Zerodha Varsity · Module 3 · Fundamental Analysis ← Prev: Ch 3–4 · Annual Report & P&L (Part 1)
Chapters 5–6. The bottom half of the profit statement — where revenue becomes real earnings — and the first side of the balance sheet: what the company owes, and to whom.
Revenue is what a company brings in; profit is what it keeps. Between the two sits a stack of expenses, and one of them — depreciation — is a cost the company records without actually spending any cash that year. Reading the expense side is where you learn to tell a business that earns money from one that just moves it around. By the end you'll compute a company's earnings per share from scratch.
Expenses are the costs incurred to earn the revenue, each with its own schedule. Walking ARBL's FY14 expense side (₹ Cr):
| Expense line item | FY14 (₹ Cr) | Note |
|---|---|---|
| Cost of materials consumed (raw material) | 2,101 | largest — lead, alloys, separators |
| Purchases of stock-in-trade | 211 | finished goods bought in |
| Change in inventories | (29.2) | made more than sold this year |
| Employee benefit expense | 158 | ~4.5% of sales |
| Finance cost | 0.7 | interest on borrowings |
| Depreciation & amortization | 64.5 | non-cash |
| Other expenses | 434.6 | mfg, selling, admin (ads ₹27.5 Cr) |
| Total expenses | 2,941.6 |
Two line items deserve a note. Change in inventories of (₹29.2 Cr) is negative because ARBL manufactured more batteries than it sold; the cost of those extra goods is stripped from this year's cost of sales and will reappear (via "purchases of stock-in-trade") when they're sold later. And employees cost just 4.5% of sales — typical for non-IT businesses, and a quiet reality check on how thin the human-cost slice usually is.
The shape of the expense stack tells you what kind of business you're holding. A manufacturer like ARBL is dominated by raw material (2,101 of 2,942 — about 71%), so its fortunes ride on commodity prices (here, lead). A services or IT firm would instead be dominated by employee cost. Before judging whether an expense is "high," ask what a healthy stack looks like for that industry.
Depreciation spreads the cost of a long-lived asset across its useful life, instead of dumping the whole cost in the year of purchase. First, two asset types: a tangible asset has physical form (laptop, machinery, building); an intangible asset has economic value but no physical form (brand, trademark, patent). Tangibles are depreciated; intangibles are amortized — same idea, different word.
Worked example: Zerodha earns ₹1,00,000 and buys a server for ₹65,000 with a 5-year useful life. Booking the full ₹65,000 this year would crush earnings to ₹35,000 and misrepresent the business — the server keeps earning for five years. So spread it: ₹65,000 ÷ 5 = ₹13,000 charged each year. Earnings this year become ₹1,00,000 − ₹13,000 = ₹87,000.
Depreciation is the clearest split between profit and cash. Zerodha actually paid ₹65,000 in cash this year, but the P&L only shows ₹13,000. That ₹52,000 gap is exactly why the cash flow statement exists — profit and cash are not the same number.
PBT is what's left after operating expenses but before tax.
For ARBL: 3,482 − 2,941.6 = ₹540.5 Cr, then less an exceptional item of ₹3.88 Cr = ₹536.6 Cr. Exceptional (extraordinary) items are one-off costs the company doesn't expect to recur, so they're shown separately rather than buried in normal expenses.
PAT is the bottom line — profit after all taxes. Subtract total tax (current corporate tax ₹158 Cr plus others, ₹169.2 Cr in all) from PBT: 536.6 − 169.2 = ₹367.4 Cr.
Earnings per share (EPS) is profit per share — one of the most-used numbers in analysis and a read on how well management stewards the business. ARBL has 17,08,12,500 shares outstanding, so EPS = ₹367.4 Cr ÷ 17.08 Cr shares ≈ ₹21.5 per share.
ARBL's FY14 tax (₹169 Cr on ₹536.6 Cr PBT ≈ 31%) reflects the ~30% corporate-tax era of 2014. India cut headline corporate tax sharply in 2019 (a concessional ~22% regime, and ~15% for new manufacturers, before surcharge/cess). So don't read "~31% effective tax" as normal today — the method (PBT − tax = PAT) is unchanged, but the rate a company pays now is materially lower. Always take the tax figure from the company's own current statement.
In one breath: subtract the expense stack (raw material dominates, depreciation is non-cash) and tax from revenue to reach PAT, then divide by shares to get EPS — the single most-quoted measure of a company's earning power.
The P&L is a movie of one year; the balance sheet is a photograph taken on 31 March, showing everything the company owns and owes since the day it was born. Its one unbreakable rule — assets always equal liabilities — feels like accounting trivia until you realise it's what lets you check whether a company's wealth is real or borrowed.
The balance sheet reports assets, liabilities and equity, on a flow basis — it accumulates from incorporation, so where the P&L covers one year, the balance sheet shows how the company evolved financially over its whole life. Assets are resources the company controls that will provide future value (plant, cash, patents). Liabilities are its obligations — loans and dues it must repay.
The balance sheet equation: Assets = Liabilities. Everything a company owns was paid for either by owners' capital or by borrowing — so the two sides must be equal. Rearranged, Shareholders' Equity = Assets − Liabilities, also called owner's capital or net worth: the owners' leftover claim after all debts are settled.
This trips up nearly everyone. If shareholders' funds are the owners' wealth, why do they appear under liabilities? Analogy: treat the company as a separate person whose only job is to run operations and create wealth for its shareholders. Once you separate the company from its owners, the statement is the company speaking about itself. From the company's point of view, the shareholders' money is an obligation it owes back to the owners — hence, a liability.
The mental switch — "the company is a person, and its owners are outsiders it owes money to" — resolves most balance-sheet confusion. Once you hold that view, the liability side reads cleanly: it's simply everyone the company owes, owners included.
Share capital = face value × number of shares. A company issuing 1,000 shares at ₹10 face value has share capital of ₹10,000. ARBL's share capital is ₹17.081 Cr at ₹1 face value, so number of shares = 17.081 Cr ÷ ₹1 = ~17.08 Cr shares (the same figure used for EPS above). On top sits Reserves & Surplus (₹1,345.6 Cr):
| Reserve | What it is |
|---|---|
| Capital reserve | Earmarked for long-term projects; belongs to shareholders but not distributable. |
| Securities premium | Amount received above face value on share issue (₹31.18 Cr). |
| General reserve | Accumulated undistributed profits, kept as a buffer (₹218.4 Cr). |
| Surplus | Where the year's profit lands and dividends are paid from. |
The surplus is the crucial link between statements: FY13 closing surplus (₹829.8 Cr) + FY14 PAT (₹367.4 Cr) = ₹1,197.2 Cr, from which the company moved ₹36.7 Cr to general reserves and paid ₹55.1 Cr dividends (plus ₹9.3 Cr dividend distribution tax), leaving ₹1,095.9 Cr closing surplus to carry into FY15.
Watch the surplus line and you can see the three statements holding hands: the P&L's bottom line (PAT) flows into the balance sheet's surplus, and last year's closing surplus becomes this year's opening. That's the proof the balance sheet is a flow, not a snapshot in isolation.
ARBL's FY14 accounts show ₹9.3 Cr of dividend distribution tax (DDT) — a tax the company paid on dividends it declared. India abolished DDT in 2020; dividends are now taxed in the hands of the shareholder at their own slab rate instead. So on a current company's accounts you won't find this line — the tax moved from the company to you.
Long-term obligations the company won't settle within a year — total ₹143 Cr for ARBL. Three items: long-term borrowing (₹interest-free sales-tax deferment from the state government, to be repaid over 14 years) — a key figure for debt ratios later; deferred tax liability (a provision for future tax, arising from differences in how depreciation is treated under the Companies Act vs Income Tax); and long-term provisions (money set aside for employee benefits like gratuity).
Assuming "no debt = good." Zero long-term borrowing can be strength, but ask why: is the company disciplined, or are banks unwilling to lend, or is management simply not investing to grow? No debt isn't automatically a virtue — context decides. (And recall: high debt shows up as high finance cost on the P&L.)
Obligations due within a year — total ₹633.7 Cr. Analogy: a phone bought on credit-card EMI is a current liability; a 15-year home loan is non-current. ARBL's four items: short-term borrowings (working-capital loans from SBI and Andhra Bank, kept low at ₹8.3 Cr); trade payables (₹127.7 Cr owed to suppliers); other current liabilities (₹215.6 Cr, mostly statutory dues); and short-term provisions (₹281.8 Cr, again employee benefits).
Splitting liabilities by time (current vs non-current) is the first thing that lets you judge financial health: a company with obligations due this year that dwarf its liquid assets is heading for a cash squeeze, no matter how profitable its P&L looks.
In one breath: the balance sheet must balance (Assets = Liabilities + Equity); the liability side stacks shareholders' funds, long-term and short-term obligations, and its surplus line is where the P&L's profit flows in.
Because the asset's cost genuinely gets "used up" over its life, and matching that cost to the years it earns revenue gives a truer picture of profit. The cash left the bank once, upfront; depreciation just spreads the accounting recognition of that cost. The gap between the one-time cash outflow and the annual depreciation charge is exactly why the cash flow statement is needed.
None conceptually — both spread an asset's cost over its useful life. The words just track the asset type: tangible assets (machinery, buildings) are depreciated; intangible assets (patents, brands, trademarks) are amortized. Same mechanism, different label.
It reframes where a manufacturer's money actually goes — overwhelmingly into raw material, not people. It's also a caution against assuming the biggest cost is always salaries. For an IT or services firm the ratio flips entirely, so the "normal" expense shape is industry-specific.
Think of the company as a separate legal person. From its own point of view, the money shareholders put in is capital it is obligated to return value on — so it's shown as something the company owes to its owners. Rearranged, equity is simply assets minus liabilities: the owners' residual claim.
Not necessarily. No debt can mean discipline and strong internal cash generation, but it can also mean banks won't lend or management isn't investing to grow. Zero borrowing removes finance cost from the P&L, but you should still ask why it's zero before calling it a strength.
The clearest link is the surplus line: the P&L's bottom line (PAT) is added to the balance sheet's surplus each year, and dividends are paid out of that surplus. Because last year's closing surplus becomes this year's opening balance, the balance sheet visibly carries forward year on year.
Expenses are the costs to earn revenue; each has a schedule, and raw material dominates a manufacturer.
Depreciation/amortization spreads an asset's cost over its useful life — a non-cash expense.
PBT = Revenue − Expenses − exceptional items; PAT = PBT − taxes (the bottom line).
EPS = PAT ÷ outstanding shares — the most-quoted measure of earning power.
The balance sheet is a flow-basis snapshot: Assets = Liabilities + Equity, always balanced.
Shareholders' funds sit on the liability side — the company owes that value to its owners.
Liabilities split by time: non-current (>365d) and current (<365d).
Surplus is where PAT lands — the visible link between the P&L and the balance sheet.
Part A. PBT = revenue − expenses − exceptional. PAT = PBT − tax. EPS = PAT ÷ shares. Share capital = FV × shares.
Part B. Rearrange the equation: Equity = Assets − (all liabilities). Then confirm Assets = Liabilities + Equity.
PART A (Rs. Cr)
PBT = 1200 - 900 - 10 = 290
PAT = 290 - 87 = 203
EPS = 203 / 5 Cr shares = 40.6 per share
Share capital = FV x shares = 2 x 5 Cr = 10
PART B (Rs. Cr)
Total liabilities (debt) = 120 + 180 = 300
Equity = Assets - liabilities = 600 - 300 = 300
Check: Assets = Liab + Equity
600 = 300 + 300 -> balances OKWhy it matters: revenue-to-EPS and the balancing check are the two computations you repeat on every company — running them by hand makes the statements feel like arithmetic, not jargon.
Reasoning: each collides with a specific point — non-cash depreciation, the "no debt" trap, why equity is a liability, and profit vs cash.
1) ERROR: depreciation == this year's cash spend.
FIX: depreciation is a NON-CASH charge spreading a past
outflow. Actual cash for assets is in the cash flow stmt.
2) ERROR: zero debt == healthiest.
FIX: ask WHY there's no debt (discipline? no lender? no
growth investment?). No-debt is context-dependent.
3) ERROR: shareholders' funds go on the asset side.
FIX: from the company's view they are owed back to owners
-> liability side. Equity = Assets - Liabilities.
4) ERROR: surplus/profit == cash in the bank.
FIX: PAT feeds surplus (an equity line), not a cash pile.
Profit and cash differ; check the cash flow statement.Why it matters: three of these four confusions all stem from mixing up profit with cash — the single most expensive beginner mistake, and the reason the cash flow statement is next.