Dubai: KEL event elaborates on how to read balance sheet

Media Release

Dubai, Jun 27: An event on ‘How to read a Balance Sheet’ was organized by KEL, Dubai recenty. The event was received well by the attendees as the presenter Mark D’Souza, chartered accountant took them through every step of interpreting financial statements. D’Souza being an authority himself in accounting, audits and management made his presentation so interesting that the delegates were glued to their seats and asking several questions.

D’Souza started his presentation saying ‘Every Entrepreneur is a finance person; otherwise he cannot run his business. He does not need any formal education in accounting to be so. Probably not every entrepreneur knows how to manage his finance efficiently. Most entrepreneurs believe that it is the job of the finance department to manage finance. Finance department only maintains accounts, they do not manage finance. What accountant does is clerical but finance management is intellectual. The single largest reason for business failure worldwide is financial mismanagement’.

He mentioned two important financial management rules:

- Never invest your money without ensuring that, the assets you acquire can generate a return, which is at least equal to cost of your capital.
- Invest your money in such a way that, the assets will generate inflow of funds, before the liabilities demand out flow.

He stressed that the ‘Your sources of funds in business are liabilities and not gifts or donations. Even if you are employed you have to think in these terms. Always think ‘as an owner’. Encourage and empower your employees to think like owner. Best decisions are made when everyone thinks and behaves like owner

D’Souza analyzed the in detail the statements of accounts including the balance sheet, income statement and cash flow statement. He also provided insights to the notes and schedules and the importance of going through each of them to ensure that the auditor has not qualified the report. He stressed on the owners and managers to review inventories and receivables on regular basis to avoid surprises at the end of the accounting period. He also gave insight into the various new accounting standards such as IFRS and comparing them to older standards.

The event was open for members and guests, which attracted many delegates and at the end of the event many were happy with the additional knowledge they acquired. The event was held at the Dunes Hotel apartments starting with the registration at 6.30 pm and the main session at 7 pm and closing at 9.30 pm followed by dinner.

Albert Rodrigues, director of events welcomed the delegates and introduced the presenter. Aloysius Fernandes did the vote of thanks and invited delegates for dinner and fellowship.

Following are some of the key points of his presentation:

1. The language of business is Accounts. Accounting principles ensure that all businesses speak in the same way.

2. Financial statements include Balance sheet,income statement (P&L) and cashflow statement with the relevant notes and schedules.

3. All terms to be used within a Balance sheet are defined clearly within International Finance Reporting Standards or IFRS

4. The analogy of running business is similar to playing a game.(e.g. cricket) – You play to win. Business is also a game to make profits. The team of players is the key, not the scorekeeper (accountant). Without the scorekeeper the match loses its meaning. What is the use of keeping scores (accounts) only at the end of the match (reporting period). Accounts have to be kept on a regular basis for decision making. If the actions are financially intelligent, then the business will make profit.

5. The first step in accounting is to record a transaction (an event that has occurred). ‘Cash book’ maintains all financial transactions and the ‘ledger’ classifies the type of transactions. The summary is what is seen in the Balance sheet. Although the accountant prepares the balance sheet, it is important to interpretit and make sense of all the figures as they provide criticalinformation on the health of your business in financial terms.

6. Income, Expenditure, Assets& Liabilities are the four main components of Financial Statements. You need to know what goes under each of these and some items depend on your business. For e.g. for a computer manufacturer – sale of computer is income, while for the end user it is an Asset. You need to understand that all payments are not expenditure and not all receiptsare Income. Some expenditure could go under Asset especially if the Asset has life of over one year. Similarly, cash received towards capital, debt etc. is a liability and not income.

7. Annual report contains Balance Sheet and Income statements with accounting policies, Directors report and Auditors Report.

8. Important to understand the notes on accounts, whichis part of the Financial Statements. Always read these notes found in the schedules as it can have significant comments that could impact you if the report is qualified. For example, sundry debtors and creditors are not confirmed, Bad debts written off etc.

9. It is important to segregate the roles for accounting and cash collection. The person, who maintains the records of the transaction, should never handle the transaction himself. You should always have a maker andchecker system to ensure effective internal control. Someone collects cash and someone else enters it in the books of accounts. Several companies now do not handle cash mainly for this reason of misuse.

10. Financial reporting has to be consistent and reliable year after year – For e.g. you need to follow the same principle for depreciation of your assets every year.

11. In UAE, all companies have to follow UAE Commercial Companies law 1984. The Balance Sheet has to be compliant with the standards and guidelines of:

a. International Accounting Standards Board - IASB
b. International Accounting Standards - IAS
c. International Finance Reporting Standards – IFRS

12. Inventory is nothing but the stock as at the end of the accounting period. What is in the books must match what is physically present. Valuation of inventory is important and use of the methods for valuation such as LIFO (what has come last goes first), FIFO (first in first out) etc.

13. Historical cost is the value at which the asset was originally purchased. Accounts show historical cost.

14. Balance Sheet is a snapshot of the company on a set date. It shows what the company owns, what the company owes and what belongs to the owners. It is broadly split into Assets & Liabilities.

a. Assets are in the form of Current Assets that has a life span of one year or less and they can be converted easily into cash, which include Cash and Bank Balances, Trade Receivables and other current assets. Assets also include non-current assets generally termed as Fixed Assets, which include assets that a company does not intend to convert to cash or that would take longer than 12 months to convert.

b. Liabilities can be in the form of Share Capital, Loans, and Current liabilities such as Dues to banks, creditors, accruals and provisions. All liabilities that are of less than 12 months validity are called current liabilities while those exceeding 12 months are termed non-current liabilities.
c. Assets – Liability = Capital.
d. Very important to note that the receivables are critical for any company and due importance must be given for regular follow up and collections. Aging statement will provide details on how long a receivable is due. Beware of long term outstanding of receivables. Always take time to review assets that are not utilized – encash your unused assets.

15. The Income Statement provides the profit and loss figures for a particular period. It provides information on the revenue and expenditure for a particular period – usually for one year. Important calculations such as Gross Margins and Net Margins are calculated based on figures in the Income statement. A few points to remember.

a. When you recognize revenue? In cash accounting revenue is recognized when you receive money. In the accrual system the revenue is recognized when invoice is generated or when customer receives goods or when ownership of goods transferred depending on the industry.

b. Cost of Sales is expense directly related to the sale including the cost of goods involved. Depreciation cannot be added to cost of sales.
c. Gross Profit is ‘Actual Sales – Cost of Sales’. It does not include any indirect expenses.

16. It is important to Analyze the income statement and look for important factors such as

i. Trends in revenue
ii. Operating income
iii. Gross margins
iv. Return on Assets
v. Return on Equity

17. Inventory - You need to be aware of the cost of carrying inventory.You need to do aging on inventory. You need to value your inventory using one of the methods such as average cost, market value or actual cost whichever is lower. To arrive at cost take purchase cost freight insurance related costs.Work in Progress (WIP)is also inventory and needs to be valued.For valuation you need to consider the various components of WIP such as raw material, related labour costs, electricity used etc.

18. Depreciation is nothing but the decrease in the value of an asset due to wear & tear or utilization for a portion of its overall life. Depreciated component is passed to expenditure. This has no cash flow impact. Depreciation is dependent on the life of an asset. Land is the only asset that is not depreciated. Fully depreciated items are shown with zero value. When you sell such assets, you book profits.

19. Companies revalue assets to ensure that they are in tune with current valuations.

20. It is important to prepare a budget at the start of the financial year and compare it periodically with actuals.

21. The Balance Sheet analysis provides information on

a. How to examine company’s liquidity
b. Insight into company’s debt and inventory
c. Current ratio – Current Assets Vs Current Liabilities
d. Account receivable vs sales
e. Inventory with cost of sales

22. Financial Ratios provide insight on how well the company can meet its obligations. It gives investors an idea on the financial stability of the company. Financial ratios of importance are:

a. Working capital ratio = Current Assets / Current Liabilities – It measures the ability to pay current liabilities as they mature.
b. Debt to Equity ratio = Total Liabilities /Shareholders Equity. Indicates the mix of funding provided by owners and creditors
c. Return on Equity = Net Income / Average Shareholders Equity. It measures the annual percentage yield on the investment made by the shareholders.
d. Return on Assets – Net Income / Average Total Assets. Itmeasures the annual percentage yield on the gross investment in the business financed collectively by the owners and creditors.
e. Debt Service Ratio – Income before interest / (Interest Principal). It measures the company’s ability to pay both the interest and the current principal installments.

23. Cash Flow

a. Important to understand the importance of managing cash flow
b. Being profitable does not necessarily mean having a good cash flow
c. Similarly, if a company brings in cash it is not necessarily profitable