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Ratio analysis is very useful tool of management accounting.

With this, we can analyze

business's financial position. We also check company's short term and long term solvency
with ratio analysis. Following are the main advantages of ratio analysis.
1. Helpful in Decision Making
All our financial statements are made for providing information. But this information is
not helpful for decision making because financial statements provide only raw
information. When we calculate different ratios in ratio analysis, at that time, we get
useful information. I can explain it with simple example. Suppose, we calculate our
interest coverage ratio which is 10times but our competitor company's interest coverage
ratio is 15 times. It means capacity of the profit of our competitor company is more than
us. By seeing this, we can take decisions for increasing our profitability.
2. Helpful in Financial Forecasting and Planning
Every year we calculate lots of accounting ratios. When we make trend of all these ratios,
we can get useful information for our future forecasting and planning. For example, we
can tell five year collection period with following way
2007 = 90 days
2008 = 70 days
2009 = 60 days
2010 = 50 days
2011 = 30 days
From this trend, we know that we are decreasing the days for collection money from our
debtors. With this information, we can make two plans. One is effective use of money
which we are getting from our debtors more fastly and second we can also check the
behavior of our debtors by comparing this with sales trend. Like this, there are lots of
ratios which are also useful for better planning.
3. Helpful in Communication
Ratio analysis are more important from communication point of view. Suppose, we have
to appoint new sales agents for our company. At that time, we can communicate them by
using our company's sales and profit related ratios. There is no need of hi-tech for
understanding the meaning of any specific ratio. For example, our gross profit in 2010 is
26.6% and in 2011, it is 28.55%. By just telling this ratio, we can understand whether our
company is growing or falling.
4. Helpful in Co-ordination
No company has all the strength points. Company's financial results shows some strength
points and some weak points. Ratio analysis can create co-ordination between strength
points and weak points.

5. Helps in Control
Ratio analysis can also use for controlling our business. We can easily create the standard
of each financial item of our balance sheet and profit and loss account. On this basis, we
can also calculate standard ratios. By comparing standard ratios with actual accounting
ratios, we can find variance. These variance may be favorable and unfavorable. On this
basis, we can control our business from financial point of view.
6. Helpful for Shareholder's decisions
For example, I am a shareholder. I want to invest in any company's shares. Before buying
any company's shares, I will be interested to know company's long term solvency. So, I
have to calculate long term solvency ratios. In which, I have to calculate fixed assets to
net worth ratio, fixed assets to long term debt ratio. On this basis, I can know the level of
fixed assets and its main resource. After checking my money's security, I will be
interested to know my return on this investment. ROI, EPS and DPS are most useful
ratios which I can calculate for knowing this.
7. Helpful for Creditors' decisions
Creditors are those persons who provide goods on credit to company or provides short
period loan to company. All the creditors are interested to know whether company will
repay their debt or not. For this, they calculate current ratio and quick liquid ratio
and average payment period. On this basis, they take decisions.
8. Helpful for employees' decisions
Every employee wants to increase his salary. He also wants to get more and more
incentives from company. For this, he takes help from company's profitability ratios.
Profitability ratios will be helpful for employees to pressure on the company for
increasing their salary.
9. Helpful for Govt. decisions
Different companies analyze their accounting ratios and publish on the net and print
newspapers. Govt. collects all these information. On this basis, Govt. makes policies. If
ratios will wrong, Govt. policies will become wrong. For example, Govt. collects income
data of all companies in different industries for calculation the national income.

2 Limited Use of Single Ratio

Sometime, we can not compare our ratios with others. For example, we have started new
business and our financial results are not still normal. At that time, our profitability ratio
will have limited use because there is not any past data of profitability ratios.
Lack of Adequate Standards
We could not make standards of all ratios. For example, we can not tell what is rule of
them of our net profit ratio because there are lots of factors affect it. In the lack of
adequate standards of ratios, we can not give exact comment on the basis of ratio
Inherent Limitation of Financial Accounting
Ratio analysis is just like simplification of financial accounting data. But there are lots of
limitations of financial accounting which you can read at here. All these limitation will be
absorbed by ratios. This is the one of the important limitation of ratio. I can say if base is
not good, everything will be wrong. If there is small portion of poison in milk, its effect
will be in everything what you will make.
Changes of Accounting Procedures
If accounting procedures will change, our accounting ratio will be changed. At that time,
we can not compare our current year ratios with our past year ratios. For example, in past
year, we had used LIFO but current year, we are using FIFO for inventory valuation. Due
to this, figures of closing stock will be different. On this basis, if we have calculated
current ratio, it will not be comparable with past current ratio.
Window Dressing
Because we have shown our financial data through window dressing. Our ratios will also
be affected from it.
Personal Bias
This is reality, I saw many CAs who waste their time to optimize different ratios by
changing the project financial statements figures for making attractive projects. All these
activities are done for getting loan. So, this will make the drawback of ratio analysis.
Different companies uses different accounting policies, so, we can not compare their

Price Level Changes

Inflation effect is ignored in calculation of ratios. So, ratio will not give perfect answer in
changing of price level.
Ratios are not Substitute of Financial Statements
Ratio analysis is important part of financial statements analysis. It can never become
a substitute of financial statements. We just use it with cash flow analysis, fund flow
analysis and other analysis.
Wrong Interpretation
We can interpretate wrongly. For explaining the effect on company's position with ratios,
there is big need of experience. Wrong interpretation will be helpful for wrong decisions.
So, it is limitation of ratio analysis that it does not explain all the facts, it has to explain.
For a new accounts manager, it may be difficult.
Definition of 'Cost Accounting'
A type of accounting process that aims to capture a company's costs of production by
assessing the input costs of each step of production as well as fixed costs such as
depreciation of capital equipment. Cost accounting will first measure and record these
costs individually, then compare input results to output or actual results to aid company
management in measuring financial performance.
in other word Cost accounting is the process of classifying,recording and appropriate
allocation of expenditure forthe determination of the costs of products or services,and for
the presentation of suitably arrange the data forthe purpose of control and guidance of
Advantages Of Cost Accounting
Following are the most important advantages of a good cost accounting system:
1) Classification and Subdivision of Costs:
In the contrast to a single profit or loss figure supplied by general accounting, the cost
accounting classifies costs and income by every conceivable subdivision of the business
enterprise. In a good costing system data regarding costs by departments, processes,
functions, products, orders, jobs, contracts and services can easily computed. This
detailed cost information for managerial control is one of the most important
contributions of cost accounting.
2) Adequacy or Inadequacy of Selling Prices:
Unit cost of production, administration and safe made possible by cost accounting aids

management in deciding the adequacy or inadequacy of selling prices i.e. neither too high
detracting business, nor too low resulting in losses to the concern.
In period of depressions, slumps, or in case of competition management forced to lower
prices even below cost of production and sale. In such circumstances, cost accounting
will help management in deciding the proper reduction.
3) Disclosure of profitable Products:
Cost Accounting will disclose activities, departments, products and territories, which
bring profit and those that result in losses. Management to determine what products
because of profit margin the sales department because of their greater profit margin
should emphasize will use this information. What products arte unprofitable or less
profitable and might be eliminated or lesser sales pressure be given to them. What
activities or territories are not producing sufficient profit and should be either further
improved or eliminated and what methods of production and distribution are most
profitable for the firm. This will increase the overall profit of the concern.
4) Control of Material and Supplies:
In a good costing system materials and supplies must be accounted for in terms of
departments, jobs, units of production or service. This will eliminate altogether or reduce
to the minimum misappropriations, embezzlements, deterioration, obsolescence, and
losses from defective, spoiled, scrap and out of date materials and supplies.
5) Maintenance of Proper Investment in Inventories:
A costing system will help in the maintenance of various inventory items of materials and
supplies in line with production and sale requirements. If these quantities are too small,
production may stop or sales may be lost. On the other hand, if quantities of such
materials and supplies are in excess of the production and sales requirements, too much
working capital may unnecessarily tie up in inventories. The detailed quantity
information furnished by the cost accountant at all times will go a long way in reducing
or eliminating this possibility.
6) Correct Valuation of Inventories:
Cost Accounting plays a basic role in the correct valuation of inventories of finished
goods, work in process, materials and supplies. The book inventory method (as opposed
to physical inventory method) made possible by cost accounting system will involve the
operation of the various inventory control accounts in such a manner that the balances of
these accounts well be inventory valuations required for periodic financial statements.
This enables the preparation of monthly financial statements without the trouble and
expense of taking monthly physical inventories.
Further, the value of inventories shown by the book inventory will be more accurate than
inventory values shown by the physical inventory method. If no cost system is in use and
inventory values computed by physical inventory method, then the value of these
inventories must either bean estimate of cost or be determined at market values. But in a
cost accounting system accurate procedures and techniques are available by which

inventory values can be computed in a relatively more exact fashion. The requirements of
management, stockholders, creditors, employees and other groups interested in the
financial statements of the firm naturally attach more emphasis on this objective of cost
accounting. In most cases, this objective of cost accounting dominates the formal cost
records and routines.
7) Whether to Manufacture or Purchase from Outsiders:
Cost records furnish information regarding the cost of manufacturing of different finished
parts, which assist management in making a decision whether to purchase these parts
from outside manufacturers or manufacture them in the factory.
8) Control of Labour Cost:
Orders, jobs, contracts, departments, processes, or services record cost of labour. In many
manufacturing enterprises, daily time reports are prepared showing the number of hours
and minutes spent and the wage rate for each worker per job or operation. This enables
management to compare the current cost of labour per job or operation with some
previously incurred or determined cost thus measuring the efficiency or inefficiency of
the labour force and assigning the work to employees best suited for it.
9) Use of Company-wide Wage Incentive Plans:
When labour cost is accounted for by jobs and operations, it is possible to use effectively
wage incentive plans or bonus schemes for the remuneration of labour force. Carefully
planned and administered incentive schemes are an effective means of enforcing superior
performance and cost reduction. Workers are more co-operative, responsive and
productive when some form of incentive offered to them for surpassing stipulated
standards of perfection and performance. Cost of accounting has developed incentive
plans, which are applicable not only to factory workers but also to clerks, salespersons,
and other executives for above standard performance.
10) Controllable and Uncontrollable Cost:
Cost accounting exhibits at each stage of production and sale the controllable and
uncontrollable items in the manufacturing, selling and administrative cost thus enabling
management to concentrate attention on those costs, which can reduced of, eliminated.
There is very little the management can do to reduce such uncontrollable items as idle
time of machines and labour, wastage in the use of materials, supplies and power can
controlled much more effectively.
11) Use of Standards for Measuring Efficiency:
A complete cost accounting system, generally, has a well-developed plan of standards to
measure the efficiency of the organization in the use of materials, incurrence of labour
and other manufacturing cost. Cora does this appraisal paring the work of factory
workers, office and sales personnel and other executive with what should have done in
manufacturing and selling a given quantity of units in a given period.
12) Reduction of Losses Due to Seasonal Conditions:
Cost accounting provides data for making a complete analysis of losses due to idle plant

and equipment or due to the use of plant and equipment beyond normal capacity,
irregular employment of labour, wastes in the use of materials. It indicates cost variations
between active and inactive periods and seasonal conditions in the business or industry.
Seasonal fluctuations in business activity affect profoundly the earnings of the concern.
In many industries, seasonal variations are responsible for higher costs and lower profits.
13) Budgeting:
In a good cost accounting system, preparation of various budgets periods in advance of
actual production and sale of goods is necessary. These budgets include budgeted
statement of profits, budgeted cost of plant improvements, budgeted cost of production,
budgeted cash receipts and payments, and so forth. These budgets show the plans of the
management for future periods and they reflect the expected results of these plans. They
are of great help in getting the sales manager, the works manager, and the treasurer into
agreement as to a plan that can sold, manufactured and financed. In fact, the use of
budgets has made costing a preventive device for the rectification of inefficiencies before
they creep into the business operations or as they occur from day to day. In other words,
budgeting, inculcates the habit of thinking and calculations before taking decisions.
14) Reliable Check on General Accounting:
Finally, an efficient and proper system of cost accounting is a most reliable and
independent check on the accuracy of the financial accounts. This check made effective
through reconciliation of the balance of profit or loss shown by the costing profit and loss
account and the balance of profit of profit or loss revealed by the general accounting
profit and loss account.

Barron's Accounting Dictionary:

Budget Control
Home > Library > Business & Finance > Accounting Dictionary
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1. A Budget is essentially a plan, a statement of expected results expressed in
numerical terms. The process of reducing plans to definite numbers forces a kind
of orderliness that helps the authority in bringing about co-ordination and
effective control over different activities of an organisation. Co-ordination and

control leads to methodical forecasts, setting up of some standards and targets.

Such standards and targets form the yardsticks for measuring efficiency of
various activities. Budget is thus the most effective device of managerial control.
It is to plan work and work the plan. The latter is more important.
Essentials of a Budget
2. The use of the Budget as a planning as well as a control instrument has
several implications. It should be based upon actual expectations rather than
ideal goals. Basing on the performance of previous years and agreed targets of
expected performances, taking into consideration the availability of the means of
production, budget is made out in such broad details as could be worked out
with as meticulous care as possible.
Technique/Procedure of Budgetary Control
3. The following technique/procedure is being used to make the budgetary
control effective: (a) Funds in the budget are provided by categories of expenditure e.g. there
are separate heads for Pay and Allowances of Military Personnel and
(b) Allotment of funds in the budget for one category of expenditure cannot
normally be used for another category e.g. funds provided for
Transportation charges cannot be used for miscellaneous expenses.
(c) No items of public expenditure should be incurred unless provision
exists to meet it in the sanctioned budget.
(d) Provision of funds under a particular head does not constitute sanction to
incur expenditure unless an authority vested with powers on his behalf by
the Govt sanctions it.
(e) Powers are vested in different authorities by Government to incur public
expenditure only up to defined financial limits and periods.
(f) The ultimate responsibility for seeing that expenditure does not exceed
the corresponding budget allotment rests on the Head of the Establishment.
(g) Budget is broadly divided into centrally and locally controlled heads.
Control in respect of centrally controlled heads is exercised at Central
Headquarters whereas in case of locally controlled heads allotment of funds
is made to lower formations that are responsible to exercise control and to
ensure that the expenditure does not exceed the allotment.
(h) The controlling authorities at Headquarters are responsible for allotting
funds under locally controlled heads. They make these allotments with the
concurrence of financial authorities at the Headquarters, after keeping back
a certain amount as reserve to meet any unforeseen calls from lower

(j) It is the responsibility of the authorities to which allotments are made to

watch the progress of expenditure and to see that it does not exceed the
allotments. In order to help the controlling authorities to exercise proper
control over expenditure against allotments, the Controller of Defence
Accounts notify the local controlling authorities by 25 th of the month,
following that to which they relate showing the serial numbers of claims
admitted in audit and the amounts debited against the allotment.
(k) Controllers of Defence Accounts are also responsible to watch progress
of expenditure against sanctioned allotments and to bring to the notice of the
allottees and the immediate higher authorities cases in which the progress of
expenditure is, in their opinion, abnormally heavy or unusually low.
(l) Where additional funds under a particular heads are required, an
application in this regard has to be made to the Central Controlling
authority, well in advance, explaining fully the reasons thereof. Similarly,
where savings can be foreseen, surrenders are required to be made
immediately, explaining the reasons thereof.
(m) Saving under one head cannot be re-appropriated to meet excess
expenditure under another head unless so authorised by DGQA HQ/Min of
Budget Heads
Steps In Budgetary Control
The procedure to be followed in the preparation and control of budget may differ from
business to
business. But, a general pattern of outline of budget preparation and control may go a
long way
to achieve the end results. The steps are as follows:
Formulation of policies: The business policies are the foundation stone of budget
Function policies should be formulated in advance. Longrange
policies with short term
projections should be made for the functional areas such as sales, production, inventory,
management, capital expenditure.
Preparation of forecasts: Based on the formulated policies, forecast should be made in
of each function. Activity based concepts should be introduced at the micro level for each
function Forecasts should not be considered as a mere estimates. Scientific methods
should be adopted for forecasting. Analysis of various factors based on past, and present,
future forecast
should be made.

Preparation of budgets: Forecasts are converted into written codified document. Such
documents can be used for coordination purposes. Function budgets will act as guidelines
Forecast combinations: While developing the budgets, through a Master Budget various
permutations and combination processes are considered and developed. Based on this,
establishment of the most preferred one which will yield optimum benefits should be
All the factor components should be identified which are likely to cause disturbances
implementing the budgets

Budgeting Money
Monthly Budgets
The Advantages of Preparing a Monthly Cash Budget
budgeting money
The Advantages of Preparing a Monthly Cash Budget
by Leann Harms, Demand Media

Youre constantly checking your account balance, wondering where your money has
disappeared to, and worse--resorting to credit cards to get through the last few days
before payday. Its time to get your spending under control and preparing a monthly cash
budget will help you get your finances back on track.
Learning Experience
Preparing a monthly cash budget will be a real eye opener if youve never taken the time
to track your daily spending habits and investigate where and how you spend your
money. Expense tracking, an essential component of budget preparation, is simply
keeping a record of every time you spend money throughout the month--even those trips
to the vending machine. Youll be surprised how those afternoon snack breaks are adding
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Establish Goals
Maybe youve been thinking about getting a new car, buying your own home or you just
want to get your credit cards paid off. Preparing a budget will help you establish longand short-term goals where your finances are concerned. Identifying where youre
spending money unnecessarily enables you to figure where you can cut back to save extra
money. For instance, in the process of preparing your budget you discover that those
weekly dry cleaning bills are costing you around $100 a month. Thats $1,200 a year that
you could save by using a home dry-cleaning product and ironing your own clothes.
Reduce Debt
Preparing a monthly cash budget is the first step toward getting out of debt. By limiting
your monthly expenses and sticking to a cash budget, youll reduce your dependency on
credit cards. As you become more accustomed to living within the parameters of your
budget, youll be able to start getting those cards paid down until eventually you wont
have to rely on them unless its absolutely necessary.
Always Ready
You can never plan for the unexpected but you can prepare for it. You never know when
you might encounter some unforeseen circumstance like job loss or medical problem and
these are the types of situations that put people under serious financial strain. Preparing a
budget will enable you to determine ways that you can start putting money away each
month to ensure you have some cash to fall back on if the need arises.
Most businesses incorporate cash budgets in their overall budgeting process. Cash
budgets review anticipated cash receipts and cash disbursement for the budget period.
Managers use this information to determine if the company needs additional financing for
the budget period. Like all processes, cash budgets come with several disadvantages.
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Cash Budgeting Advantages and Disadvantages
The Advantages of Preparing a Monthly Cash Budget

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Use of Estimates
The budgeting process relies on estimates of future events. Managers try to anticipate the
future activities of the company. The cash budget relies on estimates of future sales and
future collections received on those sales. The cash budget also relies on estimates of
future expenses that the company expects to incur. Managers base estimates on their
instinct rather than facts. Estimates limit the effectiveness of the cash budget because
factual knowledge is not available.
Lack of Flexibility

The budget process involves creating numbers to enter in the budget, publishing the
budget numbers and distributing those reports to management. Once published, these
numbers don't change. Cash budgets include information regarding the company's
expected financing needs. Once management reviews the cash budget, they make
decisions based on the expected financing needs. If the actual financing needs are less
than the budget, management has already committed to the financing for the budget
period. If the actual financing needs are more than the budget, management has not
committed to enough financing and will incur a cash deficit. Management will need to
borrow money at higher than planned interest rates to meet their cash needs.
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Managers with ulterior motives manipulate budget numbers to reflect well on themselves.
A manager making decisions that impact the cash budget may underestimate her expenses
for the budget period. This reports budgeted cash disbursements that are too low. The
manager receives praise for her work on the budget. However, when the actual expenses
occur and do not meet the budget numbers, the cash disbursements will incur a variance.
By that time the manager may be in a different position and not feel the repercussions of
her actions.
Lack of Nonfinancial Factors
When using a cash budget to analyze financing needs and financing options, nonfinancial
factors are omitted. A business owner may choose to borrow funds from one of two
banks. One bank may offer a lower interest rate, which can be quantified and reported on
the cash budget. The other bank may offer better customer service and offer nonfinancial
perks for borrowing from them. The nonfinancial factors are not reflected in the cash
Read more: The Disadvantages of a Cash Budget |

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The Benefits And Limitation Of Budgeting

July 23rd, 2006 / No comments yet
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In the earlier articles, we have discussed about the reasons/objectives and the key factors
or processes required in budgeting.
This topic deals with the basic understanding of what benefits may accrue from
budgeting and then what can be its limitations.