FADM 1, Class 3

FADM 1 - Professor Ramana

Class 3

1) Equity – Owner’s money

a. Money generated by business – Profit, which is owner’s money (because it should have been distributed as dividend after paying off debts)

b. Capital – Owner’s business money

2) Liability – Outsider’s money

a. Banker (LTL/CL), Supplier (CL), Creditor, Employees (Salary outstanding), Customer (Revenue received in advance like buying a Dell laptop, though it is delivered after 2 weeks)

3) S=A

a. Equity + Liability = Assets

b. Capital + Reserves + Liabilities = Assets

c. Capital + Retained Profit + Other Profits + Liabilities = Cash + Other Assets

i. Other Profit = Raising Capital at premium, then premium is other profit

ii. Retained profit & Cash keep on changing

d. Closing Books of Account means finding cash in hand

e. An expense is a liability; but if fully paid, is an outflow of cash; In case paid in excess, create advance expense as an asset.

4) Conservative Principle – Income unless received / is certain to be received, do not record it.

For an ongoing company, there will be a opening BS & a closing BS (Company already has assets, hence, equity & debt)

One must have a capital for any business (whether loan / retained profit is present)

BS shows accumulated profit, whereas IS shows profit for the period

Dividend is distribution of profit & not an expense (Profit / Dividend = Income – Expense)

Financing Decisions & Financial Statements:

Financing Decision:

v Sources Side of Balance Sheet reflects the Financing decision

o Liability – Outsider’s Fund

§ Long Term Debt

§ Current Liability (Provided by Suppliers, Customers, Employees)

o Capital – Owner’s money

o Reserves – Owner’s money

§ Retained Profit

§ Other Profit

Owner’s Fund

v Capital –

o Money contributed by the owner(s). It is also called as Share Capital. Money collected or rose by selling or issuing shares to the shareholders.

o Share is a unit of capital ownership of which is a condition for ownership of the company

§ Equity Share (India) / Common Shares (US) / Ordinary Shares (UK, Europe)

§ Preference Share

v Capital can be raised by Issuing shares

o Initial Public Offer (IPO)

§ Shares are issued by the company to public at large (Ownership pattern – who is owning shares - Individual, Financial Institution like bank, FII, Other corporate bodies - OCB, Government)

o Subsequent Public Offer (Further offer)

Price is when Demand = Supply, what is actual paid by buyer / accepted by Seller (Depends on my negotiating power)

Value is a perception / expected cash flow of buyer and seller (May be higher or lower than the price)