Finance for Non-finance Managers Module 2 Balance Sheet

Shahid Hussain Raja
Cambridge. UK
www.shahidhussainraja.com

 Introduction
 About the Author-Shahid Hussain Raja
 What is Financial Accounting-the Basics
 What is a Balance Sheet
 How Balance Sheet is prepared
 How to read a Balance Sheet
 How to unterprest a Balance Sheet
 Uses of a Balance Sheet
 Limitations of a Balance Sheet
 Conclusion

 Welcome to Module 2 of One day intensive course on
Finance for Non finance Managers/Professionals
 This course consists of five modules, each dealing with
different aspects of financial management.
 One of the core elements of financial management is the
three financial statements
 Module 2 relates to discussion of the Blance Sheet-what is a
Balance Sheet and how to read, interpret and use it

 Retired in 2012 as Federal Secretary, Govt. of Pakistan, held
various senior positions during 35 year’s service. Served as Chief
Instructor, National School of Public Policy, Lahore(Pakistan)
 M.A.(Economics), M.A.(Political Science), M.Sc.(Defence and
Strategic Studies).Post Graduate Diploma holder (Development
Studies- University of Cambridge). Executive Development Program
at the JF Kennedy School of Government, Harvard University, USA.
 Author of 8 books on various public policy, national/global &
financial issues. Conducts courses online and offline

 Process of recording, categorising and presenting recorded
monetary business transactions in standardised formats
during/point of time.
 Basically the job of the professional accountants
 Legal requirement but essential for management for financial
analysis, strategic management and business decisions
 Carried out under some basic principles/concepts/conventions

 This presentation has been prepared by using the material
contained in the author's book “Finance for Non-finance
Managers”
 It has been published as an ebook by Amazon and is available
at https://www.amazon.com/dp/B07TTNNTC8
 Its Spanish edition is also available at Amazon while its
Swedish edition is being published shortly.

 Any payment made or received by a firm
 There are four types of financial transactions
 Income-sale of goods or assets or earning from investments
 Expense-accounting for expenditure
 Assets- purchase of land, plants etc
 Liabilities- raw material purchased on credit
 All financial transactions originate in 3 heads of activities of a firm
 Operating-manufacturing, marketing, selling
 Investing-making investments in capital goods, bonds etc
 Financing- obtaining loans, paying interest, clearing debts

Income Expense Asset Liability
Operating Sale of
good/service
Purchase of
inputs/wages
Purchase of
Machinery
Hiring of machine
on credit
Investing Income from
government
bonds purchased
Payment for
purchase of
shares as
investment
Payments made
for purchase of
stocks and
shares/other
investment
Payment to stock
broker for
maintaining
investment
account
Financing Interest income
from a savings
account
Payment of
interest/principal
on the loan
obtained
Receivables Payables

 All financial transactions are first recorded in a General
Journal-date wise
 These are, then transferred into Accounts Ledgers as
per their respective heads of accounts-month wise
 Number of accounts vary from company to company
depending on the size of the firm

◦ Capital Account: to record investments into the business, Fixed Asset
◦ Sales Account: to record sales of the goods sold
◦ Debtor Account: to record sales of goods and services on credit
◦ Purchases Account: Record of goods/raw material purchased
◦ Creditor Account :to record goods purchased on credit
◦ Overhead Account to record expenses necessarily incurred in order to
run the business

Financial information about a business firm over/at a point of
time presented in three structured standard formats
 Balance Sheet- What a firm owns and what it owes. Shows its
financial health and liquidity position
 Income Statement-Is it earning profits or losing money.
Shows the profitability position
 Cash Flow Statement-From where cash is being generated
and where it is being spent. Shows the solvency position

 Business Organisation: entity carrying out business activities, having its
own legal entity & assumed to be going concern for indefinitely
 Assets: an economic resource that company owns(land, machinery etc)
 Liability: legal obligations to pay back in money terms (loan, payables)
 Book value: historical value of an asset
◦ Gross Book Value: price paid at the time of its purchase in the past
◦ Net Book Value: its present book value after allowing for depreciation
due to use/lapse of time

 Expenditure: One time payment made for purchase of good/service
 Expenses: Accounting for the benefits derived over period of time
from the goods for which expenditure was incurred in the past
 Variance Analysis: Difference between the budgeted amount and
actual expenditure under any head of expenditure in a budget
 Ratio Analysis: Techniques to interpret data presented in financial
statements to assess the financial health of a firm for comparison

 Depreciation: reduction in value of tangible assets due to
use/lapse of time
 Amortisation: reduction in value of an intangible asset
 Receivables: expected income from customers for goods sold
or services provided in the past
 Payables: which the firm owes to others for goods purchased
or services acquired

 Structured presentation of a firm’s assets and liabilities in a
standard format- how much it owns(assets) and how much it owes
to others(liabilities)
 Always presented on a given date every year in a standard format
and using consistent terminology
 Liabilities shows the sources of the funds while assets show the
uses of these funds
 Assets and liabilities, can be short term (less than one year
maturity) or long term (more than one year maturity)

 Short term liquidity status; Can it pay its debts right now if needed? Will it
survive the shock or collapse?+
 Long term Financial Health: Is it viable and competitive in long run ?
Covering long term liabilities with short term assets is disasterous
 Test of Management Performance: How well in managing resources,
reducing costs? Too much inventories? Too many receivables?
 Used for historical comparison: are we doing well over years ?
 Comparative Analysis: how we compare with our competitors in particular
and the industry in general?

Liabilities Assets
 Owners' Capital
1. Equity
2. Reserves/Surplus
 Borrowers’ Funds
1. Long tern Debt
2. Short Term Debt
 Working Capital
1. Creditors
2. Provisions
 Fixed Assets
◦ Land and Building
◦ Plant/machinery
 Investments
◦ Bonds, shares, government
securities
 Working Capital
◦ Raw material
◦ Finished goods inventory
◦ Debtors
◦ Cash

 Note the date on the top-31st March/30th June /30th September or
31st December
 Four Columns- Present year / last year / Changes / Reference
number
 Note the change in format –Vertical for comparison purposes
 Changes reflected in money terms-reflected also in Income
statement
 Last column-numbers in parenthesis refer to explanatory notes

what company owns, presented in ascending order of liquidity or ease of sale
1. if present market price is higher than the purchase price, then valued at purchase price
2. if present market price lower than the purchase price, then valued at market price
 Cash-checking account/very short term securities
 Marketable Securities-short term investments i.e. CDs(Banks), T.bills
(Government), Commercial Papers(MNCs)
 Account Receivables-goods sold on credit minus bad debts
 Inventories-Finished goods, work in progress, raw material
 Total Current Assets- Add all the above

Long term Investments including Intangible Assets-totally owned
subsidiaries, partial equity in other firms, patents, goodwill, copyrights etc
 Fixed(tangible)Assets-more than one year maturity-land, buildings,
machinery, equipment, vehicles
 Gross book Value-add them
 Accumulated Depreciation- Accounting purposes
 Net Book Value-after deducting accumulated depreciation
 Total Assets- Current Assets+ Investment at Net book value

what firm owes to others, presented in ascending order, starting with less
than one year maturity
 Accounts Payables-normally 30 to 60 days credit
 Bank Notes-short term loans from banks/creditors
 Other Current Liabilities-result of accruals i.e. unpaid
salaries/wages/interest/taxes for the remaining period
 Current Portion of Long Term Liabilities-Long term debts nearing
maturity
 Total Current Liabilities-Add all the above

 Long Term Debt-more than one year maturity-debentures, mortgages,
bonds
 Total Liabilities-add the current liabilities and the long term debt
 Preferred Stock-who provided initial capital
 Common Stock-who bought the shares
 Retained Earnings-profits ploughed back increase stock holders’ equity
 Total Liabilities and Stock Holders Equity- add the above

 Balance Sheet shows the liquidity position of the firm
 Liquidity-ability to pay off all liabilities if assets have to be sold. For this
purpose we use ratios
 Ratios are the quotient of a number or sum of numbers divided by another
numerical value
 Ratios tell you the relationship among selected items of the financial
statement data
 Compare these ratios with past ratios of the firm, with competitors and with
the industry and find out where do you stand

 Current Ratio
Current Assets/Current Liabilities
 Measure of liquidity in the short run
 1.2:1 means slightly more assets than liabilities
 2.5:1 means fairly good position etc
 Working Capital
Total Current Assets-Total Current Liabilities
 Not a ratio ! But the difference in $s/£s

 Debt Equity Ratio (Leverage Ratio)
Total Liabilities/Total Equity
◦ Compares debt with owners equity
◦ Smaller Debt to Equity Ratio is preferable i.e. 0.90:1 is better than 1.2:1
 Debt Asset Ratio
Total Liabilities/Total Assets x 100
◦ Written as a percentage, it shows the % share of assets owed to lenders say as
collateral
◦ Obviously lower percentage is preferred
 Equity Asset Ratio
Total Equity/Total Assets x 100
◦ Expressed as %,it Shows the share of owners in the assets

 Owners-What is happening to my equity ?
 Management-How is our firm doing ?
 Lenders-Are they worth lending money ?
 Competitors-Why they are more successful ?
 Government-Is this firm eligible for tax allowances or ?
 Employees-Are we getting equitable share ?
 Suppliers-Are they worth selling goods ?
 Shareholders-whether to purchase more shares or sell the
present ones ?

 What is our financial health-Are our assets more than our liabilities or
are we heading towards short term/long term bankruptcy?
 Are we in better position compared to past performance, same or
have even worse?
 Is owners’ equity safe? In case of termination of business, will they
get more or less than they invested?
 Are our lenders’ capital safe, trust us to lend us more at market rate
or we will be forced to get loans at more than market rate?
 Do we have enough working capital or facing cash flow difficulties

 Balance sheet as published does not show the value of a
business or what a company’s shares are worth
 Some assets are not disclosed in balance sheet, namely
internally generated goodwill, workforce skill, reputation etc.
 Items are usually valued at their cost when purchased although
their prices may have gone up due to inflation/scarcity.
 For this current cost accounting is more suitable i.e. assets are
re-valued regularly and the profit is adjusted accordingly

Finance for Non-finance Managers Module 2 Balance Sheet

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Finance for Non-finance Managers Module 2 Balance Sheet