PME

UNIT 3
FINANCIAL STATEMENTS
Q.1. Discuss the objectives of cash flow statements.
Ans: A Cash flow statement shows inflow and outflow of cash and cash equivalents
from various activities of a company during a specific period. The primary
objective of cash flow statement is to provide useful information about cash flows
(inflows and outflows) of an enterprise during a particular period under various
heads, i.e., operating activities, investing activities and financing activities.
This information is useful in providing users of financial statements with a basis to
assess the ability of the enterprise to generate cash and cash equivalents and the
needs of the enterprise to utilise those cash flows. The economic decisions that are
taken by users require an evaluation of the ability of an enterprise to generate cash
and cash equivalents and the timing and certainty of their generation.

Objectives of Cash Flow Statement

1. Useful for Short-term Financial Planning

2. Useful in Preparing the Cash Budget
3. Comparison with the Cash Budget
4. Study of the Trend of Cash Receipts and Payments
5. Explains the Deviations of Cash from Earnings
6. Helpful in Ascertaining Cash Flow from Various Activities Separately
7. Useful to Outsiders
8. Helpful in Making Dividend Decisions
9. Test for the Managerial Decisions

Q.2. Discuss limitations of financial statements.

Ans: Financial statements refer to a detailed record of an organisation that contains
financial information on every business aspect of a company. These are evaluated
based on past, present, and projected future performances.
Financial statements generally include three elements – balance sheets, income
statements and cash flow statements.
Limitations of Financial Statements:
• Too Much Dependence on Historical Costs: A significant issue that comes
up with the reliance on financial statements is that of excessive reliance on
 historical costs. As a result, balance sheets and other records might turn out
to be ambiguous since these are dependent on historical costs.
• Effect of Inflation: Related to the above-mentioned disadvantage of
financial statements, inflation has an immense impact on the cost and value
of assets. However, with a dependence on historical costs, most fixed assets
are not re-evaluated as per current market conditions.
• Lack of Accurate Records on Intangible Assets: Business enterprises
have numerous intangible assets like brand value, Research &
Developments, etc. Typically, these assets are recorded in expenditures.
• Time-specific: Financial reports like balance sheets, cash flow statements,
income statements, etc. are extremely time-specific for every functional
business enterprise. As a result, any individual looking at one of these
reports might have a biased understanding of the financial standing of a
company since a single report might vary vastly from the aggregate trend
of an institution.
• Subject to Fraud: There is always a chance of fraudulent activities on the
part of a company to project their financial statements in a fashion that fits
their ulterior motives. Often done by skewing results and doctoring aspects
of these financial statements, these can be very misleading.
• Aggregate Information: Among the limitations of financial statements, a
recurrent issue is that of aggregate data. Often, companies record their
expense and revenue related statements on an aggregate basis, rather than
that of a detailed entry.
• Missing of Data: Related to this issue mentioned above, often detailed data
is not recorded by enterprises.
• Prevalent Conventions: Accounting conventions that are involved in the
recording of financial statements also bring about certain inherent
limitations of financial statements.
• Interim Reports with no Predictive Value: Profit and loss statements and
other similar statements are restricted to a specific time frame and do not
represent the revenue-generating capability of an enterprise.
 Q.3. What is balance sheet and what are its components? What is the
importance of balance sheet?

Ans: The Balance Sheet is the statement showing the business’s financial position
at a given time. It is the statement showing the value of assets and liabilities of a
firm at a certain date. The Balance Sheet shows the report of the property owned
by the enterprise and the claims of the creditors and owners against these
properties. The total of both sides (i.e., assets and liabilities) of the balance sheet
should be equal.
The financial position of a firm is shown by its assets and liabilities on the given
date. A company is financially stable when the assets are more than the liabilities,
and it represents capital. The Balance Sheet is prepared from the Real Accounts
and Personal Accounts. Ledger accounts that have not been closed having debit
balances are shown on the assets side and those having credit balances are
shown on the liabilities side.
Components of a Balance Sheet:
Assets
Accounts within this segment are listed from top to bottom in order of
their liquidity. This is the ease with which they can be converted into cash. They
are divided into current assets, which can be converted to cash in one year or less;
and non-current or long-term assets, which cannot.
Liabilities
A liability is any money that a company owes to outside parties, from bills it has to
pay to suppliers to interest on bonds issued to creditors to rent, utilities and
salaries. Current liabilities are due within one year and are listed in order of their
due date. Long-term liabilities, on the other hand, are due at any point after one
year.
Shareholder Equity
Shareholder equity is the money attributable to the owners of a business or its
shareholders. It is also known as net assets since it is equivalent to the total assets
of a company minus its liabilities or the debt it owes to non-shareholders.
Importance of Balance Sheet:
Balance sheet analysis can say many things about a company’s achievement. Few
essential factors of the balance sheet are listed below:
 • Creditors, investors, and other stakeholders use this financial tool to know
the financial status of a business.
• It is used to analyse a company’s growth by comparing different years.
• While applying for a business loan, a company must submit a balance sheet
to the bank.
• Stakeholders can find out the business accomplishment and liquidity
position of a company.
• Company’s balance sheet analysis can detect business expansion and future
expenses.

Q.4. Explain with steps in the preparation of projected balance sheet.

Ans: If you need to create a projected balance sheet for your company, here
are some steps to follow to do so:
1. Create a format for the projected balance sheet
A projected balance sheet is something you can create many times over, especially
since they are usually used to project balances for a specified time. You may want
to make a balance sheet before a merger, prior to a sales presentation or
periodically to make sure you're keenly aware of what the next few months of the
business should look like to determine if you can make a large purchase or expand
operations in some way.
2. Gather past financial statements
Unless you're a startup without previous financial statements, gather any
statements you may have. Accountants and other financial experts use the past
financial statements of an organization to make accurate projections about the
financial future of the company through analyzing trends and reviewing ongoing
assets and liabilities that they already include on current balance sheets. Try to
gather at least two years of financial data so your projections are as accurate as
possible.
3. Review your past and ongoing assets and liabilities
Examining these items can further prepare you for completing a projected balance
sheet because you'll be reminded of and more aware of the assets you have had,
the assets you currently have and the prior and present liabilities. With these line
items displayed, you'll be in a better position to determine if those same assets and
liabilities should appear on the projected balance sheet you're creating. For
example, a mortgage debt liability that the company has paid will not need to
appear on a projected balance sheet, but an ongoing debt that has recurring
payments will.
4. Project your fixed assets
Fixed assets are tangible and more long term for the business because it's an asset
that the organization regularly uses, like production machinery or company
vehicles. Fixed assets are an easy addition to any projected balance sheet but
remember to account for depreciation. Depreciation is the reduction in value that
an asset experiences the more it's used, especially if there is normal wear and tear
present.
5. Estimate the company's debt
If you've been overseeing the company's debts, it should be a quick process to
estimate how much debt the business will have during the time you're covering in
the projected balance sheet. Review the current debts you have, including the
amounts, the payments you'll owe and pay over the next months and when the debt
should be completely paid off.
6. Forecast your equity
To forecast your equity, review last year's equity, calculate the company's net
income, account for your dividends, and add in any changes to equity. When you're
able to accurately forecast equity, you're estimating the earnings for the business
that can pass along to the stakeholders. This is also important information for
investors who want to feel assured that their investment will give them a healthy
return.

Q.5. Differentiate between fund flow and cash flow statements.

Ans: Meaning of Cash Flow
Cash flow refers to the outflow and inflow of cash or cash equivalents in an
organization in a specific period. Cash flow is recorded in the cash flow statement,
which is one of the most important financial statements in accounting.
There are many sources of cash flow in an organisation which may be categorized
as:
1. Cash Flows from Operating activities: It represents the movement of cash
from the core operations of a business.
 2. Cash Flows from Investment Activities: It represents the flow of cash due to
purchase or sale of an asset or any other investment activities for the
business.
3. Cash flow from financing activities: It involves changes in the flow of cash
involving selling or paying off financial instruments such as the issuance of
debt, issuing shares and debentures or repayment of debt.
Meaning of Fund Flow
Fund flow refers to the working capital of the company, and a fund flow statement
is prepared to visualize the changes in working capital of the company over a
period. Investors use the fund flow information to determine where capital needs
to be invested.
There are two types of inflow of funds in a business.
1. Funds generated by the business operations.
2. Long term funds raised by issuing shares or sale of fixed assets.
The following table will enumerate the most significant differences between the
cash flow and fund flow.

Cash Flow Fund Flow

Definition

Cash flow is based on the concept of outflow Fund flow is based on the concept of changes
and inflow of cash and cash equivalents during in working capital over a period of time
a particular period

What is calculated?

Cash from the operations is calculated Fund from the operation is calculated.

What it shows

It shows the short-term position of the business It shows the position of the business in the
long term
 Purpose

To show the movement of cash during the To show the changes in the financial position
beginning and end of an accounting period of business between previous and current
accounting periods

Discloses

Inflows and Outflows of cash Source and application of the available funds

Accounting Basis

Cash Basis of accounting Accrual basis of accounting

Part of Financial Statement

Yes No

Used for

Cash Budgeting Capital Budgeting

Q.6. What is detailed project report? What is its content & objectives?
Ans: The project report is a document that contains all information regarding the
proposed project. It is served as a blueprint of all operations to be undertaken for
attaining the desired results. The project report is basically the business plan of
action and clearly describes its goals and objectives. It is one that helps in
converting the business idea into a productive venture without any chaos or
confusion as it defines strategies for project execution.
Information from various aspects like technical, financial, economic, production
and managerial are together constituted in project report for better understanding.
It describes all inputs required for the accomplishment of a project so that they can
be arranged accordingly at the right time.
Contents of a Project Report
Following are the contents of a project report.
Title
The title page of the report denotes the title of a project and the author’s name. It
mentions the name and detail of industry for which the project is undertaken. This
page must clearly define the area and scope of project.
Abstract
Abstract is a summary giving details about the contents of a project report. It
provides an idea to reader regarding what is project report about. Anyone who
does not know anything about report simply by reading its abstract can make out
whether it is of their interest or not. Abstract is generally half a page long.
Acknowledgements
This section of report denotes the individuals who assisted you during your project
work. It is meant for thanking the people who provided you technical or any other
type of assistance such as your supervisor.
Contents Page
Content page talks about the main chapter and sub sections included in the report.
Chapters with proper titles are mentioned along with the page numbers telling
where the chapter/section begins and ends. It should be ensured that only
sufficient levels of subheadings are provided under each chapter.
Introduction
It is the most crucial element of the project report. The introduction talks about the
nature and scope of the report to the reader. This part summarizes what the author
set out to attain, gives a clear description regarding the background of the project,
main contributions, and relevance. The introduction shall summarize the key things
in the report and provide the sections containing the technical material.
Background
Background component sets the project report into context and describes the
layout for attaining project goals. For meeting out the proposed goals different
approaches should be evaluated for choosing the efficient one. However, this part
of report can be included as a part of introduction also, but it is ideal to present it
as a separate chapter in case if project involve extensive amount of research and
groundwork. All pieces of work which are listed should be provided with proper
sources from where they are referred.
Body Of Report
This is the central part of project report which contains three to four chapters which
describes all technical work undertaken for the completion of project. The
chapter’s structure dependent upon project which reflects the development of
project in chronological order. It should be justified why a particular approach is
chosen above other alternatives mentioned in background component. Every
interesting feature and problem during the implementation should be properly
documented. All contents relating to testing and integration should be thoroughly
discussed with the supervisor.
Conclusions And Future Work
It denotes the achievements made because of completing the project. This part of
report concludes the success and failures of a project. It also provides suggestions
for future work of project for taking it further. No project is completely perfect and
each of it come with certain limitations.
Bibliography
Bibliography tells about the books, articles, journals, manuals etc. which are used
while doing the project or referred in the report. Full and accurate information
regarding sources used such as title, author name, issue and page number should
be mentioned for readers. Providing the source of information helps readers in
validating the facts of report.
Objectives of Project Report
Selecting Best Investment Proposal: Project report is an efficient tool for
analyzing the status of any investment proposal. It shows the expected profitability
and risk associated with the project and this way helps in choosing the best option.
Approval of Project: It is essential for registration or approval purposes of the
proposed project. Different authorities like District industries centre, Directorate
of industries, government departments, etc. require project reports for giving
approval.
Tracking: The Project report assists in tracking the current activities of the
project. It helps team members and other stakeholders to check the project
progress from time to time and helps in finding out any deviations against the
original plan.
Visibility: Another important advantage of having the project report is that it gives
full insight into the project. It gives a clear description of activities to be undertaken
and avoids any confusion or disorder.
Selecting Best Investment Proposal: Project report is an efficient tool for
analyzing the status of any investment proposal. It shows the expected profitability
and risk associated with the project and this way helps in choosing the best option.
Approval of Project: It is essential for registration or approval purposes of the
proposed project. Different authorities like District industries centre, Directorate
of industries, government departments, etc. require project reports for giving
approval.
Tracking: The Project report assists in tracking the current activities of the
project. It helps team members and other stakeholders to check the project
progress from time to time and helps in finding out any deviations against the
original plan.
Visibility: Another important advantage of having the project report is that it gives
full insight into the project. It gives a clear description of activities to be undertaken
and avoids any confusion or disorder.

Q.7. What is project financing? What are the different types of sponsors in
project financing?
Ans: What is Project Financing?
Project Financing is a long-term, zero or limited recourse financing solution that is
available to a borrower against the rights, assets, and interests related to the
concerned project.
If you are planning to start an industrial, infrastructure, or public services project
and need funds for the same, Project Financing might be the answer that you are
looking for.
The repayment of this loan can be done using the cash flow generated once the
project is complete instead of the balance sheets of the sponsors. In case the
borrower fails to comply with the terms of the loan, the lender is entitled to take
control of the project.
In project finance, the funds are not raised based on balance sheet of the
sponsor, but on the future cashflows of the project as the loan amount is paid off
using the cash flows of the project.
Project financing greatly minimizes the risk of the sponsoring company as the
assets of the company cannot be sold to pay off the loan in case of default.
Types of Sponsors of Project Finance:
There are 4 types of project finance sponsors that we usually come across. They
are explained below in brief:
• Industrial Sponsors: These sponsors are directly related to the business of
the performing organization. They are huge organizations in a similar
industry and have the funds and risk tolerance to fund project.
• Public Sponsors: These sponsors are government bodies and corporations.
The main goal over here is public service and economic development.
• Contractual Sponsor: They help in building, developing, or managing a
project. They are the sponsors that get the work done in a project.
• Financial Sponsors: These sponsors are in the business of lending and are
looking for high profits and substantial rate of return by accepting high risk
projects.

Q.8. What are the steps and general rules for preparing fund flow statements?
1. Ans: Statement of Changes in Working Capital: Working capital means
the difference between the current assets and current liabilities. If there
is an increase in working capital, then it will be an application of funds, and
if there is a decrease in working capital, it will be a source of funds.
2. Funds from Operations: If the company earns a profit, it will be a source of
funds, and if there is a loss, it will be an application of funds.
3. Fund Flow Statement: After ensuring the above two requirements, the firm
will prepare the fund flow statement, which will comprise all outflow and
inflow of funds.
1. Source of Fund: It is used to know where funds have been arranged
for investment. The source of the fund can be in the form of the issue
of shares, debentures, profit from operations, dividends received on
investments, proceeds from borrowings, etc.
 2. Application of Fund: It is used to know where the arranged funds
have been invested. Application of funds can be in the purchase of
fixed assets, increased working capital, purchase of investments, the
dividend paid, repayment of borrowings, interest paid, etc.
To prepare the fund flow statement:
• This statement will find out the sources and applications of funds.
• In the above example, we have seen that increases in working capital are
Rs. 6,500 (considered as applications of funds), and the fund from an
operation is Rs. 23,110 (considered a source of funds).
• Suppose we have issued share capital in the market amounting to Rs. 5,000
(considered a source of funds). Arranged source of the funds is used to
enhance working capital and purchase fixed assets.
Conclusion
• With the help of a fund flow statement format, we can prepare the fund flow
statement. The company prepares this statement to analyze the changes in
working capital between two balance sheets. It is based on historical data.
It helps the management make future decisions, but management cannot
take the entire decision based on only the fund flow statement because it
considers only fund-based items.
• Last, management should prepare this statement because it considers all
sources, i.e., from where the funds are coming, and all applications, i.e.,
where the funds are going. This summarized statement helps management
to move further.