FINANCIAL MANAGEMENT and ACCOUNTING METHODS*

WE WILL BE COVERING THE FOLLOWING AREAS:

ACCOUNTING PROCESSFINANCIAL STATEMENTSANALYSIS OF FINANCIAL STATEMENTS4. DEBIT CREDIT LEDGER

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*1. ACCOUNTING PROCESS

*WHAT IS ACCOUNTING?

PROCEDURES ARE ESTABLISHED TO RECORD FINANCIAL EVENTS RELATING TO THE INVESTMENT AND FINANCIAL PRODUCTIVITY OF BUSINESS.

PROVIDES FINANCIAL INFORMATION TO ESTABLISH CONTROLS AND AID IN GUIDING THE VENTURE/ BUSINESS TOWARDS THE DESIRED FINANCIAL GOALS.

ACCOUNTNG IS OFTEN REFERRED TO AS LANGUAGE OF BUSINESS.

*USES OF ACCOUNTING REPORTSMANAGERS RELY ON ACCOUNTING REPORTS TO MAKE CORRECT DECISIONS IN ORDER TO IMPROVE THE CURRENT AND FUTURE FINANCIAL PERFORMANCE OF THE BUSINESS

ACCOUNTING IS A SOURCE OF PAST FINANCIAL DATA

*TYPES OF ACCOUNTINGFINANCIAL ACCOUNTING (GENERAL ACCOUNTING):

FINANCIAL ACCOUNTING DEALS WITH INFORMATION ABOUT THE FINANCIAL RESOURSES, OBLIGATIONS (LIABILITIES) AND ACTIVITIES OF AN ORGANIZATION.

DEALS WITH ALL THE EXTERNAL TRANSACTIONS, e.g., between the firm and its markets, procurement of land, labour , material, services, sale of products, goods, services, etc.

FINANCIAL ACCOUNTING INFORMATION IS DESIGNED TO HELP INVESTORS AND CREDITORS IN MAKING DECISIONS WHERE BEST TO PLACE THEIR INVESTMENT RESOURCES.

FINANCIAL ACCOUNTING INFORMATION IS ALSO USED BY THE COMPANYS MANAGERS, FOR INCOME TAX RETURNS etc.

*TYPES OF ACCOUNTING..COST OR MANAGEMENT ACCOUNTING:

MANAGEMENT ACCOUNTING DEALS WITH ACCOUNTING INFORMATION USED IN CONTROLLING AND RUNNING THE BUSINESS

MANAGERS USE THIS INFORMATION IN EVALUATING PERFORMANCE OF DEPARTMENTS/ COMPANY INDIVIDUALS, DECIDING TO INTRODUCE A NEW LINE OF PRODUCT OR NOT, etc.

COST ACCOUNTING HELPS PROVIDE THE FOLLOWING INFORMATION:TO DETERMINE THE COST OF PRODUCTS/ SERVICESPROVIDES BASIS FOR PRICING OF GOODS/ SERVICESPROVIDES MEANS OF CONTROLLING EXPENDITURE

DEALS WITH ALL INTERNAL TRANSACTIONS, i.e., transactions between various departments dealing with manufacturing are defined as internal transactions

*ACCOUNTING FUNDAMENTALS

ACCOUNTING EQUATION:

ALL ACCOUNTING IS BASED ON THE FUNDAMENTAL ACCOUNTING EQUATION, WHICH IS:

ASSETS = LIABILITIES + OWNERSHIP ..... (i)

ASSETS : All things of monetary value which the firm possesses

LIABILITIES: All things of monetary value which a firm owes to others

OWNERSHIP: It is the worth of what the firm owes its stockholders (also called equity, net worth, etc.)

EXAMPLES of Assets, Liabilities and Ownership?

*ACCOUNTING FUNDAMENTALS.2.ANOTHER IMPORTANT ACCOUNTING RELATIONSHIP IS:

REVENUES - EXPENSES = PROFIT (or LOSS) .. (ii)

THIS EQUATION SUMMERISES THE REVENUE AND EXPENSE RESULTINGFROM THE FIRMS OPERATIONS:

REVENUE : IT INCREASES THE OWNERSHIP AMOUNT OF THE FIRM. It is earned.

EXPENSES : IT DECREASES THE OWNERSHIP AMOUNT OF THE FIRM. It is incurred.

PROFIT : IT IS THE INCREASE IN MONEY VALUE RESULTING FROM A FIRMS OPERATIONS, WHICH IS AVAILABLE FOR DISTRIBUTION TO THE STOCKHOLDERS. It, therefore, represents the return on owners capital investment.

*ANNUAL RATE OF RETURN:LIKE ANY SYSTEM, THE EFFICIENCY OF A FIRMS BUSINESS CAN ALSO BE DETERMINED, AND IS INDICTED BY ITS RATE OF RETURN.

THE RATE OF RETURN IS GIVEN BY:

PROFIT (i.e. Output) ANNUAL RATE OF RETURN: CAPITAL INVESTED ( i.e. Input)

Example: Rs. 900 (Profit) = 0.3 or 30 % Rs. 3000 (Capital)

*2. FINANCIAL STATEMENTS

*FINANCIAL STATEMENTSINTRODUCTION:

COMPANIES/ FIRMS ENGAGED IN BUSINESS CARRY ON VARIOUS FINANCIAL TRANSACTIONS ON REGULAR BASIS, i.e., borrow money from bank, receive money from its sales, purchase material/ equipment on credit, pay to its creditors, etc..

THESE TRANSACTIONS ARE CALLED FINANCIAL EVENTS

FINANCIAL EVENTS ARE RECORDED IN FORM OF VARIOUS FINANCIAL REPORTS/ STATEMENTS FOR ANALYSIS/ EVALUATION, etc.

FINANCIAL REPORTS/ FINANCIAL STATEMENTS, ARE:

BALANCE SHEETINCOME STATEMENTSTATEMENT OF OWNERS EQUITYSTATEMENT OF CASH FLOWS

*FINANCIAL STATEMENTS.BALANCE SHEET:

REPRESENTS A STATEMENT OF THE FINANCIAL POSITION OF THE COMPANY/ FIRM AT A SPECIFIC/ GIVEN DATE BY INDICATING:RESOURCES THAT IT OWNSTHE DEBTS THAT IT OWESTHE AMOUNT OF OWNERS EQUITY IN BUSINESS

ITS FORMAT IS BASED ON THE BASIC ACCOUNTING Eqn. No (i),

Assets = Liability + Ownership

ASSETS: ARE LISTED ACCORDING TO THEIR RELATIVE DEGREE OF LIQUIDITY: (i) Cash or Cash equivalents (ii) Accounts Receivable (iii) Inventories (iv) Fixed and Long Term Assets

EXAMPLE OF ASSETS: CURRENT ASSETS i.e. cash, stock of raw material, cash at bank or FIXED ASSETS i.e. land, building, plant , machinery, etc.

*FINANCIAL STATEMENTSBALANCE SHEET..

LIABILITY & SHAREHOLDERS EQUITY:

THESE ARE LISTED IN THE ORDER ACCORDING TO THE NEARNESS WITH WHICH THEY ARE LIKELY TO BE PAID

(i) CURRENT LIABILITIES: Are payable within one year.

(ii) LONG TERM DEBTS: Are payable beyond one year

(iii) SHAREHOLDERS EQUITY: Will be paid only through regular cash dividends.

(iv) RETAINED EARNINGS: Represent companies cumulative profit after dividends since the firms inception, these are the earnings that have been retained or re-invested in the firm.

*BALANCE SHEET as on 30 June, 2010 ( in Thousands Rs.) LIABILITIES& ASSETS SHAREHOLDERS EQUITYCash 178 Bank Loans & Notes Payables 448Account receivable 678 Account Payable 148Inventories 1329 Accrued Taxes 36Prepaid expenses 21 Other accrued liabilities 191Accum. tax payments 35 Current Liabilities 823 Current Assets 2241 Long Term Debts 631Fixed Assets at Cost 1596 Share Holders Equity:Less Depreciation 857 Stocks 421Net Fixed Assets 739 Paid-in-Capital 361 Retained earnings 1014Investment Long term 65 Total Shareholders Equity 1796Other Assets Long Term 205

TOTAL ASSETS: 3250 TOTAL LIABILITIES AND 3250 SHAREHOLDERS EQUITY

*FINANCIAL STATEMENTSINCOME STATEMENT:

THE INCOME STATEMENT SHOWS EARNINGS, OR PROFIT AND LOSS, i.e., revenues, expenses and net profits FOR A FINANCIAL PERIOD, GENERALLY ONE YEAR

IT INDICATES THE PROFITABILITY OF THE BUSINESS OVER THE PRECEEDING YEAR (OR SOME OTHER TIME)

ITS FORMAT IS BASED ON THE BASIC ACCOUNTING EQN. No (ii), i.e. Revenue Expenses = Profit (Net sales) (Cost of Goods sold)

* INCOME STATEMENT:YEAR ENDING 30 JUNE 2010 (in Thousands Rs.)

Net SalesRs 3992Cost of Goods Sold Rs 2680Gross ProfitRs 1312Selling, General &Administrative Expenses Rs 912Earnings before Interest Rs 400& TaxesInterest Expenses (on loans)Rs 85Earnings before Taxes Rs 315Income TaxRs 114Earning After TaxesRs 201Cash Dividends Rs 143Increase in Retained Rs. 58Earnings

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INCOME STATEMENT.

NET SALES: Amount received or receivable from customers

COST OF GOODS SOLD: Represents the cost of actually producing the products that were sold during the period.

GROSS PROFIT: Revenue (sales) Expenses (cost of goods sold)

SELLING, GENERAL AND ADMINISTRATIVE EXPENSES: Are separate from cost of goods, and not included there.

EARNINGS BEFORE INTEREST AND TAXES: Operating income

INTEREST EXPENSE: Cost of borrowed funds, i.e., interest

EARNING BEFORE TAXES: Taxable income

EARNING AFTER TAXES: Amount earned for stockholders

DIVIDENDS: Amount paid to stockholders

RETAINED EARNINGS: Amount increased in the equity share of the business

*FINANCIAL STATEMENTSSTATEMENT OF OWNERS EQUITY:

THIS FINANCIAL STATEMENT SUMMARIZES THE INCREASES AND DECREASES DURING THE ACCOUNTING PERIOD IN THE AMOUNT OF OWNERS EQUITY.

INCREASES RESULT FROM EARNING NET INCOME AND FROM ADDITIONAL INVESTMENTS BY THE OWNER

DECREASES RESULT FROM NET LOSSES AND FROM WITHDRAWLS OF ASSET BY THE OWNER.

FOLLOWING EQUATION DESCRIBES THE EQUITY STATEMENT OF AN INDIVIDUAL:

Ending Equity = Beginning Equity + Investments Withdrawls + Income

*STATEMENT OF OWNERS EQUITY (EXAMPLE)Statement of Changes in Owners EquityFor the Month ending 31 Dec, 2009Mr. XYZ

Rs. Rs.

Capital on 01 Dec, 2009 20,000

Plus: Investment by Owner 30,000 Net Income 2,400 32,400

Total 52,400

Less: Withdrawl by Owner - 600

Capital on 31 Dec, 2009 51,800

*FINANCIAL STATEMENTSSTATEMENT OF CASH FLOWS:

SUMMARIZES THE CASH RECEIPTS AND CASH PAYMENTS OF THE BUSINESS OVER THE SAME TIME PERIOD AS COVERED BY THE INCOME STATEMENT

THE BASIC PURPOSE OF STATEMENT OF CASH FLOWS IS TO PROVIDE INFORMATION ABOUT THE CASH RECEIPTS AND CASH PAYMENTS OF A BUSINESS ENTITY DURING THE ACCOUNTING PERIOD. IT IS BASICALLY PREPARED AS A FORECAST

ALSO CALLED STATEMENT OF CASH RECEIPTS AND DISBURSEMENT

*STATEMENT OF CASH FLOWS (EXAMPLE)( YEAR ENDING 30 JUNE, 2009)Receipts & Jan Feb Mar Apr May June Balances (Rs.) (Rs.) (Rs.) (Rs.) (Rs.) (Rs.)SHARES 50,000SALES 2,000 10,000 12,000 15,000BALANCE B/F 7,200 4,400 200 400BALANCE C/FOVERDRAW C/F 1,400 ______ _____ ________ 50,000 7,200 7,800 10,000 12,200 15,400Payments & Balances:BUILDINGS 20,000PLANT & M/C 8,000FURNITURE 6,000STOCK 7,000PURCHASES 1,000 6,000 8,000 10,000 12,000WAGES 1,000 1,000 1,000 1,000 1,000 1,000EXPENSES 800 800 800 800 800 800 BALANCE IN 7,200 4,400 200 400 1,600 HAND C/FBALANCE B/F _____ _______ 50,000 7,200 7,800 10,000 12,200 15,400

ANALYSIS OF FINANCIAL STATEMENT*

ANALYSIS OF FINANCIAL STATEMENTThe purpose of financial statements is to enable the interested party to evaluate the firm, i.e. evaluate the firms financial condition and performance.

To evaluate a firms financial condition and performance, the financial analyst needs to perform check ups on the various aspects of a firms financial health.

A tool frequently used for these check-ups is financial ratios or index, which relates two pieces of financial data by dividing one quantity with the other.

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FINANCIAL RATIOSWe use financial ratios because this way we get a comparison that is useful than the raw numbers by themselves.

EXAMPLE:A firm has a net profit of $ 1 Million.This looks very profitable?But if the firm had invested $ 100 Million total assets.Dividing net profit by total assets, we get: 1/100 = 0.01, which is the firms return on total assets.The 0.01 figure means that each dollar of asset invested earns a 1 % return.A savings account provides a better return on investment than this, with lesser risk.In this example, the ratio provides quite a useful information.

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TYPES OF FINANCIAL RATIOS

Financial ratios are basically of two types:

1.BALANCE SHEET RATIOS

2.INCOME STATEMENT RATIOS or INCOME STATEMENT/ BALANCE SHEET RATIOS

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BALANCE SHEET RATIOS:These summarizes some aspect of the firms financial condition at a point in time, the point at which a Balance Sheet has been prepared. Both the numerator and the denominator in each ratio come directly from the balance sheet.

Balance sheet ratios can be of the following types:LIQUIDITY RATIO : It provides the basis for answering the question: Does the firm have sufficient cash or near cash assets to pay its bills on time. It is given by:

Liquidity Ratio = Current Assets Current Liabilities

FINANCIAL LEVERAGE ( OR DEBT) RATIO: Shows the extent to which the firm is financed by debt and is given by:

Financial Leverage (Debt) Ratio = Total Debt Shareholders Equity*

INCOME STATEMENT or INCOME STATEMENT/ BALANCE SHEET RATIOS:These summarizes some aspect of the firms performance over a period of time, usually a year. These are:INCOME STATEMENT RATIOS: Compare one flow item from the income statement to another flow item from the income statement.INCOME STATEMENT/ BALANCE SHEET RATIOS: Compares a flow item in the numerator (income statement) to an item in the denominator (balance sheet).These could be of the following types: a) Coverage Ratio = Earning before Interest and Taxes Interest Expenses Relates the financial charges, i.e. payable interest of a firm to its ability to pay or cover them. b) Receivable Turnover Ratio = Annual Net Credit Sales Receivables

c) Sales to Fixed Asset Ratio = Sales Fixed Assets For (b) and (c), shows how effectively the firm is using its assets.

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PROFITABILITY RATIOS:Relates profit to sales and investment. It is given by any of the Following:Profitability Ratio = Net Sales - Cost of Goods Sold Net Sales

Profitability Ratio = Net Profit after Taxes Net Sales

Profitability Ratio = Net Profit after Taxes OR Total Assets

Profitability Ratio = Net Profit After Taxes Assets - Liabilities*

End of this lecture.*

*OBJECTIVES OF FINANCIAL ACCOUNTINGPROVIDING A MEANS OF RECORDING AND CLASSIFYING FINANCIAL DATA

MAKING AVAILABLE TO OWNERS AND MANAGERS ACCOUNTING INFORMATION USEFUL FOR MAKING FINANCIAL DECISIONS

*ACCOUNTING FUNDAMENTALS.COMBINING EQUATIONS (i) AND (ii), WE GET:

ASSETS = LIABILITIES + BEGINNING + REVENUE EXPENSES ...(iii) OWNERSHIP (PROFIT)

USE OF FININACIAL STATEMENTS BY OUTSIDERSINTRODUCTION:Most outside decision makers use financial statements in making investment decisions --- that is , selecting companies in which they will invest or extend credit.

TWO FACTORS OF CONCERN TO CREDITORS AND INVESTORS ARE THE LIQUIDITY AND PROFITABILITY OF A BUSINESSORGANIZATION.

Creditors are interested in liquidity --- the ability of the business to pay its debts when they come due.Investors (as well as creditors) are even more interested in its profitability --- profitable operations increase the value of the owners equity.

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