Financial Accounting and Analysis

Submitted By:
Jyoti Malik
(Unit 1-3)

Unit-I

Chapter-1 Accounting in Business

1. Introduction to Accounting:

Systematic process of measuring the economic activity of

a business
To provide useful information to those who make
economic decisions.
Accounting information is used in many different
situations.
In the business world, accounting is utilized in much
greater depth, but each individual encounters some
activities in his/her everyday life that requires knowledge
of accounting principles.
Most basic framework of business. Without an
accounting education, students would be unprepared for
the real world.
2. Objectives of Accounting:

• To maintain a systematic record of business

transactions
– Accounting is used to maintain a systematic record
of all the financial transactions in a book of
accounts.
– For this, all the transactions are recorded in
chronological order in Journal and then posted to
principle book i.e. Ledger.
• To ascertain profit and loss
– Every businessman is keen to know the net results
of business operations periodically.
– To check whether the business has earned profits or
incurred losses, we prepare a “Profit & Loss
Account”.
• To determine the financial position
– Another important objective is to determine the
financial position of the business to check the value
of assets and liabilities.
– For this purpose, we prepare a “Balance Sheet”.

• To provide information to various users

 – Providing information to the various interested
parties or stakeholders is one of the most important
objectives of accounting.
– It helps them in making good financial decisions.

• To assist the management

– By analyzing financial data and providing
interpretations in the form of reports, accounting
assists management in handling business operations
effectively.

3. Advantages of Accounting:

1. Maintenance of business records

2. Preparation of financial statements
3. Comparison of results
4. Decision making
5. Evidence in legal matters
6. Provides information to related parties
7. Helps in taxation matters
8. Valuation of business
9. Replacement of memory

4. Limitations of Accounting:

1. Measurability
– One of the biggest limitations of accounting is that
it cannot measure things/events that do not have a
monetary value. If a certain factor, no matter how
important, cannot be expressed in money it finds no
place in accounting. Some very important qualities
like management, loyalty, reputation, etc. find no
place on the balance sheet or the income statement.
2. No Future Assessment
– The financial statements show the financial position
of the firm on the date of preparation. The users of
the statement are more interested in the future of the
company in the short term and long term. However,
accounting does not make any such estimates.

3. Historical Costs
– Accounting often uses historical costs to measure
the values. This fails to take into consideration
factors such as inflation, price changes, etc. This
skews the relevance of such accounting records and
information. This is one of the major limitations of
accounting.

3. Accounting Policies
– There is no global standard in accounting policies.
In India, we follow the Accounting Standards.
Americans follow the GAAP and then there are the
international standards, namely the IFRS. And if a
global company operates in more than one country,
there may be confusion.
– Not all accounting policies follow the same line of
thinking, and conflicts may arise due to this. It has
long been said that the whole world must agree on
uniform accounting policies but this has not
happened yet.

5. Estimates
– Sometimes in accounting estimation may be
required as it is not possible to establish exact
amounts. But these estimates will depend on the
personal judgment of the accountant. And estimates
 are extremely subjective in nature. They are
basically a person’s guess of future events. In
accounting, there are many cases where such
estimates need to be made like provision of doubtful
debt, methods of depreciation, etc.

6. Verifiability
– An audit of the financial statements does not
guarantee the correctness of such statements. The
auditor can only assure that the statements are free
from error to the best of his judgment.

7. Errors and Frauds

– Accounting is done by humans, so there will always
be the scope of human errors. There is also the fear
of possible manipulation of accounts to cover up a
fraud. Since fraud is deliberate, it is that much
harder to spot. This is one of the most dreaded
limitations of accounting.

4. Users of accounting information:

Internal users- Manger and Owner:

Internal users- Employees:

External Users- Creditors:

Accounting Terms:
Transactions:
 Economic Activity e.g. Purchase of goods; receiving cash
or cheque from debtors etc.

Involves exchange or transfer of values between two

parties (internal and external)

Change may be quantitative or qualitative e.g. Purchase

of goods for cash, depreciation of fixed assets etc.

Change should be financial in nature.

Entity:

• Net worth or Net Asset:

Net worth or net assets means the excess
of the total assets of a business over its
 total liabilities at any particular point of
time.
In short, it means owner’s capital

Drawings:

Drawing refer to cash,

goods or any other asset
withdrawn by the
proprietor from his
business for his personal,
private or domestic use
or purpose.

Assets:
 Assets means resources, things or rights
of value owned/ controlled by a business
undertaking.

Assets include: Tangible assets like lands,

buildings, Plant & machinery, etc;
intangible assets, such as Goodwill,
Patent rights, trade marks and copyrights;
Debts or amounts due to a business from
others, such as sundry debtors, bills
receivable, accrued incomes, etc.

Liabilities:

Liabilities means claims of outsiders against

a business concern which bind the
business concern to others.

In short, liabilities are outsider’s equity.

Examples of liabilities: - loans borrowed,

deposits, creditors, bank loan, bank
overdraft
Debtor:

A debtor is a person who owes money to the

business .

A debtor constitutes an asset for the business.

A debtor may be: (a) a trade debtor, (b) a loan

debtor, (c) a debtor for an asset sold on credit or
(d) a debtor for the service rendered on credit.

Creditor:
A creditor is a person to whom the business owes money.

A creditor constitutes a liability for the business

A creditor may be

(a) a trade creditor,

(b) a loan creditor,

(c) a creditor for an asset purchased on credit and

(d) an expense creditor

Good
s refer to
merchandise,
commodities,
products, articles or
things in which a
trader deals.
Purchas
es / Invento
Sales
ry
 Costs incurred in
connection with the
earnings of revenue. E.g.
Cost of goods sold or
services rendered,
administration or office
expenses, selling and
distribution expenses,
maintenance expenses,
financial expenses, etc

Expen
ses
• refers to revenue which
is not generated
Gain through routine or
regular business
activities.

• is the excess of
revenues over the
Profit expenses of a given
period of time, usually a
year.
Accounting Concepts:
1. Business Entity Concept:
The business and its owner(s) are two separate entities

2. Going Concern Concept:

It is assumed that the entity is a going concern,
i.e., it will continue to operate for an indefinitely
long period in future and transactions are
recorded from this point of view.

3.Money Measurement Concept:

• In accounting, a record is made only of those transactions
or events which can be measured and expressed in terms
of money.

4.Accounting Period Concept:

• For measuring the financial results of a business
periodically, the working life of an undertaking is split
into convenient short periods called accounting period.

5. Cost Concept:
An asset acquired by a concern is recorded in the books of
accounts at historical cost (i.e., at the price actually paid
for acquiring the asset). The market price of the asset is
ignored.

6. Dual-Aspect Concept:
Every transaction should have a two- sided effect to the
extent of same amount

7. Realization Concept:
Profit is earned when goods or services are provided
/transferred to customers. Thus it is incorrect to record
profit when order is received, or when the customer pays
for the goods.

8.Matching Concept:
 IFRS- International Financial
Reporting Standard

A set of accounting standards

• Developed by ---International Accounting Standards
Board (IASB)
• For the preparation of public company financial
statements.
• Globalization
----To reduce the differences between accounting standards.
• International Acquisitions
• Standard quality of MIS
 • Enhance confidence among the global stakeholders
Two Modes

Adoption Convergence

Indian Companies (Converged)

• IT Sector
Infosys , Wipro, NIIT
• Auto Sector
Mahindra and Mahindra
Tata Motors
• Bombay dyeing (textile)
• -Dr Reddy’s lab (pharma)
• - Bharti Airtel (telecom)
 Unit-II
Chapter-2 Asset Valuation and its Impairment

1. Valuation of Tangible Assets:

Accurate, defensible tangible asset valuation services

play a critical role in many business situations, ranging
from the mundane to the esoteric. Real and personal
property tangible asset valuations are important for tax
and financial reporting, asset monitoring, property
insurance, ad valorem taxes and replacement budgeting.
At the other end of the spectrum, valuation of tangible
assets can be an indispensable tool in establishing
prices, justifying positions to stockholders and satisfying
governmental concerns in the course of corporate
mergers, acquisitions, refinancing and restructuring.

Along with a tangible asset valuation’s important

function in specific applications such as insurance claims
and taxes, maintaining an accurate property record
increases control over major investments in facilities
and equipment. In order to optimize cash flow and
secure the most favorable tax treatment, property
owners must be able to distinguish between costs
associated with real property and personal property.
Our tangible asset valuations have stood up to review by
local, state and federal regulatory agencies, and it is
Appraisal Economics’ policy to support our tangible
asset valuations whenever they are challenged.
 2. Valuation of Intangible Assets:

An intangible asset must have:

(i) Identifiability,
(ii) Control over a resource; and

(iii) Expectation of future economic benefits flowing to be

enterprise.

Valuation of intangible assets is a complex exercise. The non-

physical form of intangible assets makes it difficult to identify
the future economic benefits that the enterprise can expect
to derive from the intangible assets.

Many intangible assets do not have alternative use and

cannot be broken down into components or parts for resale.
Further, intangible assets normally do not have an active
market. Many times, they are not separable from the
business and hence it becomes difficult to value them
separately from the business.
There are three approaches used in valuing intangible
assets:
(i) Cost approach,

(ii) Market value approach and

(iii) Economic value approach.

3. Depreciation on Fixed Assets:

 Fixed assets are company’s tangible assets that are
relatively durable and used to run operations and
generate income. They are not used to be consumed or
sold, but to produce goods or services.

Due to the long-term use, the value of fixed assets

decreases as they age. Some examples of depreciable
fixed assets are buildings, machinery, and office
equipment. Land is not one of them, because it has an
unlimited useful life and it increases in value over time.

In short, depreciation is the allocation of the acquisition

cost of a fixed asset caused by a decrease in its value. To
find out what factors affect the depreciation of fixed
assets and how to calculate them, see the explanation
below.

4. Inventory Valuation:

Inventory valuation is the monetary amount associated

with the goods in the inventory at the end of an
accounting period. The valuation is based on the costs
incurred to acquire the inventory and get it ready for
sale.
Inventories are the largest current business assets.
Inventory valuation allows you to evaluate your Cost of
Goods Sold (COGS) and, ultimately, your profitability.
The most widely used methods for valuation are FIFO
(first-in, first-out), LIFO (last-in, first-out) and WAC
(weighted average cost).
 5. Methods of Inventory Valuation:

There are three most common methods that retailers use:

• First-In-First-Out (FIFO)
• Last-In-First-Out (LIFO)
• Weighted Average Cost (WAC)
 Unit-III

Chapter-3 Financial Statement Analysis

1. Techniques of Financial Statement Analysis:

Various techniques are used in the analysis of

financial data to emphasize the comparative and
relative importance of data presented and to evaluate
the position of the firm.
Among the more widely used of these techniques,
are the following:
1. Vertical Analysis

Vertical Analysis uses percentages to show the

relationship of the different parts to the total in a
single statement. Vertical analysis sets a total figure
in the statement equal to 100 percent and
computes the percentage of each component of
that figure. The figure to be used as 100 per cent
will be total assets or total liabilities and equity
capital in the case of balance sheet and revenue or
sales in the case of the profit and loss account.

2. Trend Analysis:
Using the previous year’s data of a business enterprise,
trend analysis can be done to observe percentage changes over time
in selected data. In trend analysis, percentage changes are
calculated for several successive years instead of between two years.
Trend analysis is important because, with its long-run view, it may
point to basic changes in the nature of the business. By looking at a
trend in a particular ratio, one may find whether that ratio is falling,
rising or remaining relatively constant. From this observation, a
problem is detected or the sign of a good management is found.

3. Ratio Analysis

Ratio analysis is an important means of expressing the relationship

between two numbers. A ratio can be computed from any pair of
numbers. To be useful, a ratio must represent a meaningful
relationship, but use of ratios cannot take the place of studying the
underlying data.
 Financial Accounting and Analysis

(Unit 4-6)

Unit-IV

Chapter-4 Ratio Analysis

Ratio Analysis:
(i) It is a method or process by which the relationship
of items or groups of items in the financial
statements are computed or presented.
(ii) Is an important tool for financial analysis.
(iii) It can be expressed as a pure ratio, percentage or
as a rate.

Classification of Ratios:

1. Liquidity Ratios:
 These ratios analyse the short-term financial position of
a firm and indicate the ability of the firm to meet its
short-term commitments (Current liabilities) out of its
short-term resources (Current assets).
These are also known as ‘Solvency Ratios’. The ratios
which indicate the liquidity of a firm are:
(a) Current Ratio
(b) Liquidity ratio or Quick ratio or acid test ratio

(a) Current Ratio:

It is calculated by dividing current assets by current
liabilities.
Current ratio = Current assets where
Current liabilities

Conventionally a current ratio of 2:1 is considered

satisfactory.

Current Assets:
Includes:
Inventories of raw materials, WIP, finished goods,
stores and spares, sundry debtors/receivables, short-
term loans deposits and advances, cash in hand and
bank, prepaid expenses, incomes receivables and
marketable investments and short-term securities.

Current Liabilities:
Includes:
 Sundry creditors/bills payable, outstanding expenses,
unclaimed dividend, advances received, incomes
received in advance, provision for taxation, proposed
dividend, instalments of loans payable within 12
months, bank overdraft and cash credit.

(b) Quick Ratio or Acid Test Ratio:

This is a ratio between quick current assets and

current liabilities (alternatively quick liabilities).
It is calculated by dividing quick current assets by
current liabilities (quick current liabilities)
Quick Ratio = quick assets Where
Current liabilities/ (quick liabilities)

Conventionally a quick ratio of 1:1 is considered

satisfactory.

Quick Assets and Current Liabilities:

Quick Assets are current assets (as stated earlier)

Less prepaid expenses and inventories.

Quick Liabilities are current liabilities (as stated

earlier)
Less bank overdraft and incomes received in advance.

2. Solvency Ratio:
 Solvency ratio is calculated from the components of
the balance sheet and income statement
elements. Solvency ratios help in determining
whether the organisation is able to repay its long
term debt. It is very important for the investors to
know about this ratio as it helps in knowing about
the solvency of a company or an organisation.

The various types of solvency ratios.

(a) Debt to equity ratio:
Debt to equity is one of the most used debt solvency
ratios. It is also represented as D/E ratio. Debt to equity
ratio is calculated by dividing a company’s total liabilities
with the shareholder’s equity. These values are obtained
from the balance sheet of the company’s financial
statements.
It is an important metric which is used to evaluate a
company’s financial leverage. This ratio helps
understand if the shareholder’s equity has the ability to
cover all the debts in case business is experiencing a
rough time.
It is represented as
Debt to equity ratio = Long term debt / shareholder’s
funds
Or
Debt to equity ratio = total liabilities / shareholders’
equity
(b) Debt Ratio:
Debt ratio is a financial ratio that is used in measuring a
company’s financial leverage. It is calculated by taking
the total liabilities and dividing it by total capital. If the
debt ratio is higher, it represents the company is riskier.
The long-term debts include bank loans, bonds payable,
notes payable etc.
Debt ratio is represented as
Debt Ratio = Long Term Debt / Capital or Debt Ratio =
Long Term Debt / Net Assets

(c) Proprietary Ratio or Equity Ratio:

Proprietary ratios is also known as equity ratio. It
establishes a relationship between the proprietors
funds and the net assets or capital.
It is expressed as
Equity Ratio = Shareholder’s funds / Capital
or Shareholder’s funds / Total Assets

(d) Interest Coverage Ratio:

The interest coverage ratio is used to determine
whether the company is able to pay interest on
the outstanding debt obligations. It is calculated
by dividing company’s EBIT (Earnings before
interest and taxes) with the interest payment due
on debts for the accounting period.
It is represented as
Interest coverage ratio = EBIT / interest on long
term debt
 Where EBIT = Earnings before interest and taxes
or Net Profit before interest and tax.

3. Profitability Ratios:
Ratios help in interpreting the financial data and taking
decisions accordingly. Accounting ratios are of four types:
liquidity ratios, solvency ratios, turnover ratios,
profitability ratios. Accounting ratios measuring
profitability are known as Profitability Ratio.

Profitability Ratios are of five types. These are:

• Gross Profit Ratio

• Operating Ratio
• Operating Profit Ratio
• Net Profit Ratio
• Return on Investment

(a) Gross Profit Ratio:

Gross Profit Ratio establishes the relationship between gross
profit and Revenue from Operations, i.e. Net Sales of an
enterprise. Thus,

Gross Profit Ratio = (Gross Profit/Revenue from Operations)

x 100
Gross Profit = Revenue from Operations – Cost of
Revenue from Operations

(Cost of operations is also called as Cost of Goods Sold)

Cost of Revenue from Operations = Opening

Inventory + Net Purchases + Direct Expenses – Closing
Inventories.

Or

= Revenue from Operations – Gross Profit

(b) Operating Ratio:

It establishes the relationship between operating costs
and Revenue from Operations.
Operating cost includes Cost of Revenue from
Operations and Operating Expenses. These are those
costs which are incurred for operating activities of the
business.
Operating Ratio = (Cost of Revenue from Operations
+ Operating Expenses/Revenue from Operations) x 100
Or
=(Operating cost/Revenue from Operations) x 100
Operating Expenses = Employees Benefit Expenses +
Depreciation and Amortization Expenses + Other
Expenses (Other than Non-operating Expenses)
Or
= Office Expenses + Selling and Distribution Expenses
+ Employees Benefit Expenses + Depreciation and
Amortization Expenses.
(c) Operating Profit Ratio:
Operating Profit Ratio measures the relationship
between Operating Profit and Revenue from
Operations, i.e. Net Sales.
We compute Operating Profit Ratio by dividing
operating profit by revenue from operations (Net
Sales) and is express in Percentage.
Operating Profit Ratio = (Operating Profit/Revenue
from Operations) x 100
Operating Profit = Gross Profit + Other Operating
Income – Other Operating Expenses
Or,
= Net Profit (Before Tax) + Non-operating Expenses –
Non-operating Incomes
Or,
= Revenue from Operations – Operating Cost

(d) Net Profit Ratio:

Net Profit Ratio measures the relationship between
Net Profit and Net Sales. It shows the percentage of
Net Profit earned on Revenue from Operations.
Net Profit Ratio = (Net Profit/Net Sales) x 100
Net Profit = Revenue from Operations – Cost of
Revenue from Operations – Operating Expenses – Non-
operating Expenses + Non-operating Incomes- Tax

(e) Return on Investment:

Return on Investment or Return on Capital Employed
shows the relationship of profit (profit before interest
and tax) with capital employed. The result of
operations of a business is either profit or loss.
 The funds or sources used in the business to earn
profit/loss are proprietors’ (shareholders’) funds and
loans.
Return on Investment = (Net Profit before Interest, Tax
and Dividend/Capital Employed) x 100

4. Turnover Ratios:
Turnover Ratios are a set of financial ratios used to
measure the efficiency of various operations of a
business. Activity ratios measure the efficiency of the
firm in using its resources/ assets. These ratios are also
known as Asset Management Ratios because these
ratios indicate the efficiency with which the assets of
the firm are managed/utilized.

(A)DEBTOR / RECEIVABLE TURNOVER RATIO AND AVERAGE

COLLECTION PERIOD:
The receivable turnover ratio indicates the frequency of
conversion from debtors to cash normally in a year. It also
suggests the extent of liquidity of debtors. Average collection
period gives a time period in which debtors are converted
into cash. Both the ratios indicate the same thing but in
different terms. The former is expressed in no. of times
whereas the latter in no. of days or months. The formula for
debtor / receivable turnover ratio and average collection
period is as follows:

Debtor Turnover Ratio = Credit Sales

Average Debtors + Bills Receivable
Average Collection Period = 365 days or 12 months
Debtor Turnover Ratio

(B) Stock/ Inventory Turnover Ratio:

Inventory turnover ratio indicates how many times inventory

is sold and replaced in a financial year. In other words, the
ratio gives the frequency of conversion of inventory into cash
in a given financial year. Normally, a higher ratio is
considered good as it suggests better inventory
management.

Stock Turnover Ratio = Cost of goods sold

Average Inventory

(C) Assets Turnover Ratio:

Asset Turnover Ratio calculates the value of revenue

achieved per dollar of investment. A higher ratio indicates
better asset management and utilization and vice versa. The
ratio also depends on the business to business based on their
profit margins. With lower margins, this ratio is normally
high. The ratio is calculated as below:

Asset Turnover Ratio = Net Revenue

Assets

5. Du-pont Analysis:
 In simple words, it breaks down the ROE to analyze how
corporate can increase the return for their shareholders.
Return on Equity = Net Profit Margin * Asset Turnover
Ratio * Financial Leverage = (Net Income / Sales) * (Sales
/ Total Assets) * (Total Assets / Total Equity)

UNIT-V

Chapter-5 Statement of Cash Flows

1.Preparing of Cash Flow Statement:

This method works only if you understand the

following matters:

o You already know what the statement of cash flow

is and what parts it has (operating, investing,
financing and final reconciliation). You understand
the basics of cash flows, relationship between
individual components of financial statements
(balance sheet, income statement and others),
accounting etc. If that’s not the case, I sincerely
 recommend watching our online videos on these
topics—in particular IAS 1: Presentation of Financial
Statements and IAS 7: Statement of Cash Flows.

• Availability of various accounting information is

generally good and you can easily access them.
Sometimes you will need to do some adjustments
resulting from supporting data and it would be lovely if
you could get all pieces of info in the blink of an eye.
• You will stay cool, no nerves, no stress, just patience and
concentration on this lovely work.

Step 1: Prepare—Gather Basic Documents and Data

In order to start, you shall obtain at least the

following documents:

• balance sheet (statement of financial position) as at the

end of the current reporting period (closing B/S) and as
 at the beginning of the current reporting period
(opening B/S)
• statement of comprehensive income (profit or loss
statement + statement of other comprehensive income
if applicable) for the current reporting period
• statement of changes in equity for the current
reporting period
• statement of cash flows for the previous reporting
period—well, you can proceed further without this, but
it’s good source of potential recurring adjustments in
the current period
• information about material transactions in your
company during the current reporting period. Of course,
you can adjust your statement of cash flows also for
immaterial items, but it would not significantly change
the information value of cash flow statement (since it’s
immaterial, but careful about aggregation), so I would
not bother about it
• documents from your investment/long-term assets
department to look for major purchases, sales,
exchanges and other transactions with fixed assets
Step 2: Calculate Changes in the Balance Sheet

Now, take the closing and opening B/S and make a simple
table with 3 columns: the first column – title of caption in B/S
(for example, tangible non-current assets), the second
column—balance of this caption from the closing B/S and the
third column—balance of this caption from the opening B/S.
As you sure know, each B/S has 2 parts – assets and
equity & liabilities. Ideally, totals of both parts should be the
same, right? So when you do this simple table, please, enter
assets with “+” sign and equity & liabilities with “-“ sign. Now
do the check – if you entered the signs and numbers
correctly, total of all assets and equity & liabilities should be
0 (don’t include subtotals).
In the 4th column, calculate changes in the balance sheet over
the current period. Use simple formula: opening B/S minus
closing B/S (careful, not the vice versa!). When you calculate
all the changes correctly, total of all changes will be 0 (again,
don’t include subtotals). Just let me add that you can use
your general ledger accounts instead of balance sheets and
you will get greater details as balance sheet represent
aggregated figures. It really depends on the level of details
you need.
Step 3: Put Each Change in B/S to the Statement of
Cash Flows

By now, you should have a blank statement of cash flows

ready for further work. Ideally, you can use the statement of
cash flows from previous period and take only titles of
individual captions. Likely you will have the same items also
in the current period cash flows. Anyway, you can always
insert a line for some new items if necessary.
The rationale behind this step is that each change in the
balance sheet has also some impact on the cash flow
statement—and if not (when movement in balance sheet is
fully a non-cash item), it will be adjusted for later.
So now you should look to all changes in your balance sheet
and enter each number to the blank form of cash flow
statement. For example, you have calculated that change in
your property, plant and equipment is -10 000, so you enter
this figure in the investing part of your blank cash flows
under the title “purchases of PPE” (as a change was minus
10 000, it means that the company spent the cash to
purchase PPE).
You shall continue assigning each change in the balance
sheet to the statement of cash flows until you finish all.
When you are done, you should have a statement of cash
flows with 2 columns—1st column = titles of individual cash
flow captions and 2nd column = changes in the balance sheet
assigned. Now perform a check—total of the 2nd column shall
be 0 (without subtotals). If it’s not, you have done something
wrong, so go back and review.
Step 4: Make Adjustments for Non-cash Items from
Statement of Total Comprehensive Income

By now, you have a solid base to finish your cash flows

successfully. However, these figures do not mean anything.
We have more work to do.
Take the profit or loss statement and statement of other
comprehensive income. Then identify any numbers where
non-cash transaction might have been recorded. Typical non-
cash adjustments are usually as follows:
• depreciation expense
• interest income and expense
• income tax expense
• expense for recognition or income from derecognition
of various provisions
• change in revaluation reserves
• foreign exchange differences at the end of period
• revaluation of certain assets and liabilities at the end
of period
• barter transactions

Step 5: Make Adjustments for Non-cash Items from

Other Information

Step 5 is pretty much the same as step 4, but now you shall
look to other information sources. I listed several of them in
step 1.
So for example, you find out that your company entered into
new material lease contract. And there is a non-cash
adjustment hidden for sure, because on one side, increase
in PPE was recorded that was not purchased for cash. On the
other hand, increase in loans or lease liabilities was recorded,
but the company have not received any cash. So you shall
adjust for it, exactly the same way as described in the step 4.
Remember about your total—it should be always 0.

Step 6: Prepare Movements in Material Balance Sheet Items

to Verify Completeness

Well, this step is really for diligent, hardworking and dutiful

people. You can skip it if you want, but I recommend doing it
from very obvious reasons: you will be pretty much sure that
you have made all material non-cash adjustments in your
cash flows without omitting something important. Well, if
you are sure that you have all available information from
various departments in your company to include, than fine.
But if you are unsure about it, then rather do this step.
It’s very easy. Just take the biggest or material items in your
balance sheet and reconcile their movements between
opening and closing balance. Check whether each movement
is taken into account for in your cash flow statement so far.

Step 7: Add Up and Perform Final Check

Let’s assume that by now you have done a lot of work, made
a lot of adjustments, verified movements in material B/S
items, your totals are always 0. Great job!
In this stage, finishing your cash flows is a piece of cake.
What do you have in front of you? Huge excel file with
1st column being the headings and titles of your statement of
cash flows, 2nd column being the changes in balance sheet
and 3rd–xth columns being individual adjustments.
Now it’s time to draw the last column. And you guessed it—
your last column will be the statement of cash flows itself. In
the individual lines or items from statement of cash flows,
you shall make “horizontal” or “line” totals, or in other
words, sum up the numbers from columns 2 to x. You
effectively calculate the change in the balance sheet for the
individual caption adjusted by non-cash items, that gives you
the appropriate cash movement for that caption.
Fine. Then verify if it makes sense. For example, you will get
certain number in the line “purchases of PPE”—go and verify
this number with your accounting records, or ask your
investment department whether cash payments
for PPE during the period were as you calculated. If not even
close to that—you must have omitted something, or messed
up signs or you made some other mistake.
Finally, look to “vertical” total of the last column—if it’s 0,
you are the winner and deserve to sit back, close your eyes,
relax…. but that’s topic for another article :-).

2. Analysis of Statement of cash flows:

The statement of cash flow shows how a company spends its money (cash
outflows) and from where a company receives its money (cash inflows). The
cash flow statement includes all cash inflows a company receives from its
ongoing operations and external investment sources, as well as all cash
outflows that pay for business activities and investments during a given
quarter. This article will explain the cash flow statement and how it can help
you analyze a company for investing.

KEY TAKEAWAYS

• The statement of cash flow depicts where a company receives its

money from and how it expends its money.
• The three main components of a cash flow statement are cash flow
from operations, cash flow from investing, and cash flow from financing.
 • The two different accounting methods, accrual accounting and cash
accounting, determine how a cash flow statement is presented.
• A company's cash flow can be defined as the number that appears in
the cash flow statement as net cash provided by operating activities.
• Important indicators in cash flow analysis include the operations/net
sales ratio, free cash flow, and comprehensive free cash flow coverage.

Cash Flow Statement

A cash flow statement has three distinct sections, each of
which relates to a particular component—operations,
investing, and financing—of a company's business activities.
Below is the typical format of a cash flow statement.
Cash Flow From Operations
This section reports the amount of cash from the income
statement that was originally reported on an accrual basis. A
few of the items included in this section are accounts
receivables, accounts payables, and income taxes payable.

If a client pays a receivable, it would be recorded as

cash from operations. Changes in current assets or current
liabilities (items due in one year or less) are recorded as cash
flow from operations.

Cash Flow From Investing

This section records the cash flow from sales and purchases
of long-term investments like fixed assets that
include property, plant, and equipment. Items included in
this section are purchases of vehicles, furniture, buildings, or
land.

Typically, investing transactions generate cash outflows, such

as capital expenditures for plant, property and equipment,
business acquisitions, and the purchase of investment
securities.

Cash Flow From Financing

Debt and equity transactions are reported in this section. Any
cash flows that include payment of dividends, the repurchase
or sale of stocks, and bonds would be considered cash flow
from financing activities. Cash received from taking out a
loan or cash used to pay down long-term debt would
be recorded in this section.

For investors who prefer dividend-paying companies, this

section is important since it shows cash dividends paid
since cash, not net income, is used to pay dividends to
shareholders.

3. Classification of Cash Flows:

In financial accounting, a Cash Flow Statement, also known
as Statement of Cash Flow, is a financial statement that
shows how changes in balance sheet accounts and income
affect cash and cash equivalents, and breaks the analysis
down to operating, investing, and financing activities.
Essentially, the cash flow statement is concerned with the
flow of cash in and out of the business. The statement
captures both the current operating results and the
accompanying changes in the balance sheet. As an analytical
tool, the statement of cash flows is useful in determining the
short-term viability of a company, particularly its ability to
pay bills. International Accounting Standard 7 (IAS 7), is the
International Accounting Standard that deals with cash flow
statements.
The statement of cash flows is divided into three sections:
A. Financing activities
B. Operating activities
C. Investing activities

A. Cash flow from financing activities (CFF):

CFF is cash flow that comes into play from generating or letting
cash through the issuance of additional equity, short or long-
term debt for the firm’s operations. This covers:
(a) Cash inflow (+)
1. Sale of equity securities
2. Issuance of debt securities
(b) Cash outflow (-)
1. Dividends to shareholders
2. Redemption of long-term debt
3. Redemption of capital stock
Reporting Noncash Investing and Financing Transactions Data
for the Statement of cash flows(SOCF) is derived from three
places:
• Comparative balance sheets
• Current income statements
• Selected transaction data

B. Cash Flow from Operating Activities (CFO):

CFO is cash flow that comes into play from regular operations
such as revenues and cash operating expenses net of taxes.
This category covers:
(a) Cash inflow (+)
1. Revenue from sale of goods and services
2. Dividends (from equities of other entities)
3. Interest (from debt instruments of other entities)
(b) Cash outflow (-)
1. Payments to lenders
2. Payments to employees
3. Payments to suppliers
4. Payments to government
5. Payments for other expenses

C. Cash Flow from Investing Activities (CFI):

CFI is cash flow that comes to play through investment
activities such as the acquisition or disposition of current and
fixed assets. This category covers:
(a) Cash inflow (+)
1. Sale of property, plant and equipment
2. Sale of debt or equity securities (other entities)
3. Collection of principal on loans to other entities
(b) Cash outflow (-)
1. Purchase of property, plant and equipment
2. Purchase of debt or equity securities (other entities)
3. Lending to other entities
Example of a cash flow statement

Now that we’ve got a sense of what a statement of cash

flows does and, broadly, how it’s created, let’s check out an
example.
 Unit-VI

Chapter-6 Developments in Financial Reporting

1.Value Added Statement:

The financial statement which shows how much value

(wealth) has been created by an enterprise through
utilization of its capacity, capital, manpower, and other
resources, and how it is allocated among different
stakeholders (employees, lenders, shareholders,
government, etc.) in an accounting period.

Value added is now reported in the financial statements of

companies in the form of a statement. Value Added
Statement (VAS) is aimed at supplementing a new dimension
to the existing system of corporate financial accounting and
reporting. This is called value-added statement. This
statement shows the value created; value added (value
generated) and the distribution of it to interest groups viz.
Employees, shareholders, promoters of capital and
government.

Since VAS represents how the value or wealth created or

generated by an entity is shared among different
stakeholders, it is significant from the national point of view.
ICAI, 1985 has defined Value Added Statement as a
statement that reveals the value added by an enterprise
which it has been able to generate, and its distribution
among those contributing to its generation known as
stakeholders.

2.Economic Value Added:

Economic Value Added (EVA) or Economic Profit is a measure

based on the Residual Income technique that serves as an
indicator of the profitability of projects undertaken. Its
underlying premise consists of the idea that real profitability
occurs when additional wealth is created for shareholders
and that projects should create returns above their cost of
capital.

EVA adopts almost the same form as residual income and can
be expressed as follows:

EVA = NOPAT – (WACC * capital invested)

Where NOPAT = Net Operating Profits After Tax

WACC = Weighted Average Cost of Capital

Capital invested = Equity + long-term debt at the beginning

of the period
and (WACC* capital invested) is also known as finance
charge

Calculating Net Operating Profits After Tax (NOPAT):

One key consideration for this item is the adjustment of the

cost of interest. The cost of interest is included in the finance
charge (WACC*capital) that is deducted from NOPAT in the
EVA calculation and can be approached in two ways:

1. Starting with operating profit, then deducting the

adjusted tax charge (because tax charge includes the tax
benefit of interest). Therefore, we should multiply the
interest by the tax rate and add this to the tax charge; or
2. Start with profit after tax and adding back the net cost of
interest. Therefore, we should multiply the interest
charge by (1-tax rate).

Calculating the Finance Charge:

Finance Charge = Capital invested * WACC

and WACC = Ke*E/ (E+D) + Kd (1-t)*D/ (E+D), where Ke =
required return on equity and Kd (1-t) = after tax return on
debt

Thus, given the adjusted taxes, we can write the economic

value-added formula as follows:
EVA = NOPAT – (WACC * capital invested)
Example – Calculating Economic Value Added for a Company
 2014 2015

Capital invested (beginning of year) $54,236 $50,323

WACC 8.22% 8.28%

Finance Charge $4,460 $4,167

NOPAT $7,265 $5,356

Finance Charge $4,460 $4,169

Economic Value Added $2,805 $1,187

3. Market Value Added:

Market value added (MVA) is the amount of wealth that a

company is able to create for its stakeholders since its
foundation. In simple terms, it’s the difference between the
current market value of the company’s stock and the initial
capital that was invested in the company by both
bondholders and stockholders.
Market value added is a wealth metric used to measure the
amount of capital that shareholders have invested in excess
of the current value of the company. Simply put; it
determines whether the business has increased or decreased
in value since its inception.
MVA is computed by first finding the total market value of
the company’s shares. The stockholder’s equity or initial
capital is then subtracted from the resulting sum. A higher
MVA is preferred because it indicates that the company is
generating enough money to cover the cost of capital.

4. Shareholder Value Added:

Shareholder value added (SVA) is expressed as a
company's capital costs from stock and bond issues
subtracted from its net operating profit after tax (NOPAT).
SVA = NOPAT - Cost of Capital
For instance, if a company's NOPAT is $200,000 and its
capital costs are $50,000, its SVA would be $150,000
($200,000 - $50,000 = $150,000).
Dividends augment SVA while additional issuances of stock
lower SVA.
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