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Successful investors have always given a lot of thrust on working capital management.

A
study of top Indian companies with high return on capital employed (ROCE) shows that
many of these companies have operated on negative working capital management. These
companies are known to give good returns to their shareholders, both in terms of
dividends and capital gains. Interestingly, most of these companies belong to the FMCG
or the auto sector.

Of the 30 stocks in the Sensex, seven stocks have negative working capital and ROCEs in
the range of 20-80%. The total market capitalisation of these companies has moved up by
94% as against the entire Sensex, which moved up by 67% over the last one year.

Industries like steel and cement, which are working capital-intensive, may not show high
ROCEs on account of high capital costs. But some companies have begun to show
negative working capital. A better credit management system will help these companies
generate higher ROCEs in the long run.

Today, cement companies carry a feedstock ranging from 5-6 days; it was earlier around
15-30 days.

Overall, the cement industry's inventory turnover ratio is in the range of 10-12. Piling
cement stocks in the warehouses of the companies is no longer a phenomenon. When the
cement dispatches from the warehouses are growing at more than 20-30%, Indian cement
companies are able to move cement from factories in less than a day.

As a result of this, top cement companies such as ACC, Gujarat Ambuja, UltraTech
Cement and Madras Cement have negative working capital. The same companies have
given high returns to their shareholders in terms of dividends, bonuses as well as capital
gains.

Negative is positive

HLL, Nestle and Godrej Consumers Products Ltd have ROCE in excess of 40%. The
same goes for two-wheeler companies like Bajaj Auto, TVS and Hero Honda, which have
given high returns on their investment. The success of this high return is associated with
the way these companies have managed their working capital management cycles.

These are the companies that first sell their goods and later on pay their raw material
suppliers. This is possible only when the companies are huge in size and account for the
bulk of turnover for their suppliers. In such a situation, they are always in a position to
arm-twist the suppliers by taking more credit.

Says Jigar Shah of broking firm KR Choksey: “Companies operating in industries like
FMCG and automobiles have been able to manage working capital efficiently and, thus,
create value for shareholders by way of high ROCE.”

Leveraging on supply chain


HLL, which had a net negative working capital of Rs 183.3 crore in FY05, has been able
to maintain its creditor days at 64 as compared to receivable days at 16. The company has
generated a ROCE at 44.1%. On the other hand, Godrej Consumer Products (GCPL) is
another company with negative working capital of Rs 45.48 crore and creditor days at 53,
compared to average debtors of six days only. The company has earned an ROCE at
almost 158%.

Says Sunil Sapre, vice-president, finance, Godrej Consumer Products (GCPL): “Effective
use of ERP systems, involving trade partners in planning and monitoring working capital
items, following win-win policies, efficient operations at all levels enable GCPL to
manage working capital efficiently. It has given us an advantage of higher sales and better
ROCE.”

The strong distribution and dominant position in the FMCG industry has made these
companies to bargain with the debtors and creditors to expand the payment cycle in
favour of the company.

The FMCG companies have been able to keep their creditors almost equal to debtors and
inventory, which have resulted in a lot of cash generation for these companies, which is
again invested in the business. These companies also make investment in short-term
papers and call money, which allows them to earn good returns.

“Traditionally, the FMCG companies are known for maintaining negative working capital
which is leveraged on strong supply chain management. Since this industry accounts for
very negligible amount of debtors, the whole trade is financed by creditors from the
production side and vendors and dealers from the supply side,” says an FMCG analyst.

The fast track

For the automobile industry, the most critical factor of the working capital is inventory
management. In the two-wheeler segment, Hero Honda and Bajaj Auto have negative
working capital of Rs 1047 crore and Rs 344 crore and generate RoCE of 81% and
21.6%, respectively. The Indian automobile industry has come a long way in terms of
managing inventory. The inventory-turnover ratio in the last five years has improved
more than two times.

Companies have been able to produce fast and sell in the market and realise the cash.
Hero Honda, which had an inventory turnover ratio of as low as 18.50 in FY01 has
improved significantly to 47.59 and Bajaj Auto notched it from 17.14 for FY01 to 32.37
in FY05.

Says Ravi Sud, CFO, Hero Honda, “Hero Honda has asked its major suppliers to have
their warehouses around its manufacturing locations to reduce the inventory at our end.
The concept of direct on line has been implemented for about 100 vendors where the
material is supplied directly on the assembly line without being stored.”
Hero Honda has managed its working capital very efficiently and has been having
negative working capital for the last six years. The inventory number of days has come
down from 29 days in 1999 to 10 days in 2005 due to indigenous production. Imported
inventory has reduced to about 30 days stock in the factory and similar stock is kept in
transit due to long transportation time.

It is evident that the companies have significantly reduced the level of inventory. In the
four-wheeler and commercial vehicle segment, Tata Motors has a negative working
capital of Rs19.92 crore and a ROCE of 32.76%. The companies with good brand image
have been the major beneficiaries of the country's booming automobiles market.

On the one hand, these companies have been giving bulk orders to auto ancillaries
companies while sourcing the auto parts with the condition of extended credit cycles. On
the other hand, the dealers have been pushed to pay upfront or in advance.

Companies like Hero Honda, Bajaj Auto and TVS Motors enjoy a significant gap of
number of days between the payment to creditors and their receivables. Receivables are
managed through implementing a credit policy, which rewards efficient dealers and
penalises inefficient ones.

The dealers are required to keep 15 days paid-up stock and then enjoy 15 days credit for
stock beyond 15 days. If the payment is not received within 15 days, the interest is
charged from day one. This does not mean that companies with high working capital do
not generate returns to their shareholders. It is in the nature of some businesses to sustain
efficiency in managing their working capital, while some industries are simply working
capital-intensive.

But even for industries that have high working capital, they need to generate higher
revenues to maintain a healthy operating ratio. But negative working capital is one
important parameter that no successful investor has ever missed.

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Successful investors have always given a lot of thrust on working capital management. A
study of top Indian companies with high return on capital employed (ROCE) shows that
many of these companies have operated on negative working capital management. These
companies are known to give good returns to their shareholders, both in terms of
dividends and capital gains. Interestingly, most of these companies belong to the FMCG
or the auto sector.
Of the 30 stocks in the Sensex, seven stocks have negative working capital and ROCEs in
the range of 20-80%. The total market capitalisation of these companies has moved up by
94% as against the entire Sensex, which moved up by 67% over the last one year.

Industries like steel and cement, which are working capital-intensive, may not show high
ROCEs on account of high capital costs. But some companies have begun to show
negative working capital. A better credit management system will help these companies
generate higher ROCEs in the long run.

Today, cement companies carry a feedstock ranging from 5-6 days; it was earlier around
15-30 days.

Overall, the cement industry's inventory turnover ratio is in the range of 10-12. Piling
cement stocks in the warehouses of the companies is no longer a phenomenon. When the
cement dispatches from the warehouses are growing at more than 20-30%, Indian cement
companies are able to move cement from factories in less than a day.

As a result of this, top cement companies such as ACC, Gujarat Ambuja, UltraTech
Cement and Madras Cement have negative working capital. The same companies have
given high returns to their shareholders in terms of dividends, bonuses as well as capital
gains.

Negative is positive

HLL, Nestle and Godrej Consumers Products Ltd have ROCE in excess of 40%. The
same goes for two-wheeler companies like Bajaj Auto, TVS and Hero Honda, which have
given high returns on their investment. The success of this high return is associated with
the way these companies have managed their working capital management cycles.

These are the companies that first sell their goods and later on pay their raw material
suppliers. This is possible only when the companies are huge in size and account for the
bulk of turnover for their suppliers. In such a situation, they are always in a position to
arm-twist the suppliers by taking more credit.

Says Jigar Shah of broking firm KR Choksey: “Companies operating in industries like
FMCG and automobiles have been able to manage working capital efficiently and, thus,
create value for shareholders by way of high ROCE.”

Leveraging on supply chain

HLL, which had a net negative working capital of Rs 183.3 crore in FY05, has been able
to maintain its creditor days at 64 as compared to receivable days at 16. The company has
generated a ROCE at 44.1%. On the other hand, Godrej Consumer Products (GCPL) is
another company with negative working capital of Rs 45.48 crore and creditor days at 53,
compared to average debtors of six days only. The company has earned an ROCE at
almost 158%.
Says Sunil Sapre, vice-president, finance, Godrej Consumer Products (GCPL): “Effective
use of ERP systems, involving trade partners in planning and monitoring working capital
items, following win-win policies, efficient operations at all levels enable GCPL to
manage working capital efficiently. It has given us an advantage of higher sales and better
ROCE.”

The strong distribution and dominant position in the FMCG industry has made these
companies to bargain with the debtors and creditors to expand the payment cycle in
favour of the company.

The FMCG companies have been able to keep their creditors almost equal to debtors and
inventory, which have resulted in a lot of cash generation for these companies, which is
again invested in the business. These companies also make investment in short-term
papers and call money, which allows them to earn good returns.

“Traditionally, the FMCG companies are known for maintaining negative working capital
which is leveraged on strong supply chain management. Since this industry accounts for
very negligible amount of debtors, the whole trade is financed by creditors from the
production side and vendors and dealers from the supply side,” says an FMCG analyst.

The fast track

For the automobile industry, the most critical factor of the working capital is inventory
management. In the two-wheeler segment, Hero Honda and Bajaj Auto have negative
working capital of Rs 1047 crore and Rs 344 crore and generate RoCE of 81% and
21.6%, respectively. The Indian automobile industry has come a long way in terms of
managing inventory. The inventory-turnover ratio in the last five years has improved
more than two times.

Companies have been able to produce fast and sell in the market and realise the cash.
Hero Honda, which had an inventory turnover ratio of as low as 18.50 in FY01 has
improved significantly to 47.59 and Bajaj Auto notched it from 17.14 for FY01 to 32.37
in FY05.

Says Ravi Sud, CFO, Hero Honda, “Hero Honda has asked its major suppliers to have
their warehouses around its manufacturing locations to reduce the inventory at our end.
The concept of direct on line has been implemented for about 100 vendors where the
material is supplied directly on the assembly line without being stored.”

Hero Honda has managed its working capital very efficiently and has been having
negative working capital for the last six years. The inventory number of days has come
down from 29 days in 1999 to 10 days in 2005 due to indigenous production. Imported
inventory has reduced to about 30 days stock in the factory and similar stock is kept in
transit due to long transportation time.
It is evident that the companies have significantly reduced the level of inventory. In the
four-wheeler and commercial vehicle segment, Tata Motors has a negative working
capital of Rs19.92 crore and a ROCE of 32.76%. The companies with good brand image
have been the major beneficiaries of the country's booming automobiles market.

On the one hand, these companies have been giving bulk orders to auto ancillaries
companies while sourcing the auto parts with the condition of extended credit cycles. On
the other hand, the dealers have been pushed to pay upfront or in advance.

Companies like Hero Honda, Bajaj Auto and TVS Motors enjoy a significant gap of
number of days between the payment to creditors and their receivables. Receivables are
managed through implementing a credit policy, which rewards efficient dealers and
penalises inefficient ones.

The dealers are required to keep 15 days paid-up stock and then enjoy 15 days credit for
stock beyond 15 days. If the payment is not received within 15 days, the interest is
charged from day one. This does not mean that companies with high working capital do
not generate returns to their shareholders. It is in the nature of some businesses to sustain
efficiency in managing their working capital, while some industries are simply working
capital-intensive.

But even for industries that have high working capital, they need to generate higher
revenues to maintain a healthy operating ratio. But negative working capital is one
important parameter that no successful investor has ever missed.

Multi Page
Format
Working Capital Dubai Real Estate Leading Edge SCM
Q&A Luxury Apartments in Dubai Learn how supply chain
Get Working Capital Advice From and UAE management
Finance.Toolbox.com www.TheFirstGroup.com www.scm-institute.org
Ads by Google
Discuss this story on expressindia forums

The basics of ratio analysis


N. R. Parasuraman

WHILE the profit and loss (P&L) account of a company essentially contains revenue
items, appropriation and provisions, the balance-sheet lists out the assets and
liabilities.

While it is useful to understand the absolute quantum of each asset, liability and
revenue item in isolation, far greater understanding of its implication with respect to
the trend and performance of the company can be achieved by a `relationship' study.
For instance, if one studies profits in relation to sales for the current year and
compares it with the same relationship for a series of years, a greater understanding
of the trend and performance can be had.

The `relationship' study referred has two facets: i) the relationship of one item to
another for the current or previous years, but in respect of the same company, and
ii) the relationship of these parameters with industry figures or representative figur
es of competitors or of firms of similar size and operations. The first set enables one
to understand the performance of the company in isolation, while the second gives
an insight as to where the company stands vis-a-vis the industry or competition.

The intuitive way of arriving at a `relationship' is to develop ratios among key


parameters. After the finalised statement of accounts is ready, one ascertains the
ratio of one key parameter to another. A large number of ratios are in common use,
but som e of these are useful only for specific end uses such as project appraisal,
working capital analysis, securities analysis, and so on. This discussion is restricted
to only those ratios which are universal in nature and which can be computed easily.

The liquidity ratios give a clear indication of the extent to which a company is liquid.
Liquidity and profitability are two separate yardsticks to gauge a company's
performance. The current ratio gives an indication of the number of times by which
the c urrent assets multiply the current liabilities. In a healthy industry, the current
ratio should be upwards of 1.75. A figure of less than 1.25 would indicate that the
company's working capital management has to be pretty rigid to keep the liquidity
afloa t. The quick or acid test ratio is a modification of the current ratio in that only
the `quick' assets are considered in the numerator, and inventory, which is the
slowest of the current assets, is ignored. The measure gives the extent of fast
liquidity enjoyed by the company.

Just as important as liquidity is the level of profitability. While absolute figures of


profitability may be adequate for some cases, a better understanding of the
performance of a company can be had by studying the profits in relation to select
paramete rs such as sales, capital employed and equity capital. These relationships
are covered under profitability ratios. It may be noted that for return on equity, only
the net income after interest is taken, whereas for return on assets, the net income
before interest. This is because, in the latter ratio we are looking at what the total
investment fetched and not what is left for the equity holders.

The debt ratio can ascertain the extent of reliance of external financing. The debt-
equity ratio gives the proportion of debt to equity. In capital-intensive industries, this
ratio can be as high as four -- that is, debt can be up to four times the equit y
portion. Normally, a debt-equity ratio of two is considered acceptable. The `times
interest earned ratio' is a matter or reassurance to the lenders that their interest
dues are protected. If the company is doing well in terms of having a high times int
erest earned ratio, it means that the interest liability is only a relatively small portion
of the company's net surplus. However, if the ratio is small, there is cause for
concern for the lender.

Only the most essential and fundamental ratios are considered here. Depending on
the specific needs of the user, more ratios can be utilised.
By comparing the various ratios with those of the previous year or years, the areas
where the company has improved can be identified; as also the spheres where
finances display a fall in the performance. This will act as a good planning tool.

Ratios have far greater utility if compared with those of the industry as a whole and
those of the competitors. Specific areas which need improvement can be identified
and corrective action initiated.

Concept check

* A high profit-to-sales ratio means that the return on assets is also high. Do you
agree?

* Suppose you are viewing key ratios of a company from the angle of a term-lending
institution, and find that the quick ratio is less than one but the current ratio and the
times interest earned ratio are 1.2 and 2 respectively, what will be your assessm ent
about the interest and principal repayment capacity of the company?

Parvatha Vardhini C

A quicker way to understand a company’s performance, rather than poring over pages of accounts, notes and
schedules in the annual report is through ‘ratio analysis’. Ratios can be classified into profitability ratios, coverage,
turnover and financial ratios. We’ll take a look at a few ratios, their relevance and significance.

Profitability/ Return on Investment ratio

We start with profitability rations, as profit is the foremost objective of any business. Are the operations efficient
enough to generate profits? This is what banks/financial institutions and creditors are worried about. After all, their
money can be repaid only when the company is able to generate income from its operations, is it not?
Shareholders, too, are equally concerned about profitability, as it broadly indicates the likely return they can earn
on their investments.

The profitability ratio is calculated as: Operating profit/capital employed x 100. Operating profit is the profit before
interest and taxes (PBIT). Capital employed is share capital + reserve and surplus + long-term liabilities - (non-
business assets + fictitious assets).

Suppose the return is 8 per cent, how will you know whether this is good or bad? As a thumb rule, if the company
has borrowed funds at, say, 7 per cent, the ROI should be greater than 7 per cent for the business to be profitable.

Coverage ratios

The ROI will show if the company is profitable alright; but will the profits be enough to pay interest on loan or repay
the amount? This is where the ‘fixed interest cover’ and ‘debt service coverage’ (DSCR) ratios come in. Calculated
as PBIT/ Interest charges, the higher the fixed interest cover, the better. A comfortable interest cover would be at
least two-three times.

To find out whether a company can repay the principal portion of its loan on time, the DSCR is calculated — the
formula being, PBIT/interest + (principal payment instalment / (1 – tax rate)). A DSCR of over 1 is considered
appropriate. But here again, the higher the coverage, the better.

Turnover ratios

While the ROI is one indicator of profitability, the speed at which capital employed in the business rotates or is
unlocked, is another. The higher the rotation, the greater the profitability. The ‘fixed assets turnover’ ratio (net
sales/ net fixed assets) shows how much of the investment in fixed assets contribute towards sales. Ditto with the
working capital ratios. High volume of sales with a relatively low working capital is an indicator of efficiency.
Credit sales/average accounts receivable will give the debtors turnover ratio. Say the turnover is three times, using
this, we can calculate the collection period (months in a year/debtor’s turnover) as 12 / 3 = 4 months. This
collection period indicates the promptness or the lack of it in money collection. Generally, the receivables should
not exceed three-four months of credit sales. Such calculations can also be made for creditors. Similarly, a high
inventory turnover (cost of goods sold/average inventory) ratio indicates good sales. A low ratio, in turn, indicates
that money is locked up in stocks. The working capital ratios are useful in determining the company’s ability to
generate future cash flows from operations.

Financial ratios

Liquidity and debt-equity ratios are widely used financial ratios. Liquidity ratio, also called the ‘short-term solvency’
ratio shows the adequacy or otherwise of working capital for a company’s day-to-day operations. It is calculated as
current assets/current liabilities. An ideal current ratio would be 2, indicating that even if the current assets are to
be reduced by half, the creditors will be able to able to get their money in full.

But a lot depends on the composition of current assets. If a substantial portion of the current assets is made of
slow-moving/obsolete stocks or if the debtors comprise ageing debts, the company may not be able to pay the
creditors even if the current ratio is higher than 2.

The debt-equity ratio is calculated as total long-term debt/shareholders’ funds. It is considered ideal if the ratio is 1.
This ratio shows the extent of owners’ stake in the business as also the extent to which firm depends upon
outsiders for existence.

Ratio Analysis

Ratio Analysis is the most commonly used analysis to judge the financial strength of
a company. A lot of entities like research houses, investment bankers, financial
institutions and investors make use of this analysis to judge the financial strength of
any company.

This analysis makes use of certain ratios to achieve the above-mentioned purpose.
There are certain benchmarks fixed for each ratio and the actual ones are compared
with these benchmarks to judge as to how sound the company is. The ratios are
divided into various categories, which are mentioned below:

Profitability ratios

Profitability ratios speak about the profitability of the company. The various
profitability ratios used in the analysis are, operating margin (operating profit divided
by net sales), gross margin (gross profit divided by net sales) net profit margin (net
profit divided by net sales), return on equity (net profit divided by net worth of the
company) and return on investment (operating profit divided by total assets). As
obvious from the name, the higher these ratios the better for the company.

Solvency ratios

These ratios are used to judge the long-term solvency of a firm. The most commonly
used ratios are – Debt Equity ratio (total debt divided by total equity), Long term
debt to equity ratio (long term debt divided by equity). While the accepted norm for
debt equity ratio differs from industry to industry, the usual accepted norm for D/E is
2:1. It should not be more than this. For certain industries, a higher D/E is accepted,
e.g., in banking industry, a debt equity ratio of 12:1 is acceptable.

Liquidity ratios
These ratios are used to judge the short-term solvency of a firm. These ratios give
an indication as to how liquid a firm is. The most commonly used ratios are – Current
ratio (all current assets divided by current liabilities) and quick ratio (current assets
except inventory divided by current liabilities). The accepted norm for current ratio is
1.5:1. It should not be less than this.

Turnover ratios

These ratios give an indication as to how efficiently a company is utilizing its assets.
The most commonly ratios are sales turnover ratio, inventory turnover ratio (average
inventory divided by net sales) and asset turnover ratio (net sales divided by total
assets). The higher these ratios, the better for the company.

Valuation Ratios

Valuation ratios give an indication as to whether the stock is underpriced or


overpriced at any point of time. The most commonly used ratios are Price to Earnings
(P/E) ratio and price to book value (PBV) ratio. But care has to be taken while
interpreting these ratios. While P/E ratio of a company should be compared with the
industry P/E and the P/E of the competitors, it is the PBV that can distort.

While a lower PBV usually means a lower valuation, there can be a case where a low
PBV can be because of a very huge capital base of the company. In such a case, the
stock might be overvalued but the PBV will indicate that the stock is undervalued. On
the other extreme, a higher PBV usually means overvalued stock but that can also be
because the company has a very small capital base. So care has to taken while
interpreting these ratios.

Coverage ratios

These ratios give an indication about the repayment capabilities of a company. The
most commonly used coverage ratios are Interest coverage ratio (Interest
outstanding divided by earnings before interest and taxes) and debt service coverage
ratio (earnings before interest and taxes plus all non cash charges divided by interest
outstanding plus the term loan repayment installment). The acceptable norm for
DSCR is 2:1.

Ratio Analysis

Not all corporates can raise capital from the market. Capital
market is an information driven arena. The availability of
market capital to an existing corporate depends solely on its
perceived performance. The market watchers have, at their
disposal, various tools to make this value judgement. Ratio
analysis is one such oft used (or abused) tool. The trends in
management, financial viability and other factors relevant
from the point of view of the market can be studied from the
various financial ratios such as:

Leverage Indicators (debt-equity ratio)


Cost ratios
Current ratios
Retained earning ratios
Dividend ratios etc.

The indicators of profitability of companies are:

Profits to sales ratios


Profits (EBDIT) to total capital employed ratio,
Operating profit to sales ratios and
Profit to tangible Net worth ratio.

Other ratios and percentages:

Profit allocation ratios


Profitability ratios
Capital formation growth rates
Ratios on sources and uses of funds
Activity ratios

Ratio analysis is a useful tool of for both micro and macro


financial appraisal. Like all other analytical tools, its
usefulness depends on the user and the purpose. There are no
standard ratios applicable to all purposes and situations.
Certain ratios are more useful at micro level and others at
macro level. Broadly, ratios represent a relation between two
variables chosen and the type of relation set out has to be
seen for a particular purpose. Any number of such ratios can
be designed depending upon the purpose of the analysis. In
isolation, ratios can be used only for time-series analysis
of the company' performance. In such an analysis, continuing
inefficiencies built into the system of a corporate escape
observation. Very important factors in ratio analysis,
therefore, are benchmarking and cross-sectional analysis.
With the availability of commercial databases in the market
these tools can also be used to accurately analyse the
performance of a corporate.

Ratio analysis, therefore, should be applied, not in


isolation but with reference to a group of companies within
an industry to ascertain its financial viability, and other
relevant factors. This same tool can also be used at the time
of taking investment decisions.

RATIO ANALYSIS
Mere statistics/data presented in the different financial statements do not reveal the true picture of a financial
position of a firm. Properly analyzed and interpreted financial statements can provide valuable insights into a
firm’s performance. To extract the information from the financial statements, a number of tools are used to
analyse such statements. The most popular tool is the Ratio Analysis. Financial ratios can be broadly
classified into three groups: (I) Liquidity ratios, (II) Leverage/Capital structure ratio, and (III) Profitability
ratios.
(I) Liquidity ratios:
Liquidity refers to the ability of a firm to meet its financial obligations in the short-term which is less than a
year. Certain ratios, which indicate the liquidity of a firm, are (i) Current Ratio, (ii) Acid Test Ratio, (iii)
Turnover Ratios. It is based upon the relationship between current assets and current liabilities.
(i) Current ratio = Current Assets/ Current Liabilities
The current ratio measures the ability of the firm to meet its current liabilities from the current assets. Higher
the current ratio, greater the short-term solvency (i.e. larger is the amount of rupees available per rupee of
liability).
(ii) Acid-test Ratio = Quick Assets/ Current Liabilities
Quick assets are defined as current assets excluding inventories and prepaid expenses. The acid-test ratio
is a measurement of firm’s ability to convert its current assets quickly into cash in order to meet its current
liabilities. Generally speaking 1:1 ratio is considered to be satisfactory.
(iii) Turnover Ratios:
Turnover ratios measure how quickly certain current assets are converted into cash or how efficiently the
assets are employed by a firm. The important turnover ratios are: Inventory Turnover Ratio, Debtors
Turnover Ratio, Average Collection
Period, Fixed Assets Turnover and Total Assets Turnover
Inventory Turnover Ratio = Cost of Goods Sold / Average Inventory
Where, the cost of goods sold means sales minus gross profit. ‘Average Inventory’ refers to simple average
of opening and closing inventory. The inventory turnover ratio tells the efficiency of inventory management.
Higher the ratio, more the efficient of inventory management.
Debtors’ Turnover Ratio = Net Credit Sales / Average Accounts Receivable (Debtors)
The ratio shows how many times accounts receivable (debtors) turn over during the year. If the figure for net
credit sales is not available, then net sales figure is to be used. Higher the debtors turnover, the greater the
efficiency of credit management.
Average Collection Period = Average Debtors / Average Daily Credit Sales
Average Debtors
Average Collection Period represents the number of days’ worth credit sales that is locked in debtors
(accounts receivable).
Average Collection Period = 365 Days / Debtors Turnover
Fixed Assets turnover ratio measures sales per rupee of investment in fixed assets. In other words, how
efficiently fixed assets are employed. Higher ratio is preferred. It is calculated as follows:
Fixed Assets turnover ratio = Net. Sales / Net Fixed Assets
Total Assets turnover ratio measures how efficiently all types of assets are employed.
Total Assets turnover ratio = Net Sales / Average Total Assets
(II) Leverage/Capital structure Ratios:
Long term financial strength or soundness of a firm is measured in terms of its ability to pay interest regularly
or repay principal on due dates or at the time of maturity. Such long term solvency of a firm can be judged by
using leverage or capital structure ratios. Broadly there are two sets of ratios: First, the ratios based on the
relationship between borrowed funds and owner’s capital which are computed from the balance sheet.
Some such ratios are: Debt to Equity and Debt to Asset ratios. The second set of ratios which are calculated
from Profit and Loss Account are: The interest coverage ratio and debt service coverage ratio are coverage
ratio to leverage risk.
(i) Debt-Equity ratio reflects relative contributions of creditors and owners to
finance the business.
Debt-Equity ratio = Total Debt / Total Equity
The desirable/ideal proportion of the two components (high or low ratio) varies from industry to industry.
(ii) Debt-Asset Ratio: Total debt comprises of long term debt plus current liabilities. The total assets comprise
of permanent capital plus current liabilities.
Debt-Asset Ratio = Total Debt / Total Assets
The second set or the coverage ratios measure the relationship between proceeds from the operations of
the firm and the claims of outsiders.
(iii) Interest Coverage ratio = Earnings Before Interest and Taxes /Interest
Higher the interest coverage ratio better is the firm’s ability to meet its interest burden. The lenders use this
ratio to assess debt servicing capacity of a firm.
(iv) Debt Service Coverage Ratio (DSCR) is a more comprehensive and apt to compute debt service
capacity of a firm. Financial institutions calculate the average DSCR for the period during which the term
loan for the project is repayable. The Debt Service Coverage Ratio is defined as follows:
DSCR - Profit after tax Depreciation Other Non-cash Expenditure Interest on term loan / Interest on Term
loan Repayment of term loan
(III) Profitability ratios:
Profitability and operating/management efficiency of a firm is judged mainly by the following profitability
ratios:
(i) Gross Profit Ratio (%) = Gross Profit / Net Sales * 100
(ii) Net Profit Ratio (%) = Net Profit / Net Sales * 100
Some of the profitability ratios related to investments are:
(iii) Return on Total Assets = Profit Before Interest And Tax / (Fixed Assets Current Assets)
(iv) Return on Capital Employed = Net Profit After Tax / Total Capital Employed (Here, Total Capital
Employed = Total Fixed Assets + Current Assets - Current Liabilities)
(v) Return on Shareholders’ Equity = Net profit After-Tax / Average Total Shareholders Equity or Net Worth
(Net worth includes Shareholders’ equity capital plus reserves and surplus) A common (equity) shareholder
has only a residual claim on profits and assets of a firm, i.e., only after claims of creditors and preference
shareholders are fully met, the equity shareholders receive a distribution of profits or assets on liquidation. A
measure of his well being is reflected by return on equity.
There are several other measures to calculate return on shareholders’ equity of which the following are the
stock market related ratios:
(i) Earnings Per Share (EPS): EPS measures the profit available to the equity shareholders per share, that
is, the amount that they can get on every share held. It is calculated by dividing the profits available to the
shareholders by number of outstanding shares. The profits available to the ordinary shareholders are arrived
at as net profits after taxes minus preference dividend. It indicates the value of equity in the market.
EPS = Net profit AvailableToThe Shareholder / Number of Ordinary Shares Outstanding
(ii) Price-earnings ratios = P/E Ratio = Market Pr ice per Share / EPS
Abbreviations:NSE- National Stock Exchange of India Ltd.SEBI - Securities Exchange Board of IndiaNCFM -
NSE’s Certification in Financial MarketsNSDL - National Securities Depository LimitedCSDL - Central
Securities Depository LimitedNCDEX - National Commodity and Derivatives Exchange Ltd.NSCCL -
National Securities Clearing Corporation Ltd.FMC – Forward Markets CommissionNYSE- New York Stock
ExchangeAMEX - American Stock ExchangeOTC- Over-the-Counter MarketLM – Lead ManagerIPO- Initial
Public OfferDP - Depository ParticipantDRF - Demat Request FormRRF - Remat Request FormNAV – Net
Asset ValueEPS – Earnings Per ShareDSCR - Debt Service Coverage RatioS&P – Standard & PoorIISL -
India Index Services & Products LtdCRISIL- Credit Rating Information

Companies despatch their annual reports once every accounting year (normally 12
months). With these reports running into hundreds of pages, how do you quickly
understand a company's performance over this period? As accounts are prepared
using the double-entry system, every item is linked to at least one other item.

Hence, understanding financial ratios would help profile a company. These ratios are
broadly classified as leverage, liquidity, efficiency and profitability ratios. We shall
first focus on the profitability ratios for, as investors, we are more concerned with the
company's earnings than with its operational efficiency, capital structure or its ability
to meet debt obligations.

Margin ratios

Margin ratios, one of the key measures of profitability, show the efficiency of the firm
in retaining revenues. These can be classified further into gross margin, operating
margin and net margin ratios.

The operating margin ratio is calculated by dividing the operating income (net sales
minus production, administration and selling and distribution costs) by net sales. In
other words, it is the percentage of revenue earned in excess of production,
administration and selling and distribution costs. Realisations or billing rates and
operating cost per unit are among the key factors that drive this ratio. Volumes,
though not as pivotal as the earlier mentioned factors, also play a role.

The operating margin also serves as an indicator of the cost-competitiveness


compared to peers where individual costs cannot be determined easily. For example,
while India Cements has an operating margin of about 13 per cent, its peer, Madras
Cements has about 15 per cent.
The net profit margin, another key measure of profitability, is calculated by dividing
post-tax earnings by net sales. It is the percentage of revenue that accrues to the
owners of the entity. This ratio is a function of the operating margin, interest
coverage and the rate of incidence of tax.

While high margins are desirable, as they provide a cushion against the risk of
adverse changes, investors need to look at the structure of the margins to determine
the sustainability and scope for improvement.

A significantly high margin needs to be treated with caution as threats from new
entrants and substitute products are higher. Tendency to hike capacities, leading to
overcapacity, is also more; the recent trend in the caustic soda industry is case in
point.

While the above two measures of profitability are derived from the income statement
(simply, the profit-and-loss account) the following two return ratios are derived from
both the income statement and the balance-sheet.

Return on capital employed

This ratio indicates the profitability of an entity's capital investments. Why does this
ratio matter to an investor? If this ratio is lower than the rate at which the company
borrows, any further rise in debt will lead to negative earnings growth.

Return on Net worth

This ratio indicates an entity's profitability and efficiency, and is arrived at by dividing
earnings after taxes by the shareholder's funds. This ratio, a combination of three
underlying factors, is related to profit margin, asset management, and leverage.
When an investor goes by the price-to-book value measure, he should consider this
ratio as it aids in measuring the rate at which a company improves its shareholder
funds.

Although a high RONW is desirable, the stability of this ratio plays a significant role.
A key reason for the steady run-up in the price of Infosys Technologies is the fact
that the company has recorded an average RONW of 40 per cent over the past five
years. This would indicate that the company has grown more than four-fold in this
period.

Analysis of Financial Statement Chapter VI

Answers to the very short answers questions.

Ans.1 Analysis of Financial statement is the systematic process of identifying


the financial strength and weaknesses of the firm by establishing the
relationship between the items of the Balance Sheet and income
statement.
Ans.2 Bank and financial institutions are interested to know the financial
position and profitability of the firm before granting any loan to the firm.

Ans.3 In a comparative Balance sheet, assets, liabilities and capital of current


year are compares with that of previous years.

Ans.4 It is that statement in which net sales figure is taken as 100 and all other
figures are expressed as percentage of sales.

Ans.5 Ratio analysis is the process of computing, determining and presenting


the relationship of items and groups of items in the financial statement,
analysis of Financial statements on the basis of ratios is known as ratio
analysis.

Ans.6 Cash flow statement is a statement which shows inflows and outflows of
cash and cash equivalence of an enterprise during a specified period of
time.

Ans.7 A mutual fund company is a financial enterprises and so a dividend of


Rs. 25 lacs received by this company from its investment in units will be
cash in flow from operating activities.

Ans.8 It is classified under financing activity.

Ans.9 While preparing the cash flow statement according to AS-3 (Revised) the
activities are classified into three groups :

i) Operating activities ii) Investing activities and (iii) Financing


activities.

Ans.10 Dividend paid by a manufacturing company is classified under Financing


activities.
Industry
LIQUIDITY RATIOS 12-31-03 12-31-04 12-31-05 Average

Current Ratio

Total current assets divided by total current


liabilities. 1.3 1.1 1.1 1.4

This ratio is a rough indication of a firm's


ability to service its current obligations.
Generally, the higher the current ratio, the
greater the "cushion" between current
obligations and your Company's ability to
pay them. The composition and quality of
current assets is a critical factor in the
analysis of your Company's liquidity.

Quick Ratio

Cash plus trade receivables divided by total


current liabilities. 0.9 0.8 0.8 0.8

Also know as the "Acid Test" ratio, it is a


refinement of the current ratio and is a more
conservative measure of liquidity. The ratio
expresses the degree to which your current
Company's current liabilities are covered by
the most liquid current assets. Generally, any
value of less than 1 to 1 implies a
"dependency" on inventory or other current
assets to liquidate short-term debt.

Sales/Receivables

Net sales divided by average trade


receivables. 8.4 7.5 6.9 7.4
This ratio measures the number of times
trade receivables turn over during the year.
The higher the turnover of receivables, the
shorter the time between sale and cash
collection. If your Company's receivables
appear to be turning slow, further research is
needed and the quality of the receivables
should be examined closely.

A problem with this ratio is that it compares


one day's receivables, shown at the balance
sheet date, to total annual sales and does not
take into consideration seasonal fluctuations.
An additional problem in interpretation may
arise when there is a large proportion of cash
sales to total sales.

Days' Receivables

The sales/receivables ratio divided into 365


(days in year). 43 49 53 49

This figure expresses the average time in days


that receivables are outstanding. Generally,
the greater number of days outstanding, the
greater the probability of delinquencies in
accounts receivable. Your Company's daily
receivables may indicate the extent of the
Company's control over credit and
collections.

Cost of Sales/Inventory

Cost of sales divided by average inventory. 11.0 13.0 13.1 9.8

This ratio measures the number of times


inventory is turned over during the year.
High inventory turnover can indicate better
liquidity or superior merchandising.
Conversely, it can indicate a shortage of
needed inventory for sales. Low inventory
turnover can indicate poor liquidity, possible
overstocking, obsolescence, or in contrast to
these negative interpretations a planned
inventory buildup in the case of material
shortages.

A problem with this ratio is that it compares


one day's inventory to cost of goods sold and
does not take seasonal fluctuations into
account.

Days' Inventory

The cost of sales/inventory ratio divided into


365 (days in year). 33 28 28 37

This figure expresses the average time in days


that units are in inventory.

Cost of Sales/Payables

Cost of sales divided by average trade


payables. 8.0 5.9 5.6 8.9

This ratio measures the number of times


trade payables turn over during the year. The
higher the turnover of payables, the shorter
the time between purchase and payment. If
your Company's payables appear to be
turning slow, then the Company may be
experiencing cash shortages, disputing
invoices with suppliers, enjoying extended
terms, or deliberately expanding its trade
credit. If your Company buys on 30-day
terms, it is reasonable to expect this ratio to
turn over in approximately 30 days.

A problem with this ratio is that it compares


one day's payables to cost of goods sold and
does not take seasonal fluctuations into
account.

Days Payables

The cost of sales/payables ratio divided into


365 (days in year). 46 61 65 41
This figure expresses the average time in days
that payables are outstanding.

Sales/Working Capital

Net sales divided by working capital. 22.4 47.3 39.1 13.6

Working capital is a measure of the margin of protection for current creditors. It


reflects the ability to finance current operations. Relating the level of sales arising
from operations to the underlying working capital measures how efficiently working
capital is employed. A low ration may indicate an inefficient use of working capital
while a very high ratio often signifies overtrading - vulnerable position for creditors.
Industry
COVERAGE RATIOS 12-31-03 12-31-04 12-31-05 Average

Earnings Before Interest and Taxes


(EBIT)/Interest

Earnings before annual interest expense and


taxes divided by annual interest expense. 4.3 -0.0 1.8 2.4

This ratio is a measure of your Company's


ability to meet interest payments. A high ratio
may indicate that a borrower would have
little difficulty in meeting the interest
obligations of a loan. This ratio also serves as
an indicator of your Company's capacity to
take on additional debt.

Net Profit + Depreciation, Depletion,


Amortization/Current Maturities Long-Term
Debt

Net profit plus depreciation, depletion, and


amortization expenses divided by the current
portion of long-term debt. 3.5 0.6 2.1 3.5

This ratio expresses the coverage of current


maturities by cash flow from operations.
Since cash flow is the primary source of debt
retirement, this ratio measures the ability of
your Company to service principal
repayment and is an indicator of additional
debt capacity. Although it is misleading to
think that all cash flow is available for debt
service, the ratio is a valid measure of the
ability to service long-term debt.

Industry
LEVERAGE RATIOS 12-31-03 12-31-04 12-31-05 Average

Fixes/Worth

Fixed assets (net) divided by tangible net


worth. 0.3 1.3 0.9 0.4

This ratio measures the extent to which


owner's equity (capital) has been invested in
plant and equipment (fixed assets). A lower
ratio indicates a proportionately smaller
investment in fixed assets in relation to net
worth, and a better "cushion" for creditors in
case of liquidation. Similarly, a higher ratio
would indicate the opposite situation. The
presence of substantial leased fixed assets
(not shown on the balance sheet) may
deceptively lower this ratio.

Debt/Worth

Total liabilities divided by tangible net worth. 3.5 3.2 6.0 2.3

This ratio expresses the relationship between


capital contributed by creditors and that
contributed by owners. It expresses the
degree of protection provided by the owners
for the creditors. The higher the ration, the
greater the risk being assumed by creditors.
A lower ratio generally indicates greater
long-term financial safety. A firm with a low
debt/worth ratio usually has greater
flexibility to borrow in the future. A more
highly leveraged company has a more limited
debt capacity.
Industry
OPERATING RATIOS 12-31-03 12-31-04 12-31-05 Average

Profits Before Taxes/Tangible Net Worth

Profit before taxes divided by tangible net


worth. 48.2% -16.8% 13.3% 22.4%

This ratio expresses the rate of return on


tangible capital employed. While it can serve
as indicator of management performance,
one is cautioned to use it in conjunction with
other ratios. A high return normally
associated with effective management, could
indicate an undercapitalized firm. Whereas, a
low return, usually an indicator of inefficient
management performance, could reflect a
highly capitalized, conservatively operated
business.

Profit Before Taxes/Total Assets

Profit before taxes divided by average total


assets. 10.7% -2.7% 2.0% 6.0%

This ratio expresses the pre-tax return on


total assets and measures the effectiveness of
management in employing the resources
available to it. A heavily depreciated plant
and a large amount of intangible assets or
unusual income or expense items will cause
distortions of this ratio.

Sales/Net Fixed Assets

Net sales divided by net fixed assets. 72.3 21.9 33.5 28.5

This ratio is a measure of the productive use


of your Company's fixed assets. Largely
depreciated fixed assets or a labor intensive
operation may cause distortion of this ratio.

Sales/Total Assets

Net sales divided by net fixed asserts. 4.8 4.6 4.3 3.1

This ratio is a general measure of your


Company's ability to generate sales in
relation to total assets. It should be used in
conjunction with other operating ratios to
determine the effective employment of assets.

Depreciation Expense as Percentage of


Property, Plant and Equipment (PPE)

Annual depreciation expense divided by PPE


(net) 72.0% 30.2% 54.0% NA

This ratio indicates the reasonableness and


consistency of depreciation over time. It
should be fairly stable unless changes
occurred in depreciation methods,
composition or life of assets.
Repairs and Maintenance as Percentage of
Property, Plant and Equipment (PPE)

Annual repairs and maintenance expense


divided by PPE (net) 20.9% 2.5% 5.1% NA

This ratio is used as a measure of


reasonableness in determining classification
errors between capital expenditures and
expenses.
EXPENSE TO SALES RATIO Industry
12-31-03 12-31-04 12-31-05 Average

Depreciation, Depletion, Amortization/Sales

Annual depreciation, amortization and


depletion expenses divided by net sales. 1.0% 1.4% 1.6% 1.0%

This ratio relates depreciation, depletion and


amortization expenses to net sales.
Comparisons are convenient because the
item, net sales, is used as a constant.

Officers', Directors', Owners',


Compensation/Sales

Annual officers', directors'. owners'


compensation divided by net sales. 8.9% 12.8% 14.1% 3.4%

This ratio relates officers', directors' and


owners' compensation to net sales.
Comparisons are convenient because the
item, net sales, is used as a constant.

Industry
GOING-CONCERN EVALUATION 12-31-03 12-31-04 12-31-05 Average

"Z" Score Measure of Going-Concern


Measures the Probability of Bankruptcy for
the Company

(Working Capital / Total Assets) *.717 0.15 0.06 0.08


0.16 0.09 0.10
(Retained Earnings / Total Assets) *.847

(Operating Income / Total Assets) *3.107 0.43 -0.17 .013

(Net Worth / Total Liabilities) *3.107 0.12 0.07 0.07

(Sales / Total Assets) *.998 4.79 3.92 4.08

"Z" Score 5.65 3.97 4.45

"Z" Score Probability of


Bankruptcy

1.10 or less very high probability

1.11 to 2.60 not sure (gray area)

2.60 or higher very low probability

Industry
FACTORS USED IN COMPUTATIONS 12-31-03 12-31-04 12-31-05 Average

Cash and equivalents 31,191 8,041 3,839

Accounts receivable - beginning of year 682,770 831,112 1,086,025

Accounts receivable - end of year 831,112 1,086,025 1,284,899

Inventory - beginning of year 425,035 373,559 388,481

Inventory - end of year 373,559 388,481 452,222

Prepaid expenses 0 750 967

Total current assets 1,239,095 1,499,772 1,758,149

Total property, plant ad equipment 571,689 817,425 865,630

Total accumulated depreciation 483,603 489,513 621,401

Total assets - beginning of year 1,329,997 1,328,188 1,828,691


1,328,188 1,828,691 2,003,010
Total assets - end of year

Current portion of long-term debt 59,485 89,166 80,597

Accounts payable - beginning of year 412,245 691,790 982,168

Accounts payable - end of year 691,791 982,168 968,012

Total current liabilities 954,754 1,347,890 1,548,601

Total long-term debt 78,467 227,686 168,450

Total liabilities 1,033,221 1,575,576 1,717,051

Notes payable to owners 0 0 0

Retained earnings 246,166 204,314 237,158

Stockholders' equity - beginning of year 349,658 294,967 253,115

Stockholders' equity - end of year 294,967 253,115 285,959

Prior year sales 5,637,280 6,370,493 7,187,971

Current year sales 6,370,493 7,187,971 8,191,767

Purchases 4,424,793 5,048,906 5,643,560

Cost of sales 4,397,672 4,969,490 5,503,060

Bad debt expense 0 0 0

Officers', directors' and owners


compensation 565,000 917,500 1,154,533

Amortization expense 0 0 0

Depreciation expense 63,415 99,080 131,887

Repairs and maintenance 18,399 8,224 12,420

Provision for Federal Income Taxes 0 0 0

Operating expenses 1,789,147 2,320,555 2,606,678

Interest expense 43,280 40,627 46,059


Other expenses (net) - including interest
expense 41,501 59,616 43,914

Net income (loss) 142,170 (42,458) 38,115

Financial and Management Accounting

Unit 1

1. the success of a business entity depends on the combined effects of four factors –
land , labour ,managements and
a. capital
b. finance
c. share
d. assets
2. without accounting a business entity cannot communicate with
a. inside world
b. outside world
c. general
d. majors
3. certain ground rules were initially set for financial accounting also called
a. golden rules
b. accounting conventions or concepts
c. accounts results
d. ledgers
4. a corporate entity is a separate legal entity , entirely divorced from its ……..
a. company
b. customer
c. owners
d. none
5. a ……………… normally comes to an end with the expiry of the owners.
a. Partnership business
b. Corporate business
c. Sole proprietorship business
d. Enterprise business
6. a ………………….. entity is not distributed at all on the expiry of any equity
shareholders
a. corporate
b. sole proprietor
c. assets
d. liability
7. Human intervention normally ends with the preparation of necessary documents
called
a. Vouchers
b. Ledgers
c. Accounts
d. Balance sheets
8. the ………….. voucher is drawn to record all non-cash transaction and events.
a. Journal
b. Payment
c. Receipt
d. Memo
9. ……….. are end products of the accounting process.
a. Balance sheet
b. Profit and loss a/c
c. Financial statements
d. None
10. the three basic elements of balance sheets –
a. assets
b. liability
c. equity
d. cash
11. A…………. is a present obligation of the enterprises arising from past events
a. Assets
b. Liability
c. Cash
d. Profit
12. ………. Is the access of assets over liabilities
a. equity
b. Cash
c. Profit
d. None
13. fundamental accounting equation is
a. A=L+E
b. A=L-E
c. A=L/E
d. A=LxE
14. The amount at which equity is shown in the balance sheets is dependent on
measuring of ……….. and ………..
a. Assets , liabilities
b. Profit , loss
c. Capital , liabilities
d. Shares, debitors
15. the principle of the double entry accounting were first explained in print by ……
…….
a. Luca Fra Pacioli
b. Newton
c. Summa de
d. None
16. anticipates no profits but provide for all possible losses
a. concept of prudence
b. the realization concept
c. accounting concept
d. none
1. Unit 2
17. ……….. is a book of first entry or prime entry
a. voucher
b. journal
c. primary book
d. secondary book
18. journalise means ……………
a. recording in primary book
b. positing in secondary book
c. preparation of vouchers
d. none
19. in ground rule of journalization increase in assets and decrease in liabilities is
called
a. debit
b. credit
c. profit
d. loss
20. in ground rule of journalization income and gains is also called
a. debit
b. credit
c. both
d. none
21. ………. Records bills raised by suppliers
a. bills payable
b. bills receivable
c. bill quoted
d. cash book
22. …………. Records all residual transaction
a. bills payable
b. bills receivable
c. bill quoted
d. journal proper
23. ……….. records credit sales of goods
a. purchase day book
b. sales day book
c. return onward book
d. return inward book
24. …………. Records goods returned to the suppliers
a. purchase day book
b. sales day book
c. return onward book
d. return inward book
25. if debit side of the bank column is greater than the credit side the balance is a …
……………… balance
a. favorable
b. un favorable
c. unit
d. gain
26. bank balance analysis is done with a document called ………. statements
a. bank reconciliation
b. bank conciliation
c. bank non reconciliation
d. de reconciliation
27. ……….. is a journal and ledger
a. cash book
b. sales day book
c. return onward book
d. return inward book
1. Unit 3
28. date wise transaction is done in
a. primary book
b. ledgers
c. balance sheets
d. secondary books
29. …………. Is a self sufficient secondary book in the sense that all entries in the
primary book will be posted in this ledgers
a. general ledgers
b. debtor ledgers
c. creditor ledgers
d. none
30. ………….. has separate accounts for each supplier
a. general ledgers
b. debtor ledgers
c. creditor ledgers
d. none
31. the motive behind having subsidiary ledgers is to reduce the burden on the ……
…..
a. main ledgers
b. general ledgers
c. debtor ledgers
d. none
32. the controls maintained under general ledger is called
a. mondry
b. sundry
c. controller
d. none
33. “To” is used to represent
a. credit
b. debit
c. both
d. none
34. balancing account is also known as
a. opening account
b. closing account
c. renaming account
d. re opening account
35. the suffix ‘c/d ‘ denotes
a. carried debit
b. carried down
c. carried debtors
d. none
36. due date is normally calculated after ……………… days grace from the date of
maturity.
a. 1
b. 2
c. 3
d. 4
37. ………….. is a formal record of a particular type of transaction
a. credit
b. balance
c. account
d. ledger
38. Sundry creditor means
a. Customer
b. Supplier
c. Organization
d. Entity

Unit 4

39. the purpose of preparing a ………………. Is to check arithmetic accuracy as well


as overview of the operation on a particular date
a. balance sheet
b. trial balance
c. profit and loss a/c
d. none
40. An error committed because of lack of knowledge of the basic accounting
principles is called
a. Error of omission
b. Error of principles
c. Error of accounting
d. None
41. when wages paid for installation of machinery is debited to wages account instead
of machinery account and also not recorded in journal , it will cause
a. Error of omission
b. Error of principles
c. Error of accounting
d. None
42. if the effect of one error is set off by other called
a. Error of omission
b. Error of principles
c. Error of accounting
d. Compensating error
43. from gross profit if we deduct indirect administration and selling expenses and
add other income we get
a. net profit
b. net loss
c. net income
d. net expense
44. ………….. is arrived at by deducting he direct cost of goods sold from sales
proceeds.
a. Gross profit
b. net loss
c. net income
d. net expense
45. …………. Shows the gross profit or loss earned or incurred by a business entity
during an accounting period.
a. Trading account
b. Compensation
c. Accounting trial
d. None
46. an artificial account which appears in the trail balance to accopunt for undetected
errors.
a. Memo account
b. General account
c. Suspense account
d. None
1. Unit 5
47. …………. Is the nucleus of management process
a. decision making
b. management information
c. queries
d. none
48. decision making is linked with
a. planning
b. control
c. implementation
d. execution
49. ……….. is the last phase of management accounting
a. communication of information
b. communication of management
c. execution of information
d. none
50. analysis and interpretation of accounting reports and financial statements.
a. Interpretation phase
b. communication of information
c. communication of management
d. execution of information
51. maintenance of books and recording transactions comes under
a. book keeping
b. stock handling
c. cost accounting
d. management accounting
52. finalization of accounts , preparation of financial statements comes under
a. book keeping
b. stock handling
c. cost accounting
d. financial accounting
53. ………….. shifted focus of accounting from recording and analyzing financial
transactions to gathering information for management decisions.
a. book keeping
b. stock handling
c. cost accounting
d. management accounting
54. ………. Involves identification of various cost elements , classification of cost
into fixed and variable elements and identifying relevant costs in decision making
situation
a. Cost analysis
b. Stock analysis
c. Financial analysis
d. None
55. CVP relation ship means
a. Cost volume Profit relationship
b. Credit volume purchase relationship
c. Credit volume Profit relationship
d. None
56. ……………. Is an essential pre condition for management
a. implementation
b. planning
c. control
d. execution
57. ….. , ……….. and ………….. are three important financial characteristics of a
business entity.
a. Liquidity
b. Solvency
c. Profitability
d. Scalability
58. financial accounting lays emphasis on the past while management accounting
stresses the futures
a. true
b. false
1. Unit 6
59. Ratio is a relationship between two or more variable expressed in
a. Percentage
b. Rate
c. Proportion
d. None
60. is an important techniques of financial analysis
a. ratio analysis
b. percentage analysis
c. cost analysis
d. none
61. liquid ratio is also known as
a. acid test ratio
b. quick ratio
c. cash ratio
d. bank ratio
62. equity ratio is
a. liquidity ratio
b. solvency ratio
c. profitability ratio
d. activity ratio
63. inventory turnover is
a. liquidity ratio
b. solvency ratio
c. profitability ratio
d. activity ratio
64. gross profit ration is
a. liquidity ratio
b. solvency ratio
c. profitability ratio
d. activity ratio
65. debt equity ratio is
a. liquidity ratio
b. solvency ratio
c. profitability ratio
d. activity ratio
66. accounting ratio will be correct only if the accounting data on which they are
based are correct
a. true
b. false

Unit 7

Funds flow analysis

67. …………is a technical device designed to highlight the changes in the financial
conditions of a business enterprise between two balance sheets.
a. funds flow analysis
b. costs analysis
c. market analysis
d. management analysis
68. objectives of funds flow statement is to find out financial strength and weakness
of the business
a. a true
b. b false
69. first steps in preparation of funds flow statement is preparation of schedule
changes in working capital
a. a true
b. b false
70. funds flow statement includes
a. non trading incomes
b. b issue of shares
c. c non operating exp.
d. d all of the above
71. for the purpose of fund flow statement the term fund means…
a. net working capital
b. net assets
c. capital
d. net liability
72. FFO stands for
a. Fund form operation
b. Fund From operation
c. Funds For operation
d. None
73. the fund flow statement describes the sources from which additional funds were
derived and the uses to which these funds were put, is said by
a. newmen
b. Robert newman
c. Robert Anthony
d. None

Unit 8.

cash flow analysis


74. ……………reveals the inflow and outflow of cash during a particular period.
a. Cash flow statements:
b. Funds flow statements
c. Both
d. None
75. show the factors contributing to the reduction of cash balance in spite of
increasing profit or decreasing profit. is one of the objective of CFS
a. true
b. false
76. are the steps of preparing cash flow statements
a. opening of accounts for non –current items ( to find hidden
information )
b. preparation of adjusted p & L account
c. comparisons of current items
d. preparation of cash flow statements
77. cash from operation can be calculated from
a. cash sales –( cash purchase + cash operation expenses )
b. cash sales+( cash purchase + cash operation expenses )
c. cash sales –( cash purchase -cash operation expenses )
d. cash purchase –( cash sales + cash operation expenses )
78. net profit method involves
a. adjustment by profit & loss a/c
b. adjustment by balance sheet
c. adjustment by ledger
d. adjustment by cash book
79. fund flow is less useful than cash flow
a. true
b. false
80. sound position of cash flow means sound fund
a. true
b. false
81. cash flow statements is based on
a. receipts and payments
b. adjusted PL
c. balance sheet
d. none
82. for funds flow statements Increase in assets means increase in working capital
a. true
b. false
83. cash flow statements takes consideration of
a. cash position
b. working capital
c. assets
d. none
84. ………. Are cost which have been applied against the revenue of a particular
period
a. expenses
b. cost
c. marginal cost
d. standard cost
85. on the basis of …………. Costs are classified as direct and indirect costs
a. nature of elements
b. traceability
c. behavior
d. operation or functions
86. administration cost is a type of cost under …………. Cost classification
a. nature of elements
b. traceability
c. behavior
d. operation or functions
87. …………. Cost which doesnot changes in total amount for a given period of time
in spite of changes in quantity of ouput and volume of activity.
a. Fixed cost
b. Variable cost
c. Standard cost
d. Mixed cost
88. Cost which does changes in total amount for a given period of time in proportion
of changes in quantity of ouput and volume of activity.
a. Fixed cost
b. Variable cost
c. Standard cost
d. Mixed cost
89. Partly variable and partly fixed costs are also called
a. Semi variable costs
b. Semi fixed costs
c. Semi marginal cost
d. Standard cost
90. ………. Cost remains constant for given volume of output and at a higher level of
output it increases in a fixed amount
a. Fixed cost
b. Variable cost
c. Standard cost
d. Step costs
91. Non –controllable cost is based on ….. classification of cost
a. nature of elements
b. traceability
c. controllability
d. operation or functions
92. relevant costs are also called
a. past cost
b. future cost
c. today cost
d. tomorrow cost
93. ……. Is the cost of opportunity lost
a. opportunity cost
b. past cost
c. future cost
d. today cost
94. cost which is normally incurred at a given level of output under normal conditions
of operations is called
a. opportunity cost
b. past cost
c. future cost
d. normal cost
95. refers to an increase in cost from one alternatives to another
a. opportunity cost
b. incremental cost
c. future cost
d. normal cost
96. the difference of total costs between any two alternatives
a. opportunity cost
b. incremental cost
c. future cost
d. differential cost
97. cost per unit is also called
a. opportunity cost
b. incremental cost
c. average cost
d. differential cost
98. the cash cost associated with an activity is also known as
a. out of packet costs
b. incremental cost
c. average cost
d. differential cost
99. cost that have been already incurred also known as
a. sunk cost
b. incremental cost
c. average cost
d. differential cost
100.the difference between selling price and marginal cost is called
a. margin of benefit
b. contribution
c. profit margin
d. none
Analysis of Financial Statement

Short Answer

Ans.1 Balance Sheet as on ..........................

Liabilities Amount Assets Amount


Shree Capital Reserve and Fixed Assets
Surplus secured loans Investment, current,
Unsecured Loans Assets, Loans and
Current Liabilities and Advances Miscellaneous
Provisions Expenditure Profit &
Loss A/c

Ans.2 i) Preliminary expenses.


ii) Expenses including commission or brokerage on underwriting or
subscription of shares or debentures.

iii) Discount allowed on the issue of shares or debentures.

iv) Intererst paid out of capital during construction.

v) Development expenditure not adjusted

Ans.3 i) Capital Reserve

ii) Capital Redemption reserve

iii) Security premium account

iv) General reserve

v) Credit balance in profit and loss a/c

Ans.4 The liabilities existences of which depends on a happening in future is


known as contingent liabilities. Such liabilities are disclosed by way of a
note.

Examples of contingent liabilities are :

i) Claim against the company not acknowledge as debt.

ii) Uncalled liability on shares partly paid

Ans.5 i) Current assets

ii) Loans and advances

iii) Current liabilities

iv) Miscellaneous expenditure

v) Reserve and surplus

vi) Fixed Assets


Ans.6 Solution : Horizontal Form

Pyramid Ltd.
BALANCE SHEET as on 31st March, 2008
Liabilities Rs. Assets Rs.
Share Capital Fixed Assets
Authorised Capital At Gross Value17,00,000
....Equaity shares of Rs. ....each.... Less : Depreciation2,40,000
14,60,000
Issued, Subscribed and Paid-up=======
--------------
....Equity share sof Rs. ...each Investments
....
Fully paid-up in Cash 12,00,000 Current Assets, Loans and
Reserves and Surplus Advances
General Reserve 3,00,000 Current Assets
11,40,000
Profit and Loss A/c 1,80,000 Miscellaneous Expenditure
Secured Loans .... Discount on issue of
Debentures 40,000
10% Debentures 4,00,000
Unsecured Loans
Current Liabilities Provisions
Current Liabilities 5,60,000
---------- ----------- ------------
26,40,000 26,40,000
======= =======

Ans. The Objectives of Financial Analysis are :

i) To judge the financial stability of an enterprise.

ii) To measure the enterprise's short-term and long-term solvency.

iii) to measure the enterprise's operating efficiency and profitability.


iv) To compare intra-firm position, inter-firm position and pattern
position within industry.

v) To assess the future prospects of the enterprise.

Ans.8 Limitations of Analysis of Financial Statements are;

(i) Limitations of Financial Statements: Financial Statements are the


basis f financial analysis. Hence, the limitations of financial statements,
such as influence of accounting concepts and conventions, personal
judger disclosure of only monetary events, etc., are also the limitations
of analysis and financial statements.

(ii) Ignores the Price-Level, Changes: Financial analysis fails to


disclose current worth of the enterprise, since it is based on .financial
statements, which are merely a record of historical cost.

(iii) Not. Free from Bias: In many situations, the accountant has to
make a choice out of various alternatives available, e.g., choice in the
method of depreciation choice in the method of inventory valuation.
Since, the subjectivity is interest in personal judgment, the financial
statements are therefore not free from bias. As a result, financial
analysis also cannot be said to be free from bias.

(iv) Window Dressing: The term window dressing means presentation


of account that conceals vital facts and showing better position than
what it actually is. On account of such a situation, financial analysis may
not be a definite indicator of good or bad management.

Ans.9 Solution :
Particulars Absolute Figure Change (Base Year : 2006)
2006 2007 Absolute Percentage
Change Change
(Rs.) (Rs.) (Rs.) %
Sales 20,00,000 30,00,000 10,00,000 50%
Less : Cost of Goods Sold 12,00,000 21,00,000 9,00,000 75%
Gross Profit ,8,00,000 9,00,000 1,00,000 12.5%
Less : Indirect Taxes 4,00,000 3,60,000 (-40000) -10%
Net Profit before Tax 4,00,000 5,40,000 1,40,000 35%
Less : Tax 50% 2,00,000 2,70,000 70,000 35%
Net Profit after Tax 2,00,000 2,70,000 70,000 35%

Ans.10 COMPARATIVE BALANCE SHEET

Particulars 2005 2006 Absolute Percentage


Increase/ Increase/
(Rs.) (Rs.) Decrease Decrease
Sources of Funds
Share Capital 4,26,000 3,44,000 (82,000) (19.2)
Long-term Loan 6,96,000 4,38,000 (2,58,000) (37.1)
Current Liabilities 2,98,000 78,000 (2,20,000) 73.8
14,20,000 8,60,000 (5,60,000) (39.4)
Application of Funds
Fixed Assets 5,68,000 4,30,000 (1,38,000) (24.3)
Investments 6,000 4,000 (2,000) (33.3)
Current Assets 8,46,000 4,26,000 (4,20,000) 49.6
14,20,000 8,60,000 (5,60,000) (39.4)

Ans.11 Solution:

Since current ratio is 2 : 1, let us assume the CA = Rs. 20,000 and CL =


Rs. 10,000.

i) Repayment of current liability will improve Current Ratio because


fall in current asset will be less than twice the fall in current liability.
(Suppose Rs. 5,000 are repaid out of current liability, balance would
be CA = Rs. 15,000 and CL = Rs. 5,000. .-. Ratio will improve to 3 :
1)

ii) Purchase of goods on cash will not change the ratio, neither the
total current assets nor the total currert liabilities are affected since
there is only a conversion of one current asset into another current
asset.

iii) Sale of office equipment will improve the ratio because current
asset (cash) will increase without any change in current liability.

iv) Sale of goods for Rs 11,000; cost being Rs 10,000 will improve the
current ratio because current asset will increase by Rs. 1,000.

v) Payment of dividend will reduce the total of current assets and total
of current liabilities by the same amount. Therefore, the current
ratio will improve.

Ans.12 Statement showing the effect of different items on Debt-Equity Ratio :

Transaction Effect Reason

i) Increase Total long-term debts are increased but total


Shareholders'

Funds remain unchanged

ii) No Effect Neither the total long-term debts nor


the total Shareholders'

Funds are affected.

iii) Increase Total Shareholders' Funds are decreased by


the amount of
loss but total long- term debt remain
unchanged.

iv) Decrease Total Shareholders' Funds are increased by


the amount of
profit but total long-term debts remain unchanged.

v) Decrease Total Shareholders' Funds are increased by


the amount of

cash received but total long-term debts


remain unchanged.

vi) No Effect Neither the total long-term debts nor the


total Shareholders'

Fund are affected since there is only a


conversion of accumulated

profit into share capital.

vii) Decrease Total long-term debts are decreased but total


Shareholders'

Funds remain unchanged.

viii) Decrease Total long-term debts are decreased and


total Shareholders'

Funds are increased by the same amount.

Ans.13 Solution :

Gross Profit = 25% of Rs. 3,20,000 = Rs. 80,000

Cost of Goods sold = Sales - Gross Profit

= Rs. 3,20,000 - Rs. 80,000 = Rs. 2,40,000


Average Stock = (Opening Stock + Closing Stock) /2

= (Rs. 29,000 + Rs. 31,000)/ 2 = Rs. 30,000


Cost of Goods Sold Rs. 2,40,000
Stock Turnover Ratio = Average Stock = Rs.30,000 = 8 Times.

Ans.14 Solution :
Cost of Goods Sold
Stock Turnover Ratio = Average Stock

Cost of Goods Sold


12 = Rs. 75,000

Cost of Goods Sold = Rs. 75,000 x 12 = Rs. 9,00,000

Let selling price be = Rs. 1000

Profit = Rs. 20

Cost = Rs. 100 - Rs. 20 = Rs. 80

If cost is Rs. 80 then selling price = Rs. 100


Rs.100
If cost Rs. 9,00,000, then sales = Rs. 80 x Rs. 9,00,000 = Rs.
11,25,000

Profit = Sales - Cost of Goods Sold

= Rs. 11,25,000 - Rs. 9,00,000 = Rs.


2,25,000

Ans.15 Solution :
Net Credit Sales
Debtors Turnover Ration = Average Debtors

OIpening Debtors + Closing Debtors


Average Debtors = 2
3,50,000
8 = Average Debtors

3,50,000
= 43.750
Average Debtors = 8

Let Closing Debtors = x


Opening Debtors = x - 14,000
x + x - 14,000
= 43,750
= 2

2x = (43,750 x 2) + 14,000
x = 50,750
Closing Debtors = Rs. 50,750
Opening Debtors = 50,750 - 14,000 = 36,750

Ans.17 Solution :
Rs. 4,00,000
Cash Sales = 2 = Rs. 2,00,000

total Sales = Rs. 4,00,000 + Rs./ 2,00,000 = Rs.


6,00,000

Gross Profit on cost = 20%


20
Gross Profit on sale will be; 120 (Let the CP=10, Profit=20, SP=100+20=120

Gross Profit = 1/6 of Rs. 6,00,000 = Rs., 1,00,000

Gross Profit Rs.1,00,00 0


Gross Profit Ratio = Net Sales x 100 = Rs. 6,00,000 x 1000 = 16.67%

Ans.18 Cash Sales = 25% of total sales. It means that credit sales will be 75%
of total sales. If credit sales (75% of total sales) = Rs. 2,40,000

Total Sales will be = Rs. 2,40,000 x 100/75 = Rs. 3,20,000

Let Opening Stock = x, then Closing Stock = x + Rs. 20,000

Cost of Goods Sold = Opening Stock + Purchases -Closing Stock

= x + Rs. 2,76,000 - (x + Rs. 20,000)


= x + Rs. 2,76,000 - x - Rs. 20,000

= Rs. 2,56,000

Gross Profit = Sal;es - Cost of Goods Sold

= Rs. 3,20,000 - Rs. 2,56,000 = Rs. 64,000


Rs.64,000
Thus, Gross Profit Ratio Rs. 3,20,000 = x 100 = 20%

Note :

Profit before INterest and Tax = Net Profit 6 IOnterest on Debentures

= Rs. 80,000 + Rs. 40,000 = Rs. 1,20,000

Capital Employed = Equity Sahre Capital + Preference

Share Capital + General Reserve + Debentures - Discount on


Shares

Rs. 10,84,000 = Rs. 4,00,000 + Rs. 1,00,000+ Rs. 1,89,000 +


Rs. 4,00,000 - Rs. 5,000

x 100 = 49.76%.

Solution:
Gross Profit
i) Gross Profit Ratio = Net Sales x 100
Rs.7,87,50 0 - Rs.3,95,60 0
= Rs.7,87,50 0 x 100 = 49.76%
Cost of Goods Sold Rs. 3,95,600
ii) Stock Turnover Ratio = Average Stock = Rs. 1,97,800 = 2 times
Debt (Long - term Loans)
iii) Debt-Equity Ratio = Shareholders' Funds

Rs.87,000 + Rs. 1,25,000 Rs.2,12,00 0


= Rs.3,75,00 0 = Rs.3,75,00 0 = 0.57 : 1
Cost of Goods Sold or Sales
iv) Working Capital Turnover Ratio = Working Capital (CA - CL)
Rs.7,87,50 0
= Rs.162,000 = 2.44 Times
Working Capital Turnover Ratio = = 4.86 Times
(Based on sales)

Ans.21 Solution
Current Assets
Current Ratio = Current Liabilitie s

R.3,00,000 + Rs. 20,000 Rs. 3,20,000


Current Ratio = Rs.1,40,00 0 + Rs. 20,000 = Rs.1,60,00 0 = 2 : 1

Ans.22 Solutions :
Current Liabilities are Rs. 1,00,000 and Current Ratio is 2.5 : 1;
therefore, Current Assets = Rs. 1,00,000 x 2.5 = Rs. 2,50,000
After paying Rs. 25,000
Current Assets = Rs. 2,50,000 - Rs. 25,000 = Rs. 2,25,000
Current Liabilities = Rs. 1,00,000 - Rs. 25,000 = Rs. 75,000
Current Assets
Current Ratio = Current Liabilitie s = = 3 : 1

Ans.23 Solution :
Current Assets
Current Ratio = Current Liabilitie s

1.5 Rs. 6,00,000


1 = Rs.4,00,00 0

Let the amount paid towards Current Liabilities = X.


After the payment
=
Rs. 8,00,000-2X = Rs.6,00,000-X
Rs. 80,00,000 - Rs.6,00,000,= 2X - X
Rs. 2,00,000 = X
Current Liabilities to be paid off Rs. 2,00,000.

Ans.24 Solution :
Calculation of Quick Assets :
Quick Assets Quick Assets
Quick Ratio = Current Liabilitie s = Rs. 40,000 = 1.5
Quick Assets = Rs. 40,000 x 1.5 = Rs. 60,000
Calculation of Stock :
Stock = Current Assets - Quick Assets
= Rs. 1,00,000 - Rs. 60,000 = Rs. 40,000
Ans.25 Solution :
Calculation of Current Assets and Current Liabilities :
Current Assets - Current Liabilities = Working Capital
Current Assets - Current Liabilities = Rs. 60,000
Current Assets / Current Liabilities = 2.5
or, Current Assets - 2.5 Current Liabilities = 0
Subtracting Eqn. 2 from Eqn. 1,
1.5 Current Liabilities = Rs. 60,000
Current Liabilities = s. 60,000/1.5 = Rs. 40,000
Current Assets= Rs. 40,000 x 2.5 = Rs. 1,00,000

Ans.26 Solutions :
Current Assets
Current Ratio = Current Liabilitie s

Rs.17,00,000
2.5 = Current Liabilitie s

Rs.17,00,000
Current Liabilities = 2.5 = Rs. 6,80,000
Liquid Assets
Liquid Ratio = Current Liabilitie s
Liquid Assets
0.95 = Rs.6,80,00 0 ; Liquid Assets = Rs. 6,46,000

Stock (Inventory) = Current Assets - Liquid Assets

= Rs. 17,00,000 - Rs. 6,46,000 = Rs. 10,54,000.

Ans.27 The objectives of cash flow statement are :

i) To ascertain the specific sources (ie, operating / investing financing


activities) of cash and cash equivalents generated by an enterprise.

ii) To ascertain the specific uses (ie., operating / investing / financing


activities ) of cash and cash equivalents used by an enterprise.

iii) To ascertain the net change in cash and cash equivalents (sources
minus uses of cash and cash equivalents) between the date of two
Balance Sheets.

Ans.28 a) Financing Activities

b) Investing Activities

c) Operating Activities

d) Operating Activities

Ans.29 Solution :

Statement Showing Cash Flow from Operating Activities


Particulars Rs.
Net Profit before Tax and Extraordinary Items 49,000
Adjustment for :
Add : Goodwill Amortized 8,000
Loss on Sale of Building 5,000
Depreciation 20,000 33,000

82,000
Less : Profit on Sale of Machinery 5,000
Dividend Received 3,000 8,000
Operating Profit before Working Capital Changes 74,000
Less : Increase in Current Assets & Decrease in
Current Liabilities :
Commission Accrued 4,000
Cash Generated from Operations 70,000
Less : Tax Paid 15,000
Cash Flow from Operating Activities 55,000
Note :
Net Profit before Tax and Extraordinary items is calculated by adding
Provision for Tax and Proposed Dividend to the amount of Net Profit, i.e,,
Rs. 24,000 + Rs. 15,000 + Rs. 10,000.

Ans.30 Solution :

COMPUTATION OF CASH FLOW FROM OPERATING ACTIVITIES

Particulars Rs.
Net Profit for the year 50,000
Add : Transfer to General Reserve 10,000
Net Profit before Tax 60,000
Add : Depreciation 20,000
Loss on Sale of Machine 10,000
Preliminary Expenses Written Off 10,000
1,00,000
Less : Profit on Sale of Furniture 5,000
Operating Profit before Working Capital Changes 95,000
Add : Decrease in Bills receivable 2,000
Increase in Bills Payable 10,000
Increase in Outstanding Expenses 1,000 13,000
1,08,000
Less: Increase in Debtors 5,000
Increase in Stock 3,000
Increase in Prepaid Expenses 1,000
Decrease in Creditors 2,000 11,000
Cash Flow from Operating Activities 97,000

Ans.31 Solution :

CASH FLOW FROM OPERATING ACTIVITIES

Particulars Rs.
Net Profit 1,00,000
Add : Transfer to General Reserve 30,000
Net Profit before Tax 1,30,000
Adjustment for non-cash and non-operation expenses :

Add : Depreciation 20,000


Goodwill Written Off 7,000
27,000
Less : Gain on Sale of Machinery 3,000 24,000
Operating Profit before working capital changes 1,54,000
Add : Decrease in Current Assets and Increase in
Current Liabilities
Increase in Creditors 10,000
Decrease in Bills Receivable 3,000 13,000
1,67,000
Less : Increase in Current Assets and Decrease in
Current Liabilities :
Increase in Debtors 6,000
Increase in Prepared Expenses 200
Decrease in Bill s Payable 4,000
Decrease in Outstanding Expenses 2,000 12,200
Cash Flow from Operating Activities 1,54,800

Ans.32 Solution :
Rajan Ltd.
CASH FLOW STATEMENT for the year ended 31st December, 2002
Particualrs Rs. Rs.
A. Cash Flow from Operating Activities

B. Net Profit before tax :


Closing Balanced of Profit and Loss A/c
Closing Balance of Profit and Loss A/c 24,000
Add : Transfer to General Reserve 15,000
39,000
Less : Opening Balance of Profit and Loss A/c15,000
Net Profit before tax and extraordinary items 24,000
Adjustments for :
Add : Depreciation on Plant 10,000
Depreciation on Building 60,000
Goodwill written off 16,000 86,000
Operating profit before working capital changes 1,10,000
Adjustments for :
Increase in Creditors 12,000
Increase in Debtors (35,500)
Increase in Stock (5,000) (28,500)
Net Cash from operating activities (A) 81,500
B. Cash Flow from Investing Activities
Purchase of Plant (Note 2) (70,000)
Purchase of Building (Note 1) (40,000)
Net cash used in investing activities (B)
(1,10,000)
C. Cash Flow from financing Activities
Issue of Equity Shares 50,000
Redemption of 12% Preference Shares (25,000)
Net Cash from financing activities (C) 25,000
Net decrease in cash and cash
equivalents (A+B+C) (3,500)
Cash and cash equivalents at the beginning of the year
12,500
Cash and cash equivalents at the close of the year 9,000
Working Notes :
1. Dr. BUILDING ACCOUNT Cr.
Date Particulars Rs. Date Particulars Rs.
To Balance b/d 80,000 By Depreciation A/c
60,000
To Bank A/c 70,000 By Balance c/d 60,000
1,20,000 1,20,000

2. Dr. PLANT ACCOUNT Cr.


Date Particulars Rs. Date Particulars Rs.
To Balance b/d 40,000 By Depreciation A/c
10,000
To Bank A/c 70,000 By Balance c/d 1,00,000
1,10,000 1,10,000

Ans.33 Solution :

Particualrs Rs. Rs.


A. Cash Flow from operating Activities
Closing Balance of General Reserve A/c 70,000
Less : Operating Balance of General Reserve (50,000)
Net Profit before taxation and extraordinary items 20,000
Add : Items to be added
Goodwill amounted 8,000
Interest on long term loans 12,000 20,000
Operating Profit before Working Capital changes 40,000
Add : Decrease in Current Assets and Increase in
Current Liabilites
Increase in Creditors for goods 20,000
Increase in Bills Payable 80,000 1,00,000
Less : Increase in Current Assets and Decrease in
Current Liabilities :
Decrease in Outstanding Expenses (5,000)
Increase in Debtors (20,000)
Increase in Stock (20,000) (45,000)
Cash generated from operations 95,000
Less : Income taxes paid (Net of Refund) ....
Net Cash from Operating Activities 95,000
B. Cash Flow from Investing Activities
Purchase of Land and Building (80,000)
Purchase of Machinery (30,000)
Net Cash used in Financing Activities
(1,10,000)
C. Cash Flow from Financing Activities
Proceeds from issue of Equity Shares 50,000
Repayment of long-term borrowings (20,000)
Interest on Long-term loans (12,000)
Net Cash inflow from Financing Activities 18,000
D. Net Increase / Decrease in a Cash and Cash equivalent
(A+B+C) 3,000
E. Cash and Cash Equivalents at Beginning period
Cash in Hand 15,000
F. Cash and Cash Equivalents at End of period (D+E)
Cash in Hand 18,000

*Debenture interest @ 12% on Rs. 1,00,000.