Chapter 3 Financial Statements, Taxes, & Cash Flow

8/2/2019 Chapter 3 Financial Statements, Taxes, & Cash Flow

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Chapter 3

FINANCIAL STATEMENTS, TAXES,AND CASH FLOW

Centre for Financial Management , Bangalore


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OUTLINE

Balance Sheet

Profit and Loss Account

Finance Topics

Statement of Cash Flows

Manipulation of Bottom Line

Taxes

Free Cash Flow



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IMPORTANT QUESTIONS

Managers, shareholders, creditors and other interested groups

seek answers to the following important questions about a firm: What is the financial position of the firm at a given point of

time?

How has the firm performed financially over a given period of

time?

What have been the sources and uses of cash over a period of

time?

The accountant prepares the balance sheet, the profit and lossaccount, and the statement of cash flows to answer the above

questions



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BALANCE SHEETHorizontal Form

Liabilities + Equity AssetsShare capital Fixed assets Reserves and surplus Investments Secured loans Current assets, loans and Unsecured loans advances Current liabilities and provisions Current assets

Current liabilities Loans and advances Provisions Miscellaneous expendituresand

losses



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BALANCE SHEETVertical (or Report) Form

I. Sources of Funds

(1) Shareholders funds:(a) Capital

(b) Reserves and Surplus

(2) Loan funds:

(a) Secured loans

(b) Unsecured loans

II. Application of funds

(1) Fixed assets

(2) Investments

(3) Current assets, loans and advances

Less: Current liabilities and provisions:

Net current assets

(4) Miscellaneous expenditures and losses



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BALANCE SHEET OF HORIZON LIMITED AS ONMARCH 31, 20 X 1

A. Account Form Rs.in crore

Liabilities 20 x 1 20 x 0 Assets 20 x 1 20 x 0

Share capital 15.00 15.00 Fixed assets 33.00 32.20

Equity 15.00 15.00 Investments 1.00 1.00

Preference Current assets, loans

Reserve & surplus 11.20 10.60 and advances 23.40 15.60

Secured loans 14.30 13.10 Miscellaneous

Unsecured loans 6.90 2.50 expenditures and losses 0.50 0.50

Current liabilities

and provisions 10.50 8.10

57.90 49.30 57.90 49.30



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BALANCE SHEET OF HORIZON LIMITED AS ONMARCH 31, 20 X 1

Rs.in million

20 x 1 20 x 0

I. Sources of Funds(1) Shareholders funds: 26.20 25.60

(a) Share capital 15.00

(b) Reserves and surplus 11.20

(2) Loan funds: 21.20 15.60

(a) Secured loans 14.30(b) Unsecured loans 6.90

47.40 41.20

II. Application of Funds

(1) Fixed assets 33.00 32.20

(2) Investments 1.00 1.00

(3) Current assets, loans and advances 23.40 15.60

57.40 48.80

Less: Current liabilities and provisions: 10.50 8.10

Net current assets 12.90 40.70

(4) Miscellaneous expenditures and losses 0.50 0.50

47.40 41.20


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LIABILITIES

Share Capital

Reserves & Surplus

Secured Loans

Unsecured Loans

Current Liabilities and Provisions



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ASSETS

Fixed Assets

Investments

Current Assets, Loans, & Advances

Miscellaneous Expenditure & Losses



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PROFIT & LOSS ACCOUNT OF HORIZON LTD, FORTHE YEAR ENDING ON MARCH 31, 20 X 1

(Rs.in crore)

IncomeSales 70.1

Other income (loss)

70.1

Expenditure

Material and other expenditure 58.2

Interest 2.1

Depreciation 3.0

Profit before tax 6.8

Provision for tax 3.4

Profit after tax 3.4

Prior period adjustments 0.8

Profit available for appropriations 4.2

Appropriations 3.5

Balance carried forward 0.7


PROFIT & LOSS ACCOUNT OF HORIZON LTD FOR


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PROFIT & LOSS ACCOUNT OF HORIZON LTD, FORTHE YEAR ENDING ON MARCH 31, 20 X 1

(Rs. in crore)

20 x 1 20 x 0Net sales 70.1 62.3

Cost of goods sold 55.2 47.5Stocks 42.1Wages and salaries 6.8Other manufacturing expenses 6.3

Gross profit 14.9 14.8Operating expenses 6.0 4.9

Depreciation 3.0

General administration 1.2Selling 1.8

Operating profit 8.9 9.9Non-operating surplus/deficit 0.6Profit before interest and tax 8.9 10.5Interest 2.1 2.2Profit before tax 6.8 8.3

Provision for tax 3.4 4.1Current tax 2.1 2.9Deferred tax 1.3 1.2

Profit after tax 3.4 4.2Prior period adjustments 0.8 0.7Amount available for appropriation 4.2 4.9Appropriations 3.5 4.0Balance carried forward 0.7 0.9



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PROFIT AND LOSS ACCOUNT ITEMS

Net Sales

Cost of Goods Sold

Gross Profit

Operating Expenses

Operating Profit

Non-operating Gains and Losses

Profit Before Interest and Taxes

Interest

Profit before Tax

Income Tax Provision

Profit After Tax

Prior Period Adjustments

Amount Available for Appropriation

Appropriations

Balance Carried Forward


BALANCE SHEET AND FINANCE TOPICS


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BALANCE SHEET AND FINANCE TOPICS Share capital

Equity

Preference

Reserves and surplus

Secured loans

Debentures

Loans and advances

Unsecured loans

Current liabilities and provisions

Trade creditors

Provisions

Fixed assets (net)

Gross block

Less: depreciation

Investments

Current assets, loans and advances

Cash and bank

Receivables

Inventories

Miscellaneous expenditure and losses

Capital structure

and cost of capital

Working capital

financing policy

Capital budgeting

Portfolio management

Cash management

Credit management

Inventory management


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PROFIT AND LOSS ACCOUNT AND FINANCE TOPICS

Net sales

Cost of goods sold

Stocks

Wages and salaries

Other manufacturing expenses

Gross profit

Operating expenses

Selling and administration expenses

Depreciation

Operating profit

Non-operating surplus/deficit

Earnings before income and tax

Interest Profit before tax

Tax

Profit after tax

Dividends

Retained earnings

Revenue risk

Gross profit margin

Depreciation policy

Business risk

Financial risk

Tax planning

Return on equity

Dividend policy


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STATEMENT OF CASH FLOWS

Cash inflows

from operations

Cash inflows

from investing

activities

Cash inflows

from financing

activities

Cash outflows

from investing

activities

Cash flow

from investing

activities

Cash outflows

from financing

activities

Cash flow

from financing

activities

Operating

Investing

Financing

=

=

=

+

+

=

Cash outflows

from operations

Cash flow

from operations

Net cash flow

for the period



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CASH FLOW STATEMENT

LIABILITIES ASSETS

CAPITAL FIXED ASSETS

RESERVES & SURPLUS

INVESTMENTS

LOANS

INVENTORIES

CURRENT LIABILITIES DEBTORS

AND PROVISIONS

CASH



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SOURCES USES

FINANCING CAPITAL CAPITAL

OPERATING RES. & SURPLUS RES. & SURPLUS

FINANCING LOANS LOANS

OPERATING CURRENT LIABILITIES CURRENT LIABILITIES

& PROVISIONS & PROVISIONS

INVESTMENT FIXED ASSETS FIXED ASSETS

INVESTMENT INVESTMENTS INVESTMENTS

OPERATING INVENTORIES INVENTORIES

OPERATING DEBTORS DEBTORS



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CASH FLOW STATEMENT FOR HORIZON LTD, FORTHE PERIOD 1.4.20X0 TO 31.3.20X1

(Rs. in crore)

(A) Cash Flow from Operating Activities

Net profit before tax and extraordinary items 6.8

Adjustments for

Interest paid 2.1

Depreciation 3.0

Operating profit before working capital changes 11.9

Adjustments

Debtors (4.6)Inventories (3.3)

Advances 0.5

Trade credit 1.5

Advances 0.7

Provisions 0.2

Cash generated from operations 6.9

Income tax paid (3.4)

Cash flow before extraordinary items 3.5

Extraordinary item

Net cash flow from operating activities 3.5

(Contd.)


(C td )


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(Contd.)(Rs.in crore)

(B) Cash Flow from Investing Activities

Purchase of fixed assets (3.8)

Net cash flow from investing activities (3.8)

(C) Cash Flow from Financing Activities

Proceeds from term loans 1.2

Proceeds from inter-corporate deposits 4.4

Interest paid (2.1)

Dividend paid (2.8)

Net cash flow from financing activities 0.7

(D) Net Increase in Cash and Cash Equivalents 0.4

Cash and cash equivalents as on 1.04.20x0 0.6Cash and cash equivalents as on 31.03.20x1 1.0


A A O O O O


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MANIPULATION OF THE BOTTOM LINE1. INFLATE THE SALES FOR THE CURRENT YEAR BY ADVANCING THE SALES FROM THE

FOLLOWING YEAR

2. ALTER THE OTHER INCOME FIGURE BY PLAYING WITH NON-OPERATIONAL IETMS

3. FIDDLE WITH THE METHOD & RATE OF DEPRN

4. DEFER CERTAIN DISCRETIONARY EXPENSES TO THE FOLLOWING YEAR.

5. MAKE INADEQUATE PROVISIONS . . LIABILITIES

6. MAKE EXTRA PROVISIONS . . PROSPEROUS PERIODS . . WRITE THEM BACK . . LEAN PERIODS

7. USE TOTALLY UNACCEPTABLE ACCOUNTING PRACTICES.

8. REVALUE ASSETS . . CREATE . . IMPRN . . RESERVES

9. LENGTHEN ACCOUNTING YEAR . . ATTEMPT COVER POOR PERFORMANCE.

WHY ? PROJECT IMAGE OF LOW RISK

PROMOTE PERCEPN . . COMPETENT MGT

INCREASE MGRL COMPENN

QUALITY PROMPTNESS

OF CANDOUR IN ANALYSING PAST PERFORMANCE

REPORTING MEANINGFUL DISCUSSION . . PROSPECTS



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TAXES

Taxes may be divided into two broad categories : direct

taxes and indirect taxes.

A tax is a direct tax if the impact and incidence of the tax

is on the same person. Example : Income tax

A tax is an indirect tax if the impact is on one person but

through the process of shifting the incidence is on

another. Example : Excise duty



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CORPORATE INCOME TAX

A companys taxable income is determined by taking into

account its revenues, expenses, and deductions on accountof various incentives and reliefs. The taxable income is

subject to a tax rate of 35 percent for domestic companies

and 40 percent for foreign companies.

While computing the taxable income, among other things,

bear in mind the provisions relating to the following -

depreciation, interest expense, dividend payment, dividend

income, unabsorbed business loss and depreciation,exemptions and deductions, minimum alternate tax, and

advance tax.



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CORPORATE INCOME TAX

1. Depreciation is charged on blocks of assets which

represent a group of assets within the broad class ofassets such as buildings, plant, machinery, and

furniture, for which a common rate of depreciation is

applicable.

2. While interest on borrowings is a tax-deductible

expense, dividend on share capital is not.

3. Unabsorbed business loss of any year can be carried

forward and set off against income under the head ofbusiness of subsequent years.


CASH FLOW SUMMARY


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CASH FLOW SUMMARY

A. The cash flow identity

Cash flow from assets = Cash flow to lenders + Cash flow toshareholders

B. Cash flow from assets

Cash flow from assets = Operating cash flowNet capital spending

Change in net working capitalwhere

Operating cash flow = PBITTaxes + DepreciationCapital spending = Ending net fixed assets Beginning

net fixed assets + Depreciation

Change in net working capital = Ending net working capital

Beginning net working capital

C. Cash flow to lenders

Cash flow to lenders = Interest paidNet new borrowing

D. Cash flow to shareholders

Cash flow to shareholders = Dividends paidNet new share capital

raised Centre for Financial Management , Bangalore

SUMMING UP


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SUMMING UP

The balance sheet shows the financial position (or condition) of a firm at a given

point of time. It provides a snapshot and may be regarded as a static picture.

The income statement (referred to in India as the profit and loss account) reflects

the performance of a firm over a period of time. The cash flow statement

portrays the flow of cash through the business during a given accounting period.

Assets are classified into following categories : (i) fixed assets, (ii) investments,

(iii) current assets, loans and advances, and (iv) miscellaneous expenditures and

losses. Liabilities are classified into the following categories : (i) share capital,

(ii) reserves and surplus, (iii) secured loans, (iv) unsecured loans, and (v) current

liabilities and provisions.

The important items in the profit and loss account are: (i) net sales, (ii) cost of

goods sold, (iii) gross profit, (iv) operating expenses, (v) operating profit, (vi)non-operating surplus/deficit, (vii) profit before interest and tax, (viii) interest,

(ix) profit before tax, (x) tax and (xi) profit after tax.

The important topics in finance can be keyed to the balance sheet and the profit

and loss account.



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From a financial point of view, a firm basically generates cash and spends cash.

The activities that generate cash are called sources of cash and the activities that

absorb cash are called uses of cash. Increase in owners' equity and liabilities and

decrease in assets represent sources of cash. Decrease in owners equity and

liabilities and increase in assets, on the other hand represent uses of cash.

To understand how cash flows have been influenced by various decisions, it is

helpful to classify cash flows into three categories: cash flows from operating

activities, cash flows from investing activities, and cash flows from financing

activities.

Corporate managements have discretion in influencing the occurrence,

measurement and reporting of revenue, expenses, assets and liabilities. They

may use this latitude to manage the bottom line.

Taxes can be one of the major cash outflows for a firm. The magnitude of the tax

burden is determined by the tax code, which is subject to change.


Taxes may be divided into two broad categories: direct taxes and indirect taxes


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Taxes may be divided into two broad categories: direct taxes and indirect taxes.

A tax is referred to as a direct tax if the impact and incidence of the tax is on the

same person. Income tax, wealth tax, and gift tax are examples of direct taxes.

A tax is regarded as an indirect tax if the impact and incidence of the tax is on

different persons. Excise duty, sales tax, and customs duty are the threeimportant indirect taxes.

We have a balance sheet identity which says that the value of a firm's assets is

equal to the value of its liabilities plus the value of its equity. In the same

manner we have a cash flow identity which says that :Cash flow from assets = Cash flow to lenders + Cash flow to shareholders

C t f Fi i l M t B l

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Chapter 3 Financial Statements, Taxes, & Cash Flow

Documents