Friday 28 August 2015
Ratio Analysis
Business financial terms and ratios definitions
Introduction
acid
test
A
stern measure of a company's ability to pay its short term debts, in that stock
is excluded from asset value. (liquid assets/current liabilities) Also referred
to as the Quick Ratio.
assets
Anything
owned by the company having a monetary value; eg, 'fixed' assets like
buildings, plant and machinery, vehicles (these are not assets if rentedand not
owned) and potentially including intangibles like trade marks and brand names,
and 'current' assets, such as stock, debtors and cash.
asset
turnover
Measure
of operational efficiency - shows how much revenue is produced per £ of assets
available to the business. (sales revenue/total assets less current
liabilities)
balance
sheet
The
Balance Sheet is one of the three essential measurement reports for the
performance and health of a company along with the Profit and Loss Account and
the Cashflow Statement. The Balance Sheet is a 'snapshot' in time of who owns
what in the company, and what assets and debts represent the value of the
company. (It can only ever nbe a snapshot because the picture is always
changing.) The Balance Sheet is where to look for information about short-term
and long-term debts, gearing (the ratio of debt to equity), reserves, stock
values (materials and finsished goods), capital assets, cash on hand, along
with the value of shareholders' funds. The term 'balance sheet' is derived from
the simple purpose of detailing where the money came from, and where it is now.
The balance sheet equation is fundamentally: (where the money came from)
Capital + Liabilities = Assets (where the money is now). Hence the term 'double
entry' - for every change on one side of the balance sheet, so there must be a
corresponding change on the other side - it must always balance. The Balance
Sheet does not show how much profit the company is making (the P&L does
this), although pervious years' retained profits will add to the company's
reserves, which are shown in the balance sheet.
budget
In
a financial planning context the word 'budget' (as a noun) strictly speaking
means an amount of money that is planned to spend on a particularly activity or
resource, usually over a trading year, although budgets apply to shorter and
longer periods. An overall organizational plan therefore contains the budgets
within it for all the different departments and costs held by them. The verb
'to budget' means to calculate and set a budget, although in a looser context
it also means to be careful with money and find reductions (effectively by
setting a lower budgeted level of expenditure). The word budget is also more
loosely used by many people to mean the whole plan. In which context a budget
means the same as a plan. For example in the
capital
employed
The
value of all resources available to the company, typically comprising share
capital, retained profits and reserves, long-term loans and deferred taxation.
Viewed from the other side of the balance sheet, capital employed comprises
fixed assets, investments and the net investment in working capital (current
assets less current liabilities). In other words: the total long-term funds
invested in or lent to the business and used by it in carrying out its
operations.
cashflow
The
movement of cash in and out of a business from day-to-day direct trading and
other non-trading or indirect effects, such as capital expenditure, tax and
dividend payments.
cashflow
statement
One
of the three essential reporting and measurement systems for any company. The
cashflow statement provides a third perspective alongside the Profit and Loss
account and Balance Sheet. The Cashflow statement shows the movement and
availability of cash through and to the business over a given period, certainly
for a trading year, and often also monthly and cumulatively. The availability
of cash in a company that is necessary to meet payments to suppliers, staff and
other creditors is essential for any business to survive, and so the reliable
forecasting and reporting of cash movement and availability is crucial.
cost
of debt ratio (average cost of debt ratio)
Despite
the different variations used for this term (cost of debt, cost of debt ratio,
average cost of debt ratio, etc) the term normally and simply refers to the
interest expense over a given period as a percentage of the average outstanding
debt over the same period, ie., cost of interest divided by average outstanding
debt.
cost
of goods sold (COGS)
The
directly attributable costs of products or services sold, (usually materials,
labour, and direct production costs). Sales less COGS = gross profit.
Effetively the same as cost of sales (COS) see below for fuller explanation.
cost
of sales (COS)
Commonly
arrived at via the formula: opening stock + stock purchased - closing stock.Cost of sales is the value, at cost, of the goods or services sold during the period in question, usually the financial year, as shown in a Profit and Loss Account (P&L). In all accounts, particularly the P&L (trading account) it's important that costs are attributed reliably to the relevant revenues, or the report is distorted and potentially meaningless. To use simply the total value of stock purchases during the period in question would not produce the correct and relevant figure, as some product sold was already held in stock before the period began, and some product bought during the period remains unsold at the end of it. Some stock held before the period often remains unsold at the end of it too. The formula is the most logical way of calculating the value at cost of all goods sold, irrespective of when the stock was purchased. The value of the stock attributable to the sales in the period (cost of sales) is the total of what we started with in stock (opening stock), and what we purchased (stock purchases), minus what stock we have left over at the end of the period (closing stock).
current
assets
Cash
and anything that is expected to be converted into cash within twelve months of
the balance sheet date.
current
ratio
The
relationship between current assets and current liabilities, indicating the
liquidity of a business, ie its ability to meet its short-term obligations.
Also referred to as the Liquidity Ratio.
current
liabilities
Money
owed by the business that is generally due for payment within 12 months of
balance sheet date. Examples: creditors, bank overdraft, taxation.
depreciation
The
apportionment of cost of a (usually large) capital item over an agreed period,
(based on life expectancy or obsolescence), for example, a piece of equipment
costing £10k having a life of five years might be depreciated over five years
at a cost of £2k per year. (In which case the P&L would show a depreciation
cost of £2k per year; the balance sheet would show an asset value of £8k at the
end of year one, reducing by £2k per year; and the cashflow statement would
show all £10k being used to pay for it in year one.)
dividend
A
dividend is a payment made per share, to a company's shareholders by a company,
based on the profits of the year, but not necessarily all of the profits,
arrived at by the directors and voted at the company's annual general meeting.
A company can choose to pay a dividend from reserves following a loss-making
year, and conversely a company can choose to pay no dividend after a
profit-making year, depending on what is believed to be in the best interests
of the company. Keeping shareholders happy and committed to their investment is
always an issue in deciding dividend payments. Along with the increase in value
of a stock or share, the annual dividend provides the shareholder with a return
on the shareholding investment.
earnings
before..
There
are several 'Earnings Before..' ratios and acronyms: EBT = Earnings Before
Taxes; EBIT = Earnings Before Interest and Taxes; EBIAT = Earnings Before
Interest after Taxes; EBITD = Earnings Before Interest, Taxes and Depreciation;
and EBITDA = Earnings Before Interest, Taxes, Depreciation, and Amortization.
(Earnings = operating and non-operating profits (eg interest, dividends
received from other investments). Depreciation is the non-cash charge to the
balance sheet which is made in writing off an asset over a period. Amortisation
is the payment of a loan in instalments.
fixed
assets
Assets
held for use by the business rather than for sale or conversion into cash, eg,
fixtures and fittings, equipment, buildings.
fixed
cost
A
cost which does not vary with changing sales or production volumes, eg,
building lease costs, permanent staff wages, rates, depreciation of capital
items.
forecast
See
'budget' above.
gearing
The
ratio of debt to equity, usually the relationship between long-term borrowings
and shareholders' funds.
goodwill
Any
surplus money paid to acquire a company that exceeds its net tangible assets
value.
gross
profit
Sales
less cost of goods or services sold. Also referred to as gross profit margin,
or gross profit, and often abbreviated to simply 'margin'. See also 'net
profit'.
initial
public offering (ipo)
An
Initial Public Offering (IPO being the Stock Exchange and corporate acronym) is
the first sale of privately owned equity (stock or shares) in a company via the
issue of shares to the public and other investing institutions. In other words
an IPO is the first sale of stock by a private company to the public. IPOs
typically involve small, young companies raising capital to finance growth. For
investors IPO's can risky as it is difficult to predict the value of the stock
(shares) when they open for trading. An IPO is effectively 'going public' or
'taking a company public'.
letters
of credit
These
mechanisms are used by exporters and importers, and usually provided by the
importing company's bank to the exporter to safeguard the contractual
expectations and particularly financial exposure of the exporter of the goods
or services. (Also called 'export letters of credit, and 'import letters of
credit'.) When an exporter agrees to supply a customer in another country, the exporter needs to know that the goods will be paid for.
The common system, which has been in use for many years, is for the customer's bank to issue a 'letter of credit' at the request of the buyer, to the seller. The letter of credit essentially guarantees that the bank will pay the seller's invoice (using the customer's money of course) provided the goods or services are supplied in accordance with the terms stipulated in the letter, which should obviously reflect the agreement between the seller and buyer. This gives the supplier an assurance that their invoice will be paid, beyond any other assurances or contracts made with the customer. Letters of credit are often complex documents that require careful drafting to protect the interests of buyer and seller. The customer's bank charges a fee to issue a letter of credit, and the customer pays this cost.
The seller should also approve the wording of the buyer's letter of credit, and often should seek professional advice and guarantees to this effect from their own financial services provider.
In short, a letter of credit is a guarantee from the issuing bank's to the seller that if compliant documents are presented by the seller to the buyer's bank, then the buyer's bank will pay the seller the amount due. The 'compliance' of the seller's documentation covers not only the goods or services supplied, but also the timescales involved, method for, format of and place at which the documents are presented. It is common for exporters to experience delays in obtaining payment against letters of credit because they have either failed to understand the terms within the letter of credit, failed to meet the terms, or both. It is important therefore for sellers to understand all aspects of letters of credit and to ensure letters of credit are properly drafted, checked, approved and their conditions met. It is also important for sellers to use appropriate professional services to validate the authenticity of any unknown bank issuing a letter of credit.
letters
of guarantee
There
are many types of letters of guarantee. These types of letters of guarantee are
concerned with providing safeguards to buyers that suppliers will meet their
obligations or vice-versa, and are issued by the supplier's or customer's bank
depending on which party seeks the guarantee. While a letter of credit
essentially guarantees payment to the exporter, a letter of guarantee provides
safeguard that other aspects of the supplier's or customer's obligations will
be met. The supplier's or customer's bank is effectively giving a direct
guarantee on behalf of the supplier or customer that the supplier's or
customer's obligations will be met, and in the event of the supplier's or
customer's failure to meet obligations to the other party then the bank
undertakes the responsibility for those obligations. Typical obligations covered by letters of guarantee are concerned with:
- Tender Guarantees (Bid
Bonds) - whereby the bank assures the buyer that the supplier will not
refuse a contract if awarded.
- Performance Guarantee -
This guarantees that the goods or services are delivered in accordance
with contract terms and timescales.
- Advance Payment Guarantee -
This guarantees that any advance payment received by the supplier will be
used by the supplier in accordance with the terms of contract between
seller and buyer.
liabilities
General
term for what the business owes. Liabilities are long-term loans of the type
used to finance the business and short-term debts or money owing as a result of
trading activities to date . Long term liabilities, along with Share Capital
and Reserves make up one side of the balance sheet equation showing where the
money came from. The other side of the balance sheet will show Current
Liabilities along with various Assets, showing where the money is now.
liquidity
ratio
Indicates
the company's ability to pay its short term debts, by measuring the
relationship between current assets (ie those which can be turned into cash)
against the short-term debt value. (current assets/current liabilities) Also
referred to as the Current Ratio.
net
assets (also called total net assets)
Total
assets (fixed and current) less current liabilities and long-term liabilities
that have not been capitalised (eg, short-term loans).
net
current assets
Current
Assets less Current Liabilities.
net
profit
Net
profit can mean different things so it always needs clarifying. Net strictly
means 'after all deductions' (as opposed to just certain deductions used to
arrive at a gross profit or margin). Net profit normally refers to profit after
deduction of all operating expenses, notably after deduction of fixed costs or
fixed overheads. This contrasts with the term 'gross profit' which normally
refers to the difference between sales and direct cost of product or service
sold (also referred to as gross margin or gross profit margin) and certainly
before the deduction of operating costs or overheads. Net profit normally
refers to the profit figure before deduction of corporation tax, in which case
the term is often extended to 'net profit before tax' or PBT.
opening/closing
stock
See
explanation under Cost of Sales.
p/e
ratio (price per earnings)
The
P/E ratio is an important indicator as to how the investing market views the
health, performance, prospects and investment risk of a public company listed
on a stock exchange (a listed company). The P/E ratio is also a highly complex
concept - it's a guide to use alongside other indicators, not an absolute
measure to rely on by itself. The P/E ratio is arrived at by dividing the stock
or share price by the earnings per share (profit after tax and interest divided
by the number of ordinary shares in issue). As earnings per share are a yearly
total, the P/E ratio is also an expression of how many years it will take for
earnings to cover the stock price investment. P/E ratios are best viewed over
time so that they can be seen as a trend. A steadily increasing P/E ratio is
seen by the investors as increasingly speculative (high risk) because it takes
longer for earnings to cover the stock price. Obviously whenever the stock
price changes, so does the P/E ratio. More meaningful P/E analysis is conducted
by looking at earnings over a period of several years. P/E ratios should also
be compared over time, with other company's P/E ratios in the same market
sector, and with the market as a whole. Step by step, to calculate the P/E
ratio: - Establish total profit
after tax and interest for the past year.
- Divide this by the number
of shares issued.
- This gives you the earnings
per share.
- Divide the price of the
stock or share by the earnings per share.
- This gives the
Price/Earnings or P/E ratio.
profit
and loss account (P&L)
One
of the three principal business reporting and measuring tools (along with the
balance sheet and cashflow statement). The P&L is essentially a trading
account for a period, usually a year, but also can be monthly and cumulative.
It shows profit performance, which often has little to do with cash, stocks and
assets (which must be viewed from a separate perspective using balance sheet
and cashflow statement). The P&L typically shows sales revenues, cost of
sales/cost of goods sold, generally a gross profit margin (sometimes called
'contribution'), fixed overheads and or operating expenses, and then a profit
before tax figure (PBT). A fully detailed P&L can be highly complex, but
only because of all the weird and wonderful policies and conventions that the
company employs. Basically the P&L shows how well the company has performed
in its trading activities.
overhead
An
expense that cannot be attributed to any one single part of the company's
activities.
quick
ratio
Same
as the Acid Test. The relationship between current assets readily convertible
into cash (usually current assets less stock) and current liabilities. A
sterner test of liquidity.
reserves
The
accumulated and retained difference between profits and losses year on year
since the company's formation.
restricted
funds
These
are funds used by an organisation that are restricted or earmarked by a donor
for a specific purpose, which can be extremely specific or quite broad, eg.,
endowment or pensions investment; research (in the case of donations to a
charity or research organisation); or a particular project with agreed terms of
reference and outputs such as to meet the criteria or terms of the donation or
award or grant. The source of restricted funds can be from government,
foundations and trusts, grant-awarding bodies, philanthropic organisations,
private donations, bequests from wills, etc. The practical implication is that
restricted funds are ring-fenced and must not be used for any other than their designated
purpose, which may also entail specific reporting and timescales, with which
the organisation using the funds must comply. A glaring example of misuse of
restricted funds would be when Maxwell spent Mirror Group pension funds on
Mirror Group development.
return
on capital employed (ROCE)
A
fundamental financial performance measure. A percentage figure representing
profit before interest against the money that is invested in the business.
(profit before interest and tax/capital employed x 100)
return
on investment
Another
fundamental financial and business performance measure. This term means
different things to different people (often depending on perspective and what
is actually being judged) so it's important to clarify understanding if interpretation
has serious implications. Many business managers and owners use the term in a
general sense as a means of assessing the merit of an investment or business
decision. 'Return' generally means profit before tax, but clarify this with the
person using the term - profit depends on various circumstances, not least the
accounting conventions used in the business. In this sense most CEO's and
business owners regard ROI as the ultimate measure of any business or any
business proposition, after all it's what most business is aimed at producing -
maximum return on investment, otherise you might as well put your money in a
bank savings account. Strictly speaking Return On Investment is defined as:Profits derived as a proportion of and directly attributable to cost or 'book value' of an asset, liability or activity, net of depreciation.
In simple terms this the profit made from an investment. The 'investment' could be the value of a whole business (in which case the value is generally regarded as the company's total assets minus intangible assets, such as goodwill, trademarks, etc and liabilities, such as debt. N.B. A company's book value might be higher or lower than its market value); or the investment could relate to a part of a business, a new product, a new factory, a new piece of plant, or any activity or asset with a cost attached to it.
The main point is that the term seeks to define the profit made from a business investment or business decision. Bear in mind that costs and profits can be ongoing and accumulating for several years, which needs to be taken into account when arriving at the correct figures.
share
capital
The
balance sheet nominal value paid into the company by shareholders at the
time(s) shares were issued.
shareholders'
funds
A
measure of the shareholders' total interest in the company represented by the
total share capital plus reserves.
t/t
(telegraphic transfer)
Interntional
banking payment method: a telegraphic transfer payment, commonly used/required
for import/export trade, between a bank and an overseas party enabling transfer
of local or foreign currency by telegraph, cable or telex. Also called a cable
transfer. The terminology dates from times when such communications were
literally 'wired' - before wireless communications technology.
variable
cost
A
cost which varies with sales or operational volumes, eg materials, fuel,
commission payments.
working
capital
Current
assets less current liabilities, representing the required investment,
continually circulating, to finance stock, debtors, and work in progress.
Financial term sites:
http://www.businessballs.com/finance.htm
Allow Your Own Inner Light to Guide You
There comes a time
when you must stand alone.
You must feel confident enough within yourself to follow your own dreams.
You must be willing to make sacrifices.
You must be capable of changing and rearranging your priorities so that your final goal can be achieved.
Sometimes, familiarity and comfort need to be challenged.
There are times when you must take a few extra chances and create your own realities.
Be strong enough to at least try to make your life better.
Be confident enough that you won't settle for a compromise just to get by.
Appreciate yourself by allowing yourself the opportunities to grow, develop, and find your true sense of purpose in this life.
Don't stand in someone else's shadow when it's your sunlight that should lead the way.
You must feel confident enough within yourself to follow your own dreams.
You must be willing to make sacrifices.
You must be capable of changing and rearranging your priorities so that your final goal can be achieved.
Sometimes, familiarity and comfort need to be challenged.
There are times when you must take a few extra chances and create your own realities.
Be strong enough to at least try to make your life better.
Be confident enough that you won't settle for a compromise just to get by.
Appreciate yourself by allowing yourself the opportunities to grow, develop, and find your true sense of purpose in this life.
Don't stand in someone else's shadow when it's your sunlight that should lead the way.
MBA Interview crakers
Accounting and Financial Glossary
ACCOUNTING DEFINITION:
Accounting
is the art of recording, classifying and summarizing in a significant manner
and in terms of money, transactions and events which are, in part atleast, of a
financial character, and interpreting the result thereof.
SUB-FIELDS OF
ACCOUNTING:
1. BOOK-KEEPING: It covers procedural aspects of
accounting work and embraces record keeping function. Obviously book-keeping
procedures governed by the end product, the financial statements, i.e. profit
and loss account, and balance sheet including schedules and notes forming part
of accounts.
Profit and Loss account gives result
of economic activities for a period and Balance Sheet states the financial
position at the end of the period.
Record keeping also requires suitable
classification of transactions and events. This is also determined with
reference to the requirements of financial statements.
2. FINANCIAL
ACCOUNTING: It
covers the preparation and interpretation of financial statements and
communication to the users of accounts.
3. MANAGEMENT
ACCOUNTING: It
covers the generation of accounting information for management decisions. So it
addresses to a single user group, the management. It includes cost accounting
which deals with keeping cost records, measurement of cost of product/service
and cost control methods.
ACCOUNTING EQUATION: EQUITY + LIABILITIES = ASSETS (or)
EQUITY + LONG TERM LIABILITIES = FIXED ASSETS +
CURRENT ASSETS –
CURRENT LIABILITIES.
MEASUREMENT BASES:
There
are four generally accepted measurement bases. These are:
i)
Historical Cost
ii)
Current Cost
iii)
Realisable Value
iv)
Present Value
HISTORICAL COST: It means acquisition price. Assets
are recorded at an amount of cash or cash equivalent paid or the fair value of
consideration given at the time of acquisition. Liabilities are recorded at the
amount of proceeds received in exchange for the obligation. In some circumstances
a liability is recorded at the amount of cash or cash equivalent expected to be
paid to satisfy it in normal course of business.
CURRENT COST: Assets are recorded at the amount
of cash or cash equivalent that would have to be paid if the same or an
equivalent asset was acquired currently. Liabilities are carried at the
discounted amount of cash or cash equivalents that would be required to settle
the obligation currently.
REALISABLE VALUE: As per realizable value, assets are carried at
the amount of cash or equivalent that could currently be obtained by selling
the assets in an orderly disposal. Haphazard disposal may yield something less.
Liabilities are carried at their settlement values; i.e., the undiscounted
amounts of cash or cash equivalents expressed to be paid to satisfy the
liabilities in the normal course of business.
PRESENT VALUE: As per present value, an asset is
carried at the present discounted value of the future net cash inflows that the
item is expected to generate in the normal course of business. Liabilities are
carried at the present discounted value of future net cash outflows that are
expected to be required to settle the liabilities in the normal course of
business.
EX: Mr. X found that he can get Rs.20,00,000/- if
he would sell the machine purchased, on 1-1-82 paying Rs.7,00,000/- and which
would cost Rs.25,00,000/- in case he would buy it currently.
ACCOUNTING CONCEPTS:
Accounting
Concept is generally used to mean a ‘Notion’ only or mental idea about
something. For example, Cost, Income and Capital, Debit and Credit, Assets and
Liabilities etc., are concepts i.e., basic assumptions or conditions upon which
science of accounting is based. There is no authoritative list of these
concepts. In other words, concept means such ideas which are coupled with
different accounting procedures e.g. Appropriation and Charge, Reserve and
Provisions, Depletion and Amortisation etc. The following are some of the
important generally acceptable concepts: (ICWA)
Accounting
is the language of business; affairs of a business unit are communicated to
others as well as to those who own or manage it through accounting information
which has to be suitably recorded, classified, summarized and presented. To
make it full of meaning, accountants have agreed on a number of concepts which
they try to follow. These are given below: (SHUKLA)
BUSINESS ENTITY
CONCEPT:
Accountants treat a business as distinct from the persons who own it; then it
becomes possible to record transactions of the business with the proprietor
also. Without such a distinction, the affairs of the firm will be all mixed up
with the private affairs of the proprietor and the true picture of the firm
will not be available.
This concept has now been extended to
accounting separately for various division of a firm in order to ascertain the
results for each division separately. It has been of immense value in
determining results by each responsibility centre – Responsibility Accounting.
MONEY MEASUREMENT
CONCEPT: Accounting
records only those transactions which are expressed in monetary terms, though
quantitative records are also kept. An event, even though important, like a
quarrel between the production manager and the sales manager, will not be
recorded unless its monetary effect can be measured with a fair degree of
accuracy. It should be remembered that money enables various things of divers
nature to be added up only through money values and not otherwise.
COST CONCEPT: Transactions are entered in the
books of account at the amounts actually involved. Suppose a firm purchases a
piece of land for Rs. 1,50,000/- but considers it as worth Rs.3,00,000/-. The
purchase will be recorded at Rs.1,50,000/- and not any more. This is one of the
most important concepts – it prevents arbitrary values being put on
transactions, chiefly those resulting in acquisition of assets. Another way of
saying the same thing would be that the amount to be recorded is objectively
arrived at – as a result of the mutual agreement of the two parties involved.
Of course, sometimes accountants have
necessarily to be satisfied with an estimate only – the amount of depreciation
to be charged each year in respect of machinery is an example; the amount has
to be an estimate since the future life of the machinery cannot be known
precisely.
GOING CONCERN CONCEPT: It is assumed that the business
will exist for a long time and transactions are recorded from this point of
view. It is this that necessitates distinction between expenditure that will
render benefit over a long period and that whose benefit will be exhausted
quickly, say, within the year, of course, if it is certain that the concerned
venture will exist only for a limited time, the accounting record will be kept
accordingly.
DUAL ASPECT CONCEPT: Each transaction has two aspects,
if a business has acquired an asset, it must have resulted in one of the
following:
a) some other asset has been given up;
or
b) the obligation to pay for it has
arisen; or rather,
c) there has been a profit, leading to
an increase in the amount that the business owes to the proprietor; or
d) the proprietor has contributed
money for the acquisition of the asset.
The reserve is also true. If, for instance, there is an increase in the
money owed to others, there must have been an increase in
assets or a loss. At any time:
Assets = Liabilities +
Capital; or, rather,
Capital = Assets -
Liabilities
In other words, capital, i.e., the
owner’s share of the assets of the firm, is always what is left out of assets
after paying off outsiders. This is called the Accounting Equation. It is self
evident but very useful.
REALISATION CONCEPT: Accounting is a historical record
of transactions; it records what has happened. It does not anticipate events
though anticipated adverse effects of events that have already occurred are
usually recorded. This is of great importance in stopping business firms from
inflating their profits by recording sales and incomes that are likely to
accrue. Unless money has been realized – either cash has been received or a
legal obligation to pay has been assumed by the customer – no sale can be said
to have taken place and no profit or income can be said to have arisen.
ACCRUAL CONCEPT: If an event has occurred or a
transaction has been entered into, its consequences will follow. Normally, all
transactions are settled in cash but even if cash settlement has not yet taken
place, it is proper to bring the transaction or the event concerned into the
books. Income or profit arises only out of business operations – when there has
been an increase in the owner’s share of the assets of the firm (called owner’s
equity) but not if the increase has resulted from money contributed by the
owner himself. Any increase in the owner’s equity is called revenue and anything
that reduces the owner’s equity is expense (or loss); profit results only when
the total of revenues exceeds the total of expenses or losses
MATCHING CONCEPT: This concept recognizes that the
determination of profit or loss on a particular accounting period is a problem
of matching the expired cost allocated to an activity period. In other words,
the expenses which are actually incurred during a specific activity period, in
order to earn the revenue for the said period, must be matched against the revenue
which are realized for that period. For this purpose, expenses which are
specially incurred for earning the revenue which are realized period are to be
considered. In short, all expenses incurred during the activity period must not
be taken. Only relevant cost should be deducted from the revenue of a period
for periodic income statement, i.e., the expenses that are related to the
accounting period shall be considered for the purpose of matching. This process
of relating costs to revenue is called matching process. It should be
remembered that cost of fixed asset is not taken but only the depreciation on
such fixed asset related to the accounting period is taken. (For the purpose of
matching, prepaid expenses are excluded from the total costs but outstanding
expenses are added to the total cost for ascertaining the cost related to the
period). Like costs, all revenues earned during the period are not taken, but
revenue which are related to the accounting period are considered.
Application of matching concept
creates some problems which are noted below:
a)
Some special items of expenses, e.g., preliminary expenses, expenses in
connection with the issue of shares and debentures, advertisement expenses
etc., cannot be easily identified and matched against revenues of a particular
period.
b)
Another problem is that how much of the capital expenditure should be written
off by way of depreciation for a particular period for matching against revenue
creates the problems of finding out the expected life of the asset. As such,
accurate matching is not possible.
c)
In case of long term contracts, usually, amount is not received in proportion
to the work done. As a result, expenditures which are carried forward and not
related to the income received, may create some problems.
CONVENTIONS:
It refers to the general agreement on
the usage and practices in social or economic life, it is a customary practice,
rule, method or usage. In other words, it is an accounting procedure followed
by the accounting community on the basis of long standing customs.
Accounting Conventions can be used as
follows:
CONSISTENCY: The accounting practices should
remain in the same from one year to another – for instance, it would not be
proper to value stock-in-trade according to one method one year and according
to another method next year. If a change becomes necessary, the change and its
effect should be stated clearly.
DISCLOSURE: Apart from legal requirements, good
accounting practice also demands that all significant information should be
disclosed. Not only various assets, for
example, have to be stated but also the mode of valuation should be disclosed.
Various types of revenues to be stated but also the mode of valuation should be
disclosed. Whether something should be disclosed or not will depend on whether
it is material or not. Materially depends on the amounts involved in relation
to the asset or transaction group involved or to profits.
CONVERVATISM: Financial Statements are usually
drawn up on rather a conservative basis. Window-dressing, i.e., showing a
position better that what it is, is not permitted. It is also not proper to
show a position substantially worse than what it is. In other words, secret
reserves are not permitted.
MATERIALITY: Materiality means relative importance.
In other words, whether a matter should be disclosed or not in the financial
statements depends on its materiality, i.e., whether it is material or not.
American Accounting Association defines ‘Materiality’ as under:
“An item should be regarded as
material if there is reason to believe that knowledge of it would influence the
decision of informed investors”.
An accountant cannot ignore the
consideration of materiality of procedures. The term itself is a subjective
term. As such, an accountant should record an item of material even though it
is of small amount if the same influences the decisions of the users, viz.
proprietors, auditors, or investors etc. On the other hand if it is found that
an information is not sufficiently important to influence the quality of
periodical financial statements, the same should be treated as ‘immaterial’ and
hence should be avoided.
It has been stated above that
materiality depends on the amounts involved and the account so affected. As a
result, whether a particular item is material or immaterial depends on the
amount and nature of the same. Because, the material information helps the
management to avoid unnecessary wastage of time and money on principal matters.
It should be noted that this doctrine of materiality refers to separate
disclosure of information in the published financial statements for the user of
the same. In short, material items should separately be disclosed whereas
immaterial items may not be disclosed separately but may be combined in a consolidated
form in the published financial statements.
FUNDAMENTAL ACCOUNTING
ASSUMPTIONS:
Certain fundamental accounting
assumptions underlie the preparation of financial statements. They are usually
not specifically stated because their acceptance and use are assumed.
Disclosure is necessary if they are not followed, together with the reasons.
The following are recognized by the
International Accounting Standards Committee as fundamental accounting
assumptions.:
a)
Going Concern: The Enterprise
b)
Consistency: It is assumed that accounting policies are consistent with one
period to another.
c)
Accrual: Revenues and costs are accrued, that is, recognized as they are
earned or incurred (and not as money is received or paid) and recorded in the
financial statements or the periods to which they relate. (The considerations
affecting the process of matching costs with revenues under the accrual
assumption are not dealt with in this statement).
NOTES TO ACCOUNTS:
Notes to accounts are the explanation
of the management about the items in the financial statements i.e., profit and
loss account and balance sheet. The management gives more explanation and
information about the item of profit and loss account and the balance sheet and
any other items, by way of notes of accounts
Notes to accounts are integral part of
financial statement.
ACCOUNTING
STANDARDS:
An Accounting Standard is a selected
set of accounting policies or broad guidelines regarding the principles and
methods to be chosen out of several alternatives. Standards conform to
applicable laws, customs, usages and business environment. So there is no
universally acceptable set of standards. In India
The Council of the ICAI has so far
issued twenty eight Accounting Standards. However, AS-8 on “Research &
Development” is withdrawn consequent to issue of AS-26 “Intangible Assets”.
These are as follows:
AS
|
Title of the AS
|
Date from which
mandatory (accounting periods commencing on or after)
|
Enterprises to which
applicable at present
|
1
|
Disclosure
of Accounting Policies
|
All
|
|
2
(Revised)
|
Valuation
of Inventories
|
All
|
|
3
(Revised)
|
Cash
Flow Statements
|
See
Note - 2
|
|
4
(Revised)
|
Contingencies
and Events Occurring after the Balance Sheet Date
|
All
|
|
5
(Revised)
|
Net
Profit or Loss for the period, Prior Period Items and Changes in Accounting
Policies
|
All
|
|
6
(Revised)
|
Depreciation
Accounting
|
--
|
|
7
(Revised)
|
Accounting
for Construction Contracts
|
All
|
|
8
|
Accounting
for Research & Development
|
Withdrawn
and included in AS-26
|
All
|
9
|
Revenue
Recognition
|
All
|
|
10
|
Accounting
for Fixed Assets
|
All
|
|
11
(Revised)
|
The
Effects of Changes in Foreign Exchange Rates
|
(Any
foreign exchange transaction entered before
|
All
|
12
|
Accounting
for Government Grants
|
All
|
|
13
|
Accounting
for Investments
|
All
|
|
14
|
Accounting
for Amalgamations
|
All
|
|
15
|
Accounting
for retirement benefits in Financial Statements of Employers
|
All
|
|
16
|
Borrowing
Costs
|
All
|
|
17
|
Segment
Reporting
|
See
Note - 2
|
|
18
|
Related
Party Disclosures
|
All
|
|
19
|
Leases
|
All
|
|
20
|
Earning
Per Share
|
See
Note - 2
|
|
21
|
Consolidated Financial Statements
|
See
Note - 3
|
|
22
|
Accounting
for Taxes on Income
|
See
Note - 4
|
See
Note - 4
|
23
|
Accounting
for Investment in Associates in Consolidated
Financial Statements
|
All
|
|
24
|
Discontinuing
Operations
|
All
|
|
25
|
Interim
Financial Reporting
|
All
|
|
26
|
Intangible
Assets
|
All
|
|
27
|
Financial
Reporting of Interest in Joint Venture
|
All
|
|
28
|
Impairment
of Asset
|
See
Note - 2
All
|
|
29
|
Provisions,
Contingent Liabilities and Contingent Assets
|
All
(with
certain exceptions in respect of paragraphs 66 & 67 of the Standard)
|
NOTE
1: a) Sole Proprietary concerns / Individuals
b) Partnership Firms
c) Societies registered under the Societies
Registration Act
d) Trusts
e) Hindu Undivided Family
f) Association of persons
NOTE
2: AS - 3, AS - 17, and AS - 20 have been made mandatory in respect of
following enterprises:
i)
Enterprises whose equity or debt securities are listed on a recognized stock
exchange in India , and
enterprises that are in the process of issuing or debt securities that will be
listed on a recognized stock exchange in India
ii)
All other commercial, industrial and business reporting enterprising, whose
turnover for the accounting period exceeds Rs. 50 Crores.
NOTE
3: AS - 21 is mandatory if an enterprise presents consolidated financial statements. In other
words,
the accounting standard does
not mandate an enterprise to present consolidated financial
statements but, if the
enterprise presents consolidated
financial statements for complying with the
requirements of any status or
otherwise, it should prepare and present consolidated financial
statements in accordance with
AS - 21.
NOTE
4: AS - 22 comes into effect in respect of accounting period commencing on or
after 1-4-2001 . It
is mandatory in nature for:
(a) All the accounting periods
commencing on or after 1-4-2001 ,
in respect of the following:
(i) Enterprise
whose equity or debt securities are listed on a recognized stock exchange in India
and enterprises that are in the process of issuing equity or debt securities
that will be listed on a recognized
stock exchange in India
(ii) All the enterprises of a
group, if the parent consolidated
financial statements and the Accounting
Standard is mandatory in nature of respect of any of the enterprises of that
group in terms of (i) above.
(b) All the accounting periods
commencing on or after 1-4-2002 ,
in respect of companies not covered
by (a) above
(c) All the accounting periods
commencing on or after 1-4-2003 ,
in respect of all other enterprises.
E.O.Q. (Economic
Order Quantity):
It
is a quality of material that can be occurred at which both ordering costs and
carrying costs are minimum.
E.O.Q.=
Root 2AO/C
A=
Annual Consumption
O=
Ordering Cost per order
C=
Carrying Cost per unit per annum
Semi-Variable Cost:
These
costs are partly fixed and partly variable, in relation to output.
Ex: Telephone Bill, Electricity Bill.
Angle of Incidence:
When
both the cost curve and sales curve cuts or meet at a point that point is
called as Break Even Point.
The
angle left after their inter section is called profit angle or angle of
incidents.
Sales Curve
Margin of Safety:
Difference
between Total Actual Sales - Break Even Sales
Margin
of Safety = Total Sales - B.E.P.
Margin
of Safety will be reached faster if angle of incidents is more and vice versa.
Ex: Total Sales = 30000 ; B.E.P. Sales = 20000
therefore
Margin of Safety = 30000 - 20000 = Rs. 10000
Absorption Costing
:
Each
and every item of cost i.e., variable cost and fixed cost is charged to the
product.
Case 1 :In this case fixed cost are charged
to the product on the basis of normal capacity.
[Normal
capacity – The number of units normally produced by the company]
Case 2: in case of under absorption, that
amount should be charged to the P&L A/c
Ex:
Case-1 : Normal
units = 10,000
Actual
production = 12,000
Fixed over heads = Rs.1,00,000/-
The
absorption rate : fixed over heads = 1,00,000
Normal units 1,0000
= Rs.10/- per unit
And
total absorption should be Restricted to Rs.1,00,000/-
In
any case the absorbed amount should not exceed the actual fixed cost.
Case-2 : if the actual production is 8,000
units
The absorption Rate :1,00,000 =Rs.10/- per unit
10,000
The
amount absorbed =8000X10 = Rs.80,000
Under
absorbed Amount : 1,00,000 - 80,000= Rs.20,000/-
Which
is charged to the Profit and Loss A/c.
Marginal Costing:
This
is a technique of Decision Making.
In
the case of Marginal Costing only variable cost are absorbed by the product.
In
this case the fixed costs are considered as period cost and this should be
charged to P & L A/c.
Costing:
The
Process of determining cost is called as costing.
Variable Cost:
1.
Cost which is changing with every change in production additionally if you want
to producing one more unit we need to expend additional cost.
Ex: for 10 units – Rs.100/-
for 11th unit additionally Rs.10/-
2.
Cost per unit will not change but there is change in total cost.
Ex: for 10 units – Rs.100/-
Cost per unit = cost/unit =100/10=
Rs.10/-
11 units – 110/-
Cost per unit= 110/11 = Rs.10/-
Fixed Cost:
1.
This cost is fixed will not change with increase or decrease in production.
Ex:
Factory rent
2.
The total cost will not change but cost per unit will change.
Ex:
Rent = Rs.10000/-
1 person share =Rs.10000/-
2 persons share= Rs.5000/- each
4 persons share = Rs.2500/- each
P/V Ratio (Profit -
Volume Ratio) :
It
is a Ratio between Contribution and Sales.
P/V
Ratio = Contribution / Sales x 100
Contribution
per unit: Selling Price per unit - Variable Cost per unit
Break - Even -
Point (B.E.P.):
This
is a point at which there is no profit or no loss.
At
this point to total amount received is equal to the total cost incurred.
Total
Sales amount= Total Cost Amount (Fixed Cost + Variable Cost)
Total
Contribution = Total Fixed Cost
Ex: Selling Price = Rs.10/-
Variable Cost= Rs.5/-
Fixed Cost= Rs.10000/-
Contribution= Rs.10-Rs.5 = Rs.5/-
P/V
Ratio = Contribution x 100
= 5/10x100=50%
Sales
B.E.P.Units=
Fixed Cost/ Contribution per unit = 10000/5= 2000 units.
B.E.P.Value=
Fixed Cost/ PV Ratio = 10000/50x100 = Rs.20000/-
Statement of
Marginal Cost:
Total
Sales - Variable Cost = Contribution
Contribution
- Fixed Cost = Profit
Current Ratio: Current Assets / Current
Liabilities
Current
Assets are those which can be converted into cash in the short run.
The
term short run means - generally a period of one year.
Current
Assets = Inventories + Sundry Debtors + Cash and Bank Balances + Short Term
Loans & Advances +
Marketable
Non-Trade Securities + Prepaid Expenses.
Current
Liabilities = Cash Credit + Bank O.D. + Short Term Borrowings + Creditors +
Proposed Dividend + Unclaimed
Dividend +
Provision for Taxation (Provision for Tax - Advance Tax Paid)
Quick Ratio: Quick Assets / Quick Liabilities
Quick
Assets = Current Assets - Stock and Prepaid Expenses - Other Liquid Portion of
Current Assets
Quick
Liabilities = Current Liabilities – Cash Credit, Bank Borrowings and Other
Short Term Borrowings
Debt Equity Ratio: Debt / Equity
Debt
= Secured Loan and Unsecured Loan minus Cash Credit and Bank O.D.
Equity
= Paid-up Share Capital including Preference Capital and Pre-Reserves
Capital Employed = Net Fixed Assets + Working Capital
Inventory Turnover
Ratio = Cost of
Goods Sold / Average Inventory
Debt Service
Coverage Ratio
= Profit after Tax + Interest + Depreciation + Non-Cash Items
Interest
+ Debt Installment
Interest Coverage
Ratio =
Earning Before Interest
Interest
P.E.Ratio (Price
Earning Ratio)
= Market Price Per Share
Earning Per Share
Dividend Yield
Ratio = Dividend Per Share
Market Price Per Share
Operating Leverage = Contribution___________
Earning
Before Interest & Tax (EBIT)
Finance Leverage = Earning Before Interest &
Tax (EBIT)
Earning Before Tax
Total Leverage = Operating Leverage x Finance Leverage
EPS = Earnings available to Equity
Shareholders
No.of Equity Shares
outstanding
Memorandum of
Association (MOA)
|
Articles of
Association (AOA)
|
|
1
|
Memorandum
defines the companies constitution and scope. MOA is the companies
constitution and scope.
|
AOA
represents Rules and Regulations of the company.
|
2
|
It
is a primary document.
|
It
is a secondary document.
|
3
|
It
is subordinate to the Act.
|
It
is subordinate to MOA and Act.
|
4
|
It
is a must for every company.
|
Can
be written or taken from Company’s Act.
|
5
|
Strict
provisions for alteration.
|
Special
resolution is sufficient except where the amendment brings into effect a
private from public.
|
6
|
Ultra
virus MOA even all the members cannot ratify it. (change).
|
Ultra
virus AOA but intra virus the MOA can be ratified.
|
Shares
|
Debentures
|
|
1
|
Shares
are part of the capital of the company.
|
Debentures
constitute a loan.
|
2
|
Shareholders
are members or owners of the company.
|
Debenture
holders are creditors.
|
3
|
When
recommended by the board dividend could be declared to shareholders.
|
Fixed
amount of interest on debentures paid before dividend declaration.
|
4
|
Shares
do not carry on any charge.
|
Debentures
generally have a charge on the asset of the company.
|
5
|
Shares
have restrictions issue at a discount.
|
Debentures
do not have restrictions issue at a discount.
|
6
|
Shareholders
have voting rights.
|
Debenture
holders do not have voting rights.
|
7
|
Dividend
is payable only when profits are there.
|
Interest is payable whether profits are
there or not.
|
8
|
No
fixed dividend.
|
Rate
of interest is fixed.
|
Shareholder
|
Debenture holder
|
|
1
|
One
of the owner of the company and has proprietary interest in the company.
|
Only
a creditor of the company
|
2
|
When
the company makes profits and the board recommends, shareholder gets a share
in the profits.
|
Get
a fixed rate of interest whether the company makes profit or not.
|
3
|
No
security for his investment.
|
Normally
debentures are secured.
|
4
|
Eligible
for voting rights.
|
No
voting rights.
|
5
|
On
liquidation, shareholders are paid last.
|
Ranks
priority with regard repayment.
|
Shares
|
Stock
|
|
1
|
Has
a nominal value.
|
No
nominal value.
|
2
|
May
be fully paid or partly paid.
|
Always
fully paid.
|
3
|
Can
be transferred in whole numbers and not in fractions.
|
Can
be transferred in fractions also.
|
4
|
Each
and every share shall be of equal denominations.
|
May
be unequal amounts.
|
5
|
Shares
are identified with distance numbers.
|
Do
not have any distinctive numbers.
|
6
|
Can
be issued directly to the public.
|
Only
fully paid up shares can be converted in to stock and cannot be issued
directly.
|
Capital expenditure
|
Revenue expenditure
|
|
1
|
Expenditure
for the purchase and installation of asset.
|
Expenditure incurred for the maintenance of asset.
|
2
|
These
assets are shown at the assets side of the balance sheet
|
These
expenses are shown in the debit side of profit and loss account.
|
3
|
Expenses
are incurred for long term investment.
|
Expenditure
incurred for short term investment.
|
4
|
The
benefits will flow or enjoyed by the organization for more than one year.
Ex:
plant and machinery
|
The
benefits for the expenditure will flow or enjoyed by the organization for the
current year only.
Ex:
salaries, printing & stationary etc.
|
5
|
The
item dealt is called as asset. It is expressed or identified in its own name.
Plant
– Plant ; T.V. – T.V.
|
The
item dealt is called goods or merchandise.
Plant
– Goods ; T.V. – Goods.
|
6
|
Asset
is purchased for utilization in the business, in the normal course of
business.
|
Goods
are purchased with an intention to sell.
|
7
|
Depreciation
is to be considered for the life of asset.
|
There
is no need of depreciation.
|
Profit and Loss
Account
|
Balance Sheet
|
|
1
|
Objective
of preparing P & L Account to ascertain the net profit or loss of the
business during the year.
|
The
objective of the preparing Balance Sheet is to know the financial position of
the business on a specific date.
|
2
|
In
this account having debit and credit as such “To” and “By” are used
|
Balance
Sheet is a statement and hence “To” and “By” are not used.
|
3
|
Revenue
expenditure and incomes are recorded in the Profit and Loss Account.
|
Capital
incomes and expenditures are shown in the Balance Sheet.
|
4
|
Balancing
figure of this account either net profit or net loss.
|
Balance
Sheet will not show any balancing figure. A total of Liabilities and Assets
side should always be equal.
|
Recurring Expenses
|
Non-Recurring
Expenses
|
|
Items
which are repeated.
Ex:
Salaries & Wages
|
Items
Which Are Not Regular And Repeated.
Ex:
Buying of Machinery or Other Fixed Assets, Legal Expenses, Loss or Profit on
sale of Asset, Insurance Claims.
|
Public Limited
Company
|
Private Limited
Company
|
|
1
|
Minimum
number of members are 7.
|
Minimum
number of members are 2.
|
2
|
Maximum
number of members are unlimited.
|
Maximum
number of members are 50.
|
3
|
Minimum
directors are 3.
|
Minimum directors are 2.
|
4
|
After
getting business commencement certificate they can do business.
|
Can
start business after incorporation.
|
5
|
Public
Limited Company can go for public issue.
|
Private
Limited Company shall not issue its shares to outsiders.
|
Provision
|
Reserve
|
|
1
|
Provision
is a charge against the profits.
|
Reserve
is an appropriation on profits.
|
2
|
Is
made for known liability or expenditure.
|
It
is made for future unknown liability.
|
3
|
It
is utilized for that purpose only.
|
It
can be utilized for any future purpose.
|
4
|
Is
shown above the line.
|
Is
shown below the line.
|
5
|
Above
the line means Profit and Loss Account.
|
Below
the line means Profit and Loss Appropriation Account.
|
Partnership
|
Joint Venture
|
|
1
|
It
is a going concern.
|
It
is a terminable venture.
|
2
|
It
always has a name.
|
It
may not bear a name.
|
3
|
Persons
carrying on business are called partners.
|
Persons
carrying on business are called Co-venturers.
|
4
|
Profits
are ascertained at regular intervals, i.e., annually.
|
The
profits are ascertained for each venture separately cash basis of accounting
is followed.
|
Deposit
|
Debenture
|
|
1
|
Deposits
are amounts, received by the company from the public.
|
Debenture
is a document, which acknowledge debt, which is issued by company
|
2
|
Deposits
are short term or middle term financial sources.
|
Debentures
are long term financial sources.
|
3
|
Deposits
are unsecured.
|
Debentures
are generally secured.
|
4
|
It
is easy to rise public deposits.
|
Issue
of debentures restricted by RBI.
|
Member
|
Share holder
|
|
1
|
Name
entered in the register of members.
|
Name
not entered in the register on members.
|
2
|
Member
is also a share holder.
|
Share
holder is not a member unless name is entered in the register of members.
|
3
|
Share
warrant holder is not a member.
|
Share
warrant holder is share holder.
|
Partner
|
Director
|
|
1
|
Partner
is one of the owner.
|
Director
is one of the member of the executive body.
|
2
|
Partnership
is governed by Partnership Act, 1932.
|
Companies
is governed by the Companies Act, 1956.
|
3
|
Partner
is a unlimited liability.
|
Director
is generally not liable.
|
Company
|
Partnership
|
|
1
|
Company
comes into existence only when it is registered under the companies act.
|
A
firm is created by mutual agreement between partners. Registration is optional.
|
2
|
Members:
minimum
Private
: 2 Members
Public
: 7 Members
Maximum
Private
: 50
Public
: un limit.
|
Members:
Minimum
2
Partners.
Maximum
In
case of Banking Business : 10
In
case of Other Business : 20.
|
3
|
A
company on its incorporation enjoys a separate legal entity.
|
A
firm does not have separate legal entity.
|
4
|
In
case of company members liability is limited.
|
In
case of firm, partners are jointly or severably liable.
|
Company
|
Club
|
|
1
|
A
company is a trading association.
|
Club
is a non trading association.
|
2
|
A
company is required to be registered under the companies act.
|
Registration
of a club is not mandatory.
|
Trial Balance
|
Balance Sheet
|
|
1
|
The
Trial Balance is prepared to check the arithmetical accuracy of the books of
accounts.
|
Balance
Sheet is prepared to know the true position of assets and liabilities on a
particular date.
|
2
|
Trail
Balance does not show the financial position of business.
|
The
financial position can be known from balance sheet.
|
3
|
The
Trial Balance is prepared based on the ledger accounts.
|
The
Balance Sheet is prepared on the basis of information from Trial Balance.
|
4
|
The
preparation of Trial Balance is not compulsory.
|
The
preparation of Balance Sheet is must.
|
5
|
Trial
Balance cannot be shown as a documentary evidence.
|
Balance
Sheet will be accepted as documentary evidences by tax authorities and
courts.
|
Forfeiture of Shares
|
Surrender of Shares
|
|
1
|
Forfeiture
is proceeding against reluctant shareholder. ( defaulted in call payment)
|
Surrender
is affected with the assent of share holder.
|
2
|
Forfeiture
can be done only partly paid up shares.
|
Surrender
can be done only fully paid up shares.
|
Share Certificate
|
Share Warrant
|
|
1
|
The
holder is a registered member of the company.
|
The
bearer of a share warrant is not a registered member.
|
2
|
The
holder of a share certificate is essentially a member.
|
The
bearer of a share warrant can be a member only if the article so provided in
and as.
|
3
|
For
the issue of share certificate may not required approval of the Central Government.
|
Share
warrant can be issued Central Govt. approval is must.
|
4
|
All
companies must issue share certificates.
|
Share
warrant can be issued only by public companies.
|
5
|
Share
certificate is issued is partly or fully paid shares.
|
Share
warrant can be issued only fully paid shares.
|
6
|
Share
certificate is not negotiable.
|
Share
warrant is negotiable.
|
7
|
The
holder of a share certificate can present a petition for winding up.
|
The
holder of a share warrant cannot present a petition for winding up.
|
Promissory Note
|
Bill of Exchange
|
|
1
|
In
promissory note there is a promise to pay..
|
In
a bill there is an order to pay.
|
2
|
In
promissory note there are two parties, namely, the maker and the payee.
|
In
a bill there are three parties, namely, drawee, drawer, and payee.
|
3
|
A
promissory note is signed by the person liable to pay. So no acceptance is
needed.
|
A
bill has to be accepted by the drawee before he can be held liable.
|
Journal
|
Ledger
|
|
1
|
Journal
is the book of first or original entry. It is also called the book of first
entry or primary entry.
|
The
ledger is the book of second entry.
|
2
|
Transaction
in the journal will be recorded immediately.
|
Depending
upon his conveniences the trader records the transaction in the ledger.
|
3
|
When
once the entries are posted in to ledger, the journal losses its importance.
|
It
will never lose importance as it is the main book of accounts which is relied
upon permanently.
|
4
|
In
the preparation of final accounts journal in not useful.
|
In
the preparation of trial balance and final accounts ledger is a must.
|
5
|
The
tax authorities generally may not depend on journal.
|
In
the finalization of income tax to be paid, the tax authorities depend on
ledger.
|
Book-keeping : is complement to the accounting
process. Book-keeping is the systematic recording of financial and economic transactions.
Accounting: is the analysis and interpretation
of Book-keeping records.
Cash Book : The Cash Book is a sub division of
the original entry recording transactions involving receipts and payments of
cash. All cash transactions are first entered in the cash book and then posted
from cash book in to the ledger. Transactions are recorded chronologically in
the cash book.
Bill of Exchange : is a instrument in writing
containing an unconditional order, signed by the maker, directing a certain
person to pay a certain sum of money only to, or to the order of a certain
person or to the bearer of the instrument.
Prudence: Incomes are recognized when they
are realized, all possible expenses are provide.
Term Loans : Term Loans represents secured
borrowing and at present are the most important source of finance for new
projects. They generally carry a rate of interest. These loans are generally
repayable over a period of 6 to 10 years in annual, semi annual, or quarterly
in installments. Term loans are also provided by banks, state financial
institutions and all India
Cash Profit: Cash is arrived by adjusting the
non-cash transactions to the net profit after tax.
Net profit after tax xxxx
Add: Non-cash expenses xxx
xxxx
Add: Depreciation xxx
xxxx
Less: Non-cash incomes(credit sales)
xxx
Cash Profit xxxx
Cash Flow
Statement:
v
Accounting
Standard 3 explains about this.
v
The
statement shows how much cash is generated and expended in the organization
during the year. It also shows opening and closing balance of cash.
v
It
is use full for investors and creditors.
v
It
provides vital (important) information about companies ability to generate
future cash flow to satisfy investors and creditors expectations.
Methods in preparing
cash flows:
There
are two methods, these are a) Direct Method, and b) Indirect Method.
In
Direct Method : Gross Receipts – Gross
Payments = Net Cash Flow
In
Indirect Method : Net Profit + Non-cash
Expenditure – Non-cash Incomes (Credit Sales) = Net Cash Flow.
Classification of Cash
Flows :
i)
Operating Cash Flow
ii)
Investing Cash Flow
iii)
Financing Cash Flow
Cash : The purchasing power in hand is
called cash.
Cash Expenses : Cash is paid for expenses incurred.
Ex: Salaries, Wages paid etc.
Non-cash Expenses : it is an expenditure, there is no
cash involvement.
Expenses
are incurred but – cash is not paid ( that is cash is not going out of the
business)
Ex:
depreciation writing off, goodwill, patents, writing off preliminary expenses,
discount on issue of shares and debentures, loss on revaluation of assets and
liabilities etc., in this cases income is reduced since tax saving is effected.
Amalgamation : Involves merger of two existing companies
or a company takeover the another company.
Absorption : A company take over another
company. Amalgamation includes absorption.
Fixed Assets : These assets are acquired for long
term use in the business.
Liquid Assets : These assets also known as
circulating, fluctuating, or current assets. These assets can be converted in
to cash as early as possible.
Fictitious Assets : Fictitious assets are those assets,
which do not have physical form. They do not have any real value.
Ex:
loss on issue of shares, preliminary expenses etc.
Intangible Assets : Intangible assets are those having
no physical existence and cannot touch.
Ex:
Goodwill, Patents, and Trademarks etc.
Contingent Liabilities
: These are not the
real liabilities. They are not actual liabilities at present. They right become
a liability in respect of pending. This is not shown in balance sheet. That may
be shown as notes under balance sheet.
Del-credre Commission
: It is extra
commission paid to bear the bad debts collection loss.
Demat Account : Demat means the materialized
account. It is a separate account maintained for investments (Shares,
Securities, Debentures, Bonds etc.). It gives information about shares sought
and sold, prices at which shares were bought and sold, shares presently holding
and amount held.
IRR (Internal Rate of
Return) : This
method takes in to consideration time value. It can be said as discounted rate
of return.
Purchase Consideration
: Consideration
paid by the transferor company to the shareholders of Transferee Company.
Economic Value Added : A company or business earning
profit which is more than cost of capital (Return expected by Investors).
Impairment : Permanent decline in value of asset.
ABC Analysis : ABC Analysis is a method of
inventory control. It is popular system of inventory control. The item of
inventory is generally classified in to three types. These are:
A
: Usage value is Maximum and number of items is Minimum.
B
: Usage value is Medium and number of items is also Medium.
C
: Usage value is Lowest and number of items is Highest.
Annual Report : Annual Report is a report, which
will contain the all financial statements of the company and auditors report
and main opinions on performance of company. It is useful with previous
reports.
Sweat Equity Shares : means equity shares issued by the
company to employees, directors. Such issue should be authorized by a special
resolution passed by the company in general meeting.
Memorandum : means MOA as originally framed or
altered from time to time in pursuance of any previous company law or of this
act.
Issue of Share at a
Discount : Shares
can be issued at a discount, if the following conditions are fulfilled.
v
The
issue of shares at a discount must be a resolution passed by the members at the
general meeting.
v
The
issue should be sanctioned by the company law tribunal.
v
The
resolution authorizing the issue of shares specified the maximum rate of
discount at which the shares are to be issued.
v
The
rate of discount shall not exceed 10%. Unless company law tribunal allowed such
excess under special circumstances.
v
The
issue can be made only after one year. One year has elapsed since the company
was entitled to commence business.
v
The
shares shall be issued with in two months of the sanction by the company law
tribunal or such other period as permitted.
Shares issued at a
price less than the nominal value :
Then it is called shares issued at discount. The difference between the issued
price and nominal value is discount on issue of share. It is shown in balance
sheet under the head of miscellaneous expenditure not written off.
Shares issued at
Premium: When a
company issues shares at a price higher than the nominal value of the share
(securities) then the difference in the nominal value and the issue price is
the premium.
v
The
premium may be received in cash or in kind.
v
But
the share premium collected by a company on issue of shares is required to be
retained in a separate accounts titled as share (securities) premium account.
v
Securities
premium account can be used only for
·
paying
up of fully paid bonus shares to be issued by the company to its members.
·
To
write off preliminary expenses.
·
To
write off underwriting expenses / commission paid discount allowed on any issue
of shares or debentures of the company.
·
To
provide premium payable by a company on redemption of debentures of the
company.
·
Distribution
of securities premium amount as dividend is not permitted.
·
Security
premium is not a free reserves. It is in the nature of capital reserve.
Portfolio Management : Classification of assets get aims
at minimizing the total risk while taking the maximum returns is called
portfolio management. It refers to diversification of assets which means not
keeping all eggs in the same basket.
Good will : It is an amount paid over and above
the value of assets and liabilities of the under taking.
Goodwill
is the reputation of the business. This reputation is due to excess sales and
profit made then normal sales and profit.
Reasons
for goodwill are:
- Good
reputation
- Favourable
location
- Ability
and skill of employees
- Good
management.
Goodwill
is of two types, these are i) Purchased Goodwill and ii) Developed Goodwill
Purchased goodwill: more amounts paid for assets than
required
Ex:
Total Assets = 100000
Amount Paid= 150000
Developed Goodwill: This goodwill not be written in
books.
Goodwill
is to be calculated basically on the basis of following methods,
i)
Capitalization method and ii) Super Profit Method
Capitalization Method:
Normal Capital Employed = Future
Maintainable Profits
Normal Rate of Return
Goodwill = Normal Capital Employed –
Actual closing capital employed
Super Profit Method:
Super Profit = Future Maintainable
Profits – Actual Capital Employed x Normal
Rate of Return.
Goodwill = Super Profit x No. of years
for which super profit can be maintained.
Capital Employed = Total Assets of the
Company – Outsiders Liabilities.
Annual Report : Annual Report contains Balance
Sheet, Profit and Loss Account and Notes to accounts of the company during the
last year.
Notes to Accounts : it gives the information on the
following aspects,
i)
Accounting policies with respect to
- Fixed
assets and depreciation
- Research
and development expenditure
- Foreign
exchange transactions
- Excise
duty
- Interim
/ proposed dividend
- Investments
- Miscellaneous
expenditure
We
are downloaded more than 12W Company’s annual report from their web sites and
internet. Then we can access more than 600 files.
Cash Accounting System
: Only cash
transactions are recorded if the system is followed.
Mercantile Accounting
System : Both cash
transactions and credit transactions are recorded in this system. If cash
transactions are incurred first they are recorded first. If credit transactions
are incurred first they are recorded first. In simple to say what ever is
incurred first will be recorded first.
Discount : Discounts are two types. These are
i) Trade Discount and ii) Cash Discount
Trade Discount : It is deducted from list price or
catalogue price or tag. It is generally allowed by whole seller to retailer.
Trade Discount are not recorded in books.
Ex:
Tag Price = Rs. 100
-
Trade Discount = Rs. 10
Rs. 90 This amount is recorded in the
books.
Purchase A/c Dr 90
To Cash A/c 90
Cash Discount : This discount is given to debtors
to make them pay debts as early as possible.
Ex:
Immediately - 5%, within 15 days – 4%, within one month – 2% etc. Cash discount
is given for early or prompt payment. Cash discount are recorded in books.
Purchase A/c Dr 100
To Cash 90
To Discount 10
Substance over form :Information is to be present in
accordance with their substance and not nearly their legal from.
Ex:
Rights and benefits in Plant and Machinery, Transferred but registration is
pending. It means the expenses before starting of the production or company or
for extension of existing undertaking.
Preliminary
expenditure : is an
expenditure incurred for setting or undertaking.
Ex:
i) for drafting legal documents (MOA and AOA) – Legal Documents
ii)
Fees for registration of the company
iii) Underwriting Commission
iv) Brokerage and Charges for drafting,
printing, typing and advertising the prospectus.
Deferred Revenue
Expenses : The
benefit of the expenditure will be differed to the future periods for which the
expenditure is charges. Differed revenue expenditure is known as asset in
balance sheet.
Ex:
Preliminary expenses, Advertisement expenses
Deferred Revenue
Income : which is
income differed to the future periods. That means it is not related to one
period but related to more than one period.
Ex:
Pension Fund Scheme
Capital Reserve : Amounts received on capital items.
Revenue Receipts : Amount receive on revenue items.
Amount received by sale of goods or services show the trading and profit and
loss account credit side.
Capital Profits : Capital profits are profits
realized on sale of fixed assets or on discount of investments. They may be
distributed by way of dividend.
Revenue Profits : Revenue profits are the profits
earned by the company through its ordinary activities.
Debenture : Debenture is a document bearing the
company common seal. Which creates or acknowledges a debt. It need not be
secured (It may be secured or It may not be secured). It does not carry any
voting rights, but it carries interest.
Dividend : Dividend is a return on the
investment to the share holders. It is paid out of the divisible profits of the
company. Dividend is normally expressed in terms of percentage of the face
value of the share.
Types of Dividend : Dividend is 3 types. These are,
i)
Dividend of Preference Shares, ii) Dividend on Equity Shares and, iii) Interim
Dividend.
General Reserve : General Reserve is a Reserve which
is created to meet any future unknown liability. It can be utilized as
dividend.
Capital Reserve : Profits in the nature of capital or
profits in the form of capital nature.
Ex:
Share Premium, Share Forfeiture.
Reserve Capital : Reserve Capital is called up only
at the time of liquidation if assets held are not sufficient to meet the
liabilities.
Subsidiary Company : A company who is selling more than
51% of their shares to another company is called subsidiary company.
Holding Company : A company who is buying more than
51% of shares from another company, is called holding company. A company shall
be deemed to be a subsidiary of another company, if that other company,
v
Controls
the composition of its Board of Directors.
v
Holds
more than 50% of the voting power or paid up capital in the other company.
v
Is
the subsidiary any other company, which is the subsidiary of holding company.
Government Company : A Government Company is a company
in which not less than 51% of the paid up share capital of the company is held
by Central Government, or State Government, or partly by the by the Central
Government and partly by one or more State Governments.
Memorandum of
Association : It is
the main document of the company. This document represents constitution of that
company. It contains i) Name Clause, ii) Objective Clause, iii) State Clause,
iv) Capital Clause, v) Liability Clause, and vi) Situation Clause.
Articles of
Association : This
document represents rules and regulations of the company. It defines duties,
rights, and regulations of the company between themselves and company.
Limited Liability : Liability is limited to the face
value of the share.
Minority Interest : In a Subsidiary Company, the
majority shareholding is held by holding company (say 60% or 80% or so, the
remaining 40% or 20% is held by sum other people who are little interested in
the company. This little interest is called as minority interest). These people
are called as minority shareholders.
Stock Exchange : Stock Exchange is the place, where
stocks, shares and other securities of the listed companies bought and sold.
Mutual Fund : Mutual Fund is a fund, which
collects the investments of small saving holders and re-invest in capital
markets, like share market, debt market. It creates link between small saving
holders and capital markets. Ex: U.T.I. Mutual Funds.
Debt Securitization : It is a mode of financing, where in
securities are issued on the basis of package of assets (called pooled). This
involves the following process of activities:
v
Organizing
function
v
Pooling
function
v
Securitization
function
Primary Market : Shares are purchased directly at
the time of allotment by the company.
Secondary Market : Shares are purchased from market
through the stock exchange.
Working Capital : For running day to day activities
of a business, same capital is required which is called working capital.
Working
Capital = Current Assets – Current Liabilities or,
Excess
of Total Current Assets over Current Liabilities.
Working
Cycle or Operating Cycle : There is a complete operating cycle is the time
duration required to convert cash in to cash cycle from cash to cash
v
Conversion
of cash into raw material
v
Conversion
of raw material into work in progress
v
Conversion of work in progress into finished goods
v
Conversion
of finished goods into debtors and
v
Conversion
of debtors into cash
No.
of Operating Cycle = No. of Days in a year/Operating Cycle Period
Objective of Working
Capital Management :
Optimum Investment in current assets reducing current liabilities.
Working
Capital Management : Decisions are to be taken for effective financing of
current assets required for day to day running of the organization. Working
Capital Management refers to the procedures and policies required to manage the
working capital.
Accrued Interest :The accrued interest is to be added
to the concerned income in the credit side of the profit and loss account. The
accrued interest is to be shown as an
asset, Asset side of Balance Sheet
Accrued Interest A/c Dr
Interest A/c
Accrued Income : means income earned, but which is
not due (no right to receive on this date). Earned during the current
accounting year but have not been actually received by the end of the same
year.
Ex:
Interest on loan, Commission etc.
Outstanding Income : Income accrued and due but was not
receive.
Debtors : means taken goods on credit. People
who owes us i.e. people who has taken loan or money.
Creditors : means from whom have taken goods on
credit people to whom we owes i.e., these people have lent money to us or given
money to us.
Out Standing Salary : Salaries A/c Dr
To Out
Standing Salaries A/c
Prepaid Salary : Prepaid Salary A/c Dr
To Salary A/c
Bad Debts : Debts which are bad.
To Debtors A/c
Provision for Bad
Debts : Profit and
Loss A/c Dr
To Provision for Bad and Doubtful Debts
Accrued Expenses : The expenditure which is incurred
and the payment there of might or might not be paid.
Prepaid Expenses :Prepaid expenses are to be
deducted from such expenses in the debit side of profit and loss account. Shown
as an asset in the assets side of Balance Sheet. The amount paid for the
expenditure relating to the future years.
Out Standing
Expenditure :
Expenditure incurred but the payment for which is not yet paid and will be
shown in the balance sheet liabilities side, debited to profit and loss account
Amortization : Writing off Intangible Asset
Ex:
Patents, Good will, for this asset there is no physical existence.
Depreciation : Accounting Standard – 6 deals with
depreciation.
v
It
is charge for the use of assets in the operation,
v
It
may arise due to usage time or change of technology.
v
Two
methods are normally followed for charging the depreciation i) Written Down
Method, and ii) Straight Line Method
v
The
rates of depreciation have been specified in Schedule XIV to the Companies Act,
1956.
v
It
is mandatory for the companies to charge depreciation
v
Depreciation
cannot be charged on land.
v
Due
to fluctuation in foreign exchange, if the value of asset increases, then
depreciation should be charged on the increased value of the asset.
Written Down Value : Every year depreciation is
changing. Year by year it goes on decreasing. Depreciation is calculated on the
opening balance of this year.
Straight Line Method : Every year depreciation is same
Ex:
Total Value/Its Life
(Note:
In any method the total amount of asset must be depreciated is 95%).
Annuity Method : Interest is taken care or Interest
is added and depreciation is found.
Depreciation Fund
Method: Every year
depreciation amount is invested in investments. Interest on investments receive
in also invested. All this investments are sold, when new assets is to be
purchased.
Depletion Method : This method is use in mines, quarries.
The total quantity of tones are estimated. Depreciation per tone is now
calculated.
Cost
per tone = Total Cost / Estimated Tones
Capital Budgeting : Analyzing and selection of
investment projects whose returns are expected to extend beyond one year.
Net Present Value : It is the difference between
inflows and outflows.
IRR : The rate which present value of
inflows are equal to present value of outflows.
PI: also called as benefit cost ratio.
It shows relationship between present value of inflow and present value of
outflows. i.e. inflows / outflows.
Capital Structure : It refers to the proportion of debt
equity and preference capital.
Beta : Market Risk – Systematic Risk
Stand Demat : Industry Risk – Unsystematic Risk
Portfolio Management : means group of securities.
ADVANCED FINANCIAL ACCOUNTING
Funds Flow Statement:
A
statement that uses net working capital as a measure of liquidity position is
referred to as funds flow statement.To
go to the roots, this funds flow statement was termed “where got and where gone
statement. This statement records the increases and decreases in different
items of the balance sheet. Later it was called funds statement. In 1963
Accounting Principles Board (APB) changed the name of the “statement as
statement of sources and applications of funds”.
Uses
and importance of Funds Flow Statement:
v
An
essential too for the financial analysis and management.
v
Reveals
the changes in the working capital and gives the details of the sources from
which working capital has been financed.
v
Helps
in the analysis of the financial operations and explains causes for the changes
on the liquidity position of the company.
v
Helps
in dividend distribution and the formulation of an ideal dividend policy.
v
Helps
in making correct decisions in planning and development of the company.
Concept of Sources and
uses of Funds:
v
An
increase in non-current liabilities or a decrease in non-current assets of the
firm is considered as source of funds.
v
An
increase in the non-current assets and a decrease in the non-current
liabilities is a use of funds.
v
A
decrease in net working capital during the accounting period, is considered to
be a source of funds.
v
An
increase on net working capital during the accounting period is considered to
be a use of funds.
Net Working Capital =
Current Assets – Current Liabilities
Funds: The term funds means working capital i.e., the excess
of current assets over current liabilities.
Flow of Funds: The term flow means movement and
includes both “Inflow” and “Outflow”.
Ratio Analysis: It is the relationship between two
financial values. To make it clear the word relationship stands for a financial
ratio which is the result of two mathematical values.
Gross Profit Ratio = Gross Profit / Sales x 100
This
ratio tells us the result from trading Activity (from Buying and Selling). To
know the Operating Efficiency of the Organisation.
Net Profit Ratio = Net Profit / Sales x 100
It
indicates the final result to organization and overall efficiency of the
organization.
Operating Profit Ratio
= Operating Profit
/ Sales x 100
This
ratio speaks of the operational performance of the organization and refer the
managerial efficiency of the firm.
Earning per Share = Equity Shareholders / No. of
Equity Shareholders
It
reveals the profit available to ordinary shareholders.
Dividend Yield Ratio = Dividend per Share / Market Value
per Share
It
is very significant to the new investors.
Dividend per Ratio = Dividend Payable / No. of
Ordinary Shares.
It
indicates the amount of dividend to be paid to ordinary shareholders.
Return on Investment = Return / Investment x 100
Cost of Goods Sold
Ratio = Cost of
Goods Sold / Sales x 100
Cost of Goods Sold = Opening Stock +Purchases + Wages
– Closing Stock
Operating Exp. Ratio = Operating Exp. / Sales x 100
Operating Expenses = (Office Administrative Exp. +
Selling & Distribution Exp. + Financial Exp.)
Office &
Administration Exp. Ratio =
Office & Admn. Exp. / Sales x 100
Selling &
Distribution Exp. Ratio
= Selling & Distribution Exp. /
Sales x 100
Financial Exp. Ratio =
Financial Exp. /
Sales x 100
Above
five ratios make us know the relationship between various expenses and sales.
The
lower the ratio the greater is the profitability, and higher the ratio the
lower is the profitability
Operating Ratio = Cost of Goods Sold + Operating
Expenses / Sales x 100
Operating
Ratio tells us the efficiency of the conduct of business operation. A high
ratio means the operating expenses are high and margin is less. Therefore the
lower is the ratio the higher is the position.
Non-Operating Expenses
Ratio = Non –
Operating Expenses / Sales x 100
Current Ratio = Current Assets / Current
Liabilities
This
ratio explains whether the firm is able to meet short term obligations or not.
The higher ratio is an indication of the soundness of the organization.
Current Assets = Cash in Hand + Cash at Bank +
Sundry Debtors + Bills Receivable + Stock + Prepaid Exp. + Short term
investment etc.
Current Liabilities = Sundry Creditors + Bills Payables
+ Overdraft + Outstanding Expenses.
The
current ratio tells us the ability of the firm to meet its short term
obligation.
Liquidity Ratio = Liquid Assets / Current
Liabilities
Liquid Assets = Current Assets – Stock
The
liquid ratio is very helpful in measuring liquidity position and firms capacity
to pay off short term obligation. The liquid ratio is a measure of liquidity.
Absolute Liquidity
Ratio = Liquid
Assets – Debtors / Liquid Liabilities
Liquidity Liabilities = Current Liabilities – Bank
Overdraft
It
gives a more meaningful measure of liquidity. The satisfactory ratio will be 1
: 1 i.e., Rs.1 worth of absolute liquid assets are sufficient for Rs.1 worth of
current liabilities.
Fixed Assets to
Proprietors Funds =
Fixed Assets / Proprietors Funds
This
ratio establishes the relationship between the fixed assets and proprietors
funds. Proprietors funds also indicates the general financial strength of a
firm.
Total Assets to
Proprietary Funds =
Total Assets / Proprietary Funds
Current Assets to
Proprietor Funds =
Total Current Assets / Proprietary Funds
Capital Gearing Ratio
= Equity Share
Capital / Fixed Interest - Bearing Securities
Debt Equity Ratio = Debt or External Equities /
Equity or Internal Equities
It
is one of the important structural ratios and establishes relationship between
debt capital and equity capital. Debt capital is a cheaper source of finance.
This ratio helps us in assessing the risk factor that arises in the use of debt
capital in capital structure.
Stock Turnover Ratio = Cost of Goods Sold / Average Stock
It
reveals the movement of stock in the organization. If the no. of times is more
it indicates the fast movement of stock. If the no. is less it indicates slow
movement of stock in the organization.
Debtors Turnover Ratio
= Credit Sales /
Average Debtors & Bills Receivable
This
ratio gives a picture of how many times debtors made payments to the firm.
Creditors Turnover
Ratio = Credit
Purchases / Average Creditors & Bills Payable
This
ratio focuses light on how many times credit facility is allow to the firm. The
lower the ratio the higher the facility of credit.
Working Capital
Turnover Ratio =
Sales (or) Cost of Sales / Working Capital
To
know the relationship between working capital and sales.
Fixed Assets Turnover
Ratio = Sales (or)
Cost of Sales / Fixed Assets
To
know the effective utilization of fixed assets in production.
Total Assets Turnover
Ratio = Sales /
Capital Employed
To
test the managerial efficiency and business performance. This ratio measures
how efficiently assets are employed overall.
Ratio: The relationship between two
financial values.
Gross Profit: Sales – Cost of Goods Sold
Equity: Proprietary Funds
Debt: Long term and short term
liabilities
Operating exp.: The aggregate of office and
administrative expenses, selling & distribution and financial expenses.
Financial Leverage: The use of fixed rate of sources
along with owners equity is described as financial leverage.
Amalgamation : When two or more companies carrying
one similar business taken over by a newly formed company for the progress in
business, it is called amalgamation.
Absorption : It one or more companies are taken
over by a company already in existence, it is called absorption.
Reconstruction : It means reorganization of
company’s financial structure.
Purchase Consideration : Purchase consideration means the
purchase price agreed upon, which is paid by the purchasing company inorder to
pay to the Vendor Company.
Lump sum Method :
Lump sum amount is paid to Vendor.
HOLDING COMPANIES:
It is obvious that Holding Companies
can nominate the majority of directors in other companies which are known as
subsidiary companies and therefore a holding company usually holds the majority
of paid up equity share capital. When a company reaches the stage of floating
another company holding majority of shares, it becomes a parent company. The
existing companies in order to avoid competition float a company which holds a
majority of their shares.
Sec. 4 of the Companies Act, 1956
defines a Holding Company and Subsidiary Company by their relation to each
other. A company shall be deemed to be a subsidiary of another if, but only if,
v
The
other company controls the composition of its Board of Directors; or
v
The
other company a) holds more than half of the nominal value of its equity
capital, or b) if it is an existing company (i.e., a company formed before 1st
April 1956) with both equity and preference shareholders, having equal voting
rights, the other company controls more than half of the total voting power; or
v
It
is a subsidiary of any company which is the other company’s subsidiary.
To make it clear a company is termed
to be the holding company of another only when the other is its subsidiary.
Therefore a holding company is one which has control over one or more other
companies. It is to be noted that there is no liquidation of subsidiary
company. Moreover, its separate legal entity cannot be disturbed. The point is
only acquisition of shares in the subsidiary company but not its assets or
liabilities. Preparing consolidated
Balance Sheet is common.
Goodwill or Capital Reserve: When the Holding Company purchases
the shares of subsidiary company by
paying more than face value, the excess paid is treated as Goodwill. When the
holding company purchases shares from the subsidiary company, less than the
face value, the difference between face value and the amount paid is treated as capital reserve.
Capital Profits: The profits and reserve in the
subsidiary company on the date of shares acquired by the holding company is
treated as capital profits.
Revenue Profits: Profits earned by subsidiary
company after acquiring the shares by holding company are called Revenue
Profits.
Minority Share Holders
Interest: The
amount related subsidiary company is treated as minority shareholders interest.
Contingent
Liabilities:
Contingent Liability is a liability which may or may not arise.
Inter company
Transactions:
Transactions between the holding company and the subsidiary company are known
as inter company transactions.
VALUATION OF SHARES:
Net Assets Method: In this method valuation of shares
is based on asset valuation.
Net Tangible Assets: (Assets - Liabilities) - Intangible
Assets
Yield Method: This is also known as earning
capacity or Market Value Method. Investors in general and small investors in
particular pay for the shares on the basis of the income or yield expected.
Therefore, the expected dividends are taken as the basis in this method.
Fair Value Method: this is also called earning
capacity valuation method or dual method. This is geared to rectify one of the
limitations of the earlier method that the value of the share is based on the
dividend but not on the earnings. This method relates the value of the share to
the earning efficiency in terms of profitability of the company as the market
price of the share is based on the earnings of the company rather than the
dividend declared.
Intrinsic value: Means the potential price of a
company’s common stock.
Liquidation: Winding up of the company.
Net Worth: Means the sum of paid up share
capital plus reserves plus the preference share capital.
VALUATION OF GOODWILL:
Goodwill is the reputation and image
built up which places the business in position to have long run survival,
success and growth, success and growth besides positively influencing the
earnings.
Factors affecting
goodwill: Profitability
of Business, Brand Equity, Product of Service Quality, Customer Acceptance,
Business Location and Access etc.
Average Method: In this method which takes into
account the average profits for the past few years and the value of goodwill is
calculating as some years purchase of this amount.
Super Profit Method: The excess of actual profits over
the normal profit is known as super profit. A business unit may posses some
advantages which enable it to earn extra profits over and above the amount that
would be normally earned, if the same capital is employed elsewhere in a
business of same risk class.
Annuity Method: Under this method goodwill is
calculated by taking the average super profit as the value of an annuity over a
certain number of years. An annuity is a series of equal periodic payments
occurring at equal intervals of time. In other words goodwill is calculated by
finding the present value of an annuity discounted at a given rate of interest
which is usually the normal rate of return.
Value Added
Statements: The
Statements which show changes in value added which are created by production.
Historical Cost
Accounting: The
accounting statements which are prepared on the basis of past transactions.
Inflation Adjusted
Statements:
Accounting statements are adjusted on the basis of established price index.
Replacement Cost: It is the cost of replacing an
existing employee.
Annuity: A series of receipts or payments of
a fixed amount for a specialized number of years.
Present Value: The value of sums received in
future being discounted by an appropriate capitalization rate.
FINANCIAL MANAGEMENT
Financial Management: Concerns the acquisition,
financing, and management of assets with some overall goal.
Future Value: The value at some future time of a
present amount of money, or a series of payment, evaluated at a given interest
rate.
Net Present Value: The Present Value of an investment
projects net cash flows minus the projects initial cash outflow.
Present Value: The current value of a future amount
of money, or a series of payments, evaluated at a given interest rate.
Price / Earning Ratio: The market price per share of a
firm’s common stock divided by the most recent 12 months of earnings per share.
Risk: The variability of returns from
those that are expected.
Capital Structure: The mix of a firm’s permanent long
- term financing represented by debt, professed stock, and common stock equity.
Compound Interest: Interest paid on any previous
interest earned, as well as on the principal borrowed.
Funds: Funds include not only cash but
also the total current assets or financial resources.
Profit Maximisation: It is a criterion for economic
efficiency as profits provide a yard stick by which economic performances can
be judged under condition of perfect competition.
Wealth Maximisation: It stands that the management
should seek to maximize the present value of the expected returns of the firm.
Discounting: A reduction of some further amount
of money to a present value at some appropriate rate in accordance with the
concept of the time value of money.
Sole Proprietorship: A sole proprietorship is a firm
owned by an individual. He owns all assets and owes all liabilities of the
business.
Partnership Firm: A partnership firm is a business
unit carried on by two or more persons with an intention to share profits or
losses. The limitations are i) Unlimited liability ii) Limited life iii)
difficulty in transferring ownership and iv) Limitations in raising funds.
Joint Stock Company: A joint stock company is a legal
entity created under the law and empowered to own assets, to incur liabilities,
and to engage in business. It is an artificial person created by the law. The
capital of a company is divided into small portions and each portion is called
a “share”. Investors who buy these share are shareholders and they are the
owners of the company.
Co-operatives: Cooperative societies are
associations formed voluntarily by the people to render service to the members
of their society. They are formed to protect and safeguard the economic
interest of the weaker sections of the society from the exploitation of
stronger sections of the society.
SECURITIES AND
EXCHANGE BOARD OF INDIA
The
SEBI Act, 1992 was promulgated after withdrawing the Capital Issues (Control)
Act. SEBI is broad in its application covering wide ranging issues. The powers
and functions of SEBI Act are:
v
Regulating
the business of stock exchanges
v
Registering
and regulating the working of Stock Brokers,
Sub Brokers, Share Transfer Agents, Bankers to
the Issue, Trustees of Trust Deeds, Registrars to an issue, Merchant Bankers,
Underwriters, Portfolio Mangers, Investment Advisors.
v
Registering
and regulating the working of Depositors, Custodians of Securities, Credit
Rating Agencies
v
Registering
and regulating the working of Venture Capital Fund, Collective Investment
Schemes, Mutual Funds
v
Promoting
self regulating organizations.
v
Prohibiting
fraudulent and unfair trade practices
v
Promoting
investors education
v
Prohibiting
insider trading
v
Regulating
substantial acquisition of shares, takeover of companies.
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