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  1. 1. Understanding The Balance of a Company MFM – 1st Year, Division B Mumbai Education Trust MFM (FIRST YEAR), DIV: B First Semester Financial Accounting Project onUNDERSTANDING THE BALANCE SHEET OF A COMPANY 1
  2. 2. Understanding The Balance of a Company MFM – 1st Year, Division B Presented bySr. No. Name Roll No. 1 Nidhi GANDHI 75 2 Ameya MAHURKAR 89 3 Pranav PRAJAPATI 98 4 Durgashree DATE 111 5 Unnati UMROOTKAR 114 2
  3. 3. Understanding The Balance of a Company MFM – 1st Year, Division B Under the Guidance of : Mr. L. N. Chopde Mumbai Educational Trust’s INSTITUTE OF MANAGEMENT (PART TIME MANAGEMENT) CERTIFICATEThis is to certify that project titled UNDERSTANDING THE BALANCE SHEET OF A CO.is based on original study conducted by the group under my guidance and this had notformed a basis for the award of any other degree of this institute / university.Place : MumbaiDate : 21st December 2009 ( Mr. L. N. Chopde ) 3
  4. 4. Understanding The Balance of a Company MFM – 1st Year, Division B MUMBAI EDUCATIONAL TRUST’S INSTITUTE OF MANAGEMENT (PART TIME MANAGEMENT) CERTIFICATE FROM THE ORGANISATIONThis is to certify that the group has / have successfully completed a study onUNDERSTANDING THE BALANCE SHEET OF A CO. and has / have submitted theproject report on the same.The study conducted was satisfactory. We wish him / them all the best. 4
  5. 5. Understanding The Balance of a Company MFM – 1st Year, Division BPREFACE 5
  6. 6. Understanding The Balance of a Company MFM – 1st Year, Division B ACKNOWLEDGEMENTSWe would sincerely like to thank Prof. L. N. Chopde sir for his valuable guidance withoutwhich the project would never have been accomplished. 6
  7. 7. Understanding The Balance of a Company MFM – 1st Year, Division BEXECUTIVE SUMMARY 7
  8. 8. Understanding The Balance of a Company MFM – 1st Year, Division B TABLE OF CONTENTSSr. No. Particulars Page No. 1 Introduction 9 2 Profile of the Company 9 3 Hero Honda’s Logo 11 4 Hero Honda’s Mandate 11 5 Hero Honda’s Mission 11 6 Award’s & Recognitions 12 7 Corporate Profile 13 8 Subsidiaries 13 Hero Honda’s performance on the 9 BSE and NSE in the last 14 FY2009-2010 10 Meaning of the Balance Sheet 15 11 Concepts of the Balance Sheet 15 12 Ratio Analysis 28 13 Conclusion 32 14 Bibliography 33 8
  9. 9. Understanding The Balance of a Company MFM – 1st Year, Division BIntroductionEvery organization needs funds for smooth running of activities. The Balance Sheet is astatement of Assets and Liabilities of a Company expressed in monetary terms as on aparticular date. This gives us the financial position of the company at a given point oftime.Assets are items of monetary value owned by a Company. Liabilities are the monetaryclaims that the Company owes to the outsider.A Balance Sheet is prepared and published by Companies, not on their own volition, butbecause of statutory obligation, imposed by the Companies Act, under which everypublic limited Company is required to prepare and publish its Balance Sheet, and otherrelated documents. Within 6 months from the close of the accounting period. The Actfurther insists that the financial statements should be audited by a chartered accountantwho has to report to the shareholders whether or not he accounts are “true and fair”.The main parts to a balance Sheet are: a) Sources of Funds b) Application of FundsIn this project we will understand the balance sheet of Hero Honda Motors Ltd. We willunderstand each and every line items of the balance sheet and some important financialratios.Profile of the CompanyHero Honda Motors Ltd. is the worlds largest manufacturer of two – wheelers, based inIndia.Hero Honda is not a Company. It is the integration of two cultures that’s namely Indianand Japanese.The company is a joint venture between Indias Hero Group and Honda Motor Company,Japan that began in 1984.In 2001, the company achieved the coveted position of being the largest two-wheelermanufacturing company in India and the ‘World No.1’ two-wheeler company in terms ofunit volume sales in a calendar year by a single company. Hero Honda has retained thatcoveted position till date.Today, every second motorcycle sold in the country is a Hero Honda bike. Every 30seconds, someone in India buys Hero Hondas top-selling motorcycle – Splendor.VisionThe Hero Honda story began with a simple vision – the vision of a mobile and anempowered India, powered by Hero Honda. This vision was driven by Hero Honda’scommitment to customer, quality and excellence, and while doing so, maintaining thehighest standards of ethics and societal responsibilities. Hero Honda believes that thefastest way to turn that dream into a reality is by remaining focused on that vision. 9
  10. 10. Understanding The Balance of a Company MFM – 1st Year, Division BStrategyHero Honda’s key strategy has been driven by innovation in every sphere of activity –building a robust product portfolio across categories, exploring new markets,aggressively expanding the network and continuing to invest in brand building activities.ManufacturingHero Honda bikes are manufactured across three globally benchmarked manufacturingfacilities. Two of these are based at Gurgaon and Dharuhera which are located in thestate of Haryana in northern India. The third and the latest manufacturing plant is basedat Haridwar, in the hill state of Uttrakhand.TechnologyIn the 1980’s Hero Honda pioneered the introduction of fuel-efficient, environmentfriendly four-stroke motorcycles in the country. Today, Hero Honda continues to betechnology pioneer. It became the first company to launch the Fuel Injection (FI)technology in Indian motorcycles, with the launch of the Glamour FI in June 2006.ProductsHero Hondas product range includes variety of motorcycles that have set the industrystandards across all the market segments. The company also started manufacturingscooter in 2006. Hero Honda offers large no. of products and caters to wide variety ofrequirements across all the segments.DistributionThe companys growth in the two wheeler market in India is the result of an intrinsicability to increase reach in new geographies and growth markets. Hero Hondasextensive sales and service network now spans close to 4500 customer touch points.These comprise a mix of authorized dealerships, Service & Spare Parts outlets, anddealer-appointed outlets across the country.BrandThe company has been continuously investing in brand building utilizing not only thenew product launch and new campaign launch opportunities but also through innovativemarketing initiatives revolving around cricket, entertainment and ground- level activation.Hero Honda has been actively promoting various sports such as hockey, cricket andgolf. Hero Honda was the title sponsor of the Hero Honda FIH Hockey World Cup thatwas played in Delhi during Feb-March 2010. Hero Honda also partners theCommonwealth Games Delhi 2010. 10
  11. 11. Understanding The Balance of a Company MFM – 1st Year, Division BHERO HONDA’s LogoHERO HONDAS MissionHero Honda’s mission is to strive for synergy between technology, systems and humanresources, to produce products and services that meet the quality, performance andprice aspirations of its customers. At the same time maintain the highest standards ofethics and social responsibilities.This mission is what drives Hero Honda to new heights in excellence and helps theorganization forge a unique and mutually beneficial relationship with all its stake holders.HERO HONDAS MandateHero Honda is a world leader because of its excellent manpower, proven management,extensive dealer network, efficient supply chain and world-class products with cuttingedge technology from Honda Motor Company, Japan. The teamwork and commitmentare manifested in the highest level of customer satisfaction, and this goes a long waytowards reinforcing its leadership status.As Brijmohan Lall Munjal, the Chairman, Hero Honda motors succinctly pointsout………….“We pioneered India’s motorcycle industry, and its our responsibility now to take theindustry to the next level. We’ll do all it takes to reach there.” 11
  12. 12. Understanding The Balance of a Company MFM – 1st Year, Division BAwards and Recognitions 12
  13. 13. Understanding The Balance of a Company MFM – 1st Year, Division BYearAwards&Recognitions2010Company oftheYearawardedbyEconomicTimesAwardsforCorporateExcellence2008-09.CNBCTV18OverdriveAwards2010HallofFame toSplendorNDTVProfit Car 13
  14. 14. Understanding The Balance of a Company MFM – 1st Year, Division BCorporate Profile 14
  15. 15. Understanding The Balance of a Company MFM – 1st Year, Division BNo.NameoftheDirectorsDesignation1Mr.BrijmohanLallMunjalChairman&Whole-timeDirector2Mr.PawanMunjalManagingDirector&CEO3 15
  16. 16. Understanding The Balance of a Company MFM – 1st Year, Division BSubsidiariesHero Cycles Ltd.Hero Honda Finlease Ltd.Munjal Showa Ltd.Sunbeam Auto Ltd.Hero Financial Services Ltd.Munjal Auto Industries LtdHero Honda Motors Performance on the BSE and NSE for fiscal 2009-2010 16
  17. 17. Understanding The Balance of a Company MFM – 1st Year, Division BMeaning of a Balance SheetA quantitative summary of a companys financial condition at a specific point in time,including assets, liabilities and net worth. The first part of a balance sheet shows all theproductive assets a company owns, and the second part shows all the financingmethods (such as liabilities and shareholder’s equity).A balance sheet is prepared at the end of the year to know the financial position of anorganization. It is the statement of assets and liabilities of an organization. It is astatement which shows sources of funds and the application of funds.The Companies Act, 1956 has laid down a vertical and a horizontal format of thebalance sheet. The vertical format of the balance sheet is an abridged format which issupported by various schedules. Horizontal format is not supported by schedulesbecause entire info is disclosed in the horizontal format only. Companies are given anoption to follow either of the formats. However, most companies follow the verticalformat.Concepts of the Balance SheetShare Capital:It is the capital collected by the Company from the members of the public bysubscription to the shares. Total share capital of the Company is divided into small units 17
  18. 18. Understanding The Balance of a Company MFM – 1st Year, Division Bhaving fixed denomination. Each unit is called as a share and the fixed denomination ofthe share which is mentioned under capital clause of the Memorandum of association iscalled as the Face Value of the share. It is also called as Nominal Value of a share. Asper SEBI (Securities and Exchange Board of India) Guidelines, Face Value of a sharecannot be less than Re. 1.Authorized Capital:It is the maximum amount of capital that can be raised by the Company by issue ofshares. It is mentioned under capital clause of Memorandum of Association. Thecompany is authorized to raise the capital to the extent of authorized capital.Issued Capital:It is a part of the authorized capital which is offered to the public for subscription. It is thecapital for which applications are invited by the Company for subscription.Subscribed Capital:Capital for which applications are received for subscription to the share capital. If thenumber of shares applied is more than the number of shares issues it is called oversubscription. In such a case the shares are allotted to the applications proportionately. Ifthe number of shares applied is equal to the number of shares issued it is called parsubscription. In this case all eligible applicants get allotment. If number of shares appliedis less than the number of shares issued it is called under subscription. In this case,eligible applicants get following allotments.Paid-up Capital:It is part of the subscribed capital which is actually paid-up by the shareholders.As per the Company’s law the following information has to be disclosed about sharecapital:Types of Shares – Equity Shares or Preference SharesNumber of SharesFace Value of each ShareAmount paid per ShareIssue of Bonus SharesIssue of Shares for consideration other than CashHero Honda’s Share Capital consists of : 18
  19. 19. Understanding The Balance of a Company MFM – 1st Year, Division BReserves and SurplusGeneral Reserve / Revenue Reserve / Free Reserve:Amount kept aside out of profit for meeting future contingencies. It is called as Freereserve because it can be use freely for any purpose. It is available for distribution asdividend among shareholders.Dividend Equalization Reserve:It is the amount kept aside out of profit for equalizing the rate of dividend. It is divisibleprofit.Capital reserve:It is a reserve created out of capital profits. It is the profit which is non-recurring. For e.g.Profit on sale of capital assets, profit on reissue of forfeited shares, profit prior toincorporation etc.Capital reserve can be utilized for writing off capital losses and for issue of fully paidbonus shares. Capital reserve cannot be utilized for payment of dividend to theshareholders.Securities Premium:It is the excess of issue price over Face Value of securities issued. It includes premiumon issue of shares and on debentures. Securities premium can be utilized for thefollowing purposes only. 1) To write – off preliminary expenses/formation expenses of the company. 19
  20. 20. Understanding The Balance of a Company MFM – 1st Year, Division B 2) To issue fully paid bonus shares. 3) To adjust premium on redemption of preference shares. 4) To adjust premium on buyback of Equity shares. 5) Securities premium cannot be utilized for payment of Dividend.Workmen compensation fund:It is an amount kept aside out of profit for payment of compensation to the workers whoreceive personal injury due to an accident which takes place during the course ofemployment. If there is no liability against the fund the entire amount of the fund is a partof accumulated profit which can be utilized for any purpose.Revaluation Reserve:It is a reserve created out of the appreciation incase on land and building. The companyappoints expert re-valuer to bring the current price of building into the books. Theamount of appreciation recommended is added to the book value of the building andtransferred to revaluation reserve. Revaluation reserve is of capital nature. It cannot beutilized for payment of dividend. It cannot be used to issue bonus shares.Capital Redemption Reserve:It is the reserve created out of divisible profit for redemption of preference shares. Theamount of Capital Redemption Reserve is the nominal value of preference share capitalredeemed out of divisible profits. Capital redemption reserve can be utilized for paymentof dividend.Investment Allowance Reserve:It is a reserve created as per the provisions of the Indian IT Act, 1961. The amount ofreserve created is equal to 25% of cost of machinery purchased during the year. Thereserve can be utilized for replacement of machinery after 8 years.As per the provisions of the Companies Act, the following information should bedisclosed about every reserve. Balance at the beginning of the year (openingbalance), additions during the year, utilization during the year and closingbalance.Hero Honda’s Reserves and Surplus consists of: 20
  21. 21. Understanding The Balance of a Company MFM – 1st Year, Division BProfit & Loss a/c Balance (Retained Earnings)It is the amount of profit left in the business after making all the appropriations. It iscalled as retained earnings. It can be utilized for any purpose.Secured LoansLoans taken by the company against the security of assets is called as secured loans. Ifthe loan is taken against the security of fixed assets it is called as a mortgage loan.Secured loans have the following features: 1) It carried fixed rate of interest. 2) Interest payable irrespective of profits. 3) No right of management. 4) Refundable after a certain period. 5) Secured by the assets.In case there is any default in repayment of loan the asset given as a security isdisposed off and the claim is recovered.DebenturesAcknowledgment of debt by a company from the members of the public by issue of aninstrument. It is a written given by the company to the lenders for repayment of a certainamount with interest on a certain date.Categories of debentures: a) On the basis of registration: 1) Registered Debentures: 21
  22. 22. Understanding The Balance of a Company MFM – 1st Year, Division B They are registered with the company and they are transferable as per the procedure of transfer laid down by the law. Interest on such debentures is paid by issue of Interest Warrants. 2) Bearer Debentures: These debentures are transferrable by mere delivery of the instruments. It goes on changing hands at any number of times. The company cannot have a record of the holder on the date of payment of interest. Therefore interest is paid by issue of interest coupon.b) On the basis of security: 1) Secured Debentures: These debentures are secured by the assets of the company. 2) Unsecured Debentures: These debentures are not secured by the assets of the company.c) On the basis of Redemption: 1) Redeemable Debentures: These are refundable after certain period. 2) Irredeemable Debentures: These are not refundable after certain period. The refund depends on the desire of the Company.d) On the basis of conversion: 1) Convertible Debentures: These are convertible into equity shares. 2) Non-convertible Debentures: These cannot be converted into equity shares.e) Zero coupon Bond or Debentures: These type of debentures do not carry any rate of interest. These are issued at a price lower than future value on redemption, the debenture holder is paid equal to the future value.f) Collable Bonds: It is the amount of debentures which can be repaid by the company on receiving a call from debenture holders. In other words, such debentures are refundable at any time at the request of debenture holders.g) Bonus Debentures: These are the debentures issued by the company to the shareholders out of profits of the company. The holders are not required to pay any amount to the 22
  23. 23. Understanding The Balance of a Company MFM – 1st Year, Division B company. The amount payable by the holders is adjusted out of the profits of the company.Unsecured LoansAmount of loan taken by the company without creating any change on the assets. Theamount of loan is repayable after a certain period. In case of any default, the amountcan be recovered from the company by taking legal action. a) Unsecured Debentures b) Unsecured bank loan c) Unsecured loan from financial institutions d) Unsecured loan from Directors e) Public deposits are fixed deposits accepted by the companies from the members of the public as per the provisions of acceptance of deposit rules specified by Companies Act. Public deposits as a source of finance has the following features: 1) Unsecured 2) Accepted for maximum period of 3 years 3) Rate of interest not to exceed 12.5% 4) Refundable after a certain period 5) Do not have right of management 6) Interest is payable irrespective of profit 7) In case of default, amount can be recovered through legal action. 8) The companies are required to announce through leading newspapers about acceptance of deposit as per the format laid down by the law. 9) The deposits are acknowledged by the company by issue of deposit receipt. 10) In case the deposits are not refunded by the companies after a specified period, the responsible officer is penalized by the penalty which is equal to the amount of deposit.Hero Honda’s Loan Funds consists of:Current Liabilities & Provisions:These are the obligation which is required to be paid within the operating cycle periodout of current assets. 23
  24. 24. Understanding The Balance of a Company MFM – 1st Year, Division BCurrent liabilities:Current Liabilities are what a company currently owes to its suppliers and creditors.These are short-term debts that normally require that the company convert some of itscurrent assets into cash in order to pay them off. These are all bills that are due in lessthan a year. As well as simply being a bill that needs to be paid, liabilities are also asource of assets. Any money that a company pulls out of its line of credit or gains theuse of because it pushes out its accounts payable is an asset that can be used to growthe business. There are five main categories of current liabilities: Accounts Payable,Accrued Expenses, Income Tax Payable, Short-Term Notes Payable and Portion ofLong-Term Debt Payable.Accounts Payable:Accounts Payable is the money that the company currently owes to its suppliers, itspartners and its employees. Basically, these are the basic costs of doing business that acompany, for whatever reason, has not paid off yet. One companys accounts payable isanother companys accounts receivable, which is why both terms are similarlystructured. A company has the power to push out some of its accounts payable, whichoften produces a short-term increase in earnings and current assets.Accrued Expenses:Accrued expenses are bills that the company has racked up that it has not yet paid.These are normally marketing and distribution expenses that are billed on a setschedule and have not yet come due. A specific type of accrued expense is Income TaxPayable. This is the income tax a company accrues over the year that it does not haveto pay yet according to various federal, state and local tax schedules. Although subjectto withholding, there are some taxes that simply are not accrued by the government overthe course of the quarter or the year and instead are paid in lump sums whenever thebill is due.Short-Term Notes:Short term note payable is the amount that a company has drawn off from its line ofcredit from a bank or other financial institution that needs to be repaid within the next 12months. The company also might have a portion of its Long-Term Debt come due withthe year, which is why this gets counted as a current liability even though it is calledlong-term debt -- one of those little accounting quirks.Provision:It is an amount kept aside out of income/profit for the known liabilities. For e.g. Provisionfor taxation is amount kept aside out of income for payment of tax obligation where aspayment of dividend. In case it is recommended are declared. For e.g. Provision fordividend tax (15.7%). It is the amount kept aside out of profit for payment of Dividend taxon the dividend that could be distributed during the year. Dividend tax I is about 15.7%of the dividend distribution. Provision for interim dividend.Hero Honda’s Current Liabilities and Provisions consist of: 24
  25. 25. Understanding The Balance of a Company MFM – 1st Year, Division BFixed assetsLong – term assets which are held in business for production of goods and services andgeneration of revenue. They are called as long – lived assets. These assets are held orused in business and not for sale. For e.g. Furniture and Fixtures, Patents andcopyrights etc.Goodwill: Intangible fixed asset, having realizable value. Goodwill though intangible isnot fictitious. Fictitious assets are intangible; they cannot be converted into cash. Theseare assets which do have physical existence but they cannot be seen by eyes.Land & building: It is the cost of purchasing or constructing the building for businesspurpose. The company may build building for residential purpose of its employees. Allthese are included in building account.Furniture and fittings: It includes assets like tables and chairs etc. used for helpingoperational functions of the company.Machinery & Plant: It includes the purchase price, taxes, transport, insurance in transit,assembling and testing of machinery and plants.Vehicles: It includes cars, trucks, buses and any other vehicles that the company hasbought for use in the business.Capital work – in – progress: It includes the cost of assets manufactured during theyear but on the date of balance sheet the manufacturing is not completed. For e.g.construction of building, manufacturing of machine for own use in the factory. The costincurred on such assets is shown as capital work – in – progress. 25
  26. 26. Understanding The Balance of a Company MFM – 1st Year, Division BAs per the provision of the Company’s Law, fixed assets are to be presented in thebalance sheet of companies less provision for depreciation to date. Gross block is equalto total cost of the Fixed Assets.Provision for Depreciation represents the total accumulated depreciation right from thedate of acquisition to the date of balancing. Net block is the total written down value(WDV) of the fixed assets. It is also called as book value of the Fixed Assets.Cost of the assets include acquisition costs, installation cost charges, import duty,documentation charges, freight, transit insurance, stamp duty and registration.As per the provisions of the Company Law, total provision for depreciation should bededucted from the cost of fixed assets. Company’s can provide depreciation as perStraight line method (SLM) or Written down Value method (WDV) as per the rate ofdepreciation specified in the schedule.XIV of Company’s Act the Company’s are given the option of following any method outof the two. Most of the companies follow SLM of depreciation. For Income Tax purpose,Income Tax Act recognizes WDV method. The Income Tax Act has laid down rates ofdepreciation for taxation purposes. Companies have to provide depreciation as per theCompanies Law for calculation of accounting profit. While deducting the tax liability,depreciation adjustment is made in the profit on account of depreciation, by income taxofficer.Hero Honda’s Fixed Assets consists of:Investments 26
  27. 27. Understanding The Balance of a Company MFM – 1st Year, Division BInvestments are the assets held by the Company for generation of incomes on accountof interest or dividend. As per the provisions of the Company’s Law following informationhas to be disclosed about investment: a) Pattern of investment. b) Cost, Market Value, Nominal Value. c) Quoted / Unquoted d) Trading / Non-Trading e) Terms and ConditionsHero Honda’s Investments consists of:Current assets & Loans & AdvancesCurrent AssetsCurrent assets are the assets held for consumption or conversion during the operatingcycle period. Current Assets are assets that a company has at its disposal that can beeasily converted into cash within one operating cycle. An operating cycle is the time thatit takes to sell a product and collect cash from the sale. It can last anywhere from 60 to180 days. Current assets are important because it is from current assets that a companyfunds its ongoing, day-to-day operations. If there is a shortfall in current assets, then thecompany is going to have to dig around to find some other form of short-term funding,which normally results in interest payments or dilution of shareholder value through theissuance of more shares of stock. There are five main kinds of current assets -- Cash &Equivalents, Accounts Receivable and Inventories.Cash & Equivalents:Cash and cash equivalents are assets that are money in the bank, literally cold, hardcash or something equivalent, like bearer bonds, money market funds. Cash andequivalents are completely liquid assets, and thus should get special respect fromshareholders. This is the money that a company could immediately mail to you in theform of a fat dividend if it had nothing better to do with it. This is the money that thecompany could use to buy back stock, and thus enhance the value of the shares thatyou own.Hero Honda’s Cash and Cash equivalents consists of: 27
  28. 28. Understanding The Balance of a Company MFM – 1st Year, Division BSundry Debtors:Sundry debtors are customers who owe money to the Company.. The reason why thecustomers owe money is that the product has been delivered but has not been paid foryet. Companies routinely buy goods and services from other companies using credit.Although typically debtors are almost always turned into cash within a short amount oftime, there are instances where a company will be forced to take a write-off for debtors ifit has given credit to someone who cannot or will not pay. This is why you will seesomething called allowance for bad debt in parentheses beside the Sundry Debtorsnumber. The allowance for bad debt is the money set aside to cover the potential for badcustomers, based on the kind of receivables problems the company may or may nothave had in the past. However, even given this allowance, sometimes a company will beforced to take a write-down for accounts receivable or convert a portion of it into a loan ifa big customer gets in real trouble. Looking at the growth in debtors relative to thegrowth in revenues is important -- if debtors are up more than revenues, you know that alot of the sales for that particular quarter have not been paid for yet. We will look atdebtors turnover and days sales outstanding ratios to measure Sundry Debtors.Hero Honda’s Sundry Debtors consists of: 28
  29. 29. Understanding The Balance of a Company MFM – 1st Year, Division BInventories:Inventories are the components and finished products that a company has currentlystockpiled to sell to customers. Not all companies have inventories, particularly if theyare involved in advertising, consulting, services or information industries. For those thatdo, however, inventories are extremely important. Inventories should be viewedsomewhat skeptically by investors as an asset. First, because of various accountingsystems like FIFO (first in, first out) and LIFO (last in, first out) as well as real liquidationcompared to accounting value, the value of inventories is often overstated on thebalance sheet. Second, inventories tie up capital. Money that it is sitting in inventoriescannot be used to sell it. Companies that have inventories growing faster than revenuesor that are unable to move their inventories fast enough are sometimes disasters waitingto happen. We will look at inventory turnover later as another way to measure inventory.Hero Honda’s Inventories consists of:Loans and AdvancesThese are the short-term advances given by the Company which are recoverable incash. For e.g. Expenses paid in advance, Advance payment of Income Tax, Advance toStaff, Advances to Suppliers, Bills Receivable, and Security Deposit with CustomsAuthority etc. 29
  30. 30. Understanding The Balance of a Company MFM – 1st Year, Division BHero Honda’s Loans and Advances consist of:Miscellaneous ExpenditurePreliminary expenses / formation expenses, expenses on issue of shares / debentures,underwriting commission, discount on issue of shares / debentures, deferred revenueexpenditure, amalgamation adjustment account. As per the accounting policy fictitiousassets are to be written off over certain number of years. The amount written off isshown over certain number of years. The amount written off is shown in the IncomeStatement and the remaining unwritten off is shown in the Balance Sheet undermiscellaneous expenses.Contingent LiabilitiesThe liabilities which are likely to arise in future on happening of certain events are calledas contingent liabilities. Whether the liabilities will arise or not depends on thehappenings in the future. For e.g. Arrears of preference dividend, Claim forcompensation pending in the court of law, Amount payable on calls on sharespurchased etc.Deferred Tax Assets / LiabilitiesAccounting profit is the profit arrived as per the Income statement prepared according toprovisions of Indian Companies Act, accounting standards and generally acceptedaccounting principles. The profit disclosed in the Income statement may not be acceptedby the Income Tax officer for taxation purpose because accounting profit shown by theincome statement is not arrived as per the provisions of the Income Tax Act.Example:While deciding accounting profit depreciation is provided as per the Indian CompaniesAct whereas for determination of taxable profit, depreciation is provided as per IncomeTax Act. Bad debt provisions maybe made in the accounting profit and loss a/c but theIncome Tax officer does not allow bad debt provision unless the loss on bad debt isactually incurred. As a result, the accounting profit differs from taxable profit because ofthis difference in treatment; the tax liability provided differs from tax payable decided bythe Income Tax officer. As a result, Deferred Tax Asset or Deferred Tax Liability arises. 30
  31. 31. Understanding The Balance of a Company MFM – 1st Year, Division BIf the amount of tax payable as per Income Tax Law is more than the amount of taxpayable as per the accounting principles Deferred Tax Asset arises.If the amount of tax payable as per Income Tax Law is less than the amount of taxpayable as per the accounting principles Deferred Tax Liability arises.Hero Honda’s Deferred Tax Assets / Liabilities consist of:Ratio Analysis:Ratio Analysis enables the business owner/manager to spot trends in a business and tocompare its performance and condition with the average performance of similarbusinesses in the same industry. To do this compare your ratios with the average ofbusinesses similar to yours and compare your own ratios for several successive years,watching especially for any unfavorable trends that may be starting. Ratio analysis mayprovide the all-important early warning indications that allow you to solve your businessproblems before your business is destroyed by them.Balance Sheet Ratio Analysis FormulaImportant Balance Sheet Ratios measure liquidity and solvency (a businesss ability topay its bills as they come due) and leverage (the extent to which the business isdependent on creditors funding). They include the following ratios:Liquidity RatiosThese ratios indicate the ease of turning assets into cash. They include the CurrentRatio, Quick Ratio, and Working Capital.Current Ratios: The Current Ratio is one of the best known measures of financialstrength. It is figured as shown below: Total Current AssetsCurrent Ratio = ____________________ Total Current LiabilitiesThe main question this ratio addresses is: "Does your business have enough currentassets to meet the payment schedule of its current debts with a margin of safety forpossible losses in current assets, such as inventory shrinkage or collectable accounts?" 31
  32. 32. Understanding The Balance of a Company MFM – 1st Year, Division BA generally acceptable current ratio is 2 to 1. But whether or not a specific ratio issatisfactory depends on the nature of the business and the characteristics of its currentassets and liabilities. The minimum acceptable current ratio is obviously 1:1, but thatrelationship is usually playing it too close for comfort.If you decide your businesss current ratio is too low, you may be able to raise it by: • Paying some debts. • Increasing your current assets from loans or other borrowings with a maturity of more than one year. • Converting non-current assets into current assets. • Increasing your current assets from new equity contributions. • Putting profits back into the business.Quick Ratios: The Quick Ratio is sometimes called the "acid-test" ratio and is one of thebest measures of liquidity. It is figured as shown below: Cash + Government Securities + ReceivablesQuick Ratio = _________________________________________ Total Current LiabilitiesThe Quick Ratio is a much more exacting measure than the Current Ratio. By excludinginventories, it concentrates on the really liquid assets, with value that is fairly certain. Ithelps answer the question: "If all sales revenues should disappear, could my businessmeet its current obligations with the readily convertible `quick funds on hand?"An acid-test of 1:1 is considered satisfactory unless the majority of your "quick assets"are in accounts receivable, and the pattern of accounts receivable collection lags behindthe schedule for paying current liabilities.Working Capital: Working Capital is more a measure of cash flow than a ratio. Theresult of this calculation must be a positive number. It is calculated as shown below:Working Capital = Total Current Assets - Total Current LiabilitiesBankers look at Net Working Capital over time to determine a companys ability toweather financial crises. Loans are often tied to minimum working capital requirements.A general observation about these three Liquidity Ratios is that the higher they are thebetter, especially if you are relying to any significant extent on creditor money to financeassets.Leverage Ratio 32
  33. 33. Understanding The Balance of a Company MFM – 1st Year, Division BThis Debt/Worth or Leverage Ratio indicates the extent to which the business is relianton debt financing (creditor money versus owners equity): Total LiabilitiesDebt/Worth Ratio = _______________ Net WorthGenerally, the higher this ratio, the more risky a creditor will perceive its exposure inyour business, making it correspondingly harder to obtain credit.Management RatiosOther important ratios, often referred to as Management Ratios, are also derived fromBalance Sheet and Statement of Income information.Inventory Turnover Ratio: This ratio reveals how well inventory is being managed. It isimportant because the more times inventory can be turned in a given operating cycle,the greater the profit. The Inventory Turnover Ratio is calculated as follows: Net SalesInventory Turnover Ratio = ___________________________ Average Inventory at CostAccounts Receivable Turnover Ratio: This ratio indicates how well accounts receivableare being collected. If receivables are not collected reasonably in accordance with theirterms, management should rethink its collection policy. If receivables are excessivelyslow in being converted to cash, liquidity could be severely impaired. The AccountsReceivable Turnover Ratio is calculated as follows:Net Credit Sales/Year__________________ = Daily Credit Sales365 Days/Year Accounts ReceivableAccounts Receivable Turnover (in days) = _________________________ Daily Credit SalesReturn on Assets Ratio: This measures how efficiently profits are being generated fromthe assets employed in the business when compared with the ratios of firms in a similarbusiness. A low ratio in comparison with industry averages indicates an inefficient use ofbusiness assets. The Return on Assets Ratio is calculated as follows: Net Profit Before TaxReturn on Assets = ________________________ Total AssetsReturn on Investment (ROI) Ratio: The ROI is perhaps the most important ratio of all. Itis the percentage of return on funds invested in the business by its owners. In short, thisratio tells the owner whether or not all the effort put into the business has been 33
  34. 34. Understanding The Balance of a Company MFM – 1st Year, Division Bworthwhile. If the ROI is less than the rate of return on an alternative, risk-freeinvestment such as a bank savings account, the owner may be wiser to sell thecompany, put the money in such a savings instrument, and avoid the daily struggles ofsmall business management. The ROI is calculated as follows: Net Profit before TaxReturn on Investment = ____________________ Net WorthThese Liquidity, Leverage and Management Ratios allow the business owner to identifytrends in a business and to compare its progress with the performance of others throughdata published by various sources. The owner may thus determine the businesssrelative strengths and weaknesses.Hero Honda Motors Ltd. Financial RatiosDESCRIPTION Mar-1 Mar- Mar- Mar- Mar- Mar-0 0 09 08 07 06 5Performance RatiosROA (%) 60.24 36.63 33.65 35.52 49.94 53.88ROE (%) 61.43 37.77 35.48 38.30 55.46 61.58ROCE (%) 76.48 50.99 49.09 51.66 72.75 81.04Asset Turnover(x) 4.53 3.87 4.18 4.78 5.19 5.71Inventory Turnover(x) 43.97 42.06 40.62 45.97 46.82 43.81Debtors Turnover(x) 129.92 60.54 38.06 46.74 81.27 128.94Efficiency RatiosReceivable days 2.81 6.03 9.59 7.81 4.49 2.83Inventory Days 8.30 8.68 8.98 7.94 7.80 8.33Payable days 25.56 25.22 26.76 25.20 32.18 37.43Financial StabilityRatiosTotal Debt/Equity(x) 0.02 0.03 0.05 0.08 0.11 0.14Current Ratio(x) 0.76 0.66 0.71 0.88 0.77 0.55Quick Ratio(x) 0.64 0.45 0.47 0.61 0.55 0.34Conclusion 34
  35. 35. Understanding The Balance of a Company MFM – 1st Year, Division BThe balance sheet is an important tool for investors to gain insight into a company andits operations. The balance sheet is a snapshot at a single point in time of thecompany’s accounts - covering its assets, liabilities and shareholders’ equity. Thepurpose of the balance sheet is to give users an idea of the company’s financial positionalong with displaying what the company owns and owes. It is important that all investorsknow how to use, analyze and read this document.The main types of ratios that use information from the balance sheet are financialstrength ratios and activity ratios. Financial strength ratios, such as the working capitaland debt-to-equity ratios, provide information on how well the company can meet itsobligations and how they are leveraged. This can give investors an idea of howfinancially stable the company is and how the company finances itself. Activity ratiosfocus mainly on current accounts to show how well the company manages its operatingcycle (which include receivables, inventory and payables).These ratios can provide insight into the companys operational efficiency.From the ratios calculated above if we try and analyze the Balance Sheet of Hero HondaMotors Ltd, its Current Ratio shows that the Liquidity position of the company is not verysatisfactory as the current ratio is 0.46:1, which is much below the ideal ratio of 2:1. TheCompany should increase the current assets and decrease the current liabilities.Hero Honda takes 130 days to convert its debtors to cash and 44 days to convert itsinventories into sales.Bibliography 35
  36. 36. Understanding The Balance of a Company MFM – 1st Year, Division BHero Honda Motors Ltd. Website: http://www.herohonda.com/Annual Report of the company: http://www.herohonda.com/invest_annual_reports.htmGoogle Search 36