Module 3 Fundamental Analysis

Chapter 6

Understanding Balance Sheet Statement (Part 1)

132

M3-Ch6-title

6.1 – The balance sheet equation

While the P&L statement gives us information pertaining to the profitability of the company, the balance sheet gives us information pertaining to the assets, liabilities, and the shareholders equity. The P&L statement as you understood, discusses about the profitability for the financial year under consideration, hence it is good to say that the P&L statement is a standalone statement. The balance sheet however is prepared on a flow basis, meaning, it has financial information pertaining to the company right from the time it was incorporated. Thus while the P&L talks about how the company performed in a particular financial year; the balance sheet on the other hand discusses how the company has evolved financially over the years.

Have a look at the balance sheet of Amara Raja Batteries Limited (ARBL):

M3-Ch6-Chart1

As you can see the balance sheet contains details about the assets, liabilities, and equity.

We had discussed about assets in the previous chapter. Assets, both tangible and intangible are owned by the company. An asset is a resource controlled by the company, and is expected to have an economic value in the future. Typical examples of assets include plants, machinery, cash, brands, patents etc. Assets are of two types, current and non-current, we will discuss these later in the chapter.

Liability on the other hand represents the company’s obligation. The obligation is taken up by the company because the company believes these obligations will provide economic value in the long run. Liability in simple words is the loan that the company has taken and it is therefore obligated to repay back.  Typical examples of obligation include short term borrowing, long term borrowing, payments due etc. Liabilities are of two types namely current and non-current. We will discuss about the kinds of liabilities later on in the chapter.

In any typical balance sheet, the total assets of company should be equal to the total liabilities of the company. Hence,

Assets = Liabilities

The equation above is called the balance sheet equation or the accounting equation. In fact this equation depicts the key property of the balance sheet i.e the balance sheet should always be balanced. In other word the Assets of the company should be equal to the Liabilities of the company. This is because everything that a company owns (Assets) has to be purchased either from either the owner’s capital or liabilities.

Owners Capital is the difference between the Assets and Liabilities. It is also called the ‘Shareholders Equity’ or the ‘Net worth’. Representing this in the form of an equation :

Share holders equity = Assets – Liabilities

6.2 –A quick note on shareholders’ funds

As we know the balance sheet has two main sections i.e. the assets and the liabilities. The liabilities as you know represent the obligation of the company. The shareholders’ fund, which is integral to the liabilities side of the balance sheet, is highlighted in the snapshot below. Many people find this term a little confusing.

M3-Ch6-Chart2

If you think about it, on one hand we are discussing about liabilities which represent the obligation of the company, and on the other hand we are discussing the shareholders’ fund which represents the shareholders’ wealth. This is quite counter intuitive isn’t it? How can liabilities and shareholders’ funds appear on the ‘Liabilities’ side of balance sheet? After all the shareholders funds represents the funds belonging to its shareholders’ which in the true sense is an asset and not really a liability.

To make sense of this, you should change the perceptive in which you look at a company’s financial statement. Think about the entire company as an individual, whose sole job is run its core operation and to create wealth to its shareholders’. By thinking this way, you are in fact separating out the shareholders’ (which also includes its promoters) and the company. With this new perspective, now think about the financial statement. You will appreciate that, the financial statements is a statement published by the company (which is an entity on its own) to communicate to the world about its financial well being.

This also means the shareholders’ funds do not belong to the company as it rightfully belongs to the company’s shareholders’. Hence from the company’s perspective the shareholders’ funds are an obligation payable to shareholders’. Hence this is shown on the liabilities side of the balance sheet.

6.3 –The liability side of balance sheet

The liabilities side of the balance sheet details out all the liabilities of the company. Within liabilities there are three sub sections – shareholders’ fund, non-current liabilities, and current liabilities. The first section is the shareholders’ funds.

M3-Ch6-Chart3

To understand share capital, think about a fictional company issuing shares for the first time. Imagine, Company ABC issues 1000 shares, with each share having a face value of Rs.10 each. The share capital in this case would be Rs.10 x 1000 = Rs.10,000/- (Face value X number of shares).

In the case of ARBL, the share capital is Rs.17.081 Crs (as published in the Balance Sheet) and the Face Value is Rs.1/-. I got the FV value from the NSE’s website:

M3-Ch6-Chart4

I can use the FV and share capital value to calculate the number of shares outstanding. We know:

Share Capital = FV * Number of shares

Therefore,

Number of shares = Share Capital / FV

Hence in case of ARBL,

Number of shares = 17,08,10,000 / 1

= 17,08,10,000 shares

The next line item on the liability side of the Balance Sheet is the ‘Reserves and Surplus’. Reserves are usually money earmarked by the company for specific purposes. Surplus is where all the profits of the company reside. The reserves and surplus for ARBL stands at Rs.1,345.6 Crs. The reserves and surplus have an associated note, numbered 3. Let us look into the same.

M3-Ch6-Chart5

As you can notice from the note, the company has earmarked funds across three kinds of reserves:

  1. Capital reserves – Usually earmarked for long term projects. Clearly ARBL does not have much amount here. This amount belongs to the shareholders, but cannot be distributed to them.
  2. Securities premium reserve / account – This is where the premium over and above the face/par value of the shares sits. ARBL has a Rs.31.18 Crs under this reserve
  3. General reserve – This is where all the accumulated profits of the company which is not yet distributed to the shareholder reside. The company can use the money here as a buffer. As you can see ARBL has Rs.218.4 Crs in general reserves.

The next section deals with the surplus. As mentioned earlier, surplus holds the profits made during the year. Couple of interesting things to note:

    1. As per the last year (FY13) balance sheet the surplus was Rs.829.8Crs. This is what is stated as the opening line under surplus. See the image below:

M3-Ch6-Chart6

  1. The current year (FY14) profit of Rs.367.4 Crs is added to previous years closing balance of surplus. Few things to take note here:
    1. Notice how the bottom line of P&L is interacting with the balance sheet. This highlights a very important fact – all the three financial statements are closely related
    2. Notice how the previous year balance sheet number is added up to this year’s number. This highlights the fact that the balance sheet is prepared on a flow basis, adding the carrying forward numbers year on year
  2. Previous year’s balance plus this year’s profit adds up to Rs.1197.2 Crs. The company can choose to apportion this money for various purposes.
    1. The first thing a company does is it transfers some money from the surplus to general reserves so that it will come handy for future use. They have transferred close to Rs.36.7 Crs for this purpose
    2. After transferring to general reserves they have distributed Rs.55.1 Crs as dividends over which they have to pay Rs.9.3 Crs as dividend distribution taxes.
  3. After making the necessary apportions the company has Rs.1095.9 Crs as surplus as closing balance. This as you may have guessed will be the opening balance for next year’s (FY15) surplus account.
  4. Total Reserves and Surplus = Capital reserve + securities premium reserve + general reserves + surplus for the year. This stands at Rs.1345.6 Crs for the FY 14 against Rs.1042.7 Crs for the FY13

The total shareholders’ fund is a sum of share capital and reserves & surplus. Since this amount on the liability side of the balance sheet represents the money belonging to shareholders’, this is called the ‘shareholders funds’.

6.4 – Non Current Liabilities

Non-current liabilities represent the long term obligations, which the company intends to settle/ pay off not within 365 days/ 12 months of the balance sheet date. These obligations stay on the books for few years. Non-current liabilities are generally settled after 12 months after the reporting period.

Here is the snapshot of the non-current liabilities of Amara Raja batteries Ltd.

M3-Ch6-Chart7

The company has three types of non-current liabilities; let us inspect each one of them.

The long term borrowing (associated with note 4) is the first line item within the non-current liabilities. Long term borrowing is one of the most important line item in the entire balance sheet as it represents the amount of money that the company has borrowed through various sources. Long term borrowing is also one of the key inputs while calculating some of the financial ratios. Subsequently in this module we will look into the financial ratios.

Let us look into the note associated with ‘Long term borrowings’:

M3-Ch6-Chart8

From the note it is quite clear that the ‘Long term borrowings’ is in the form of ‘interest free sales tax deferment’. To understand what interest free sales tax deferment really means, the company has explained just below the note (I have highlighted the same in a red box). It appears to be some sort of tax incentive from the state government. The company plans to settle this amount over a period of 14 years.

You will find that there are many companies which do not have long term borrowings (debt). While it is a good to know that the company has no debt, you must also question as to why there is no debt? Is it because the banks are refusing to lend to the company? or is it because the company is not taking initiatives to expand their business operations. Of course, we will deal with the analysis part of the balance sheet later in the module.

Do recollect, we looked at ‘Finance Cost’ as a line item when we looked at the P&L statement. If the debt of the company is high, then the finance cost will also be high.

The next line item within the non-current liability is ‘Deferred Tax Liability’. The deferred tax liability is basically a provision for future tax payments. The company foresees a situation where it may have to pay additional taxes in the future; hence they set aside some funds for this purpose. Why do you think the company would put itself in a situation where it has to pay more taxes for the current year at some point in the future?

Well this happens because of the difference in the way depreciation is treated as per Company’s act and Income tax. We will not get into this aspect as we will digress from our objective of becoming users of financial statements. But do remember, deferred tax liability arises due to the treatment of depreciation.

The last line item within the non-current liability is the ‘Long term provisions’. Long term provisions are usually money set aside for employee benefits such as gratuity; leave encashment, provident funds etc.

6.5 – Current liabilities

Current liabilities are a company’s obligations which are expected to be settled within 365 days (less than 1 year). The term ‘Current’ is used to indicate that the obligation is going to be settled soon, within a year. Going by that ‘non-current’ clearly means obligations that extend beyond 365 days.

Think about this way – if you buy a mobile phone on EMI (via a credit card) you obviously plan to repay your credit card company within a few months. This becomes your ‘current liability’. However if you buy an apartment by seeking a 15 year home loan from a housing finance company, it becomes your ‘non-current liability’.

Here is the snapshot of ARBL’s current liabilities:

M3-Ch6-Chart9

As you can see there are 4 line items within the current liabilities. The first one is the short term borrowings. As the name suggests, these are short term obligations of the company usually undertaken by the company to meet day to day cash requirements (also called working capital requirements). Here is the extract of note 7, which details what short term borrowings mean:

M3-Ch6-Chart10

Clearly as you can see, these are short term loans availed from the State bank of India and Andhra Bank towards meeting the working capital requirements. It is interesting to note that the short term borrowing is also kept at low level, at just Rs.8.3Crs.

The next line item is Trade Payable (also called account payable) which is at Rs.127.7 Crs. These are obligations payable to vendors who supply to the company. The vendors could be raw material suppliers, utility companies providing services, stationary companies etc. Have a look at note 8 which gives the details:

M3-Ch6-Chart11

The next line item just says ‘Other current liabilities’ which stands at Rs.215.6 Crs. Usually ‘Other current Liabilities’ are obligations associated with the statutory requirements and obligations that are not directly related to the operations of the company. Here is note 9 associated with ‘Other current liabilities’:

M3-Ch6-Chart12

The last line item in current liabilities is the ‘Short term provisions’ which stands at Rs.281.8 Crs. Short term provisions is quite similar to long term provisions, both of which deals with setting aside funds for employee benefits such as gratuity, leave encashment, provident funds etc. Interestingly the note associated with ‘Short term Provisions’ and the ‘Long term provisions’ is the same. Have a look at the following:

M3-Ch6-Chart13

Since note 6 is detailing both long and short term provisions it runs into several pages, hence for this reason I will not represent an extract of it. For those who are curious to look into the same can refer to pages 80, 81, 82 and 83 in the FY14 Annual report for Amara Raja Batteries Limited.

However, from the user of a financial statement perspective all you need to know is that these line items (short and long term provisions) deal with the employee and related benefits. Please note, one should always look at the associated note to run through the details.

We have now looked through half of the balance sheet which is broadly classified as the Liabilities side of the Balance sheet. Let us relook at the balance sheet once again to get a perspective:

M3-Ch6-Chart14

Clearly,

Total Liability = Shareholders’ Funds + Non Current Liabilities + Current Liabilities

= 1362.7 + 143.03 +  633.7

Total Liability = Rs.2139.4 Crs


Key takeaways from this chapter

  1. A Balance sheet also called the Statement of Financial Position is prepared on a flow basis which depicts the financial position of the company at any given point in time. It is a statement which shows what the company owns ( assets) and what the company owes (liabilities)
  2. A business will generally need a balance sheet when it seeks investors, applies for loans, submits taxes etc.
  3. Balance sheet equation is Assets = Liabilities + Shareholders’ Equity
  4. Liabilities are obligations or debts of a business from past transactions and Share capital is number of shares * face value
  5. Reserves are the funds earmarked for a specific purpose, which the company intends to use in future
  6. Surplus is where the profits of the company reside. This is one of the points where the balance sheet and the P&L interact. Dividends are paid out of the surplus
  7. Shareholders’ equity = Share capital + Reserves + Surplus. Equity is the claim of the owners on the assets of the company. It represents the assets that remain after deducting the liabilities. If you rearrange the Balance Sheet equation, Equity = Assets – Liabilities.
  8. Non-current liabilities or the long term liabilities are obligations which are expected to be settled in not less than 365 days or 12 months of the balance sheet date
  9. Deferred tax liabilities arise due to the discrepancy in the way the depreciation is treated. Deferred tax liabilities are amounts of income taxes payable in the future with respect to taxable differences as per accounting books and tax books.
  10. Current liabilities are the obligations the company plans to settle within 365 days /12 months of the balance sheet date.
  11. In most cases both long and short term provisions are liabilities dealing with employee related matters
  12. Total Liability = Shareholders’ Funds + Non Current Liabilities + Current Liabilities. . Thus, total liabilities represent the total amount of money the company owes to others

132 comments

  1. Durgesh kumar says:

    Why this lon term advances and loan included in asset side?

    • Karthik Rangappa says:

      Because these are monies given out by the company to debtors and the company expects this to be repayed….when the debtors repay the money it will be in the form of cash or cash equivalents which is an asset. Hence we treat long term advances and loan as assets.

      • Venkatp says:

        It was a very informative website to understand balance sheet for non finance people . I found that in spite of learning a lot about balance sheet I could not apply this learning’s correctly for balance sheet of banks or financial services company. It would be great if you could add a separate chapter about understanding balance sheet / P&L of Banks or financial services companies . Thanks in advance , as I know you will come up with this new chapter 🙂

        • Karthik Rangappa says:

          Glad you liked the website.

          Yes, understanding banks and NBFC financial statements is a little tricky. Its not the best of my strengths, hence have avoided talking about it. Maybe, we could invite someone who will be able to write about this.

  2. J V Indudhar says:

    Simply superb what ever doubts I had till now have been cleared by this single chapter. Thanks a lot Karthik

  3. Masood says:

    As i checked note on other current liabilities, Commission to Non Executive Chairman – 17 Cr, which is around 4.7 % of profit.
    Is it normal in the industry, that they pay such huge commission. I feel this is a bit negative. ?? Please let me know your ideas on this.

    • Karthik Rangappa says:

      Between 2-5% of profits is quite normal. However to get a true sense compare it with Exide to understand how peers are placed. However I would be a bit concerned in case of ARBL. Also, I’ve mentioned about this here, check section 2.4, point 7.

  4. Ajit Kumar says:

    In the balance sheet of Exide Industries (see attachment), we don’t see any Short term of Long term borrowing. But the company do have about 1 Crore finance cost. I was wondering if I want to compare Amaraja Batteries with Exide industries, what data I should pick for short and long term borrowing.

  5. Tilak Shetty says:

    Just a question, why cash rich companies having debt in their books ? ARBL’s books showing debt despite having surplus reserves & cash deposits.

    • Karthik Rangappa says:

      Well a little amount of debt is not bad 🙂 It helps boosting Return on Equity.

      • Arvind Dureja says:

        on contrary it will impact margins, wouldn’t it?
        because of int outgo.

        • Karthik Rangappa says:

          Nope, how would it impact margins? Margins are mainly P&L derivative.

          • Arvind Dureja says:

            are surplus and general reserve cash set aside by company for future?
            if so then why surplus and general reserve are not show under current asset as cash & cash equivalent??

          • Karthik Rangappa says:

            Yes, in fact dividends are paid out from surpluses. Moneies parked under the current assets and liabilities have 365 day window during it will be utilized…clearly General reserves would not fit into this definition.

          • Arvind Dureja says:

            sir if surplus and general reserve are cash set aside by company for future then rolta has over 2000 cr of Reserve and Surplus so why have they defaulted on interest payment of 42 cr??
            quite confusing.

          • Karthik Rangappa says:

            The company should give an explanation for this!

  6. manoj says:

    well actually capital reserves (excluding revaluation reserve) can be distributed (during bonus issue):::
    capital redemption reserve a/c Dr xx
    Capital reserve (excluding revaluation reserve) Dr xx
    Securities premium (earned in cash/cash eq) Dr xx
    Divisible profit Dr xx
    To bonus to share holders A/C XX

    Bonus to share holders A/C Dr XX
    To equity share capital A/C XX

  7. gopal says:

    Question, In moneycontrol.com they show “debt”. How do they calculate Debt? and should an investor look at debt (or) liability of a company on whole?

    Thanks!

  8. DEB says:

    Dear Karthik
    First of all I would like to say that u r really superb!!!!! I have a request if u can elaborate the note no-14 (Inventories).
    Thanks

  9. DEB says:

    I want to see the calculation on note 14 (Inventories). Request you to explain.

  10. mohanraj says:

    Thanks for the detail explaination of balance sheet,but could you take example from moneycontrol bse stock page where the term ” total dept ” is placed in financial’s options.
    i wanted know when the value of total dept is good compared to other term’s in balance sheet side.
    please keep an open mind considering the possibilities of winding up of that particular bse stock, for to my strategy to work i think i am to steps away from completion.
    so i would really appreciate your help on detail explaination for avoiding the possible bse stocks that are threat for winding up,please guide me more on this matter in any way not just balance sheet reference, if you think i need to consider any other condition or step to avoid winding up.
    Thank you for what u have done,ill be expecting a reply.

    • Karthik Rangappa says:

      Please do keep the following points in consideration –

      1) Debt should be low, if the debt is high make sure interest coverage is good (more than 1 at least)
      2) Company should be growing revenues at a good CAGR (15% +)
      3) Healthy margins
      4) Double digit ROE
      5) Good stable management

  11. ajay says:

    Hi Karthik,
    Amazing content on every page ! Thanks !
    Question, pl have a look at the snippet, I don’t understand the “liabilities for expenses” part a sizable part of “other current liabilities” . Is it good? Is it bad? What is it actually?

    • Karthik Rangappa says:

      Ajay – I supposed this is coming form an accounting perspective. Need to get some clarity on this myself. Will get back to you shortly.

  12. Satyajit says:

    First of all – Thanks a lot for this wonderful material, amazing clarity. Will ask you a few doubts , Hope you would answer them ..

  13. Romeo says:

    Respected Sir,
    I had taken loan from a family member and at that time it was shown in liabilities in balance sheet, now I have returned it so that amount has to be shown in asset side ??
    The returned loan amount has to be added to my Capital account ?
    Waiting for your reply.
    Thank You.

    • Karthik Rangappa says:

      Is this your personal balance sheet? I would suggest you speak to the CA about it, I may not be the right person.

  14. ganesh l deshmukh says:

    my question is whether cash credit hypo credit balance add in loans and advances total in Assets side and same show in Lablities side in Deposit head

  15. Asad Affan says:

    Sir, my question is why we add net profit in reserve and surplus and my second question is that every month i pay TDS on rent but by mistake we did pay 1000 less in October month now i paid in Jan-16’s month tell how i will be adjust and what will b entry?? Please!

    • Karthik Rangappa says:

      Balance sheet is used to carry profits year on year, hence we add back this years profits to all the others and maintain it under Reserves & Surplus.

      I cant seem to understand your 2nd question.

  16. rohan says:

    I am getting confused by the term shareholders funds. Please explain what does it means.
    share capital means money that company got by selling shares i.e 170 million?
    how come “reserves and surplus” part of shareholders fund?

    • Karthik Rangappa says:

      Shareholders funds should reflect the funds that belong to the share holders of the company. Profits earned by the company belong to the shareholders and since the profits are accumulated in reserves and surplus (year on year), the reserves and surplus belongs to the share holders funds. Same with share capital.

  17. Anushka says:

    What does the term ‘DEBT’ include? Only long term liability or short term liability as well.
    And how are provisions debt to a company ? They are just cash set aside.

    • Karthik Rangappa says:

      Provisions is not debt – like you said its cash set aside. Debt includes both long term + short term debt.

  18. rani m das says:

    Why hort term provisions are added in P& L account. It has to be deducted right?

  19. Winay says:

    That means Liabilities & profit should be > than the company will be good for investing purpose
    tell the investing sign dear

  20. sidharth says:

    why share capital = FV x Total Shares
    During IPO many companies have face value as 10. but they are listed with higher values
    Eg: coffee day has face value 10, but they are listed as 328.
    here share holders fund is actually 328/share.
    But when we calculating share capital, if we multiplied by face value, share capital is just 10/share. why this contradiction or am I missing any fundamentals?

    • sidharth says:

      I think I got answer for my question. that remaining value higher than face value is “securities premium reserve”.
      Is my understanding right?

  21. Hitesh says:

    What is retained earnings and how can we find it from financial statements?

    • Karthik Rangappa says:

      Retained earnings is the amount the company retains after paying for all the expenses including the finance charges.

      • Hitesh says:

        So in this case will the retained earnings of the company be equal to reserves and surplus i.e. 1345.62 crs?

        • Karthik Rangappa says:

          Retained earnings flows into the Reserves and Surplus and gets accumulated there. Retained earnings is for this year, but the Reserves and Surplus is accumulated every year.

  22. Arvind Dureja says:

    is the shareholders funds kept in a bank or is it being used as working capital?
    what i mean is, should we use shareholders fund as cash or is it how the company has working capital?

  23. Renu Bala says:

    Hi karthik, really liking all your modules.
    one query regarding balance sheet, what changes will happen in balance sheet when company goes through IPO. Lets suppose a fresh issue of 1lakh shares of FV 10rs are issued at issue price of 100 rs . This amount of 1cr raised, where this money will sits in balance sheet?? and also capital arising from 1lakh *10 rs = 10 lakh rs, will this amount sits in share capital??

    • Karthik Rangappa says:

      No structural changes in the balance sheet as such. The share holding obviously changes. Plus the premium over the face-value would sit in the ‘Securities Premium reserve’.

  24. aniket says:

    what does negative reserve and surplus means?

    • Karthik Rangappa says:

      Reserves and Surplus indicates the undistributed profits of the company, which technically belongs to the equity holders. A negative R&S indicates that the company has a negative networth. As a rule of thumb, you have to be cautious about investing in such companies.

  25. [email protected] says:

    Hi Karthik,
    simple but professionally explained. kudos..

  26. Amit D ubey says:

    U are Gopichanda of stock lessons. A number of stock market champions will emerge from zerodha university.

  27. amit dubey says:

    It is your humility. But what is appreciable that u have taken pains to educate laymen about Stock Market in such a methodical manner for free and i have been reading your modules again and again which gives me immense confidence. Earlier it was headlong plunge without having solid knowledge of intricacies of stock market. I bet if you convert the modules into a book it will be one of the best seller . looking forward to such guided material in future too.

    • Karthik Rangappa says:

      Thanks for the kind words Amit, we will continue to do our best to serve the trading/investing community. Please stay tuned for more organized content!

  28. John says:

    How to shortlist the companies as there are 6000 companies listed in BSE and 2000 in NSE and if we go according to the sectors aswell, there also they have a long list of all, so can you please help me to understand that how to shortlist.

  29. Sumit Mochahari says:

    This seems helpful to me
    Thnx

  30. GAURAV LUTHRA says:

    Hi Karthik,
    Thank you for this wonderful module. I have a doubt while looking at a balance sheet, whether we have to look at consolidated balance sheet or standalone? and why? The numbers are different in both the balance sheet.

    What is the major difference between them?

    • Karthik Rangappa says:

      Consolidates takes in the financials of its subsidiaries as well, so in a sense it gives a true and much larger picture of a firm. Hence I’d suggest you take in the consolidated numbers.

  31. Dhinakaran says:

    Karthik, Thank you for the crystal clear explanation. Instead of ARBL, I took DLF for balance sheet analysis. I have few questions. Can you please clarify.
    1) As per the 2016 annual report, securities premium account is 1076038 Lakh RS. How can it be so huge?
    2) I understand, preferential capital is issuing preferred stocks(Wrong?). In 2013 it is 1799 Crores but in 2015 it is 0 which reduced the share capital. Did the company bough back the preferential shares or the contract is over? Why there is no corresponding reduction in reserves?
    3) Also, can i consider general reserves as high liquid cash equivalents?

    • Karthik Rangappa says:

      1) That’s 10K Cr, which is quite large. Have you seen the associated notes for an explanation?

      2) Depends on how the allotment is structured. Most likely they would have bought back. Again, reading the associated notes for this line item for every year starting 2013 will help.

      3) No

  32. vimal says:

    While analysing the Reliance industries balance sheet, I have noticed the share capital in standalone is 3240 crores and the consolidated statement has only 2948 crores. If the consolidated statement gives the whole financial position of the company then why there is decrease in share capital in consolidated statement. I hope you could help me with this..

  33. Aneesh says:

    How to calculate change in debt.. Which is using for FCFE

  34. Krishna says:

    Sir GM, when & why we add TDS on payment to Reserve & Surplus ? and same for depreciation also (Its both are going to add but amount written in minus) pls help thanks

  35. Dhinakaran says:

    Karthik, The interest and dividend income (in other income) in P/L statement – Is this interest and dividend generated from the investing the Reserves and Surplus ?

  36. Manish Parab says:

    hello Karthik , Happy new year to you, thanks for Sharing all this information. I have a doubt regarding ShareHolders Equity, if Asset = Liabilities then Asset – Liabilities = 0 , which in-turn means ShareHolders Equity = 0 ?

    • Karthik Rangappa says:

      Thanks Manish. Wishing you the same.

      Its ‘Assets = Liabilities + Shareholders equity’

      Which makes Share holders equity = Assets – Liabilities.

  37. Sanket says:

    Does the company have all its reserves mentioned above in cash?

  38. James says:

    Respected Sir,

    Need help in a fundamental concept !!!

    ‘Security Premium Reserve’ represents extra amount paid for the shares. Haven’t got this! Sir, please define it with reference (or extension, if required) to your Story in Chapter 4 &5 of Module 1 for conceptual understanding.
    +
    Also, please clarify if that extra amount (premium) points to share price on stock exchange? E.g.: share price for AMARAJABAT=848.15/per share on BSE(4-Mar-17). Does that mean Security Premium Reserve (Extra Price for issues)=(848.15-Real FV)x No. of Shares.???
    (or)
    If it points to extra price paid during bids in book building process during IPO(if cutoff>bid price), but there you replied in a comment that amount over cut off is refunded ?
    (or)
    shares were bought later at FV price(not as listed on stock exchange), if yes, who bought common people or … ?
    (or)
    company issued extra shares later on that were not traded but sold to only some buyers who paid extra (if yes, on what price, FV or listed price on stock exchanges) ?
    (or)… … …???

    Please add a simple equation/formula as well in your example. I hope I have made my confusion/lack of understanding clear.

    Sorry for troubling you on this topic here.
    Thanks a lot in advance.

    • Karthik Rangappa says:

      Security premium reserve is the amount excess of the FV, collected by the company – usually at the time of IPO/FPO. Yes, it is share price minus the FV. However, I’m not too sure about this – I guess an average price over ‘n’ trading sessions are taken for share price.

      • James says:

        Ohhh! ok! getting it a bit !!
        Sir, please just verify once which of my UNDERSTANDINGs (same, but 1- with share price while 2- with FV) below is correct so that i can debug programming of mind clearly @ 1 go.
        ,
        UNDERSTANDING 1 –
        —————————-
        1)
        That means, if company (during IPO/FPO) issue 1lakh shares of FV 10 & shares are listed on BSE/NSE at 122.20/-, then,
        Security Premium per share = 122.20(share price) – 10(FV) = 112.20/-
        Total Security Premium this time during FPO = 112.20(SP-FV) X 1Lakh (no. of shares sold this time)
        2)
        Next FPO (after 8 years) company issues 2lakhs additional shares with FV 5 that were traded @180/-, then
        Security Reserves per share = 180(new Share price) – 5(new FV) = 175/-.
        Total Security Premium this time during FPO=175 X 2Lakh (no. of shares sold this time)
        So,
        Security Premium Reserve (in 2016) = (112.20 X 1Lakh in 2008) + (175 X 2Lakh in 2016)

        UNDERSTANDING 2 –
        —————————-
        1)
        That means, if company (during IPO/FPO) issue 1lakh shares of FV 10 & shares are listed on BSE/NSE at 122.20/- but firstly bought by institutions/company/merchant bankers/lead managers at FV 15 & then sold by them at exchange to earn profit @122.20/-, then,
        Security Premium per share = 15(bought FV) – 10(issued FV)=5
        Total Security Premium this time during FPO = 5 X 1Lakh (no. of shares sold this time)
        2)
        Next FPO (after 8 years) company issues 2lakhs additional shares with FV 5 that were traded @180/- but bought at FV 15, then
        Security Reserves per share = 15(bought FV) – 5 (new issued FV) = 10
        Total Security Premium this time during FPO =10 X 2Lakh (no. of shares sold this time)
        So,
        Security Premium Reserve (in 2016) = [5 X 1Lakh (in 2008)] + [10 X 2Lakh (in 2016) ]
        !!! –
        Your one line answer will program my mind firmly !!!
        Thanks for your kind attention to my queries!

        • Karthik Rangappa says:

          Understanding 1 is right. Although, I’m a little uncertain of how the SPR is treated over a long term on the balance sheet. Also, please note the premium is over the issue price and not the traded price.

          • James says:

            Thanks a lot sir for your reply, now it is
            CRYSTAL CLEAR !!!
            Also, I understood here how a company makes real money just selling shares of real monetary value (FV) of 10/- at price of (issue price) 122.20/-.
            WOW!!! That’s really a wonderful way to get deserving (monetary) appreciation of years of hard work.

            Thank you sir & HATS OFF to your efforts (& that of Zerodha Varsity) to understand our queries & reply to it.

          • Karthik Rangappa says:

            Good luck, James!

            Happy reading.

  39. James says:

    Respected Sir,
    Just one more query!!
    as the share price of company increases on stock exchanges, the valuation of company would also have increased, right?
    Where the valuation numbers on balance sheet resides, after all valuation shows company’s financial position?
    or
    Should i ask how valuation of company affect its (which of the) financial statements?

    Thanks a lot!!!

    • Karthik Rangappa says:

      Yes.

      No, ideally, the company should not focus on valuations. Remember, valuation is a bi product and not the main agenda of the company. However, market cap of the company gives you a rough estimate of the size of the company.

      • James says:

        Ohh!! But, can I say that the Valuation affects Revenue (Security Premium Reserves) part of the Balance Sheet when the company undergoes IPO or FPO or issue new shares to public or any investor/s ?
        ?
        In that case, “Shareholder’s fund -> Share capital” will increase as per FV (10/-), while “Shareholder’s fund -> Reserve & Surplus -> Security Premium Reserves” will increase as per (share price/issued price – FV) (150.10-10).
        ?

  40. MSP says:

    Hi Karthik,

    If Reserve and Surplus is showing negative, this means company has incurred a loss, however , rest of the parameters are good, in this case, which other specific point needs to be looked on, to take a call on the company.

    Regards,
    MSP

  41. paranthaman says:

    why do an investee company looking out to get invested from a company with more reserves and surplus ?and why cant they accept when the investor have enough balance to invest their needs.

    • Karthik Rangappa says:

      Sorry, I’m unable to figure out the question. Can you please elaborate?

      • Paranthaman says:

        Sorry that i confused u 🙁 , Actually, company mandate has told us to find an investor with 200 reserves and surplus. And we have found somebody with less than 200, that is more than enough for the time , But he refused to accept the investment. is there any way technically he is trying to maintain the bad accounts ?

        i don’t know how to explain more precisely.

  42. Akash says:

    I have two queries:
    1. Why would a company avail loan for its working capital requirement when interest is to be paid by the company and although company is making good profits?
    2. U said “Share capital = No. of shares x FV”. But market cap is defined as “Market cap = No. of shares x Share price”. Does the share capital and market capital differ only in terms of FV and Actual share price only?

    • Karthik Rangappa says:

      1) Sometimes the money could be stuck in receivables etc. In such a case, you will need to avail a WC loan. This is a common practise, especially with manufacturing companies.

      2) Both are different and yes, thats how they differ.

  43. Ayush says:

    Why the general reserve is deducted from the surplus?

    • Karthik Rangappa says:

      Its not deducted, its a part of the Reserves and surplus.

      • Venkatp says:

        Let me thank you for making efforts to create a webpage for explaining Balance sheet / P&L of Banks and NBFC. I am sure it will be up in a short time.
        I have a doubt & request you to kindly clarify the same
        For a company A the long term borrowing(LTB) is shown as 78000 crore and short term borrowing(STB) is 15000 crore. In P&L financial cost is shown as 2500 crore ? I was trying to work out the interest rate of 78000+15000 = 93000 crore on payment of 2500 crore interest — it works out to 2.5% approximately .Even if we consider LTB only then interst rate works out to 3.2 % . Seems to be an erroneous calculation . Let me know how the interest rate is calculate on an approximate basis for LTB+STB

        • Karthik Rangappa says:

          You can capitalize your interest cost. For example check out Hindalco’s balance sheet. Match their debt to interest payment. You will note that they are paying out much less finance charge in P&L. However, when you see the associated note, you will see the actual interest paid.

  44. Kabilan says:

    Hi Karthick,

    Thanks for your effort and time in making this wonderful tutorial. I recently joined Zerodha and very new to share market but I have little knowledge on Accounting.

    I have a question -> 1)Why is the surplus is coming under liabilities, even though the cash is coming in assets.
    I tried understanding a scenario, where the company decides to convert the part of surplus into cash. In such a scenario, Liability will decrease(as amount from surplus is deducted) and cash will increase(which in turn increases assets) causing imbalance in balance sheet.
    It would be a great help if you can help me in understanding this concept.

    Cheers,
    Kabilan

    • Karthik Rangappa says:

      From the companies perspective, the money in reserves and surplus belongs to the shareholders. Hence its a liability to the company. Expenditure from surplus is usually in the form of dividends and buy backs, which in turn will impact share capital, same side of the balance sheet (in case of buy back)…and in case of dividend, the cash is flushed out. Again balancing the balance sheet.

  45. Anonymous says:

    What is the difference between shareholder’s fund and share capital. I see the first contributes to the total liability and the second to the shareholder’s equity.

    • Karthik Rangappa says:

      Shareholder’s funds includes share capital and reserves. Share capital depicts how much capital the promoters brought in.

  46. deepak says:

    Sir if assets=liability then share holders equity shall be 0 all the time.

    • Karthik Rangappa says:

      Shareholders equity = assets – liability

      • deepak says:

        As this article mentions assets = liability then share holders equity is zero always.

        Share holders equity = Assets -liabilities
        Assets=liabilities
        Share holder equity = Assets- Assets (Since assets=liability)
        Share holder equity=0

  47. Anonymus says:

    Sir how to invest in zerodha and what is the minimum amount if it is allowed?

  48. deepak says:

    1. Sir in case share capital changes from previous year does this also means the outstanding shares have also changed.?

    2. How come a company can raise capital above authorized capital. Is it permitted by the law? If yes whats the purpose of authorized capital.(In case a company issues shares at premium it is inviting more money than it is authorized to).

    3. In case the company is not listed how many equity shares it can have?

    • Karthik Rangappa says:

      1) Yes
      2) Authorized capital can be changed by a board resolution of directors. Also, every corporate action leads to this change.
      3) No restriction as such.

  49. Arghya Das says:

    Hi Suppose Number Of Share Outstanding Is 170,812,500. Is It Including Promoter Group Holding Or It Is The Number Of Share Owned By Non Promoter Participant?

  50. Pradeep says:

    Hi Karthik,

    Thank you very much for the wonderful tutorial. You have made it easy to understand for a non-finance guy like me. Thank you again – for sharing your knowledge.

    Pradeep

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