Chapter 1 ACCOUNTING IN ACTION Definition of Accounting: Accounting is a services activity.

Its function is to provide quantitative information, primarily financial in nature, about economic entities that is to be useful in making economic decisions, in making reasoned choices among alternative courses of action. ---- AICPA (1970). Accounting is defined as the process of identifying, measuring, and communicating economic information to permit informed judgments and decisions by users of the information. --- AAA (1966). Objectives of Accounting: 1. Making decisions concerning the use of limited resources, including the identification of crucial decision areas and determination of objectives and goals. 2. Effectively directing and controlling an organizations human and material resources. 3. Maintaining and reporting on the custodianship of resources. 4. Facilitating social functions and controls (with respect to taxation, detection and protection of frauds, government control on public utility services, government incentives for encouraging trade and commerce, statistics on economic activities, et.). Scope of Accounting: 1. Data Creation and Collection: Historic and Predictive 2. Data Recording using Accounting Methods (GAAP) and Data Processing (Manual, Mechanical and Electronic) 3. Data Evaluation that includes: (a) Budgetary Control including Standard Costing and Variance Analysis (b) Performance Analysis (c) Cash Flow Analysis (d) Analysis and Interpretation of Accounting Information (for external and internal decision makers) (e) Auditing 4. Data Reporting to internal management (according to their demand) and external stakeholders (financial statements and notes accompanying those statements) 5. Accounting Theory in the heart of the above.

Information Needs of the Users of Financial Statements According to paragraph 9 of the Framework for the Preparation and Presentation of Financial Statements of the IASB (International Accounting Standards Board), the users of financial statements include present and potential investors, employees, lenders, suppliers and other trade creditors, customers, governments and their agencies and the public. They use financial statements in order to satisfy some of their different needs of information. These needs include the following: (a) Investors: The providers of risk capital and their advisers are concerned with the risk inherent in, and return provided by, their investments. They need information to help them determine whether they should buy, hold or sell. Shareholders are also interested in information which enables them to assess the ability of the enterprise to pay dividends. (b) Employees: Employees and their representative groups are interested in information about the stability and profitability of their employers. They are also interested in information which enables them to assess the ability of the enterprise to provide remuneration, retirement benefits and employment opportunities. (c) Lenders: Lenders are interested in information that enables them to determine whether their loans, and the interest attaching to them, will be paid when due. (d) Suppliers and other trade creditors: Suppliers and other creditors are interested in information that enables them to determine whether amounts owing to them will be paid when due. Trade creditors are likely to be interested in an enterprise over a shorter period than lenders unless they are dependent upon the continuation of the enterprise as a major customer. (e) Customers: Customers have an interest in information about the continuance of an enterprise, especially when they have a long-term involvement with, or are dependent on, the enterprise. (f) Governments and their agencies: Governments and their agencies are interested in the allocation of resources and, therefore, the activities of enterprises. They also require information in order to regulate the activities of enterprises, determine taxation policies and as the basis for national income and similar statistics. (g) Public: Enterprises affect members of the public in a variety of ways. For example, enterprises may make a substantial contribution to the local economy in many ways including the number of people they employ and their patronage of local suppliers. Financial statements may assist the public by providing information about the trends and recent developments in the prosperity of the enterprise and the range of its activities.

Role of Accounting: Role as watchdogs scorekeeping function (recording data for a later evaluation of performance) Role as helpers (1) attention directing function (reporting and interpretation of information for the purpose of focusing on inefficiencies of operation or opportunities for improvement); and (2) problem solving function (presenting a concise analysis of alternative courses of action) Role as decision maker regarding information decision for choosing needed information for action choice Role as an associate with business world maintaining records and documents of organizations, preparation and presentation of financial statements through which capital investments are invited, creditworthiness is verified and basis for income tax determination is found Role as a professional doing auditing, tax consultancy, other professional services as a person of trust Role as technicians being skilled in business management techniques working as a part of management and as an external consultant on different issues such as accounting system design, short- and long-term planning, etc.

Functions of Accounting: Types of Accountants Private Accountants (accountants employed in private firms) Public Accountants (independent professional accountants for public services) Government Accountants (accountants employed in government units) Areas of Accounting Management Accounting General accounting, Cost accounting, Preparation of budgets, Internal audit Audit of financial Advisory services to statements management Financial Accounting Preparation of financial statements

Tax Accounting Preparation of tax return, Tax planning Preparation of tax return, Tax planning

Forensic Accountants (accountants hired by both private and government units)

Preparation of General accounting, Review of tax financial Cost accounting, return, Help to statements, Preparation of taxpayers, Review of financial budgets, Internal Writing statements, audit regulation, Writing regulation, Investigation Investigation of of violation of violation of laws laws 1. Detection of: Preparators of theft and frauds in corporate entities; money-laundering; identity-theft;

 tax evasion; insurance frauds such as arson; 2. Identification of materials assets in divorces

Parties involved with Accounting and Users of Accounting Information:

Accounting StandardsSetters
Preparers of Financial Statements

Generally Accepted Accounting Principles (GAAP) Financial Statements Audit Reports Generally Accepted Auditing Standards (GAAS)

Users of Accounting Information

Auditors

Auditing StandardsSetters

Internal Users: Management

External Users:
Investors (owners) Employees Lenders Suppliers and other trade creditors Customers Government and its representatives Public Regulatory agencies

Accounting as an Information System: An accounting system consists of the personnel, procedures, devices, and records used by an organization (1) to develop accounting information and (2) to communicate this information to decision makers. The basic purpose of the accounting is to meet the organizations needs for accounting information as efficiently as possible. Many factors affect the structure of the accounting information system (AIS) within a particular organization. Among the most important are (1) the organizations needs for accounting information and (2) the resources available for operation of the system. Viewing accounting as an information system focuses attention on the information accounting provides, the users of the information, and the support for financial decisions that is provided by the information. These relationships are depicted below:

ACCOUNTING AS AN INFORMATION SYSTEM

Information Users:
Managers Investors (owners) Employees Lenders Suppliers and other trade creditors Customers Government and its representatives Public Regulatory agencies

Financial Information Provided: - Profitability - Financial Position - Cash Flows

Decisions Supported:
- Performance evaluations - Stock investments - Tax strategies - Labour relations - Resource allocations - Lending decisions - Borrowing

Output of Accounting Financial Statements: The output of accounting process is called financial statements. In the general sense of the word, a statement is simply a declaration of something believed to be true. A financial statement is simply a monetary declaration of what is believed to be true about an enterprise. When accountants prepare financial statements, they are describing in financial terms certain attributes of the enterprise that they believe fairly represent its financial activities. According to paragraph 7 of International Accounting Standard (IAS) 1, a complete set of financial statements includes: (a) balance sheet; (b) income statement; (c) statement of changes in equity; or statement of changes in retained earnings; (d) cash flow statement; and (e) accounting policies and explanatory notes.

Accounting Process/Cycle: The sequence of accounting procedures used to record, classify and summarize accounting information is often termed as accounting cycle. In another way, the procedures established by every business unit to provide the data to be reported on the financial statements are collectively referred to as the accounting process or accounting cycle. The term cycle indicates that these procedures must be repeated continuously to enable the business to prepare new up-to-date financial statements at reasonable intervals. In a broader coverage, the accounting cycle includes the following steps:

1.

2. 3. 4. 5.

6.

7.

Identification of transactions: Occurrence of transactions explicitly (affecting the concerned business unit for an involvement with an external party) or implicitly (such as depreciation occurring as the result of ownership of a fixed asset, consumption of office supplies purchased earlier and recorded as asset), where the financial effect is measurable in definite monetary terms and then preparation or collection of source documents of those transactions to ensure their objectivity of occurrence. Journalizing (Journalize or record transactions): Enter all transactions in the journal by analyzing them into debit(s) and credit(s) accounts, thus creating a chronological record of events. Posting to the ledger (Posting to ledger accounts): Post debits and credits from the journal to the proper ledger accounts with a running balance, thus creating a record classified by accounts. Preparation of a trial balance: Prove the equality of debits and credits in the ledger. Adjusting entries (Make end-of-period adjustments): Make adjusting entries in the general journal and post to ledger accounts. The purpose is to assign to each accounting period appropriate amounts of revenue and expenses Adjusting entries are made to: (i) convert assets to expenses result from cash being paid prior to an expense being incurred, (ii) convert liabilities to revenues result from cash being received prior to revenue being earned, (iii) accrue unpaid expenses result from expenses being incurred before cash is paid, and (iv) accrue uncollected revenue result from revenue being earned before cash is received. Preparation of an adjusted trial balance: Prove again the equality of debits and credits in the ledger. Note that the figures mentioned in the adjusted trial balance are the amounts used in the preparation of financial statements. Preparation of financial statements and appropriate disclosures: Financial statements prepared include: income statement (showing the results of operations of the concerned enterprise for the period concerned), statement of changes in retained earnings (showing the changes in the retained earnings during the period), balance sheet (showing the financial position of the enterprise at the end of the period), and cash flow statement (showing the results of cash activities for the period). Financial statements should be accompanied by notes disclosing facts and accounting policies necessary for the proper interpretation of those statements.

8.

9. 10.

Closing entries (Journalize and post the closing entries): The closing entries zero the revenue, expense, and dividends accounts, making them ready for recording the events of the next accounting period. These entries also bring the balance in th Retained Earnings account up-to-date. Preparation of a post-closing trial balance: This step ensures that ledger remains in balance after posting of the closing entries. Reversing entries: Reversing entries eliminate those accounts originated at the time of giving adjusting entries, which are not listed in the chart of accounts (the complete list of all ledger accounts). This step ensures that ledger remains with the accounts listed in the chart of accounts.

Financial Statements According to paragraph 7 of IAS 1 (revised 1997), Presentation of Financial Statements, a complete set of financial statements includes the following components: (a) balance sheet; (b) income statement; (c) a statement showing either: (i) all changes in equity [i.e., statement of changes in equity]; or (ii) changes in equity other than those arising from capital transactions with owners and distributions to owners [i.e., statement of changes in retained earnings]; (d) cash flow statement; and (e) accounting policies and explanatory notes. Balance Sheet: It refers to the list of an entitys (enterprises) assets, liabilities and owners equity as of a specific date. It is also called a statement of financial position. Asset means a resource controlled by the enterprise as a result of past events and from which future economic benefits are expected to flow to the enterprise. Liability means a present obligation of the enterprise arising from past events, the settlement of which is expected to result in an outflow from the enterprise of resources embodying economic benefits. Equity means the residual interest in the assets of an enterprise after deducting all its liabilities. Income Statement: It refers to the list of an entitys (enterprises) revenues, expenses and net income or loss for a specific period. It is also called a operating statement or a statement of operation. Income is defined as the increases in economic benefits during the accounting period in the form of inflows or enhancements of assets or decreases of liabilities that result in increases in equity, other than those relating to contributions from equity participants. The term revenue means the gross inflow of economic benefits during the period arising in the course of the ordinary activities of an enterprise when those inflows result in increases in equity, other than increases relating to contributions from equity participants. Expenses means the decreases in economic benefits during the accounting period in the form of outflows or depletions of assets or incurrence of liabilities that result in decreases in equity, other than those relating to distributions to equity participants. Statement Changes in Retained Earnings: It refers to the financial statement showing summary of changes in the retained earnings during a specific period. Retained earnings is the portion of owners (shareholders) equity created by earning net income and retaining the related resources in the business. Statement Changes in Equity:

It refers to the financial statement showing summary of changes in owners/shareholders equity (i.e., the capital and retained earnings) during a specific period. Cash Flow Statement (CFS): It is the financial statement that reports the impact of a firms operating, investing, and financing activities on cash flows during a specific period (between two balance sheet dates). Operating activities are the principal revenue-producing activities of the enterprise and other activities that are not investing or financing activities. Investing activities are the acquisition and disposal of long-term assets and other investments not included in cash equivalents. Financing activities are activities that result in changes in the size and composition of the equity capital and borrowings of the enterprise. The main purpose of a CFS is to provide information to decision makers about a companys cash inflows and outflows during the period. Accounting Policies and Explanatory Notes: According to paragraph 21 of IAS 1, Accounting policies are the specific principles, bases, conventions, rules and practices adopted by an enterprise in preparing and presenting financial statements. Explanatory Notes are the important accompanying part of the basic financial statements. According to the principle of adequate disclosure (the most important accounting policy to the users of accounting information), the financial statements should be accompanied by any information necessary information for the statements to be interpreted properly. Since the basic components of the financial statements are always a summary presentation, most disclosures appear within the several pages of notes that accompany the financial statements. The explanatory notes to the financial statements of an enterprise should (i) present information about the basis of preparation of the financial statements and the specific accounting policies selected and applied for significant transactions and events; (ii) disclose the information required by regulatory provisions that is not presented elsewhere in the financial statements; and (iii) provide additional information which is not presented on the face of the financial statements but that is necessary for a fair presentation. Relationships among Financial Statements: All the financial statements are related to an accounting period, which is usually a year. At the beginning and ending points in time of that accounting period, an enterprise prepares the balance sheet that gives a static look in financial terms of where the enterprise stands. The other financial statements (income statement, statement of changes in equity/retained earnings, and cash flows statement) cover the intervening period of time between the two balance sheets and help explain important changes that occurred during the period. From balance sheet, we understand where an enterprise stands financially at two points in time. From income statement, we understand the changes that occurred during the intervening period in terms of the enterprises profit-seeking activities. From statement of changes in retained earnings, we understand the

10

changes that occurred during the intervening period in terms of the enterprises earnings and distribution/appropriation of those earnings. From statement of changes in equity, we understand the changes that occurred during the intervening period in terms of the enterprises earnings and distribution/appropriation of those earnings and in addition the changes in terms of capital transactions of the owners. From cash flows statement, we understand the changes that occurred during the intervening period in terms of the enterprises cash activities.

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Specimen Financial Statements of BEXIMCO INFUSIONS LTD.: Below is the presentation of two-year comparative financial statements of Beximco Infusions Ltd. STATEMENT OF CHANGES IN INCOME STATEMENT RETAINED EARNINGS For the Year Ended 31 December For the Year Ended 31 December 2002 2001 2002 2001 Taka Taka Taka Taka Revenue from 328,288,0 314,977,2 Retained Earnings Sales 05 27 at Cost of Goods (192,857, (172,353, beginning of the 117,600, 80,411,0 Sold 430) 390) year 234 15 135,430, 142,623, Add: Net Profit 35,003,4 51,168,7 Gross Profit 575 837 after Tax 85 24 Operating (76,119,1 (66,464,7 Less: Expenses 17) 23) Appropriation for Profit from 59,311,4 76,159,1 Tax-holiday (12,180, (13,979, Operation 58 14 Reserve 260) 505) (20,509,0 (19,847,9 Less: Finance Cost 22) 34) Appropriation for Net Profit Dividend of (10,000, before Previous Year 000) Contribution to 38,802,4 56,311,1 Retained WPPF 36 80 Earnings at Contribution to (1,847,73 (2,681,48 end of the year 130,423 117,600 WPPF 5) 5) ,459 ,234 Net Profit 36,954,7 53,629,6 before Tax 01 95 Income Tax (1,951,21 (2,460,97 Expense 6) 1) Net Profit after 35,003,4 51,168,7 Tax 85 24

BALANCE SHEET As on 31 December 2002 ASSETS: Taka Non-Current 322,788, Assets 211 Property, Plant and Equipment 322,189,0 Carrying Value 61 Long-term Security Deposit 599,150 232,219, Current Assets 916 Inventories 84,028,95

2001 Taka 328,278, 824 327,679,6 74 599,150 189,808, 694 65,958,35

CASH FLOWS STATEMENT For the Year Ended 31 December 2002 2001 Taka Taka Cash Flows from Operating Activities Cash Flows from Investing Activities Cash Flows from Financing 24,878,1 44 (6,368,1 82) 50,141,3 80 (249,754 )

(24,057,

(46,287,

12

Accounts Receivable Advances and Deposits Cash and Cash Equivalent Total Assets EQUITY & LIABILITIES Shareholders' Equity Issued Share Capital Tax-holiday Reserve Retained Earnings Non-Current Liabilities Long-term Borrowing Deferred Liability Provision for Gratuity Current Liabilities Short-term Borrowings Long-term Borrowing Current Maturity Loan from Associated Undertaking 17% Debenture Current Maturity Creditors and Other Accrued Expenses Dividend Payable Provision for Income Tax Payables

4 105,971,6 68 41,624,54 2 594,752 555,008, 127 341,666, 665 100,000,0 00 111,243,2 06 130,423,4 59 16,342,1 10 12,790,43 7

1 81,833,34 0 35,875,21 0 6,141,793 518,087, 518 316,663, 180 100,000,0 00 99,062,94 6 117,600,2 34 34,629,1 64 31,561,45 4

Activities Net Increase/ (Decrease) in Cash & Cash Equivalents Cash & Cash Equivalents at beginning of the Year Cash & Cash Equivalents at end of the Year

003) (5,547, 041) 6,141,79 3

461) 3,604,1 65 2,537,62 8 6,141,7 93

594,752

3,551,673 196,999, 352 103,616,4 55 38,371,31 1

3,067,710 166,795, 174 81,156,94 0 31,561,45 4 10,775,00 0 3,222,673 22,428,73 0 10,502,89 7 1,145,350 6,002,130

1,363,964 35,472,18 6 10,965,72 3 415,000 6,794,713

13

Total Liabilities Total Liabilities and Shareholders' Equity

213,341, 462 555,008, 127

201,424, 338 518,087, 518

Profit versus Cash Flow: There is a misconception that a profitable enterprise has no liquidity (cash availability) problem. Under conventional accrual basis accounting, in measuring periodic profit, periodic revenue is offset by all the expenses incurred in producing that revenue. Revenue is the price of goods and services rendered during a given accounting period. Expenses are the costs of the goods and services used up in the process of earning revenue. Here the accounting principle followed is called the matching principle which ascertains the relationship between revenues and expenses. Here timing is an important factor in matching (offsetting) revenue with related expenses. In case of preparing annual income statement, one years expenses are offset against only that years revenues. Thus it is often required at year-end to provide adjusting entries to calculate the periodic revenues and expenses. Adjusting entries are made to: (i) convert assets to expenses result from cash being paid prior to an expense being incurred, (ii) convert liabilities to revenues result from cash being received prior to revenue being earned, (iii) accrue unpaid expenses result from expenses being incurred before cash is paid, and (iv) accrue uncollected revenue result from revenue being earned before cash is received. Due to this type of adjusting entries, profit and cash flows are not an alternative to other. In case of full cash transactions (that means, there is no credit transactions), profit will be fully realized in cash, but this is only cash inflow from operating activities (in case of loss, this will be an operating outflow of cash). Here, cash flow from operating activities can be shown as follows: Cash flow from operating activities Net Profit Noncash Noncash + Income Expense Nonoperating Income Nonoperating Expense

Cash flows (inflow or outflow) may be generated by financing activities and also by investing activities. Thus, due to cash flows from other activities (financing or investing), an enterprise may have adequate liquidity but that does not mean that it is a profitable enterprise. It is noted here that the wealth of the owners of an enterprise (shareholders in case of corporate entities) is based upon the movement of cash and accounting policies and conventions should have no effect upon the value of the enterprise. This means that pure accounting or book entries (noncash items) should be excluded in case of financial management decisions.

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Analysis of Financial Statements Financial Statement Analysis Financial statement analysis involves the application of analytical tools to financial statements and supplemental data included with the financial statements to enhance the ability of decision makers to make optimal decisions. How can we determine: The ability of an organization to pay loans? Whether we are earning a fair return on our investment? The adequacy of cash flow to pay operating expenses? How to improve the overall performance of the company? The best answer is: Financial Statement Analysis. Limitations of Financial Statement Analysis When comparing companies and interpreting financial statement analysis, differences in accounting methods and cost flow assumptions need to be considered. Ratios of a company should be compared with industry standards. Rather than focus on a single ratio, decision makers need to evaluate a company by comparing ratios to those of previous years, budgeted amounts, and industry standards. Financial statements, and thus financial ratios, are prepared using historical costs and are not adjusted for the effects of increasing prices.

Horizontal analysis Horizontal analysis is used to analyze changes in accounts occurring between years. Example BEXIMCO INFUSIONS LIMITED INCOME STATEMENT for the Year Ended December 31, 2001 and 2002 2002 2001 Increase Increas e (Decrease) (Decrea se) Taka Taka Taka % Revenue from Sales 328,288,00 314,977,22 13,310,778 4.2 5 7 Cost of Goods Sold (192,857,43 (172,353,39 (20,504,040 11.9 0) 0) ) Gross Profit 135,430,5 142,623,8 (7,193,262 (5.0) 75 37 ) Operating Expenses (76,119,11 (66,464,72 (9,654,394 14.5 7) 3) ) Administrative (2,829,105) (2,534,032) (295,073) 11.6 Expenses Selling & Distribution Expenses (73,290,012 (63,930,691 (9,359,321) 14.6 ) )

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Profit from Operation Finance Cost

59,311,45 76,159,11 8 4 (20,509,022 (19,847,934 ) ) Net Profit before Contribution to 38,802,43 56,311,18 WPPF 6 0 Contribution to WPPF (1,847,735) (2,681,485) Net Profit before 36,954,70 53,629,69 Tax 1 5 Income Tax Expense (1,951,216) (2,460,971) Net Profit after Tax 35,003,48 51,168,72 5 4

(16,847,65 6) (661,088) (17,508,74 4) 833,750 (16,674,99 4) 509,755 (16,165,23 9)

(22.1) 3.3 (31.1) (31.1) (31.1) (20.7) (31.6)

Changes in the Income Statement are analyzed above using the horizontal analysis. A few results with respect to the income statement items of Beximco Infusions Ltd. have been given below to show the changes from 2001 to 2002: Sales Cost of goods sold Total operating expenses Operating income Net income increased by increased by increased by decreased by decreased by 04.2% 11.9% 14.5% 22.1% 31.6%

Note that focusing on net income without looking at other changes in income statement items would definitely be a mistake in this case. From 2001 to 2002, although sales revenue has been increased by an small amount (4.2%), the gross profit has been decreased by higher figure (5.0%) and operating income decreased by over 22%. Net after-tax income has been decreased by a greater amount (31.6%). Changes in the other financial statements are analyzed below using the horizontal analysis. BEXIMCO INFUSIONS LIMITED STATEMENT OF CHANGES IN RETAINED EARNINGS For the Year Ended December 31, 2001 and 2002 2002 2001 Increase Increase (Decrease) (Decreas e) Taka Taka Taka % Retained Earnings at beginning of the 117,600,2 80,411,01 37,189,219 46.2 year 34 5 Add: Net Profit after 35,003,48 51,168,72 (16,165,239 (31.6) Tax 5 4 ) Less: Appropriation for Tax-holiday (12,180,2 (13,979,5 1,799,245 (12.9) Reserve 60) 05) Less: Appropriation for Dividend of (10,000,0 - (10,000,000 Previous Year 00) ) Retained Earnings at end of 130,423, 117,600, 12,823,22 10.9

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the year

459

234

BEXIMCO INFUSIONS LIMITED BALANCE SHEET as on December 31, 2001 and 2002 2002 2001 Increase Increase (Decrease) (Decreas e) ASSETS: Taka Taka Taka % Non-Current Assets 322,788, 328,278, (5,490,613 (1.7) 211 824 ) Property, Plant and Equipment 322,189,0 327,679,6 (5,490,613) (1.7) Carrying Value 61 74 Long-term Security 599,150 599,150 0 0.0 Deposit Current Assets 232,219, 189,808, 42,411,22 22.3 916 694 2 Inventories 84,028,95 65,958,35 18,070,603 27.4 4 1 Accounts Receivable 105,971,6 81,833,34 24,138,328 29.5 68 0 Advances and 41,624,54 35,875,21 5,749,332 16.0 Deposits 2 0 Cash and Cash 594,752 6,141,793 (5,547,041) (90.3) Equivalent Total Assets 555,008, 518,087, 36,920,60 7.1 127 518 9

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EQUITY AND LIABILITIES

2002

Taka 341,666, 665 100,000,0 00 Tax-holiday Reserve 111,243,2 06 Retained Earnings 130,423,4 59 Non-Current 16,342,1 Liabilities 10 Long-term Borrowing - Net of Current 12,790,43 Maturity (Secured) 7 Deferred Liability - Provision for 3,551,673 Gratuity Current Liabilities 196,999, 352 Short-term Borrowings 103,616,4 (Secured) 55 Long-term Borrowing - Current 38,371,31 Maturity (Secured) 1 Loan from Associated Undertaking (Unsecured) 17% Debenture - Current Maturity 1,363,964 (Secured) Creditors and Other Payables 35,472,18 6 Accrued Expenses 10,965,72 3 Dividend Payable 415,000 Provision for Income 6,794,713 Tax Total Liabilities and Shareholders' 555,008, Equity 127 Shareholders' Equity Issued Share Capital Trend Analysis:

2001 Increase Increase (Decrease) (Decreas e) Taka Taka % 316,663, 25,003,48 7.9 180 5 100,000,0 0 0.0 00 99,062,94 12,180,260 12.3 6 117,600,2 12,823,225 10.9 34 34,629,1 (18,287,05 (52.8) 64 4) 31,561,45 (18,771,017 (59.5) 4 ) 3,067,710 483,963 15.8 166,795, 30,204,17 174 8 81,156,94 22,459,515 0 31,561,45 6,809,857 4 10,775,00 (10,775,000 0 ) 3,222,673 (1,858,709) 22,428,73 13,043,456 0 10,502,89 462,826 7 1,145,350 (730,350) 6,002,130 792,583 518,087, 36,920,60 518 9 18.1 27.7 21.6 (100.0) (57.7) 58.2 4.4 (63.8) 13.2 7.1

It is also a horizontal analysis of financial statements over several years. It can be used to build prediction models to forecast financial performance in the future and to identify problem areas by looking for sudden or abnormal changes in accounts. Vertical Analysis

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Vertical analysis compares financial statements of different companies and financial statements of the same enterprise across time after controlling for differences in size. Common size financial statements are statements in which all items have been restated as a percentage of a selected item on the statement. Vertical analysis uses common size financial statements to remove size as a relevant variable in ratio analysis. Comparative Balance Sheets Individual asset accounts are stated as a percentage (%) of total assets. Individual liability and stockholders equity are stated as a percentage (%) of total liabilities and shareholders equity (L & SE).

BEXIMCO INFUSIONS LIMITED COMMON SIZE BALANCE SHEETS As on December 31, 2001 and 2002 2002 2001 ASSETS: Non-Current Assets Property, Plant and Equipment Carrying Value Long-term Security Deposit Current Assets Inventories Accounts Receivable Advances and Deposits Cash and Cash Equivalent Total Assets EQUITY AND LIABILITIES Shareholders' Equity Issued Share Capital Tax-holiday Reserve Retained Earnings Taka 322,788 ,211 322,189, 061 599,150 232,219 ,916 84,028,9 54 105,971, 81,833,340 668 41,624,5 35,875,210 42 594,752 6,141,793

2002 2001 Common Common Size Size Taka % % 328,278,8 58.2 63.4 24 327,679,67 58.1 63.2 4 599,150 0.1 0.1 189,808,6 41.8 36.6 94 65,958,351 15.1 12.7 19.1 7.5 0.1 100.0 61.6 18.0 20.0 23.5 15.8 6.9 1.2 100.0 61.1 19.3 19.1 22.7

555,008 518,087,5 ,127 18 341,666 ,665 100,000, 000 111,243, 206 130,423, 316,663,1 80 100,000,00 0 99,062,946 117,600,23

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459 Non-Current 16,342, Liabilities 110 Long-term Borrowing - Net of Current 12,790,4 Maturity (Secured) 37 Deferred Liability - Provision for 3,551,67 Gratuity 3 Current Liabilities 196,999 ,352 Short-term Borrowings 103,616, (Secured) 455 Long-term Borrowing - Current Maturity 38,371,3 (Secured) 11 Loan from Associated Undertaking (Unsecured) 17% Debenture - Current Maturity 1,363,96 (Secured) 4 Creditors and Other Payables 35,472,1 86 Accrued Expenses 10,965,7 23 Dividend Payable 415,000 Provision for Income 6,794,71 Tax 3 Total Liabilities and Shareholders' 555,008 Equity ,127

4 34,629,16 4 31,561,454 3,067,710 166,795,1 74 81,156,940 31,561,454 10,775,000 3,222,673 22,428,730 10,502,897 1,145,350 6,002,130 518,087,5 18

2.9 2.3 0.6 35.5 18.7 6.9 0.2 6.4 2.0 0.1 1.2 100.0

6.7 6.1 0.6 32.2 15.7 6.1 2.1 0.6 4.3 2.0 0.2 1.2 100.0

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Common Size Comparative Income Statements Percentages are based on net sales. The gross profit percentage is usually closely watched. BEXIMCO INFUSIONS LIMITED COMMON SIZE INCOME STATEMENTS For the Year Ended December 31, 2001 and 2002 2002 2001 2002 2001 Common Common Size Size Taka Taka % % Revenue from Sales 328,288,00 314,977,2 100.0 100.0 5 27 Cost of Goods Sold (192,857,43 (172,353, (58.7) (54.7) 0) 390) Gross Profit 135,430,5 142,623, 41.3 45.3 75 837 Operating Expenses (76,119,11 (66,464, (23.2) (21.1) 7) 723) Administrative (2,829,105) (2,534,03 (0.9) (0.8) Expenses 2) Selling & Distribution Expenses (73,290,012 (63,930,6 (22.3) (20.3) ) 91) Profit from 59,311,45 76,159,1 18.1 24.2 Operation 8 14 Finance Cost (20,509,022 (19,847,9 (6.2) (6.3) ) 34) Net Profit before Contribution 38,802,43 56,311,1 11.8 17.9 to WPPF 6 80 Contribution to WPPF (1,847,735) (2,681,48 (0.6) (0.9) 5) Net Profit before 36,954,70 53,629,6 11.3 17.0 Tax 1 95 Income Tax Expense (1,951,216) (2,460,97 (0.6) (0.8) 1) Net Profit after Tax 35,003,48 51,168,7 10.7 16.2 5 24 Beximco Pharmaceutical Ltd. (BPL) & Beximco Infusions Ltd. (BIL) COMMON SIZE INCOME STATEMENTS For the Year Ended December 31, 2002 BPL BIL BPL BIL Common Common Size Size Taka Taka % % 2,522,942, 328,288,0 Revenue from Sales 523 05 100.0 100.0 Cost of Goods Sold (1,620,493 (192,857,4 (64.2) (58.7)

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Gross Profit Operating Expenses Administrative Expenses Selling & Distribution Expenses Profit from Operation Other Income Finance Cost Net Profit before Contribution to WPPF Contribution to WPPF Net Profit before Tax Income Tax Expense Net Profit after Tax

,149) 902,449,3 74 (357,339, 989) (79,926,75 9) (277,413,2 30) 545,109,3 85 7,266,435 (170,994,4 95) 381,381,3 25 (19,148,86 2) 362,232,4 63 (20,552,41 5) 341,680,0 48

30) 135,430,5 75 (76,119,1 17) (2,829,105 ) (73,290,01 2) 59,311,45 8 0 (20,509,02 2) 38,802,43 6 (1,847,735 ) 36,954,70 1 (1,951,216 ) 35,003,48 5

35.8 (14.2) (3.2) (11.0) 21.6 0.3 (6.8) 15.1 (0.8) 14.4 (0.8) 13.5

41.3 (23.2) (0.9) (22.3) 18.1 0.0 (6.2) 11.8 (0.6) 11.3 (0.6) 10.7

Beximco Pharmaceutical Ltd. (BPL) & Beximco Infusions Ltd. (BIL) COMMON SIZE BALANCE SHEETS As on December 31, 2002 BPL BIL BPL BIL Common Commo Size n Size ASSETS: Taka Taka % % 4,780,464, 322,788,2 Non-Current Assets 825 11 70.7 58.2 1,982,226, 232,219,9 Current Assets 375 16 29.3 41.8 6,762,69 555,008, Total Assets 1,200 127 100.0 100.0 EQUITY AND LIABILITIES Shareholders' 4,441,096, 341,666,6 Equity 192 65 65.7 61.6 Non-Current 812,591,9 16,342,11 Liabilities 99 0 12.0 2.9 1,509,003, 196,999,3 Current Liabilities 009 52 22.3 35.5 Total Liabilities and 6,762,69 555,008, Shareholders' Equity 1,200 127 100.0 100.0

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Ratio Analysis Ratio analysis is useful in assessing the impact of transactions on ROI, residual income, EVA, and other key measures of performance. Ratio analysis provides additional information necessary to enhance the decision-making ability of the users of the information. Ratios Liquidity Ratios Formula Current Assets Current Liabilities What the ratio measures Measures the entitys liquidity. This ratio tells us the amount of current assets for every Taka of current liabilities. 2.0 is considered to be a good CR. This ratio is a stricter test of a companys ability to pay its current debts with highly liquid current assets. This ratio removes inventories and prepaid assets from the CA amount used in the calculation. A quick ratio of less than 1.0 should be of concern. Cash flow from operations is sometimes used as the numerator because all debt is paid with cash. The ratio is indication of whether enough cash is being generated from operations to pay current obligations. This gives an indication of the additional finance necessary upon an expansion of sales.

Current Ratio (CR)

Quick Ratio

Quick Assets Current Liabilities

Cash Flow from Operations to Current Liabilities Ratio Working Capital per Taka of Sales

Net Cash Provided by Operating Activities Average Current Liabilities (Working Capital Cash) Sales

Ratios Activi ty Ratios

Accounts Receivables Turnover

Formula Net Credit Sales Average Accounts Receivable

What the ratio measures This ratio tells that on average, how much was sold on account and subsequently collected accounts receivable.

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Number of Days Sales Are in Receivables

Number of Days in the Period Accounts Receivable Turnover

Inventory Turnover Ratio

Cost of Goods Sold Average Inventory

Number of Days Inventory Is Held Before Sale

Number of Days in the Period Inventory Turnover

Solvency Ratios

Cash-toCash Operating Cycle Ratio Debt to Equity Ratio Times Interest Earned

Number of Days in Inventory + Number of Days in Receivables Total Liabilities Total Stockholders Equity (Net Income + Interest Expense + Income Tax) Interest Expense

This number is the average number of days to collect a credit sale. This may vary according to the credit policy of the particular business and the industry standards. This ratio has an impact on ROI as part of the turnover of assets. Determines how many times during the time period that the value of the inventory was sold. Determining what is good is dependent on the industry and company standards. Grocery stores would have a much higher expected turnover than car dealerships. Another way to look at inventory turnover is to calculate the number of days inventory is held before it is sold. This may vary according to the particular business and industry standards. This ratio has an impact on ROI as part of the turnover of assets. Measures the length of time between the purchase of inventory and the collection of cash from sales. A solvency ratio which measures the ability to stay financially healthy over the long-run. Indicates the preference of debt or equity financing of the entity. Measures a companys ability to meet current interest payments to creditors by specifically measuring its ability to meet current-year interest payments out of current-year earnings. Especially important to bankers and other lenders. Measures the amount of cash generated from operating activities that is available to repay principal and interest in the upcoming year.

Debt Service Coverage Ratio

Cash Flow from Operations Before Interest and Taxes Interest and Principle

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Payments Cash Flow from Operations to Capital Expenditur es Ratio Degree of Financial Leverage1 (Cash Flow from Operations Total Dividends Paid) Cash Paid for Acquisitions

(Net Income + Interest Expense + Income Tax) (Net Income + Income Tax)

The ratio indicates the amount of cash generated for every Taka 1 interest and principal paid. Measures a companys ability to use cash flow from operations to finance its acquisitions of property, plant, and equipment. The ability to use cash from operations diminishes the need to acquire outside financing such as debt. Measures the impact of a change in operating income on change in earning on equity capital. Employed to plan the ratio between debt and equity so that earning per share (EPS) is improved.

Ratios Profit ability Ratios

Return on Assets

Formula [Net Income + Interest Expense (net of tax)] Average Total Assets (Net Income Preferred Dividends) Average Common Stockholders Equity (Net Income Preferred Dividends) Average Number of Common Shares Outstanding Current Market Price EPS

Return on Common Stockholde rs Equity Earnings Per Share (EPS) Price Earnings Ratio

What the ratio measures Considers the return to investors on all assets invested in the company. Interpretation is based on the companys required return on assets, industry standards, and trends. Measures the return to common stockholders as a percentage of stockholders equity. Adequacy of return is dependent on a number of factors including the risk of the investment. Used to measure performance. Used to compare the performance of companies across different industries. Important for investors as it is the relationship of earnings to dividends and the market price of a companys stock. P/E is very dependent on the industry.

The term leverage is used in financial management to describe an enterprises ability to use fixed cost assets or funds to increase the returns to its owners (equity shareholders in case of a company). The leverage associated with the employment of fixed cost assets is referred to as operating leverage, while the leverage resulting from the use of fixed cost sources of funds is known to as financial leverage. The degree of operating leverage is calculated by dividing contribution margin (i.e., sales revenue minus variable costs) with earning before interest and income tax.

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Basic Data for Calculating Ratios BEXIMCO INFUSIONS LIMITED Symbol A Total Current Assets B Quick Assets C Total Current Liabilities D Net Cash Provided by Operating Activities E Average Current Liabilities F Cash G Working Capital H Sales I Working Capital Cash J Net Credit Sales (80% of total sales) K Accounts Receivable L Average Accounts Receivable Accounts Receivable Turnover M (Times) N O P Q R S T U V W X Y A1 B1 C1 D1 E1 F1 G1 H1 I1 J1 K1 Cost of Goods Sold Ending Inventory Average Inventory Number of Days in the Period (Days) Inventory Turnover (Times) Number of Days in Inventory (Days) Number of Days in Receivables (Days) Total Liabilities Total Stockholders Equity Net Income before Interest & Tax Interest Expense Cash Flow from Operations before Interest & Taxes Interest and Principle Payments Cash Flow from Operations Total Dividends Paid Cash Paid for Acquisitions Net Income + Interest Expense (net of tax) Total Assets Average Total Assets Net Income Preferred Dividends Average Common Stockholders Equity Average Number of Common Shares Outstanding (No.) Current Market Price EPS

2002 Taka 232,219,916 148,190,962 196,999,352 24,878,144 181,897,263 594,752 35,220,564 328,288,005 34,625,812 262,630,404 105,971,668 93,902,504 2.80 Taka 192,857,430 84,028,954 74,993,653 365 2.57 142 131 Taka 213,341,462 341,666,665 57,463,723 20,509,022 48,533,142 46,940,033 37,802,792 6,368,182 55,512,507 555,008,127 536,547,823 35,003,485 329,164,923 1,000,000 Taka 232 35.00

2001 Taka 189,808,694 123,850,343 166,795,174 50,141,380 151,693,085 6,141,793 23,013,520 314,977,227 16,871,727 251,981,782 81,833,340 40,916,670 6.16 Taka 172,353,390 65,958,351 56,923,050 365 3.03 121 59 Taka 201,424,338 316,663,180 73,477,629 19,847,934 71,888,497 42,406,031 56,898,447 249,754 71,016,658 518,087,518 499,627,214 51,168,724 304,161,438 1,000,000 Taka 250 51.17

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L1

Net Income before Tax but after Interest

36,954,701

53,629,695

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Ratios Calculated from the above Data BEXIMCO INFUSIONS LIMITED Ratios Formula Current Ratio Quick Ratio Cash Flow from Operations to Current Liabilities Ratio Working Capital per Taka of Sales Accounts Receivables Turnover Number of Days Sales Are in Receivables Inventory Turnover Ratio Number of Days Inventory Is Held Before Sale Cash-to-Cash Operating Cycle Ratio Debt to Equity Ratio Times Interest Earned Debt Service Coverage Ratio Cash Flow from Operations to Capital Expenditures Ratio Degree of Financial Leverage Return on Assets Return on Current Assets Current Liabilities Quick Assets Current Liabilities Net Cash Provided by Operating Activities Average Current Liabilities (Working Capital Cash) Sales Net Credit Sales Average Accounts Receivable Number of Days in the Period Accounts Receivable Turnover Cost of Goods Sold Average Inventory Number of Days in the Period Inventory Turnover Number of Days in Inventory + Number of Days in Receivables Total Liabilities Total Stockholders Equity (Net Income + Interest Expense + Income Tax) Interest Expense Cash Flow from Operations Before Interest and Taxes Interest and Principle Payments (Cash Flow from Operations Total Dividends Paid) Cash Paid for Acquisitions (Net Income + Interest Expense + Income Tax) (Net Income + Income Tax) [Net Income + Interest Expense (net of tax)] Average Total Assets (Net Income Preferred

Symb ols AC BC DE

2002 1.18 0.75 0.14

200 1 1.14 0.74 0.33

IH JL QM NP QR S+T UV WX

0.11 2.80 131 2.57 142 272 0.62 2.80

0.05 6.16 59 3.03 121 180 0.64 3.70

YA1

1.03

1.70

B1C1

5.94

227. 82

YL1 D1F1 G1H1

1.31 0.10 0.11

1.34 0.14 0.17

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Common Stockholders Equity Earnings Per Share (EPS) Price Earnings Ratio

Dividends) Average Common Stockholders Equity (Net Income Preferred Dividends) Average Number of Common Shares Outstanding Current Market Price EPS 51.1 7 4.89

G1I1 J1K1

35.00 6.63

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