Business Enterprise

Management Science-II

Prof. R.Madumathi

MODULE 2 Business Enterprise Business Enterprise •

The business enterprise during its existence, over a period of time, accumulates certain real properties termed as assets of the business enterprise.

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These assets are acquired by the business through funds that are made available through borrowings or through owners' contribution.

Financial Statements •

Financial Statements present the financial activities of the business. The accounting premise in the formulation of financial statements can be stated as:

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Assets = Liabilities + Owners' Contribution

Types Of Financial Statements •

Balance Sheet

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Income Statement

•

Cash Flow Statement

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Balance Sheet The balance sheet consolidates the asset value and capital and liability value of a business enterprise as on a specific day of the accounting year. In order to acquire the assets, the business enterprise has to use its own capital or has to borrow the required funds. The matching of assets (application of funds) with the sources of funds is shown in the balance sheet statement.

Balance Sheet Components

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Owner’s Contribution / Capital Share Capital •

Owners' contribution is the fund that has been provided by the promoters and shareholders of the business enterprise. Their contribution is termed as capital. The capital of a business enterprise that has many public/private owners in units called shares is referred to as share capital.

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The shares may be issued as ordinary share capital or preference share capital. Ordinary share capital is the shares that are usually issued by business enterprises, which carries with them a voting right. They are entitled to a share in the profits of the business enterprise too. The profits may either be distributed among the shareholders as dividend or retained with the business enterprise itself as reserves.

Owner’s Contribution / Capital Share Capital •

Certain type of shareholders may have special preference with respect to the dividend payments or the capital amount according to the terms of issue. They are referred to as Preferential shareholders

Reserves •

The capital reserves (profits) may arise from revaluation of assets, the purchase of shares of other business enterprises or due to the payback of its own shares.

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Revenue reserves (profits) represent profits that are retained in the business enterprise to be used latter. Both the capital

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reserves and the revenue reserves belong to owners and hence they are owners' funds.

Liabilities •

Debentures are long term loans issued to the public with a face value (usually Rs.100) at specific contractual interest rates and repayable at the designated time.

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Long-term loans are mostly from financial institutions. Long-term loans are also availed from other sources such as company subsidiaries.

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Convertible debt is a long-term financing instrument with the option of being converted into any other type of financial instrument especially shares at the time of conversion.

Fixed Assets • • • • • • • • • • • • •

Fixed assets can be defined as those assets that are bought for use in the business and not for resale such as equipment, plant, land, buildings, furniture, vehicles etc. In addition to the physical assets, a business may also acquire certain non-physical assets called intangible assets such as patents, copyrights, trade marks, brand names, goodwill etc.

Investments

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A business may also buy other businesses in the form of their shares or other instruments such as deposits. They are referred as investments.

Net Working Capital •

Net working capital is the difference arrived at by comparing current assets with current liabilities and provisions.

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A positive net working capital position indicates a surplus current assets position, while a negative net working capital indicates an excess current liabilities position.

Components Of Net Working Capital Current Assets: Current assets hardly exist in the business for more than a year. They are the assets that keep rotating in the business. Current assets arise because of the operational cycle of business. A simple illustration of an operational cycle is when cash is used to buy inventory and inventory is sold and cash is got back into the business.

Certain important components of current assets are: – Inventory, – Debtors, – Accounts receivable, – Bank balance, – Cash balance, and – Pre-payments.

Components Of Networking Capital Current Liabilities: Current liabilities are due for repayment by the business within the accounting year. The components of current liabilities may be:

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Management Science-II

Prof. R.Madumathi

– – – –

Creditors, Accounts Payable, Bank overdraft, Accrued expenses etc.

Components Of Net Working Capital Provisions: Provisions are profits set aside for specific future purpose. Provisions are created usually in terms of – – – –

Bad debts Accounts Receivables Tax payable Dividend payable etc.

Balance Sheet

(Rs. crores) Mar Mar 1998 1999 12 12 months months

Mar 2000 12 months

Mar 2001 12 months

Mar 2002 12 months

Total Share Capital

40.12

40.12

40.12

64.19

64.19

Equity Share Capital Preference Share Capital Reserves

40.12

40.12

40.12

64.19

64.19

0.00

0.00

0.00

0.00

0.00

220.38 264.39 317.29 347.01 346.37

Revaluation Reserves

0.00

Networth

260.50 304.51 357.41 411.20 410.56

Secured Loans

145.42 168.94 123.36 163.46 76.29

Unsecured Loans

47.43

Total Debt

192.85 216.86 174.44 226.82 110.77

Sources Of Funds

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0.00

47.92

0.00

51.08

0.00

63.36

0.00

34.48

Management Science-II

Total Liabilities

Balance Sheet

Prof. R.Madumathi

453.35 521.37 531.85 638.02 521.33

(Rs. crores) Mar 1998

1999

2000

Mar 2001

Mar 2002

Gross Block

303.92

410.60

468.17

544.83

595.88

Less: Accumulated Depreciation

94.18

116.29

141.29

172.42

213.96

Net Block

209.74

294.31

326.88

372.41

381.92

Capital Work in Progress

21.72

6.80

2.46

3.95

2.43

Investments

46.07

49.78

40.54

44.07

63.34

Inventories

165.97

160.89

186.12

198.91

155.95

Sundry Debtors

80.74

79.95

86.66

121.65

118.96

Cash and Bank Balance

19.59

22.34

18.98

11.84

22.13

Total Current Assets

266.30

263.18

291.76

332.40

297.04

Loans and Advances

103.73

69.60

103.54

125.27

142.92

Total Current Assets, Loans & Advances

370.03

332.78

395.30

457.67

439.96

Deferred Credit

0.00

0.00

0.00

0.00

0.00

Fixed Deposits

23.70

15.96

12.07

8.83

2.02

Current Liabilities

100.60

80.48

141.04

105.54

209.63

Provisions

93.72

81.82

98.20

138.64

161.83

Total Current Liabilities & Provisions 194.32

162.30

239.24

244.18

371.46

Net Current Assets

175.71

170.48

156.06

213.49

68.50

Miscellaneous Expenses

0.11

0.00

5.91

4.10

5.14

Application Of Funds

Total Assets

453.35

521.37

531.85

638.02

521.33

Contingent Liabilities

28.62

24.43

28.14

29.11

52.57

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Income Statement •

The revenues and costs incurred during an accounting period are reported in the income statement.

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The income statement shows a profit when revenues exceed costs.

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The income statement shows a loss when revenues are lesser than the • costs.

Indian Institute of Technology Madras

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Revenue •

Revenue is the gross inflow of cash, receivables or other consideration arising in the course of the ordinary activities of a business.

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from the sale of goods,

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from the rendering of services, and

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•

from the use by others of enterprise resources yielding interest, royalties and dividends.

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Revenue is measured by the charges made to customers or clients for goods supplied and services rendered to them and by the charges and rewards arising from the use of resources by them.

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In an agency relationship, the revenue is the amount of commission and not the gross inflow of cash, receivables or other consideration.

Cost Of Goods Sold •

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Cost of goods sold is the business’s expenses directly associated with the product. Cost of goods sold includes the money the business spent to buy the raw materials needed to produce its products, the money it spent on manufacturing its products and labor costs associated with this manufacture. Gross profit on sales (also called gross margin) is the difference between all the revenue the business earns and the sales of its products minus the cost of what it took to produce them.

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Gross Profit on Sales = Net Sales - Cost of Goods Sold

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When all expenses incurred in the production of the goods and services (cost of goods sold) is reduced from the money made from selling them (net sales), the gross profit on sales is arrived at.

Operating Expenses •

Operating expenses are normal expenses incurred in the day-today operation of running a business. Typical items in this category include sales or marketing expenses, salaries, rent, and administration costs.

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Depreciation is the gradual loss in value of equipment and other tangible assets over the course of its useful life.

Indian Institute of Technology Madras

Management Science-II

Prof. R.Madumathi

Earnings Before Interest And Taxes •

Earnings before interest and taxes (EBIT) is the sum of operating and non-operating income. This includes besides operating income what is referred to as "other income“ (or other loss) and "extraordinary income" (or extraordinary loss). As its name indicates, it is a business's income excluding interest expenses and income tax expenses. EBIT is calculated as follows:

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EBIT = Operating Income +(-) Other Income (Loss) ƒ + (-) Extraordinary Income (Loss

Extraordinary Income(Loss) •

Extraordinary income (or loss) occurs when money is gained (or lost) resulting from an event that is deemed both unusual and infrequent in nature. Examples of such extraordinary happenings could include damages from a natural disaster or the early repayment of debt.

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Many businesses may not have either other income or extraordinary income in a given year. If this is the case, then earnings before income and taxes is the same as its operating income.

Net Earnings •

Net earnings or net income is often referred to as the bottom line of the business. It measures the amount of profit a business makes after all of its income and all of its expenses. It also represents the total net profit that may be distributed to its shareholders. The computation of net earnings is arrived at by subtracting the interest and tax expenses from EBIT.

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Net Earnings = Earnings Before Interest and Taxes Interest Expense - Income Taxes

Profit & Loss Account (Rs. in Crores)

Indian Institute of Technology Madras

Management Science-II

Prof. R.Madumathi

Mar 1998

Mar 1999

Mar 2000

Mar 2001

Mar 2002

Income Sales Turnover Excise Duty Net Sales Other Income Stock Adjustments Total Income

1,021.17 1,127.93 1,341.60 1,498.99 1,639.93 149.23 871.94 17.05

161.17 966.76 22.05

174.60 189.98 198.11 1,167.00 1,309.01 1,441.82 13.62 18.50 31.24

12.52

2.34

20.35

901.51

991.15

1,200.97 1,338.28 1,434.91

Raw Materials 404.00 Power & Fuel 16.88 Cost Employee 42.81 Cost Other Manufacturing 146.97 Expenses Selling and Admin 129.14 Expenses Miscellaneous 24.63 Expenses Preoperative Exp 0.00 Capitalised Total 764.43 Expenses Operating 120.03 Profit

449.49

538.34

590.40

591.64

18.02

20.59

22.13

24.40

48.41

57.22

71.82

90.86

157.43

176.56

193.98

207.53

143.03

185.10

208.60

245.18

28.87

31.94

41.76

37.52

0.00

0.00

0.00

0.00

845.25

1,009.75 1,128.69 1,197.13

123.85

177.60

10.77

-38.15

Expenditure

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191.09

206.54

Management Science-II

Prof. R.Madumathi

Profit & Loss Account (Rs. in Crores) Mar 1998 Mar 1999

Total Value Addition Preference Dividend Equity Dividend Corporate Dividend Tax

Mar 2000

Mar 2001

Mar 2002

12 months

12 months

12 12 12 months months months

360.43

395.76

471.41 538.29 605.49

0.00

0.00

0.00

0.00

0.00

30.09

32.09

40.12

44.93

57.77

3.01

3.39

4.41

6.86

2.29

401.20

401.20 641.90 641.90

Per share data (annualised) Shares in issue 401.20 (lakhs) Earning Per Share 16.07 (Rs) Equity Dividend (%) 75.00

18.32

23.16

15.51

17.61

80.00

100.00 70.00

90.00

Book Value (Rs)

75.90

89.09

63.96

64.93

64.06

Cash Flow Statement The flow of funds for a business may be looked at as a continuous process, in a way linking every use of fund with a source. The cash flow statement is a method by which we express the increase or decrease of cash flows into the business over a specified duration. This is derived from the balance sheets of the business. In a typical cash flow statement, changes are expressed in three categories – operating activities, – investing activities and – financing activities

Indian Institute of Technology Madras

Management Science-II

Prof. R.Madumathi

Cash Flow Components

Indian Institute of Technology Madras

Management Science-II

Prof. R.Madumathi

Types Of Cash Flows •

Cash flows from operating activities indicate the net cash accruing to a business from its trading / manufacturing /

Indian Institute of Technology Madras

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Prof. R.Madumathi

business activity. This cash flow is adjusted with respect to changes in current assets and liabilities of the business. •

Cash flows from investing activities show purchase or sale of fixed assets and other cash flows from investments made by the business.

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Cash flows from financing activities indicate the increase or decrease in cash through sources such as equity, debt or any other related flow such as dividend.

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Cash flow statement gives the net inflow / outflow of cash from operating activities, financing activities & investment activities.

Indian Institute of Technology Madras

Management Science-II

Indian Institute of Technology Madras

Prof. R.Madumathi

Management Science-II

Prof. R.Madumathi

Particulars

Amount (Rs.)

Cash flows from Operating Activities Cash generated from operations 84,000 Income tax paid (15,000) Cash flow from extraordinary item 3,000 (Earthquake insurance claim) Net Cash provided by Operating Activities Cash Flows from Investing Activities Purchase of Plant and Machinery (1,73,000) Sale of Plant and Machinery 22,000 Purchase of Investments (26,000) Sale of Investments 42,000 Interest received 7,000 Net cash used in Investing Activities Cash Flows from Financing Activities Issuance of share capital 1,00,000 Repayment of unsecured loan (1,000) Repayment of secured loan (27,000) Dividend paid (25,000) Interest paid (22,000) Net cash provided by financing activities Net Decrease in Cash and Cash Equivalents Cash and cash equivalents at the beginning Cash and cash equivalents at the end

Amount (Rs.)

72,000

(1,28,000)

25,000 (31,000) 51,000 20,000

Uses Of Financial Statements •

Financial statements of business are audited statements and hence are reliable subject to the limitations of audit.

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Financial statements are relied upon by investors, lenders and other stakeholders to evaluate the business.

Indian Institute of Technology Madras

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Prof. R.Madumathi

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Financial statements being quantitative data can be used for projecting future performance.

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