Preparing Financial Statements Smartly
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Chapter 2
Preparing
Financial Statements
Smartly
Introduction
Reading financial statements is a crucial skill for any accounting and finance
professional, as they want to review one’s financial health.
Now, we will learn what a financial statement is and get to know the types of financial
statements, and their structure and components. We will also get familiarized with
financial terms that will be used further. In the last section of this chapter, we will
learn what equity and private equity are.
Structure
In this chapter, we will discuss the following topics:
●
What is a Financial Statement?
●
Types of Financial Statements
o
Advantages and Disadvantages of Financial Statements
o
Balance Sheet
o
Cash Flow Statement
o
Income Statement
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●
Balance Sheet
o
Equity and Liabilities
o
Share Capital
o
o
o
o
o
o
o
Shareholders’ Fund
Reserve and Surplus
Non-Current Liabilities
Current Liabilities
Assets
Non-Current Assets
Current Assets
●
Income Statement
●
Cash Flow Statement
o
Terms Related to Income Statement
o
Operating Activities
o
Financial Activities
o
Investment Activities
●
Depreciation and Amortization
●
Accounting and Financial Terms
●
Public Equity and Private Equity
o
o
Public Equity
Private Equity
Objectives
Before learning ratios, working capital, and financial modeling, we must learn how
to study the financial statements. What are the components of a financial statement?
What is the structure of a balance sheet, an income statement, and a cash flow
statement? What are the financial terms we will use in our journey of learning to use
Excel for Accounting and Finance?
Financial Statement
Financial statements are formal records of the financial activities and position
of a business, person, or other entity. A financial statement is a collection of the
financial information of a business, and it reveals the financial health of a business.
In financial statements, businesses report both the individual line-by-line items and
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the total amounts to provide a comprehensive view of their financial performance.
The line-by-line items include various accounts and transactions, such as revenues,
expenses, assets, and liabilities. These items are presented in a structured manner
that allows readers to understand the company's financial position, operations, and
cash flows. In addition to the detailed information, financial statements also include
the total amounts or summary information, such as net income, total assets, and
total liabilities, to give an overall picture of the company's financial health.Financial
statements include true statements of the company's operational budget, assets,
expenses, liabilities, earnings, and the net worth of liabilities and assets. Financial
analysts, accountants, investors, and planners use these statements to enable
decision-making expansions, future planning, fundraising, market launches, and
such.
There are three important financial statements: balance sheet, income statement, and
cash flow statement.
Each type of financial statement reports different types of information for a period
(for example, month, quarter, or year). Using financial statements gives you insight
into several areas of your business’s financial health.
Here’s the breakdown of what each financial summary reveals:
●
Income statement: Business’s profits and losses.
●
Cash flow statement: Business’s incoming and outgoing money.
●
Balance sheet: Business’s assets, liabilities, and equity.
Who needs the Financial Statements of a Business/Company?
The following persons/entities want to look at the financial statements of a business/
company:
Investors: Investors want to know about the financial health of a business.
Banks and Lending Institutions: They want to know whether a company can repay
loans.
Creditors: Creditors want confirmation before lending credit to a business.
Government: Governments want to derive information about the taxes to be
collected from a business.
Employees: Employees of a company want to know how well the company is doing
– salary, bonus, and increment.
Managers: Managers want to get information about the performance of a business.
Auditors: Auditors to give a report that is an independent opinion on the company's
position.
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Balance Sheet
The balance sheet displays the company’s assets, liabilities, and shareholders’
equity at a point in time.
Figure 2.1: Balance Sheet Format with Numbers
Figure 2.1 is the format and example of a balance sheet. It shows the balance sheet of
ABC & XYZ Limited for the period ending 31st March 2016. It also has the figures for
the period ending 31st March 2015 for comparison and reporting purposes.
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A balance sheet is divided into two sections and further subsections.
●
Equity and Liabilities
o
Shareholder’s Funds
o
Current Liabilities
o
●
Non-Current Liabilities
Assets
o
o
Non-Current Assets
Current Assets
According to Accounting rule, following is the equation of the Balance Sheet:
Assets = Equity + Liabilities
Or
Total Assets (Current + Non-Current) = Total Liabilities (Current + Non-Current) +
Shareholders’ Funds (Share Capital + Reserve and Surplus)
Equity and Liabilities
Equity: This is the value of the fund as capital introduced at the time of starting a
business, and the shareholders also invest the funds while the company is in process
or working.
Liabilities: They are existing debts and obligations. There are two types of liabilities:
current liabilities and non-current liabilities. Current liabilities are those that must
be paid in less than a year, and non-current liabilities are those that have to be paid
after a year. Now, we will learn about all the sections and subsections of a balance
sheet.
Shareholders’ Fund
The amount of shareholders' funds yields an approximation of theoretically how
much the shareholders would receive if a business were to liquidate after all the
debts were paid off. Shareholders’ funds is the owner's claim after subtracting total
liabilities from total assets. If it is positive, the business has enough assets to pay all its
liabilities; and if it is negative, the business doesn’t have enough assets to pay all its
liabilities. Reserves and surplus, and retained earnings are part of the shareholders’
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funds. We can see the figures of the shareholders’ funds on the liabilities side of a
balance sheet, as shown in Figure 2.2:
Figure 2.2: Shareholder’s Funds in Balance Sheet
Example: Shareholders’ Fund for Company ABC & XYZ Limited in Figure 2.1.
Shareholder’s Equity = Total Assets – Total Liabilities
= (74,06,34,081 +93,49,47,090) –
+ 81,07,61,746)
= 74,76,07,655
(11,72,11,770
As per the preceding equation, the shareholders’ fund is positive, which it means the
company can pay their liabilities easily.
The shareholders’ fund divided into two components:
●
●
Share capital
Reserves and surplus
Share capital
Share capital is the amount invested by a company’s shareholders for use in
the business when a company is first incorporated, or the amount of money the
companies raise from the issue of common shares of the company from public and
private sources.
Let’s take an example: Mr. Ram and Mr. Shyam started a business named ABC
Infotech Limited (name taken only for educational purpose), and invested ₹10 crore
each; the company’s share capital will be ₹20 crore.
But now they want to expand their business and need ₹50 crore more, so they decide
to launch an IPO in stock market. They issue 10 lakh shares of ₹500 face value.
In this process, they sold 9 lakh shares and raised ₹45 crore. So, in the balance sheet,
the share capital will be ₹65 Crores (₹10 crore from each shareholder and ₹45 crore