FINANCE

COMPENDIUM
2020

“ An Investment in
knowledge pays the best
interest.
“
-Benjamin Franklin

Department of Management Studies

INDIAN INSTITUTE OF TECHNOLOGY DELHI
(Institute of Eminence, Govt. of India)
 What is Finance?
Finance is a field that is concerned with the allocation
(investment) of assets and liabilities over space and time, often
under conditions of risk or uncertainty. Finance can also be
defined as the art of money management.

Banking
Since money and equivalent monetary benefits are the
buzzwords in the world of finance, the first and foremost area
that holds importance and affects our day-to-day lives is the
Banking Sector. We interact and deal with a bank in some way
or the other every now and then.
E.g., You must have contacted (or about to contact) your bank to
pay the first instalment towards your IIT Delhi fees by now.
Money can be viewed as the blood, and Banks are the veins
through which it flows in any economy; hence, countries ensure
the smooth functioning of it.
However, have you ever given a thought on how the Banks
function? What are the key terms you must know in Banking?
Alternatively, carrying the analogy forward, what is the heart of
this system that keeps pumping money and keeps the economy
running.

For more info on Banks and its operations

Click here

So, here are few of the Banking terms you should be aware of
as an MBA student (which you already are):

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Reserve Bank of India (RBI):
Reserve Bank of India is the central bank of India. Only RBI is
authorized to plan, prepare and implement the monetary policy
of India. It is called 'bank of all banks' as it regulates all other
banks in India and has superiority over them. The primary
objective of RBI is maintaining price stability, keeping inflation in
check while ensuring consistent growth of the country.
Maintaining price stability not only ensures a stable economy but
also maintains public confidence in the system, protect
depositors' interest and provide cost-effective banking services
to the public. It also manages the Foreign Exchange
Management Act, 1999 to facilitate external trade & payment,
promote orderly development and maintenance of foreign
exchange market in India. Lastly, it also issues and exchanges or
destroys currency and coins not fit for circulation to give the
public an adequate supply of currency notes & coins that too in
good quality.
To know more on why we need inflation Click here

Monetary Policies
The RBI often gives out its Monetary policy wherein it
manages the liquidity to create economic growth. Liquidity
means how much money is there in the supply to the public at
a given point of time. That includes credit, cash, and money
market mutual funds. The primary objective of central banks
behind the monetary policy is to manage inflation. The
second is to reduce unemployment, but only after they have
controlled inflation.

Tools that RBI have to keep inflation in check are mentioned

next.

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 CRR
Cash Reserve Ratio (CRR) is the share of the total deposits with
the bank that is mandated by the Reserve Bank of India (RBI) to
be maintained with the latter in the form of liquid cash. It means
the banks do not have access to that much amount for any
economic activity or commercial activity. Banks cannot lend this
money to corporates, individual borrowers, or for any
investment purposes. So, the CRR amount remains in current
account with RBI and banks do not earn any interest on that.

SLR
SLR or statutory liquidity ratio is the amount (a percentage of
the total bank deposits)that is invested in particular specified
securities predominantly central government and state
government securities. Once again this percentage is of the
total bank deposits available as far as the particular bank is
concerned. In SLR, the money goes into investment
predominantly in the central government securities as
mentioned earlier, which means the banks earn a small
amount of interest on that investment as against CRR where it
earns zero.

Repo Rate
When the Banks run out of funds, they can approach the RBI for
a loan to meet their obligations. Repo rate is the rate at which
the central bank of the country (Reserve Bank of India in case of
India) lends money to commercial banks in the event of such
shortfall.

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Reverse Repo Rate
Reverse repo rate is the rate at which the central bank of a
country (Reserve Bank of India in case of India) borrows money
from commercial banks within the country. It is a monetary
policy instrument which can be used to control the money
supply in the country.
For more info on RBI tools Click here

Basel Norms
In today's dynamic environment, even the banks are exposed to
a variety of risks. Cases of big banks collapsing due to their
inability to sustain the risk exposures are readily available in the
news. In light of this, the Basel Committee on Banking
Supervision (BCBS) which is a part of Bureau of International
Settlement (BIS) has given 'Basel Norms for Banking' to tackle
the risks involved.
Basel is a city in Switzerland and the headquarters of the
Bureau of International Settlement (BIS). BIS is an international
financial institution owned by central banks which fosters
international monetary and financial cooperation and serves as
a "bank for central banks". The Reserve Bank of India is a part of
sixty-member BIS central banks team. Every two months BIS
hosts a meeting of the governor and senior officials of central
banks of member countries to review the financial position on
central banks of the world.

Basel I:

In 1988, BCBS introduced a capital measurement system

called Basel capital accord, also called Basel 1. It focused
almost entirely on credit risk. It defined capital and structure
of risk weights for banks. The minimum capital requirement
was fixed at 8% of risk-weighted assets (RWA). RWA
means assets with different risk profiles.

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For e.g., An asset backed by collateral would carry lesser risks
as compared to personal loans, which have no collateral.
Assets of banks were classified and grouped into five categories
according to credit risk, carrying risk weights of:
0%, 10%, 20%, 50%,, 100% and some assets are given no rating
India adopted Basel 1 guidelines in 1999.

Basel II:
In 2004, BCBS came up with Basel II norms which are an
extension of Basel I. These norms incorporate credit risk of
assets held by financial institutions to determine regulatory
capital ratios.
It is based on three main pillars:
1. Minimal Capital Requirements: banks to maintain 8% minimum
capital ratios of regulatory capital over risk-weighted assets
2. Regulatory Supervision: separating credit risks from
operational risks and quantifying both
3. Market Discipline: Reducing the scope or possibility of
regulatory arbitrage by attempting to align the real or economic
risk precisely with regulatory assessment

Basel III:
Basel III or Basel 3 released in December 2010 is the third in
the series of Basel Accords. These guidelines were introduced
in response to the financial crisis of 2008. These accords deal
with risk management aspects for the banking sector.

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 In a nutshell, we can say that Basel III is the global regulatory
standard (agreed upon by the members of the Basel
Committee on Banking Supervision) on bank capital adequacy,
stress testing, and market liquidity risk.
Objectives/aims of the Basel III:
1. Improve the banking sector's ability to absorb shocks arising
from financial and economic stress, whatever the source
2. Improve risk management and governance
3. Strengthen banks' transparency and disclosures

CIBIL Score
CIBIL Score is a three-digit numeric summary of the credit
history of an individual issued by TransUnion CIBIL, India's
leading credit information company which maintains one of the
largest collections of consumer information globally. The
score is derived using the credit history found in the CIBIL
Report (also known as CIR, i.e. Credit Information Report). CIR is
an individual's credit payment history across loan types and
credit institutions over a while. CIR does not contain details of
the savings, investments or fixed deposits held by an
individual.

The CIBIL score, calculated based on credit behaviour as

reflected in the 'Accounts' and 'Enquiries' section of CIR,
ranges between 300-900. A score above 700 is generally
considered good. Credit Score plays a critical role in the loan
and credit card approval process. This is the first screening
criterion applied by banks and financial institutions when
reviewing your loan application.

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 NPA
A Non-performing asset (NPA) is defined as a credit facility in
respect of which the interest and/or instalment of principal has
remained 'past due' for a specified period. In simple terms, an
asset is tagged as non- performing when it ceases to generate
income for the lender. Once the borrower has failed to make
interest or principal payments for 90 days, the loan is considered
to be a non-performing asset. As per RBI provisional data on
global operations, as on 31.3.2019, the aggregate amount of
gross NPAs of PSBs and Scheduled Commercial Banks (SCBs)
were Rs. 8,06,412 crore and Rs. 9,49,279 crore respectively.

Types of Business Entities

There are several business structures:

1. Sole Proprietorship: A business where there is only one

owner; in other words, he/she owns 100% of the equity of the
business is known as a sole proprietorship. This business
structure is generally seen in small and new companies, the
sole owners bear all the risk of the business, and in return, is
the sole owner of the profits that the business makes.
2. Partnership: When a company or a business is owned from
2 to 100 owners, it is known as a partnership. As the name
suggests, the risk factor is divided among the owners, along
with the profit that the business makes. The profits that the
owners make from the business is shown in their personal tax
returns. All the partners (regardless of their ownership
percentage) share the complete liability of the debt that the
business owes.
3. Limited Liability Companies (LLCs): In this type of business
structure, the owners have a limited liability partnership which
is limited to the capital contributions that the owner makes.
There are two kinds of LLCs, namely private and public.
For more info on this Click here

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 NBFCs
A Non-Banking Financial Corporation (NBFC) is an entity that
offers various banking services (except for demand deposits), but
they do not have a banking license from the RBI. There are
several NBFCs and below is a non-exhaustive list of some of
these:

1. Asset Financing Companies (AFCs)

2. Investment Companies (ICs)
3. Loan Companies (LCs)
4. Micro Finance Institution (MFIs)
5. Housing Finance Companies (HFCs)
For more info on NBFCs Click here

Time Value of Money

The concept of Time Value of Money (TVM) holds significant
relevance in taking any financing decisions. According to this
concept, the same value of money received at two different
points of time is not same. In other words, the value of the same
amount of money received today is higher than the value of the
same amount of money received on a future date. This is
explained by the element of interest involved between the two
points of time under consideration.

Discounting
Discounting is the process of determining the present value of a
payment or a stream of payments that is to be received in the
future. Given the time value of money, a rupee is worth more
today than it would be worth tomorrow.
The value calculated at the start of the period, i.e., time=0,
which is the time of making the investment is called Present
Value for an investment.
For more info on Discounting Click here

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 Compounding
Compounding is the process in which an asset's earnings are
reinvested to generate additional earnings over time. There is
an exponential growth because the investment will generate
earnings from both its initial principal and the accumulated
earnings from preceding periods.
The value calculated at the end of the period, i.e., on maturity
date is called Compounded Value for an investment.

Net Present Value

Net Present Value (NPV) of a financial decision is the difference
between the present value of all cash inflows and the present
value of cash outflows from a particular investment.
A positive net present value indicates that the projected
earnings generated by a project or investment exceed the
anticipated costs. It is assumed that an investment with a
positive NPV will be profitable, and an investment with a
negative NPV will result in a net loss. This concept is the basis
for the Net Present Value Rule, which dictates that only
investments with positive NPV values should be considered.
For more info on NPV Click here

IRR
The internal rate of return (IRR) is a measure of an investment's
rate of return. The term internal refers to the fact that the
internal rate excludes external factors, such as inflation, the cost
of capital, or various financial risks. IRR only shows the rate a
particular financial decision, if taken, is offering the investor after
discounting the time value of money effect.
However, the decision of whether to invest or not depends
on its comparison with Required Rate of Return (RRR).
RRR is the rate one expects from any investment, and
it may vary from individual to individual based on their
preferences and risk-taking ability.

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If the IRR>RRR, then it is advised to invest as the actual return
exceeds the expected return in this case. If the IRR<RRR, then
the investment does not meet the expectations of the individual
and he/she should not invest in the same.
If IRR=RRR, it is the indifferent case.
For more info on IRR Click here

Stock Market
A stock market, equity market or share market is the
aggregation of buyers and sellers (a loose network of economic
transactions, not a physical facility or discrete entity) of stocks
(also called shares), which represent ownership claims on
businesses; these may include securities listed on a public stock
exchange, as well as stock that is only traded privately.

Primary Market
The primary market is part of the capital market, where the
newly issued securities are traded for the first time. Here, the
investor purchases the securities from the issuer directly.
Primary markets create long term instruments through which
corporate entities raise funds from the capital market. It is also
known as the New Issue Market (NIM). Once the securities are
sold in NIM, they move to the secondary market, where other
prospective investors purchase it.

Secondary Market
The secondary market, also called the aftermarket and follow
on public offering, is the financial market in which previously
issued financial instruments such as stock, bonds, options,
and futures are bought and sold. The securities that are sold
in the primary market are next sold in the secondary market
itself. NSE and BSE are the two Indian secondary markets
having index as Nifty and Sensex, respectively.
For more info on Stock Market Click here

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 Sensex
The BSE SENSEX (also known as the S&P Bombay Stock
Exchange Sensitive Index or simply the SENSEX) is a free-float
market-weighted stock market index of 30 well-established and
financially sound companies listed on Bombay Stock Exchange.
The 30 component companies, which are some of the largest
and most actively traded stocks, are representative of various
industrial sectors of the Indian economy. The 30 companies are
decided based on the market capitalization of the companies.
Nifty
The NIFTY 50 index is National Stock Exchange of India's
benchmark broad-based stock market index for the Indian equity
market. Full form of NIFTY is National Stock Exchange Fifty. It
represents the weighted average of 50 Indian company stocks in
12 sectors and is one of the two leading stock indices used in
India. Nifty is owned and managed by India Index Services and
Products (IISL), which is a wholly-owned subsidiary of the NSE
Strategic Investment Corporation Limited.

SEBI
Securities and Exchange Board of India (SEBI) is the regulator
and controller of capital markets of India. Capital markets include
Stock Markets, Bonds/Debentures Markets etc. The primary
objective of SEBI is to protect the investors' rights and maintain
their confidence in the market. To ensure this, SEBI keeps a lot of
checks and balances to keep things transparent and within
acceptable ranges at all point of times. SEBI was established in
1988 and given statutory powers on 30 January 1992 through
the SEBI Act, 1992.
Mutual Funds
A mutual fund collects money from investors and invests the
money on their behalf. It charges a small fee for managing
the money. Mutual funds are an ideal investment vehicle
for regular investors who do not know much about
investing, as financial experts manage it. Investors
can choose a mutual fund scheme based on their
financial goal and start investing to achieve the goal.

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 Bull and Bear Market
Since only two factors, namely drive the markets, the
performance of a particular stock (this includes any externalities
affecting its performance) and the sentiments of the
buyers/sellers; the bull and bear form represent the
performance of the market as a whole. The terms "bull" and
"bear" market is used to describe whether the stocks are
appreciating or depreciating in value. At the same time, because
the market is determined by investors' attitudes, these terms
also denote how investors feel about the market and the
ensuing trends.
A bull market is a situation where the market is on the rise. It is
typified by a sustained increase in market share prices. In such
times, investors often have faith that the uptrend will continue
over the long term. Typically, in this scenario, the country's
economy is strong, and employment levels are high.
A bear market is one that is in decline. Share prices are
continuously dropping, resulting in a downward trend that
investors believe will continue. During a bear market, the
economy will typically slow down, and unemployment will rise
as companies begin laying off workers.

Fundamental Analysis
It is a technique to analyse the behaviour of stock prices in the
long run. The belief here is that one should buy a good stock and
leave it to increase in its value over the years. The premise is that
in the long run, the actual or fair value of an equity share is equal
to its intrinsic value. The intrinsic value of a share is the present
value of all future expected cash inflows from the share. If the
intrinsic value is higher than the current price of the share, the
share is under-priced and hence a good buy.

On the other hand, if the intrinsic value is less than the

current price of the share, it is over-priced and hence a
good sell. However, it all depends on the company’s
performance and future prospects. A fundamental
researcher analyses the company and its prospects
to conclude his/her investing decisions.
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 Technical Analysis
Technical Analysis is based on the premise that 'history repeats
itself'. Hence future price movements can be well predicted
based on past price and volume data. Technical analysts are
therefore called 'chartists' because they study various charts
and patterns to predict 'What price should be'. Technical
analysis is done on the basis of trend analysis of past prices.
Technical analysis is used primarily to time the market, i.e., in
identifying the right time to buy or sell. It must be noted that
technical analysis predicts future prices over a short period and
hence may not be useful for a long-term investor who wants to
buy and hold the securities.

Speculation
Speculation is an investment in an asset that offers a potentially
significant return but is also very risky; a reasonable probability
that the investment will produce a loss. It can be defined as the
assumption of considerable risk in obtaining commensurate
gain. Considerable risk means that the risk is sufficient to affect
the decision. Commensurate gain means a higher risk premium.
Speculative assets are high risk-high return assets and hence
should be invested in with caution.

Derivatives Markets
A derivative is an instrument whose value is derived from the
value of one or more underlying, which can be commodities,
precious metals, currency, bonds, stocks, stocks indices, etc.
Four most common examples of derivative instruments are
Forwards, Futures, Options and Swaps.

1.) Forwards: A forward contract is a customized contract

between two parties, where settlement takes place on a
specific date in future at a price agreed today. The main
features of forward contracts are:

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· They are bilateral contracts and hence exposed to counterparty
risk.
· Each contract is custom designed, and hence is unique in terms
of contract size, expiration date and the asset type and quality.
· The contract price is generally not available in public domain.
· The contract has to be settled by delivery of the asset on
expiration date.
· In case the party wishes to reverse the contract, it has to
compulsorily go to the same counterparty, which being in a
monopoly situation can command the price it wants

2.) Futures: Futures are exchange-traded contracts to sell or buy

financial instruments or physical commodities for a future
delivery at an agreed price. There is an agreement to buy or sell
a specified quantity of financial instrument commodity in a
designated future month at a price agreed upon by the buyer
and seller. To make trading possible, BSE specifies certain
standardized features of the contract.

3.) Options: Options are financial instruments that

are derivatives based on the value of underlying securities such
as stocks. An options contract offers the buyer the opportunity to
buy or sell—depending on the type of contract they hold—the
underlying asset. Unlike futures, the holder is not required to buy
or sell the asset if they choose not to.
• Call options allow the holder to buy the asset at a stated
price within a specific timeframe.
• Put options allow the holder to sell the asset at a stated price
within a specific timeframe

4.) Swaps: A swap is a derivative contract through which two

parties exchange the cash flows or liabilities from two
different financial instruments. Most swaps involve cash
flows based on a notional principal amount such as a
loan or bond, although the instrument can be almost
anything.

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Usually, the principal does not change hands. Each cash
flow comprises one leg of the swap. One cash flow is generally
fixed, while the other is variable and based on a benchmark
interest rate, floating currency exchange rate or index price.
The most common kind of swap is an interest rate swap. Swaps
do not trade on exchanges, and retail investors do not generally
engage in swaps. Instead, swaps are over-the-counter contracts
primarily between businesses or financial institutions that are
customized to the needs of both parties.

Financial Accounting

GAAP
GAAP (generally accepted accounting principles) is a collection
of commonly-followed accounting rules and standards for
financial reporting. The acronym is pronounced "gap."
GAAP specifications include definitions of concepts and
principles, as well as industry-specific rules. The purpose of
GAAP is to ensure that financial reporting is transparent and
consistent from one organization to another.
There is no universal GAAP standard, and the specifics vary from
one geographic location or industry to another. In the United
States, the Securities and Exchange Commission (SEC) mandates
that financial reports adhere to GAAP requirements. The Financial
Accounting Standards Board (FASB) stipulates GAAP overall, and
the Governmental Accounting Standards Board (GASB) stipulates
GAAP for state and local government. Publicly traded companies
must comply with both SEC and GAAP requirements.

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Accounting Concepts

Full Disclosure Concept

For a business, the full disclosure principle requires a company
to provide the necessary information so that people who are
accustomed to reading financial information can make
informed decisions concerning the company.
The required disclosures can be found in a number of places,
including the company's financial statements including any
supplementary schedules and notes (or footnotes).
The disclosures in the notes to the financial statements include
the effects of foreign currencies, contingent liabilities, leases,
related-party transactions, stock options, and much more.

Accounting Period Concept

All the transactions are recorded in the books of accounts on
the assumption that profits on these transactions are to be
ascertained for a specified period. This is known as accounting
period concept. Thus, this concept requires that a balance
sheet and profit and loss account should be prepared at
regular intervals. This is necessary for different purposes like
calculation of profit, ascertaining financial position, tax
computation etc. Further, this concept assumes that the
indefinite life of a business is divided into parts. These parts are
known as Accounting Period. It may be of one year, six months,
three months, one month, etc. But usually, one year is taken as
one accounting period which may be a calendar year or a
financial year.

Accrual Concept
The meaning of accrual is something that becomes due,
especially an amount of money that is yet to be paid or
received at the end of the accounting period. It means that
revenues are recognized when they become receivable.
Though cash is received or not received, and the
expenses are recognized when they become payable
though cash is paid or not paid.

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Both transactions will be recorded in the accounting period to
which they relate. Therefore, the accrual concept makes a
distinction between the accrual receipt of cash and the right to
receive cash about revenue and actual payment of cash and
obligation to pay cash as regards expenses.

Conservatism Concept
The conservatism principle is the general concept of
recognizing expenses and liabilities as soon as possible when
there is uncertainty about the outcome, but to only recognize
revenues and assets when they are assured of being received.
Thus, when given a choice between several outcomes where
the probabilities of occurrence are equally likely, you should
recognize that transaction resulting in the lower amount of
profit, or at least the deferral of a profit. Similarly, if a choice of
outcomes with similar probabilities of occurrence will impact the
value of an asset, recognize the transaction resulting in a lower
recorded asset valuation.
Under the conservatism principle, if there is uncertainty about
incurring a loss, you should tend toward recording the loss.
Conversely, if there is uncertainty about recording a gain, you
should not record the gain.

Matching Concept
The matching concept states that the revenue and the
expenses incurred to earn the revenues must belong to the
same accounting period. So once the revenue is realized, the
next step is to allocate it to the relevant accounting period. This
can be done with the help of the accrual concept.

Economic Entity Concept

This concept assumes that, for accounting purposes, the
business enterprise and its owners are two separate
independent entities. Thus, the business and personal
transactions of its owner are separate.

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 For example, when the owner invests money in the business,
it is recorded as liability of the business to the owner. Similarly,
when the owner takes away from the business cash/goods
for his/her personal use, it is not treated as a business
expense.
Thus, the accounting records are made in the books of
accounts from the point of view of the business unit and not
the person owning the business. This concept is the very basis
of accounting.

Going Concern Concept

This concept states that a business firm will continue to carry
on its activities for an indefinite period of time. Simply stated, it
means that every business entity has continuity of life. Thus, it
will not be dissolved in the near future. This is an important
assumption of accounting, as it provides a basis for showing
the value of assets in the balance sheet; For example, a
company purchases a plant and machinery of Rs.100000, and
its life span is 10 years. According to this concept every year,
some amount will be shown as an expenses and the balance
amount as an asset. Thus, if an amount is spent on an item
which will be used in business for many years, it will not be
proper to charge the amount from the revenues of the year in
which the item is acquired. Only a part of the value is shown
as expense in the year of purchase, and the remaining
balance is shown as an asset.

Materiality Concept
The materiality concept is the principle in financial accounting
and reporting that firms may disregard trivial matters, but
they must disclose everything that is important to the
report audience. Items that are important enough to
matter are material items.

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Money Measurement Concept
This concept assumes that all business transactions must be
in terms of money that is in the currency of a country. In our
country, such transactions are in terms of rupees. Thus, as per
the money measurement concept, transactions which can be
expressed in terms of money are recorded in the books of
accounts. For example, sale of goods worth Rs.200000,
purchase of raw materials Rs.100000, Rent Paid Rs.10000 etc.
are expressed in terms of money, and so they are recorded in
the books of accounts. But the transactions which cannot be
expressed in monetary terms are not recorded in the books
of accounts. For example, sincerity, loyalty, honesty of
employees is not recorded in books of accounts because
these cannot be measured in terms of money although they
do affect the profits and losses of the business concern.

For a detailed understanding of Accounting Concepts Click

Here

Financial Statements
Profit and Loss/Income Statement
The income statement is one of the major financial
statements that is used to show the profitability of a company
during the time interval specified in its heading. The period of
time that the statement covers is chosen by the business and
will vary.

It captures two aspects of a business–Revenue & Expenses

over a given period (usually one year or one accounting
period) through both operating and non-operating activities.

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Operating activities: All the activities that contribute to
generating revenue from the business’s core operations
(manufacturing, marketing and selling of goods) are clubbed
under this head.
Non-operating activities: All activities that are not a part of the
business’s core operations are called non- operating activities.
Items like interest income, dividend income, foreign exchange
gains etc. are the business’s non-operating activities.

Revenue: This is income generated by a company from its

main business activities (sales of goods or services) and is
also called turnover or top line.
The Income statement has another head called ‘Other
Revenue’. This is income generated from its non- operating
activities.

Cost of Goods Sold (COGS): All the expenses that lead to

adding value to the raw material/semi-finished goods before
the finished product is kept away for storage or is sent out of
the factory constitute a part of the head ‘Cost of Goods Sold.
This also includes items like electricity cost at the factory,
worker wages, carriage-in cost of the raw material etc.
Gross Profit = Revenue- COGS

Selling General & Administrative Expenses (SG&A): This head

constitutes all the operating expenses like storage costs,
selling expenses, employee’s salaries, marketing costs, R&D
overheads etc. Selling costs include direct selling expenses
such as those that can be directly linked to the sale of a
specific unit such as credit, warranty and advertising
expenses. SG&A expenses include salaries of non-sales
personnel, rent, heat and lights

EBITDA = Total Gross Profit–SG&A

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Depreciation: It is used in accounting to try to match the
expense of an asset to the income that the asset helps the
company earn.
For example, if a company buys machinery for $1 million and
expects it to have a useful life of 10 years, it will be
depreciated over 10 years. Every accounting year, the
company will expense $100,000 (assuming straight-line
depreciation), which will be matched with the money that the
equipment helps to make each year Amortization: It is like
depreciation as a concept except that it is applied only to
intangible assets. For example, suppose ABC Medical firm
spent $30 million dollars on a piece of medical equipment
and that the patent on the equipment lasts 15 years, this
would mean that $2 million would be recorded each year as
an amortization expense.

EBIT (Operating Profit) = EBITDA – DA

Other Revenue: This includes interest income, dividend

income, profit from the sale of assets etc.

Other Expenses: This includes any non-operating expense or

loss.
Tax Expenses: A tax expense is a liability owing to federal,
state/provincial and municipal governments.
• Current Tax – tax expected to be paid on current years
income
• Deferred Tax – net effect of recognizing deferred tax
liability/assets
• Deferred Tax Assets – higher taxes paid in the current year
will result in lower taxes in future years
• Deferred Tax Liabilities – tax saved in the current year will
reverse and result in higher taxes in future

For more info on Income statement Click Here.

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Balance Sheet

A Balance Sheet is a financial statement that summarizes a

company's assets, liabilities and shareholders' equity at a
specific point in time. The balance sheet gets its name from
the fact that the two sides of the equation below – assets on
the one side and liabilities plus shareholders' equity on the
other – must balance out.

Assets = Liabilities + Shareholders' Equity

Assets
An asset is anything of value that can be converted into cash.
Assets are owned by individuals, businesses and
governments.
Assets can be broadly divided into two categories:
• Current Assets:
All assets that are reasonably expected to be converted into
cash within one year in the normal course of business
Current assets are important to businesses because they are
the assets that are used to fund day-to-day operations and
pay ongoing expenses
Example: Cash, accounts receivable, inventory, prepaid
expenses
• Non-Current Assets:
Assets that are expected to be converted into cash in a time
frame greater than a year, anything that
isn't a current asset
Example: Property, plant and equipment, Intellectual Property,
Goodwill

Liabilities
Liabilities are a company's legal debts or obligations that
arise during the course of business operations.

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Liabilities
are the money that a company owes to outside parties, from
bills it has to pay to suppliers to interest on bonds it has issued
to creditors to rent, utilities and salaries.
Liabilities can be broadly divided into two categories:
• Current liabilities are debts payable within one year, ex
Interest payable, rent, tax, utilities, wages payable, customer
prepayments while
• Long-term liabilities are debts payable over a longer period
like long term debt and pension fund liability.

Owner's Equity
It is the portion of the balance sheet that represents the capital
received from investors in exchange for stock (paid-in capital)
and retained earnings. A stockholders' equity represents the
equity stake currently held on the books by a firm's equity
investors
Owner's Equity = Total Assets–Total Liabilities
Stockholders' equity is often referred to as the book value of
the company, and it comes from two main
sources
• The original source is the money that was originally invested
in the company, along with any additional investments made
thereafter

• The second comes from retained earnings that the company

is able to accumulate over time through its operation.

For more info on Balance Sheet Click Here

To understand the relationship between Balance Sheet and
Income Statement Click Here

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Cash Flow Statement

The statement of cash flow reports the impact of a firm's

operating, investing and financial activities on cash flows over
an accounting period. The cash flow statement is designed to
convert the accrual basis of accounting used in the income
statement and balance sheet back to a cash basis.
The cash flow statement reveals the following information:
1. How the company obtains and spends cash
2. Why there may be differences between net income and
cash flows
3. If the company generates enough cash from operation to
sustain the business
4. If the company generates enough cash to pay off existing
debts as they mature
5. If the company has enough cash to take advantage of new
investment opportunities

The following terms are used in this Statement with the

meanings specified:
• Cash comprises cash on hand and demand deposits with
banks.
• Cash equivalents are short term, highly liquid investments
that are readily convertible into known amounts of cash and
which are subject to an insignificant risk of changes in value.
• Cash flows are inflows and outflows of cash and cash
equivalents.
• Operating activities are the principal revenue-producing
activities of the enterprise and other activities that are not
investing or financing activities.
• Investing activities are the acquisition and disposal of long-
term assets and other investments not included in cash
equivalents.
• Financing activities are activities that result in changes in
the size and composition of the owners' capital (including
preference share capital in the case of a company) and
borrowings of the enterprise.

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Segregation of Cash Flows
The statement of cash flows is segregated into three sections:
1. Operating activities
2. Investing activities
3. Financing activities

Cash Flow from Operating Activities (CFO)

CFO is cash flow that arises from normal operations such as
revenues and cash operating expenses net of taxes.

This includes:
=> Cash inflow (+)
1. Revenue from the sale of goods and services
2. Interest (from debt instruments of other entities)
3. Dividends (from equities of other entities)
=> Cash outflow (-)
1. Payments to suppliers
2. Payments to employees
3. Payments to government
4. Payments to lenders
5. Payments for other expenses

Examples of cash flows from operating activities are:

(a) Cash receipts from the sale of goods and the rendering of
services
(b) Cash receipts from royalties, fees, commissions and other
revenue;
(c) Cash payments to suppliers for goods and services
(d) Cash payments to and on behalf of employees.
(e) Cash receipts and cash payments of an insurance enterprise
for premiums and claims, annuities and other policy benefits
(f) Cash payments or refunds of income taxes unless they
can be specifically identified with financing and investing
activities
(g) Cash receipts and payments relating to futures
contracts, forward contracts, option contracts and swap
contracts when the contracts are held for dealing
or trading purposes.

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Cash Flow from Investing Activities (CFI):
CFI is cash flow that arises from investment activities such as
the acquisition or disposition of current and fixed
assets.

This includes:
=> 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

=> Cash outflow (-)

1. Purchase of property, plant and equipment
2. Purchase of debt or equity securities (other entities)
3. Lending to other entities

Examples of cash flows arising from investing activities are:

(a) Cash payments to acquire fixed assets (including

intangibles). These payments include those relating to
capitalized research and development costs and self-
constructed fixed assets,
(b) Cash receipts from disposal of fixed assets (including
intangibles)
(c) Cash payments to acquire shares, warrants or debt
instruments of other enterprises and interests in joint ventures
(other than payments for those instruments considered to be
cash equivalents and those held for dealing or trading
purposes)
(d) Cash receipts from disposal of shares, warrants or debt
instruments of other enterprises and interests in joint ventures
(other than receipts from those instruments considered to be
cash equivalents and those held for dealing or trading
purposes)
(e) Cash advances and loans made to third parties (other
than advances and loans made by a financial enterprise)

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(f) Cash receipts from the repayment of advances and loans
made to third parties (other than advances and loans of a
financial enterprise)
(g) cash payments for futures contracts, forward contracts,
option contracts and swap contracts except when the
contracts are held for dealing or trading purposes, or the
payments are classified as financing activities
(h) cash receipts from futures contracts, forward contracts,
option contracts and swap contracts except when the
contracts are held for dealing, or trading purposes, or the
receipts are classified as financing activities

Cash flow from financing activities (CFF)

CFF is cash flow that arises from raising (or decreasing) cash
through the issuance (or retraction) of additional shares, short-
term or long-term debt for the company's operations. This
includes:
=> Cash inflow (+)
1. Sale of equity securities
2. Issuance of debt securities
=> Cash outflow (-)
1. Dividends to shareholders
2. Redemption of long-term debt
3. Redemption of capital stock

Examples of cash flows arising from financing activities are:

(a) Cash proceeds from issuing shares or other similar
instruments
(b) Cash proceeds from issuing debentures, loans, notes,
bonds, and other short or long-term borrowings
(c) Cash repayments of amounts

For more info on Cash Flow Statement Click Here

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