Financial Statements

Meaning and Characteristics

 Learning Objectives

At the end of this session, you will be able to:

• Define the characteristics of financial statements

• Discuss the advantages of financial statements
• Explain the limitations of financial statements
Characteristics of Financial Statements

Understandability

Timeliness Relevance

Comparability Reliability
Advantages of Financial Statements

Analyse the past trend

Helps plan for the future

Gauge the profitability

Estimate solvency position

Plan Working Capital Requirements

Estimate cash flow position

Facilitates objective decision making

Limitations of Financial Statements

Based on historical cost Intangible assets not

Inflationary effects
method recorded

Based on specific time Not always comparable Subject to fraud and

period across companies biasness

No discussion of non-
Not verified
financial issues
Conclusion

An important tool in the hand of the manager that requires careful manoeuvring
Components of Financial Statements

Income
Balance Sheet Cash Flow
Statement
Income Statement

Measure of periodic performance

Prepared on accrual basis

Records income and expenses

Helps measure profitability of a business

Analysts restate income statement to understand it better

Helps Measure profits in steps

• Gross Profit
• Operating Profit
• Earning Before Tax
Balance Sheet

• Measure of financial performance on a given date

• Records Sources and Application of Funds
• Sources of Funds = Application of Funds
• Provides information on:
 Solvency Position
‒ Non Current Assets
‒ Long Term Liabilities
‒ Owners Equity
 Liquidity Position
‒ Current Assets
‒ Current Liabilities
Cash Flow Statement

• Help understand the liquidity position of the company

• It is divided into three parts
‒ Cash Flow from Operations – prepared by indirect
method
‒ Cash Flow From Investing – prepared by direct
method
‒ Cash Flow from Financing – prepared by direct
method
Notes to Accounts

Helps in Full Disclosure

Provides both qualitative and quantitative information

Enables users take informed decision

Users of Accounts

Investors
Internal Users
• Shareholders
• Board of Directors Lenders
• Private Equity Investors
• Managers
• Acquirers

Suppliers Customers Regulators

 Framework for Financial Statement Analysis

Analyze Strategy
• What is the value proposition – low cost or differentiation
• What are the sources of competitive advantage – customer satisfaction, scale (supplier power, fixed
costs), network effects, first mover, etc.
• How long can the advantage be sustained – competition, growth opportunities
• What are the strategic risks?

Access past and current performance Accounting analysis

• Comparative and common size analysis
• Cash flow analysis Earnings management can
• Ratio Analysis distort the usefulness of
numbers. Aim is to detect these
practices in the financial
statements and to the extent
possible adjust for it before
Forecast future performance doing valuation.
based on strategy and past performance
 Types of Revenues

• Operating Income
• Other Operating Income
• Other Income

Illustration
Abhishek Bottlewala

Source of Revenue Categorized as

Bottles Operating Income
Bottle caps Other Operating Income
Income from Dividend,
Other Income
Profit from Sale of P&M
Operating Income

• Main Source of Revenue

• Provides sustainability
• Major source of revenue
• Recurring in nature
• Expenses netted from operating and other income
 Returns
 Excise Duty
Other Operating Income

Recurring in nature

Stable in nature

Byproduct of operating income

At times, main source of future growth

Other Income

Highly Volatile

Can be recurring in nature

• Dividend Income
• Interest Income

Can be non recurring in nature

• Sale of Assets
• Sale of Investments
 Illustration – ITC (Operating Income)

Particular (Rs. Crores) 2018 2019

Operating Income
FMCG - Cigarettes 34062.67 22913.27
Other Operating Income
FMCG – Other 11339.31 12517.07
FMCG 2671.88 2846.08
Hotels 1480.02 1728.15
Agri Business 4474.22 6075.3
Paperboard Paper and Packaging 3695.41 4230.4
Other 1525.46 1884.24
Revenue from Operations 56577.09 49348.43
 Illustration – ITC (Operating Income in %)

Segment Revenue 2016 2017 2018 2019

FMCG – Cigarettes 62% 62% 60% 46%

FMCG – Others 18% 18% 20% 25%

Hotels 2% 2% 3% 4%

Agri Business 8% 9% 8% 12%

Paperboards, Paper and Packaging 7% 6% 7% 9%

Others 3% 2% 3% 4%

Total 100% 100% 100% 100%

Illustration – ITC (Other Income)

Other Income (Rs. Cr) 2018 2019

Interest income 964.74 1312.79
Dividend income 8.48 8.38
Other non-operating income 19.22 25.9
Other gains and losses 839.42 826.72
Total 1831.86 2173.79

Other Income (In %) 2018 2019

Interest income 52.7% 60.4%
Dividend income 0.5% 0.4%
Other non-operating income 1.0% 1.2%
Other gains and losses 45.8% 38.0%
Total 100.0% 100.0%
 Cost of Goods Sold

Direct cost of manufacturing a product

Raw Material is the main component

40% to 70% of sales for manufacturing company

Managing Cost of Goods Sold

Highly volatile in case raw material is commodity

Industry Major Raw Material

Packaged Food Industry Farm Produce
Tyre Industry Rubber
Chocolate Cocoa, Sugar
 Cost of Goods Sold Calculation

Cost of Goods Sold

Opening Stock + Purchase – Closing Stock

Raw material – Rubber Tree Work in Process – Finished Goods

Treaded Rubber Tyres
 Cost of Goods Sold – Example MRF

Particular 2018 2019

Cost of materials consumed 8946.93 10220.40
Purchases of Stock-in-Trade 44.89 29.86

Changes in inventories of Finished Goods, Stock-

76.04 (608.60)
in-Trade and Work-in-Progress

Cost of Goods Sold 9067.86 9641.66

Source : Standalone Income Statement – 2019-2020

 Cost of Materials Consumed – MRF Ltd.

Particular (Rs. Crores) 2018 2019

Opening Stock of Raw Materials (April of previous year) 1013.44 950.15
Purchases during the year 8883.64 10368.92
Closing Stock of Raw Materials (950.15) (1098.67)
Cost of Materials Consumed 8946.93 10220.40

NOTE 19 : Cost of Materials Consumed

Changes in Inventories of Finished Goods Stock-in-trade and Work-in-progress

Particulars (Rs. Cr.) 2018 2019

Closing Stock
Finished Goods 670.53 1218.45
Stock-in-Trade 41.95 41.29
Work-in-Progress 210.14 271.48
922.62 1531.22
Opening Stock of Raw Materials
Finished Good 857.49 670.53
Stock-in-Trade 28.36 41.95
Work-in-Progress 221.86 210.14
1107.7 922.62
Differential Excise Duty on Opening and Closing Stock of Finished Goods (109.05) 0

Changes in Inventories of Finished Goods Stock-in-trade and Work-in-progress (Note 20) (608.60) 76.04
 Understanding Gross Profit – MRF Ltd.

Particular 2018 2019

Revenue from Operations: 15181 15837
Less: Excise Duty 405.2 0
Net Revenue 14776 15837
Less:COGS 9068 9642
Gross Profit 5708 6195
 Analyzing Gross Profit – MRF Ltd.

Particular 2018 2019 "+/- (%)"

Revenue from Operations 15181 15837 4%
Less: Excise Duty 405.2 0 
Net Revenue 14776 15837 7%
Less:COGS 9068 9642 6%
Gross Profit 5708 6195 9%
Gross Profit % 38% 39%
Operating Expenses

• Recurring in nature
• Indirect Expenses
• Following are broad classification of Operating Expenses

 Employees cost (Salary and related perks including PF and

Gratuity, Training Cost)
 Office and Administration Cost (Office Expenses including
rent and upkeep of office premises)
 Selling and Distribution Expenses (Packaging expenses,
logistics{related to Sales Delivery}, Distribution expenses,
Advertising and Sales Promotion, Commission to Sales Agents
etc.)
 Operating Expenses – Reported in Income Statement- ITC Ltd.

In (Rs. Cr.) 2018 2019

Employee benefits expense 3760.9 4177.88
Depreciation and amortization expense 1236.28 1396.61
Other expenses 7349.6 8348.11
Operating Expenses – Reported in Income Statement - ITC Ltd. (% of
Sales)

% of Sales 2018 2019

Employee benefits expense 30.5% 30.0%
Depreciation and amortization expense 10.0% 10.0%
Other expenses 59.5% 60.0%

A high percentage of other expenses necessitates restatement in order to analyse operating expenses.
 Other Expenses – Break Up

Particular 2018 2019 "+/- (%)"

Revenue from Operations 15181 15837 4%
Less: Excise Duty 405.2 0  
Net Revenue 14776 15837 7%
Less:COGS 9068 9642 6%
Gross Profit 5708 6195 9%
Gross Profit % 38% 39%
 Other Expenses – Break Up

Other Expenses 2018 2019

Power and fuel 653.5 746.73
Consumption of stores and spare parts 268.69 301.34
Insurance (Factory) 85.68 84.35
Contract processing charges 862.04 902.55
Repairs
Buildings 61.31 64.25
Machinery 220.62 235.44
Others 62.82 80.55

Loss on sale of property, plant and equipment - Net 8.81 105.05

Loss on sale of stores and spare parts - Net 3.72 16.79

 Other Expenses – Break Up

Rent 332.84 337.84

Rates and taxes 222.39 263.56
Maintenance and upkeep 222.14 270.09
Bank and credit card charges 25.1 25.98
Information technology services 147.16 171.48
Legal expenses 42 50
Consultancy/Professional fees 338.4 405.47
Postage, telephone, etc. 34.12 32.82
Printing and stationery 18.59 19.37
Travelling and conveyance 359.98 400.81
Miscellaneous expenses 971.13 1014.38
Warehousing charges 152.97 166.85
Advertising/Sales promotion 902.24 994.63
Market research 132.64 135.2
Design and product development 46.49 57.15
Hotel reservation/Marketing expenses 34.8 42.76
Retail accessories 134.36 155.37
Brokerage and discount - sales 7.89 13.1
Commission to selling agents 27.98 14.43
Doubtful and bad debts 30.82 32.56
Doubtful and bad advances, loans and deposits 4.03 6.01
Outward freight and handling charge 904.07 1176.49
Training and Development 30.27 24.71
Other Expenses 7349.6 8348.11
 Other Expenses – Reclassification (Manufacturing Expenses)

Manufacturing Expenses (Rs. Cr.) 2018 2019

Power and fuel 653.5 746.73
Change in carrying value of biological asset 0 0
Consumption of stores and spare parts 268.69 301.34
Insurance (Factory) 85.68 84.35
Contract processing charges 862.04 902.55
Repairs
Buildings 61.31 64.25
Machinery 220.62 235.44
Others 62.82 80.55

Loss on sale of property, plant and equipment - Net 8.81 105.05

Loss on sale of stores and spare parts - Net 3.72 16.79
 Other Expenses – Reclassification (Office and Administration Expenses)

Office and Administration Expenses (Rs. Cr.) 2018 2019

Rent 332.84 337.84
Rates and taxes 222.39 263.56
Maintenance and upkeep 222.14 270.09
Bank and credit card charges 25.1 25.98
Information technology services 147.16 171.48
Legal expenses 42 50
Consultancy/Professional fees 338.4 405.47
Postage, telephone, etc. 34.12 32.82
Printing and stationery 18.59 19.37
Travelling and conveyance 359.98 400.81
Miscellaneous expenses 1150.13 1138.33
 Other Expenses – Reclassification (Selling and Distribution Expense)

Selling and Distribution Expenses (Rs. Cr.) 2018 2019

Warehousing charges 152.97 166.85
Advertising/Sales promotion 902.24 994.63
Market research 132.64 135.2
Design and product development 46.49 57.15
Hotel reservation/Marketing expenses 34.8 42.76
Retail accessories 134.36 155.37
Brokerage and discount - sales 7.89 13.1
Commission to selling agents 27.98 14.43
Doubtful and bad debts 30.82 32.56
Doubtful and bad advances, loans and deposits 4.03 6.01
Outward freight and handling charge 904.07 1176.49
Other Expenses – Reclassification (Employee Cost)

Employee Cost (Rs. Cr.) 2018 2019

Training and Development 30.27 24.71
 Operating Expenses (Restatement)

Operating Expenses 2018 2019

Employee benefits expense (2017- Pg. 237, 2019 - Pg. 239) 3760.9 4177.88
Training and Development 30.27 24.71
Employee Cost 3791.17 4202.59
Manufacturing Expenses 2227.19 2537.05
Depreciation and amortization expense (2017- Pg. 237, 2019 - Pg. 239) 1236.28 1396.61

Manufacturing Expenses (including Depreciation 3463.47 3933.66

Administration 2713.85 2991.8
Selling and Distribution Expenses 2378.29 2794.55
Operating Expenses 12346.78 13922.6
 Operating Expenses (Analysis)

Operating Expenses 2018 2019

Employee benefits expense 30.5% 30.0%
Training and Development 0.2% 0.2%
Employee Cost 30.7% 30.2%
Manufacturing Expenses 18.0% 18.2%
Depreciation and amortization expense 10.0% 10.0%
Manufacturing Expenses (including Depreciation 28.1% 28.3%
Administration 22.0% 21.5%
Selling and Distribution Expenses 19.3% 20.1%
Operating Expenses 100.0% 100.0%
 Operating Profit

Operating Profit (Rs. Cr.) 2018 2019

Gross Profit 25623.6 26754.45

Operating Expenses 12346.78 13922.6
Operating Profit(EBIT) 13276.82 12831.85
 Operating Profit

Operating Profit (Rs. Cr.) 2018 2019

Gross Profit 25623.6 26754.45

Operating Expenses 12346.78 13922.6

Operating Profit 13276.82 12831.85

 Operating Profit Margin (%)

Operating Profit margin (%) 2018 2019 Increase/ Decrease %

Net Revenue from Operations 43448.94 48352.68 11%
Operating Profit(EBIT) 13276.82 12831.85 -3%
Operating Profit margin (%) 30.6% 26.5%  
EBITDA

Important Parameter for manufacturing companies

Particular (Rs. Cr.) 2018 2019

Operating Profit (EBIT) 13373.45 14283.12
Add: Non Cash Expenses 1219.27 1228.57
EBITDA 14592.72 15511.69

Non Cash Expenses (Rs. Cr.) 2018 2019

Depreciation and Amortization Expenses 1236.28 1396.61
Loss on sale of property, plant and equipment - Net 8.81 105.05
Loss on sale of stores and spare parts - Net 3.72 16.79
Doubtful and bad debts 30.82 32.56
Doubtful and bad advances, loans and deposits 4.03 6.01
Non Cash Expenses 1283.66 1557.02
 NOPAT

Operating Profit adjusted for tax

In Rs. Cr. 2018 2019

Operating Income(EBIT) 15246.68 17009.75
Tax Rate(T) (%) 34% 33%
NOPAT (EBIT *(1-T)) 10065.1 11401.4
 Earnings before Tax (EBT)

EBT – Profit before paying Tax

Particular (Rs. Cr.) 2018 2019

Operating Profit (EBIT) 15246.68 17009.75
Finance costs ((2017- Pg. 237, 2019 - Pg. 239) 89.91 45.42
Other Income ((2017- Pg. 237, 2019 - Pg. 239) 1831.86 2173.79
Share of profit/ (loss) of Associates and Joint Ventures ((2017- Pg. 237,
2019 - Pg. 239) 7.58 11.7
Exceptional Item ((2017- Pg. 237, 2019 - Pg. 239) 412.9 0
EBT 17409.11 19149.82
 Profit After Tax (PAT)

Profit Available to Shareholders

Particular (Rs. Cr.) 2018 2019

EBT 14859.07 16026.32

Less: Tax 5358.21 5549.09
Profit After Tax 9500.86 10477.23
 Analyzing the Profit Metrics

Margins 2018 2019

EBITDA 38% 38%
Operating Profit (EBIT) 35% 35%
NOPAT Margin 20% 19%
EBT 40.1% 39.6%
PAT Margin 26.5% 26.5%
Dividend

Dividend is not expense

It does not reduce profits

It is distribution of profits

• As profit is owned by equity shareholder

It reduces retained earnings

To define dividend

• Dividend is distribution of profits to the shareholders

 Terms Related to Dividend

Dividend Payout “ How much of the proportion of Earnings is shared“

Dividend Payout = DPS/EPS

Dividend Yield = “How much dividend is earned per rupee invested”

Dividend Yield= DPS/Market Price per share

Retained Earning = “ Part of profit not paid as dividend”

Retained Earnings = Net Profit – Dividends

Retained Earning is Transferred to Reserves and Surplus

Reserves and Surplus (At the end of the year) = Reserves and Surplus (At the beginning of the year)+ Retained
Earnings
Dividend – ITC Ltd.

Dividends are distribution of profits

Particular (Rs. Cr.) ITC Ltd. 2018 2019

Profit After Tax 11492.68 12835.9
No. of Outstanding Shares (Diluted) 1220.43 1225.86
Earnings per share 9.42 10.47
Dividend 6285.21 7048.70
Dividend per Share 5.15 5.75
Dividend Yield 2% 3%
Dividend Payout Ratio 54.7% 54.9%
Share Price as on 31st March Closing Price 297.25 177.9
 Income Statement

Consolidated Statement of Profit and Loss – ITC Ltd.

Particular Note 2018 2019

Revenue From Operations* 22A, 22B 47688.55 49862.11
Other Income 23 1831.86 2173.79
Total Income 49520.41 52035.90
Cost of materials consumed 11943.75 13403.01
Purchases of Stock-in-Trade 2883.97 4220.51
Changes in inventories of finished goods, Stock- 1027.76 (203.19)
in-Trade,
Work-in-progress and intermediates
Excise Duty 4239.61 1509.43
 Income Statement

Particular Note 2018 2019

Employee benefits expense 24 3760.90 4177.88
Finance costs 25 89.91 45.42
Depreciation and amortization 1236.28 1396.61
Other expenses 26 1027.76 (203.19)
Total Expenses 4239.61 1509.43
Share of profit/ (loss) of Associates and Joint Ventures 7.58 11.70
Profit before exceptional items and tax (III-IV+V) 16996.21 19149.82
Exceptional Items 412.90
PBT 17409.11 19149.82
Tax expense 27 6323.92 5816.33
Profit for the Year 11492.68 12835.90
 Income Statement
Particular Note 2018 2019
Other Comprehensive Income 86.17 10.92
A i. Items that will not be reclassified to profit or loss:
• Exchange differences in translating the financial statements of foreign operations 360.84 397.71
• Effective portion of gains/(losses) on designated portion of hedging instruments in a cash flow hedge 10.29 (21.05)

ii. Income tax relating to items that will not be reclassified to profit or loss (7.45) (4.54)
iii. Items that will be reclassified to profit or loss: Share of profit/ (loss) of Associates and Joint Ventures (33.40) 3.04

Other Comprehensive Income [A (i+ii)+B (i+ii)] (6.08) (60.23)

Total Comprehensive Income for the year (X+XI) (18.69) 0.85
Attributable to:
Owners of the parent 221.48 243.57
Non Controlling Interest 11669.47 12919.28
Earnings per equity share (Face Value ` 1.00 each): 221.31 243.02
Basic EPS in Rs. 9.26 10.30
Diluted EPS in Rs. 9.20 10.24
 Long Term Liabilities

Sources for funding Long Term Capital Expenditure or Assets

Following are the major long term liabilities

• Equity Shareholders Fund (Equity Share Capital and Reserves and Surplus)
• Preference Shares
• Minority Interest/Non Controlling Interest
• Debt
 Term Loans
 Non Convertible Bond and Debentures
 Convertible Bonds and Debentures
• Deferred Tax Liability
 Equity Shareholder’s Fund

Two Components of Equity Shareholder’s Fund

1. Equity Share Capital
2. Reserves and Surplus

• Equity Share Capital (Face Value X No. of Share Outstanding)

• Reserves and Surplus
 Statutory Reserves
 General Reserve
 Revaluation Reserves
 Profit and Loss account
• Reserves and Surplus
 Amount in the beginning of the year
 Retained Earnings
 Preference Shares

Preference Shares have qualities of both equity and debt

They have fixed dividends
They are paid dividends before the equity shareholders

Preference Shares

Cumulative versus Non Redeemable versus Non

Cumulative Redeemable
 Non-Controlling Interest

Minority stake in the subsidiary in which the company has controlling stake.

It is added to the company’s total shareholding.

It is treated as equity share capital for all practical purposes.

 Debt

• Debt carries fixed obligations for the company

• Inability to pay debt leads to bankruptcy of the company
• Types of debts include

Secured versus unsecured Term Loan Debentures and Bonds Convertible Bonds

Foreign Currency
Subordinated Debt
Convertible Bonds
 Deferred Tax Liability

Laws allow companies to maintain two separate sets of books for financial and tax purposes.
If income tax books show higher tax deferred tax liability arises
If Income Tax shows lower tax deferred tax asset arises

Income Tax Book Tax Deferred Tax Deferred Tax

Financial Books Tax Obligation
Obligation Liability Assets
Rs. 100 Rs. 70 Rs. 30 -
Rs. 70 Rs. 100 - Rs. 30
 Non-Current Assets

Long term capital expenditure

Benefits accrued in more than one accounting period

Cash outflow

Expensed in more than one accounting period as a non cash item

• Example: Depreciation, Amortization

Following are the major Non Current Assets

• Plant property and equipment
• Intangible assets
• Non current investments
 Plant Property and Equipment's

• Land and Building

• Plant and Machinery
• Movable Assets such as cars, trucks etc owned by the company

Performa
• Gross Block (At the beginning of the year)
• Add: Additions
• Less: Sales/ Disposals
• Less: Accumulated Depreciation
• Less: Impairment (If any)
• Net Block (At the end of the year)

These assets are operating in nature

 Intangible Assets

Intangible assets include Performa

• Goodwill from consolidation Gross Block

• Less Accumulated Amortization
• Trademark, Knowhow and Copyright
• Less Impairment
• Software Acquisition cost
• Net Block
 Non-Current Investments

Investments can be:

Operating in nature Non Operating in nature

Coca Cola Investing in its subsidiaries Shares of unrelated companies

Debt Instruments of unrelated companies

Government Securities
Summary

In this session, we have discussed about:

• Computing and recording non-current assets

• Analysing long term assets