Financial Reporting & Analysis

Session One
Manju Jaiswall IIM Calcutta

Session Plan

Session Topic No. 1&2 Understanding Financial Statements-I Accounting framework, Preparation and presentation of Balance Sheet & Income Statement Maria Hernadez Associates (HBS case) 3 Understanding Financial Statements-II Cash flow statement Chemalite Inc. (HBS case) Exercises on cash flow statement 4 Corporate Accounting Policy choices Earnings Management behaviour in firms Microsofts Financial Reporting Strategy (HBS case)
5 Financial Statements Analysis-I Basic analytical tools for financial statements Financial Statements Analysis-II Intra & Inter firm/Industry Analysis Ratio & DuPont Analysis
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Coal India Ltd.

Consolidated sales of the company for the fiscal ended March 2010 was higher by 14% to Rs 46689.29 crore and the net profit was up by 142% to Rs 9833.70 crore, albeit on a lower base. The EPS for the fiscal was Rs 15.2. The offer price band of Rs 225-245 discounts the FY2010 consolidated earning by 14.8-16.1 times, which is largely in line with the P/Es at which other global coal majors (especially Asian) are trading..
Particulars Quarter Ended Mar. 2012 Sales 18819.29 OPM % 42.62 PBDT 8990.49 PBT 7641.24 NP 5644.38 Mar. 2011 15396.19 33.3 6061.7 3753.36 2790.86 Year Ended % Var. Mar. 2012 Mar. 2011 % Var. 22 75758.41 65841.79 15 28 48.25 48.46 0 48 40998.58 35294.75 16 104 33502.01 27616.37 21 102 25122.92 18924 3313

Powergrid Corporation (PGCIL)

A capex of about Rs 17,814 crore was incurred with Rs 14,100 crore of assets being commissioned in FY 2012. Assets are getting commissioned at a faster pace, thus improving the overall Return on Equity (ROE) for the company. Net sales were up by 20% to Rs 10,035.33 crore and PAT rose 21% to Rs 3254.95 crore in FY 2012. We expect PGCIL to register sales of Rs 12283.24 crore and net profit of Rs 3934.16 crore in FY 2013. EPS works out to Rs 8.5. The share price trades at Rs 112, which discounts the projected FY2013 EPS by 13.1 times.
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Ambuja Cements Ltd Industry :Cement - Major - North India (Rs in Crs) Financial Performance 10-Dec Year End Equity Paid Up 305.97 Networth 7330.25 Capital Employed 7395.28 Gross Block 8778.82 Net Working Capital ( Incl. Def. Tax) 210.42 Current Assets ( Incl. Def. Tax) 3200.82 Current Liabilities and Provisions ( Incl. 2990.4 Def. Tax) Total Assets/Liabilities (excl Reval & 10385.22 W.off) Gross Sales 8257.03 Net Sales 7390.21 Other Income 320.23 Cost of Production 3918.27 Selling Cost 1399.36 PBIDT 2097.75 PBDT 2049.06 PBIT 1710.56 PBT 1661.87 PAT 1263.61

9-Dec 304.74 6471.05 6636.75 6224.13 -247.44 2008.77 2256.21 8890.25 7721.42 7076.87 255.84 3760.15 1228.2 2122.72 2100.29 1825.73 1803.3 1218.37

8-Dec 304.52 5673.02 5961.69 5706.94 485.05 2368.01 1882.96 7840.37 7075.51 6167.71 554.67 3127.67 1111.95 2261.66 2229.6 2001.9 1969.84 1402.27

7-Dec 304.48 4660.88 4991.3 5231.05 39.49 1615.11 1575.62 6560.7 6396.2 5597.91 1008.96 2466.19 1006.82 3024.54 2948.69 2788.2 2712.35 1769.1

6-Dec 303.37 3490.58 4355.96 4542.5 91.02 1189.9 1098.88 5447.13 7016.7 6220.39 158.78 2922.6 1131.31 2280.95 2167.72 1954.83 1841.6 1503.25

CESC Ltd

Financial Performance
Year End Equity Networth Capital Employed Gross Block Sales Other Income PBIDT PBDT PBIT PBT EPS (Rs.) Dividend (%) Payout (%) Ratio Analysis Debt-Equity Current Ratio Invtry Turnover Debtors Turnover Interest Cover ROCE (%) RONW (%) 10-Mar 125.6 3,823.09 7,531.28 9,990.13 3,354.89 194.75 963.31 727.69 757.67 522.05 33.84 40 11.76 0.96 1.25 14.9 7.43 3.22 10.71 12.01 9-Mar 125.6 3,392.34 6,635.33 7,938.32 3,088.23 170.02 832.47 639.77 657.57 464.87 31.94 40 12.46 0.91 1.35 15.91 8.6 3.41 10.82 12.87 8-Mar 125.6 2,972.16 5,541.07 7,129.21 2,828.90 179.21 753.2 571.36 584.75 402.91 27.62 40 14.41 1.03 1.29 16.47 7.75 3.22 11.62 14.31 7-Mar 84.98 1,993.40 4,544.23 6,647.82 2,530.29 98.59 705.99 498.64 548.05 340.7 34.79 35 9.98 1.38 1.37 14.94 5.4 2.64 12.68 16.5 6-Mar 82.98 1,650.56 4,120.06 6,222.71 2,555.13 74.9 695.3 451.32 441.45 197.47 21.04 25 11.79 1.73 1.42 16.29 4.68 1.93 11.78 13.92

Snapshot view
Rs crores Equity Vodafone 404.09 Idea Cellular 2635.36 MTNL 630

Net worth Capital employed

Sales

9248.31 12262.06
2733.66

3542.27 10057.02
6719.99

11921.36 11921.36
4722.52

Fixed Assets Total Assets

Working Capital PBT

1577.30 13138.33
4273.01 357.64

13888.89 15912.58
-1121.43 1116.86

15842.58 20834.01
4406.53 811.46

Role of Accounting
Accounting is a system that provides information on:
Amounts of resources. How resources were financed. How were the resources invested. Results achieved by using those resources.

For:
Parties inside and outside the organization.
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Business Activities
All businesses are involved in three types of activity

financing, investing, and operating

The accounting information system keeps track of the results of each of these business activities.
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The Accounting process

Economic activities Fin/Inv/Op

Accounting connects decision makers with economic activities and the cycle continues with the results of their decisions

Accounting Information

Actions (decisions)

Decision makers
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Users & Uses of Accounting Information

Who Uses Accounting Data
Internal Users
Finance Management Customers Creditors Marketing Regulatory Agencies Investors Human Resources Taxing Authorities

External Users
Labor Unions

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Users & Uses of Accounting Information

Questions Asked by Internal Users
1. Can we afford to give our employees a pay raise? 2. What price for our product will maximize net income?

User
Human Resources

Marketing Management

3. Which product line is most profitable?

4. Is cash sufficient to pay dividends to the stockholders?

Finance

Users & Uses of Accounting Information

Questions Asked by External Users
1. Is the company earning satisfactory income? 2. How does Vodafone compare in size and profitability with MTNL? 3. Will Kingfisher Airlines be able to pay its debts as they come due?

User
Investors

Investors

Creditors

Process of Accounting
Creating Accounting heads
Asset, Liability, Equity, Income & Expense

Double Entry system Accounting Equation Assets = Owners Equity + Liabilities

Resources financed by = business creditors + lenders + capital provided by owners. Resources Invested in = Fixed Asset + Investment + Current Assets LHS = RHS

Yields Financial Statements

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Purpose of Financial Accounting

To provide financial information about an organization, its current financial position as well as its ability to generate earnings & cash flows, to various interested parties. Such parties include
Investors Creditors & Others including the Regulators, Industry Associations, Researchers including Academicians & (Wall) Street Analysts, General Public, etc.

It should be noted that all these interested parties are external to the organization.

Thus Accounting Information used for decision making meets certain qualitative characteristics.

Financial Statements: Elements

Elements measuring financial position:
Assets Liabilities Equity

Elements measuring performance

Revenue / Income (includes gains) Expenses (includes losses)

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Balance Sheet ASSETS Cash Accts Receivable / Debtors Inventories Total Current Assets Gross Fixed Assets Less: Deprn. Net Fixed Assets Total Assets LIABILITIES Accts payable / Creditors Short term Bank loan Accrued Expenses Total Current Liabilities Long-term debt Total External Liability Common stock/Share Capital Retained earnings Total Owner's Equity Total Liab & Owner's Equity 2013 85,632 878,000 1,716,480 2,680,112 1,197,160 380,120 817,040 3,497,152 2013 436,800 300,000 408,000 1,144,800 400,000 1,544,800 1,721,176 222,780 1,952,352 3,497,152 2012 7,282 632,160 1,287,360 1,926,802 1,202,950 263,160 939,790 2,866,592 2012 524,160 636,808 489,600 1,650,568 723,432 2,374,000 460,000 32,592 492,592 2,866,592

Income Statement 2013 2012 Sales 7,035,600 6,034,000 COGS (5,875,992) (5,528,000) Other expenses (550,000) (519,988) EBITDA 609,608 (13,988) Deprn. & Amortn. (116,960) (116,960) EBIT 492,648 (130,948) Interest Exp. (70,008) (136,012) EBT 422,640 (266,960) Taxes (169,056) 106,784 Net income 253,584 (160,176) Dividend 63,396 0 Retained Earnings 190,188 (160,176)

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Financial Elements - Definition

Assets are Probable Future economic benefits. Liabilities are probable Future Sacrifices of economic benefits. Equity is the residual interest in the assets of an entity that remains after deducting its liabilities. In business enterprises, the equity is the ownership interest.

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Accounting Equation
Travel Assets =Vagabond Liabilities + Agency Owners Equity Balance Sheet December 31, 2007 $300,000 = $80,000 + $220,000 Assets Liabilities & Owners' Equity Cash $ 22,500 Liabilities: Notes receivable 10,000 Notes payable $ 41,000 Accounts receivable 60,500 Accounts payable 36,000 Supplies 2,000 Salaries payable 3,000 Land 100,000 Total liabilities $ 80,000 Building 90,000 Owners' Equity Office equipment 15,000 Capital stock 150,000 Retained earnings 70,000 Total $ 300,000 Total $ 300,000
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Financial Elements - Definition

Revenues / Incomes inflows that result from an entitys central operation or core activities or principal business.
Examples: Sales for Manufacturing & Trading Companies, Interest & Investment Income for Banks. Increase Owners Equity

Expenses outflows that result from an entitys central operations.

Examples: Raw Material Expenses, Personnel Expenses, Manufacturing Expenses, Selling Expenses, etc. Decreases Owners Equity

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Communicating with Users

Companies prepare four financial statements from the summarized accounting data:

Balance Sheet

Income Statement

Retained Earnings Statement

Statement of Cash Flows

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Communicating with Users

Income Statement Retained Earnings Statement

Net income is needed to determine the ending balance in retained earnings.

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Communicating with Users

Balance Sheet Retained Earnings Statement

Ending balance in retained earnings is needed in preparing the balance sheet.

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Exercise
Lamda Inc. had assets of $ 2,80,000 and liabilities of $ 1,20,000 at the beginning of the year and assets of $ 4,00,000 and liabilities of $ 1,40,000 at the end of the year. During the year, there was an investment of $ 40,000 in the business by the owners, and the company paid dividends of $ 48,000. What amount of net income did the company earn during the year?

Illustration

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Exercise
Tarech Corp.engaged in activities during the first year of its operation that resulted in the following: service revenue - $4800, total expenses $ 2450, dividends $410. In addition, the year end balance of selected accounts were as follows cash $1890, other assets $1000, accounts payable $450 & Common stock $500.

In proper format, prepare the Income Statement, statement of Retained earnings and balance sheet for the firm.

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Illustration

Accounting equation in balance- an illustration

Few of us jointly promote a trading Co. on 1-1-12 to buy & sell few consumer durable items, contributing 5 lakhs each (6 of us) to the share capital.
Assets = Liabilities + Owners Equity Cash (30 lakhs) = 0 + Equity share capital (30 lakhs)

Business Entity Concept

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Contd
Took a bank loan Rs 20 lakhs.
Assets = Liabilities + Owners Equity Cash (20) = Bank Loan (20)

Cumulative Impact
Cash (50) = Loan (20) + Equity share capital (30)
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Contd
Rented a showroom, paid 5 lakhs as refundable advance. Rent is 1 lakh p.m.
Assets = Liabilities + Owners Equity

Advance rent (5) + Cash (-5) = 0

Cumulative Impact
Advance (5) + Cash (45) = Loan (20) + Equity share capital (30)
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Contd
Bought furniture for the showroom for 5 lakhs.
Assets = Liabilities + Owners Equity

Furniture (5) + Cash (-5) = 0

Cumulative Impact
Furniture (5) + Advance (5) + Cash (40) = Loan (20) + Equity share capital (30) Historical Cost Assumption
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Contd
Purchased inventory for 60 lakhs. Paid 50% in cash and agreed to pay the balance in 60 days time.
Assets = Liabilities + Owners Equity Inventory (60) + Cash (-30) = Creditors (30)

Cumulative Impact
Furniture (5) + Inventory (60)+ Advance (5) + Cash (10) = Creditors (30) + Loan (20) + Equity share capital (30)
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Contd
Sold 40 lakhs worth of inventory for 50 lakhs;

cash sales 30 lakhs, & balance on credit.

Assets = Liabilities + Owners Equity Inventory (-40) + Debtors (20) + Cash (30) = Sales (50) Cost of goods sold (40)

Cumulative Impact
Furniture (5) + Stock (20)+ Debtors (20) + Advance (5) + Cash (40) = Creditors (30) + Loan (20) + Equity share capital (30) + { Sales (50) Cost of goods sold (40) }
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Contd
Manager informs about the following dues staff salary 2 lakhs, advertisement expenses 2 lakhs, interest 20,000 & rent 1 lakh.
Assets = Liabilities + Owners Equity 0 = Expenses payable (5.2) + OE (-5.2)

Cumulative Impact
Furniture (5) + Stock (20)+ Debtors (20) + Advance (5) + Cash (40) = Creditors (30) + Expenses payable (5.2) + Loan (20) + Equity share capital (30) + {Sales (50) Cost of goods sold (40) Expenses (5.2)}
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Contd
Dividend paid to investors 1 lakh
Assets = Liabilities + Owners Equity Cash (-1) = OE (-1)

Cumulative Impact
Furniture (5) + Stock (20)+ Debtors (20) + Advance (5) + Cash (39) = Creditors (30) + Expenses payable (5.2) + Loan (20) + Equity share capital (30) + {Sales (50) Cost of goods sold (40) Expenses (5.2)} Dividend (1)
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Balance Sheet as at 31-01-12

Liabilities Share capital Reserves & Surplus 30 3.8 Assets Fixed Assets

Furniture

Owner's Equity
Loan from Bank

33.8
20

Current Assets Loans & Advances

Inventory Debtors Rent Advance 20 20 5 39 84

Current Liabilities & Provisions

Cash

Creditors
Expenses payable

30
5.2 89 89
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Income Statement for the month ending 31-01-12

Income Sales Other Income Total Income Expenditure Cost of goods sold 40 50 0 50

Salary
Advertisement rent

2
2 1 45

PBDIT
Depreciation Interest PBT Tax PAT/Disposable profit Dividend

5
0 0.2 4.8 0 4.8 1

Balance profit carried to B/S

3.8

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Cash Flow Summary Receipts cash from fresh equity Bank loan cash received from customers Payments cash paid to supplier cash paid for advance rent purchase of furniture paid dividend Balance of cash closing -30 -5 -5 -1 -41 39
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30 20 30 80

Interdependence of Financial Statements

Balance Sheet as at 2012 Income Statement for the month ending 31-01-12 Cash Flow Summary Receipts 50 0 50 cash from fresh equity Bank loan 30 20

Liabilities
Share capital 30

Assets
Fixed Assets Furniture 5

Income Sales Other Income Total Income Expenditure

Reserves & Surplus Owner's Equity

cash received from customers

30 80

3.8 33.8 Current Assets Loans & Advances Inventory 20 20

Cost of goods sold Salary Advertisement rent

40 2 2 1 45 Payments cash paid to supplier cash paid for advance rent purchase of furniture paid dividend

-30

Loan from Bank

20

Debtors Rent Advance

PBDIT 5 39 84 Depreciation Interest Cash 30 5.2 89 89 PBT Tax PAT/Disposable profit Dividend Balance profit carried to B/S

5 0 0.2

-5

-5 -1 -41

Current Liabilities & Provisions Creditors Expenses payable

4.8 0 4.8 1 3.8 Balance of cash closing

39

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Financial Accounting Regulations (FAR)

FAR
Conventions/ Principles
Full Disclosure Materiality Conservatism Historical Cost Accrual & Cash basis Revenue Recognition Matching
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Assumptions
Going Concern Accounting period
Money measurement

Standards

Separate Entity

Basic Accounting Assumptions

An understanding of basic accounting assumptions is vital to understand the process of accounting. Accounting concepts underlying the recording of transactions:
Separate Entity Concept Money Measurement Concept Going Concern Concept Accounting Period Concept
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