Understanding Financial Statements

[A] Balance Sheet

We have discussed in the earlier lesson how the three types of Assets are essential for carrying out various types of the Economic Activities. These are:- 1 Fixed Assets 2 Current  Assets and  3 Non Current & Intangible Assets.

Fixed Assets:

These assets assist or facilitate in carrying out the economic activity (i.e. business, industry, profession, agriculture etc)

Current Assets:  

These assets gets converted into cash during the Operating or Business Cycle or they are Cash or  En-cashable securities/ investments; Inventory i.e. Raw Material, Semi Finished goods, (SIP,WIP), Finished goods and Consumables (e.g. oil, grease, tools, jigs, spares etc) & Trade Debtors. Cash or En-cashable securities/ investments & FDs & also certain advance payment form part & parcel of current assets & are classified as OCA- other Current Assets

Non Current & Intangible Assets 

They represent the Asset which can't be classified as CA or FA e.g. Investment in sister concerns, Non en-cashable securities, old or very slow moving stock,  Overdue debtors (NPA), FDs with Electricity Boards etc.  

There is  also another class of assets i.e. Intangible or Fictitious assets. These assets do not have physical existence, cannot be perceived, touched or felt like goodwill, trademarks, know-how, royalty, pre-operative expenses, losses etc. Some of these assets may be essential for carrying out the business/economic activity. 

Understanding Balance Sheet & Financial Statements 

FUNDS FLOW - A business starts by raising funds. Thus there is an Increase in Liability. This increase in liability is seen as the source of Funds from the point of view of Funds Flow. These funds which are generated as a consequence of raising liability are used in acquiring various CA, FA & Intangible Assets and thus there is an Increase in Assets.  This increase is Use of Funds.

Opposite of above also applies i.e. any Decrease in Liability, say,  TL repaid is a use of Funds. And any Decrease in Assets brings in funds i.e. it is a Source of Funds, say, a Motor Car is sold. Thus comparison of two Balance Sheets can give us Funds/ Cash flows.  

Balance Sheet Format as Prescribed by Company's Amended Act 2013 

For the financial year on or after 2014-15 Annual Compliances will be as per Companies Act, 2013. New Annual Forms will be prepared with new requirements.

 Financial Statements: - Earlier in Companies Act 1956, Companies were required to prepared (Balance Sheet and Statement of Profit & Loss Account) as a part of Annual Report. But now in Companies Act, 2013 there is a requirement to prepare the following as a part of Financial Statements as per Section 128-138 of Companies Act  (Chapter IX) :-

a). Balance Sheet and Statement of Profit & Loss Account

b). Cash Flow Statement (Except Small Companies and OPC)

c). Consolidated Financial Statement. 

Key Features of Revised Schedule VI 

The revised schedule contains General Instructions, Part I – Form of Balance Sheet; 

General Instructions for Preparation of Balance Sheet, Part II – Form of Statement of 
Profit and Loss;

General Instructions for Preparation of Statement of Profit and Loss

• The Revised Schedule VI has eliminated the concept of ‘schedule’ and such information is now to be furnished in the notes to accounts. 
• The revised schedule gives prominence to Accounting Standards (AS) i.e. in case of any conflict between the AS and the Schedule, AS shall prevail. 
• The revised schedule prescribes a vertical format for presentation of the balance sheet. Therefore, no option is there to prepare the financial statement in horizontal format. It ensures application of uniform format of Balance Sheet 
• All Assets and liabilities classified into current and non-current and presented separately on the face of the Balance Sheet.  

Bankers View

On receipt of Balance Sheet, a banker classifies it in 3 main groups on both Assets and Liabilities side to undertake its analysis in technical terms. It is called a Balance Sheet Spread. The main heads are:-

A] LIABILITIES

1. Current Liabilities & OCL             CL
2. Term Liabilities.     -                     TL
3. Capital and Reserves. -               NW

CL- All liabilities due within 12 months from B/S date.

TL - All liabilities due after 12 months from BS date.
NW - Net Worth i.e. Capital and Reserves and Profit not distributed.
CL + TL are repayable to outsiders hence called as Outside liabilities.
NW is Owner's capital and payable only at closure of business. Are called OWN Funds.

B] ASSETS

1. Current assets & OCA            - CA
2. Fixed Assets.                          - FA
3. Non Current assets.               - NCA

CA - are assets meant for conversion into cash within business cycle (e.g. RM to SFG to FG to Cash or Debtors to Cash) or they are cash or equivalent.

FA- Not meant for cash. Help in carrying out economic activity.

NCA - Assets which can't be classified in either class, eg, old stocks, old debtors (NPA); FD with Electricity Board. They also include another class i.e. Intangible or Fictitious assets i.e. not having physical existence, eg,  goodwill, trademarks, know-how, royalty etc.

Annex II CMA FORMAT Abridged Format

The rearranged form of Balance sheet appears as follows under three major heads on both the sides i.e. 3 groups on the Liability side & 3 Groups on Asset side

This format is commonly referred to by bankers as Balance Sheet Spread or CMA format (Credit Monitoring Arrangement format).

For Working Capital Appraisal, the bankers often seek the Financial Statements for the following periods: 

1. Actuals for the past two years
2. Current Year estimates
3. Projections for next year

Limitations of Balance Sheet

1. It only takes into account things expressed in money terms
2. Values shown for some assets are not exact but only estimated
3. A balance sheet assumes that the value of money remains unchanged over a period of time

As such to assess the true position of a unit/company in totality it is essential to study and take into account following aspects while assessing the credit proposals. 

• Nature of company’s products and impact of technological developments. 
• The skill and moral of management and its employees
• The activities of the competitors
• The general economic and market trends

[B] Profit and Loss Statement / Operating Statements

1. Another useful financial statement in the hands of a banker is a Trading / Manufacturing / Profit and Loss account. It is also referred to as Statement of Income and Expenditure, Statement of Operations, Statement of Revenue and Expenditure.
2. Schedule VI part II of Companies Act 1956 does not state any format but enlists requirements and minimum disclosure which are statuary. 
3. Income Tax Act requires that it should be prepared and Audited for each Financial Year i.e. from 1st April to 31st  March of the year for Firms and Companies with:- 

• Turnover of Rs 40 lakhs & above and for Professionals where the receipts exceed Rs20 lakhs. & in certain other cases.
• As per SEBI guidelines the Companies who are Shares are quoted on Stock Exchange it is essential to publish Quarterly results with certain Ratios and Cash flow.

    These statements do not throw light on operations, as such we translate them in a format called “Operating Statement”, which is more meaningful and reflects operating strength or weakness of the concern. 

Profit And Loss Statement indicates 

1. Profitability of the concern
2. Gross fund generating capacity
3. It is useful to for fixing the repayment of Demand or Term Loans
4. How gainful is the Main activity of the concern
5. About the efficiency of the concern to utilise its assets

Thus, Operating Statement consists of five parts: 

Written by: Waman Gokhale, former Deputy General Manager, Central Bank of India