BASICS OF FINANCEBASICS OF FINANCE

By Asish K Das By Asish K Das Sr DGM (Fin) PSNRSr DGM (Fin) PSNR

SYSTEM OF ACCOUNTING

ECONOMIC ACTIVITY

BOOK KEEPING

FINANCIAL ACCOUNTINGMANAGEMENT ACCOUNTING

FINANCIAL STATEMENTS ACCOUNTING INFORMATIONFOR MANAGEMENT DECISIONS

USERS OF FINANCIALSTATEMENTS

INVESTORS,EMPLOYEES,LENDERSSUPPLIERS/CREDITORS,BUYERS,

GOVT.AGENCIES,PUBLIC

MANAGEMENT

RECORDING OF DATA

TRANSACTIONS& EVENTS

FINANCIAL STATEMENTSFINANCIAL STATEMENTS

• BALANCE SHEET

• PROFIT AND LOSS ACCOUNT

• CASH FLOW STATEMENTS

BALANCE SHEET AS ATBALANCE SHEET AS AT

LIABILITESLAST CURRENT

YEAR YEAR

SHARE CAPITAL RESERVE &SURPLUS SECURED LOANS UNSECURED LOANS CURRENT LIABILITIES PROVISIONS

ASSETSLAST CURRENT

YEAR YEAR

FIXED ASSETS

INVESTMENTS

CURRENT ASSETS

INTRODUCTION

“Financial statements are the reports prepared by an organisation to reflect the operations and the state of affairs of the organisatiion. They are prepared periodically in accordance with accounting principles, concepts and assumptions to evaluate the performance of an organisation and are used by various stakeholders of the business.”

The financial statements prepared by any business organisation are classified into the following three heads :

•BALANCE SHEET

•PROFIT AND LOSS ACCOUNT

•CASH FLOW STATEMENT

BALANCE SHEET

“A balance sheet shows a company’s assets ( or economic resources ) and liabilities represented by those resources at a particular date. It is a financial photograph and, like other kinds of photographs, the picture may be quite different either earlier or later. The balance sheet describes the assets used in a business and how those assets have been financed.”

Characteristics of Balance Sheet

•The balance sheet is prepared as on a particular date. It means the balance sheet describes the state of affairs of the business organisation as on a particular date.

•The balance sheet is prepared only after the preparation of the Profit and loss account

•The capital is the difference of the assets and the liabilities and hence the sum total of the two sides of the balance sheet tallies.

PROFIT AND LOSS ACCOUNT

“It is a statement that shows up the result of operations during the period. It gives the profit or loss resulting from the operations of the organisation by comparing all the revenues earned during the period and the moneys spent to earn those revenues and incomes and other losses suffered during that period.”

Principles in Preparing Profit and Loss Account

•Only revenue receipts are to be considered

•Only revenue expenses should be considered

•Expenses and incomes should be considered even though they are merely accrued and not actually paid

CASH FLOW STATEMENTS

“ Cash flow statement is a report about the cash generation and cash absorption by an organisation for a period between two balance sheets date. It traces the movements of cash and cash equivalents in the functioning of the organisation and reports the various sources and applications of cash.”

The cash flow statement shows the inflows and outflows of cash and cash equivalents. The enterprise should disclose the components of cash and cash equivalents and should present a reconciliation of the amounts in its cash flow statement.

CURRENT ASSSETS CURRENT ASSSETS :

Current assets are those assets which can be easily and quickly realised (converted into cash) within A short period of time I.e. one financial year without losing its value .e.g. Debtors,inventories,bill receivables,marketable securities,short term investments etc.

CURRENT LIABILITIES:CURRENT LIABILITIES:

Current liabilities means all those liabilities which are to be met by the company within one financial year .e.g creditors, bills payables,short term loans,etc. It is wise to settle these liabilities out of current assets only.

LIQUID ASSETSLIQUID ASSETS:

Liquid assets mean those assets of a business which can be converted into cash within very short period of time without losing value . Normally all current assets except inventories are considered liquid assets. These include those assets which rotate very quickly in the business.These are called liquid assets because they are more or less as liquid as cash.

DEBT:DEBT: Means that part of capital employed in a business which is funded by the outsider. It is borrowed fund. Debt can be short term as well as long term e.g. loan from financial institution , banks debentures issued to public etc.

FIXED ASSETSFIXED ASSETS: The purpose of investment is fixed assets is not to convert these assets into cash but these add to the profit generating capacity of the business .These include capital machinery, tools & plants etc.with the help of which production is done.

DEPRECIATION DEPRECIATION : It means reduction in the value of fixed assets due to use, natural wear & tear, passage of time etc. It is the proportion of fixed assets value which is used or consumed during the period. The purpose of providing depreciation is to charge an appropriate cost of use of fixed assets in the profit & loss account.

EQUITY / SHAREHOLDER FUNDS/NET WORTH :Represent shareholders fund i.e.share capital , all the reserves and retained earnings of the business less accumulated losses, if any. In other words it is that part of assets of the business which is owned by shareholders.

CAPITAL EMPLOYED:Total funds which are invested by owners and outsiders in the business is generally known as CAPITAL EMPLOYED. But if some parts of parts of funds is in excess and is used for investments outside business, it is not taken as part of capital employed.

SHARE CAPITAL (EQUITY &PREFERENCE)+ ACCUMULATED PROFIT(RESERVE & SURPLUS)+ LONG TERM LOANS-FICTITIOUS ASSETS LIKE DISCOUNT ON ISSUE OF SHARE & DEBENTURES AND PRELIMINARY EXPENSES. OR FIXED ASSETS LESS CUM. DEPRECIATION + WORKING CAPITAL.

CONTINGENT LIABILITIES

These are the liabilities which depend upon happening or non happening of an event .These are not included in

the Balance Sheet but are shown as foot note for information purposes only e.g.:

1. Bills discounted with the bank but not yet cleared.2. Claims against the co.not acknowledged as debt.3. Income tax sales tax demands pending appeals.

Working capital

it It means the amount of funds required for day to day working .It means those funds which are always in rotation of workingCycle. Gross working capital means the sum of current assets only whereas net working capital is the excess of current assets over current liabilities.

WORKING CAPITAL CYCLE :

RAW MATERIAL

WORK IN PROGRESS

FINISHED GOODS

TRADE DEBTORS

CASH/ BANK

TRADE CREDITORS

RATIO ANALYSISRATIO ANALYSISPROFITABILITY RATIOS

•GROSS PROFIT RATIO

•NET PROFIT RATIO, EXPENSES RATIO

•RETURN ON INVESTMENT

•RETURN ON EQUITY

ACTIVITY RATIOS

•CAPITAL TURNOVER RATIO

•FIXED ASSETS TURNOVER RATIO

•NET WORKING CAPITAL RATIO

•DEBTORS TURNOVER RATIO

•STOCK TURNOVER RATIO, DEBTORS TURNOVER RATIO OR COLL PERIOD

LIQUIDITY RATIO

•CURRENT RATIO

•QUICK RATIO

SOLVENCY RATIO / DEBT EQUITY RATIO

•INTEREST COVERAGE RATIO

•DEBT TO TOTAL FUNDS RATIO

• WHAT IS BUDGET?

• A BUDGET IS A PLAN EXPRESSED IN QUANTITATIVE, USUALLY IN MONETARY TERMS COVERING A SPECIFIC PERIOD OF TIME USUALLY ONE YEAR.

• THE BUDGET REPRESENTS A SET OF YARDSTICKS OR GUIDELINES FOR USE IN CONTROLLING INTERNAL OPERATIONS OF AN ORGANISATION.

• IN A BUSINESS ORGANISATION REPRESENTS AN ESTIMATE OF

FUTURE COSTS AND REVENUES.

ADVANTAGES

• EFFICIENCY AND IMPROVEMENT IN WORKING

• MOTIVATE MANAGERS TO ACHIEVE GOALS

• BENCHMARK FOR CONTROLLING ONGOING OPERATIONS

• HELPS IN REDUCING WASTAGES AND LOSSES

• HELPS IN COORDINATION & INTEGRATION OF EFFORTS OF VARIOUS DEPARTMENTS TO ACHIEVE OVERALL OBJECTIVES

CAPITAL BUDGET

CAPITAL BUDGET INVOVES PLANNING FOR ACQUISITION OF ASSETS. THIS INCLUDES PURCHASE, CREATION & CONSTRUCTION OF IMMOVABLE FIXED ASSETS AND ADDITIONS/REPLACEMENTS THERETO IN RESPECT OF FACTORY/OFFICE COMPLEX/TOWNSHIP AND CUSTOMER PROJECT RELATED CAPITAL WORKS.

THESE ASSETS ARE INTENDED TO BE CONTINUALLY USED IN THE BUSINESS FOR THE PURPOSE OF EARNING REVENUE - DIRECTY OR INDIRECTLY.

COSTING & COST

CONTROL CONCEPT & PRACTICES

COSTING• Costing is the process of recording, classifying

and summarizing costs for determining the cost of a product or the cost of providing services.

• It is a quantitative method that accumulates, classifies, summarizes and interprets information to the management for decision making.

OBJECTIVES OF COSTING

• Determination of selling price.

• Determining and controlling cost.

• Providing basis for taking policy decisions.

• Facilitating preparation of MIR

CONCEPT OF COST

Cost means the amount of expenditure

(actual or notional) incurred on or attributable

to a given product or services.

ELEMENTS OF COST

• Material cost

• Labour cost

• Overheads

CLASSIFICATION OF COST :(A) According to Nature or Behaviour• Variable cost – Cost which varies directly in proportion with

every increase or decrease in the volume of output or production is known as variable cost.

• Fixed cost – Cost which does not vary but remains constant within a given period of time and a range of activity in spite of the fluctuations in production / output is known as fixed cost.

• Semi-variable cost – Cost which does not vary proportionately but simultaneously does not remain stationary at all times is known as semi-variable cost.

COST CONTROL & COST REDUCTION

Cost control and cost reduction are two different concepts.

• Cost control is achieving the cost target as its objective.

• Cost reduction is directed to explore the possibilities of improving the targets.

Thus, cost control ends when targets are achievedwhereas cost reduction has no visible end. It is acontinuous process.