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Schedule VI, which governs the presentation of financial statements such as balance sheet and profit and loss account, has undergone a makeover after five decades. Investors can look forward to better disclosures.

With the results season in full swing, it will not be long before annual reports arrive at your doorstep. While you may immediately be tempted to stack them with old newspapers, taking the time to go through them this year may pay off.

Yes, looking at the numbers, you may realise that the company's finances are not as healthy as you thought they were and reconsider your investment decision in that stock.

This is because certain changes have been made to the way in which companies present the Balance Sheet and Profit and Loss Account. ‘Schedule VI', which governs the presentation of these financial statements, has undergone a makeover after five decades, paving the way for improved disclosure of financial information.

WHAT'S CURRENT?

The most important change to look out for is the new method of classifying current assets and liabilities, which has far-reaching implications. A beginner's textbook on accounting will tell you that unlike fixed assets or long-term liabilities, current assets and liabilities are the most liquid and can be converted into cash in a short period of time.

This serves as a good measure to gauge the liquidity position of the company — does the company have enough funds to meet its payment obligations? Although it may differ for each industry, as a thumb rule, current assets should be twice that of current liabilities for a company said to be comfortable on liquidity.

Consider a simplistic example. Your company took a five-year term loan on January 1, 2008, maturing on December 31, 2012. When it prepares the financial statements as on March 31, 2012, according to the old Schedule VI, this loan will continue to appear as a long-term liability even though there are only nine months to go before the obligation to repay arises.

But as an investor, wouldn't you like to know that there is this huge repayment coming up shortly ? You certainly don't want the value of your stock markets investments to plummet when it is discovered that the company does not have enough funds to repay the loan.

Companies struggling to meet obligations arising from FCCBs (Foreign Currency Convertible Bonds) that would mature shortly are good examples. For instance, with its FCCBs partly due for payment in June 2012, Suzlon Energy is rumoured to be selling a portion of its stake in RE power to raise funds.

Under the new Schedule VI, whether it is the term loan or the FCCB approaching its maturity date, these would be reclassified as a current liability although they were originally considered long-term borrowings. To the extent, the current ratio (i.e. ratio of current assets to liabilities) would stand altered, providing an updated picture of the liquidity position.

IMPACT ON COMPANY'S BORROWING ABILITY

Besides the above mentioned instances, long-term debts could also become current liabilities for other reasons. Experts give the example of Letters of Credit, which are commonly availed by companies for time periods such as 180 days, 360 days, etc. They are now not classified into current and non-current.

Under the new Schedule VI, even though the L/Cs may be rolled over several times, it would be current as it is still repayable to the bank at the end of 180 days.

Similarly, a long-term borrowing can become short-term if there is a violation of debt covenants imposed by banks — for example, if as part of loan agreement the bank has said that it has a right of recall if the company has defaulted on interest payment or if its debt/equity ratio moves beyond a certain point, then these loans may have to be classified as current liabilities under certain circumstances.

The new Schedule VI requires a detailed disclosure of all such defaults on borrowings. Besides, with stricter disclosure norms, the actual working capital (current assets – current liabilities) requirements may be much clearer. Hence, companies that might have obtained higher loans based on inflated working capital will now have to become more efficient.

It is important for you, as investor, to understand this because all this will impact a company's ability to raise finances to fund its future growth plans. The credit limits can be lowered or cost of borrowings increased, for such companies.