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Analysis of Financial Statements
Analysis of Financial Statements
Analysis of Financial Statements
1.0
Objectives
Introduction
Purposes and Objectives of Financial Statements
Nature of Financial Statements
Characteristics of Financial Statements
Qualities of Ideal Financial Statements
Preparation of Financial Statements
Vertical Financial Statement Statements of a Proprietor
Vertical Statements for Companies
Exercise
OBJECTIVES
1.1
INTRODUCTION
2
management in taking various decisions. Consumer, all over the
world, are becoming increasingly aware of their right and are using
financial statement extensionally today to find out the degree of
exploitation by the industries. Tax legislature makes it obligatory on
the part of business entities to draw fair and objective financial
statement. The financial statement serves as instruments to
regulate equity and debentures issued by companies.
1.2
Executives
Trade
Creditors
Consumers
& Society
Financial
Information
Shareholders
& Prospective
Investors
Labourers
Bankers
Fig. 1.1
a) Executives :
Financial
statements
provide
sufficient
accounting
information to the executives and managers to enable them to
decide on important issues facing them. The common issues facing
corporate managers to-day, like efficient capital utilization,
maintaining the profitability though cost control, dividend paying
capacity of the company and observing credit standards, can be
tackled effectively, if the executives have a proper understanding of
analysis of the financial statement.
b) Bankers :
Bankers take precautions before advancing loans to their
constituents. Every banker, before sanctioning credit, wishes to be
assured the borrowers ability to repay the loans when they become
due; to ascertain the companys ability to pay interest charges on
loans and their respective due dates. Therefore, they scrutinize and
study the financial statements in depth and analyse them to
ascertain the borrowers liquidity, solvency, profitability of his
business and his financial strength.
4
c) Trade Creditors :
Credit facilities mass distributors of goods produced but a
manufactures or a wholesalers would not provide credit facilities
indiscreetly to everyone. Before opening an account of the trader
concerned, the manufacturer and wholesaler studies the financial
statements of the trader, supplemented by various trade and bank
references, to ascertain his creditworthiness. This information could
be obtained from the financial statement.
d) Shareholders and Prospective Investors :
Shareholders, who have permanent interest in the life and
operations of the company, are ever desirous of knowing about
their companys year to shareholders are particularly interested in
the future of the company. The financial statements provide the
share-holders all the information they require. What is said for the
shareholders holds equally good for the prospective investors.
e) Labourers :
Labourers contribute to the earnings of the company and
they are the people who work on raw materials with the aid of
capital goods to produce wealth. They are also interested in their
wages and salaries, bonus and working conditions. As far as
bonus, working conditions and other incentives are concerned, they
largely depend on the companys profitability and liquidity. The
labourers are also interested in the business as a going concern
as it only ensures their permanent employment.
f)
5
Thus, financial statements are affected by three factors i.e.,
recorded facts, accounting conventions and personal
judgements.
a)
Internal Audience
Articulation
Historical Nature
Legal & Economical Consequences
Technical Terminology
Summarization and Classification
Money Terms
Valuation Methods
Accrual Basis
Estimates and Judgement
Verifiability
Conservatism
6
a) Internal Audience : financial statements are intended for those
who have an interest in a given business enterprise. They have
to be prepared on the assumption that the user is generally
familiar with business practices as well as the meaning and
implication of the terms used in that business.
b) Articulation : The basic financial statements are interrelated
and therefore are said to be articulated.
Example : Profit and Loss account shows the financial results
of operations and represents an increase or decrease in
resources that is reflected in the various balances in the
balance sheet.
c) Historical Nature : Financial statements generally report what
has happened in the past. Though they are used increasingly
as the basis for the future by prospective investors and
creditors, they are not intended to provide estimates of future
economic activities and their effect on income and equity.
d) Legal and economic consequences : Financial statements
reflect elements of both economics and law. They are
conceptually oriented towards economics, but many of the
concepts and conventions have their origin in law.
Example : Conventions of disclosure and materiality
e) Technical Terminology : Since financial statements are
products of a technical process called accounting, they
involve the use of technical terms. It is, therefore, important that
the users of these statements should be familiar with the
different terms used therein and conversant with their
interpretations and meanings.
f)
7
i)
j)
g) Consistency.
Financial Statements :
8
Account or Income and Expenditure Account or simply Income
Statement.
Revenue Account may be split up or divided into
Manufacturing Account, Trading Account, Profit and Loss
Account and Profit and Loss Appropriation Account, Revenue
Account is prepared for a period, covering one year.
1.6.2
9
The purpose of preparing the Manufacturing Account, as
already mentioned, is to ascertain the cost of goods manufactured.
It should, therefore, include all the expenses relating to
manufacture of goods, i.e. purchase of raw materials, i.e. expenses
such as carriage, freight etc. and all others expenses incurred to
convert raw materials into finished goods.
To give a clear idea the elements of cost are enumerated
under various heads like prime cost, factory cost etc. Manufacturing
or Production A/c is prepared to describe the various elements of
cost in creating the finished goods.
Cost Elements :
There are three major elements of production cost viz.
a) Direct materials,
b) Direct labour, and
c) Factory overheads direct material and direct labour constitute
direct cost and the latter constitutes indirect cost.
a) Direct Materials :
It refers to such materials which are incorporated into the
physical units of product manufactured. It is readily and definitely
ascertainable.
b) Direct Labour :
It refers to the labour performed in physical contact with the
product. It is the amount of wages paid to the workers who are
engaged in converting raw materials into finished goods. It can be
easily ascertained.
c) Factory or Production overhead :
It is not easily assignable to a particular product. It is an
indirect cost and includes :
i)
ii)
10
Important point regarding Manufacturing Account :
a. Stocks :
The distinguishing feature of a manufacturing concern is the
type of stock held. A trading concern holds only stock of finished
goods. A manufacturing concern holds stock of materials, semi
finished or work in process as well as finished goods.
b. Direct Material Consumed :
It is customary to show in the Manufacturing A/c the value of
raw materials consumed for manufacturing goods during a
particular period.
It is computed as follows :
Rs.
Opening stock of Raw Materials
Add : Purchase of Raw Materials
Add : Carriage or Freight Inwards
Less : Rejected or returned Materials
Less : Closing stock of Raw Materials
XX
XX
XX
XX
XX
XX
c. Work in Process :
This represents materials put in process which is not
completely converted in Finished Goods. Opening and closing
works in process are shown in the Manufacturing A/c on Debit side
and Credit side respectively. However, their figure (difference)
appears on the debit side either as an addition or deduction.
d. Sale of Scrap :
In manufacturing operations there may be certain scrap
which may or may not have a sale value. In order to find out correct
cost of manufacturing the goods it is necessary to credit
manufacturing A/c by the amount of scrap.
e. Factory Expenses :
These expenses include for processing or manufacturing
goods i.e. converting raw materials into finished goods. These
include expenses like (1) Power and Fuel, (2) Rent, Rates, Taxes,
Insurance, Repairs and Depreciation on assets used for
manufacture, (3) Factory Stores and Spares, (4) Factory
Supervision.
11
1.6.4 Balance Sheet :
Balance Sheet defined :
It is not possible to define the whole Balance Sheet except in
vague terms. The definition of the balance sheet given by the
American Institute Certified Public Accountants is as follows :
Balance Sheet is a list of balances in the asset, liability or
net worth accounts. This definition is accurate but not meaningful.
Accounting Standards Board, India has defined balance
Sheet as a statement of the financial position of an enterprise as at
a given date which exhibits its assets, liabilities, capital, reserves
and other account balances at their respective book values.
A more meaningful definition of balance Sheet will be as
under:
Balance Sheet shows the sources from which funds
currently used to operate the business have been obtained (i.e.
liabilities and owners equity) and the types of property and property
rights, in which these funds are currently locked up (i.e. assets).
Balance Sheet may be considered as a summarised sheet of
balances remaining in the books of account, after the preparation of
the profit and Loss Account. Thus a Balance Sheet can be rightly
called as a statement of position as it now contains assets and
liabilities generally. It is a document of the financial position of an
enterprise, as it indicates what the business owns and what it owes
on a particular date. The things that the business owns are called
Assets and the various sums of money that it owes are called
liabilities (including that of the owners).
The term Balance Sheet comes from the fact that the total
assets must be equal to total liabilities, they balance each other.
The liabilities side shows the various sources from which money
made available for the assets, and the assets side shows the way
those funds are employed in the business.
While preparing final accounts, all nominal accounts from the
trial Balance are closed by transferring them to Trading and Profit
and Loss Account. The other account balances, not transferred to
Revenue Accounts, will be either personal or real accounts A
collection of all these balances is known as a Balance Sheet. So,
we can rightly term the Balance sheet as a sheet of balances.
As we have seen earlier, a balance Sheet is so called
because it's two aides must always balance, i.e., the assets
12
must be equal The Liabilities plus owners' funds. This can be
expressed in the form of an equation.
Assets = Liabilities + Net Capital
A = L + NC (Capital + Reserves Fictitious Assets)
The entire balance sheet rests on the above equation. Thus,
the above equation is called the Balance Sheet Equation or
Accounting Equations.
Fig. 1.3
The Balance Sheet is given various titles as follows :
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
13
Thus, Balance Sheet may be rightly called as the Statement
of Assets and Liabilities that shows the financial position of a
business enterprise on a particular date. All items appearing in
Balance Sheet are either capital receipts or capital payments or
personal accounts and balance of undistributed profits.
Why Balance Sheet Balance :
Balance sheet is a statement of assets and liabilities. Are
business transaction are recorded in the books of accounts under
the double entry system recording both the credit and debit
aspects of each and every business transaction. The total of all
debits must be equal to the total of all credit and therefore, the
resulting balance also must be agree.
This can also be explained thus : since the liabilities side
(left hand side) on the balance sheet shows the sources of fund
and the assets side (right hand side) show the employment of
funds the total assets must be equal to total liabilities.
Function of the Balance Sheets :
The three important function performed by balance sheet are :
a) It gives the summery of the firms assets and liabilities.
b) It is a measure of the firm liquidity.
c) It is measure of the firms solvency.
Format of Balance Sheets :
A balance sheet may be presented in various forms. They are :
1. Conventional format
2. Vertical format
3. Step format.
1. Conventional Format :
The conventional from or the customary form of balance
sheets is also called horizontal form or account form or T form
of the balance sheets. It shows the assets i.e. debit balance on the
right and side and liabilities i.e. the credit balances and owners
equity on the left hand side.
But, in countries like the U.S. and Canada, the assets
(debit items) are shown on the left hand side and liabilities (credit
items) on the right hand side of the balance sheet.
This method of presenting the balance sheet is also known
as balance array form.
14
Arrangement of assets and liabilities :
In the horizontal form of balance sheet presentation, the
assets are shown either in order of liquidity or in order of
permanence.
The arrangement in order of liquidity shows the order in
which the assets could be realized to satisfy business liabilities and
the liabilities in the order of earliest, relative maturity or discharge.
The order of liquidity is adopted by concern whose operations are
mostly cash like banking companies, investment and finance
companies, etc.
The order of permanency indicates the relative degree of
permanency of assets and liabilities .mostly ,manufacturing and
trading companies adopted this order of showing fixed assets first
followed by less fites and current asset and on the liabilities side ,
the liability to be paid last as the first , followed by relatively less
permanent liabilities.
A. in order of liquidity
Liability
Current Liability
Long term liability
Capital & Reserve
Assets
Current Assets
Fixed Assets
Other Assets
B. in order of permanence
Capital & Reserve
Long term Liability
Current Liability
Fixed Assets
Current Liability
Other Assets
Rs.
15
Less : Cost Of Goods Sold
Opening Stock
Purchase
Less : Return
Carriage
Import Duty
Doctor
Fright
Wages and Salaries
Motive Power
Depreciation on Machinery
Less : Closing Stock
Gross Profit
Less : Operating Expenses
A. Office and Administration Expenses :
Staff Salaries
Rent, Rates and Taxes
Unproductive Wages
Repairs
Insurance
Printing and Stationary
Water & Electricity
Office Cleaning
Postage and Telephones
Staff Welfare Expenses
Conveyance Charges
Misc. Expenses
Depreciation on Office Bldg. & Furniture
B. Selling Expenses :
Carriage Outwards
Commission Allowed
Travelling Expenses
Entertainment Expenses
Sales Promotion Expenses
Advertising
Bad Debts
Warehouse Expenses
C. Finance Expenses :
Cash Discount
Bank Charges
16
Bad Debts
Provision for Discount
Provisions for Bad Debts
Interest on Loans
Net Operating Profit / Loss
Add : Non Operating Income
Interest Earned
Misc. Incomes
Profit on sale of Fixed Asset
Interest on Loan given to Outsiders
Dividend on Investments
Compensation received as per Court Order
Less : Non Operating Expenses & Losses
Loss on sale of Fixed Asset
Loss by Fire
Penalty
Net Profit before Tax
Less : Income Tax
Net Profit after Tax
Rs.
17
APPLICATIONS OF FUNDS :
Fixed Assets
Goodwill
Land & Building
Plant & Machinery
Furniture & Fixtures
Vehicles
Patents & Copyrights
Current Assets
Stock of goods
Debtors
Bills Receivable
Marketable Investments
Cash & Bank
Prepaid Expenses
Less : Current Liabilities
Creditors
Bills Payable
Bank Overdraft
Expenses payable
Working Capital
TOTAL
18
Balance Sheet as on 31st march, 2009
Rs.
Rs.
SOURCES OF FUND :
Own Fund
Capital Fund
2,43,825
Add : Surplus
20,895
Add : Donations
16,000
2,80,720
Funds
Prize Trust Funds
18,250
20,000
38,250
3,18,970
APPLICATIONS Of FUND :
Fixed Assets
Buildings
Furniture
73,125
11,000
Library Books
16,845
1,00,970
Investments
Prize Fund Investments
General Investments
Current Assets
17,875
2,00,000
Debtors
3,000
Outstanding Subscriptions
2,400
Interest accrued
450
Cash
200
Bank
7,500
375
Prepaid Insurance
250
2,17,875
14,175
Current Liabilities
Sundry Creditors
O/s Salaries
Subscriptions in advance
B
Working Capital (a b)
TOTAL
12,500
1,200
350
14,050
125
3,18,970
19
Rs.
20
B. UNSECURED LOANS
Debentures
Bonds
Bank Loans
Loans from Financial Institutions
Public Deposits
Loans from Directors
Other Loans
TOTAL
APPLICATIONS OF FUNDS
I. FIXED ASSETS
TANGIBLE
Land and Building
Leasehold Property
Plant and Machinery
Furniture & Fittings
Vehicles
Live Stock
Railway Sidings
(At Cost less Depreciation)
INTANGIBLE
Goodwill
Patents
Copy rights
Trade Marks & Designs
II. INVESTMENT
Govt. Securities
Shares
Debentures
Immovable Properties
Capital of Partnership Firms
Long term Loans given
Sinking Fund Investments
III. CURRENT ASSETS, LOANS
ADVANCES QUICK ASSETS
Cash & Bank
Debtors (Net)
Bills Receivable
Marketable Investments
&
21
LOANS & ADVANCES
Other Current Assets
Inventory
Prepaid Expenses
Advance Tax
Advance for Goods
LESS : CURRENT LIABILITIES
QUICK LIABILITIES
Creditors
Bills Payable
Advances Received
Expenses Payable
Accrued Interest
Provision for Taxation
Provision for Dividend
Unclaimed Dividend
OTHER LIABILITIES
Bank Overdraft
NET
CURRENT
ASSETS/WORKING
CAPITAL
TOTAL
Land,
Buildings,
Plant and Machinery,
Vehicles,
Furniture & Fittings,
Railway sidings,
22
g) Live stock
h) Development of Property
i) Intangible Assets such as patents, copyrights, goodwill, etc.
Classification of Fixed Assets :
a) Tangible movable assets;
b) Tangible immovable assets; and
c) Intangible assets.
a) Tangible movable assets are the assets which can be seen,
touched and moved from one place to another place. Plant and
Machinery, furniture and fixtures, transportation equipments
etc. are tangible movable assets.
b) Tangible immovable assets are the assets which can be
seen and touched but cannot be moved from one place to
another place. Such assets include land, buildings, mines, oil
wells, etc.
c) Intangible assets are the assets which cannot be seen and
touched. However, their existence can only be imagined such
as patents, trade marks, copyrights, goodwill, etc. Their
existence is very important for the business. Intangible assets
have several characteristics.
Fixed Assets = Tangible Assets + Intangible Assets
Characteristics of an Intangible Assets :
Intangible Assets :
a) enables business managers to attain the goals of profitability,
b) is long term in nature, and whose benefit is available to the
business for more than the current accounting period,
c) has a determinable acquisition cost, except in the case of self
generated assets.
d) is used in conducting business activities, and
e) provides certain rights or privileges to the business.
Presentation of Fixed Assets :
Gross Block
Less Provision for Depreciation
Net Blocks
23
b. Wasting Assets :
Fixed assets normally get depreciated due to constant use,
wear and tear, and efflux of time. Mere passage of time is sufficient
for certain fixed assets to lose their values.
But there are certain fixed assets known as wasting assets
like mines, quarries which do not depreciate due to the passage of
time, but depreciation in their value is caused by extraction or
depletion.
Example : Forests, quarries, mines, oil wells, etc.
If there is no extraction from these assets, their values will
not decrease but still they can be depreciated under certain special
circumstances.
The depreciation of these assets is directly related to the
output. They are depreciated under Depletion method. The
acquisition cost of the asset is reduced in the same proportion as
the actual output bears to the quantity of mineral contained in the
asset. Alternatively, the depletion cost per unit is calculated and
every year it is multiplied by the quantum of output and the amount
of depletion is computed.
Valuation of Fixed Assets :
Most fixed assets are valued at cost. Certain assets
depreciate or decrease in value due to usage.
The cost of an assets includes its purchase price plus all
other expenses necessary or incidental in acquiring and preparing
the asset to bring it into usable or working condition. To illustrate,
the cost of a fixed asset will include :
a) Invoice price,
b) Sales tax,
c) Cost of shipment and delivery charges to purchaser, such as
freight, insurance, customs duty and clearing charges,
d) Cost of insurance during installation,
e) Installation cost,
f) Cost of materials used to set up or operate the asset, and
g) Cost of material, labour etc., required to conduct trial runs of
the equipment.
The cost of an asset is to be written off during the life of the
asset on a graduated basis or on time basis or on use basis.
24
Thus, fixed assets will appear in the balance sheet at cost less
depreciation. Since fixed assets are not acquired for resale, the
expected realizable value of such assets is not taken into account
while valuing them for balance sheet purposes.
2. Investments :
Investments may be short-term. Short-term investments
are marketable securities and they represent temporary
investments of idle funds. These investments can be disposed
off by the company at its own will at any time. Investments are
shown at cost. Cost includes brokerage, fees and all other
expenses incurred on acquisition of investments. However, the
market value is shown by way of a note.
Long-term investments are held for a long time. They are
required to be held by the very nature of business. Here the
intention of the investor is to retain the securities for a longer
period of time. For example, a company engaged in generating
electricity may be required to hold the bonds of the Electricity
Board. These bonds are retained by the company so long as the
company uses electric power.
As per Schedule VI of the Indian Companies Act 1956,
investments are shown separately, showing the nature of
investments and the mode of valuation of various classes of
securities. Clear cut distinction should be made between :
a) Investments in Government or Trust Securities.
b) Investments in shares, debentures or
separately fully paid and partly paid shares.
bonds
showing
25
Quoted investments refer to securities in respect of
which permission has been granted to deal in a recognised
Stock Exchange.
Other investments should be considered as unquoted
investments.
Note : The interest accrued on investments should be shown
under the heading current assets and not under this head.
Investments whether Fixed Assets or Current Assets :
The answer to this question lies in the classification of
investments. Investments, for balance sheet purposes can be
classified into long-term investments and marketable investments.
This basis of distinction, between long-term and marketable
investments, depends on the nature and purposes of such
investments.
Long term investments are those investments which satisfy any
of the following conditions :
a) They do not meet the test of ready marketability.
b) They are required to be held by the business by the very
nature and conditions of the business.
Example: Sometimes, an export house is required to
subscribe to the shares of the concerned Export Promotion
Council.
c) They are made to foster operational relationships with other
entities.
Example: An automobile manufacturing company may
subscribe to the share capital of a tyre manufacturing entity.
d) Investments may be made to exercise a degree of control over
a corporate entity.
Example: Recently, in 1982, Modi Rubbers Ltd., acquired
controlling interest in Firestone Tyre Company.
e) They may be made in order to promote and float a new
company. Before issuing the shares of a new company, the
promoters may acquire a reasonable percentage of the total
interest in the company so that it may create a favourable
impression in the minds of the investing public.
f)
26
g) They may be acquired to diversify and broad-base the
operations of a company.
Investments which satisfy any of the above conditions are
termed as Long term Investments and classified as fixed assets.
Long term investments are Fixed Assets.
Marketable Investments are those investments which
are acquired by the company by employing its surplus funds
or cash temporarily.
These investments can be disposed off by the company at
its free will and thus convert it into cash as and when the need
arises. Hence, these investments are considered as good as cash ,
and are often called secondary cash resources.
Short term investments are grouped under Current
Assets.
3. Current Assets and Quick Assets :
Current Assets :
Current Assets include cash, assets that are likely to
become or converted into cash, or assets that are otherwise
consumed in the balance sheet date (or within the normal
operating business cycle, if it is longer than one year) and the cash
thus generated is available to pay current liabilities.
Current assets are not intended for long-term use in
business.
Current assets represent employment of money by the
company on a short-term basis. They circulate within the group.
For example, cash becomes raw material when material is
purchased, material becomes finished goods, finished goods
become cash or debtors when sold and so on. Usually, the
following assets are classified as current assets :
Current Assets include :
Stock
1. Stock of raw materials
2. Stock of work in progress
3. Stock of finished goods
4. Stock of packing materials
27
Debtors
Gross
Less Provision for doubtful debts
Cash and Bank
1. Cash on hand
2. Bank Balance
Loans and Advances
1. to subsidiary
2. to firms
Marketable Investments
Other Current Assets:
1. Interest accrued on investments
2. Loose Tools
3. Bills of Exchange
4. Prepaid expenses, advance payment of tax
5. Balances with customs, port, trusts, etc.
Current Assets = Stock + Debtors + Cash & Bank + Loans &
Advances + Marketable Securities + Other
Current Assets
In fact, total current assets are known as Gross Working
Capital. Current assets less current liabilities are known as net
working capital.
Quick Assets :
These assets are known as near cash assets. In other
words, quick assets are those which can be converted into
cash quickly. Therefore, they are also known as liquid assets.
Cash and bank balances are the most liquid assets. Debtors and
cash advances can be converted into cash at a short notice.
Therefore, they are also regarded as quick assets. Marketable
investments, if can be converted into cash, fall into the category of
quick assets. Inventory does not fall in this category of quick
assets, since it cannot be converted into cash quickly, as material
is to be converted into saleble goods and then they should be sold.
If sale is on credit, there is a further delay in realization.
Expenses paid in advance do not satisfy the criteria of quick
assets. They cannot be converted into cash. They can be received
in the form of services.
Quick Assets = Current Assets Inventory Prepayments
28
Valuation of Quick Assets :
Quick assets, as we have seen earlier, include cash and
other assets that are quickly converted into cash. Quick assets
are current assets less inventories and prepaid expenses.
The quick assets are realized in cash in a very short time.
Some of the quick assets may be already in realized form as cash
and bank balance. As such, the quick assets should be shown at
their realizable value. For Example, Debtors and Bills Receivable
are shown less any provision for doubtful debts.
In order to arrive at a conservative valuation of these assets,
when there are any chances of bad debts or losses in their
realization, a provision has to be made to take care of the same
and the provision should be shown by way of deduction from the
respective asset.
Sometimes, it is possible that the realizable value of certain
quick assets, like marketable investments, may be more than their
cost. Under those circumstances, keeping in line with the
convention of conservatism, the investments should be valued at
cost or market value whichever is lower. However, it is in
agreement with the convention of disclosure, that a note should be
provided showing their market value. An illustrative extract of
Balance Sheet is provided below :
Balance Sheet as at_______
Assets
Investments (at cost)
(Market value Rs.7,50,000/-)
Rs.
5,00,000
29
Bank Balances:
a) With scheduled banks.
b) With others.
Information has to be disclosed about the balances with
scheduled banks on Current Accounts, Call Accounts and Deposit
Accounts. In the case of non-scheduled banks, the names of the
bankers, the balances lying with each such banker on Current
Accounts, Call Accounts and Deposit Accounts and the maximum
amount outstanding at any time during the year from each banker,
and the nature of interest of any director or his relative of the
company in each of them have to be disclosed.
The Act has not made any distinction between nationalized
and non- nationalized banks. All nationalized banks are scheduled
banks. Scheduled banks are those banks whose names appear in
the schedule released by the Reserve Bank of India.
3. Sundry Debtors :
The ability to buy now and pay later is an accepted fact in
business. Selling on account is one of the ways of attracting
customers. This creates debtors or accounts receivable. The total
amount receivable from debtors should be shown under this
heading. The provision for doubtful debts should be deducted from
debtors in the balance sheet. Debtors should be classified into two
categories as debtors due for more than six months and debtors
less than six months. Debtors should also be classified according
to their nature and reliability.
Debts due by directors or other officers of the Company or
any of them , either severally or jointly with any other person, or
debts due by firms or private companies respectively, in which any
director is a partner is to be separately stated. Debts due from
other companies under the same management have to be
disclosed with the names of the companies.
The maximum amount due by directors or other officers of
the company, at any time, during the year, to be shown by way of a
note.
Debtors appear in the balance sheet as under :
30
Illustration 8 :
Balance Sheet as at _____
Rs.
Considered Good :
Over six months Unsecured
Others :
Secured
Unsecured
Considered Doubtful :
Less : Provision for Doubtful Debts
Rs.
28,000
18,00,000
6,00,000
2,00,000
26,28,000
2,00,000
24,28,000
Inventories or Stock-in-Trade :
Definition and Meaning :
In simple words, inventory may be defined as the aggregate
of all those items of materials and goods which are held for sale, or
for production or for processing. Inventory also includes the goods
sent on consignment and remaining with the consignee, goods-intransit, goods sent on sale or return basis and unapproved
(reduced to cost), etc. If there are any damaged or obsolete items,
they should be excluded from the stock or adequate provision
should be made for the same. Stock should be valued at their cost
or realizable value whichever is lower. Inventory includes the
following :
a) Raw Materials,
b) Work-in-progress,
c) Consumable stores,
d) Finished Goods and Merchandise,
e) Stores and spare parts,
f) Loose tools.
Impact of Inventory on Financial Statements :
Impact on Balance Sheet : Inventory values have direct impact on
current assets and the financial position of the concern. Balance
Sheet and the result of operations reflected by Profit and Loss
Account will not be true and fair, if inventory is overvalued, since
this will lead to over statement of profits. The overstatement of
profit in the Profit and Loss Account liability side of balance sheet
will be overstated. Under-valuation of inventory leads to
understatement of profit.
31
Impact on Income Statement : Valuation of Inventory will affect
the cost of goods sold.
Cost goods sold is computed as under :
Goods available for Sale = Opening Inventory + Purchase
during the period Returns
Cost of Goods Sold = Goods available for Sale Closing
Inventory
Cost of goods sold has direct impact on net income. If
closing inventory is over-stated, cost of goods sold will be understated and income will be over-stated. If the closing inventory is
understated, cost of goods sold will be over-stated and net income
will be under-stated.
If opening inventory is over-stated, cost of goods sold will be
over-stated, and income will be under-stated. If opening inventory
is under-stated, cost of goods sold will be under-stated and income
will be over-stated. Thus under-valuation or over-valuation of
stocks will invariably affect profit or loss and therefore, the Profit
and Loss account will not be true, fair and objective.
Valuation of Inventory :
The above paragraph shows clearly that the value of
inventory has strong influence on financial statements. Therefore,
inventory should be properly valued. The generally accepted
principle of valuation of inventory is cost or market price
whichever is lower. This principle is based on the convention of
conservatism. Cost of inventory may be computed under FIFO or
average cost methods.
In financial statements, the method of valuation of inventory
should be disclosed.
Illustration 9 :
Stocks, stores & spare parts : (As Valued & Certified by
the Management)
2009 (Rs)
a) Stores and Spares (at Cost)
b) Stock in Trade :
i) Finished Goods
(at cost or Estimated Realisable Value, whichever is
lower)
ii) Saleable Waste (at Estimated Realisable Value)
c) Raw materials (at Cost)
13,00,000
10,00,000
2,00,000
50,00,000
32
Floating Assets :
Floating Assets are those current assets which are
produced or purchased and held in possession with a view to
convert them into cash in the normal course of business. They
are called floating assets because their balances keep on
changing. They do not remain same or fixed.
Example : Stock in trade, raw materials, semi finished goods or
work-in-progress, sundry debtors, bills receivable etc.
Hidden Assets :
There are cases, where certain valuable assets are not
disclosed in the Balance Sheet, though they exist and the business
benefits from them. These assets are termed as Hidden Assets.
They may consist of assts which through continue to exist
physically either written off completely (charged to revenue) in
the year of acquisition or subsequently and therefore do not appear
in the balance sheet.
They may consist of assets which are generated or created
over the period of time for which no specific acquisition cost is
incurred like in the case of goodwill generated by running business.
The examples of such hidden assets are :
a) Machinery in respect which depreciation is allowed to be
claimed for @ 100% in the year in which it is put to use.
b) Scientific Research assets, which are also allowed to be
written off completely under the income Tax Act, in the year in
which they are put to use.
c) Technical know-how, built up by expenditure on research and
development over the years. Normally, R & D expenditure are
charged to revenue.
d) The value of secret processes or formulae developed.
e) Options of lease.
f)
g) Copyrights.
h) Exclusive trading agreements.
i)
j)
Goodwill created.
33
strengthened by these hidden assets, but one should not overlook
the fact that what is reflected in the Balance Sheet is not the real
financial strength of the organization.
4. Loans and Advances :
Loans and advances given are current assets. It includes
different types of advances such as advances against salary,
advances against machinery, advances to subsidiary, prepaid
expenses on account of rent, taxes, insurance, etc.
The item, Current Assets, Loans and Advances is divided into
two parts :
A. Current Assets, and
B. Loans and Advances.
This may appear as under :
Illustration 10 :
Balance Sheet as at 31st March, 2009
Assets
Loans and Advances :
(Unsecured and Considered Good)
Advances recoverable in cash or kind or for
value to be received :
Suppliers
Others
Duty Drawback Recoverable
Deposits
Prepaid Expenses
Tax deducted at Source
Rs.
Rs.
10,00,000
2,00,000
1,00,000
2,00,000
50,000
50,000
16,00,000
5. Fictitious Assets :
Fictitious Assets are really not assets but debit balances not
charged to revenue. These assets cannot be realized or
converted into cash. Hey are only expenses incurred (debit
items) shown on the assets side of the Balance Sheet. The reason
behind such a procedure is that these expenditures could not be
suitably charged to the profit and loss account of the year in which
they were incurred.
Fictitious Assets are not real and are shown in the balance
sheet of a company under Miscellaneous Expenditure (to the
extent not written off or adjusted) on the Assets side.
34
The examples of fictitious assets are :
a) Preliminary expenses.
b) Brokerage on issue of shares and debentures.
c) Discount on issue of shares and debentures.
d) Share or debenture issue expenses.
e) Heavy Advertisement and Publicity expenditure.
6. Miscellaneous Expenditure :
As we have seen earlier under Fictitious Assets,
Miscellaneous Expenditure includes items which satisfy the
condition of an asset but do not fit into the concept of fixed assets,
investments or current assets. This category includes :
a)
b)
c)
d)
e)
Preliminary Expenses,
Commission and Brokerage on issue of shares,
Discount on issue of shares, and
Development expenditure not adjusted.
Interest paid out of capital during construction.
35
But, sole traders normally prefer to arrange their assets in
the order of liquidity i.e., from most liquid to least liquid.
1.8.3 Liabilities :
The term liability when used in accounting, means a debt.
A debt is something that a person or an organization owes to
another person or organization. A liability is recognised when a
legally binding obligation is created.
In other words, Liabilities are the claims of outsiders
against the business. It may also be said that liabilities are
various amounts that a business owes to outsiders other than the
owners. As we have discussed in the first chapter, the business is
a separate entity from the proprietors. From this point of view, the
funds belongings to the proprietors are also a liability to the
business; hence, capital appears on the liabilities side of the
Balance Sheet. But the dues to the proprietors will be paid after all
other external liabilities are paid off.
Technically speaking, all liabilities shown in a balance sheet
are claims against all assets shown in it. But, there may be certain
cases where a liability has a claim against a specific asset. Even
under such circumstances, the liabilities are shown separately, not
as a deduction from the specific assets.
Example: if machinery worth Rs.50,000/- is purchased on
cash payment of Rs.35,000/- and the balance to be paid at a later
date, the balance sheet would show Rs.50,000/- against machinery
on the assets side and liability of Rs.15,000/- on the liability side.
The balance sheet would not show Rs.15,000/- the
difference between Rs.50,000/- the value of the asset and
Rs.35,000/- the cash payment.
Similarly,
when
12%
mortgage
Debentures
of
Rs.50,00,000/- are issued against the security of Land and
Buildings worth Rs.1 Crore, the Debentures will appear on the
liabilities side of the balance sheet at Rs.50 Lakhs and Land and
Building at Rs.1 Crore on the assets side.
a) Debts and obligations.
b) Estimates of future debts arising out of past dealings.
c) Adjustments to the estimated of future liability for taxes
required to apportion actual tax demands over the periods for
which taxes are due.
d) The constituents of owners equity.
36
Classification of Liabilities :
The liabilities of an enterprise may be classified into three
categories
a) Permanent Funds or Proprietors Funds.
b) Semi-permanent Funds or Long-term Borrowings.
c)
Rs.
Assets
Sundry Assets
50,000
15,000
65,000
30,000
10,000
40,000
5,000
12,000
8,000
25,000
1,30,000
Rs.
1,30,000
1,30,000
Proprietors Funds :
37
Shareholders Funds. This is also known as the Net Worth of the
business. Owners Equity refers to the claim of the owners and it is
made up of:
Contributions by the proprietors by way of :
Share Capital
(May be Equity Share Capital only or Equity and
Share Capital)
Preference
Plus : Reserves
Plus : Profit and Loss Account (Cr.) Balance (Surplus)
Less : Accumulated Losses
Less : Fictitious Assets (If any)
Proprietors Funds are regarded as shock absorbers. Any
reduction in the value of assets of the company is absorbed by
proprietors funds. They provide the margin of safety to the
creditors. So long as the reduction in assets does not exceed
proprietors funds, creditors have no problem as they can expect
full payment of their dues.
Owners equity or proprietors funds increase either through
fresh investments by the owners or by an increase in the earnings
retained i.e., profits not distributed.
Retained earnings is the difference between the total
earnings to date and the total cash appropriations (dividends, etc,)
to date. In other words, retained earnings is that part of the total
earnings which have been retained for use in the business.
Decrease in owners equity is caused either by withdrawals
of cash or assets by the owners or through losses suffered by the
business from unprofitable activities.
The presentation of proprietors funds in balance sheet
depends on the type of business organization and statutory
requirements. This can be illustrated as under :
1.8.5 Share Capital :
Share capital is the amount that is raised by a company
from the public at large, through the issue of shares.
There are different concepts of share capital from the legal
and accounting points of view.
38
The following chart details the different concepts of capital :
Companys Share Capital
Authorised Capital
(Registered or Nominal Capital)
1. Issued Capital
1. Subscribed Capital
1. Called up Capital
1. Paid up Capital
2. Unissued Capital
2. Unsubscribed Capital
2. Uncalled Capital
3. Reserve Capital
A. Authorised Capital :
Authorised Capital is the maximum capital a company can
raise as mentioned in the Memorandum of Association under its
Capital Clause. It is also called as the Registered Capital or
Nominal Capital of the Company.
B. Issued and Unissued Capital :
A company usually does not need the entire registered
capital. The capital may be raised as and when necessary. Only a
part of the authorised capital may be issued at a time. Issued
capital is that part of the authorised capital; which is actually
offered to the prospective investors for subscription. Therefore, the
issued capital may be equal to or less than the authorised capital.
The balance of the authorised capital which is not issued is called
the unissued capital.
Some authors prefer to define issued capital as the nominal
amount of that part of authorised capital which is allotted by the
company and includes the shares taken up by the subscribers to
39
the Memorandum of Association. This definition is to keep in line
with schedule VI part I of the Indian Companies Act, 1956.
C. Subscribed Capital :
The issued capital may not be fully subscribed by the public.
Subscribed capital is that part of the issued capital which has
been subscribed or taken up by the public i.e., aggregate
nominal value of the shares for which applications are received
from the public. Therefore, the subscribed capital may be equal to
or less than the issued capital.
D. Called up Capital Uncalled Capital :
The company may not need the entire capital subscribed by
the public. The company, therefore, may collect the capital in
several installments. The called-up capital is that portion of the
subscribed capital which has been called or demanded by the
company to be paid. The capital that is not demanded from the
shareholders is called uncalled capital.
E. Paid up Capital :
Paid up capital is that part of the called up capital which has
been actually paid by the members. The paid-up capital is the
called-up amount less calls not paid. (calls unpaid or calls-inarrears).
F. Reserve Capital :
A company may determine by a special Resolution that any
portion of its subscribed capital shall not be called up except in
the event of and for the purpose of the company being wound up.
Such portion of the subscribed capital not to be called except for
the said purpose is known as Reserve Capital. It is that part of
the uncalled capital which may only be demanded on winding up or
liquidation, but not when the company is a going concern.
Reserve Capital is different from Capital reserve,
reserves and reserve funds, which are profits of a company set
aside or provided for emergencies or to be utilized for a particular
purpose.
40
Y Ltd.
Balance Sheet as at 31st December, 2009
Rs.
Share Capital :
Authorised :
45,00,000 Equity Shares of Rs.10/- each.
1,50,000 Preference Shares of Rs.100/- each.
Issued :
37,00,000 Equity Shares of Rs.10/- each.
40,000 9.5% Redeemable Cumulative
Shares of Rs.100/- each.
3,70,00,000
Preference
Subscribed :
37,00,000 Equity Shares of Rs.10/- each fully called up.
(of the above 10,000 Equity Shares of Rs.10/- each
allotted as fully paid up in pursuant to a contract to
vendors of machinery, for consideration other than cash)
40,000, 9.5% Redeemable Cumulative Preference
Shares of Rs.100/- each fully called.
Less: Calls unpaid (Other than Directors)
4,50,00,000
1,50,00,000
6,00,00,000
40,00,000
4,10,00,000
3,70,00,00
40,00,000
4,10,00,000
15,000
4,09,85,000
41
depreciation, renewals or diminution in value of assets or retained
by way of providing for any known liability.
G. Revenue Reserves or Free Reserves :
These reserves represent amounts set aside out of divisible
profits. They are appropriations of profits. Reserves may be
created for a specific purpose or for a general purpose. Reserve
created for a specific purpose is called a specific reserve
and a reserve created for a general purpose is called a
general reserve. General reserves are free and can be utilized
for :
a) Payment of Dividends.
b) Development and expansion,
c) Any other purpose the company thinks proper.
General Reserve is also called a revenue reserve or a free
reserve. A free reserve is a reserve which is available for any
purpose, including payments of dividend. It is not earmarked for
any specific purpose.
H. Capital Reserves :
Schedule VI of the Companies Act does not really define the
term Capital Reserve. It states that it shall not include any amount
regarded as free for distribution through the Profit and Loss
Account. The term capital reserve is used to describe reserves
which cannot legally be distributed as dividends e.g., share
premium, capital redemption reserve account, etc.
Capital reserve is created out of capital profits which do not
arise in the normal course of business. the following reserves are
capital reserves :
a)
b)
c)
d)
e)
f)
g)
h)
42
Capital Reserves are not available for distribution as
dividends; but they can be utilized for :
a)
b)
c)
d)
e)
f)
43
J. Secret Reserves :
Secret reserves are those reserves which exist but are not
disclosed in the balance sheet. They are not created either by
debiting Profits and Loss Account or Profit and Loss Appropriation
account. Such reserves are created as a result of certain
manipulations and adjustments.
For example:
a)
b)
c)
d)
Long-term Liabilities :
44
sources of long-term finance. These borrowings are termed as
fixed liabilities or term liabilities or long term-loans. They may
take various forms such as debentures, public deposits, bank
loans, deferred payments, etc. they may be fully secured or partly
secured or unsecured.
Technically, a long-term liability can be defined as a liability
falling due on a date later than the expiration of one whole
accounting period.
A. Secured loans :
It refers to loans which are secured by a fixed or floating
charge on the assets of the business. It includes :
a) Debunkers,
b) Loan and advance from banks,
c) Loan and advance from subsidiaries and
d) Other loan and advances.
The natures of securities should be specified in each case.
The interest accrued and due on secured loan should be include
under the appropriate subheads under the head secured loan but
the interest accrued and not due on secured loans is required to be
shown under current liabilities. Loans from directors, securities,
treasurers and mangers should be shown under this head, if such
loans are guaranteed. In respect of debentures, the terms of
redemptions or conversion should be stated. The particulars of any
redeemed debentures which the company has power to reissue
should be stated by way of note.
B. Unsecured loans :
It refers to the loans which are not secured by assets of the
business. It is not covered by any security. It includes :
a) A fixed deposits,
b) Loans and advance from subsidiaries,
c) Short-term loan and advances:
i) from banks, ii) from other,
d) Other loans and advance : loan from directors, secretaries,
treasurers and managers should be shown separately.
Loan Fund = Secured loans + unsecured loans
45
1.8.8 Distinction between Own Fund and owed Fund :
Own Fund
1. Nature
2. Claimant
3. Income
4. Stability of
Income
5. Tenure
6. Refund on
liquidation
7. Security
Owed Fund
It is semi-permanent fund.
It is refunded before own
fund.
1.8.8
Rs.
Rs.
2,00,000
1,00,000
50,000
10,000
3,60,000
50,000
40,000
20,000
5,000
1,15,000
A. Current Liabilities :
Current liabilities are those short-term obligations of an
enterprise which mature within one year or within the
operating cycle. They constitute short-term sources of finance.
Current liabilities arise in the regular current operations of the
business.
46
They are as follows :
i)
ii)
iii)
iv)
vi)
vii)
47
B. Provisions :
Provision means any amount retained by way of
providing for any known liability of which the amount cannot
be determined with substantial accuracy. They are at best
estimates. Provisions have to be made for maintaining the integrity
of assets or for known liabilities. Although the amount of liability is
not certain it has to be provided for, on best estimates. The
examples of provisions are as under :
a)
b)
c)
d)
48
a) Discounted Bills of Exchange.
b) Disputed liability on account of income-tax, etc., about which
appeal has been filed.
c)
Bonds executed.
1.9
EXERCISE
49
Illustration:
Balance Sheet as on 30th September, 2009
Liabilities
Rs.
Assets
Rs.
2,25,000
1,74,586
35,520
52,320
45,790
16,595
3,998
7,500
5,61,309
2
TOOLS OF ANALYSIS OF FINANCIAL
STATEMENTS
Unit Structure:
50
2.0
2.1
2.2
2.3
2.4
2.5
2.6
2.0
Objectives
Introduction
Analysis of the Financial Statements
Trend Ration and Trend Analysis
Comparative Statement
Common-size Statement
Exercise
OBJECTIVES
2.1
INTRODUCTION
2.2
51
There are various methods or techniques that are used in
analyzing financial statements, such as comparative statements,
schedule of changes in working capital, common size percentages,
funds analysis, trend analysis, and ratios analysis.
Financial statements are prepared to meet external reporting
obligations and also for decision making purposes. They play a
dominant role in setting the framework of managerial decisions.
Following are the limitations of Financial Statements:
2.2.1 Limitation of Financial statement :
Following are the limitations of financial statements:
1. The information being of historical nature does not reflect the
future.
2. It is the outcome of accounting concept, convention combined
with personal judgement.
3. The statement portrays the position in monetary term. The profit
or loss position excludes from their purview things which cannot
be expressed or recorded in term of money.
As the information provided in the financial statements is not
an end in itself as no meaningful conclusions can be drawn from
these statements alone. However, the information provided in the
financial statements is of immense use in making decisions through
analysis and interpretation of financial statements. To overcome
from the limitations it becomes necessary to analyse the financial
statements. The analytical tools generally available to an analyst for
this purpose are:
1.
2.
3.
4.
5.
6.
7.
52
1. Absolute date (money values or rupee amount).
2. Increases and decreases in absolute data in term of money
values.
3. Increases or decreases in absolute data in term of percentage.
4. Comparisons expressed in ration.
5. Percentage of total.
Comparative financial statement are very useful to the
analyst as they Provide information necessary for the study of
financial and operating trend over a period of years They indicate
the duration of the movement With respect of the financial position
and operating results Financial data become more meaningful
When compared with similar data for a previous period or a number
of prior periods such statement are very helpful in measuring the
effect of the conduct of a business during the period under
Consideration The comparative profit and loss account Will present
a review of operating activities of the business The comparative
balance sheet shows the effect of operations on the assets and
liability I, e change in the financial position during the period under
consideration.
Comparisons loss their significant and tend to become
misleading if the date being compared do not reflect the consistent
application of generally accepted accounting principles from date to
date or period to period The absence of the comparability of
statement should be indicated in the footnotes that accompany the
financial statement as well as in the accounts report In the
preparation of comparative financial statement uniformity is
essential Care must be taken to see that all account heads or group
of these like administrative expenses; fixed assets; current assets;
long term fund short term fund etc have the same connotation
Otherwise; comparison will be vitiated.
53
It is better to work out the ratio of various items to sales in
term of percentage and enter these also in the statement As
common size statement are most valuable in marketing
Comparisons between the companies in the some industry. A
common size statement shows the relation of each component to
the whole. It is useful in vertical financial analysis and comparison
of two business enterprises at a certain date.
(3) Trend Analysis :
The analysis is an important and useful technique of analysis
and interpretation of financial statement under the technique the
ration of different items for various periods are calculate for the
company over a definite period of time say three to five years and
then we can analysis trend highlighted by this ratio Trend analysis
can be done in three following way.
(i) Trend percentage,
(ii) Trend ratio,
(iii) Graphic and diagrammatic representation.
In the statement the percentage column are more relevant
than the figure.
Utility of Trend Analysis :
a) It is a simple technique. it does not involve tedious calculation
and required trained experts
b) It is brief method to indicate the future trend
c) It is reduces the chances of errors as it provides the opportunity
to compare the percentage with absolute figures
(4) Average Analysis :
It is an improment over trend analysis method. When trend
ratio have been determined these figure are compared with industry
averages These trend can be presented on the graph paper also in
the shape of curve in this from the analysis and comparation
become more comprehensive and impressive.
(5) Statement of changes in Working Capital :
To Know an increase or decrease in working capital over a
period of time, the preparation of a statement of change in Working
Capital is also very useful The statement give an accurate
summary of the events That effected the amount of working capital
The amount of net working capital as determined by deducting the
total of current liability from the total of the current assets It is a
rough estimated which may be arrived at by using balance sheet
54
data only But it does not explain the detailed reasons for the
changes in working capital and methods of financing additional
requirement of working capital Hence the preparation of fund flow
statement becomes necessary.
(6) Funds flow and Cash flow Analysis :
The statement of sources and application of funds also
called were got were gone statement provides the missing link in
the complement of final account statement It demonstrates the
manner by which periods activities call upon and generate the
financial resources of the business unit and the resultant ebb and
flow of these resources through the temporary reservoirs of firm
assets. In the process, it high lights the changes in the financial
structure of an undertaking funds flow analysis is a valuable aid to
the financial executive and creditor For evaluating the use of funds
by the firm and determining how these uses were financed A Funds
flow statement indicates where fund come from and the here it was
used during the period under review These statement can be
prepared separately also The are important tool of communication
and are very helpful for financial executives in planning the
intermediate and long term financing of the firm.
(7) Ratio Analysis :
An absolute figure after does not convey much meaning It is
only in the light of other information that the significance of a figure
is realized A person. S weight is 80 kg. Is he fact? One can not
answer this question unless one knows Known unless together with
the amount of profit the amount of figures expressed mathematical
is called ratio The ratio between 4 and 10 is 0 4 or 40% 0 4 and
40% are ratios Accounting ratio relationships expressed in
mathematical terms between figures Which have a causes an effect
relationship or which are connected with each other in some
manner or the other Obviously no purpose will be served by
working out ratio between entirely unrelated figure such as discount
on debenture and sales Ratio may be worked out on the basis of
figure contained in the financial statement and, therefore, may be
classified as follows :
(a) Income statement ratio
(b) Position statement (balance sheet) ratio, and
(c) Inter-statement ratio
Ratio as tools for establishing true profitability and financial
position of a company may be classified as:
1. Profitability ratios.
2. Turn over ratios
55
3. Financial ratio
To say the same thing in different word, ratios will portray the
financial position while others will portray the causes that lead to a
change in it In the net shall ratio analysis give the answer of the
following problem whether the capital structure of the business is
in proper order, whether the profitability of the business is
satisfactory, Whether the credit policy in relation to sales and
purchases is sound and whether the company is credit worthy.
2.3
56
3) Expressing the percentage change in value of variable from
base year as shown below.
2.3.3 Following is the example of Trend analysis
Years
Sales
Percentage
( + ) Increase or
( - ) Decrease
1980
1981
1982
1983
1984
1985
1986
20,000
35,000
28,000
30,000
35,000
14,000
22,000
Assets
A) Current Assets
Inventory
Debtor
Cash balance
Total (A)
1986
Rs.
1987
Rs.
1988
Rs.
20,000
30,000
20,000
30,000
50,000
55,000
70,000
Trend Percentage
( base year 1988 )
1986
1987
1988
25,000
60,000
30,000
100
100
100
150
167
175
125
200
150
1,15,000
1,15,000
100
164
164
250,000
1,25,000
80,000
300,000
150,000
1,00,000
3,00,000
1,60,000
1,20,000
100
100
100
120
120
125
120
128
150
4,55,000
5,50,000
5,80,000
100
121
127
5,25,000
6,65,000
6,95,000
100
127
132
B) Fixed Assets
Building
Plant
Investment
Total (B)
Total Assets (A + B)
2.3.4 ILLUSTRATION:
Calculate trend percentage from the following figures of X L
td, taking 1979 as the base and interpret.
57
Year
Sales
Stock
1979
1,881
709
321
1980
2,340
781
435
1981
2,655
816
458
1982
3,021
944
527
1983
3,768
1,154
672
Solution :
Trend percentage
Profit before
Tax (Rs. in
Lakhs)
Sales
Stock
Profit
Tax
709
321
100
100
100
2,340
781
435
124
110
136
1981
2,655
816
458
141
115
143
1982
3,021
944
527
161
133
164
1983
3,768
1,154
672
200
162
209
Years
before
Sales (Rs.
in Lakhs)
1979
1,881
1980
Stock (Rs.
in Lakhs)
Interpretation :
The study of the above given statement of Trend percentage
reveals that
(i) The sales of the farm as continuously increased over a period of
a five year commencing from 1979. However there has been a
substantial increase in the amount of sales in the 1983 when it
increased by 39%.
(ii) The trend of Stock is also upward although the increase in this
item has been constant yet in 1983 the increased has been
exceptionally.
(iii) The Profit of the firm has increased at much higher rat in
comparison to increase in Sale and Stock during the period
under study.
The overall analysis of the financial items indicated that the
firm is doing well, and therefore, its financial position it bound to be
good.
2.3.5 Trend percentage:
A horizontal comparison of various items one by one along
with their percentage to the total can be done to know the trend of
that particular item over a period. The study of a trend will indicate
58
the direction of movement over a long time One can gate a better
view of things unaffected by short term influences by study of long
term trend percentage. For example if the total assets of a
company growing steadily at a certain period that is the Percentage
over a long period it is increasing steadily it is definitely a good
indicator of the growth of a company. If a company is suffering
losses uniformly over a long period it is not a good indicator of the
operation position of the company. See celebration of a statement
showing trend percentage on the next page.
In the statement the percentage columns are more relevant
that the figures. A horizontal corporation over the reveals the
following significant point.
2. Sales volume has been steadily rising over the 10.year period
except a small setback in 1979.
3. The percentage of goods consumed has rising over the 10 year
period from 34.93 of sales to 42.43 A rise of nearly 25% the
rise in staff cost over the 10 year period is nearly 40% from
`17.66% of Sales to 24.28%. Similarly, there has been a
substantial rise in other expenses from 13.60% to 18.93 of
sales. All costs have been rising excepting a small decline in
depreciation content.
4. The consequence of the rise in all cost components is the
decline in the profit margin. The operating income has declined
from 27.35% in 1971 gradually to 7.33% in 1980.
In absolute figure through the sales have increased to 2.73
time over a 10 year period, the operating income has declined from
Rs.728 Lakhs to Rs.518 Lakhs. However, the after tax profit has
increased from Rs.288 Lakhs to Rs.348 Lakhs mainly as a
consequence of other sources of other income of and taxation
burden. The analysis shows the profitability of a sound and well
managed company.
2.4
COMPARATIVE STATEMENT
59
position embodied in such statement. In any comparative
statement columns for more than one years position or working
can be drawn and figures may be provided. The annual date can be
compared with similar monthly or quarterly data can be compared
with similar data for the same months or quarterly of previous
years. In such statement the figure can be shown at the following
value.
a. In absolute money value
b. Increase or decrease in absolute values
c. By the way of percentages
d. By the way of commonsize statement
Two comparable units can be compared regarding
profitability and financial position. The two organization may not
have the identical heads of account In order to get over the
difficulty, the data must first be property set before comparison In
the preparation of comparative financial statement, uniformity is
essential.
2.4.2 Importance of Comparative Statement:
These statements are very useful in measuring the effect of
the conduct of a business enterprise over the period under
consideration. Regardless of its financial strength at a given point
of time, the enterprises must operate successfully if it hopes to
continue as a going concern. The income statement measures the
effects of operation. But the progress of these operations may be
viewed over number of periods by preparing the income statement
in a comparative form. Similarly the effect of operation of financial
position and the progress of a business in term of financial position
can be presented by means of a comparative balance sheet. The
accounting authorities in U. S. A. have strongly recommended and
encouraged the preparation of financial statement in the
comparative from Recognising the importance of comparative
financial date for two years, the Indian companies Act 1956 has
made this fact compulsory that in the balance sheet of a company
the figure for the previous year should also be given to facilitated
comparison. Though the balance sheet is a useful statement, the
comparative balance sheet is even more useful for the it contains
not only the data of a single balance sheet but also for the past
years which may be useful in studying the trends.
2.4.3 Preparation of Comparative Statements:
The form of comparative balance sheet consists of two or
more columns according to the number of year we prepare the
balance sheet, for the date of original balance sheet and columns
60
for the increases or decreases in various items. Here is a proforma
of comparative balance sheet for two years
ABC Co. Ltd.
Specimen of Comparative Balance Sheet for the ended 31st
Dec. 1980 and 1981
(Amount in Lakhs of rupees)
Dec. 31
1980
Dec. 31
1981
Increase
(+) /
Decrease
(-)
Amount
Cash
240
80
- 160
- 66
1.24
120
96
- 24
- 40
1.60
Merchandise Inventory
260
320
+ 66
+ 46
2.46
Prepaid Expenses
100
80
- 20
- 40
1.60
720
656
- 64
- 18
1.82
480
720
+ 240
+ 100
2.0
60
80
+ 20
+ 66
2.66
240
480
+ 240
+ 200
4.00
780
1,280
+ 500
+ 128
2.20
1,500
1,936
+ 436
+ 58
2.58
Trend creditors
234
510
+ 276
+ 108
3.08
Accrued Expenses
400
360
- 40
- 20
1.08
634
870
+ 236
+ 74
2.74
Equity Capital
400
500
+ 100
+ 50
2.50
Retained Earnings
466
566
+ 100
+ 42
2.42
Total Capital
866
1,066
+ 200
+ 46
2.46
1,500
1,936
+ 436
+ 58
2.58
Rate
Assets :
Current Assets :
Fixed Assets :
Total Assets
Liabilities and Capital :
Current Liability :
61
sheet, a comparative income statement show the operating results
for a number of accounting periods so that the changes in absolute
date from one period to another may be explained and analysis.
The Comparative income statement contains the some columns as
the comparative balance sheet and provides the same in the
figures.
Specimen of a Comparative Income Statement
ABC Co. Ltd.
Comparative Income Statement for the year ended 31st Dec.
1980 and 1981
(Amount in Lakhs of Rupees)
Dec. 31
1980
Dec. 31
1981
Increase (+)
/ Decrease
( - ) Amount
1370
1442
+ 72
+ .6
838
926
+ 88
+ 21.0
Gross Profit
532
516
- 16
- 6.4
188
182
-6
- 6.4
94
92
-2
- 4.2
282
274
-8
- 5.6
Operating Profit
250
242
-8
- 6.4
44
50
+6
+ 2.8
294
292
-2
- 1.4
44
44
Nil
Nil
250
248
-2
- 1.6
124
124
Nil
Nil
126
124
-2
- 3.2
Net Sales
Operating Expenses :
Selling Expenses
2.5
COMMON-SIZE STATEMENT
62
likewise, assets and liabilities can be shown as percentage of total
assets and total equities respectively in common sized balance
sheet. Thus expressing each monetary item of financial statement
as a percentage of some total of which that item as apart
transforms a financial statement what is referred as common size
statement such a statement show the relative significance of the
items contend in the financial statement and facilitate comparisons.
It point out efficiencies and in efficiencies that are otherwise
difficult to see and of this reason is a valuable management tool a
common size statement is especially useful when data for more
than one year are used.
Vertical analysis is the procedure of preparing and
presenting common size statements. Common size statement is
one that shows the items appearing on it in percentage form as well
as in dollar form.
Common size statements are particularly useful when
comparing data from different companies.
Common size statements are also very helpful in pointing
out efficiencies and inefficiencies that might otherwise go unnoticed
Illustration 1
The balance sheet of Shaheen Ltd are given for the year
2007 and 2008 convert them into common size balance size
balance sheet and interpret the changes.
Balance sheet
Liabilities
Equity share
2007
Rs
2008
Rs.
Assets
Buildings
2007 Rs.
2008 Rs.
1,80,000
2,00,000
1,46,800
1,91,000
Capital reserve
50,000
70,000
40,000
55,000
20,000
30,000
Furniture
10,000
20,000
Freehold property
20,000
12,000
Trade creditors
30,000
40,000
Goodwill
25,000
30,000
Bills payable
80,000
60,000
Cash balance
25,000
20,000
Bank overdraft
90,000
80,000
Sunday debtors
30,000
35,000
Provisions
30,000
20,000
Inventories Bills
receivable(temporary)
70,000
57,000
4,46,800
4,91,000
4,46,800
4,91,000
63
1987
1987
Assets
Amt. (Rs.)
Percentage
Amt. (Rs.)
Percentage
Sundry Debtor
30,000
6.71
35,000
7.13
Cash balance
25,000
5.59
20,000
4.07
Inventories
70,000
15.71
57,000
11.60
Investment (Temporary)
36,500
8.17
42,000
8.55
Bill Receivable
10,300
2.30
20,000
4.08
1,71,800
38.44
1,74,000
35.43
1,80,000
40.29
2,00,000
40.75
40,000
8.95
55,000
11.20
Furniture
10,000
2.24
20,000
4.07
Freehold Property
20,000
4.48
12,000
2.44
Goodwill
25,000
5.60
30,000
6.11
Total (B)
2,75,000
61.5
3,17,000
64.57
4,46,800
100.00
4,91,000
100.00
Trade Creditors
30,000
6.17
40,000
8.15
Bill Payable
80,000
17.91
60,000
12.22
Bank Overdraft
90,000
20.14
80,000
16.29
Provision
30,000
6.71
20,000
4.07
Total (C)
2,30,000
51.47
200,000
40.73
A. Current Assets
Total (A)
B. Fixed Assets
Building
Liabilities
C. Current Liabilities
64
D. Long-term Liabilities
Equity Share
1,46,800
32.86
1,91,000
38.90
Capital Reserve
50,000
11.19
70,000
14.26
20,000
4.48
30,000
6.11
Total (D)
2,16,800
48.53
2,91,000
59.27
4,46,800
100.00
4,91,000
100.00
Interpretation :
1. Out of every rupee of sales 60.72 per cent in 1986 and 63.63
per cent in 1987 account for cost of goods sold.
2. The percentage ratio of gross profit to sales was 39.28 per cent
in 1986 which was reduced 36.37 percent 1987.
3. The operating expenses increased from 15.71 per cent of sales
in 1986 to 16.37 per cent in 1987 All this reduced the
percentage ratio of net income after taxi to sales from 14.15 per
cent in 1986 to 12.00 per cent in 1987.
4. The operating expenses increased from 15.71 per cent of sales
in 1986 to 16.37 per cent in 1987 All this reduced to percentage
ratio of net income after tax to sales from 14.15 per cent in
1987.
In the ultimate analysis it can be said that the operating
efficiency of the concern has not been satisfactory during the period
under study.
Illustration 2 : Following the Balance Sheet of X Co. Ltd and Y Co.
Ltd as on 31.12.1990.
Particulars
Assets
Sundry Debtors
Stock
Prepaid Expenses
Other Current Assets
Total Current Assets
Fixed Assets (Net)
Total
Liabilities
Sundry Creditors
Other
Total Current Liabilities
Fixed Liabilities
Total Liabilities
Capital
Total
X Co. Ltd
Y Co. Ltd
27
220
100
11
10
368
635
1,003
72
226
174
21
21
514
513
1,027
42
78
120
225
154
62
216
318
345
658
534
493
1,003
1,027
65
Interpretation:
1. The study of common size balance show that 61.56 per cent
total asset in 1986 were fixed This percentage increased 64.57
per cent 1987 if concern requires considerable investment in
fixed assets these percentage might be acceptable if the
company needs be acceptable if the company need liquid
assets the interested parties might have cause to be concerned
about the decreasing trend liquidity.
2. There was a wide shift from the use of creditor provided fund to
the use of owner equity fund in 1986 external equity (current
liability) and owner equity (long term liability) accounted from
51.47 per cent and 48.73 per cent for external equities and
59.27 per cent for owner equity These changes indicate that the
concern has started to use internal sources more frequently than
external sources more frequently than external sources in the
generation of fund for this business.
3. The concern has not only succeeded in getting its current
liability down from 51.47 per cent in 1986 to 40.73 per cent in
1987 of their respective of the total equity In but it has also
increased the percentage of its revenue and surplus from 4.48
per cent in 1986 to 6.11per cent in 1987 of other respective total
equities.
Illustration 3: From the income statement give below you are
required to prepare common sized income statement.
1986
Rs.
1987
Rs.
1,40,000
1,65,000
85,000
1,05,000
Gross Profit
55,000
60,000
12,000
16,000
Administrative Expenses
10,000
11,000
22,000
27,000
33,000
33,000
13,000
13,200
Net Income
19,800
19,800
Particulars
Sales
Operating Expenses
66
Solution :
Common size income statement
(For the year ending 1986 and 1987)
1986
Particulars
Amt. (Rs.)
Sales
1987
Percentage
Amt. (Rs.)
Percentage
1,40,000
100.00
1,65,000
100.00
85,000
60.72
1,05,000
63.63
Gross Profit
55,000
39.28
60,000
36.37
12,000
8.57
16,000
9.70
Administrative Exp.
12,000
7.14
11,000
6.67
22,000
15.71
27,000
16.67
33,000
23.57
33,000
20.00
13,000
9.42
13,200
8.00
19,800
14.15
19,800
12.00
Solution:
Common Size Balance Sheet (as on 31st December 1992)
X Co. Ltd Amount
(Rs. in Lakhs)
percentage
Assets :
A) Current Assets
Cash
Sundry Debtor
Stock
Prepaid Expenses
Other
Total (A)
B) Fixed Assets
Total (B)
Total Assets (A+B)
Liabilities :
C) Current Liabilities
Sundry Debtor
Others
Total (C)
D) Long Term Liabilities
Fixed Liabilities
Capital
Total (D)
Total liabilities (C+D)
27
220
100
11
10
368
635
635
1003
2.69
21.93
9.97
1.10
1.00
36.69
63.61
63.31
100.00
72
226
174
21
21
514
513
513
1027
7.01
22.01
16.94
2.04
2.04
50.04
49.96
49.96
100.00
42
78
120
4.19
7.78
11.97
154
62
216
14.99
6.04
21.03
225
658
883
1003
22.43
65.60
88.03
100.00
318
493
811
1027
30.97
48.00
78.97
100.00
67
Comments :
1. The study of common size balance sheet show that 63.31 per
cent of total assets of the X. company L t d were fixed whereas
the some percentage for Y Co was 49.96.
2. The current liability of X Co L td were 11.97 per cent of total
liability and for Y Co L td this percentage was 21.03 both the
companies have used more equity capital.
Illustration 4 : You given the following common size
percentage of AB Company Ltd for 1997 and 1988.
1997
1998
Inventory
5.20
5.83
Debtors
10.39
7.35
Machinery
49.35
45.35
Building
27.27
29.59
Creditors
20.78
Overdraft
10.81
31.17
Capital
51.95
49.67
Long-term loan
16.88
17.91
Total Liabilities
3,85,000
4,63,000
Cash
1998
Assets
Amt. (Rs.)
Percentage
Amt. (Rs.)
Percentage
Inventory
20,000
5.20
27,000
5.83
Debtors
40,000
10.39
55,000
11.88
Cash
30,000
7.79
34,000
7.35
Total (A)
90,000
23.38
1,16,000
25.06
1,90,000
49.35
2,10,000
45.35
Building
10,05,000
27.27
1,37,000
29.59
Total (B)
2,95,000
76.62
3,47,000
74.94
3,85,000
100.00
4,63,000
100.00
Assets :
A. Current Assets
B. Fixed Assets
Machinery
68
Liabilities :
C. Current Liabilities
Creditors
80,000
20.78
1,00,000
21.59
Overdraft
40,000
10.39
50,000
10.81
Total (C)
1,20,000
31.17
1,50,000
32.40
2,00,000
51.95
2,30,000
49.67
65,000
16.88
83,000
17.91
2,65,000
68.83
3,13,000
67.55
3,85,000
100.00
4,63,000
100.00
D. Long-term Liabilities
Capital
Loan
Total (D)
Total Liabilities (C+D)
= 23.38* 15.59*
= 7.79
* Current
** Inventory + debtor
* Current Assets
2.6
EXERCISE
69
5. Write short note on
a.
b.
Trend analysis
c.
Practical Problems:
1.
1987
1988
1987
1988
Rs.
Rs.
Rs.
Rs.
Sundry Creditors
55,000
83,000
Cash
25,000
18,000
Bills Payable
20,000
16,000
Sundry Debtors
1,60,000
2,00,000
Proposed Dividend
40,000
50,000
Bills Receivable
20,000
30,000
Proposed Dividend
42,000
50,000
Stock in trend
77,000
1,09,000
1,50,000
1,00,000
Machinery
80,000
2,00,000
General Reserve
40,000
70,000
Building
2,00,000
1,70,000
30,000
48,000
Goodwill
1,15,000
90,000
3,00,000
4,00,000
6,77,000
8,17,000
6,77,000
8,17,000
Liability
6% Debenture
Capital
Assets
70
2. From the following information prepare a comparative statement
and make brief comments.
Income Statement
(For the year ended 31st March 1987 and 1988)
Particulars
1987
1988
Rs.
Rs.
Sales
2,80,000
3,10,000
1,92,000
2,22,000
Gross Profit
88,000
88,000
15,000
12,000
18,000
18,000
33,000
30,000
55,000
58,000
22,000
23,200
33,000
34,800
1984
Rs.
Rs.
Share Capital
5,00,000
6,50,000
Machinery
2,80,000
3,20,000
6% Debenture
3,40,000
2,00,000
Building
3,50,000
3,50,000
Sundry creditor
1,60,000
67,000
Investment
2,65,000
2,65,000
Provision for
doubtful debtor
Goodwill
70,000
55,000
45,000
3,000
Bank balance
40,000
30,000
75,500
1,65,000
Inventory
60,000
40,000
Bill receivable
40,000
25,000
10,80,000
10,85,000
Liabilities
10,80,000
10,85,000
Assets
1983
1984
Rs.
Rs.
71
4. Following income statement of a business is given the for the
year ending 31st December, 1987 and 1988 prepare a common size
statement and make comments on the business result.
Income Statement (for the ending on 31st Dec. 1987 and 1988)
Particulars
Gross Sales
1987
1988
Rs.
Rs.
7,20,000
8,40,000
40,000
50,000
Net Sales
6,80,000
7,90,000
5,00,000
5,80,000
1,80,000
2,10,000
Advertising Expenses
10,000
12,000
Sales Salary
12,000
16,000
7,000
5,000
Depreciation Expenses
10,000
16,000
39,000
49,000
Office Salaries
50,000
75,000
Insurance
20,000
35,000
Depreciation
5,000
16,000
Bad Debs
3,000
12,000
78,000
1,38,000
1,17,000
1,87,000
63,000
23,000
Operating Expenses :
Selling Expenses
Delivery Expenses
72
3
RATIO ANALYSIS AND
INTERPRETATION I
Unit Structure :
3.0
Objectives
3.1
Introduction
3.2
Meaning of Ratio
3.3
Modes of Expressing an Accounting Ratio
3.4
Objectives of Ratios
3.5
Classification of Ratios
3.5.1 Traditional Classification
3.5.2 Functional Classification of Ratios
3.5.3 Classification from the view point of user
3.6
Balance Sheet Ratio
3.6.1 Current Ratio
3.6.2 Liquid Ratio
3.6.3 Proprietary Ratio
3.6.4 Stock Working Capital Ratio
3.6.5 Capital Gearing Ratio
3.6.6 Debt-Equity Ratio
3.7
Revenue Statement Ratios
3.7.1 Gross Profit Ratio
3.7.2 Operating Ratio
3.7.3 Expenses Ratio
3.7.4 Net Profit Ratio
3.7.5 Net Operating Profit Ratio
3.7.6 Stock Turnover Ratio
3.8
Combines Ratio / Composite Ratios
3.8.1 Return on Capital Employed
3.8.2 Return on Proprietors Funds
3.8.3 Return on Equity Share Capital
3.8.4 Earning per Share
3.8.5 Dividend Payout Ratio
3.8.6 Price Earnings Ratio
3.8.7 Debt Service Ratio
3.8.8 Debt Service Coverage Ratio
3.8.9 Creditors Turnover Ratio
3.8.10 Debtors Turnover Ratio
73
3.9
Limitations of Ratios
3.0
OBJECTIVES :-
3.1
INTRODUCTION :-
During the half of the 19th century, the bankers have started
using accounting ratios for analyzing credit standing of prospective
buyer (debtors). But the ratios analysis of bankers was very much
restricted to the study of current ratios only.
In 1919, Alexander was has criticized such restrictions and
narrow analysis and pointed out the possible dangers of such
analysis. He expressed in his view that in order is get clear picture
of financial health of the business enterprise, one has to take into
account various other relationships other than current ratios. Then
the ratio analysis is considered as strong and efficient tools of
analyzing the financial statement.
Ratio analysis is the method or process of expressing
relationship between items or group of items in the financial
statement are computed, determined and presented. It is an
attempt to draw quantitative measures or guides concerning the
financial health and profitability of an enterprise. It can be used in
trend and static analysis.
It is the process of comparison of one figure or item or group
of items with another, which make a ratio, and the appraisal of the
ratios to make proper analysis of the strengths and weakness of the
operations of an enterprise.
3.2
MEANING OF RATIOS :-
74
3.3
45 days,
52
8
6.5 weeks or
12
8
1.5 months
75
The ratios are useful for the following parties.
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.
12.
13.
3.4
OBJECTIVES OF RATIOS :-
76
3.5
CLASSIFICATION OF RATIOS: -
The ratios are used for different purposes, for different users
and for different analysis.
The ratios can be classified as under:
a) Traditional classification
b) Functional classification
c) Classification from users point of view
3.5.1 Traditional classification :
As per this classification, the ratios readily suggest through
their names, their respective resources. From this point of view,
the ratios are classified as follows.
a) Balance Sheet Ratio :- This ratio is also known as financial
ratios. The ratios which express relationships between two
items or group of items mentioned in the balance sheet at the
end of the year.
Example : Current ratio, Liquid ratio, Stock to Working Capital
ratio, Capital Gearing ratio, Proprietary ratio, etc.
b) Revenue Statement Ratio :- This ratio is also known as
income statement ratio which expresses the relationship
between two items or two groups of items which are found in the
income statement of the year.
Example : Gross Profit ratio, Operating ratio, Expenses Ratio,
Net Profit ratio, Stock Turnover ratio, Operating Profit ratio.
c) Combined Ratio :- These ratios shows the relationship
between two items or two groups of items, of which one is from
balance sheet and another from income statement (Trading A/c
and Profit & Loss A/c and Balance Sheet).
Example : Return on Capital Employed, Return on Proprietors'
Fund ratio, Return on Equity Capital ratio, Earning per Share
ratio, Debtors' Turnover ratio, Creditors Turnover ratio.
3.5.2 Functional Classification of Ratios :
The accounting ratios can also be classified according their
functions as follows.
a) Liquidity Ratios :- These ratios show relationship between
current assets and current liabilities of the business enterprise.
Example : Current Ratio, Liquid Ratio.
77
b) Leverage Ratios :- These ratios show relationship between
proprietor's fund and debts used in financing the assets of the
business organization.
Example : Capital gearing ratio, debt-equity ratio, and
proprietary ratio.
This ratio measures the relationship between proprietors fund
and borrowed funds.
c) Activity Ratio :- This ratio is also known as turnover ratio or
productivity ratio or efficiency and performance ratio. These
ratios show relationship between the sales and the assets.
These are designed to indicate the effectiveness of the firm in
using funds, degree of efficiency, and its standard of
performance of the organization.
Example : Stock Turnover Ratio, Debtors' Turnover Ratio,
Turnover Assets Ratio, Stock working capital Ratio, working
capital Turnover Ratio, Fixed Assets Turnover Ratio.
d) Profitability Ratio :- These ratios show relationship between
profits and sales and profit & investments. It reflects overall
efficiency of the organizations, its ability to earn reasonable
return on capital employed and effectiveness of investment
policies.
Example : i) Profits and Sales : Operating Ratio, Gross Profit
Ratio, Operating Net Profit Ratio, Expenses
Ratio etc.
ii) Profits and Investments : Return on Investments,
Return on Equity Capital etc.
e) Coverage Ratios :- These ratios show relationship between
profit in hand and claims of outsiders to be paid out of profits.
Example : Dividend Payout Ratio, Debt Service Ratio and Debt
Service Coverage Ratio.
3.5.3 Classification from the view point of user :
Ratio from the users' point of view are classified as follows.
a) Shareholders' point of view :- These ratios serve the
purposes of shareholders. Shareholders, generally expect the
reasonable return on their capital. They are interested in the
safety of shareholders investments and interest on it.
Example : Return on proprietor's funds, Return on capital,
Earning per share.
78
b) Long term creditors :- Normally leverage ratios provide useful
information to the long term creditors which include debenture
holders, vendors of fixed assets, etc. The creditors interested to
know the ability of repayment of principal sum and periodical
interest payments as and when they become due.
Example : Debt equity ratio, return on capital employed,
proprietary ratio.
c) Short term creditors :- The short-term creditors of the
company are basically interested to know the ability of
repayment of short-term liabilities as and when they become
due. Therefore, the creditors has important place on the
liquidity aspects of the company's assets.
Example : a) Liquidity Ratios - Current Ratio, Liquid Ratio.
b) Debtors Turnover Ratio.
c) Stock working capital Ratio.
d) Management :- Management is interested to use borrowed
funds to improve the earnings.
Example : Return on capital employed, Turnover Ratio,
Operating Ratio, Expenses Ratio.
3.6
79
c) Significance : This ratio tests the credit strength and solvency
of an organization. It shows strength of working capital, it
indicates ability to discharge short term liabilities.
3.6.2 Liquid ratio :
This ratio expresses the relationship between liquid assets
and liquid liabilities. This ratio is also known as quick ratio or acid
test ratio. This ratio is calculated by dividing liquid assets by liquid
liabilities. Standard quick ratio is 1:1.
Liquid Ratio =
80
c) Purpose: - This ratio is exercised to indicate the long term
solvency of the business.
d) Significance: This ratio shows general financial strength of the business.
1) It determines the extent of trade on equity.
2) It indicates long term solvency of business.
3) It tests credit strength of business.
4) It can be used to compare proprietary ratio with others firms
or industry.
3.6.4 Stock-working capital ratio :
This ratio establishes relationship between stock and
working capital. Alternatively it is known as "Inventory-working
capital ratio".
a) Formula :Stock-Working Capital Ratio =
Stock
Working Capital
81
Alternatively this ratio is also known as "Leverage ratio" or
"Financial leverage ratio" or " Capital structure ratio".
a) Formula :Capital bearing Fixed Interest or dividend
Capital Gearing Ratio=
Capital not bearing Fixed Interest or dividend
Debt
Long Term Debts
OR
OR
Equity
Shareholders Fund
b) Components :1) Debts includes all liabilities including short term & long term
i.e. mortgage loan and debentures.
2) Shareholders' funds consist of Preference share capital,
Equity share capital, Capital and Revenue Reserves,
Surplus, etc.
82
c) Significance :1) It shares favorable or non favorable capital structure of the
company.
2) It shows long term capital structure.
3) It reveals high margin of safety to creditors.
4) It makes us understand the dependence on long terms
debts.
d) Standard :- Standard debt- equity ratio is 2:1. It means debts
should be double the shareholders funds.
3.7
Gross Profit
100
Sales
b) Components of this ratio are :1) Net sales = Total sales less sales return
2) Gross profit = Sales - Cost of sales
3) Cost of sales = (opening stock + purchases + direct labour +
other direct charge) - closing stock
c) Significance :1) This ratio analyse the basic profitability of business.
2) It shows the degree to which the selling price per unit may
decline without resulting in loss from operations.
3) Yearly comparisons of gross profit ratio reveal the trend of
trading results.
3.7.2 Operating Ratio :
This ratio studies the relationship between cost of activities
and net sales i.e. cost of goods sold and net sales. This ratio
83
shows the percentage of cost of goods sold with net sales. This
ratio is expressed in percentage.
a) Formula :Operating Ratio =
Operating Cost
100
Net Sales
100
Administrative expenses
Net sales
100
84
3) Cost of material consumed ratio=
100
100
100
c) Purpose and significance :1) This ratio helps us to know the cause behind overall
changes in operating ratio
2) Purpose of this ratio is to take corrective action.
3) It indicates the efficiency of management in controlling
expenses and improving profitability.
4) This ratio enables the income tax department to judge the
correctness and reliability of income disclosed in income tax
returns.
5) Analytical study of this ratio can be judged by trend of
expenses.
6) Comparative study of year to year expenses can be
possible.
3.7.4 Net profit ratio :Net profit ratio indicates the relationship between net profit
and net sales. Net profit can be either operating net profit or net
profit after tax or net profit before tax. Alternatively this ratio is also
known as "Margin on sales ratio". Normally this ratio is calculated
& expressed in percentage.
a) Formula :Net profit ratio =
OR
Net profit
Net sales
NPBT
100
Net sales
OR
100
OR
NPAT
100
Net sales
ONP
100
Net sales
85
4) It indicates the portion of net sales is available for
proprietors.
5) It is clear index of cost control, managerial efficiency, sales
promotion, etc.
3.7.5 Net operating profit ratio :
Operating profit ratio indicates the relationship between
operating profit and net sales.
This ratio is expressed in
percentage.
a) Formula :Net operating profit ratio=
b) Components :1) Net operating profit is equal to gross profit minus all
operating expenses or sales minus cost of goods sold and
operating expenses.
2) Net sales are equal to sales minus sales returns.
c) Significance :1) It signifies higher operating efficiency of management and
control over operating cost.
2) It indicates profitability of various operations of the
organization i.e. buy, manufacture, sales, etc.
3) It shows ability of organization to generate operating profit
out of its daily operations.
3.7.6 Stock Turnover Ratio :
Stock turnover ratio shows relationship between costs of
goods sold and average stock. This ratio is also known as
"Inventory Ratio" or "Inventory Turnover Ratio" or "Stock Turn
Ratio" or "Stock Velocity Ratio" or "Velocity of Ratio".
This ratio measures the number of times of stock turns or
flows or rotates in an accounting period compared to the sales
affected during that period. This ratio indicated the frequency of
inventory replacement. This ratio is expressed as rate.
a) Formula :Stock Turnover Ratio =
86
2) Average Stock=
3.8
b) Components :1) Net profit before tax, interest & dividends (PBIT)
2) Capital employed
Capital employed = i) Equity share capital
ii) Add. Preference share capital
reserve & surplus
iii) Add. Long term borrowings (Term
loan + Debentures)
87
iv) Less:
Fictitious
assets
like
miscellaneous expenses not written
off.
v) Less profit & loss A/c Dr. Balance
(loss)
c) Purpose :1) Purpose of this ratio is to measure overall profitability from
the total funds made available by owners and leaders.
2) Purpose of this ratio is to judge how efficient the business
concern is in managing the funds at its disposal.
d) Significance: 1) This ratio is effective tools to measure overall managerial
efficiency of business.
2) Comparison of this ratio with other company and this
information can be obtained for determining future course of
action.
3) This ratio indicate the productivity of capital employed and
measure the operating efficiency of the business.
3.8.2 Return on Proprietors Funds :
This ratio measures the relationship between net profit after
tax & interest and proprietors fund. This ratio is alternatively known
as "Return on proprietors' equity" or "Return on shareholders'
investment" or "Investors' ratio".
This ratio is expressed in
percentage.
a) Formula :Return on Proprietor's Fund =
100
88
2) With the help of this ratio company can decide to rise finance
from external sources even from public deposit it ratio is
satisfactory.
3) Shareholders can expect to capitalize its reserves and issue
bonus shares when ratio is higher for reasonable period of
time.
3.8.3 Return on equity share capital :
This ratio explains relationship between net profit (after tax
and interest and dividend on preference share) and equity share
holders' funds. This ratio is expressed in percentage.
a) Formula :Return on Equity Capital =
100
b) Components :1) Net profit after tax & interest and preference dividend.
2) Equity share capital by adding reserves or deducting
miscellaneous expenditures.
c) Purpose :Purpose of this ratio is to calculate amount of profit available to
take care of equity dividend, transfer to reserves, etc.
d) Significance :1) It is useful to the investors while deciding whether to
purchase or sale of shares.
2) This ratio helps to make comparative study of equity capital
with other company and it will be appreciate if there is high
return.
3.8.4 Earning per share :
Earning per share is calculated to find out overall profitability
of the organization. It represents earnings of the company whether
or not dividends are declared.
Earning per share is determined by dividing net profit by the
number of equity shares.
89
a) Formula :Earning per shares (EPS) =
b) Components :1) Net profit after tax & interest - less preference dividend.
2) No. of equity shares.
c) Purpose :Purpose of this ratio is to calculate the amount of profits
available on each equity share to take care of equity dividend,
transfer to reserves, etc.
d) Significance :1) This ratio helps the investors or shareholders to take
decision while purchasing or selling shares.
2) This ratio shows the possibilities of issue of bonus shares.
3) Higher ratio indicates overall profitability.
3.8.5 Dividend payout ratio :
This ratio shows relationship between dividends paid to
equity shareholders out of profit available to the equity share
holders.
a) Formula: This ratio is calculated as follows.
Dividend per equity shares
Dividend payout ratio =
Earning per shares
b) Components: 1) Dividend per equity shares means total dividend paid to
equity shareholder dividend by number of equity shares.
2) Earning per shares as per Para 3.8.4.
c) Purpose: - Purpose of this ratio is to measure the dividend
paying capacity of the company.
d) Significance: 1) Higher ratio signifies that the company has utilized the larger
portion of its earning for payment of dividend to equity
shareholders.
2) It says lesser amount of earning has been retained.
90
3.8.6 Price earnings ratio (PE Ratio) :
This ratio measures relationship between market price of
equity shares and earnings per share. It is usually expressed as a
fraction.
a) Formula: Price Earning Ratio=
b) Components :1) Profit before interest & tax means net profit before payment
of interest on loan and tax.
2) Interest means interest on long term loans.
c) Purpose :1) Purpose of this ratio is to measure the interest paying
capacity the company.
2) The purpose of this ratio is to find out the number of times
the fixed financial charges are covered by income before
interest and tax.
91
d) Significance :1) It is important from the lenders' point of view.
2) It indicated whether the company will earn sufficient profits to
pay periodical interest charges.
3) It shows that the company will be able is pay interest
regularly.
3.8.8 Debt service coverage ratio :
Debt service coverage ratio shows the relationship between
net profit and interest plus loan installments payable. This ratio is
expressed in pure number.
a) Formula :Debt service coverage Ratio =
OR
Credit purchases
Creditors + Bills payable
OR
Creditors turnover ratio
92
b) Components: 1) Credit purchases means gross credit purchases minus
purchases returns.
2) Average creditors mean average of opening and closing
amount of creditors. If details are not given then only closing
creditors may be considered as average creditors.
3) Amount of bills payable.
c) Purpose: Purpose of this ratio is to.
1) Calculate the speed with which creditors are paid off on aan
average during the year.
2) Calculate the creditors' velocity to indicate the period taken
by the average creditors to be paid off.
3) Judge how efficiently the creditors are managed.
3.8.10 Debtors' Turnover Ratio :
This ratio shows relationship between credit sales and
average trade debtors.
Alternatively this ratio is known as
"accounts receivable turnover ratio" or "turnover of debtors' ratio".
This ratio is expressed as a rate.
a) Formula :Debtors turnover ratio =
Credit sales
Average debtors
OR
OR
Credit sales
Accounts receivable
Credit sales
Debtors + Bills receivable
OR
365 days
Credit sales
OR
Average debtors
93
c) Purpose :- Purpose of this ratio is to.
1) Calculate the speed with which debtors get settled on an
average during the year.
2) Calculate debtors' velocity to indicate the period of credit
allowed to average debtors.
3) Judge how efficiently the debtors are managed.
3.9
LIMITATIONS OF RATIOS: -
94
d) Operating Ratio
e) Capital Gearing Ratio
2. Give the formula and components of the following ratios.
a) Debt Service Ratio
b) Price Earning Ratio
c) Return of Equity Share Capital Ratio
d) Stock Turnover Ratio
e) Net Profit Ratio
f) Debt Equity Ratio
g) Proprietary Ratio
4
RATIO ANALYSIS AND
INTERPRETATION II
Unit Structure :
4.0
Objectives
4.1
Illustration
4.2
Exercise
4.0
OBJECTIVES :-
4.1
ILLUSTRATIONS :-
1. Following is the trading A/c and profit and loss A/c for the
year ended 31st December, 2009.
95
Particulars
To Opening Stock
To Purchases
To Wages
To Factory Expenses
To Gross Profit c/d
Rs.
40,000
4,00,000
1,00,000
1,40,000
3,80,000
Particulars
By Sales
By Closing Stock
10,60,000
To Administrative Expenses
To Selling Expenses
To Interest on Loan
To Debenture Interest
To Net Profit c/d
1,20,000
80,000
10,000
16,000
1,64,000
40,000
40,000
84,000
1,64,000
9,00,000
1,60,000
10,60,000
By Gross Profit b/d
By Interest Received
3,90,000
To Tax Provision
To Proposed Dividend
To Balance Profit
Rs.
3,80,000
10,000
3,90,000
By net profit b/d
1,64,000
1,64,000
96
Balance sheet as on 31st December, 2009
Liabilities
Rs.
Assets
Rs.
4, 00,000
3,50,000
3,00,000
Machinery
3,00,000
8% debentures
2,00,000
Furniture
2,00,000
Reserves
1,00,000
Goodwill
1,00,000
Patents
1,00,000
Vehicles
2,80,000
2,00,000
Investment
1,00,000
1,50,000
Stock
1,60,000
2,80,000
Debtors
1,80,000
60,000
60,000
Bills receivable
60,000
40,000
proposed dividend
40,000
18,30,000
18,30,000
97
Solution :
a) Current Ratio =
Current Assets
Current Liabilities
4,00,000
7,70,000
CA
Stock
CL Bank Overdraft
2,40,000
6,20,000
0.519 : 1
4,00,000 1,60,000
7,70,000 1,50,000
0.387 : 1
3,00,000 2,00,000
4,00,000 1,00,000 60,000 NIL
5,00,000
5,60,000
d) Stock Turnover Ratio =
0.893
Cost of Goods Sold
Average Stock
5,20,000
1,00,000
* Cost of Goods Sold = Sales
5.20 times
Closing Stock
= 9, 00,000
3, 80,000
= 5, 20,000
* Average stock
2,00,000
2
e) Debtor Turnover Ratio =
1,00,000
Credit Sales
Debtors + B.R.
9,00,000
1,80,000 60,000
3.75
98
Debtors + B.R.
Credit Sales
No. of working
days in a year
1,80,000 + 60,000
360
9, 00,000
2,40,000
360 = 96 days
90,000
Credit Purchases
Creditors + BP
4,00,000
2,80,000 60,000
4,00,000
3, 40,000
1.716
(1,64,000 16,000)
100
10,60,000
1,80,000
100
10,60,000
i) Stock Working Capital Ratio =
Closing Stock
Working Capital
1,60,000
3,70,000
j) Operating Ratio =
16.98%
0.43
81.11%
99
k) Earnings per Share = Net Profit after Tax and
=
Preference Dividend
No. of Equity Shares
8
2.425
m) Net Profit Ratio =
Rs.2.425
3.298
1,64,000 40,000
100
9,00,000
1,24,000
100
9,00,000
Gross Profit
100
Sales
3,80,000
100
9,00,000
o) Proprietory Ratio =
13.78%
42.22%
Proprietors Fund
100
Total Assets
8,60,000
100
18,30,000
p) Debt Equity Ratio =
46.99%
Borrowed Fund
Proprietor's Fund
2,00,000
8,60,000
0.232 : 1
100
q) Operating Profit Ratio =
Operating Profit
100
Sales
1,70,000
100
9,00,000
18.89%
Working Notes: W.N.1 Vertical income statement for the year ended 31st
December, 2009.
Particulars
1. Net Sales
2. Less: Cost of Goods Sold
Opening Stock
Purchases
Wages
Factory Expenses
Less: Closing Stock
cost of Cost sold
3. Gross Profit
4. Less: Operating Expenses
a) Administrative Expenses
b) Selling Expenses
c) Financing Expenses
- Interest on Share Term Loan
5. Operating Profit
6. Add: Nom-operating Income
- Interest received
7. Net Profit interest & Tax
8. Less: Interest on Debenture
9. Net Profit before Tax
10. Less: Income Tax
11. Net Profit after Tax
12. Less: Preference Dividend
(9% of 3, 00,000)
13. Net Profit available for Equity
shareholders.
14. Less: Equity Dividends
(40,000 - 27,000)
15. Retained Earnings
Rs.
Rs.
Rs.
9,00,000
40,000
4,00,000
1,00,000
1,40,000
6,80,000
1,60,000
5,20,000
3,80,000
1,20,000
80,000
10,000
2,10,000
2,10,000
1,70,000
10,000
1,80,000
16,000
1,64,000
40,000
1,24,000
27,000
97,000
13,000
84,000
101
W.N.2 Vertical balance sheet as on 31st December, 2009.
Particulars
. Sources of Funds
I. Owner's / shareholder's funds
a) Equity Share Capital
b) Reserves & Surplus
Reserve
P & L A/c
c) Preference Share Capital
II. Borrowed / Loan Funds
8% Debentures
CAPITAL EMPLOYED (I + II)
B. Application of funds
I. Fixed Assets
Land & Building
Machinery
Furniture
Vehicles
Goodwill
Patents
II. Investments
III. Working Capital
a) Current Assets
Quick Assets
Debtors
Bills Receivables
Non-quick Assets
Closing Stock
b) Less: Current Liabilities
Quick Liabilities
Creditors
Bills Payable
Provision for Tax
Proposed Dividends
Short Term Loan
Rs.
Rs.
Rs.
4,00,000
1,00,000
60,000
1,60,000
3,00,000
8,60,000
2,00,000
10,60,000
3,50,000
3,00,000
2,00,000
2,80,000
1,00,000
1,00,000
13,30,000
1,00,000
1,80,000
60,000
2,40,000
1,60,000
4,00,000
2,80,000
60,000
40,000
40,000
2,00,000
6,20,000
Non-quick Liabilities
Bank Overdraft
Working Capital (CA-CL)
CAPITAL EMPLOYED (I+II+III)
1,50,000
(7,70,000)
(3,70,000)
10,60,000
102
2. M/s Raj & Sons presents you the following balance sheet as
on 31st December, 2008.
Liabilities
Rs.
Share capital
Equity share of Rs. 10 each
Reserve fund
7% debentures
Overdraft
Creditors
10,00,000
1,00,000
3,00,000
2,00,000
3,00,000
Assets
Fixed assets
Stock
Debtors
Cash
19,00,000
Calculate -
Rs.
10,00,000
4,00,000
3,00,000
2,00,000
19,00,000
I) Liquidity ratios
II) Solvency ratios
III) Debt-equity ratio
Solution :
1) Liquidity ratios :-
a) Current Ratio =
Current Assets
Current Liabilities
9,00,000
5,00,000
1.8 : 1 or 1.8
Liquid Assets
Liquid Liabilities
5,00,000
3,00,000
1: 66 : 1
OR
If Liquid Liabilities = Current Liabilities, then Acid Test Ratio is as
under
5,00,000
1: 1
5,00,000
Stock
c) Stock Working Capital Ratio =
Working Capital
4,00,000
9,00,000 5,00,000
4,00,000
4,00,000
1: 1
103
2) Solvency ratios :-
Shareholders Funds
Total Tangible Assets or Total Assets
11,00,000
19,00,000
0.58 : 1 or 0.58
100 = 58%
Shareholders' Funds
Fixed Assets
11,00,000
10,00,000
1.1: 1
OR
= 1.1
100=11.1%
Shareholders' Funds
Current Assets
11,00,000
10,00,000
1.1: 1
OR
= 1.1
100=100%
Outsiders' Funds
Shareholder's Fund
8,00,000
11,00,000
0.73 : 1
Outsiders' Funds
Shareholder's Fund
3,00,000
8,00,000
0.373 : 1
104
3. From the following financial statements of M/s Sunny Ltd.
calculate.
1) Current Ratio
2) Liquid Ratio
3) Gross Profit Ratio
4) Net Profit Ratio
5) Net Profit to Capital Employed Ratio
6) Fixed Assets Turnover Ratio
7) Sales to Capital Ratio
8) Debtors Turnover Ratio
Balance sheet as on 31st March, 2009.
Liabilities
Share capital
Rs.
1, 50,000
Assets
Fixed Assets (Net)
Rs.
80,000
Reserve
60,000
Current Assets
24,000
Stock
1, 88,000
Debentures
60,000
Debtors
1, 64,000
Current Liabilities
1, 52,000
Cash
14,000
4, 46,000
4, 46,000
Rs.
64,000
6,84,000
48,000
38,000
28,000
4,000
Rs.
7,48,000
5,96,000
1,52,000
1,18,000
34,000
4,000
30,000
105
Solution :
1) Current Ratio =
Current Assets
Current Liabilities
2.4078 : 1
2 : 41: 1
2) Liquid Ratio =
Liquid Assets
Liquid Liabilities
1,78,000
1.171: 1
1,52,000
1.17 : 1
Gross Profit
100
Sales
1,52,000
100
7, 48,000
20.3208%
20.32%
4.01%
OR
Net Profit beforeTax
Sales
34,000
100
7,48,000
4.55%
100
4.545%
106
10.20%
OR
If Net Profit before Tax is considered then Net Profit to Capital
employed will be as under.
Net Profit before Tax
=
100
Capital Employed
34,000
100
2,94,000
11.56%
5,96,000
80,000
7.45 Times
Sales
Capital Employed
7,48,000
2,94,000
2.54 Times
8) Debtors Turnover Ratio =
6,84,000
1,64,000
4.17 Times
107
4. From the following financial statement of X co. Ltd. for the
year ended 31st December, 2009, calculated the following
ratios.
I)
II)
III)
IV)
V)
VI)
VII)
VIII)
IX)
X)
Current Ratio
Liquid Ratio
Operating Ratio
Stock-Turnover Ratio
Turnover to Fixed Assets Ratio
Return on Total Resources
Return on Proprietors Fund
Net Profit to Capital Employed
Debtors Velocity
Creditors' Turnover Ratio.
Balance sheet as on 31st March, 2009.
Liabilities
Rs.
Assets
Rs.
5,00,000
3,50,000
General Reserve
3,00,000
2,50,000
2,00,000
Stock
3,00,000
Sundry Creditors
2,00,000
Sundry debtors
2,00,000
1,00,000
12,00,000
12,00,000
Trading and profit & Loss A/c for the ended 31st December
2009.
Particulars
To Opening Stock
To Purchases (Credit)
To Gross Profit
Rs.
Particulars
1,00,000 By Sales
8,00,000 By Closing Stock
9,00,000
18,00,000
To Office &
Administrative Expenses
To Selling & Distribution
Expenses
To Other Expenses
To Net Profit
By Gross Profit
2,00,000 By Profit on Sale
of Assets
1,00,000
25,000
6,00,000
9,25,000
Rs.
16,00,000
2,00,000
18,00,000
9,00,000
25,000
9,25,000
108
Solution :
I) Current ratio=
Current Assets
Current Liabilities
6,00,000
2,00,000
3 :1
Liquid Assets
Liquid Liabilities
3,00,000
2,00,000
2,00,000 1,00,000
2,00,000
1.5 : 1
7,00,000 3,25,000
16,00,000
10,25,000
16,00,000
0.64 : 1
OR
0.64
100 = 64%
COGS
Averages Stock
7,00,000
1,50,000
4.67 Times
Turnover
Fixed Assets
16,00,000
6,00,000
VI) Return on Proprietors Fund =
7,00,000
(1,00,000 2,00,000)
2
2.67 : 1
0.60 : 1
OR
= 0.60
100=60%
109
Net Profit after Tax & Interest
Capital Employed
6,00,000
10,00,000
0.60 : 1
OR
= 0.60 100 = 60%
VIII) Debtors Velocity Ratio =
Debtors
365
Credit Sales
2,00,000
365
16,00,000
46 Days
Creditors
365
Credit Purchases
2,00,000
365
8,00,000
91 Days
4.2
EXERCISE :-
110
Trading and profit & Loss Account for the year ended 31st
December, 2009.
Particulars
To Opening Stock
To Purchases
To Gross Profit c/d
Rs.
Particulars
1,50,000
12,90,000
2,10,000
Rs.
By Sales
By Closing Stock
15,00,000
1,50,000
16,50,000
To Administrative Expenses
To Rent & Taxes
To Interest
To Selling Expenses
To Depreciation
To Income Tax Provision
To Net Profit
20,000
14,000
22,500
11,000
50,000
60,000
60,000
16,50,000
By Gross Profit b/d
By Profit on Sale of Fixed
Assets
2,10,000
27,500
2,37,500
2,37,500
Rs.
2,50,000
50,000
2,00,000
3,50,000
30,000
55,000
65,000
Assets
Rs.
Fixed Assets
Bank Balance
Short term Investment
Debtors
Stock
10,00,000
6,50,000
25,000
75,000
1,00,000
1,50,000
10,00,000
Rs.
Assets
Rs.
6,00,000
Fixed Assets
9,00,000
Reserve
2,00,000
Stock
3,00,000
6% Debentures
5,00,000
Marketable Investment
1,00,000
Current Liabilities
2,00,000
Debtors
1,50,000
Bank Overdraft
1,00,000
1,00,000
Preliminary Expenses
16,00,000
50,000
16,00,000
111
Net profit for the years was Rs.75,000/-.
Prepare a statement suitable for analysis and indicate the
soundness of the financial positions of the company by calculating
the following ratios and comment on the same.
a)
b)
c)
d)
e)
f)
g)
Current Ratio
Liquid Ratio
Proprietary Ratio
Return on Capital Employed
Return on Proprietors Equity
Return on Equity Capital
Stock Working Capital Ratio
(M.U.B.Com. April 1999)
Rs.
Assets
Rs.
2, 00,000
Fixed Assets
3, 00,000
1, 38,000
Stock
1, 00,000
Debentures
2, 00,000
Debtors
1, 22,000
Creditors
32,000
Bills Receivable
Bills Payable
12,000
Bank Balance
5, 82,000
8,000
52,000
5, 82,000
112
Answer :1.
a) Current Ratio = 1.72:1
b) Liquid Ratio = 0.97:1
c) Stock Turnover Ratio - 8.6 Times
d) Debtors Turnover Ratio - 15
e) Operating Ratio - 89%
f)
j)
113
5
RATIO ANALYSIS AND
INTERPRETATION III
Unit Structure :
5.0
Objectives
5.1
Introduction
5.2
Reverse Ratios or Indirect Ratios
5.3
Illustrations
5.4
Exercise
5.0
OBJECTIVES :-
5.1
INTRODUCTION :-
5.2
114
ratios, the detailed knowledge of income statements and balance
sheet with all components and angles is essential. It is the
extension of direct ratios. The basis objective of indirect ratio is to
check the complete clarity and understanding of entire ratio
analysis. This system or angle of ratio analysis checks the
arithmetical accuracy of the financial statement.
5.3
ILLUSTRATION :-
Stock
Debtors
Cash
Creditors
Bank Overdraft
Outstanding Expenses
Total Purchases
Cash Purchases
Gross Profit Ratio
I) Current Ratio =
Current Assets
Current Liabilities
10,00,000
4,00,000
2.5 : 1
Liquied Assets
Liquid Liabilities
2,00,000
3,60,000
0.55 : 1
1,70,000 30,000
3,00,000 60,000
115
Credit Purchases
Average Creditors
9,30,000 30,000
3,00,000
9,00, 000
3,00,000
3 Times
365
3
12
3
4 Months
52
3
17.33
17 Weeks
Credit Sales
Average Debtors
12,40,000
1,70,000
7.39 Times
7.12 Weeks
12
7.29
1.64 Months
=
=
50.04 Days
116
9,30,000
25
75,000
Gross Profit = Rs. 3,10,000
II) Sales = Purchases + Gross Profit
= 9,30,000 + 3,10,000
=12,40,000 Rs.
Sales = Rs.12,40,000
Cost of Goods Sold
Average Stock
12,40,000 3,10,000
8,00,000
9,30,000
8,00,000
1.66 Times
52
1.66
44.73 W eeks
12
1.66
10.32 Months
117
I) Gross profit ratio =
20 =
Gross profit
100
Sales
60,000
100
Sales
20 Sales = 60,000
100
100
5
Sales = 60,000
2,40,000
Average stock
6=
Average stock =
2,40,000
6
5,000)
2
5,000
40,000
2 40,000
5,000
80,000
5,000
80,000 5,000
2
75,000
2
37,500
118
Opening stock = Rs. 37,500
Closing stock = Opening stock + 5,000
= 37,500 + 5,000
= Rs. 42,500
V) Calculation of debtors
Debtors
12
Credit
Debtors
12
3,00,000
2=
12 Debtors = 3,00,000
Debtors =
3,00,000 2
12
Creditors
2,45,000
Creditors
2,45,000
2,45,000
365
365
365
73
73
Rs.
Rs.
Current Assets
Debtors
50,000
Stock
42,500
92,500
119
Creditors
49,000
49,000
43,500
Rs.45,000
10 Times
15%
20%
4:1
Rs.1,00,000
Rs.10,000
Rs.51,000
10 =
10
10
10
= 4,80,000
a) Cost of Goods Sold = 48,000
10 = Rs. 4,80,000
120
Gross Profit = 20% on Sales = 25% on cost
Gross Profit = 25% of Rs.4,80,000
= Rs.1,20,000
c) Total sales = Cost of Goods Sold + Gross Profit
= 4,80,000 + 1,20,000
Rs.6,00,000
d) If Cash Sales are 1, Credit Sales are 3
Total Sales are 4
1
Rs.1,50,000
4
3
* Credit Sales = 6,00,000
Rs.4,50,000
4
* Cash Sales = 6,00,000
10,000 10
1
Rs. 1, 00,000
15
1
15
5)
Net profit
Sales
Net profit
6,00,000
100
100
Calculation of Expenses
121
Expenses + Depreciation + Net Profit = Gross Profit
Expenses + 10,000 + 90,000 = 1,20,000
Expenses = 1,20,000 - 10,000 - 90,000
Expenses = Rs.20,000
6)
4,50,000
Debtors
12 Debtors = 2 4, 50,000
4,50,000 2
12
Debtors =
Rs.75,000
7)
12
Credit Purchases
Creditors
12
4,86,000
Creditors
1
1
4,86,000
Creditors
12
1
Creditors =
4,86,000
12
8)
Current Assets
Current Liabilities
122
4
1
Current Assets
40,500
4 = Rs. 1,62,000
Cash = Rs.36,000
Calculation of Capital
Total Assets = Total Liabilities
2,52,000 = Capital + LTL + N.P. + Creditors
2,52,000 = Capital + 1,00,000 + 90,000+ 40,500
Capital = 2,52,000 - 1,00,000 - 90,000 - 40,500
= 2,52,000 - 2,30,500
= 21,500
Trading and profit & Loss A/c for the year ended 31st march
2009.
Particulars
Rs.
45,000
4,86,000
1,20,000
Particulars
By Sales: Credit (I)
Cash (I)
By Closing
(given)
Stock
6,51,000
To Expenses (Bal. figure)
20,000
To Depreciation on
10,000
Rs.
4,50,000
1,50,000
51,000
6,51,000
By Gross Profit b/d
1,20,000
90,000
1,20,000
1,20,000
Rs.
Rs.
Rs.
123
Capital (9)
21,500
Net profit
90,000
1,00,000
Creditors (7)
40,500
90,000
Current Assets
Cash (8)
36,000
Stock (given)
51,000
Debtors (6)
75,000
2,52,000
2,52,000
Rs.
4,37,500
?
1,09,375
?
Particulars
By Sales
By Closing Stock
?
To Administrative Expenses
To Interest on Debentures
To Provision for Tax
To Net Profit
2,66,000
37,500
?
3,30,000
Rs.
?
?
?
By Gross Profit b/d
By Commission
?
62,500
1, 20,000
Rs.
Assets
Share capital
General reserve
Profit & Loss A/c
(Including opening balance)
10% debentures
Creditors
Proposed dividend (C.Y)
Provision for tax (C.Y)
6,25,000
?
1,34,375
?
?
?
?
?
Rs.
7,75,000
?
?
?
78,000
124
You are required to complete the financial statement with the help
of the following information:1) Current Ratio is 2:1.
2) Stock Turnover Ratio is 1.60.
3) Proposed dividends are 25% of Share Capital.
4) Gross Profit Ratio is 50%.
5) Transfer to General Reserve is 70% of proposed dividends.
6) Provision for tax is 50% of net profit.
7) There is no opening balance in General Reserve A/c.
8) Creditors Turnover Ratio (on Purchase and Closing
Creditors) is 10:2.
Solution :
I) Proposed dividend = 25% of 6,25,000 = Rs.1,56,250
II) Transfer to General Reserve = 70% of proposed dividend
70% of 1,56,250 = Rs. 1,09,375
III) Provision for Tax - 50% of Net Profit
50% of 3,30,000 = Rs.1,65,000
IV) After debiting provision for tax Rs.1,65,000 to Profit & Loss A/c
Gross profit = Total of Dr. Side of P & L A/c - Commission
Received
Total of Debit side of Profit & Loss A/c = 2,66,000 + 37,500 +
1,65,000 + 3,30,000
= 7,98,500
Gross profit = 7,98,500 - 62,500
Gross profit = 7,36,000
V) Calculation of Sales
Gross Profit Ratio =
50
Gross Profit
100
Sales
7,36,000
100
Sales
50 Sales = 7,36,000
100
7,36,000
50
100
Sales =
125
VI)
1.6
14,72,000 7,36,000
Average Stock
7,36,000
(Op. Stock + Closing Stock)
2
1.6
7,36,000
4,37,500 Closing Stock
2
1.6
1.6
7,36,000
7,72,000
1.6
Rs.4,82,500
Purchases
Creditors
6,71,625
Creditors
Creditors =
6,71,625 2
10
Creditors = 1,34,325
126
Current Liabilities = Creditors + proposed dividend + provision
for tax
= 1,34,325 + 1,56,250 + 1,65,000
= 4,55,575
Current Assets = Current Liabilities
2
= 4,55,575
2
= 9,11,150
X)
XI) Long Term Investment: Total Liabilities = Total Assets = Rs. 16,99,325
Total Assets = P & M + LTI + Stock + Debtors + Bank
16,99,325 = 7,75,000 + LTI + 4,82,500 + 3,50,650 + 78,000
Long Term Investment = 16,99,325 - 16,86,150
= Rs.13.175
XII) Calculation of Debentures
Interest =
37,500
1
Debentures 10
100
Debentures
100
Debentures = 37,500
10
100
10
Rs.3,75,000
Trading and P & L A/c for the year ended 31st March 2007
Particulars
To Opening Stock
To Purchases (VII)
To Direct Expenses
To Gross Profit C/d (IV)
Rs.
4,37,500
6,71,625
1,09,375
7,36,000
Particulars
Rs.
By Sales (V)
By Closing Stock (VI)
14,72,000
4,82,500
19,54,500
To Administrative Expenses
To Interest on Debentures
To Provision for Tax (III)
2,66,000
37,500
1,65,000
3,30,000
19,54,500
By Gross Profit b/d
By Commission
7,36,000
62,500
127
To Net Profit
7,98,500
7,98,500
Rs.
Assets
Rs.
Share Capital
General Reserve (II)
Profit & Loss A/c
(including opening balance)
10% Debentures (XII)
Creditors (VIII)
Proposed Dividend (C.Y.) (I)
Provision for Tax (C.Y.) (II)
6,25,000
1,09,375
1,34,375
7,75,000
13,175
4,82,500
3,50,650
78,000
3,75,000
1,34,325
1,56,250
1,65,000
16,99,325
16,99,325
Rs.
3,00,000
?
30,000
70,000
?
Assets
Fixed Assets
Current Assets :
Stock
Debtors
Cash
Ratio of the company are as follows: 1. Reserves and Surplus to Share Capital - 1:1
2. Sales to Net Worth Ratio is 1:5:1
3. Sales to Debtors Ratio is 6:1
4. Gross Profit Ratio 20% on Sales
5. Net Working Capital is Rs.1,80,000
6. Stock Turnover Ratio is 6 times
7. Current Ratio - 2:5:1
8. Acid test Ratio - 1:5:1
Net worth = Share capital + Reserve and surplus
Solution :
1.
Rs.
?
?
?
?
128
Working Capital = Current Assets - Current Liabilities
Current Assets = Current Liabilities + Working Capital
Current Assets
Current Ratio =
Current Liabilities
2.5
Current Liabilities + Working Capital
=
1
Current Liabilities
2.5 Current Liabilities = CL + WC
2.5 CL = CL + 1,80,000
2.5 CL - CL = 1,80,000
1.5 CL = 1,80,000
CL = 1,80,000 x 1.5
= 2,70,000
= Rs.2,70,000
2.
3.
4.
Calculation of Sales
Sales to Net Worth = 1.5:1
Sales
1.5
Net Worth
1
Sales = 1.5 x 6,00,000
= Rs.9,00,000
5.
Calculation of Debtors
Sales
6
Debtors 1
9,00,000 6
Debtors
1
9,00,000
Debtors
6
= 1,50,000
Debtors = Rs.1,50,000
129
6.
Stock calculation
Stock Turnover Ratio =
6=
6=
6
1
Stock =
7.
7,20,000
6
Rs.1,20,000
8.
Creditors = CL - BOD
= 2,70,000 - 70,000
= Rs.2,00,000
Balance sheet as at 31st December 2009
Particulars
Rs.
Assets
3,00,000
3,00,000
Current Assets
Loan
30,000
Current Liabilities
Creditors (8)
Bank Overdraft(given)
2,00,000
EXERCISES :-
4,50,000
Stock (6)
1,20,000
Debtors (5)
1,50,000
Cash (7)
1,80,000
70,000
9,00,000
5.4
Rs.
9,00,000
130
1. From the following information of Abhay Ltd.
summarized Balance Sheet as at 31st March 2009
1.
2.
3.
4.
5.
6.
prepare
Rs.
1,50,000
1,00,000
25,000
0.75
2.5
1.5
Working Capital
Reserve & Surplus
Bank Overdraft
Fixed Assets Proprietary Ratio
Current Ratio
Liquid Ratio
Rs.
Assets
Rs.
Share Capital
Fixed Assets
Stock
Debtors
Bank Loan
Creditors
2,00,000
?
?
Additional information :
1)
2)
3)
4)
5)
6)
7)
8)
2.5
1.5
Rs.1,50,000
131
d)
e)
f)
g)
h)
i)
4. M/s Rajesh & Co. gives you the following information. Prepare
Trading and Profit & Loss Account for the year ended 31st
March 2004 and Balance Sheet as on that date.
Opening Stock
Stock Turnover Ratio
Net Profit Ratio on Turnover
Gross Profit Ratio on Turnover
Current Ratio
Long Term Loan
Depreciation on Fixed Assets @ 10%
Closing Stock
Credit Period allowed by Supplier
Average Debt Collection Period
90,000
10 times
15%
20%
4:1
Rs.2,00,000
Rs.20,000
Rs.1,02,000
one month
two months
Rs.10,00,000
Rs.60,000
8 times
20%
35%
132
1. Capital Rs.5,00,000, Reserve & Surplus Rs.1,00,000, Creditors Rs.75,000,
Bank Overdraft - Rs.25,000, Fixed Assets - Rs.4,50,00, Stock - Rs.1,37,500,
Liquid Assets - Rs.1,12,500 and Balance Sheet total Rs.7,00,000
2. Share Capital - Rs.8,00,000, Reserve & Surplus - Rs.2,00,000, Bank loan Rs.2,00,000, Creditors - Rs.3,00,000, Fixed Assets - Rs.9,00,000, Debtors Rs.3,00,000, Stock - Rs.3,00,000, Balance Sheet Total - Rs.15,00,000.
3. Net Worth - Rs.3,12,500, Long Term Loan - Rs.87,500, Current Liabilities Rs.1,00,000, Fixed Assets - Rs.2,50,000, Stock - Rs.1,00,000, Debtors Rs.1,00,000, Cash - Rs.50,000, Balance Sheet Total - Rs.5,00,000
4. Cash Sales - Rs.3,00,000, Credit Sales - Rs.9,00,000, Gross Profit Rs.2,40,000, Purchases (Bal. figure) - Rs.9,72,000, Net Profit - Rs.1,80,000,
Fixed Assets - Rs.2,00,000, Debtors - Rs.1,50,000, Cash - Rs.72,000,
Capital - Rs.43,000, Balance Sheet Total - Rs.5,04,000.
5. Opening Stock - Rs.77,250, Closing Stock - 85,250, Gross Profit Rs.3,50,000, Purchases - Rs.6,58,000, Net Profit - Rs.2,00,000, Other
expenses (Bal. figure) - Rs.90,000.
6
CASH FLOW STATEMENT / ANALYSIS
Unit Structure :
6.0
Objectives
6.1
Introduction
6.2
6.2.2
6.2.3
6.3
Illustrations
6.4
Model Questions
133
6.0
OBJECTIVES:
6.1
INTRODUCTION:
4) Inflow of cash results in inflow of funds but inflow of funds may not
necessarily result in inflow of cash.
134
A Cash flow statement is useful for short-term planning. Business
enterprise needs sufficient cash to meet its obligations in the near future.
A historical analysis of the different securities and applications of cash
enables the management to make reliable cash flow projections for the
immediate future. Thus, a cash flow statement is an important financial
tool for management. However, it has its own limitations. Cash flow
statement cannot be equated with the income statement. The cash
balance as disclosed by the cash flow statement may not represents the
real liquid position of the business.
6.2
6.2.1
Cash flows from operating activities are primarily derived from the
pre-revenue producing activities of the enterprise. The following are the
examples.
6.2.2
135
These include activities on which expenditure has been incurred
for resources intended to generate future income and cash flows, such as
:
6.2.3
6.3
ILLUSTRATION :
1. You are required to calculate the cash from operations from the
following
136
Particulars
To Purchases
Dr. Rs.
Particulars
Cr. Rs.
20,00,000 By Sales
To Wages
5,00,000
To Gross Profit
5,00,000
30,00,000
30,00,000
30,00,000
To Salaries
To Rent
To Depreciation
1,00,000
To Goodwill written
off
To Net profit
5,00,000
Machinery
50,000
50,000
1,00,000
5,50,000
5,50,000
Solution :
Rs.
1,00,000
1,00,000
50,000
1,50,000
2,50,000
50,000
137
operating profit
Cash from business operations
2,00,000
Liabilities
Share
Capital
30.03.08
(Rs. In
Lakhs)
125
30.03.09
(Rs. In
Lakhs)
30.03.08
(Rs. In
Lakhs)
Assets
Cash
150 Bank
30.03.09
(Rs. In
Lakhs)
&
10
12
Reserve &
Surplus
10
13 Debtors
30
45
Bank Loan
55
40 Stock
35
25
Creditors
40
44 Machinery
65
55
90
110
230
247
Land
Building
230
247
&
138
Solution
(i) Working
1
Rs Lakhs
(1300000-100000)
Depreciation
Decrease in Stock
10
Increase in creditors
4
19
15
4
7
Machinery Account
Rs.
Lakhs
To Balance b/d
65
65
Rs.
Lakhs
By
Bank
By
Depreciation
By
Loss on Sale
By
Balance c/d
5
65
139
(Rs.
Lakhs)
Add:
(1) Depreciation
Operating Profit
Capital changes
before
(Rs.
Lakhs)
Working
8
10
15
-1
-20
-15
25
-15
in
cash
and
10
cash
2
10
12
140
31.03.2008
31.03.2009
2,00,000
2,50,000
General Reserve
50,000
60,000
30,500
30,600
Secured Loans
70,000
Liabilities
Share Capital
Creditors
1,50,000
1,35,200
30,000
35,000
5,30,500
5,10,800
2,00,000
1,90,000
1,50,000
1,69,000
Stock
1,00,000
74,000
80,000
64,200
Cash
500
600
Bank
8,000
Goodwill
5,000
5,30,500
5,10,800
Assets
Debtors
Additional information:
141
(6) Loss on Sale of Machinery Rs. 200 was written off to general reserve.
You are required to prepare the Cash Flow Statement as per AS-03
Solution
the
year
66,300
Depreciation on Building
10,000
Depreciation on Machinery
12,000
Decrease in Stock
46,000
Decrease in Debtors
15,800
Decrease in Creditors
-14,800
-28,000 1,07,300
1,800
Purchase of Machinery
3
88,300
-8,000
-6,200
-70,000
Dividend Payment
-23,000
-93,000
8,100
equivalent
at
the
500
end
8,600
142
Working:-
(1)
Rs.
Increase in Profit and Loss account
(30600-30500)
Add:
100
Depreciation
22,000
33,000
Transfer to Reserve
10,200
Dividend paid
23,000
88,200
88,300
Rs.
To
Machinery (Loss)
To
Balance c/f
Rs.
200 By
60,000 By
Balance b/d
50,000
P&L A/c
10,200
60,200
(3)
60,200
Rs.
To
Bank
28,000 By
(Bal.figure)
To
Balance c/f
Rs.
By
Balance b/d
30,000
P&L A/c
33,000
35,000
63,000
63,000
143
(4)
Machinery A/c
Rs.
To
Balance b/d
To
Share Capital
To
Bank
Rs.
1,50,000 By
25,000 By
8,000 By
By
Depreciation
12,000
1,800
1,69,000
1,83,000
(5)
200
1,83,000
Shares issued
50,000
20,000
Machinery
25,000
Goodwill
45,000
5,000
Balance Sheet
Liabilities
2008
Rs. In
Lakhs
2009
Rs. In
Lakhs
Assets
2008
Rs. In
Lakhs
2009
Rs. In
Lakhs
144
Share capita
10.00
8.00 Machinery
7.00
5.00
2.10 Building
6.00
4.00
1.00
3.00
Debentures
2.00
1.00
0.70 Debtors
5.00
7.00
Proposed Dividend
2.00
1.00 Stock
4.00
2.00
Creditors
7.00
2.00
2.00
25.00
20.00
25.00
- Investments
20.00
Additional Information:
Solution:
Particulars
Rs.
A)
1.
Net Profit
2.
0.40
Proposed Dividend
2.00
0.80
Rs.
145
General Reserve
0.50
Depreciation
1.25
3.
4.
5.
4.55
-0.15
-2.00
Decrease in Debtors
2.00
Decrease in Creditors
-1.20
-1.20
-0.50
4.80
3.10
-3.45
-2.00
3. Increase in Investment
-1.00
4. Sale of Machine
0.35
- 6.10
2.00
2. Issue of Debentures
2.00
3. Dividend payment
D)
-1.00
3.00
-
2.00
2.00
146
Working
Rs.
1)
3,00,000
2,10,000
Increase
90,000
50,000
Net Profit
40,000
(2)
Machinery A/c
Rs.
Rs.
To
Balance b/d
5,00,000 By
Depreciation
1,25,000
To
Bank
3,45,000 By
Cash (Sales)
20,000
Balancing figures
By
Balance c/f
8,45,000
(3)
8,45,000
Rs.
To
Bank
To
Balance c/d
50000 By
100000 By
Rs.
Balance b/d
70000
80000
150000
(4)
7,00,000
150000
147
Rs.
Rs.
To
Bank
1,00,000 By
Balance b/d
1,00,000
To
Balance c/d
2,00,000 By
2,00,000
3,00,000
3,00,000
Cash/Bank A/c
Rs.
To
To
To
Debtors
To
Rs.
50,000
By
Creditors
3,00,000
By
2,00,000
28,00,000
By
General Expenses
2,00,000
1,00,000
By
1,00,000
By
Income Tax
2,50,000
By
Dividend
By
3,00,000
By
1,50,000
32,50,000
Solution
Anand Ltd.
Cash Flow Statement for the year 31.03.09
20,00,000
50,000
32,50,000
148
Particulars
A)
Rs.
Rs.
2800000
-2000000
-100000
-200000
-250000
250000
-200000
100000
-100000
Dividend Payment
300000
-300000
-50000
-50000
100000
50000
150000
Balance Sheet
Liabilities
31.3.08
31.3.09
Assets
31.3.08
31.3.09
149
Share Capital
10.00
12.00
General
Reserves
2.25
2.50
Retained
Earnings
1.10
1.25
10% Debentures
5.00
4.00
Bank Loan
2.00
Creditors
Fixed Assets
25.00
28.00
5.00
6.00
20.00
22.00
Stock
4.00
4.50
2.50
Debtors
3.00
2.50
6.60
5.45
Bank
1.10
1.40
Outstanding
Expenses
0.05
0.30
Preliminary Expenses
0.30
0.20
1.40
2.60
28.40
30.60
28.40
30.60
Rs. Lakhs
Net Sales
40.00
Less:
31.00
Gross Profit
Less:
9.00
General Expenses
2.90
Depreciation
1.00
0.10
4.00
Net Profit
5.00
2.60
PAT
2.40
Less:
0.25
Payment of Dividend
2.00
Net Income
2.25
0.15
150
Add:
1.10
Balance c/d
1.25
Solution:
Particulars
A)
Sales
Rs. Lakhs
Rs.
Lakhs
40.00
3.00
43.00
2.50
40.50
31.00
2.90
33.90
6.60
0.05
Closing Stock
4.50
45.05
40.50
151
0.30
Opening stock
4.00
9.75
35.30
5.20
1.40
3.80
C)
-3.00
0.50
Issue of Shares
2.00
Redemption of Debentures
-1.00
Payment of Dividend
-2.00
-0.50
0.30
E)
1.10
F)
1.40
Note: Cash flow from operating activities can also be calculated using
indirect method as follows:
5.00
Depreciation
1.00
0.10
Operating Profit
1.10
6.10
0.50
0.25
152
Increase in Stock
-0.50
Decrease in Creditors
-1.15
0.90
5.20
Q.1
Q,2
Q.3
(2)
(3)
(4)
(5)
From the following Profit & Loss Account you are required to compute
cash from operations.
Rs.
To
Salaries
50,000 By
To
Rent
10,000 By
Rs.
Gross Profit b/d
Profit on Sale of
2,50,000
50,000
153
Land
To
Depreciation
20,000 By
To
10,000
To
40,000
To
Proposed Dividends
50,000
To
50,000
To
Net Profit
Income
Refund
Tax
30,000
1,00,000
3,30,000
Q.4
3,30,000
Balance Sheet
Liabilities
2008
Rs. In
Lakhs
2009
Rs. In
Lakhs
Assets
2008
Rs. In
Lakhs
2009
Rs. In
Lakhs
41.00
40.00
Equity Shares
40.00
Less:
40.00 Depreciation
11.00
15.00
40.00
50.00
30.00
25.00
General Reserve
2.00
2.00 Debtors
20.00
24.00
1.00
1.20 Stock
30.00
35.00
Debentures
6.00
7.00 Cash
1.20
3.50
0.30
0.50
81.50
88.00
Creditors
12.00
Prepared
11.00 Expenses
3.00
4.20
Proposed Dividend
5.00
5.80
12.50
6.80
81.50
88.00
Bank Overdraft
154
Q.5
Balance Sheet
Liabilities
2008
Rs. In
Lakhs
2009
Rs. In
Lakhs
Share Capital
70.00
74.00
Bank
9.00
7.80
Debentures
12.00
6.00
Debentures
14.90
17.70
Creditors
10.00
12.00
Stock
49.20
42.70
RDD
0.70
0.80
Building
20.00
30.00
10.40
10.40
Goodwill
10.00
5.00
103.10
103.20
103.10
103.20
Reserve
Surplus
Assets
2008
Rs. In
Lakhs
2009
Rs. In
Lakhs
&
Additional information
(1) Dividends amounted to Rs. 3.50 Lakhs were paid during the year.
(2) Building was purchased for Rs. 10 Lakhs.
(3) Rs. 5 Lakhs were written off on Goodwill.
(4) Debentures of Rs. 6 Lakhs were repaid during the course of the year.
You are required to prepare Cash Flow Statement.
155
7
WORKING CAPITAL CONCEPT - I
Unit Structure:
7.0
7.1
7.2
7.3
7.4
7.5
7.6
7.7
7.8
7.9
7.10
7.11
7.12
7.13
Objectives
Introduction
Meaning of Working Capital
Definitions of Working Capital
Types of Working Capital
Importance or Advantages of adequate working capital
Danger of inadequate working capital
Danger of excess working capital
Factors determining working capital requirement
Importance of adequate working capital
Sources of working capital
Methods of projecting working capital requirements
Projection of working capital requirements
Exercise
7.0 OBJECTIVES :
After studying the unit the students will be able to:
Define Working Capital.
Explain types of working capital.
Understand the importance of adequate working capital.
Elaborate the determinants of working capital.
Know the sources of working capital.
7.1 INTRODUCTION :
Capital required for a business can be divided into two
categories i.e. Fixed capital and working capital. Fixed capital is
the part of total capital which is used for purchasing permanent a
fixed asset like land, Buildings, Plant and machinery, furniture and
156
fixtures, vehicles, etc. This capital is invested by organization in the
beginning of running the business. In addition to fixed capital an
organization requires additional capital for financing day to day
activities like purchase of Raw materials, payment of direct and
indirect expenses, carrying out production, investment in stocks
and stores, receivables and assets to be maintained in the form of
cash is generally known as working capital (fluctuating capital). In
other words, this capital refers to the investment in current assets
such as cash inventory, receivables, etc. All such assets are likely
to be convertible into cash within one a year.
Receivables
Cash
Sales
Finished goods
Raw materials
Work in progress
157
7.3.2 Shubin: - "Working capital is the amount of funds necessary
to cover cost of operating the enterprise."
7.3.3 Hoaglandi: - "Working capital is descriptive of that capital
which is not fixed. But the more common use of the working
capital is to consider it as the difference between the block
value of the current assets and current liabilities."
7.3.4 Gerestenberg: - "Circulating capital wears current assets
a company that are changed in the ordinary course
business from one to another, as for example, from cash
inventories, inventories to receivables, and receivables
cash."
of
of
to
to
158
which it operates. It is used to produce goods necessary to satisfy
the customer's demand.
159
at cash working capital. The cash working capital indicated the
working capital at cost because stocks and debtors are at cost.
7.4.7 Positive working capital: When a net current asset is in
positive figure. Therefore it is called positive working capital. This
working capital shows favorable liquidity solvency position of the
company.
7.4.8 Negative working capital: In this case, difference between
current assets and current liabilities is negative figure. Therefore, it
is called are negative working capital. It means current liabilities are
more than the current assets. This capital indicates lack of liquidity
and adverse solvency position of the company.
160
required material at lower rate and holds its inventories for higher
rate. Thus it helps to maximize profits.
7. Increase in productivity: Fixed assets of the firm cannot work
without sufficient amount of working capital. Because large scale
investment in various fixed assets is largely depending on the
manner in which its current assets are managed.
8. Research programmes: It is not possible to undertake
research programmes, innovations and technical developments
without having sufficient amount of working capital in the
organizations.
9. High morale: Maintaining of sufficient amount of working capital
makes us possible to create environment of security, confidence,
high morale among the staff and it helps in creating overall
efficiency of the business.
10. Liquidity and solvency: A sound position of working capital
enables a firm to make payment of dividends to its investors
regularly. This helps in gaining confidence in the mind of investors
and also helps in creating favorable market environment to raise
additional funds in the near future.
11. Contented labour force: A firm having enough amount of
working capital will be in a position to pay its workers well and in
advance. This way contented labour force contributes to increased
production of quality goods.
Low
161
f) It is not possible to pay short terms liabilities due to
inadequate working capital. This leads to borrow loan or
funds at high rate of interest.
g) Credit worthiness of a firm may be damaged due to lack
of liquidity. It will lose its reputation. Thus firm may not
be
able to get credit liabilities.
h) Low liquidity position may lead to liquidate the firm
because it cannot be able to meet its debts at the date of
maturity.
162
b) Terms of purchases and sales: - Credit terms granted by the
concerns to its customers as well as credit terms granted by its
supplier also affect the working capital. It credit terms of purchases
are more favorable and those sales less liberal, less cash will be
invested in the inventory. Working capital requirement can be
reduced it terms of credit are more. The ratio of credit and cost
purchases or sales affect the level of working capital. If firms
purchases on credit and sales cash then requires less working
capital and if firm purchases on cash and sales on credit, then it
requires large working capital. This means funds are tied up in
debtors and bills receivables.
c) Manufacturing cycle: - The quantum of work capital needed is
influenced by the length of manufacturing cycle.
The
manufacturing process always involves time lag between the time
when raw materials are fed into the production line and finished
products are finally turned out by it. The length of period of
manufacture in turn needs on the nature of product as well as
production technology used by a concern.
d) Size of business unit: - Amount of working capital requirement
is depending on the scale of operation of the business organization.
Large business organization performs large business activities
which require huge working capital than small scale organization.
e) Turnover of inventories: - A business organization having low
turnover of inventory would need more working capital where as
high turnover of inventory need small or limited working capital.
f) Turnover of circulating capital: - The speed with which
circulating capital completes its cycle if conversion of cash into
inventory of raw material, raw material into finished goods, finished
goods into debts and debts into cash, which decides need of
working capital in the organization. Slow movement of working
capital cycle necessitates large provision of working capital.
g) Seasonal variations production: - In case of seasonal
production in the industries like sugar, oil, mills, etc need more
working capital during peak seasons as well as slack seasons.
h) Degree of mechanization: - In highly mechanized concerns
having low degree of independence, on labour, requirement of
working capital reduced. Conversely, in labour intensive industries
greater sum of working shall be required to pay wages and related
facilities.
i) Growth and expansion: - Every firm wants to grow over a period
of time and with the increase in its size, the working capital
163
requirements are bound to increase. The growing company would
need, therefore, larger amount of working capital.
j) Policy regarding dividend: - Dividend policy of a firm will also
influence the working capital position.
The company which
declares large amount of dividends in the form of cash requires
large working capital to pay off such dividends. But sometimes,
companies issues bonus shares by way of dividend in such cases
working capital requirements will be comparatively less. This is
depending on Psychology of shareholders i.e. whether they prefer
cash income or capital appreciation.
k) Inflation: - A business concern requires more working capital
during the inflation period. This factor may be compensated to
some extent by rise in selling price of inventory.
l) Changes in technology: - Changes in production technology
have an impact on the need of more working capital.
m) Depreciation policy: - Charges of depreciation on assets do
not involve any cash outflows. Depreciation affects tax liability and
retention profits. It is allowable expenditure while calculating net
profits. Higher depreciation will mean lower disposal of profit and
therefore dividend will be paid in smaller amount. Thus cash will be
preserved.
7.9
IMPORTANCE
CAPITAL :
OF
ADEQUATE
WORKING
164
Short-term source
Internal source
1) Depreciation
2) Taxation provision
3) Accrued expenses
External source
1) Trade credit
2) Credit paper
3) Bank credit
4) Customer's credit
5) Govt. Assistance
6) Loan from directors
7) Security of employees
7.11 METHODS
OF
PROJECTING
CAPITAL REQUIREMENTS :
WORKING
7.12 PROJECTION
OF
REQUIREMENTS :
WORKING
CAPITAL
165
2) Raw materials: - The finance manager has to estimate the
quantity and cost of raw materials. Lengths of time of raw materials
remain in the store before issue for production is considered longer
period of stay of raw material need greater working capital. This
must be valued at cost.
3) Labour and overheads: - Expenses incurred on wages and
overheads are considered while ascertaining raw materials.
4) Work-in-progress: - While ascertaining work-in-progress the
period of processing' or 'period of production cycle' has to be
considered. Longer the production cycle, greater the working
capital requirement. Therefore, the finance manager has to
consider the amount required for raw materials, wages and
overheads while estimating volume of production.
5) Finished Goods: - The period of storing finished goods before
sale has to be taken into consideration. This is depending on
season, sales forecasting, etc. If the sales are seasonable and
production is throughout the year, then working capital requirement
would be the higher during the slack seasons.
6) Sundry Debtors: - While calculating amount of sundry debtors,
period credit allowed to customers is to be taken into consideration.
This period is known as "time lag in payment by debtors". If this
period is longer, required working capital will be higher in the
absence of similar time lag in payment to creditors. The sundry
debtors are value at sales price while calculating working capital.
7) Cash and bank balance: - As per past experience every
businessman is suppose to know the amount cash float or bank
balance necessary to pay day is day payments. This amount is
given in the information and added in the amount of working capital
required.
8) Prepaid Expenses: - There may be some expenses i.e.
insurance, sales promotion would be paid in advance and in this
case working capital requirement would be higher is that extent.
9) Sundry Creditors: - The period of credit allowed by supplier has
to be taken in to consideration while estimating required amount of
working capital. It longer the period credit from suppliers, lower will
be the working capital requirements.
10) Creditors for expenses: - Time lag in payment of wages and
overheads also should be considered while deciding amount of
working capital requirements. If there is no time lag in payment of
wages and overheads, more working capital will be required and
166
there will be less requirement of working capital when there is timelag in payment of wages and overheads.
11) Advance from customers: - If and when advance required
from customers then there will be lower working capital
requirements.
12) Contingencies: - After calculating the amount of working
capital as discussed above, a provision for contingencies may be
made to make allowances for likely variations. This is the sort of
cushion against uncertainties involved in estimating working capital.
7.13 EXERCISE
1.
2.
3.
4.
167
8
WORKING CAPITAL CONCEPT - II
Unit Structure:
8.0
8.1
8.2
8.3
Objectives
Calculation of figures required for working capital projection
Illustrations
Exercises
8.0 OBJECTIVES :
After studying the unit the students will be able to:
Calculate the figures required for Working Capital Projection.
Draw the statement of Working Capital.
Solve the practical
requirement.
8.1
problems
on
Working
Capital
cost of material
per unit
Raw material
holding period
365 days or 52
Weeks or 12 months
Process period
365 days or 52
weeks or 12 months
168
8.1.3 Stock of finished goods: - The investment in finished stock
by a firm is decided as follows:
Budget production
p.a (units)
Cost of goods
Produced p.u.
Finished goods
holding period
365 days or 52 weeks
or 12 months
Selling Price
per unit
At Cost Price
Budgeted credit sales
P.a units
Cost of sale
per unit
8.1.5 Cost and bank balance: - Required amount of cash & bank
can be determined on the basis of cash budget. This budgeted
cash and bank balance should be enough to meet day to day
expenses. This is readily given in the problem and included in the
list of current assets.
8.1.6 Advance payment: - The payment of expenses for the
period which is not expired. It is calculated as follows.
Expenses
365 days or 52 weeks
or 12 months
Period of prepayment
P.a. unit
Wages or expenses
per unit
Lag in payment
365 days or 52
169
Weeks or 12 months
Working
Rs.
xxx
xxx
xxx
xxx
xxx
xxx
xxx
xxx
xxx
b) Overheads
xxx
xxx
xxx
xxx
Total
xxx
xxx
xxx
xxx
Rs.
xxxx
(Units x Rate X period of
credit)
(Units x Rate x Lag in
Payment)
(Units x Rate x Lag in
Payment)
xxx
xxx
xxx
xxx
xxxx
xxxx
xxx
170
D. Working Capital
8.2
xxxx
ILLUSTRATIONS :
Solve problems:
1. Sanket Ltd. had an annual sale of 50,000 units, at Rs.100 per
unit. The company works for 50 weeks in the year.
The cost details of the company are as follows:
Elements of cost
Raw Materials
Labour
Overheads
Profit per unit
Sales price per unit
50, 000
1, 000 units per week.
50
b) Debtors are valued at selling price and finished goods at
sales loss profits.
c) It has been assumed that the labour and overheads
accrue on an average, so half the labour and overheads
would be included in work in progress.
a) Sales per week
Rs.
Rs.
1,20,000
60,000
10,000
20,000
90,000
2,40,000
10,00,000
14,50,000
171
B. Less: - Current Liabilities
I) Creditors
II) Outstanding wages
III) Outstanding Overheads
1, 20,000
20,000
40,000
1, 80,000
1, 27,000
1, 90,500
14, 60,500
2. A factory produces 48,000 units during the year and sells them
for Rs. 50 per unit. The cost structure of a product is as follows.
Raw Materials
Labour
Overheads
60%
15%
10%
Profit
85%
15%
Selling price
100%
II.
III.
IV.
V.
VI.
VII.
VIII.
172
Solution:
Statement showing working capital requirement.
Particulars
A. Current Assets
I. Stock
Raw Materials
(48,000 x
1
12
Work-in-progress
- Raw Materials
(48,000 x
1
12
x Rs.30 x 1m)
- Labour
(48,000 x
1
12
x Rs.7.5 x
- Overheads
(48,000 x
1
12
x Rs.5 x
(48,000 x
(48,000 x
1
12
1
12
1
12
Rs.
x Rs.30 x 1m)
1
2
1
2
m)
m)
Rs.
1,20,000
1,20,000
15,000
10,000
x Rs.42.5 x 3 m)
x 90% x Rs.50 x 2m)
3,60,000
44,000
1,45,000
5,10,000
4,04,000
11,79,000
Total
B. Current Liabilities
I. Sundry Creditors
(48,000 x
(48,000 x
(48,000 x
(90%)
(10%)
1
x Rs.30 x 1.5m)
12
1
1
x Rs.7.50 x 2 m)
12
1
1
x Rs.5 x 2 m)
12
1,80,000
15,000
10,000
9,74,000
1,08,222
10,82,222
(100%)
Working notes.
1)
Cost Structure
Raw material
Labour/Wages
Overheads
Add. Profits
Selling price
2)
2,05,000
%age
60
15
10
85
42.50
15
7.50
50.00
Sundry debtors
Normal selling price
10% above normal selling price
Rs.50.00
Rs.55.00
173
3)
5 1
5 50 5 55
10
Cash & Bank balance
974000 10
90
= 10,8,222.222
4)
Rs. 1, 08,222
M = Months
40.00
Labour
15.00
Overheads Manufacturing
20.00
10.00
85.00
Additional Information:
a) Selling price - Rs. 100/- per unit.
b) Raw material in stock - average 4 weeks.
c) Work-in-progress - average 4 weeks.
d) Finished goods in stock - average 4 weeks.
e) Credit allowed to debtors - average 8 weeks.
f) Credit allowed by supplier - average 4 weeks.
g) Cash at bank is expected to be Rs. 50,000.
h) All sales are a credit basis.
i) All the activities are evenly spread out during the year.
j) Debtors are to be valued at sales.
174
Solution:
Statement of working capital requirement.
Particulars
Rs.
Rs.
A. Current Assets
I. Stock
Raw Materials
(52,000 x
1
52
1,60,000
x Rs.40 x 4 weeks)
Work-in-progress
Raw Materials
1,60,000
1
2
30,000
Overheads
1
2
40,000
(52,000
Labour
2,30,000
52 x Rs.75 x 4 weeks)
3,00,000
8,00,000
52 x Rs.100 x 8 weeks)
50,000
15,40,000
1,60,000
13,80,000
Working Notes:
1)
Particulars
Raw materials
40.00
Labour
15.00
Manufacturing overheads
20.00
75.00
10.00
W= weeks
85.00
15.00
100.00
175
II.
III.
Cost structer
Rs.
Raw Materials
Labour
Overheads
Total Cost Profit
Profit
19,50,000
11,70,000
7,80,000
39,00,000
19,50,000
Rs.
10.00
6.00
4.00
20.00
10.00
Sales price
58,50,000
30.00
2)
3)
4)
Balance Rs.10 per unit will be divided in the ratio of 3:2 i.e.
Rs.6 labour and Rs.4 overheads.
5)
W = week
176
Statement of working capital requirements for the year 2009.
Particulars
Rs.
A. Current Assets
I. Raw Materials
(19,5,000
52 x 10 x 2w)
II. Work-in-progress
Raw Materials
(19,5,000
52 x 10 x 2w)
75,000
(19,5,000 52 x 6 x 2w x
50%)
(19,5,000 52 x 4 x 2w x
50%)
22,500
Labour
Overheads
Rs.
75,000
15,000
11, 2,500
(19,5,000
52 x 20 x 2w)
1, 50,000
IV. Debtors
(19,5,000
52 x 30 x 4w)
4, 50,000
V. Cash
Given
50,000
Total
B. Less Current Liabilities
I. Creditors
II. Outstanding wages
III. Outstanding overheads
Total
C. Working Capital (A-B)
8, 37,500
(19,5,000
(19,5,000
(19,5,000
52 x 10 x 2w)
52 x 6 x 2w)
52 x 4 x 2w)
75,000
45,000
30,000
1, 50,000
6, 87,500
10,000 units
Production
90%
Cost structure
Crude material
Wages
Overheads
Profit
25% on sales
177
Other information: I.
II.
III.
IV.
V.
VI.
VII.
VIII.
IX.
X.
2)
Cost structure
Rs.
Crude material
30.00
20.00
Wages
25.00
9000
Variable overheads
Total Cost
Profit 25% on sales (Means 331/3 of cost)
Selling price
3)
M = months
12.00
15.00
102.00
34.00
136.00
178
Statement of working capital
Particulars
Rs.
Rs.
A. Current Assets
a) I. Stock:
Crude Material
Other direct material
(9000 12
(9000 12
Rs.30 2 m)
20 1 m)
45,000
15,000
60,000
II. Work-in-progress
Crude material
Other direct material
Wages
Overheads
(9000
(9000
(9000
(9000
30
20
25
15
22,500
15,000
9,375
5,625
52,500
75,000
12
12
12
12
1 m)
1 m)
1 m 50%)
1 m 50%)
1,53,000
51,000
2,04,000
45,000
27,000
50,000
6,42,500
(9000 12 102 2 m)
(9000 12 136 1 m 50%)
(9000 12 136 4 50%)
(9000 12 30 2 m)
(9000 x 3 x 1)
Given
(9,000
(9,000
(9,000
12 x 20 x 1 m)
12 x 25 x 1 m)
12 x 15 x 0.5 m)
15,000
18,750
5,625
Total
39,375
6,03,125
2)
Rs. 4,00,000
5% Debentures
Rs. 1,00,000
Rs. 2,50,000
60%
10%
20%
10%
3)
4)
5)
6)
179
7)
8)
9)
7,20,000
1,20,000
2,40,000
Total
10, 80,000
1,20,000
12, 00,000
e) M = months
Statement of working capital requirements
Particulars
Working (units x
Rate x Period)
Rs.
Rs.
A. Current Assets
I. Stock of Raw materials
1, 20, 000 6
2m
12
1, 20,000
II. Work-in-progress
Raw Materials
Labour
Overheads
1, 20, 000 6
1m
12
1, 20, 000 1 1
m
12
2
1, 20, 000 2 1
m
12
2
60,000
5,000
10,000
21,000
180
III. Finished goods
IV. Debtors
a) Raw materials
b) Labour
c) Overheads
1, 20, 000 9
3m
12
1, 20, 000 6
3m
12
1, 20, 000 1
3m
12
1, 20, 000 2
3m
12
2, 70,000
1, 80,000
30,000
60,000
V. Cash
30,000
Total
B. Less: Current liabilities
Creditors
Working Capital
2,70,000
7, 11,000
1, 20, 000
6 2m
12
1, 20,000
(A B)
1, 20,000
5, 91,000
8.3. EXERCISES :
1. You are required to prepare a statement showing the working
capital required to finance the level of activity of 27,000 units per
year from the following information.
Per unit
Rs.
Raw materials
24.00
Direct labour
6.00
Overheads
18.00
Total Cost
48.00
Profit
12.00
Selling price
60.00
Information:
I.
II.
III.
IV.
V.
VI.
VII.
181
(Ans. Raw materials - Rs. 1,08,000; work in progress - Rs. 40,500; Finished
stock - Rs. 2, 16,000; Debtors Rs. 4, 05,000; Creditors Rs. 10, 8,000;
Labour/wages Rs. 6,750; working capital Rs. 6, 23,750)
1
Raw material 33 % of sales
3
ii.
iii.
90,000 units
Rs. 10.00
60% of selling price
10% of selling price
20% of selling price
2 months requirement
1 month
4 month
182
Credit for material
Credit allowed to customers
Average cash balance
Average bank balance
2 month
3 month
Rs. 30,000
Rs. 20,000
1, 08,000
1, 44,000
72,000
Rs.
3, 60,000
3, 24,000
36,000
It is estimated that:
a) Raw materials are carried in stock for one months and
finished goods for 15 days only.
b) The production cycle take one month.
c) One month's credit is granted both for purchase of raw
materials and sales of finished goods.
d) Production and overheads are even through the year.
(Ans. Raw materials Rs, 9,000, WIP Rs. 18,000 finished goods Rs. 13,500,
Debtors Rs. 30,000, Creditors Rs. 9,000, working capital Rs. 61,500)
50%
20%
10%
183
b) Finished goods remain in the godown for 2 months before
sales.
c) Each unit of production will be in process for one month.
d) Credit allowed by creditors is one month and allowed to
debtors is 2 months.
e) Selling price per unit is Rs. 9.00
f) Production in 2010 is expected to be 1, 00,000 units.
(Ans. Raw materials - Rs. 37,500, work-in-progress- Rs. 48,750, Finished goods
- Rs. 1, 20,000, Debtors - Rs. 1, 20,000, Creditors - Rs. 37,500, working capital Rs. 2, 88,750)
CAPITAL BUDGETING
Unit Structure:
9.0
Objectives
9.1
Introduction
9.2
Meaning of a project
9.3
Project Planning
9.4
Project Report
184
9.5
Types of projects
9.6
9.7
9.8
Project financing
9.9
Cost of Project
9.10
Means of Finance
9.11
Promoters contribution
9.12
Margin Money
9.13
Capital structure
9.14
9.15
Trading on Equity
9.16
9.17
9.18
Institutional considerations
9.19
Venture Capital
9.20
Project appraisal
9.21
Model Questions
9.0
OBJECTIVES :
9.1
INTRODUCTION :
185
The financial requirements of business can be classified as shortterm and long-term financial requirements. Short-term funds are required
for meeting working capital needs. It is usually required for a period up to
one year. Long-term funds are required to a great extent for meeting the
fixed capital requirements of the business. It is required for a period of 1
to 5 years or more. Fixed capital is required for investment in land,
building, plant and machinery, vehicles and furniture etc. Short-term
funds are required for making day to day payments like wages, raw
materials, traveling, stationery etc. the requirements of short-term funds
are usually met by taking short-term loans, overdraft or getting the bills
discounted from the banks. The long-term funds are raised by issue of
shares, debentures, loans from financial institutions and banks.
9.2
MEANING OF A PROJECT :
186
determining the resources required, obtain the resources and effectively
manage the business venture.
9.3
PROJECT PLANNING:
9.4
PROJECT REPORT:
187
(2)
(3)
(4)
(5)
(1)
(2)
188
they are also entitled to operate the project subsequent to their
commercial launching. For example, power sector.
(3)
(4)
(1)
(2)
(3)
(4)
189
exports or by lending institutions. It is prepared after conducting the
feasibility study. It is useful to find out commercial viability of the project
and rate of success or failure of the project.
(a)
(b)
(c)
190
9.9
COST OF PROJECT :
(a)
(b)
i)
ii)
iii)
iv)
v)
vi)
The working capital refers to the capital required for day to day
operations of a business enterprise. It includes the following costs.
i)
ii)
iii)
iv)
(a)
(b)
(c)
(d)
191
192
forms of financing their requirements and their relative proportions in total
capitalization are known as capital structure decision. A firm has the
choice to raise funds for financing its project from different sources in
different proportions as follows:
(a)
(b)
(c)
(d)
(e)
The theory of optional capital structure deals with the issue of the
right mix of debt and equity in the long-term capital structure of a firm.
This theory states that if a company takes on debt the value of the firm
increases up to a point. Beyond that point if debt continues to increase
then the value of the firm will start to decrease. If the company is unable
to repay the debt within the specified period, then it will affect the goodwill
of the company in the market. Therefore, the company should select its
appropriate capital structure with due consideration to the factors of debt
and equity.
The term trading on equity is derived from the fact that debts are
contracted and loans are raised mainly on the basis of equity capital. The
concept of trading on equity provides that the capital structure of a
company should include equity as well as debt. Again the proportion of
debt in the capital structure should also be optimal. Those who provide
debt have a limited share in the firms earnings and hence want to be
protected in terms of earnings and values represented by equity capital.
Since fixed charges do not vary with the firms earnings before interest
and tax, a magnified effect is produced on earnings per share. The
determination of optional level of debt is a formidable task and is a major
policy decision. EBIT EPS analysis is a widely used tool to determine
the level of debt in a firm.
193
PBIT
Interest Coverage Ratio = -------------------Interest on Debt
(b)
194
DSCR = -----------------------------------------------------------Interest on Loan + Loan repayment in a year
9.16.1 Illustration 1
Preeti Ltd. has the following data for projections for the next five
years. It has an existing term-loan of Rs. 360 lakhs repayable over the
next 5 years and has got sanctions for new term loan for Rs. 450 lakhs
which is also repayable in 5 years. As a finance manager you are
required to calculate (a) interest coverage ratio and (b) debt service
covering ratio for each of the 5 years and offer your comments
Rs. In Lakhs
Particulars
Profit after tax
Depreciation
Taxation
Interest on Term Loan
Repayment of Term Loan
1
480
155
125
162
178
2
575
150
203
125
178
3
635
140
254
87
178
4
650
135
275
50
178
5
685
120
299
16
178
Solution
Particulars
PBIT
Interest
Interest Coverage
1
767
162
4.73
2
903
125
7.22
3
976
87
11.22
4
975
50
19.5
5
1000
16
62.5
Total
4621
440
10.50
Particulars/Years
Total
195
PAT
Depreciation
Interest on Loan
Total
Interest on Term Loan
Repayment of Term Loan
Total
DSCR
480
155
162
797
162
178
340
2.34
575
150
125
850
125
178
303
281
635
140
87
862
87
178
255
3.25
650
135
50
835
50
178
228
3.66
685
120
16
821
16
148
164
5.00
3025
700
440
4165
440
860
1300
3.20
9.16.2 Illustration 2
(a)
(b)
(c)
Solution:
196
Option
I
(Rs.
Lakhs)
Option
II
(Rs.
Lakhs)
Option
III
(Rs.
Lakhs)
60
40
100
100
30
70
12
5.83
60
40
100
8
92
27.60
64.40
10
6.44
60
40
100
4
96
28.80
67.20
10.50
6.4
197
(a)
(b)
(c)
(d)
(e)
Share capital
Debenture or bonds
Retained earnings
Loans from financing institutions
Loans from commercial banks.
(a)
Share Capital:
(i) Preference Shares: Preference shares are those shares which have
first preference for payment of dividend and refund of capital at the time
of winding up of the company. Long-term funds can be revised by public
limited companies through a public issue of shares. The preference
shares carry a fixed rate of dividend. If the company cannot raise capital
by issue of equity shares due to depression in the stock market, it can
raise capital by issue of preference shares. However, a very few
companies in India have issued preference shares for raising long-term
funds. Preference shares are normally cumulative i.e. the dividend
payable in a year of loss gets carried over to the next year till there are
adequate profits to pay the cumulative dividends. The Companies Act,
1956 provides that no profit, no dividend.
198
(ii) Equity or Ordinary Shares: Ordinary shares are those shares which
are not preference shares. Ordinary shares are a source of permanent
capital. Ordinary shares holders are owners of the company and they
undertake the risk of the business. They are entitled to dividends after
the income claims of other stakeholders are satisfied. Similarly in the
event of winding up, ordinary shareholders can exercise their claim on
assets after the claims of the other suppliers of capital have been met.
They elect the directors to run and manage the business of the company.
The cost of equity shares is usually highest. This is due to the fact that
the shareholders expect higher rate or return on their investment as
compared to other suppliers of long-term funds.
Thus, ordinary
shareholders carry a higher amount of risk and so expect a higher return.
A company, having substantial ordinary share capital may find it easier to
raise funds, in view of the fact that share capital provides a security to
other suppliers of funds.
199
convertible debentures. Indian companies have been issuing convertible
debentures or bonds with a number of schemes, options, incentives like
warrants etc. The issue of convertible debenture has distinct advantages
from the point of view of the issuing company. Such an issue enables the
management to raise equity capital indirectly without diluting the equity
holding, until the capital raised has started earning an added return to
support the additional shares. Such securities can also be issued even
when the equity market is not very good. Convertible bonds are normally
unsecured and, therefore, their issuance may ordinarily not impair the
borrowing capacity. The debentures or bonds are issued subject to the
SEBI guidelines. Public issue of debentures now require that the issue
be rated by a credit rating agency. The credit rating is given after
evaluating factors like track record of the company, profitability, debt
servicing capacity, creditworthiness and the perceived risk of lending.
(1)
(2)
(3)
(4)
(5)
(6)
(7)
200
201
The sources from which a business meets its financial
requirements can be classified according to the period, ownership and
source of generation. The sources of funds according to the period in
undue long-term sources of funds such as shares, debentures and term
loans and short-term, sources such as public deposits, advances from
customers and trade creditors. According to ownership the share capital
and retained earnings are owned sources. While debentures and term
loans are borrowed funds. According to source of generation, internal
sources are retained earnings and funds and external sources such as
shares and debentures or term loans.
202
203
(i)
(ii)
(iii)
(iv)
1
2
3
4
204
institutions in India.
5
8
9
10
What is venture capital financing? What are the methods of venture capital
financing?
Explain the advantages of equity financing.
What is debenture (debt) financing? Why are debentures considered
cheaper than equity as a source of long-term finance?
Write short notes on the following:a) Debt service coverage ratio.
b) Trading on equity
c) Promoters contribution
d) Project report
10
205
Unit Structure:
10.0
Objectives
10.1
Capital Budgeting
10.2
10.3
Model Questions
10.0 OBJECTIVES:-
206
investment. The future costs and revenues associated with each
investment alternative are:
(1)
(2)
(3)
(4)
(5)
Capital costs
Operating costs
Revenue
Depreciation
Residual value
An investment decision implies the choice of an objective, a
technique of appraisal, and length of service i.e. the life of the project.
The life of the project may be determined by taking into consideration the
following factors:
(a)
(b)
(c)
Technological obsolescence
Physical deterioration
A decline in demand for the output of the project
(i)
(ii)
(iii)
(iv)
There are several methods used for evaluating and ranking the
capital investment proposals. The basic approach is to compare the
investment in the project with benefits derived there-from. Following are
the important methods or techniques of capital budgeting:
207
The term pay-back period refers to the period in which the project
generates the necessary cash to recoup the initial investments. The payback period is generally expressed in years. The method recognizes the
recovery of original investment in a project. While deciding between the
two or more projects, the usual decision is to accept the project which has
a shortest payable payback is a rough measure of liquidity and rate of
profitability. Thus, the payback period is the number of years required to
recover the cost of the investment. The pay-back period is determined
as follows:
Initial Investment
Pay-back Period = -----------------------Annual Cash Inflow
Illustration 1
Year
1
2
3
4
5
60,000
80,000
50,000
40,000
30,000
The pay-back period falls in the fourth year. In the first 3 years
Rs. 1,90,000 are recovered. Rs. 10,000 are left out from the initial
investment. The actual pay-back period can be determined as under:-
10,000
Pay-back Period
= 3 + --------- x 2
40,000
208
= 3 + 0.25 years
= 3.25 years
The term average annual net profit is the average of earning (after
depreciation and tax) over the whole of the economic life of the project.
The projects can be ranked on the basis of their accounting rate of return.
The project which gives higher rate of return will be preferred for
investment.
Illustration 2
209
A machine is available for purchase of a cost of Rs. 8,00,000. It
is expected to have a life of 5 years and have a scrap value of Rs.
1,00,000 at the end of five years period. The machine will generate the
following profits over its life as under:-
Year
1
2
3
4
5
Amount (Rs.)
2,00,000
3,00,000
4,00,000
1,50,000
50,000
You are
Solution
Total profit before depreciation over the life of machine = Rs. 11 lakhs
11,00,000
Average Profit = ----------- = Rs. 2,20,000
5
7,00,000
Average Depreciation = ----------- = Rs. 1,40,000
5
Average Annual Profit after depreciation
210
= Rs. 80,000
Original Investment
= Rs. 8,00,000
80,000
Rate of Return
8,00,000 + 1,00,000
Average Investment = Rs. ----------------------- = 4,50,000
2
80,000
Accounting Rate of Return = ----------- x 100
4,50,000
= 17.78%
(a)
(b)
(c)
211
The objective of the firm is to create wealth by using existing and
future resources to produce goods and services. In order to create
wealth, the discounted cash inflows must exceed the present value of
cash outflows. Thus, the net present value is obtained by discounting all
cash inflows and outflows attributable to a capital investment project. For
this purpose, rate of discount is chosen suitably. There are three
methods of discounting cash flows, which are given below:-
Net present value method (NPV) is the most suitable method used
for evaluating the capital investment projects. Under this method cash
inflows and outflows associated with each project are worked out. The
present value of the cash flows is calculated by discounting the cash
flows at the rate of return acceptable to the management. The rate of
return is considered as a cut-off rate. It is generally determined on the
basis of cost of capital suitably adjusted to allow for the risk element
involved in the project. The cash outflows represent the investment and
commitments of cash in the project at various points of time. The working
capital is taken as a cash outflow in the initial year. The cash inflow
represents the net profit after tax but before depreciation. As depreciation
is non-cash expenditure, it is added back to the net profit after tax in order
to determine the cash inflows. The cash inflows and outflows are
discounted at a certain rate and present value of cash flows are
calculated. The difference between the present value of cash inflows and
present value of cash outflows is called net present value (NPV). If the
NPV is positive, the project is accepted and if it is negative, the project is
rejected. This exercise involved in calculating the present value is called
discounting.
Illustration 3
212
Year
1
2
3
4
(a) What is the net present value of the project assuming a 10 % risk-free
rate? Should the project be accepted?
(b) If the project is risky and it is decided to use a higher rate to allow for
the perceived risk. Assuming that rate is 15%, what will be the net
present value of the project? Should the project be accepted?
Solution:
(a)
Net Present Value at 10% discounting rate
Year
Cash inflows
(Rs)
Discount factor at
10%
50000
0.9091
45455
40000
0.8254
33056
30000
0.7513
22539
20000
0.6830
13660
114710
100000
14700
(b)
Net Present Value at 15% discounting rate
213
Year
Cash inflows
(Rs)
Discount factor at
15%
50000
0.8696
43480
40000
0.7561
30244
30000
0.6575
19725
20000
0.5718
11436
104885
100000
4885
Illustration 4
214
X Ltd is considering purchase of a machine in replacement of an
old one. Two models viz. modern and sky are offered at price of Rs.
22.5 lakhs and Rs. 30 lakhs respectively. Further particulars regarding
these models are given below:-
Particulars
Modern
Sky
Years
Rs. Lakhs
Rs. Lakhs
1
2
3
4
5
6
5.00
7.50
10.00
9.00
8.50
-
6.00
8.00
10.00
12.00
10.50
9.50
P.V.Factor
1
2
3
4
5
6
0.893
0.797
0.712
0.636
0.567
0.507
Solution:
Calculation of Net Present Values
Years
P.V.Factor
1
2
3
4
5
6
0.893
0.797
0.712
0.636
0.567
0.507
Less
Modern
Sky
CFAT
PV
CFAT
PV
5.00
7.50
10.00
9.00
8.50
-
4.465
5.977
7.120
5.724
5.954
6.00
8.00
10.00
12.00
10.50
9.50
2.50
5.358
6.376
7.120
7.632
5.953
6.084
29.240
38.523
22.500
30.000
215
outflows
Net present value
6.740
8.523
(b) Considering net present value method, both the models have positive
net present value and their initial investments are different. Hence, the
decision will be based on Profitability Index which is calculated as
follows:-
Modern
Sky
Profitability Index
PVCI
= ---------
29.240
= -------
PVCO
38.523
=
22.500
1.299
------30.00
1.284
216
higher internal rate of return would be preferred. The internal rate of
return can be calculated by using trial and error method.
Illustration 5
Year
1
2
3
4
5
Year
1
2
3
4
5
At 10 %
0.91
0.83
0.75
0.68
0.62
At 14 %
0.88
0.77
0.67
0.59
0.52
Solution
Year
Gross
Yield
(Rs.) 1
Depreciati
on (Rs.) 2
Balance
(Rs.) 3
Income Tax
(Rs.) 4
Net Cash
inflows (Rs.)
5
CFAT
(2+5) 6
1
2
80,000
80,000
40,000
32,000
40,000
48,000
12,000
14,400
28,000
33,600
68,000
65,600
217
3
4
5
90,000
90,000
75,000
25,600
20,480
81,920
64,400
69,520
- 8,920
19,320
20,856
-
45,080
48,664
75,000
70,680
69,144
81,920
Year
CFAT
D.F. 10 %
D.F. 14%
PV @ 10 %
PV @ 14%
1
2
3
4
5
68,000
65,600
70,680
69,144
81,920
0.91
0.83
0.75
0.68
0.62
0.88
0.77
0.67
0.59
0.52
61,880
54,448
53,010
47,018
50,790
59,840
50,512
47,356
40,795
42,598
2,67,146
2,41,101
The present value of cash flows at 14% rate works out to Rs.
2,41,101. Therefore, IRR lies above 14%.
Year
CFAT
D.F.@
16 %
D.F.
@
D.F.@
22 %
PV
(Rs)
PV
(Rs)
PV
(Rs)
18 %
1
68,000
0.862
0.847
0.820
58,616
57,596
55,760
65,600
0.743
0.718
0.672
48,741
47,100
44,063
70,680
0.641
0.609
0.551
45,305
43,044
38,945
69,144
0.552
0.516
0.451
38,167
32,912
31,184
81,920
0.476
0.437
0.370
38,994
35,791
30,310
218
The Net present value at 22% discounting factor is around zero.
Hence, the actual IRR is 22 %. As the cost of capital is 10% which is a
cut-off rate, and IRR is 22%, the project is recommended.
Illustration 6
The FFM Ltd is in the tax bracket of 35%, and discounts its cash
flows at 16%, in the acquisition of an asset worth Rs. 10 lakhs. It is given
two offers either to acquire the asset by taking a loan @ 15% per annum
repayable in five yearly installments of Rs. 2,00,000 each plus interest or
to lease-in the asset at yearly rentals of Rs. 3,24,000 for five years. In
both the cases, the installment is payable at the end of the year.
Applicable rate of depreciation is 15% using written down value (WDV)
method.
Years
1
2
3
4
5
P.V. Factor
0.862
0.743
0.641
0.552
0.476
Solution:
219
Year
Principal
(Rs.)
Interest
(Rs.)
Depre.
(Rs.)
Tax
( Rs.)
Net
Cash
Inflows
(Rs.)
D.F.
D.V.
(Rs.)
2,00,000
1,50,000
1,50,000
1,05,000
24,500
0.862
2,11,190
2,00,000
1,20,000
1,27,500
86,625
2,33,375
0.743
1,73,398
2,00,000
90,000
1,08,375
69,431
2,20,569
0.641
1,41,385
2,00,000
60,000
92,118
53,241
2,06,759
0.532
1,14,131
2,00,000
30,000
78,301
37,905
1,92,095
0.476
91,437
7,31,641
Year
Rental
(Rs.)
Tax
(Rs.)
Net
Cash
inflows.
(Rs.)
D.F.
P.V.
(Rs.)
3,24,000
1,13,400
2,10,600
0.862
1,81,537
3,24,000
1,13,400
2,10,600
0.743
1,56,476
3,24,000
1,13,400
2,10,600
0.641
1,34,995
3,24,000
1,13,400
2,10,600
0.552
1,16,251
3,24,000
1,13,400
2,10,600
0.476
1,00,246
6,89,505
Q.1
A
2,00,000
B
2,00,000
C
2,40,000
D
2,10,000
220
Cash inflows
st
1 Year
nd
2 Year
rd
3 Year
th
4 Year
th
5 Year
Q.2
50,000
50,000
50,000
50,000
50,000
40,000
50,000
70,000
75,000
75,000
75,000
75,000
60,000
40,000
20,000
Q.3
75,000
75,000
60,000
80,000
1,00,000
Project A (Rs.)
25,000
15,000
10,000
12,000
6,000
Project B (Rs.)
10,000
12,000
18,000
25,000
8,000
4,000
The cost of capital of the company is 10%. The following are the present
value factors @ 10%.
Year
PV Factors @ 10 %
1
0.9091
2
0.8264
3
0.7513
4
0.6830
5
0.6209
6
0.5645
Which project should be selected and why? Evaluate the project under:
(a) Payback method
(b) NPV method.
221
11
Unit Structure:
11.0
Objectives
11.1
Introduction
11.2
11.3
11.4
11.5
11.6
11.7
11.8
11.9
Summing Up
11.10 Exercise
11.0 OBJECTIVES
222
After studying the unit the students will be able to:
11.1 INTRODUCTION
223
information at the right place for use by the right people at the right time.
Even if any one of these requirements is not fulfilled, the organization
cannot be successful in its mission.
11.2 MEANING
AND
COMPONENTS
MANAGEMENT INFORMATION SYSTEM
OF
224
An 'MIS' is a planned system of the collecting, processing, storing
and disseminating data in the form of information needed to carry out the
functions of management. In a way it is a documented report of the
activities that were planned and executed.
225
element of Software may be absent. In an automated Management
Information System, the software provides the necessary impetus that
is required to exploit the benefits arising out of the revolution in
information technology. We have to select the best software that can
provide the solutions in the form of best organizational practices that
can help the organization to forge ahead remain ahead of others.
226
mechanism, which would control the induction of new technology
products into the existing system. Any such inductions should be
based on the merits of the technology and the product. A cost benefit
analysis should be desired wherever possible.
227
14. Compliance with external requirements : As explained earlier, the
information and data including the personal of customers, which
happen to be the preserve of the company, are subjected to threats of
misuse and intrusion. Any such untoward incident could lead to huge
losses to the company in terms of money and reputation.
15. Critical Success Factors : Any success can be judged only against
some bench marks. In order to measure the success of an MIS, it
should be necessary that certain factors are identified that would
indicate the growth or maturity of the MIS as a process of the
organization. Comparison of the actual results against those Success
Factors is a good measure of performance. Such factors could
number of break down, uninterrupted service etc.
INFORMATION
Need :
Besides the need of MIS for effective decision making, the need
also arises from the point of view of planning and controlling. In order to
guide the management in planning the allocation of resources of the
Company, it becomes essential to know the results of operations. This
would help to plan about the allocation and or reallocation of resources
and to maximize the benefits.
228
229
A management information system is an integrated man
machine systems that provides information to support the planning and
control function of manager in an organization.
The output of an MIS is information that sub serves managerial
functions. When a system provides information to persons who are not
managers, then it will not be considered as part of an MIS. For .example,
an organization often processes a lot of data which it is required by law to
furnish to various government regulatory agencies. Such a system, while
it may have interfaces with an MIS, would not be a part of it, Instances of
such systems is salary disclosures and excise duty statements. By the
same token to sophisticated computer aided design system for
engineering purposes would also not be a part of an MIS.
230
Generally, MIS is concerned with planning and control. Often
there are elaborate systems for information that assists operations. For
example, the car manufacturer will have a system for providing
information to the workers on the shop floor about the job that needs to
be done on a particular batch of material. There may be route sheets,
which accompany the rate materials and components in their movement
through various machines. This system per se provides only information
to support operation. It has no managerial decision-making significance. It
I not part of an MIS. If, however, the system does provided information on
productivity, machine utilization or rejection rates, then we would say that
the system is part of an MIS.
Generally MIS has all the ingredients that are employed in
providing information support to manager to making planning and control
decisions. Managers often use historical data on an organizations
activities as well as current status data make planning and control
decisions. Such data comes from a data base which is contained in files
maintained by the organization . This data base is an essential
component of an MIS. Manual procedures that are used to collect and
process information and computer hardware are obvious ingredients of an
MIS . These also form part of the MIS. In summary , when we say that
an MIS is an integrated man machine systems that provided information
to supports the planning and control function of managers in an
origination . It does the following function.
- sub serves managerial function
- collects stores , evaluates information systematically and routinely
- supports planning and control decisions
- Includes files , hardware , software , software and operations research
models.
Effective management information systems are needed by all
business organization because of the increased complexity and rate of
change of todays business environment . For Example, Marketing
manager need information about sales performance and trends, financial
manger returns, production managers needs information analyzing
resources requirement and worker productivity and personnel manager
require information concerning employee compensation and professional
development. Thus, effective management information systems must be
developed to provide modern managers with the specific marketing ,
financial, production and personnel information products they required to
support their decision making responsibilities .
231
An MIS provides the following advantages:
1. It Facilitates planning: MIS improves the quality of plants by providing
relevant information for sound decision making . Due to increase in the
size and complexity of organizations, managers have lost personal
contact with the scene of operations.
2. In Minimizes information overload: MIS change the larger amount of
data in to summarized form and there by avoids the confusion which may
arise when managers are flooded with detailed facts.
3. MIS Encourages Decentralization: Decentralization of authority is
possibly when there is a system for monitoring operations at lower levels.
MIS is successfully used for measuring performance and making
necessary change in the organizational plans and procedures.
4. It brings Co ordination: MIS facilities integration of specialized
activities by keeping each department aware of the problem and
requirements of other departments. It connects all decision centers in the
organization .
5. It makes control easier: MIS serves as a link between managerial
planning and control. It improves the ability of management to evaluate
and improve performance . The used computers has increased the data
processing and storage capabilities and reduced the cost.
6. MIS assembles, process,
Disseminates the information.
stores,
Retrieves,
evaluates
11.4 PURPOSE
AND
SIGNIFICANCE
MANAGEMENT INFORMATION SYSTEM
and
OF
232
233
management and the top level management are better placed as
related to the future in terms of uncertainty. Approaches like what if
analysis can help the organization in planning for steps to be taken
during an exigency.
11.5 LEVELS
OF
MANAGEMENT
INFORMATION REQUIREMENTS
VIS--VIS
234
Let us discuss each type of Information System and its
requirement for a particular level of Management.
Function
TPS
: Order
Tracking,
Order
Reservation Processing
Manufacturing
Finance
: Online Securities
Management
Trading
Processing,
and
Cash
235
Accounting
Accounts
Human Resources
2. Knowledge
Level
System
for
Knowledge
Level
Management : This type of System caters to the information
requirements of knowledge level of the organization. They help an
organization in integration of new knowledge into the business and to
in controlling the flow of paper in its offices. There are two sets of
Knowledge level people. They are (1) knowledge workers and (2)
Data workers. Knowledge workers are like engineers, doctors,
lawyers etc. They in fact create new information for the purpose of
utilization in the business. Computer aided design is an example of
knowledge work system. The data workers consist of primarily
Secretaries, Accountants, Record Clerks and Managers. The people,
who use, manipulate and disseminate information fall under this
category. The system which is used by this category helps to do their
work faster. An example is Word processing. Such a system is also
known as Office automation System.
236
problems, the ESS provide the Top Level Management information to
address unstructured decisions and create a generalized computing
and communications environment rather instead of providing any
specific application. They provide information to the top level
management on external events such as new tax laws or other
regulations or about the competitors besides the summarized
information from internal management information system.
237
Management (SCM), Customer Relationship Management (CRM), project
management and database retrieval applications.
11.6.1 Meaning of Computer :
238
process will be written together and loaded into the computer. Such set
of transactions put together is called software. While hardware is a
visible part of a computer, software is an invisible part of a computer.
Software is also denoted as programme.
239
In most cases, information systems are formal, computer based
systems that play an integral role in organizations. Although information
systems are computer based, it is important to note that any old computer
or software program is not necessarily an information system. "Electronic
computers and related software programs are the technical foundation,
the tools and materials, of modern information systems.
Limitations :
240
ln this discussion we are going to discuss the problems in
Installing and operating he MIS and the Limitations of MIS. The following
limitations are identified.
241
organization as a whole. In order to make this possible, it becomes
necessary to archive large volume of data to be Used under such
situations. In the case of new organizations, this may not be possible
because of paucity of large volume of data. Even in cases of old
Organizations, it becomes very difficult to maintain and protect the data
because of many threats associated with it.
242
same solutions or similar solutions can bring in the same advantages
which the earlier movers have derived from implementing those solutions.
9. Social Impact :
243
society's perception about the company which may be either positive or
negative.
12. MODEL cannot take into account all the variables - too many and
due to changing circumstances.
244
business practices cannot be subject to change.
circumstances, the IT model becomes out dated.
Under
such
245
We have seen that there are new concepts and new technology
products coming into the market every other day. It becomes very
essential that the employees of the organization be given training in order
to understand the benefits arising out of such new products and concepts
and to integrate them into our existing systems. Thus there is a necessity
of providing continuous training to the employees. This will increase the
HR Costs.
246
overcome by observing precautions and following Objective practices for
information and related technology. The Information Systems Audit and
Control Association, (ISACA) USA has been constantly evolving practices
and Control objectives which can reduce the minimize the risks
associated with Information and related technology. Presently, the ISACA
has advocated COBIT-3. COBIT stands for Controlled Objectives for
Information and Related Technology.
below.
247
Identify solutions
Acquire and maintain application software
Acquire and maintain technology architecture
Develop and maintain IT procedures
Install and accredit systems
Manage changes
4. Monitoring :
Monitor the processes
Assess internal control adequacy
Obtain independent assurance
Provide for independent audit
248
11.9 SUMMING UP
11.10 EXERCISE
1.
2.
3.
4.
12
249
Unit Structure:
12.0
Objectives
12.1
Introduction
12.2
Types of Information
12.3
12.4
Levels of MIS
12.5
12.6
12.7
Summing Up
12.8
Exercise
12.0 OBJECTIVES
12.1 INTRODUCTION
250
functional manager / process manager. Every business Manger or
Functional Manager or Process Manager needs to make decisions. The
manager has to make decisions in order to maximize the benefits by
utilization of resources available. When it comes to decision making, it
becomes important that the manager gets all the relevant information on
time. Unless the decision is made in the light of all the relevant and
required information, the decision cannot be a correct one. Hence it is
imperative that the informational needs of each function are properly
understood and a proper Information System as can help discharge of the
Decision-making, Planning and Control functions of a Manager is
designed and put in place.
1. Operational :
251
2. Knowledge level :
3. Tactic level :
4. Strategic level :
252
objectives. After all, the Information System is expected to help the
management in making decisions in order to attain the objectives of the
business. For example, if the objective of a business is to become a
market leader, the performance of the company in terms of market share
would be very relevant information which the Management has to be
aware of very frequently. Similarly, in the case of a raw material intensive
manufacturing industry, the most critical piece of information would be
centered around the wastage of materials. But in the case of a Hotel
Industry, the importance would be on the No. of rooms lost without
selling. Apparently, the focus in the case of Manufacturing Industry, as it
seems is upon the scheduling and production, in the case of Hotel
Industry, it is upon Sales and Marketing. In fact, for the same type of
business, depending upon the locational requirements or legal
requirements or owing to some other external or internal factors, the
nature of information requirement, even though fundamentally would be
the same, some type of information which would be very relevant and
mandatory or critical in nature, in one particular location or environment
would not be required or would be irrelevant for the same size and type of
business functioning under another location or environment.
For
example, for a Hotel Industry which is functioning in a place where water
is scarce or environment is of great concern, there would be great
emphasis on usage of water / disposal of waste while the importance of
water may not be that important in a place where water is available in
plenty. Thus it is very essential that the Information System should be
business objective specific.
a) Supervisory Level :
Each level of Management would be in need of information from
different perspectives. For example, a supervisor who is a charge of a
253
scale of a Sales Counter may have to decide instantaneously whether to
extend credit to a particular customer. He may be needing information at
that instant in order to decide as to whether to give credit or not. The
information he would needing would be supplied by the sales department
and the Accounts department. This information is provided by the
Transaction Processing Systems viz., Sales Order Processing System
and accounts receivable processing system. Any system which produces
information at the transaction level is known as Transaction Processing
System. Transaction processing system generates the information in
large volumes and provides the source data for design of other
Information Systems. The transaction processing system is suitable for
solving well structured problems.
b) Knowledge Level :
The next level of Information System is focused towards the
knowledge level of an organization. This level of Management comprises
of skilled people like engineers who make use of systems like CAD
(Computer aided design) and the white collared people in the office, who
make use of systems like word processing, e-mail etc. The first set of
knowledge level people creates the information and the second set of
people process the data created by the first set. Like Transaction
Processing System, the Knowledge Systems is capable of solving only
well structured problems.
c) Managerial Level :
This level comprises of the Middle Level Management. There are
two types of Information Systems used by the middle level management.
They are:
1. Management Information System and
2. Decision Support System
254
and knowledge level system in a summarized form. It is prepared
periodically, say, every week fortnight or a month. The normal MIS takes
into account only the internal factors. The decision Support System takes
into account external factors also. For example, operational data like
volume of sales. Operational capability etc. of the competitors would be
included.
d) Strategic Level :
The information system which is used by the top management is
known as Executive Support System. The Executive Support System
enables the top level management to take Strategic decisions. Apart
from containing relevant internal data great emphasis would be given to
the external factors. The presentation in the ESS may include graphs,
charts etc. to enable better understanding of the internal and external
environments. The ESS is used to solve un-structured problems.
AND
THE
255
Assume that a Hypothetical Company is in an industry which is
highly raw material intensive. Supposing the Controller of the company
wants to reduce the material costs of the product in order to get a
strategic advantage over the competitors.
In the above example, you would notice that the Organization has
to plan for the course of action, fix standards and Control the result. For
all such managerial activities, the management is in need of the
information about the present material costs, the cost of wastage of
materials at present, the comparative study of the different options or
alternative courses of actions, the basis for selection of a particular
course of action You would have realised the importance of information
for decision making process.
12.6 BUSINESS
FUNCTIONS
INFORMATIONAL NEEDS
AND
THE
256
Marketing
Production
Human Resources
Purchasing
Finance and Accounting
Invetory control
Project Control
Management Reporting
257
c) Effectiveness of marketing plans :- An organization can be floating
many marketing plans at any point of time. It becomes essential that
the Marketing manager needs information about the success of the
marketing plans which are launched. For example, he would need to
know the incremental quantity of products sold as a result of the
launch of a particular marketing plan.
d) Effectiveness of advertising plans :- As in the case of Marketing
Plans, the effectiveness of Advertising plans has to be analysed, in
order to judge their performance. Hence the information on
incremental sales of the products would be required in the course of
as well as after the implementation of such advertisement plans.
e) Product Mix :- Information on the Product mix is essential to enable
the Marketing Manager to understand the buying preferences of
customers.
f) After sales service:- This sort of information is required by a
marketing manager in order to give a proper feed back about the
quality of production to the production department as well as to study
about the satisfaction of the customers with the product.
g) Other information :- The following other information also would be
required for a marketing manager.
Effect of Pricing Policy - What has been the change in the pattern of
consumption of the customers after a change in price.
Customer Satisfaction - The level of satisfaction of the customers.
Market Research - Market research is an important tool in
understanding the changing market factors, customers' demands,
level of satisfaction or dissatisfaction. Market research will provide a
very important clue as to the company's unanswered questions and
can provide a valuable guide to the company's top management in
devising its marketing and sales strategies from the point of view of its
strategic planning. Market research can be conducted by either the
organization itself or can be out sourced from other professionals who
have expertise in Market research.
258
nerve centre of the Production Management System. Production
Scheduling involves planning for the Production quantity, the materials
required, job scheduling (assigning machine to appropriate skilled
labourers) and the maintenance of the Inventory of WIP. The materials to
be kept as WIP will form an important input as far as the purchasing
function is concerned. A well managed Production function contributes to
a better Inventory Control and hence higher Return on Investment. Thus it
boils down to the following aspects.
a)
b)
c)
Materials Management
Production Planning
Job Scheduling
Personnel Selection
Personnel Recruitment
Personnel Training Methods
Organizational Policies as related to personnel
Performance Evaluation and Compensation Methods
4. Purchasing :
259
Business Partners and the Data base about our production plan has to be
shared with them. The process also requires selection of vendors who are
capable of meeting our requirements without failure even once. This
needs information about the suppliers' History and the experience of the
firm with them in earlier occasions. A proper procedure has to be in place
for development of vendors who can co-operate with the firm regularly on
need.
of
Financial
6. Inventory Control :
While there are certain traditional models like ABC Analysis, VED
Analysis, FSND Analysis, Buffer Stock, Maximum Level, Minimum Level
etc. The present day's situation is that companies are moving towards the
"JIT", which stands for 'Just in time Inventory'. Under this concept, the
inventory has to be maintained at virtually 'zero level'. However, for the
260
concept to work, the organization has to adopt the best practices in
relation to the Sales forecasting, co-ordination with the Sellers and the
buyers, Production scheduling and materials planning. Hence the
information on the quantum and schedule of off take by our customers
need to be known by the organization and at the same time, the
organization should share the information on the quantum of our off take
to our suppliers.
7. Project Control :
Any project, whether a short term one or Long term one should
adopt techniques of Project control like PERT and CPM. Programme
Evaluation and Review Techniques (PERT) help to adopt a modular
approach in managing the activities involved in the project and thus
enables to control the costs of the project. Critical Path Methods (CPM)
help to analyse the most critical path, which will have an impact on the
final completion of the project. This analysis would help in weighing
alternative ways of allocation of resources in order to complete the project
on time, if some exigencies arise.
8. Management Reporting :
12.7 SUMMING UP
261
Various techniques and models are available in order to manage different
functions effectively. There should be a system of reporting to the
Management, who would be kept informed about the progress of planning
activities and to enable taking control actions to correct deviations.
12.8 EXERCISE
13
OBJECTIVE TYPE QUESTIONS
Chapter 1
Analysis and Interpretation of financial statements
1. Rewrite the following sentences by selecting correct choice.
a) An asset which is shown in the balance sheet but it has
no real balance.
(i)
Fixed Asset
(ii)
Current Asset
(iii)
Wasting Asset
(iv)
Intangible Asset
262
(ii) Revenue Expenditure
(iii) Deferred Revenue Expenditure
(iv) Misc. Expenditure
c) Which of the following is not a financial statement?
(i)
Balance Sheet
(ii)
(iii)
(iv)
Trial Balance
Previous Year
(ii)
Future Year
(iii)
Current Year
(iv)
Percentage
100 %
(ii)
50 %
(iii)
10 %
(iv)
0%
_____
is taken
(ii)
263
(iv) Receipts from customer for sale of goods are known as
______ receipts.
(v)
Group B
1. Bank overdraft
2. Owned Funds
Fixed Asset
3. Intangible Asset
Non-operating Expenditure
Current Liability
5. Depreciation
goodwill
4. State whether the following statements are true or false:(i) Issue of shares is an internal source of Finance.
(ii) A comparative balance sheet is prepared for the purpose
of intra-firm comparison.
(i) Common size statements are used for vertical analysis
only.
(ii) Analysis of profit & loss account means breaking down
the profit & loss account into its various components.
(iii) Accounting principles are generally accepted guidelines
used by accountants for the purpose of preparing the
financial statements.
Answers:
Q 1. (a)- (iii)
(b)- (ii)
(c)- (iv)
(d)- (i)
264
(e)- (i)
Q 2. (i) Total Assets
(ii) Horizontal
(iii) Capital
(iv) Revenue
(v) Working Capital
Q 3.
Group A
(i)
(ii)
(iii)
(iv)
(v)
Group B
(iv)
(i)
(v)
(iii)
(ii)
Q 4. (i) True
(ii) False
(iii) False
(iv) True
(v) False
Chapter 2
Ratio Analysis
ii) The Balance sheet ratios deal with the relationship between two
____________.
(a)
265
iii) The relationship between capital entitled to fixed rate of return and the
capital not so entitled to fixed rate of return is known as:
(a) Fixed Capital (b) Working Capital (c) Gearing Capital
(d) owned
Capital .
iv)
v)
Group B
Net Profit
266
2. Current Ratio
3. Operating ratio
Trading results
4. Capital gearing
Debenture capital
i b,
ii C , iii - C , iv b, v a
Q.2
Q.3
1 ---- iii
2 ----- iv
3 ---
4 --- V
5 --- ii
Q.4
(a) False (b) True (c) True (d) True (e) False
(d) Quick
267
Chapter 3
Q.1 Choose the correct answer:(a) Cash from operations is equal to:(i) Net profit plus increase in outstanding expenses
(ii) Net profit plus increase in debtors
(iii) Net profit plus increase in stock
(iv) Net profit plus Depreciation
(b) Increase in the amount of debtors results in:(i) Decrease in cash
(ii) Increase in cash
(iii) No change in cash
(iv) Increase overdraft
(c) Cash flow statement reveals the effects of transactions involving:(i) Reduction in cash
(ii) Increase in cash
(iii) Movement of cash
(iv) Bank transactions
(d) Net cash flow does not necessarily mean net income
of the:-
(i) Company
(ii) Firm
(iii) Business
(iv) Entity
(e) The amount of closing stock put on the credit side of trading account
increases the amount of net profit without increasing:(i) Funds from operations
(ii) Cash from operations
(iii) Surplus from operations
268
(iv) Deficit from operations
Q 2. Fill in the blanks:(i) A cash flow statement depicts the change in cash position from one
______ to another.
(ii) Depreciation does not result in _______ of cash.
(iii) Increase in creditors from one period to another will result in ________
of cash from operations.
(iv) Payment of tax will result in decrease of cash and hence it is ________ of
cash.
(v) Cash Flow Statement is a useful ________ instrument.
Q 3. Match the following:Group A
1. Cash flow statement
2. Depreciation
3. Funds from operations
Group B
i Sources of funds
ii Reduction in net profit
iii Change in cash position
4. Opening stock
5. Creditors
Q 4. State whether the following statements are true or false:(a) Cash Flow Statement reveals the effects of transactions involving
movement of cash.
(b) The term Funds means Current assets in case of cash flow analysis.
(c) A cash flow statement can very well be equated with an income
statement.
(d) The funds flow statement and Cash flow statement are one and the
same.
(e) A company should keep large balance of cash in hand so that it can
meet all contingencies.
Answers:
Q.1 a iv , b i , c iii , d iii , e ii
269
Q.2 i- period , ii outflow , iii increase , iv application ,
supplementary
Q.3 1 iii
2v
3i
4 ii
5 iv
Q.4 a True, b false, c false, d false, e false
Chapter 4
Working Capital
Q.1 Rewrite the following sentences by selecting correct choicea) The period required for the whole operation starting with cash and
ending up with Cash plus
i) operating cycle
ii) Trading Cycle
iii) Working Cycle
iv) Main Cycle
270
iv) Net Assets
c) The cost to be excluded from the cost of goods sold for the purpose of
determining working in process and finished goods is
i) Interest
ii) Depreciation
iii) Taxation
iv) Dividend
ii) Lower
iii) More
iv) earlier
271
Group B
1. Receivables
3) Debtors
4) Bank Balance
5. Quick Assets
Answers:
Q .1. a-i,
b-iii,
Q .2 i Reduce
Q.3
1 -3
2 -4
3 -1
4-5
c-ii,
d- iii,
ii unforeseen
e-ii
iii 50%
iv selling
v- circulating
272
5-2
Q .4 a False,
b False,
c False, d True,
e- True
Chapter 5
Capital Budgeting
273
(c) The cash inflows on account of operations are presumed to have been
reinvested at the cut-off
rate in case of
(i) ARR
(ii) DCF method
(iii) IRR
(iv) PI
Q2. Fill in the blanks (i) The cut-off point refers to the point below which a project would not be
_______.
(ii) Capital budgeting includes both raising of long-term funds as well as their
________.
(iii) All capital investment proposals for increasing revenue require
additional _______ capital.
(iv) Different capital investment proposals have different degrees of risk and
________.
274
(v) The term pay-back refers to the period in which the project will
generate the necessary cash to recoup the initial---
Group B
i. Accept or Reject
3. Profitability index
iii. NPV
(a) The internal rate of return and Net Present Value are synonymous terms.
(b) Tax concessions have no role to play in estimating the cash flows from a
project.
(c) Discounted cash flow technique takes into account the time value of
money.
(d) Pay back method takes into account the cash flows after the pay back
period.
(e) Cash flows from a project cannot be estimated accurately.
Answers:
Q.1 a iii , b i , c ii , d i , e i
v-
275
Q.3 1 - iii
2-v
3 - iv
4-i
5 ii
Q.4 a false
b false
c true
d false
e true
Chapter 6
Low order
(ii)
High order
(iii)
Medium order
Decision making
276
(ii)
Reporting
(iii)
Planning
(iv) Controlling
c) The potential impact of computers and MIS on middle
management level is
(i)
Insignificant
(ii)
Significant
(iii)
Not significant
Top management
(ii)
Middle management
(iii)
Lower management
(ii)
(iii)
277
(3) _______ is the glue that holds the functional systems
together.
(4) Accuracy in reporting is not of vital _______.
(5) The primary objective of MIS reporting is to enable the
management to make scientific and ________ decisions.
Group B
1 Regular reports
i. Control reports
2 Operating reports
3 External reports
4 Report of overtime
(1) a ii , b i , c ii , d ii , e ii
(2) (i) Functions
(v) Sound
(3)
Group A
(ii) Output
(iii) Database
Group B
(iv) Importance
278
1
2
3
4
5
iii
i
v
iv
ii
(4) (i) false (ii) true (iii) false (iv) false (v) true
Topics at Glance
Sr.
No.
Topics
Interpretation
No. of
Lectures
1.
Analysis and
Statement
of
Financial
25
2.
Ratio Analysis
20
3.
15
4.
10
279
5.
Capital Budgeting
6.
Concept of
environment
MIS
15
Reports
in
computer
05
Total
90
280
Sr.
No.
1
Topics
1.1
1.2
1.3
2.1
281
(iv) Net Profit Ratio
(v) Net Operating Profit Ratio
(vi) Stock Turnover Ratio
(C) Combined Ratios
(i) Return on Capital employed (Including Long Term Borrowings)
(ii) Return on proprietors Fund
(iii) Return on Equity Capital
(iv) Earning per share (EPS)
(v) Price Earning Ratio (P/E Ratio)
(vi) Dividend Pay out Ratio
(vii) Debt Service Ratio
(viii) Debt service coverage Ratio
(ix) Debtors Turnover Ratio
(x) Creditors Turnover Ratio
2.2
2.3
Working Capital-Concept
Estimation / Projection of Requirements in case of Trading and
Manufacturing Organization.
5
5.1
Capital Budgeting
Introduction:
(i) Types of capital
(ii) Sources of capital
282
5.2
6
6.1
6.2
Duration 3 Hours
No of questions to be asked
No of questions to be answered
Question No. 01
20 Marks
Question No. 02
Compulsory Objective
16 Marks
16 Marks
each
Note:
(1) From Question No. 03 to Question No. 09 not more than one question
may be theory including short problems/questions.
(2) Student to answer any four out of Question No. 03 to Question No. 09.
283
(3) Objective questions to be based on all topics and include Inter alia
questions like:
(a) Multiple choice (b) Fill in the blanks (c) Match the columns (d) True
or False
Reference Books
Title of Books
Cost and
Accounting
Author /s
Essential of Management
Accounting
P.N. Reddy
Publishers
Taxmann
Himalaya
Advanced
Accounting
Holl
Financial
Accounting
Wisdom
Introduction of
Management Accounting
Charles T Horngren
Pearson Education
Management Accounting
I.M. Pandey
Vikas
House
Cost and
Accounting
Publishing
Galgotia
Management Accounting
Fundamentals of Financial
Management
Vyuptakesh Sharma
Pearson Education
284
Question Paper
Financial Accounting and Auditing Paper-V
April 2010
Duration: 3 Hours
N.B:
(1) Question No.1 and 2 are compulsory and carry 20 Marks and
16 Marks respectively.
(2) Attempt any four questions from the rest, carrying 16 Marks
each.
(3) Working Notes should form part of your answer.
(4) Proper presentation and neatness is essentials.
(5) Use of simple calculator is allowed.
Rs. 10
Rs. 5
285
7. The time-lag in payment of labour will be 1 month.
8. The time-lag in payment of overheads will be half a month.
9. The cash and Bank Balance is expected to be Rs. 25,000/10. Calulate debtors on cost basis.
11. 20% of the purchase will be on cash basis.
2. (a) Re-write the following sentences by selecting correct choice.
(8)
A very high current ratio will(a) increase the profitability
(c) Stock
286
(b) Match the coloumns and rewrite the following sentences (8)
Group A
Group B
Rly sidings
Efficiency
Debtors
in
collection
from
Trend Analysis
More risk
Retained earnings
Dividend layout
Current liabilities
Payback period
Fixed Assets
Trading efficiency
10
3. From the following information for the year ended 31st March, 2010 of
M/s. NITIN Ltd. Prepare Balance-sheet with as many details as
possible.
(16)
Current Ratio
25%
Debtors Turnover
4 times
6 times
Rs. 6,00,000
1 th of cost
4
Current Liabilities
Rs. 1,25,000
4. CHETAN LTD. is considering purchase of a machine two machinesLPX machine and GPX machine are available, each costing Rs.
5,00,000.
In comparing profitability of machines, a discounted rate of 10% is to
be considered.
Expected profits after tax and before Depreciation are as follows:
(16)
287
Year
1,60,000
2,00,000 2,50,000
1,50,000 2,00,000
60,000
1,50,000 2,00,000
3,00,000 2,00,000
0.909
0.826
0.751
0.683
0.621
31st
March,
2009
Rs.
31st
March,
2010
Rs.
Assets
5,00,000
____
57,000
31st
March,
2010
Rs.
11,00,000 13,00,000
3,00,000 Investments
2,60,000
2,60,000
2,00,000 Stock
7,40,000
8,99,000
10,50,000
9,90,000
1,50,000
2,10,000
1,00,000 Sundry
Debtors
Sundry
Creditors
31st
March,
2009
Rs.
1,50,000
1,80,000 Bank
Balance
1,00,000
80,000
for
1,70,000
2,10,000 Cash in
Hand
30,000
20,000
Provision for
Depreciation
2,00,000
3,35,000 Preliminary
Expenses
20,000
16,000
Proposed
Equity
Dividend
Provision
Taxation
34,50,000 37,75,000
34,50,000 37,75,000
Additional Information:
(1) Preference Shares were redeemed on 1.4.2009. Company pays
Preference dividend on 31st March every year.
(2) Fixed Assets of Rs. 2,00,000/- were purchased on 31.03.2010 against
which equity shares of Rs. 2,00,000/- were issued at par.
288
(3) Dividend received on investment was Rs. 26,000/(4) Proposed Equity Dividend for 2008-09 Rs. 1,50,000/- was paid during
2009-10.
(5) Provision for Taxation for 2008-09 Rs. 1,70,000/- was paid during
2009-10.
Prepare Cash Flow Statement for the year ended 31st March, 2010 by
indirect method as per AS-3 from the above information.
6. M/s. Sudesh Ltd. carrying on Business furnishes their position as on
31st December, 2007, 2008 and 2009 as under :
(16)
Liabiliti
es
2007 Rs.
2008
Rs.
2009
Rs.
2008 Rs.
2008
Rs.
2009
Rs.
Equity
Share
Capital
3,00,000
3,00,000
4,00,000
Fixed
Assets
3,00,000
3,00,000
4,00,000
Pref.
Share
Capital
2,00,000
2,00,000
2,50,000
Investme
nts
1,00,000
1,00,000
1,00,000
General
Reserve
50,000
1,00,000
1,00,000
Debtors
1,00,000
1,50,000
2,00,000
Secured
Loan
1,00,000
1,00,000
50,000
Stock
50,000
1,00,000
50,000
Sundry
Creditor
s
40,000
80,000
80,000
Advanced
paid
50,000
50,000
50,000
Bills
payable
10,000
20,000
20,000
Cash
50,000
50,000
50,000
Bank
25,000
40,000
45,000
Discount
on Issue
of Shares
25,000
10,000
5,000
7,00,000
8,00,000
9,00,000
7,00,000
8,00,000
Assets
9,00,000
Rs.
Particulars
By Sales
Rs.
9,00,000
289
Raw Materials
Work in Progress
Finished Goods
To Purchase of Raw
Materials
To Freight
To Octroi
To Import Duty
To Direct Wages
To Direct Expenses
To Factory Power
To Factory Salaries
To Factory Repairs
To Factory Rent
To
Depreciation
on
Machinery
To Gross Profit
Total
72,000
12,000
48,000
4,80,000
12,000
48,000
6,000
1,20,000
36,000
24,000
12,000
36,000
60,000
24,000
66,000
10,56,000
By Sales of Factory
Scrap
By Closing Stock:
Raw Materials
Work in Progress
Finished Goods
Total
6,000
60,000
18,000
72,000
10,56,000
8. Following is the Profit and Loss Account of Moon Enterprises Ltd. for
the year ended 31.03.2010.
(16)
Particulars
To Opening Stock
To Purchases
To Wages
To Factory Expenses
To Office Salaries
To
General
Administrative Exps.
To Selling Expenses
To Depreciation on
Machinery
To Provision for Tax
To Trf. To Gen.
Reserve
To Net Profit
Rs.
4,00,000
9,80,000
2,90,000
1,90,000
1,20,000
1,30,000
Particulars
By Sales-Credit 18,00,000
-Cash 7,00,000
By Closing Stock
By Sale of Scrap
By Dividend Received
Rs.
25,00,000
6,00,000
10,000
1,000
1,12,500
2,50,000
1,40,500
2,00,000
2,98,000
31,11,000
31,11,000
You are required to compute the following ratios(1) Gross Profit Ratio
(2) Stock-Turnover Ratio
(3) Administrative Expenses Ratio
(4) Net Profit before Tax Ratio
Preparing Revenue Statement in vertical form is not required.
9. (a) Complete the following Comparative Statement of Himalaya
Products Ltd. by ascertaining the missing figures.
(8)
290
Particulars
Gross Profit
Less: Expps.
Administrative
Selling
Financial
Operating Net
Profit
Year ended
31-03-2009
Rs.
?
1,00,000
Year ended
31-03-2010
Rs.
?
?
50,000
?
?
60,000
25,000
2,00,000
Increase/
% Increase/
(Decrease)
(Decrease)
Rs.
?
?
20,000
20.00
10,000
5,000
1,00,000
?
25.00
100.00
(b) Complete the following Income Statement of Narayan Ltd. for the
year ended 31st March, 2010 and also prepare Commonsize
Revenue statement.
(4)
Less:
Less:
Add:
Less:
Particulars
Net Sales
Cost of goods sold
Gross Profit (25% on sales)
Operating Expenses
Operating Net Profit
Non Operating Income
Non Operating Expenses
Net Profit before Tax
Rs.
16,00,000
?
?
?
2,00,000
1,00,000
?
2,80,000
(4)