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KR editions 134 to 136

KR-134 : Management XII

Hi everyone,

  • We saw how our college whizkid setup a corporate. And we also saw that depending on the demand for the stocks a company's stock price can rise (which depends on how the company performance and what the public feels about the company's future). 

  • A problem now arises for our whizkid; not all the stockholders are going to be actively involved in the functioning of the company. 

  • How can he tell the stockholders about how the company is performing, how much revenue it is generating, how much it is spending etc.

  • After all, the stockholders will want to know how the money they invested is being used in the company.

  • Our whizkid knows that he has to give the investors (the stockholders) some regular update on these issues. An update every quarter (once in 3 months) will be pretty informative. Along with that a complete yearly report (annual report) can also be provided to the investors to judge the company.

  • That brings us to the topic of annual reports. Every company produces an annual report which will usually consist of the following sections - Letter from the head (CEO or someone from the top management) and Financial statements.

  • The CEO in the letter will usually provide a perspective of how the company fared in the last year (why revenues went up or down), the challenges faced in the following year and what the company hopes to achieve in the future.

  • The financial statements comprise of - Balance sheet, Income statement, Cash flow statement, Retained earnings statement.

We'll take a look into some of these statements in the future editions (we'll try to cover some terms that one usually finds in these statements).

KR-135 : Management XIII

Let's start with the first finance statement in an annual report.

THE BALANCE SHEET:

This generally appears in two forms: the vertical and horizontal forms (the main difference between the two being the format of the report).

We will find that there are 2 main columns in these reports: 

  • ASSETS

  • LIABILITIES and EQUITY

In the horizontal form of the report ASSETS will be on the left and LIABILITIES + EQUITY will be on the right side.

If you take a look at the report you'll find that the total of the left hand side will equal the total of the right hand side. Which means:

                 ASSETS = LIABILITIES + EQUITY

This is an important equation in accounting. At any given point of time the above equation will be satisfied in a corporation. We'll examine this later.

So what are assets?

Anything that the corporate owns is an asset - like: 

  • Bonds or market securities (similar to the bonds we buy; we buy a bond; the bond seller (a bank) promises to give us a slightly higher interest and we get back the money after a certain period of time like 5/10 years). 

  • Accounts receivable (money that the corporate is expecting to receive within a short period- perhaps the company gave some service or sold some products for which it hasn't yet collected the money). 

  • Inventories (i.e. the physical products) 

  • Plant and equipment

 Generally the assets will be arranged in order of liquidity. What's liquidity? That's in the next edition.

Tip: It would be a good idea to take a look at the balance sheets of companies to get a feel of what is reported in a balance sheet.

KR-136 : (GAAP and balance sheet-II)

We came across the term liquidity; what's liquidity?

  • The more sooner something can be converted into cash (money), the more liquid that "something" is. Or we can also say it as: the faster we can get cash for something the more liquid it is.

  • Cash in a bank account (a savings account) tops the liquidity chart while assets like land come below. So, in balance sheets, the asset details will be arranged in order of liquidity (i.e. from the most liquidable asset to the least).

Before we continue we need to fill up a gap we've left out; the gap of GAAP!

  • You may have come across this in a few places (or in the economics section of the newspaper); what is GAAP? 

  • GAAP is an acronym for Generally Accepted Accounting Principles. Companies can produce financial reports in different ways by applying different standards. This will end up confusing the outside world (or investors) and also lead to unscrupulous accounting practices. So all companies should adhere to some accounting standard. GAAP is a set of standards/ principles that most companies follow in preparing their financial reports (in fact you'll find companies stating that "this report has been prepared in conformance to GAAP" or some clause like that).

Another word on account receivables (in simpler terms):

  • If you were a regular customer in a grocery store then one fine day you might call up the shop and order some goods. You might tell the owner "put the amount in my account". The owner still delivers the goods to you based on trust. 

  • Now for the grocer, the money you owe will be categorized under "accounts receivable". 

  • And if you were to prepare a balance sheet at this point of time, you would categorize the money you owe the grocer under "accounts payable". 

  • Receivable comes under the asset column while payable comes under the liability part of the balance sheet.

Hope the concept of receivable and payable is clear.

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