Understanding Financial Statements Financial and Management Accounting Study of Financial Statements - Balance Sheet Analysis and Profit and Loss(Income Statement)

Understanding Financial Statements Balance Sheet Shows what the entity owns and owes (the difference being the owners’ residual interest) at a particular date. ASSETS, LIABILITIES, AND CAPITAL The properties owned by a business enterprise are referred to as assets and the rights or claims to the properties are referred to as liabilities and equities. If the assets owned by the business amount to K1,000,000, the liabilities and equities on the assets must also amount to K1,000,000. The relation between the two may be stated in the form of an equation, as follows: Assets =Liabilities + Equities

BALANCE SHEET ANALYSIS Equity and Liabilities are sources of funds Sources of Funds Capital 2)Reserves & Surplus- 3) Term Liabilities 4) Current Liabilities

BALANCE SHEET ANALYSIS Assets-what we own (they are ours) Uses of Funds 1) Fixed Assets-(Motor vehicle, cooking Equip 2) Intangible Assets 3) Non Current Assets 4) Current Assets- (cash, inventory, debtors etc)

BALANCE SHEET ANALYSIS Part of Equity (Capital) Reserves 1) Subsidy Received From The Govt 2) Development Rebate reserve 3) Revaluation of fixed assets 4) Issue of Shares at Premium 5) General Reserves Surplus The credit balance in profit and loss account

BALANCE SHEET ANALYSIS Tangible Net Worth This refers to the total funds arrived by paid-up capital , Reserves and P&L Surplus Less Intagible Assets

BALANCE SHEET ANALYSIS Term Liabilities-Loan Redeemable preference shares Debentures (Secured loan by property) Deferred payments guarantees Term loans and unsecured loans from friends, relatives, directors repayable over a period of time Note: Repayment is more than one year

BALANCE SHEET ANALYSIS Current Liabilities Working capital bank borrowings (overdraft) Trade creditors unsecured loans, unless the repayment is on deferred terms sundry creditors advances from dealers and customers interest accrued but not paid tax provisions Dividend declared and payable

BALANCE SHEET ANALYSIS Contingent Liabilities Tax disputes Legal litigations Bills and cheques discounted with banks Claims against the company not acknowledged

BALANCE SHEET ANALYSIS What we own Fixed Assets Infrastructure like land & building plant & machinery Vehicles, Cooking equipment Furniture & fixtures Computers Depreciation-They lose their usefulness with time Straight line method Written down Value Method

BALANCE SHEET ANALYSIS Non Current Assets Deferred recievables/Overdue recievables(like disputed amounts and Over Due > 6 mths) Non moving stocks/inventory/un usable spares Investment/Lending to associate concern Borrowing of the directors from the company

BALANCE SHEET ANALYSIS Intangible Assets Deferred Revenue Expenditure Goodwill Trade mark Patents

BALANCE SHEET ANALYSIS Current Assets Raw materials, work-in-progress, finished goods, spares and consumables Trade debtors Sundry debtors and recievables < 6 mths Advances paid to suppliers of raw materials and others Cash and bank balances Interest receivables Other current assets such as Government securities, Bank deposits ..etc

Profit & Loss Account It is a summary of revenue earned and expenses incurred which ultimately results in profit or loss of to the company Operating revenue = Sales revenue Non_operating revenue = Other income ( out of sale of investments, interest, commission and discount etc) Hence operating profit is a yard stick for operating profit of the company Operating profit = Sales Revenue- Operating Cost

Profit and Loss account Measuring profit Income Expenses The profit and loss statement shows the trading performance of the business and the distribution of profit. Net Profit Drawings or dividends Increase in assets goes to B/S as surplus Retained profit

Or measuring loss Turnover Costs Net Loss Drawings or dividends Decrease in assets Retained loss

Profit & Loss Account Gross Sales Gross sales includes excise duty to be charged to the customer, central sales tax applicable, state sales tax applicable, the discount o be allowed to distributors/dealers/customers. The gross sales appears in the P&L account comprises of all the above part from the basic unit price. Net Sales The sales figure excluding all the factors explained above are the net sales.

Profit & Loss Account Cost of production This is the cost incurred right from the procurement of raw material to the finished good. For ex in a garment firm following cost is incurred while production 1) cost of raw material cloth, buttons, canvas, hooks, zips etc 2) Maintenace of sewing machines 3) payment of wages to workers 4) power 5) washing, ironing,packing etc. Cost of Prod exclu selling & admn exp & int cost

Profit & Loss Account Selling And General Administarative Expenses Maintaining office staff for admn & acctg marketing effort payment of salaries/Tr All to marktg personnel All the expenses which are not directly connected to manufacturing are classifed as selling and/or general expenses

Profit & Loss Account Cost of goods sold Cost of goods sold includes all manufacturing expenses and the adjustments for opening and closing stock Cost of Goods sold = Opening stock + Purchases + Manufacturing expenses - Closing stock Gross Profit is arrived deducting figure of cost of goods sold from the sales figure ie Gross profit = Sales - Cost of goods sold.

Cost of sales (Direct costs) £ £ Production wages 110,000 Material costs Opening stock 01.01.XX 110,000 Plus purchases during the year 500,000 610,000 Less closing stock 31.12.XX 195,000 415,000 415,000 Cost of Sales 525,000

Profit & Loss Account Operating Profit is arrived deducting selling, administrative and general expenses , provision for bad debts, interest and miscellaneous expenses from the gross profit. ie Op Profit = Gr Prof - (Sel & adm exp + Prov bad debt + mis exp ) Profit Before Tax When other income is added and other expenses are deducted from the operating profit we get profit before Tax ie PBT = Op Profit + oth Inc - oth exp Net Profit When provision for taxes is deducted from the Profit Before Tax we get Net profit ie Net Profit = PBT - taxes

Expenses (overheads) Other Costs Wages and salaries (admin) Heating and lighting Rent and rates Telephone Advertising Car expenses Printing and stationery Accountant fee Insurances Provision for bad debts Other Costs Depreciation

Profit & Loss Account Non Operating Income/Expenses The income earned by the unit from other than manufacturing and seling operations is classified under this head . i.e a) Interest earned on fixed deposits b) Dividends and profit earned by sale of assets and share. All those expenses which are not directly connected with operations of the unit are classified under this head. i.e a) Preliminary expenses written off b) Loss suffered due to sale of assets & share

Profit and Loss Account SIMPLE COMPANY LTD - Profit and loss account for year ending 31.12.XXXX £ Turnover 950,000 Cost of sales (Direct costs) 525,000 Gross profit 425,000 Expenses (Overheads) 325,000 Other Costs (Depreciation) 10,000 Operating profit 90,000 Non-operating income 24,000 Interest payable 15,000 Profit on ordinary activities before taxation/Net profit 99,000 Corporation tax 22,500 Profit after tax 76,500 Dividends 30,000 Retained profit for the period 46,500 Trading account Profit and Loss Account Appropriation Account

Further Reading Dyson, J.R. ; Accounting for Non-accounting Students Chapter 3 (Covers book-keeping) Chapter 4 (Covers Profit and Loss and Balance Sheet) Chapter 5 (Covers adjustments) Chapter 6 (covers all of these in a company context) A substantial amount of reading is necessary.