Introduction to

Finance
L3
 Balance sheet

Financial Profit and Loss statement (or

statements account)

Cash Flow statement

 Financial Statements
• Financial statements are reports compiled by the business/firm that explains/ provide
overview of the financial performance of the company.
• Financial statements provide governments, investors, executives, and lenders with a
picture of a company's financial activities and profitability.
• Statements required by Generally Accepted Accounting Principles (GAAP) are the balance
sheet, the income statement, and the statement of cash flows.
• The balance sheet provides an overview of assets, liabilities, and shareholders' equity as a
snapshot in time.
• The income statement reports a company's revenues and expenses, including a company's
profit figure called net income.
• The cash flow statement (CFS) tracks how a company uses its cash to pay its debt
obligations and fund its operating expenses and investments.
Balance Sheet
A balance sheet is a two-sided financial statement. The left side records an organizations
assets, while the right side depicts shareholder’s equity and business liabilities

BS provides a summary of company’s financial standing in a specific accounting period.

It shows the capital in a business, what all assets business owns, and what are the
liabilities( owes to others) of the business

Lenders and investors use the balance sheet to make an informed decision before
financing a business
Balance sheet

Assets Liabilities and SHs Equity Capital

• An asset is any resource an organization owns and can
use to produce value. Business can use an asset to • Liabilities: The amount business owes to others.
provide services or make products that generate income. These are the debts of the firm/company
Alternatively, a business can sell assets to get revenue. ✓ Outstanding rent
✓ Accounts receivable ✓ Accounts payable (unpaid loans, debt to suppliers
✓ Real estate, buildings, plants etc.)
✓ Inventory/stock ✓ Unpaid salaries
✓ Other investments ✓ Payable tax
✓ Machineries and Equipments
✓ Vehicles
• Shareholder’s Equity (or Capital) :
o It is the difference between asset and liabilities of the
✓ Trademarks and patents company. It is the balance of assets left over after a business
✓ Cash, Bank account deposits pays off all its liabilities.
o It is the money that would go to the owners of SHs should the
business liquidate.
o SHs equity is also called share capital
• Balance Sheet
Balance sheet
The Equity (Shareholders’/stockholders’ Equity) is the difference between the firm’s
assets and liabilities, is an accounting measure of the firm’s net worth.

The assets on the left side show how the firm uses its capital (its investments), and the
right side summarizes the sources of capital, or how a firm raises the money it needs.

Because of the way stockholders’ equity is calculated, the left and right sides must
balance

The Balance Sheet Identity : 𝐴𝑠𝑠𝑒𝑡𝑠 = 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑦 + 𝑐𝑎𝑝𝑖𝑡𝑎𝑙

i.e. 𝐴𝑠𝑠𝑒𝑡𝑠 = 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 + 𝑆𝑡𝑜𝑐𝑘ℎ𝑜𝑙𝑑𝑒𝑟𝑠’ 𝐸𝑞𝑢𝑖𝑡𝑦
Assets
• Assets are generally divided into current assets and long-term (or non-current)
assets.
• Current Assets are either cash or assets that are most liquid
(liquid asset are those assets that could be converted into cash within a short
period. Liquidity of an asset is measured by how fast it can be converted into cash).
• Some of the categories in Current Account (CA) are as follows:
✓ Cash, bank a/c deposits
✓ Marketable securities (short-term , low-risk investments such as govt. bonds,
or other money-market instruments)
✓ Accounts receivables: Amount owed to the firm by customers who have
purchased goods and services on credit
✓ Inventories: Raw-materials, work-in-progress and finished goods stock
✓ Pre-paid expenses
Assets

• Long-term assets or non-current assets:

✓ This includes tangible assets that generate value/ produce benefits for the
business for more than one year
✓ Eg: Property, Plants & Machineries, Equipment, Building
✓ Depreciation: Equipment and Machines tend to wear out or become less
valuable or obsolete over time. Hence firms will reduce the value recorded for
these items each year by deducting depreciation expense.
Thus, the firm reduces the value of fixed assets (other than land) over time
according to a depreciation schedule that depends on the asset’s life span.
Depreciation is not an actual cash expense that the firm incurs, rather it is a
way of recognizing that some long –term (or fixed) assets wear out and thus
becomes less valuable over time
Assets

• Long-term assets or non-current assets:

✓Goodwill and Intangible assets: Brand names, trademarks, patents,
customer relations and relationship with employees etc.
✓Like depreciation if a firm accounts (considers/assess) that value of these
intangible assets declined over time, it will reduce the amount listed on the
balance sheet by an amortization or impairment charge. This charge
captures the change in value of the acquired intangible assets. Like
depreciation amortization in not an actual cash expense. The amortization
is relevant when acquisition or mergers occur.
 Liabilities

• Liabilities: Divided into current and non-current (or long-term) liabilities

• Current Liabilities :
• Liabilities that should be obliged/satisfied within one year are known as current liabilities
(CL).
• Some items of CL are as follows:
1. Accounts (a/c) payable : the amounts owed to suppliers for credit purchase of
goods/services
2. Short-term debt: Exchange notes payable, current maturities of ling-term debt which
are all repayments of debt that will occur within the next 1 year
3. Unpaid – salaries and –taxes
4. Deferred revenue: revenue received for products (Goods or services) not yet
delivered
5. Dividends payable : Dividends that have been declared to be awarded to
shareholders but have not been yet paid
6. Accrued expenses: These are expenses yet to be paid, but have a high probability of
being paid
Long-Term Liabilities

• Long-term Liabilities or non-current liabilities are liabilities that extend beyond one
year. Following are such items:
• Long-term debt: Any loan, mortgages, bond funds or debt obligation with maturity
of more than 1 year.
• Leases are long-term contracts that obligate the firm to make regular lease
payments in exchange for use of an asset
Shareholder’s Equity

• Total Liability = Current Liability + Non-current Liability

• Total Asset= Current Assets + Non-current assets
• Shareholder’s (SHs) Equity/Stockholders Equity/ Book value of Equity/ SHs Equity capital
= Total Assets-Total Liabilities
SHs Equity is a company’s total assets minus its total liabilities. It represents the amount of
money that would be returned to SHs (or left over for SHs) if all the assets are liquidated, and all
debts are paid off. It is an accounting measure of the net worth of the firm
• Retained Earnings (REs): REs are part of SHs Equity capital. This the amount of net earnings
that were not paid to SHs as dividends
Balance Sheet (BS)

• A BS thus consist of all the assets and liabilities of the company. It shows the value and
nature of these items which helps in assessing the financial position of the firm .
• However, BS does not show any revenues or expenses.
• Balance Sheet follows Asset= Liability + capital ;and both of its sides are always equal
• Net working capital (NWC)= Current asset – current liabilities
• NWC indicates the capital available in the short term to run the business
• Firms with low (or negative) NWC may face shortage of funds unless they generate
sufficient cash from ongoing activities
Market Value v/s Book value

First, many of the assets listed on

Ideally, the balance sheet would the balance sheet are valued Second, and probably more
provide us with an accurate based on their historical cost important, problem is that many
assessment of the true value of rather than their true value today. of the firm’s valuable assets are
the firm’s equity. Unfortunately, The true value today of an asset not captured on the balance
this is unlikely to be the case. may be very different from, and sheet.
even exceed, its book value.
Market Value v/s Book value
• or example, the expertise of the firm’s employees,
the firm’s reputation in the marketplace, the
relationships with customers and suppliers, the
value of future research and development
innovations, and the quality of the management
team. These are all assets that add to the value of
the firm that do not appear on the balance sheet.
• Hence, the book value of equity, while accurate from
an accounting perspective, is an inaccurate
assessment of the true value of the firm’s equity.
• Successful firms are often able to borrow in excess
of the book value of their assets because creditors
recognize that the market value of the assets is far
higher than the book value. Thus, it is not surprising
that the book value of equity will often differ
substantially from the amount investors are willing
to pay for the equity.
Market Value v/s Book value
The total market value of a firm’s equity equals the number of shares outstanding times the firm’s market price per share:

𝑴𝒂𝒓𝒌𝒆𝒕 𝑽𝒂𝒍𝒖𝒆 𝒐𝒇 𝑬𝒒𝒖𝒊𝒕𝒚 = 𝑺𝒉𝒂𝒓𝒆𝒔 𝒐𝒖𝒕𝒔𝒕𝒂𝒏𝒅𝒊𝒏𝒈 ∗ 𝑴𝒂𝒓𝒌𝒆𝒕 𝒑𝒓𝒊𝒄𝒆 𝒑𝒆𝒓 𝒔𝒉𝒂𝒓𝒆

Market value of equity is also known as market capitalization or market cap

The market value of a stock does not depend on the historical cost of the firm’s assets; instead, it depends on what investors
expect those assets to produce in the future.

𝑩𝒐𝒐𝒌 𝒗𝒂𝒍𝒖𝒆 = 𝑨𝒔𝒔𝒆𝒕𝒔 − 𝑳𝒊𝒂𝒃𝒊𝒍𝒊𝒕𝒚 = 𝑩𝒐𝒐𝒌 𝒗𝒂𝒍𝒖𝒆 𝒐𝒇 𝒆𝒒𝒖𝒊𝒕𝒚

𝑩𝒐𝒐𝒌 𝒗𝒂𝒍𝒖𝒆
𝑩𝒐𝒐𝒌 𝒗𝒂𝒍𝒖𝒆 𝒑𝒆𝒓 𝒔𝒉𝒂𝒓𝒆 =
𝒏𝒐. 𝒐𝒇 𝒐𝒖𝒕𝒔𝒕𝒂𝒏𝒅𝒊𝒏𝒈 𝒔𝒉𝒂𝒓𝒆𝒔
Price to book ratio (P/B ratio)

P/B ratio is also known as the Market to Book ratio

𝑀𝑎𝑟𝑘𝑒𝑡 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝑒𝑞𝑢𝑖𝑡𝑦

𝑃/𝐵 =
𝐵𝑜𝑜𝑘 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝑒𝑞𝑢𝑖𝑡𝑦

• Market value of equity: Perception of market regarding the companies net worth
• PB ratio implies how many times of BV is the MV
• It signals whether the stock is overpriced or underpriced
• The market-to-book ratio for most successful firms substantially exceeds 1, indicating that the value of the firm’s assets
when put to use exceeds their historical cost.
• Variations in this ratio reflect differences in fundamental firm characteristics as well as the value added by management.
• Analysts often classify firms with low market-to-book ratios as value stocks, and those with high market-to-book ratios as
growth stocks.
P/B ratio • Book Value= 479094 cr
• Book value per share=1058
• Price per share: 1283
• P/B ratio= ?
• No.of Outstanding shares=?
• Market Cap=?
P/B ratio
Book Value= 479094 cr

Book value per share=1058

Price per share: 1283

P/B ratio= 1.21

Number of O/S shares=452 cr

Market cap: 579916 cr

EXAMPLE : Reliance Industries Limited (RIL)
Market-cap trends Reliance Industries
P/B ratio RIL