The aim of this article is to determine relationship between components of income statement and balance sheet. Income statement has basically three components:
- Revenue
- Expense
- Profit
Balance Sheet on the other hand has two components:
- Asset
- Liability
- Owners equity
Asset is financed with the help of liability and owner's equity. Liability refers to long term and short term debt along with other components of current liability such as account's payable and pre- received income. Owners equity on the hand has two components - equity share capital and reserves and surplus. Equity share capital is the product of outstanding shares and face value of shares. In other words equity share capital is shown at book value which is far removed from market value. Long term debt is of two types secured and unsecured debt. Most of the debt is in form of secured debt. Ideally companies choose to finance long term assets with long term debts or internal accruals. However, in case of Indian companies using cross border acquisition as a method of future growth it should be noted that issuing new debts become inevitable.
It is important to describe long term assets into two parts- Operating Non Current Assets and Non Operating Non Current Assets. The growth of a company comes through operating non current assets. Hence , it is important to see how long is it taking for a company to yield returns from increase in non current operating assets. For example, Tata Motors has seen it's non current operating assets grow by more than three times in the last 5 years whereas it's operating profits has marginally declined from 3654 cr. to 3380 cr. Hence, with increase in debt due to inorganic growth, the company is now forced with a sutation wherein it's net profit is under immense pressure due to increasing interest and declining operating profit.
This is when the cross border acquisition has worked for the company. There are cases where cross border acquisitions do not work for the company then the pressure on operating profits and net profit is considerable and even lead the company to bankruptcy. Thus, it is important to understand that financing of growth is as important as growth itself. Hence, any news on capacity augmentation must be seen in view of how the company manages it's balance sheet (increase in operating non current asset matched with increase in debt, equity or decrease in cash.)
It is important to describe long term assets into two parts- Operating Non Current Assets and Non Operating Non Current Assets. The growth of a company comes through operating non current assets. Hence , it is important to see how long is it taking for a company to yield returns from increase in non current operating assets. For example, Tata Motors has seen it's non current operating assets grow by more than three times in the last 5 years whereas it's operating profits has marginally declined from 3654 cr. to 3380 cr. Hence, with increase in debt due to inorganic growth, the company is now forced with a sutation wherein it's net profit is under immense pressure due to increasing interest and declining operating profit.
This is when the cross border acquisition has worked for the company. There are cases where cross border acquisitions do not work for the company then the pressure on operating profits and net profit is considerable and even lead the company to bankruptcy. Thus, it is important to understand that financing of growth is as important as growth itself. Hence, any news on capacity augmentation must be seen in view of how the company manages it's balance sheet (increase in operating non current asset matched with increase in debt, equity or decrease in cash.)
Author: Abhishek Sinha
Abhishek Sinha has approximately 8 year of experience in equity research, business research and consultancy. He has also had the privilege of managing a small portfolio of INR 3 million. However, his interest lies in teaching and "demystifying concepts." He has taught students right from the age of 3 years at PP1, to 40 years at executive courses and believes teaching is not about knowing the concepts; it is about relating the concepts to the audience. At present he is "gainfully employed" at Vignana Jyothi Institute of Management, Hyderabad; where he loves to teach finance to an enthusiastic bunch of management students. His hobbies include analyzing income statement, balance sheet and cash flow.> Google +
Just like in the Balance Sheet Sources and Application of funds are clearly stated,
ReplyDeleteyour article gives a clear understanding of the fundamentals we learned with a real life situation!
sir its quite good n important knwldge for ay one..in very simple words.... sir u have given a example of manufacturing co. sir can u explain wd an exmple of service industry bcoz today indian service industry like banking, aviation are in deep trouble becoz of the same reason(non current operating asset) from my opinion..
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