Tuesday, January 25, 2011

How to read Financial Annual Report

If you’re new to investing & looking at a business with an interest in investing in Bse/Nse stocks, you need to read its financial reports. Of course,  you don’t need to read everything, just the key parts. These Financial statements will help you figure profitability and liquidity ratios and get a better sense of cash flow .

Reading a companys financial report is never the easiest thing to do, and annual reports can be especially daunting. You may be relieved to know that you don’t actually need to scour every page. The following parts best serve to give you the big picture .

1.       The Profit & Loss statement on the year passed and the Last Quarter;
2.     The Balance Sheet ;
3.     The Directors’ Report on the year passed and the future plans;
4.     Annexure to the Directors’ Report containing particulars regarding     conservation of energy etc;
5.     Auditors’ Report as per the Manufacturing and Other Companies   (Auditors’ Report) Order, 1998) along with Annexure;
6.     Schedules to Balance Sheet and Profit and Loss Account;
7.     Accounting policies adopted by the company and notes on accounts giving details   about changes if any, in method of valuation of stocks, fixed assets, method of depreciation on fixed assets, contingent liabilities, like guarantees given by the banks on behalf of the company, guarantees given by the company, quantitative details regarding performance of the year passed, foreign exchange inflow and outflow etc. and
8.     Statement of cash flows for the same period for which final accounts have been presented.

   Key pointers to balance sheet and profit and loss statements:

  •      A balance sheet represents the financial affairs of the company and is also referred to as “Assets and Liabilities” statement and is always as on a particular date and not for a period.
  •     A profit and loss account represents the summary of financial transactions during a particular period and depicts the profit or loss for the period along with income tax paid on the profit and how the profit has been allocated (appropriated).
  •    Net worth means total of share capital and reserves and surplus. This includes preference share capital unlike in Accounts preference share capital is treated as a debt. For the purpose of debt to equity ratio, the necessary adjustment has to be done by reducing preference share capital from net worth and adding it to the debt in the numerator.
  •      Reserves and surplus represent the profit retained in business since inception of business.  “Surplus” indicates the figure carried forward from the profit and loss appropriation account to the balance sheet, without allocating the same to any specific reserve.  Hence, it is mostly called “unallocated surplus”.  The company wants to keep a portion of profit in the free form so that it is available during the next year for appropriation without any problem. In the absence of this arrangement during the year of inadequate profits, the company may have to write back a part of the general reserves for which approval from the board and the general members would be required.
  • Secured loans represent loans taken from banks, financial institutions, debentures (either from public or through private placement), bonds etc. for which the company has mortgaged immovable fixed assets (land and building) and/or hypothecated movable fixed assets (at times even working capital assets with the explicit permission of the working capital banks)

Usually, debentures, bonds and loans for fixed assets are secured by  fixed assets, while loans from banks for working capital, i.e., current assets are secured by current assets.  These loans enjoy priority over unsecured loans for settlement of claims against the company.

  Unsecured loans represent fixed deposits taken from public (if any) as per the provisions of Section 58 (A) of The Companies Act, 1956 and in accordance with the provisions of Acceptance of Deposit Rules, 1975 and loans, if any, from promoters, friends, relatives etc. for which no security has been offered. 

Such unsecured loans rank second and subsequent to secured loans for settlement of claims against the company.  There are other unsecured creditors also, forming part of current liabilities, like, creditors for purchase of materials, provisions etc.

    Gross block = gross fixed assets mean the cost price of the fixed assets.  Cumulative depreciation in the books is as per the provisions of The Companies Act, 1956, Schedule XIV.  It is last cumulative depreciation till last year + depreciation claimed during the current year.  Net block = net fixed assets mean the depreciated value of fixed assets.

     Capital work-in-progress – This represents advances, if any, given to building contractors, value of building yet to be completed, advances, if any, given to equipment suppliers etc.  Once the equipment is received and the building is complete, the fixed assets are capitalised in the books, for claiming depreciation from that year onwards.  Till then, it is reflected in the form of capital work in progress.

     Investments – Investment made in shares/bonds/units of Unit Trust of India etc. This type of investment should be ideally from the profits of the organisation and not from any other funds, which are required either for working capital or capital expenditure.  They are bifurcated in the schedule, into “quoted and traded” and “unquoted and not traded” depending upon the nature of the investment, as to whether they can be liquidiated in the secondary market or not.

     Current assets – Both gross and net current assets (net of current liabilities) are given in the balance sheet.

      Miscellaneous expenditure not written off can be one of the following –
Company incorporation expenses or public issue of share capital, debenture etc. together known as “preliminary expenses” written off over a period of 5 years as per provisions of Income Tax.  Misc. expense could also be other deferred revenue expense like product launch expenses.
Other income in the profit and loss account includes income from dividend on share investment made in other companies, interest on fixed deposits/debentures, sale proceeds of special import licenses, profit on sale of fixed assets and any other sundry receipts.

     Provision for tax could include short provision made for the earlier years.

     Provision for tax is made after making all adjustments for the following:

·        Carried forward loss, if any;
·        Book depreciation and depreciation as per income tax and
·        Concessions available to a business entity, depending upon their activity (export business, S.S.I. etc.) and location in a backward area (like Goa etc.)

    As per the provisions of The Companies Act, 1956, in the event of a limited company declaring dividend, a fixed percentage of the profit after tax has to be transferred to the General Reserves of the Company and entire PAT cannot be given as dividend.

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