Financial statements - Balance Sheet & Profit and Loss Account

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In this MBA Seminar topic, we are going to look into various aspects of financial statement such as Balance Sheet, Profit and Loss Account. A financial statement can be termed as a collection of data organised based on logical and standard accounting procedures.

Four Basic Financial statements are

  • Balance Sheet
  • Income Statement
  • Statement of Cash Flows
  • Statement of Owner Equity

Balance Sheet

Main purpose of balance sheet is to determines solvency of business- ability to meet both long term and short term obligations. It will give concise summary of firm’s resources and obligations. Balance sheet gives a measure of firm’s liquidity.

The basic Principles of Balance Sheet are 
  • The balance sheet is regarded as a separate accounting entity( entity concept)
  • The figures are expressed in monetary units (monetary concept)
  • The balance sheet assumes that the company is a going concern (going concern concept)
  • The fixed assets are stated at cost less depreciation ( cost concept)
  • The current assets are stated at cost or market value, whichever is lower (conservative concept)
  • Assets are equal to liabilities (dual aspect concept)

The Balance Sheet should contain Name, to know what it represents (Partnership, individual, combined). It needs to be consistent over time. It should contain statement date. It should list all the assets and liabilities. Balances should be provided at the bottom of form. Balance is. Assets - Liabilities = Equity.

For example, financial statement for XYZ Company As on 31.3.2014.

LiabilitiesAssets
Current Liabilities
  • Accounts payable
  • Interest payable
  • Salary payable
Current assets
  • Cash
  • Inventories
  • Debtors
Long Term Liabilities Fixed assets
Equity Investments

Balance Sheet Asset Types

Different types of asset types are 

  • Current assets 
    • Consumed or converted to cash in 12 months e.g. Inventory, prepaid expenses, cash, savings
  • Long Term or Fixed assets 
    • e.g. land, buildings, stocks
    • Selling would typically decrease volume or size of business

Asset Value Determination is based on book value (cost basis), which is useful for trend analysis and Fair Market Value, which is useful to determine liquidation value. 

Balance Sheet Debt Types

Different types of balance sheet are

  • Current liabilities 
    • To pay in the next 12 months e.g. bills, accrued interest, taxes
  • Long Term 
    • Scheduled originally to be paid in more than one year e.g. land debt, house payments

A part of Balance Sheet should contain current Liabilities -- What you owe someone else (against what you own). Some of the Current Liabilities are - What you are scheduled to pay in the next 12 months, Unpaid bills, accrued interest, property taxes, Operating loans and Principal payments on term debts to be made in the next 12 months.

Another part of the Balance Sheet should contain Long Term Liabilities such as What you owe to someone else (against what you own), Long Term Liabilities, What was scheduled originally as more than one years, Land debt, house payments, Match up to the long term assets.

Equity

  • Preferred Stock (cumulative, Non cumulative, convertible, cumulative convertible) 
  • Common Stock or ordinary shares
  • Contributed capital in excess of par
  • Retained earning
  • Revenue reserve: from profit of normal business operations
  • Capital reserve: Premium on issue of shares or gains on revaluation of assets

Debentures can be Convertible or Non convertible. 

How to Build a Balance Sheet

To to Build a Balance Sheet, we need to do a count of Current, Long Term, Rupee Prices for each of the above. It is recommend to have cost and market value for both assets. For Machinery, depreciation schedule (Straight line or WDV) should be considered. Next thing is to assemble the above into a standard format. Then add up the assets and up the debts. Assets minus debts = net worth or equity.

Balance sheet give picture of company in time -- a specific point, as on 31.3.20XX. It shows financial position- of the firm and its ability to handle risk. It gives net result of past. It is useful component to track and monitor financial progress. It is the basic building block for financial analysis.

Balance Sheet does NOT necessarily tell you if the business is making money and it does NOT tell you where net worth came from. Change in Net Worth is due to Retained Earnings from profits earned and retained in business and Market Valuation Equity from change in market value of assets. 

Profit and Loss Account

It is a report of a firm’s activities during a given period of time. It shows revenue and expenses of the firm, the effect of interest and tax, and the net income for the period. Different functions of P & L Account are 

  • Gives concise summary of firm’s revenue and expenses
  • Measures firm’s profitability

For accurate accounting, first identify revenue. Then match the corresponding cost to revenue. Revenue occurs when the earning process is complete and an exchange has taken place. Depreciation is a non cash charge used to match expenditure of creating asset with resulting revenue. Three estimate are required to calculate depreciation. They are 

  • Assets useful life
  • Its salvage value
  • Method of allocation (straight line, WDV)

To recognize expense, various principles used are

  • Principle of associating cause and effect
  • Principle of systematic and rational allocation (depreciation)
  • Immediate recognition principle (selling and administrative expenses and all losses
Attachments:
Download this file (Financial statements.ppt)Financial statements - Balance Sheet & Profit and Loss Account[PPT Presentation]164 Kb

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