![2. Basics OF Profit and Loss Accounts
Money that comes from Sales –> Income
Income - Variable Cost = Contribution i.e the surplus from income that covers for the
foxed costs
Contribution - Fixed Cost = Profit Before Interest and Tax (PBIT) aka Operating Profit
If PBIT is +ve –> operationally we are making a profit - operating profit
PBIT - Interest on Long term Loans = Profit Before Tax (PBT) aka Taxable profit
PBT - Tax = Profit after Tax (PAT) aka Net Profit
PAT - Dividend = Retained Earnings –> Net worth
USA norm for PBIT is EBIDTA - Earnings before Interest Depreciation Tax and
Amortization
Amortization: like depreciation - you spread the expenditure across a period e.g. you
don’t depreciate Brand Name/Goodwill. IPL/EPL teams bought would be typically
amortized.
“Profit is a liability for a business -cause it is the investor’s money to be returned. So is
Loss an Asset?”
3. CASH FLOW STATEMENT
The following table illustrates the fundamentals before one ventures into drafting a cashflow
statement.
Operating Investment Finance
PBDIT
(-) Increase in Working
Capital [other than cash]
(+) Decrease in working
capital
(-) Taxation
Sale proceeds from
fixed Assets or
investments
(-)Purchase of fixed
Assets/investments
(+) Interest from
investments
Issue of share capital
(+) Long term loan taken
(-)Repayment of loan
(-) Drawings
(-) Pyment on Interest of loans
(-) Dividend paid on capital
A successful business depicts the following traits:
Share Capital is issued only to purchase fixed assets and investments and for drawings.
Sale proceeds from fixed asset/investments are used only to purchase fixed
assets/investments
Operational profits are used for repayment of loans and for further investments.
Other points:](https://image.slidesharecdn.com/basicsoffinance-12888993532162-phpapp02/85/Basics-Of-Finance-3-320.jpg)
Basics Of Finance
- 1. Sourced from TIE Website I’m posting these notes for the benefit of entrepreneurs. Hope it helps 1. What is the GOAL for running a business? One cannot have multiple goals for an organisation. It has to be unique. The multiple goals like profit creation, customer satisfaction, social responsibility etc. are interim goals that are necessary conditions but not sufficient condition to run an organisation sufficiently. The necessary and sufficient condition for any commercial organisation is that to make Money! Profit belongs to the investor. The firm cannot make money while ignoring the necessary conditions; the firm cannot ignore making money while pursuing the necessary conditions. 2. For every action there is a Financial Reaction 1. Profit is an absolute term. 2. ROI (return on investment) is a relative term that decides Profit. 3. Healthy Cash flow is a must for survival. Normally people get drunk on profit eventhough they are not cost efficient. People talk about cost only in downturns its like talking of common cold only during Monsoon. 3. Drivers of the bottom line: 1. Revenue: Wealth is only created by Sales/earning revenue - not by cutting cost. 2. Cost: Normally people get drunk on profit even though they are not cost efficient. People talk about cost only in downturns its like talking of common cold only during Monsoon. 3. Investment: The money blocked in business is investment. It brings down profitability - affects cash flow and ROI negatively. 4. The four Ms of business: 1. Men 2. Machine 3. Methods- the most critical parameter affecting the bottom line. 4. Material (finished goods) 5. The four ‘R’s that an investor should look at: 1. Return 2. Risk 3. Raise 4. Realization
- 2. 6. Other Important Points 1. You are creating wealth when you make profits more than the expected rate of returns i.e. existing in the current market. 2. We cannot compromise on strategy at the cost of survival and vice versa. 3. Brand is a set of promises that I’ve been fulfilling for long or have promised to full fill in the future. What’s in Store: Notes from My First Lessonon Finance- part two Basics of the Balance Sheet Fundamentals of the Profit and Loss account The Cash flow statement Validating your assumptions The Seven financial reactions to any decision you would take. 1. Basics of the BALANCE SHEET In simple terms the balance Sheet has 2 columns viz. Money required and Money Funded: Money Required Money Funded Capital employed Capital Employed Investing Financing I Own I Owe Operations Finance Application of Funds Source of Funds Fixed Assets + Working Capital Net Worth + Loaned Funds Money Required.: Fixed Assets + Working capital (cycle) - Liquid cash is the worst asset- it cant get liquid any further and we don’t get any returns on it. Although some amount of petty cash is a must for day to day business expenses- more than that is a waste. Money Funded : (Share Capital + reserves = ) Net Worth + loaned Funds - Net Worth = Money brought in by the owner and that retained in the business. - Reserves = assets, land, Accounts receivable etc. Reserve Rich not= Cash rich Equity is more expensive than debt “Profit is a liability for a business -cause it is the investors money to be returned. So is Loss an Asset?”
- 3. 2. Basics OF Profit and Loss Accounts Money that comes from Sales –> Income Income - Variable Cost = Contribution i.e the surplus from income that covers for the foxed costs Contribution - Fixed Cost = Profit Before Interest and Tax (PBIT) aka Operating Profit If PBIT is +ve –> operationally we are making a profit - operating profit PBIT - Interest on Long term Loans = Profit Before Tax (PBT) aka Taxable profit PBT - Tax = Profit after Tax (PAT) aka Net Profit PAT - Dividend = Retained Earnings –> Net worth USA norm for PBIT is EBIDTA - Earnings before Interest Depreciation Tax and Amortization Amortization: like depreciation - you spread the expenditure across a period e.g. you don’t depreciate Brand Name/Goodwill. IPL/EPL teams bought would be typically amortized. “Profit is a liability for a business -cause it is the investor’s money to be returned. So is Loss an Asset?” 3. CASH FLOW STATEMENT The following table illustrates the fundamentals before one ventures into drafting a cashflow statement. Operating Investment Finance PBDIT (-) Increase in Working Capital [other than cash] (+) Decrease in working capital (-) Taxation Sale proceeds from fixed Assets or investments (-)Purchase of fixed Assets/investments (+) Interest from investments Issue of share capital (+) Long term loan taken (-)Repayment of loan (-) Drawings (-) Pyment on Interest of loans (-) Dividend paid on capital A successful business depicts the following traits: Share Capital is issued only to purchase fixed assets and investments and for drawings. Sale proceeds from fixed asset/investments are used only to purchase fixed assets/investments Operational profits are used for repayment of loans and for further investments. Other points:
- 4. Cash flow statement cannot be easily fudged and one should not try to do so just for the sake of impressing potential investors. Working Capital is technically the working capital ‘gap’ and is always a cycle. 3. Validating your assumptions o Apply Ockham’s razor : Get as close to reality as possible. o Possible ways to validate: - Get an industry insider to invest in you. One of the best ways to validate as he is a better judge of the industry trends and unsolved problems through his experience than you are with your market research.- Get a gainful employee to join your Co. If s/he can leave his stable and plush job to join your new venture it means either your venture is super or that he is a bozo. o Mistrust the obvious. o Understand your sphere of influence, concern and control. 4. THE 7 FINANCIAL REACTIONS TO ANY DECISION YOU TAKE There are seven distinct and finite financial reactions that can take place for any decision we make 1. Increase in Sales Volume 2. Decrease in Fixed Cost 3. Increase in Selling Price 4. Decrease Variable Cost 5. Change in Product Mix 6. Reduction of Fixed Assets 7. Reduction of Working Cap (gap) That brings us to the end of my notes from my first lesson in finance. They seems pretty logical to me , however I do not endorse or assure that these would work for everybody/anybody- as an explorer and a learner I just wanted to share this the likeminded readers. Cheers!