent on the industry.

18
Basic Data for Calculating Ratios
BEXIMCO INFUSIONS LIMITED 2002 2001
Symbol Taka Taka
A Total Current Assets 232,219,916 189,808,694
B Quick Assets 148,190,962 123,850,343
C Total Current Liabilities 196,999,352 166,795,174
D Net Cash Provided by Operating Activities 24,878,144 50,141,380
E Average Current Liabilities 181,897,263 151,693,085
F Cash 594,752 6,141,793
G Working Capital 35,220,564 23,013,520
H Sales 328,288,005 314,977,227
I Working Capital – Cash 34,625,812 16,871,727
J Net Credit Sales (80% of total sales) 262,630,404 251,981,782
K Accounts Receivable 105,971,668 81,833,340
L Average Accounts Receivable 93,902,504 40,916,670
M Accounts Receivable Turnover (Times) 2.80 6.16
Taka Taka
N Cost of Goods Sold 192,857,430 172,353,390
O Ending Inventory 84,028,954 65,958,351
P Average Inventory 74,993,653 56,923,050
Q Number of Days in the Period (Days) 365 365
R Inventory Turnover (Times) 2.57 3.03
S Number of Days in Inventory (Days) 142 121
T Number of Days in Receivables (Days) 131 59
Taka Taka
U Total Liabilities 213,341,462 201,424,338
V Total Stockholders’ Equity 341,666,665 316,663,180
W Net Income before Interest & Tax 57,463,723 73,477,629
X Interest Expense 20,509,022 19,847,934
Y Cash Flow from Operations before Interest & Taxes 48,533,142 71,888,497
A1 Interest and Principle Payments 46,940,033 42,406,031
B1 Cash Flow from Operations – Total Dividends Paid 37,802,792 56,898,447
C1 Cash Paid for Acquisitions 6,368,182 249,754
D1 Net Income + Interest Expense (net of tax) 55,512,507 71,016,658
E1 Total Assets 555,008,127 518,087,518
F1 Average Total Assets 536,547,823 499,627,214
G1 Net Income – Preferred Dividends 35,003,485 51,168,724
H1 Average Common Stockholders’ Equity 329,164,923 304,161,438
I1 Average Number of Common Shares Outstanding (No.) 1,000,000 1,000,000
Taka Taka
J1 Current Market Price 232 250
K1 EPS 35.00 51.17
L1 Net Income before Tax but after Interest 36,954,701 53,629,695

19
Ratios Calculated from the above Data
BEXIMCO INFUSIONS LIMITED
Ratios Formula Symbols 2002 2001
Current Ratio Current Assets ÷ Current Liabilities A÷C 1.18 1.14
Quick Ratio Quick Assets ÷ Current Liabilities B÷C 0.75 0.74
Cash Flow from Net Cash Provided by Operating
Operations to Current Activities ÷ Average Current D÷E 0.14 0.33
Liabilities Ratio Liabilities
Working Capital per (Working Capital – Cash) ÷ Sales
I÷H 0.11 0.05
Taka of Sales
Accounts Receivables Net Credit Sales ÷ Average Accounts
J÷L 2.80 6.16
Turnover Receivable
Number of Days Sales Number of Days in the Period ÷
Q÷M 131 59
Are in Receivables Accounts Receivable Turnover
Inventory Turnover Cost of Goods Sold ÷ Average
N÷P 2.57 3.03
Ratio Inventory
Number of Days Number of Days in the Period ÷
Inventory Is Held Inventory Turnover Q÷R 142 121
Before Sale
Cash-to-Cash Number of Days in Inventory +
S+T 272 180
Operating Cycle Ratio Number of Days in Receivables
Debt to Equity Ratio Total Liabilities ÷ Total
U÷V 0.62 0.64
Stockholders’ Equity
Times Interest Earned (Net Income + Interest Expense +
W÷X 2.80 3.70
Income Tax) ÷ Interest Expense
Debt Service Cash Flow from Operations Before
Coverage Ratio Interest and Taxes ÷ Interest and Y÷A1 1.03 1.70
Principle Payments
Cash Flow from (Cash Flow from Operations – Total
Operations to Capital Dividends Paid) ÷ Cash Paid for B1÷C1 5.94 227.82
Expenditures Ratio Acquisitions
Degree of Financial (Net Income + Interest Expense +
Leverage Income Tax) ÷ (Net Income + Income Y÷L1 1.31 1.34
Tax)
Return on Assets [Net Income + Interest Expense (net
D1÷F1 0.10 0.14
of tax)] ÷ Average Total Assets
Return on Common (Net Income – Preferred Dividends) ÷
Stockholders’ Equity Average Common Stockholders’ G1÷H1 0.11 0.17
Equity
Earnings Per Share (Net Income – Preferred Dividends) ÷
(EPS) Average Number of Common Shares G1÷I1 35.00 51.17
Outstanding
Price Earnings Ratio Current Market Price ÷ EPS J1÷K1 6.63 4.89

20