Introduction
of the business. A sole trader furnishes a Trading and Profit and loss Account which depicts the result of the business transactions of the sole trader. Along with the Trading and Profit and Loss Account he also prepares a Balance Sheet which shows the financial position of the business.
Therefore, reading financial statements is important for investor to know the conditions of company.
Investor need to watch these financial statements
1. Balance sheet
2. Profit and Loss Account.
3. Cash flow statements
A new investor who come from non-accounting background, face difficult to understand financial statements.So, we are going to break some terms into simple terms.
1. Balance Sheet:
Business needs some resources which have longer life (say more than a year).
Such resources are, therefore, not related to any particular accounting period, but are to be used overt he useful life thereof. The resources do not come free. One requires finance to acquire them. This funding is provided by owners through their investment, bank & other through loans, suppliers by way of credit terms.
The Balance Sheet shows the list of resources and the funding of the resources i.e. assets and liabilities (towards owners and outsiders). It is also referred as sources of funds (i.e. liabilities & capital) and application of funds (i.e. assets). Let us discuss these statements in depth.
A. Liabilities
(a) Capital:
This indicates the initial amount the owner or owners of the business contributed. This contribution could be at the time of starting business or even at a later stage to satisfy requirements of funds for expansion, diversification etc. As per business entity concept, owners and business are distinct entities, and thus, any contribution by owners by way of capital is liability.
(b) Reserves and Surplus:
The business is a going concern and will keep making profit or loss year by
year. The accumulation of these profit or loss figures (called as surpluses) will keep on increasing or decreasing owners’ equity.
(c) Long Term or Non-Current Liabilities: These are obligations which are to be settled over a longer period of time say 5-10 years. These funds are raised by way of loans from banks and financial institution .Such borrowed funds are to be repaid in installments during the tenure of the loan as agreed. Such funds are usually raised to meet financial requirements to procure fixed assets. These funds should not be generally used for day-to-day business activities. Such loan are normally given on the basis of some
security from the business e.g. against a charge on the fixed assets. So, long term loan are called as
“Secured Loan” also.
(d) Short Term or Current Liabilities:
A liability shall be classified as Current when it satisfies any of the following :
• It is expected to be settled in the organisation’s normal Operating Cycle,
• It is held primarily for the purpose of being traded,
• It is due to be settled within 12 months after the Reporting Date, or
• The organization does not have an unconditional right to defer settlement of the liability for at least
12 months after the reporting date (Terms of a Liability that could, at the option of the counterparty,
result in its settlement by the issue of Equity Instruments do not affect its classification)
Current liabilities comprise of :
(i) Sundry Creditors - Amounts payable to suppliers against purchase of goods. This is usually settled within 30-180 days.
(ii) Advances from customers – At times customer may pay advance i.e. before they get delivery of goods. Till the business supplies goods to them, it has an obligation to pay back the advance in case
of failure to supply. Hence, such advances are treated as liability till the time they get converted to sales.
(iii) Outstanding Expenses: These represent services procured but not paid for. These are usually settled within 30–60 days e.g. phone bill of Sept is normally paid in Oct.
(iv) Bills Payable: There are times when suppliers do not give clean credit. They supply goods against a promissory note to be signed as a promise to pay after or on a particular date. These are called as bills payable or notes payable.
B. Assets
In accounting language, all debit balances in personal and real accounts are called as assets. Assets are broadly classified into fixed assets and current assets.
(a) Fixed Assets: These represent the facilities or resources owned by the business for a longer period of time. The basic purpose of these resources is not to buy and sell them, but to use for future earnings. The benefit from use of these assets is spread over a very long period. The fixed assets could be in tangible
form such as buildings, machinery, vehicles, computers etc, whereas some could be in intangible form
viz. patents, trademarks, goodwill etc. The fixed assets are subject to wear and tear which is called as
depreciation. In the balance sheet, fixed assets are always shown as “original cost less depreciation”.
(b) Investments: These are funds invested outside the business on a temporary basis. At times, when
the business has surplus funds, and they are not immediately required for business purpose, it is prudent
to invest it outside business e.g. in mutual funds or fixed deposit. The purpose if to earn a reasonable
return on this money instead of keeping them idle. These are assets shown separately in balance sheet.
Investments can be classified into Current Investments and Non-current Investments.
Non-current Investments are investments which are restricted beyond the current period as to sale or
disposal.
Whereas, current investments are investments that are by their nature readily realizable and is intended
to be held for not more than one year from the date on which such investment is made
(c). Current Assets:
An asset shall be classified as Current when it satisfies any of the following :
• It is expected to be realised in, or is intended for sale or consumption in the organisation’s normal
Operating Cycle,
• It is held primarily for the purpose of being traded,
• It is due to be realised within 12 months after the Reporting Date, or
• It is Cash or Cash Equivalent unless it is restricted from being exchanged or used to settle a Liability
for at least 12 months after the Reporting Date.
Current assets comprise of:
(i) Stocks: This includes stock of raw material, semi-finished goods or WIP, and finished goods.Stocks are shown at lesser of the cost or market price. Provision for obsolescence, if any, is also reduced. Generally, stocks are physically counted and compared with book stocks to ensure that there are no discrepancies. In case of discrepancies, the same are adjusted to P & L A/c and stock figures are shown as net of this adjustment.
(ii) Debtors: They represent customer balances which are not paid. The bad debts or a provision for bad debt is reduced from debtors and net figure is shown in balance sheet.
(iii) Bills receivables: Credit to customers may be given based on a bill to be signed by them payable to the business at an agreed date in future. At the end of accounting period, the bills accepted
but not yet paid are shown as bills receivables.
(iv) Cash in Hand: This represents cash actually held by the business on the balance sheet date. This cash may be held at various offices, locations or sites from where the business activity is carried
out. Cash at all locations is physically counted and verified with the book balance. Discrepancies if any are adjusted.
(v) Cash at Bank: Dealing through banks is quite common. Funds held as balances with bank are also treated as current asset, as it is to be applied for paying to suppliers. The balance at bank as per
books of accounts is always reconciled with the balance as per bank statement, the reasons for differences are identified and required entries are passed.
(vi) Prepaid Expenses: They represent payments made against which services are expected to be received in a very short period.
(vii) Advances to suppliers: When amounts are paid to suppliers in advance and goods or services are not received till the balance sheet date, they are to be shown as current assets. This is because
advances paid are like right to claim the business gets.
[ Please note that both current assets and current liabilities are used in day-to-day business activities. The current assets minus current liabilities are called as working capital or net current assets. The following report is usual horizontal form of balance sheet. Please note that the assets are normally shown in descending order of their liquidity. Also, capital, long term liabilities and short term liabilities are show]
BAD DEBTS
Debts : The amount which is receivable from a person or a concern for supplying goods or services is called Debt.
Debts may be classified into :
(i) Bad debts;
(ii) Doubtful debts and
(iii) Good debts
(i) Bad Debts : Bad debts are uncollectable or irrecoverable debt or debts which are impossible to collect is called Bad Debts. If it is definitely known that amount recoverable from a customer can not be realized at all, it should be treated as a business loss and should be adjusted against profit.
In short, the amount of bad debt should be transferred to Profit and Loss Account for the current
year to confirm the principles of matching
(ii) Doubtful Debts : The debts which will be receivable or not cannot be ascertainable at the date of preparing the final accounts (i.e., the debts which are doubtful to realise) is known as doubtful
debts. Practically it cannot be treated as a loss on that particular date, as such, it cannot be written off. But, it should be charged against Profit and Loss Account on the basis of past experience of the firm.
(iii) Good Debts : The debts which are not bad i.e., there is neither any possibility of bad debts nor any doubts about its realization, is called good debts. As such, no provision is necessary for it.
Comments
Post a Comment