2. Session Outline
1. Basic Concepts
2. Balance Sheet
3. Income Statement
4. General Principles of Financial Management
5. Analyzing costs for Decision Making
3. Balance sheet vs P&L - Stock and Flow
Balance sheet is a stock – at a fixed
point in time
P&L statement is a flow – for a
specific period
4. Balance Sheet
Balance Sheet
1. Three components –
1. Assets – What you OWN
2. Liabilities – What you OWE
3. Shareholder’s equity – Net worth of company (Difference between the above two - What
shareholders will get)
These are listed as of that date for which the balance sheet is made.
5. Income Statement
Income Statement (Profit & Loss statement)
1. One final figure – the net profit or loss
1. Total revenues – Sales (and any other components)
2. Total expenses – Business expenses (and other components)
This is the profit/loss for the period for which income statement is prepared.
6. Balance sheet vs P&L - Stock and Flow
Balance sheet is about Stock (assets/liabilities)
P&L is about Flow (profits/losses)
In Balance sheet, you would show things like “How much cash does the firm have as of Nov 29
2020?”
This is an asset (you own this much cash)
It makes no sense to ask “How much profit does this firm have as of Nov 29 2020?”
Instead, you ask: “How much profit did this firm make in 2020 (say Jan 1 2020 to Nov 29 2020)?”
This is the income statement.
7. An example – Wayne Enterprises
Manufacturer of Batmobiles
8. An example – Wayne Enterprises
Remember that a firm is a separate legal entity.
Financial statements are prepared for the firm, not for the owners/CEO/shareholders.
All assets belong to the firm.
All liabilities are against the firm, not shareholders.
The surplus reserves go to the shareholders who invest in the firm.
So the firm owes this money to the shareholders – shareholder’s equity is a liability to them.
9. Balance sheet
𝐴𝑠𝑠𝑒𝑡𝑠 = 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 + 𝑆ℎ𝑎𝑟𝑒ℎ𝑜𝑙𝑑𝑒𝑟′𝑠 𝐸𝑞𝑢𝑖𝑡𝑦
This always holds true.
It’s called a balance sheet – because A always balances (L + SE)
This is because of something called “double entry” – every transaction is recorded in at least two
accounts.
You never “get” something for free without “giving” something.
10. Wayne Enterprises - Balance sheet (as of 29/11/2020)
𝐴𝑠𝑠𝑒𝑡𝑠 = 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 + 𝑆ℎ𝑎𝑟𝑒ℎ𝑜𝑙𝑑𝑒𝑟′𝑠 𝐸𝑞𝑢𝑖𝑡𝑦
Example 1: WE buys a piece of land for $1 Million, using the cash it has.
Solution: Asset (Cash) decreases and Assets (Land) increases
Assets
Cash: $2 Million
Other Assets: $10 Million
Liabilities
Loan: $5 Million
Shareholder’s Equity: ((10+2) – 5)= $7 Million
Assets
Cash: (2-1)= $1 Million
Land: $ 1 Million
Other Assets: $10 Million
Liabilities
Loan: $5 Million
Shareholder’s Equity: ((10+1+1) – 5)= $7 Million
11. Wayne Enterprises - Balance sheet (as of 29/11/2020)
𝐴𝑠𝑠𝑒𝑡𝑠 = 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 + 𝑆ℎ𝑎𝑟𝑒ℎ𝑜𝑙𝑑𝑒𝑟′𝑠 𝐸𝑞𝑢𝑖𝑡𝑦
Example 2: : WE buys a piece of land for $1 Million, by taking a new loan.
Assets
Cash: $2 Million
Other Assets: $10 Million
Liabilities
Loan: $5 Million
Shareholder’s Equity: ((10+2) – 5)= $7 Million
12. Wayne Enterprises - Balance sheet (as of 29/11/2020)
𝐴𝑠𝑠𝑒𝑡𝑠 = 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 + 𝑆ℎ𝑎𝑟𝑒ℎ𝑜𝑙𝑑𝑒𝑟′𝑠 𝐸𝑞𝑢𝑖𝑡𝑦
Example 2: WE buys a piece of land for $1 Million, by taking a new loan.
Solution: Assets (Land) increases and Liabilities (Loan) increases
Assets
Cash: $2 Million
Other Assets: $10 Million
Liabilities
Loan: $5 Million
Shareholder’s Equity: ((10+2) – 5)= $7 Million
Assets
Cash: $2 Million
Land: $ 1 Million
Other Assets: $10 Million
Liabilities
Loan: 5+1 = $6 Million
Shareholder’s Equity: ((10+2+1) – 6)= $7 Million
13. Wayne Enterprises - Balance sheet (as of 29/11/2020)
𝐴𝑠𝑠𝑒𝑡𝑠 = 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 + 𝑆ℎ𝑎𝑟𝑒ℎ𝑜𝑙𝑑𝑒𝑟′𝑠 𝐸𝑞𝑢𝑖𝑡𝑦
Example 3: The Mayor of Gotham city hands over land worth $1M as a gift.
Assets
Cash: $2 Million
Other Assets: $10 Million
Liabilities
Loan: $5 Million
Shareholder’s Equity: ((10+2) – 5)= $7 Million
14. Wayne Enterprises - Balance sheet (as of 29/11/2020)
𝐴𝑠𝑠𝑒𝑡𝑠 = 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 + 𝑆ℎ𝑎𝑟𝑒ℎ𝑜𝑙𝑑𝑒𝑟′𝑠 𝐸𝑞𝑢𝑖𝑡𝑦
Example 3: The Mayor of Gotham city hands over land worth $1M as a gift.
Solution: Assets (Land) increases and Shareholder’s equity increases
Assets
Cash: $2 Million
Other Assets: $10 Million
Liabilities
Loan: $5 Million
Shareholder’s Equity: ((10+2) – 5)= $7 Million
Assets
Cash: $2 Million
Land: $ 1 Million
Other Assets: $10 Million
Liabilities
Loan: $5 Million
Shareholder’s Equity: ((10+2+1) – 5)= $8 Million
15. Wayne Enterprises - Balance sheet (as of 29/11/2020)
Assets
Current Assets (Can be converted to cash within a year – approximately)
Cash and Bank balance: $5 Million
Receivables: $12 Million (What your customers owe you for your goods)
Inventory: $ 7 Million (The goods you still have in stock, which are unsold)
Current investments: $2 Million (Firms usually invest in short term securities – govt bonds, bills)
Loans/Advances: $1 M (Firms might lend out money or pay suppliers in advance)
16. Wayne Enterprises - Balance sheet (as of 29/11/2020)
Assets
Non-Current Assets (Cannot be converted to cash within a year – approximately)
Land: $20 Million
Machinery: $15 Million
Intellectual Property: $ 10 Million
Long-term investments: $5 Million (Firms might invest in stocks, bonds, real estate etc)
Long term Loans/Advances: $3 M (Firms might lend out money)
Total Assets = CA + NCA = $75 M
Depending on the firm you decide what to mention – blindly writing all these is nonsensical.
17. Depreciation
In 2010, you buy a car for Rs 10 lakh.
In 2015, you prepare your balance sheet & P&L.
The car isn’t worth 10L now obviously.
This is because the value depreciates.
Simple depreciation is linear.
If the car has a life of 10 years, every year it loses Rs 1L value.
𝐷𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛 =
𝐹𝑖𝑛𝑎𝑙 −𝐼𝑛𝑖𝑡𝑖𝑎𝑙 𝑣𝑎𝑙𝑢𝑒
𝑇𝑖𝑚𝑒
= (10-0)/10 = 1 Lakh per year
18. Depreciation
In your balance sheet for 2015
Under assets, you will mention the car – but its value is now
only Rs 5 lakh, not 10 lakh
If you make a P&L statement for year 2015,
Under your expenses, depreciation for your car will be 1 lakh
(that’s how much it depreciated in the year 2015)
Amortization – depreciation for intangible assets
19. Wayne Enterprises - Balance sheet (as of 29/11/2020)
Liabilities
Current Liabilities (financial obligations due within a year – approximately)
Trade payables: $22 Million
Short term loans: $5 Million
Customer advances: $ 3 Million (Customers might prepay for their goods)
Non-Current Liabilities (financial obligations not due within a year – approximately)
Secured loans: $11 Million (Loans against which you have offered collateral)
Unsecured Loans: $3.5 M (Loans against which you have not offered collateral)
Deferred Taxes: $0.5 M (Taxes due but not yet paid)
Shareholder’s equity = TA – (CL + NCL) = $75 M – 30M -15M = $30M
Depending on the firm you decide what to mention – blindly writing all these is nonsensical.
20. Wayne Enterprises – Income Statement (for 29/11/2019 -
29/11/2020)
Gross Sales: $45 M
Less Cost of Goods sold: $22M (Directly linked to production)
Material Cost: $9 M
Labour Cost: $13 M
Distribution costs: $2 M
Overhead costs: $1 M (Not linked to production – rent, electricity, insurance, clerks etc)
Gross Profit: (45 – 22 -2 -1) = $20 M
Less Sales, General and Administrative expenses: $7M
EBITDA: $13 M (Earnings before interest, tax, depreciation and amortization)
21. Wayne Enterprises – Income Statement (for 29/11/2019 -
29/11/2020)
EBITDA: $13 M (Earnings before interest, tax, depreciation and amortization)
Less depreciation and amortization: $1M
Operating Profit : $12M
Other income: Income from dividends: $ 0.25M (The firm has shares in other companies)
EBIT: $12.25 M (Earnings before interest and tax)
Less interest expenses: $ 0.75M
PBT: $11.5M (Profit before taxes)
Less Income tax: $1.2M
PAT: $10.3M (Profit after tax)
Less Dividends: $0.3M (paid out to shareholders)
Net Income: $10 M
22. General Principles of Financial Management
Analyze the Financial Statements submitted in (1) and 2) to identify 1-2 decisions you have made
(or you would like to make) regarding (i) investment management, management of finances,
working capital management.
Basically – pick a few items from the balance sheet and income statement and comment.
23. General Principles of Financial Management
1. Investment Management
1. High cash balance –an opportunity cost as interest is foregone (but retain enough for liquidity)
2. Investments (current, non-current) – are they too low? Could you keep more cash here? How much
are you earning from them (dividends) – is it a good return?
2. Management of Finances
1. Liabilities (current and non-current loans) – are you over-leveraged (too much debt)? Is the interest
payment too high? Can you pay off debt? Or is the loan cheap – should you borrow more?
2. If applicable - How much have you lent (Assets – short/long term loans)? Are you getting good
returns?
24. General Principles of Financial Management
3. Working Capital Management
1. Are trade receivables very high? Customers like it, but this is an interest free loan you are giving
them. High receivables are also risky if they don’t pay up.
2. Trade payables – if you delay paying your suppliers, you get an interest free loan – but suppliers
won’t like to do business with you
3. Inventory – Low inventory means you face stockouts (customers want to buy but you don’t have
goods to sell) while high inventory leads to high storage cost, damage to goods
Pick 2-3 similar questions and answer them in your assignment.
When you create the balance sheet / income statement, make sure you raise such questions (eg. Show
high cash balances or high trade receivables).
25. Analyzing Costs for Decision making
Analyze the items in (2) to identify 1-2 items that are direct costs; indirect costs; fixed costs;
variable costs; and semi-variable costs.
This is to be done from the P&L statement, not the balance sheet.
26. Analyzing Costs for Decision making
1. Direct costs – directly linked to production of goods (such as material, labour costs)
2. Indirect costs – not directly linked to production (general expenses like sales, rent,
administrative expenses)
3. Fixed costs - remain the same regardless how much you produce (rent, insurance, interest
payment, administrative salaries)
4. Variable costs – are directly linked to how much you produce (material, some labour)
5. Semi-variable – a combination. Usually fixed up to a level then varies with production (Sales,
power etc)
No hard classification in many cases.
Variable cost is usually direct (but not always – eg Sales, power)
