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Regroup the assets and liabilities in the “Analytical form” of balance sheet
Calculate the financial ratios relating both to Profit and Loss and Balance
Sheet
Interpret the financial ratios for their impact on business enterprise
Appreciate the limitations to the study of financial statements and ratios
Prepare funds flow statement given two successive dates balance sheets
Learning points:
♦ Interest is charged to income before determining the profit of the organisation. Once the profit of
the organisation is determined, tax is paid at the stipulated rate and the dividend is paid only after
this. Thus, dividend is profit allocation.
♦ This difference between “interest” and “dividend” gives opportunity to business enterprises, to
have a mix of capital of the owners and loans taken from outside, so that they can save on tax,
through the interest charged as expense on the income. The amount of tax so saved is called “tax
shield” on the interest.
♦ In the case of profit distributed among the partners as well in the case of dividend distributed
among the shareholders, these are not taxed again in the hands of the owners.
Example no. 2
The balance sheet is also known as “Assets and Liability” statement. A sample balance sheet is shown
below:
(Rupees in lacs)
Liabilities Assets
Share capital: 100 Fixed Assets 60
Reserves: 150 Less: Depreciation 30
(Retained profits Net Fixed Assets: 30
over a period of Investments: 80
time) Current Assets:
Net worth 250 Bills Receivable 100
Suppose profit for the year is Rs.30 lacs after paying tax and dividend. This would be transferred to
the balance sheet and the reserves at the end of the current year would be Rs.150 lacs + Rs.30 lacs =
Rs.180 lacs. Similarly the depreciation claimed on the fixed assets and shown as an operating expense
would also get transferred to the balance sheet to reduce the value of the fixed assets.
Let us assume that there is no increase in the fixed assets during the year that there are no other
changes and the depreciation for the year is Rs.10 lacs. We can construct the balance sheet for the
next year without much change, excepting to accommodate these figures of depreciation and increase
in reserves.
The balance sheet as at the end of the next year would look as under:
(Rupees in Lacs)
Liabilities Assets
Share capital 100 Fixed assets 60
Reserves and surplus 180 Less: depreciation 40
Net worth 280 Net fixed assets 20
Bank overdraft 30 Investments 100
Creditors for expenses 10 Bill Receivable 120
Other current liabilities 15 Cash and Bank 35
Total current Other current assets 60
liabilities 55 Total current assets 195
Total liabilities 335 Total Assets 335
We see that between the two balance sheets, there are two changes –
Investment has gone up by Rs.20 lacs and
Bill receivable has gone up by Rs.20 lacs.
The total is Rs.40 lacs. Where have these funds come from? This amount is the total of profit
transferred to balance sheet from the profit and loss account and depreciation added back, as it does
not involve any cash outlay. The figure is Rs.30 lacs + Rs.10 lacs = Rs.40 lacs. This figure is referred
to as “internal accruals”.
This need not be the case all the times. Where we use these funds entirely depends upon the business
priority and what we have shown is only a sample.
Learning points:
♦ The business enterprise generates funds from operations, known as “internal accruals” comprising
depreciation (which is added back, being only a book-entry) and profit after tax and dividend;
♦ Where these funds are used is entirely dependent upon business exigencies;
♦ Depreciation claimed in the books as an expense goes to reduce the value of the fixed assets in
the books, while profit after tax and dividend is shown as “Reserves” and increases the net worth
of the company.
Example no. 3
Purchases during the year: Rs.600lacs
Example no. 4
Let us assume the production for the year was Rs.1000lacs
Then, sales for the year could only be Rs.980lacs derived as follows:
Production during the year: Rs.1000lacs
Add: Opening stock: Rs. 100lacs
Deduct: Closing stock: Rs. 120lacs
Sales for the year: Rs. 980lacs.
On the other hand, in case the closing stocks would have been Rs.90lacs, the sales would have been
Rs.1010lacs, more than the production value. Thus, the difference between the opening and closing
stocks of work-in-progress and finished goods affects income and thereby profit. The companies
always use this as a tool, either to increase or decrease income. In case they show more closing
stocks, income is less and thereby profit is less and tax is saved and similarly if they show less closing
stocks, income is more and profit is also more.
Let us see some of the important types of ratios and their significance:
Liquidity ratios;
Turnover ratios;
Profitability ratios;
Investment on capital/return ratios;
Leverage ratios and
Coverage ratios.
Liquidity ratios:
Current ratio: Formula = Current assets/Current liabilities.
Min. Expected even for a new unit in India = 1.33:1.
Significance = Net working capital should always be positive. In short, the higher the net working
capital, the greater is the degree of overall short-term liquidity. Means current ratio does indicate
liquidity of the enterprise.
Too much liquidity is also not good, as opportunity cost is very high of holding such liquidity. This
means that we are carrying either cash in large quantities or inventory in large quantities or
receivables are getting delayed. All these indicate higher costs. Hence, if you are too liquid, you
compromise with profits and if your liquidity is very thin, you run the risk of inadequacy of working
capital.
Range – No fixed range is possible. Unless the activity is very profitable and there are no immediate
means of reinvesting the excess profits in fixed assets, any current ratio above 2.5:1 calls for an
examination of the profitability of the operations and the need for high level of current assets. Reason
= net working capital could mean that external borrowing is involved in this and hence cost goes up in
maintaining the net working capital. It is only a broad indication of the liquidity of the company, as all
assets cannot be exchanged for cash easily and hence for a more accurate measure of liquidity, we
see “quick asset ratio” or “acid test ratio”.
stocks turn over would give us a measure of the profitability of the operations, while receivables turn
over ratio would indicate the liquidity in the system.
Debtors turn over ratio – this indicates the efficiency of collection of receivables and contributes to
the liquidity of the system. Formula = Total credit sales/Average debtors outstanding during the year.
Hence the minimum would be 3 to 4 times, but this depends upon so many factors such as, type of
industry like capital goods, consumer goods – capital goods, this would be less and consumer goods,
this would be significantly higher;
Conditions of the market – monopolistic or competitive – monopolistic, this would be higher and
competitive it would be less as you are forced to give credit;
Whether new enterprise or established – new enterprise would be required to give higher credit in the
initial stages while an existing business would have a more fixed credit policy evolved over the years
of business;
Hence any deterioration over a period of time assumes significance for an existing business – this
indicates change in the market conditions to the business and this could happen due to general
recession in the economy or the industry specifically due to very high capacity or could be this unit
employs outmoded technology, which is forcing them to dump stocks on its distributors and hence
realisation is coming in late etc.
Average collection period = inversely related to debtors turn over ratio. For example debtors
turn over ratio is 4. Then considering 360 days in a year, the average collection period would be 90
days. In case the debtors turn over ratio increases, the average collection period would reduce,
indicating improvement in liquidity. Formula for average collection period = 360/receivables turn over
ratio. The above points for debtors turn over ratio hold good for this also. Any significant deviation
from the past trend is of greater significance here than the absolute numbers. No minimum and no
maximum.
Inventory turn over ratio – as said earlier, this directly contributes to the profitability of the
organisation. Formula = Cost of goods sold/Average inventory held during the year. The inventory
should turn over at least 4 times in a year, even for a capital goods industry. But there are capital
goods industries with a very long production cycle and in such cases, the ratio would be low. While
receivables turn over contributes to liquidity, this contributes to profitability due to higher turn over.
The production cycle and the corporate policy of keeping high stocks affect this ratio. The less the
production cycle, the better the ratio and vice-versa. The higher the level of stocks, the lower would
be the ratio and vice-versa. Cost of goods sold = Sales – profit – Interest charges.
Current assets turn over ratio – not much of significance as the entire current assets are involved.
However, this could indicate deterioration or improvement over a period of time. Indicates operating
efficiency. Formula = Cost of goods sold/Average current assets held in business during the year.
There is no min. Or maximum. Again this depends upon the type of industry, market conditions,
management’s policy towards working capital etc.
Fixed assets turn over ratio
Not much of significance as fixed assets cannot contribute directly either to liquidity or profitability.
This is used as a very broad parameter to compare two units in the same industry and especially when
the scales of operations are quite significant. Formula = Cost of goods sold/Average value of fixed
assets in the period (book value).
Profitability ratios –
Profit in relation to sales and profit in relation to assets:
Profit in relation to sales – this indicates the margin available on sales;
Profit in relation to assets – this indicates the degree of return on the capital employed in
business that means the earning efficiency. Please appreciate that these two are totally
different.
Example no. 5
Units A and B are in the same type of business and operate at the same levels of capacities. Unit A
employs capital of 250 lacs and unit B employs capital of 200lacs. The sales and profits are as under:
Parameter Unit A Unit B
Sales 1000lacs 1000lacs
Profits 100lacs 90lacs
Profit margin on sales 10% 9%
Return on capital employed 40% 45%
While Unit A has higher profit margins, Unit B has better returns on capital employed.
While both the units have the same net profit to sales ratio, the significant difference lies in the fact
that while Unit A has less cost of production and more office and selling expenses, Unit B has more
cost of production and less of office and selling expenses. This ratio helps in controlling either
production costs if cost of production is high or selling and administration costs, in case these are high.
Net profit/sales ratio – net profit means profit after tax but before distribution in any form = Formula =
Net profit/net sales. Tax rate being the same, this ratio indicates operating efficiency directly in the
sense that a unit having higher net profitability percentage means that it has a higher operating
efficiency. In case there are tax concessions due to location in a backward area, export activity etc.
available to one unit and not available to another unit, then this comparison would not hold well.
Profit After Tax (PAT) – Dividend on Preference Share Capital / Net worth – Preference share capital.
Although reference is equity here, all equity shareholders’ funds are taken in the denominator. Hence
Preference dividend and Preference share capital are excluded. There is no standard range for this
ratio. If it comes down over a period it means that the profitability of the organisation is suffering a
setback.
Return on capital employed (pre-tax)
Earnings Before Interest and Tax (EBIT) / Net worth + Medium and long-term liabilities. This gives
return on long-term funds employed in business in pre-tax terms. Again there is no standard range for
this ratio. If it reduces, it is a cause for concern.
Earning per share (EPS)
Dividend per share (DPS) + Retained earnings per share (REPS). Here the share refers to equity share
and not preference share. The formula is = Profit after tax (-) Preference dividend (-) Dividend tax both
on preference and equity dividend / number of equity shares. This is an important indicator about the
return to equity shareholder. In fact P/E ratio is related to this, as P/E ratio is the relationship between
“Market value” of the share and the EPS. The higher the PE the stronger is the recommendation to sell
the share and the lower the PE, the stronger is the recommendation to buy the share.
This is only indicative and by and large followed. There is something known as industry average EPS. If
the P/E ratio of the unit whose shares we contemplate to purchase is less than industry average and
growth prospects are quite good, it is the time for buying the shares, unless we know for certain that
the price is going to come down further. If on the other hand, the P/E ratio of the unit is more than
industry average P/E, it is time for us to sell unless we expect further increase in the near future.
Leverage ratios
Leverages are of two kinds, operating leverage and financial leverage. However, we are concerned
more with financial leverage. Financial leverage is the advantage of debt over equity in a capital
structure. Capital structure indicates the relationship between medium and long-term debt on the one
hand and equity on the other hand. Equity in the beginning is the equity share capital. Over a period of
time it is net worth (-) redeemable preference share capital.
It is well known that EPS increases with increased dose of debt capital within the same capital
structure. Given the advantage of debt also, as even risk of default, i.e., non-payment of interest and
non-repayment of principal amount increases with increase in debt capital component, the market
accepts a maximum of 2:1 at present. It can be less. Formula for debt/equity ratio = Medium and long-
term loans + redeemable preference share capital / Net worth (-) Redeemable preference share
capital.
From the working capital lending banks’ point of view, all liabilities are to be included in debt. Hence
all external liabilities including current liabilities are taken into account for this ratio. We have to add
redeemable preference share capital and reduce from the net worth the same as in the previous
formula.
Coverage ratios
Interest coverage ratio
This indicates the number of times interest is covered by EBIT. Formula = EBIT / Interest payment on
all loans including short-term liabilities. Minimum acceptable is 2 to 2.5:1. Less than that is not
desirable, as after paying interest, tax has to be paid and afterwards dividend and dividend tax.
Asset coverage ratio
This indicates the number of times the medium and long-term liabilities are covered by the book value
of fixed assets.
Formula = Book value of Fixed assets / Outstanding medium and long-term liabilities. Accepted ratio is
minimum 1.5:1. Less than that indicates inadequate coverage of the liabilities.
Debt Service coverage ratio
This indicates the ability of the business enterprise to service its borrowing, especially medium and
long-term. Servicing consists of two aspects namely, payment of interest and repayment of principal
amount. As interest is paid out of income and booked as an expense, in the formula it gets added back
to profit after tax. The assumption here is that dividend is ignored. In case dividend is paid out, the
formula gets amended to deduct from PAT dividend paid and dividend tax.
Formula is:
PAT (+) Depreciation (+) Amortisation (DRE write-off) (+) Int. on med. & long-term liabilities
Interest on medium and long-term borrowing (+) Instalment on medium and long-term borrowing.
This is assuming that dividend is not paid. In the case of an existing company dividend will have to be
paid and hence in the numerator, instead of PAT, retained earnings would appear. The above ratio is
calculated for the entire period of the loan with the bank/financial institution. The minimum acceptable
average for the entire period is 1.75:1. This means that in one year this could be less but it has to be
made up in the other years to get an average of 1.75:1.
Liquidity of the company, i.e., whether the Current ratio and quick ratio or acid test ratio.
company is in a position to meet all its short- Current ratio = Current assets/current liabilities.
term liabilities (also called “current liabilities”) Quick ratio = Current assets (-) inventory/
with the help of its current assets current liabilities. Current ratio should not be
too high like 4:1 or 5:1 or too low like less than
1.5:1. This means that the company is either
too liquid thereby increasing its opportunity cost
or not liquid at all, both of which are not
desirable. Quick ratio could be at least 1:1.
Quick ratio is a better indicator of liquidity
position.
Whether the company has acquired new fixed Examination of increase in secured or
assets during the year and if so, what are the unsecured loans for this purpose. Without
sources, besides internal accruals to finance the adequate financial planning, there is always the
same? risk of diverting working capital funds for fixed
assets. This is best assessed through a funds
flow statement for the period as even net cash
accruals (Retained earnings + depreciation +
amortisation) would be available for fixed
assets.
Profitability of the company in general and Percentage of profit before tax to total income
operating profits in particular, i.e., whether the including other income, like dividend or interest
main operations of the company like income. Operating profit, i.e., profit before tax
manufacturing have been in profit or the profit (-) other income as above as a percentage of
of the company is derived from other income, income from the main operations of the
Relationship between the net worth of the Debt/Equity ratio, which establishes this
company and its external liabilities (both short- relationship. Formula = External liabilities +
term and long-term). What about only medium preference share capital /net worth of the
and long-term debts? company (-) preference share capital
(redeemable kind). From the lender’s point of
view, this should not exceed 3:1. Is there any
sharp deterioration in this ratio? Is so, please
be on guard, as the financial risk for the
company increases to that extent.
For only medium and long-term debts, it cannot
exceed 2:1.
Has the company’s investments in Difference between the market value of the
shares/debentures of other companies reduced investments and the purchase price, which is
in value in comparison with last year? theoretically a loss in value of the investment.
Actual loss is booked upon only selling. The
periodic reduction every year should warn us
that at the time of actual sales, there would be
substantial loss, which immediately would
reduce the net worth of the company. Banks,
Financial Institutions, Investment companies or
NBFCs would be required to declare their
investment every year in the balance sheet at
cost price or market price whichever is less.
Relationship between average debtors (bills Average debtors in the year/average creditors in
receivable) and average creditors (bills payable) the year. This should be greater than 1:1, as
during the year. bills receivable are at gross value {cost of
development (+) profit margin}, whereas;
creditors are at purchase price for software or
components, which would be much less than
the final sales value. If it is less than 1:1, it
shows that while receivable management is
quite good, the company is not paying its
creditors, which could cause problems in future.
Too high a ratio would indicate that receivable
management is very poor.
Future plans of the company, like acquisition of Directors’ report. This would reveal the
new technology, entering into new collaboration financial plans for the company, like whether
agreement, diversification programme, they are coming out with a public issue/Rights
expansion programme etc. issue etc.
Has the company revalued its fixed assets Auditors’ comments in the “Notes to Accounts”
during the year, thereby creating revaluation relevant for this. Frequent revaluation is not
reserves, without any inflow of capital into the desirable and healthy.
company, as this is just an entry passed in the
books?
Has the company during the year given any Any increase in unsecured loans. If the loans
unsecured loans substantially other than to are to group companies, then all the more
employees of the company? reason to be cautious. Hence, where the figures
have increased, further probing is called for.
Are the company’s unsecured loans (given) not Any comments to this effect in the notes to
recoverable and very old? accounts should put us on caution. This
examination would indicate about likely impact
on the future profits of the company.
Has the company been regular in payment of its Any comments about over dues as in the “Notes
dues on account of loans or periodic interest on to Accounts” should be looked into. Any serious
its liabilities? default is likely to affect the “credit rating” of
the company with its lenders, thereby
increasing its cost of borrowing in future.
Has the company defaulted in providing for Any comments about this in the “Notes to
bonus liability, P.F. liability, E.S.I. liability, Accounts” should be looked into.
gratuity liability etc?
Whether the company is holding very huge Cash balance together with bank balance in
cash, as it is not desirable and increases the current account, if any, is very high in the
opportunity cost? current assets.
How many times the average inventory has Relationship between cost of goods sold and
turned over during the year? average inventory during the year (only where
cost of goods sold cannot be determined, net
sales can be taken as the numerator). In a
manufacturing company, which is not in capital
goods sector, this should not be less than 4:1
and for a consumer goods industry, this should
be higher even. For a capital goods industry,
this would be less.
Has the company issued fresh share capital Increase in paid-up capital in the balance sheet
during the period and what is the purpose for and share premium reserves in case the issue
which it has raised equity capital? If it was a has been at a premium.
public issue, how did it fare in the market?
Has the company issued any bonus shares Increase in paid-up capital and simultaneous
during the year? reduction in general reserves. Enquiry into the
company’s ability to keep up the dividend rate
of the immediate past.
Has the company made any rights issue in the Increase in paid-up capital and share premium
period and what is the purpose of the issue? If reserves, in case the issue has been at a
it was a public issue, how did it fare in the premium.
market?
What is the increase in sales income over last Comparison with previous year’s sales income
year in % terms? Is it due to increase in and whether the growth has been more or less
numbers or change in product mix or increase in than the estimate.
prices of finished products only?
What is the amount of provision for bad and In percentage terms, how much is it of total
doubtful debts or advances outstanding? debts outstanding and what are the reasons for
such provision in the notes to accounts by the
auditors?
What is the amount of work in progress as Is there any comment about valuation of work in
shown in the Profit and Loss Account? progress by the auditors? It can be seen that
profit from operations can be manipulated by
increase/decrease in closing stocks of both
finished goods and work in progress.
Whether the company is paying any lease Examination of expenses schedule would show
rentals and if so what is the amount of lease this. What is the comment in notes to accounts
liability outstanding? about this? Lease liability is an off-balance
sheet item and hence this examination, to
ascertain the correct external liability and to
include the lease rentals in future also in
projected income statements; otherwise, the
company may be having much less disclosed
liability and much more lease liability which is
not disclosed. This has to be taken into
consideration by an analyst while estimating
future expenses for the purpose of estimating
future profits.
Has the company changed its method of Auditors’ comments on “Accounting” policies.
depreciation on fixed assets, due to which, Change over from straight-line method to
there is an impact on the profits of the written down value method or vice-versa does
company? affect the deprecation charge for the year
thereby affecting the profits during the year of
change.
Has the company changed its method of Auditors’ comments on “Accounting” policies.
valuation of inventory, due to which there is an
impact of the profits of the company?
Whether the company had sufficient income to Interest coverage ratio = earnings before
pay the interest charges? interest and tax/total interest on all short-term
and long-term liabilities. Minimum should be
3:1 and anything less than this is not
satisfactory.
Whether the finance charges have gone up Relationship between interest charges and sales
disproportionately as compared with the income – whether it is consistent with the
increase in sales income during the same previous year or is there any spurt?
period?
Is there any explanation for this, like substantial
expansion or new project or diversification for
which the company has taken financial
assistance? While a benchmark % is not
available, any level in excess of 6% calls for
examination.
Whether the % of employee costs to sales has Relationship between “payment to and
increased? provision for employees” and the sales. In case
any undue increase is seen, it could be due to
expansion of activity etc. that would be included
in the Directors’ Report.
Whether the % of selling expenses in relation to Relationship between “selling and marketing”
sales has gone up? expenses and the sales. Any undue increase
could either mean that the company is in a very
competitive industry or it is aggressive to
increase its market share by adopting a
marketing strategy that would increase the
marketing expenses including offer of higher
commission to the intermediaries like agents
etc.
Whether the company had sufficient internal Debt service coverage ratio = Internal accruals
accruals {Profit after tax (-) dividend (+) any (+) interest on medium and long-term external
non-cash expenditure like depreciation, liabilities/interest on medium and long-term
preliminary expenses write-off etc.} to meet liabilities (+) repayment of medium and long-
repayment obligation of principal amount of term external liabilities. The term-lending
loans, debentures etc.? institution or bank looks for 1.75:1 on an
average for the loan period. This is a very
critical ratio to indicate the ability of the
company to take care of its obligation towards
the loans it has taken both by way of interest as
well as repayment of the principal.
Return on investment in business to compare it Earnings before interest and tax/average total
with return on similar investment elsewhere. invested capital, i.e., net worth (+) debt capital.
This should be higher than the average cost of
funds in the form of loans, i.e., interest cost on
loans/debentures etc.
Return on equity (includes reserves and surplus) Profit after tax (-) dividend on preference share
capital/net worth (-) preference share capital
(return in percentage). Anything less than 15%
means that our investment in this company is
earning less than the average return in the
market.
How much earning has our share made? (EPS) Profit after tax (-) dividend on preference share
capital/number of equity shares. In terms of
percentage anything less than 40% to 50% of
the face value of the shares would not go well
with the market sentiments.
Whether the company has reduced its dividend Relationship between amount of dividend
payout in comparison with last year? payout and profit after tax last year and this
year. Is there any reason for this like liquidity
crunch that the company is experiencing or the
need for conserving cash for business activity,
like purchase of fixed assets in the immediate
future?
Is there any significant increase in the “Notes on Accounts” as given at the end of the
contingent liabilities due to any of the following? accounts.
Disputed central excise duty, customs duty, Any substantial increase especially in disputed
income tax, octroi, sales tax, contracts amount of duties should put us on guard.
remaining unexecuted, guarantees given by the
banks on behalf of the company as well as the
guarantees given by the company on behalf of
its subsidiary or associate company, letter of
credit outstanding for which goods not yet
received etc.
Has the company changed its policy of Substantial change in vendor charges, or
outsourcing its work from vendors and if so, subcontracting charges.
what are the reasons?
Has the company opened any branch office in Directors’ Report or sudden spurt in general and
the last year? administration expenses.
♦ The auditors’ report is based more on information given by the management, company
personnel etc.
♦ To an extent at least, there can be manipulation in the level of expenditure, level of
closing stocks and sales income to manipulate profits of the organisation, depending upon the
requirement of the management during a particular year.
♦ One cannot come to know from study of financial statements about the tax planning of
the company or the basis on which the company pays tax, as it is not mandatory under the
provisions of The Companies’ Act, 1956, to furnish details of tax paid in the annual statement
of accounts.
♦ Notwithstanding all the above, continuous study of financial statements relating to an
industry can provide the reader and analyst with an in-depth knowledge of the industry and
the trend over a period of time. This may prove invaluable as a tool in investment decision or
sale decision of shares/debentures/fixed deposits etc.
Funds flow statement – its format and construction
Financial funds flow statement is different from what the students would have learnt by this time as
“Funds flow for Management Accounting”. Financial funds flow statement bifurcates the funds into
short-term and long-term instead of working capital and funds from operations etc. It further bifurcates
the long-term funds into internal and external resources.
The purpose of this bifurcation is to ensure proper financial planning. Financial planning essentially
involves planning for resources and obtain matching resources in terms of duration, rate of interest
etc. For example, short-term resource cannot be used for fixed assets. This is called “diversion” of
funds and could land the enterprise in serious shortfall of working capital funds. Similarly long-term
funds would always be more than long-term use, as internal accruals are a part of long-term funds
along with share capital. These could be used for short-term as well as long-term purposes. Please
refer to the Chapter on “Working capital management”.
Increase in liability = source of funds; decrease in assets = source of funds
Increase in assets = use of funds; decrease in liability = use of funds
Thus a liability can reduce during a year and increase because of fresh borrowing. Let us take for
example, term loans. During the period under review, a part of the outstanding loan would have been
paid during the year and the enterprise would have taken fresh loans. Thus in the following statement,
increase in term-loans has been shown as a source of fund and decrease in term-loan has been shown
as use of fund. This is true of all medium and long-term liabilities. The student should keep this in
mind while preparing funds flow statement. He should not be tempted to adjust and
present only the net position as a source or use. For example fresh loan taken = Rs. 100 lacs
and loans repaid during the year = Rs. 30 lacs. The student may be tempted to present the net
position of Rs. 70 lacs as source of funds. This will not give the correct picture.
However in the case of short-term source or use, only net position has to be presented as
they are constantly fluctuating and do not stay in business for a long period of time.
Keeping these in mind let us examine the following funds flow statement and comment at the end:
1999-2000
Long-term funds 2000-2001
Less:
Dividend paid 80 80
Add:
Amount amortised 15 15
Decrease in investments 25 15
Short-term liabilities 0 0
Decrease in inventory 0 0
Decrease in receivables 52 0
1999- 2000-
Long-term use 2000 2001
Increase in investment 75 50
Short-term use
EBIDT 2500
Interest 500 (on M&T liabilities - 340 and the rest working capital)
Book depreciation 240
Income tax depreciation 360
Misc. expense written off during the year 120
Income tax 40%
Dividend on preference share capital 30 (rate 10%)
Dividend on equity share capital 200 (rate 20% - FV Rs. 25/-)
Reserves 500 (excluding profit retained in business during the year)
Medium and long term liability to be met during the period 500
WDV of fixed assets -3500
Outstanding medium and long-term liabilities 2400
Outstanding current liabilities - 2000 including dividend payable for the year and provision for
tax for the year as under
Misc. expenses outstanding (yet to be written off) – Rs. 240 lacs
Find out -
Profit before tax
Profit subject to tax as per Income tax calculation
Amount of income tax payable
Profit after tax
Profit retained in business
Gross cash accruals
Net cash accruals
Debt/equity ratio (both)
Asset coverage ratio
Interest coverage ratio
Debt service coverage ratio
Earnings ratio
Also indicate the desirable minimum or maximum within brackets against each parameter,
wherever applicable
10. From the following construct the funds flow statement in the proper format including summary and
offer your comments (all figures in lacs of rupees)
Increase in share capital – 250
Sale of fixed assets – 50
Increase in inventory – 100
Decrease in cash and bank – 20
Repayment of loans for fixed assets – 80
Profits after tax for the period – 120
Dividend declared along with tax – 36