Professional Documents
Culture Documents
Introduction
According to American Institute of Certified Public Accountants, “Accounting is the art of recording,
classifying and summarising the economic information in a significant manner and in terms of money,
transactions and events which are, in part at least, of a financial character, and interpreting the results
thereof.”
In Simple words, accounting is the process of collecting, recording, classifying, summarising and
communicating financial information to the users for judgment and decision-making.
Objectives of Accounting
1. To keep systematic and complete records of financial transactions in the books of accounts
according to specified principles and rules to avoid the possibility of omission and fraud.
2. To ascertain the profit earned or loss incurred during a particular accounting period which
further help in knowing the financial performance of a business.
3. To ascertain the financial position of the business by the means of financial statement i.e.
balance sheet which shows assets on one side and Capital & Liabilities on the other side.
4. To provide useful accounting information to users like owners, investors, creditors, banks,
employees and government authorities etc who analyze them as per their requirements.
5. To provide financial information to the management which help in decision making, budgeting
and forecasting.
6. To prevent frauds by maintaining regular and systematic accounting records.
Advantages of Accounting
1. It provides information which is useful to management for making economic decisions.
2. It help owners to compare one year’s results with those of other years to locate the factors
which leads to changes.
3. It provide information about the financial position of the business by means of balance sheet
which shows assets on one side and Capital & Liabilities on the other side.
4. It help in keeping systematic and complete records of business transactions in the books of
accounts according to specified principles and rules, which is accepted by the Courts as evidence.
5. It help a firm in the assessment of its correct tax Liabilities such as income tax, sales tax, VAT,
excise duty etc.
6. Properly maintained accounts help a business entity in determining its proper purchase price.
Limitations of Accounting
1. It is historical in nature; it does not reflect the current worth of a business.Moreover, the figures
given in financial statements ignore the effects of changes in price level.
2. It contains only those informations which can be expressed in terms of money. It ignores
qualitative elements such as efficiency of management, quality of staff, customers satisfactions
etc.
3. It may be affected by window dressing i.e. manipulation in accounts to present a more favorable
position of a business firm than its actual position.
4. It is not free from personal bias and personal judgment of the people dealing with it. For
example different people have different opinions regarding life of asset for calculating
depreciation, provision for doubtful debts etc.
5. It is based on various concepts and conventions which may hamper the disclosure of realistic
financial position of a business firm. For example assets in balance sheet are shown at their cost
and not at their market value which could be realised on their sale.
Basic accounting terms
Business Transaction
An Economic activity that affects financial position of the business and can be measured in terms of
money e.g., purchase of goods for use in business.
Account: Account refers to a summarized record of relevant transactions of particular head at one
place. All accounts are divided into two sides. The left side of an account is called debit side and the
right side of an account is called credit side.
Capital: Amount invested by the owner in the firm is known as capital. It may be brought in the form of
cash or assets by the owner.
Drawings: The money or goods or both withdrawn by owner from business for personal use, is known
as drawings. Example: Purchase of car for wife by withdrawing money from business.
Assets: Assets are valuable and economic resources of an enterprise useful in its operations. Assets can
be broadly classified as:
1. Current Assets: Current Assets are those assets which are held for short period and can be
converted into cash within one year. For example: Debtors, stock etc.
2. Non-Current Assets: Non-Current Assets are those assets which are hold for long period and
used for normal business operation. For example: Land, Building, Machinery etc.
They are further classified into:
a. Tangible Assets: Tangible Assets are those assets which have physical existence and can
be seen and touched. For Example: Furniture, Machinery etc.
b. Intangible Assets: Intangible Assets are those assets which have no physical existence and
can be felt by operation. For example: Goodwill, Patent, Trade mark etc.
Liabilities: Liabilities are obligations or debts that an enterprise has to pay after some time in the
future.
Liabilities can be classified as:
1. Current Liabilities: Current Liabilities are obligations or debts that are payable within a period of
one year. For Example: Creditors, Bill Payable etc.
2. Non-Current Liabilities: Non-Current Liabilities are those obligations or debts that are payable
after a period of one year. Example: Bank Loan, Debentures etc.
Receipts
1. Revenue Receipts: Revenue Receipts are those receipts which are occurred by normal operation
of business like money received by sale of business products.
2. Capital Receipts: Capital Receipts are those receipts which are occurred by other than business
operations like money received by sale of fixed assets.
Expenses: Costs incurred by a business for earning revenue are known as expenses. For example: Rent,
Wages, Salaries, Interest etc.
Expenditure: Spending money or incurring a liability for acquiring assets, goods or services is called
expenditure. The expenditure is classified as :
1. Revenue Expenditure: If the benefit of expenditure is received within a year, it is called revenue
expenditure. For Example: rent, Interest etc.
2. Capital Expenditure: If benefit of expenditure is received for more than one year, it is called
capital expenditure. Example: Purchase of Machinery.
3. Deferred Revenue Expenditure: There are certain expenditures which are revenue in nature but
benefit of which is derived over number of years. For Example: Huge Advertisement
Expenditure.
Profit: The excess of revenues over its related expenses during an accounting year is profit.
Profit = Revenue - Expenses
Gain: A non-recurring profit from events or transactions incidental to business such as sale of fixed
assets, appreciation in the value of an asset etc.
Loss: The excess of expenses of a period over its related revenues is termed as loss.
Loss = Expenses - Revenue
Goods: The products in which the business deal in. The items that are purchased for the purpose of
resale and not for use in the business are called goods.
Purchases: The term purchases is used only for the goods procured by a business for resale. In case
of trading concerns it is purchase of final goods and in manufacturing concern it is purchase of raw
materials. Purchases may be cash purchases or credit purchases.
Purchase Return: When purchased goods are returned to the suppliers, these are known as
purchase return.
Sales: Sales are total revenues from goods sold or services provided to customers. Sales may be
cash sales or credit sales.
Sales Return: When sold goods are returned from customer due to any reason is known as sales
return.
Debtors: Debtors are persons and/or other entities to whom business has sold goods and services
on credit and amount has not received yet. These are assets of the business.
Creditors: If the business buys goods/services on credit and amount is still to be paid to the persons
and/or other entities, these are called creditors. These are liabilities for the business.
Bill Receivable: Bill Receivable is an accounting term of Bill of Exchange. A Bill of Exchange is Bill
Receivable for seller at time of credit sale.
Bill Payable: Bill Payable is also an accounting term of Bill of Exchange. A Bill of Exchange is Bill
Payable for purchaser at time of credit purchase.
Discount: Discount is the rebate given by the seller to the buyer. It can be classified as :
1. Trade Discount: The purpose of this discount is to persuade the buyer to buy more goods. It
is offered at an agreed percentage of list price at the time of selling goods. This discount is
not recorded in the accounting books as it is deducted in the invoice/cash memo.
2. Cash Discount: The objective of providing cash discount is to encourage the debtors to pay
the dues promptly. This discount is recorded in the accounting books.
Account : Account refers to a summarised record of relevant transaction of particular head at one
place.
Income: Income is a wider term, which includes profit also. Income means increase in the wealth of
the enterprise over a period of time.
Stock : The goods available with the business for sale on a particular date is known as stock.
Cost : Cost refers to expenditures incurred in acquiring manufacturing and processing goods to
make it saleable.
Voucher: The documentary evidence in support of a transaction is known as voucher. For example,
if we buy goods for cash we get cash memo, if we buy goods on credit, we get an invoice, when we
make a payment we get a receipt.
Goods and Service Tax (GST) : GST is an indirect tax which is levied on the supply of goods and
service.
Double Entry System
In the double-entry system, transactions are recorded in terms of debits and credits. Since a debit
in one account offsets a credit in another, the sum of all debits must equal the sum of all credits.
The double-entry system of bookkeeping or accounting makes it easier to prepare accurate
financial statements and detect errors.
Features of Double Entry System
(i) Every transaction has two fold aspects, i.e., one party giving the benefit and the other receiving
the benefit.
(ii) Every transaction is divided into two aspects, Debit and Credit. One account is to be debited and
the other account is to be credited.
(iii) Every debit must have its corresponding and equal credit.
Advantages:
1. Under this method both the aspects of each and every transaction are recorded. So it is
possible to keep complete account.
2. Since both the aspects of a transaction are recorded, for each debit there must be a
corresponding credit of an equal amount. Therefore, total debits must be equal to total
credits.
3. Under this system profit and loss account can be prepared easily by taking together all the
accounts relating to income or revenue and expenses or losses and thereby the result of the
business can be ascertained.
4. A balance sheet can be prepared by taking together all the accounts relating to assets and
liabilities and thereby the financial position of the business can be assessed.
5. Under this system mistakes and deflections can be detected - this exerts a moral pressure on
the accountant and his staff.
6. Under this system necessary statistics are easily available so that the management can take
appropriate decision and run the business efficiently.
7. All the necessary details about a transaction can be obtained quickly and easily.
8. The total amount owed by debtors and the total amount owed to creditors can be
ascertained easily.
9. Sale, purchase of goods, stock, revenue, expenses and profit or loss of different years can be
compared and the success or failure of the business measured. Thereafter the causes of
failure can be found out and necessary remedial measures taken to ensure success of the
business.
Disadvantages:
Despite so may advantages of the system, double entry system has some disadvantages which are
as follows:
1. Under this method each transaction is recorded in books in two stages (journal and ledger)
and two sides (debit and credit). This results in increase of number and size of books of
account and creation of complications.
2. It involves time, labor and money. So it is not possible for small concerns to keep accounts
under this system.
3. It requires expert knowledge to keep accounts under this system.
4. As the system is complex, there is greater possibility of committing errors and mistakes.
TYPES OF ACCOUNTS
(1) Personal Account: As the name suggests these are accounts related to persons.
(a) These persons could be natural persons like Suresh’s A/c, Anil’s a/c, Rani’s A/c etc.
(b) The persons could also be artificial persons like companies, bodies corporate or association of
persons or partnerships etc. Videocon Industries A/c, Infosys Technologies A/c etc.
(c) There could be representative personal accounts as well. Although the individual identity of
persons related to these is known, the convention is to reflect them as collective accounts
(2) Real Accounts: These are accounts related to assets or properties or possessions. Depending on
their physical existence or otherwise, they are further classified as follows:-
(a) Tangible Real Account – Assets that have physical existence and can be seen, and touched. e.g.
Machinery A/c, Stock A/c, Cash A/c, Vehicle A/c, and the like.
(b) Intangible Real Account – These represent possession of properties that have no physical
existence but can be measured in terms of money and have value attached to them. e.g. Goodwill
A/c, Trademark A/c, Patents & Copy Rights A/c, Intellectual Property Rights A/c and the like.
(3) Nominal Account: These accounts are related to expenses or losses and incomes or gains e.g.
Salary and Wages A/c, Rent of Rates A/c, Travelling Expenses A/c, Commission received A/c etc.
I N D I A N AC C OU NT I NG
NA M E O F I ND I A N A CC O U NTI NG ST A ND A R D
ST A N D A R D N O ( I A S NO )
Ind AS 105 Non-current Assets Held for Sale and Discontinued Operations
Ind AS 2 Inventories
Ind AS 17 Leases
Ind AS 41 Agriculture
Unit -2
JOURNAL
A journal is often referred to as Book of Prime Entry or the book of original entry. In this book
transactions are recorded in their chronological order. The process of recording transaction in a
journal is called as ‘Journalisation’.
The entry made in this book is called a ‘journal entry’.
Functions of Journal
(i) Analytical Function: Each transaction is analysed into the debit aspect and the credit aspect. This
helps to find out how each transaction will financially affect the business.
(ii) Recording Function: Accountancy is a business language which helps to record the transactions
based on the principles. Each such recording entry is supported by a narration, which explain, the
transaction in simple language
(iii) Historical Function: It contains a chronological record of the transactions for future references.
Advantages of Journal
The following are the advantages of a journal:
(i) Chronological Record: It records transactions as and when it happens. So it is possible to get a
detailed day to- day information.
(ii) Minimizing the possibility of errors: The nature of transaction and its effect on the financial
position of the business is determined by recording and analyzing into debit and credit aspect.
(iii) Narration: It means explanation of the recorded transactions.
(iv) Helps to finalize the accounts: Journal is the basis of ledger posting and the ultimate Trial
Balance.
The Trial balance helps to prepare the final accounts.
The specimen of a journal book is shown below.
Explanation of Journal
(i) Date Column: This column contains the date of the transaction.
(ii) Particulars: This column contains which account is to be debited and which account is to be
credited. It is also supported by an explanation called narration.
(iii) Voucher Number: This Column contains the number written on the voucher of the respective
transaction.
(iv) Ledger Folio (L.F.): This column contains the folio (i.e. page no.) of the ledger, where the
transaction is posted.
(v) Dr. Amount and Cr. Amount: This column shows the financial value of each transaction. The
amount is recorded in both the columns, since for every debit there is a corresponding and equal
credit.
All the columns are filled in at the time of entering the transaction except for the column of ledger
folio. This is filled at the time of posting of the transaction to ‘ledger’.
Sub-division of Journals
Journal is divided into two types -(i) General Journal and (ii) Special Journal.
Recording of transactions in this book is called journalising and the record of transactions is known
as journal entry.
(ii) Special Journal
It is subdivided into Cash Book, Purchase Day Book, Sales Day Book, Returns Inward Book, Returns
Outward Book,
Bills Receivable Book and Bills Payable Book. These books are called subsidiary books.
Ledger Posting
As and when the transaction takes place, it is recorded in the journal in the form of journal entry.
This entry is posted again in the respective ledger accounts under double entry principle from the
journal. This is called ledger posting.
The rules for writing up accounts of various types are as follows:
Assets: Increases on the left hand side or the debit side and decreases on the credit side or the
right hand side.
Liabilities: Increases on the credit side and decreases on the debit side.
Capitals: The same as liabilities.
Expenses: Increases on the debit side and decreases on the credit side.
Incomes or gain: Increases on the credit side and decrease on the debit side.
Personal Ledger: The ledger where the details of all transactions about the persons who are related
to the accounting unit, are recorded, is called the Personal Ledger.
Impersonal Ledger: The Ledger where details of all transactions about assets, incomes & expenses
etc. are recorded, is called Impersonal Ledger.
Again, Personal Ledger may be divided into two groups:
Viz. (a) Debtors’ Ledger, & (b) Creditors’ Ledger.
(a) Debtors’ Ledger: The ledger where the details of transactions about the persons to whom goods
are sold, cash is received, etc. are recorded, is called Debtors’ Ledger.
(b) Creditors’ Ledger: The ledger where the details of transactions about the persons from whom
are purchase goods on credit, pay to them etc. are recorded, is called Creditors’ Ledger.
Impersonal Ledger may, again be divided into two group, viz, (a) Cash Book; and (b) General Ledger.
(a) Cash Book: The Book where all cash & bank transactions are recorded, is called Cash Book.
(b) General Ledger: The ledger where all transactions relating to real accounts, nominal accounts,
details of Debtors’ Ledger and Creditors’ Ledger are recorded, is called General Ledger.
General Ledger may, again, be divided into two groups. viz, Nominal Ledger; & Private Ledger.
(a) Nominal Ledger: The ledger where all transactions relating to incomes and expenses are
recorded is called Nominal Ledger.
(b) Private Ledger: The Ledger where all transactions relating to assets and liabilities are recorded is
called Private Ledger.
Advantages of sub-division of Ledger:
The advantages of sub-division of ledger are:
(a) Easy to Divide work : As a result of sub-division, the division of work is possible and records can
be maintained efficiently by the concerned employee.
(b) Easy to handle : As a result of sub-division, the size and volume of ledger is reduced.
(c) Easy to collect information: From the different classes of Ledger a particular type of transactions
can easily be found out.
(d) Minimizations of mistakes: As a result of sub-division chances of mistakes are minimized.
(e) Easy to compute : As a result of sub-division, the accounting work may be computed quickly
which is very helpful to the management.
(f) Fixation of responsibility: Due to sub-division, allotment of different types of work to different
employees is done for which concerned employee will be responsible.
TRIAL BALANCE
Trial balance may be defined as a statement or a list of all ledger account balances taken from
various ledger books on a particular date to check the arithmetical accuracy. According to the
Dictionary for Accountants by Eric. L. Kohler, Trial Balance is defined as “a list or abstract of the
balances or of total debits and total credits of the accounts in a ledger, the purpose being to
determine the equality of posted debits and credits and to establish a basic summary for financial
statements”. According to Rolland, Trial Balance is defined as “The final list of balances, totaled and
combined, is called Trial Balance”.
Feature’s of a Trial Balance
1. It is a list of debit and credit balances which are extracted from various ledger accounts.
2. It is a statement of debit and credit balances.
3. The purpose is to establish arithmetical accuracy of the transactions recorded in the Books of
Accounts.
4. It does not prove arithmetical accuracy which can be determined by audit.
5. It is not an account. It is only a statement of account.
6. It is not a part of the final statements.
7. It is usually prepared at the end of the accounting year but it can also be prepared anytime as
and when required like weekly, monthly, quarterly or half-yearly.
8. It is a link between books of accounts and the Profit and Loss Account and Balance sheet.
2. Ledger Form: This form of a trial balance have two sides i.e. debit side and credit side. In fact, the
ledger form of a trial balance is prepared in the form of an account. Each side of the trial balance
will have particulars (name of the account) column, folio column and the amount column.
Specimen of ledger form of Trial Balance
*Purpose of a Trial Balance
It serves the following purposes:
1. To check the arithmetical accuracy of the recorded transactions.
2. To ascertain the balance of any ledger Account.
3. To serve as an evidence of fact that the double entry has been completed in respect of every
transaction.
4. To facilitate the preparation of final accounts promptly.
2. Balance Method or Net Trial Balance: Under this method, all the ledger accounts are balanced.
The balances may be either “debit-balance” or “credit balance”.
Advantages:
(a) It helps in the easy preparation of final accounts.
(b) It saves time and labour in constructing a Trial Balance.
Disadvantages: Errors may remain undisclosed irrespective of the agreement of Trial Balance.
3. Compound Method: Under this method, totals of both the sides of the accounts are written in
the separate columns. Along with this, the balances are also written in the separate columns. Debit
balances are written in the debit column and credit balances are written in the credit column of the
Trial Balance.
Advantages: It offers the advantage of both the methods.
Disadvantages: Lengthy process and more time consumed in the preparation of a Trial Balance.
*Errors Disclosed by a Trial Balance
The errors which cause a mismatch in the trial balance totals are frequently referred to as errors
disclosed in a Trial Balance. However, the mismatch does not automatically point to the actual
errors. It is only the diligence and ingenuity of the person preparing the accounts which would help
in the location of the errors.
The various errors which would cause a mismatch in the trial balance totals are as follows:
(i) Wrong Totaling in a Subsidiary Book
(ii) Wrong Calculation of Balances in a Ledger Account
(iii) Partial Omission of an Entry
(iv) Posting an Aspect of a Transaction More than Once
(v) Debit Entries Wrongly Recorded as Credit Entries of Vice-versa
(vi) Errors in Totaling the Debit Column or the Credit Column of the Trial Balance
(vii) Balance of Ledger Accounts are Wrongly Transferred to the Trial Balance
(viii) Omitting to Include an Account’s Balance in the Trial Balance
(1) Re-total the debit and credit columns of the Trial Balance. Find out the amount of difference by
the two columns, divided by 2 and see similar amount appears in the Trial Balance. If similar figure
exists, see whether it is in the correct column. It is also possible that such a balance might have
been recorded on the wrong side, causing a difference of double the amount.
(2) See that Cash balance and Bank balance are properly listed in the Trial Balance.
(3) If still the difference exists, divide the difference by 9. If the difference is evenly divisible by 9,
the error is likely to occur from the transposition or trans-placement of figures. Disarrangement of
figures is transposition and trans-placement means the digits of the numbers are moved to the left
or right.
(4) Confirm that the opening balances have been correctly brought forward in the current year,
from the previous year.
(5) Recheck the amounts listed in the Trial balance and confirm that all the ledger balances have
been copied down.
(6) Check the totals in the lists of Sundry Debtors and Sundry Creditors.
(7) Re-compute the Account balances.
(8) Check the casting and carry forward of all subsidiary books.
(9) Verify the postings of individual items from the subsidiary books.
(10) After making complete checking of journal, ledger and subsidiary books, if the errors cannot be
located, then transfer the difference to a Suspense Account and when the mistake is found out the
Suspense Account is closed.
Unit – 3
CASHBOOK
A Cash Book is a special journal which is used for recording all cash receipts and all cash payments.
Cash Book is a book of original entry since transactions are recorded for the first time from the
source documents. The Cash Book is larger in the sense that it is designed in the form of a Cash
Account and records cash receipts on the debit side and cash payments on the credit side. Thus, the
Cash Book is both a journal and a ledger.
Types of Cash Book
There are different types of Cash Book as follows:
(i) Single Column Cash Book- Single Column Cash book has one amount column on each side. All
cash receipts are recorded on the debit side and all cash payments on the payment side, this book
is nothing but a Cash Account and there is no need to open separate cash account in the ledger.
(i) Double Column Cash Book- The Double Column Cash Book having two amounts. Columns on
each side as under:
(a) Cash and discount columns
(b) Cash and bank columns
(c) Bank and discount columns
(iii) Triple Column Cash Book- Triple Column Cash Book has three amount columns, one for cash,
one for Bank and one for discount , on each side. All cash receipts, deposits into book and discount
allowed are recorded on debit side and all cash payments, withdrawals from bank and discount
received are recorded on the credit side. In fact, a triple-column cash book serves the purpose of
Cash Account and Bank Account both.
Thus, there is no need to create these two accounts in the ledger.
(iv) The multi-column cash book having multiple columns on both the sides of the cash book.
(v) The petty Cash Book.
PURCHASE DAY BOOK
The purchase day book records the transactions related to credit purchase of goods only. It follows that
any cash purchase or purchase of things other than goods is not recorded in the purchase day book.
Periodically, the totals of Purchase day book are posted to Purchase account in the ledger.
(ii) Return Outward Book- This book contains the transactions relating to goods that are returned by
us to our creditors e.g. goods broken in transit, not according to the sample etc. It’s also known as
Purchase Return Book.
(iii) Bills Receivable Book- It is such a book where all bills received are recorded and there from
posted directly to the credit of the respective customer’s account. The total amounts of the bills so
received during the period (either at the end of the week or month) is to be posted in one sum to
the debit of Bills Receivable A/c.
(iv) Bills Payable Book- Here all the particulars relating to bills accepted are recorded and there
from posted directly to the debit of the respective creditor’s account. The total amounts of the bills
so accepted during the period (either at the end of the week or month) is to be posted in one sum
to the credit of Bills Payable Account.
Unit- 4 Financial Accounting
Financial accounting is a specialized branch of accounting that keeps track of a company's financial
transactions. Using standardized guidelines, the transactions are recorded, summarized, and
presented in a financial report or financial statement such as an income statement or a balance
sheet.
Trading Accounts
The account which is prepared to determine the gross profit or gross loss of a business concern is
called trading account.
It should be noted that the result of the business determined through trading account is not true
result. The true result is the net profit or the net loss which is determined through profit and loss
account.
The trading accounting has the following features:
1. It is the first stage of final accounts of a trading concern.
2. It is prepared on the last day of an accounting period.
3. Only direct revenue and direct expenses are considered in it.
4. Direct expenses are recorded on its debit side and direct revenue on its credit side.
5. All items of direct expenses and direct revenue concerning current year are taken into
account but no item relating to past or next year is considered in it.
6. If its credit side exceeds it represents gross profit and if debit side exceeds it shows gross
loss.
Balance sheet
A balance sheet is a financial statement that reports a company's assets, liabilities and
shareholders' equity at a specific point in time, and provides a basis for computing rates of
return and evaluating its capital structure. It is a financial statement that provides a snapshot
of what a company owns and owes, as well as the amount invested by shareholders.
It is used alongside other important financial statements such as the income statement and
statement of cash flows in conducting fundamental analysis or calculating financial ratios.
The balance sheet is based on the fundamental equation: Assets = Liabilities + Equity.
Types of Liabilities:
1. Current Liabilities
Current liabilities, also known as short-term liabilities, are debts or obligations that need to be
repaid within a year. Current liabilities should be closely watched by management to make sure
that the company possesses enough liquidity from current assets to guarantee that the debts or
obligations can be repaid.
Examples of current liabilities:
Accounts payable, Interest payable, Income taxes payable, Bills payable, Bank account overdrafts,
Accrued expenses, Short-term loans
Current liabilities are used as a key component in several short-term liquidity measures. Below are
examples of metrics management teams and investors look at when analyzing a company and
performing financial analysis.
2. Non-current Liabilities
Non-current liabilities, also known as long-term liabilities, are debts or obligations that are due in
over a year’s time. Long-term liabilities are an important source of a company’s long-term
financing. Companies take on long-term debt to acquire immediate capital to fund the purchase of
capital assets or invest in new capital projects.
Long-term liabilities are crucial in determining a company’s long-term solvency. If companies are
unable to repay their long-term liabilities as they become due, then the company will face a
solvency crisis.
List of non-current liabilities:
Bonds payable, Long-term notes payable, Deferred tax liabilities, Mortgage payable, Capital lease
3. Contingent Liabilities
Contingent liabilities are liabilities that may occur depending on the outcome of a future event.
Therefore, contingent liabilities are potential liabilities. For example, when a company is facing a
lawsuit of $100,000, the company would face a liability if the lawsuit proves successful. However, if
the lawsuit is not successful, the company would not face a liability. In accounting standards, a
contingent liability is only recorded if the liability is probable and the amount can be reasonably
estimated.
“Financial management is the activity concerned with planning, raising, controlling and administering
of funds used in the business.” – Guthman and Dougal
“Financial management is that area of business management devoted to a judicious use of capital and
a careful selection of the source of capital in order to enable a spending unit to move in the direction
of reaching the goals.” – J.F. Brandley
“Financial management is the operational activity of a business that is responsible for obtaining and
effectively utilizing the funds necessary for efficient operations.”- Massie
Investment Decisions: Managers need to decide on the amount of investment available out of the
existing finance, on a long-term and short-term basis. They are of two types:
Long-term investment decisions or Capital Budgeting mean committing funds for a long period
of time like fixed assets. These decisions are irreversible and usually include the ones pertaining
to investing in a building and/or land, acquiring new plants/machinery or replacing the old ones,
etc. These decisions determine the financial pursuits and performance of a business.
Short-term investment decisions or Working Capital Management means committing funds for a
short period of time like current assets. These involve decisions pertaining to the investment of
funds in the inventory, cash, bank deposits, and other short-term investments. They directly
affect the liquidity and performance of the business.
Financing Decisions: Managers also make decisions pertaining to raising finance from long-term
sources (called Capital Structure) and short-term sources (called Working Capital). They are of two
types:
Financial Planning decisions which relate to estimating the sources and application of funds.
It means pre-estimating financial needs of an organization to ensure availability of adequate
finance. The primary objective of financial planning is to plan and ensure that the funds are
available as and when required.
Capital Structure decisions which involve identifying sources of funds. They also involve
decisions with respect to choosing external sources like issuing shares, bonds, borrowing from
banks or internal sources like retained earnings for raising funds.
Dividend Decisions: These involve decisions related to the portion of profits that will be distributed as
dividend. Shareholders always demand a higher dividend, while the management would want to
retain profits for business needs. Hence, this is a complex managerial decision.
Functions of Financial Management/ Finance Functions
1. Estimation of capital requirements: A finance manager has to make estimation with regards
to capital requirements of the company. This will depend upon expected costs and profits
and future programmes and policies of a concern. Estimations have to be made in an
adequate manner which increases earning capacity of enterprise.
2. Determination of capital composition: Once the estimation have been made, the capital
structure have to be decided. This involves short- term and long- term debt equity analysis.
This will depend upon the proportion of equity capital a company is possessing and
additional funds which have to be raised from outside parties.
3. Choice of sources of funds: For additional funds to be procured, a company has many choices
like-
a. Issue of shares and debentures
b. Loans to be taken from banks and financial institutions
c. Public deposits to be drawn like in form of bonds.
Choice of factor will depend on relative merits and demerits of each source and period of
financing.
4. Investment of funds: The finance manager has to decide to allocate funds into profitable
ventures so that there is safety on investment and regular returns is possible.
5. Disposal of surplus: The net profits decision have to be made by the finance manager. This
can be done in two ways:
a. Dividend declaration - It includes identifying the rate of dividends and other benefits
like bonus.
b. Retained profits - The volume has to be decided which will depend upon expansional,
innovational, diversification plans of the company.
6. Management of cash: Finance manager has to make decisions with regards to cash
management. Cash is required for many purposes like payment of wages and salaries,
payment of electricity and water bills, payment to creditors, meeting current liabilities,
maintainance of enough stock, purchase of raw materials, etc.
7. Financial controls: The finance manager has not only to plan, procure and utilize the funds
but he also has to exercise control over finances. This can be done through many techniques
like ratio analysis, financial forecasting, cost and profit control, etc.
Role of a Financial Manager
1. Raising of Funds
In order to meet the obligation of the business it is important to have enough cash and liquidity. A
firm can raise funds by the way of equity and debt. It is the responsibility of a financial manager to
decide the ratio between debt and equity. It is important to maintain a good balance between
equity and debt.
2. Allocation of Funds
Once the funds are raised through different channels the next important function is to allocate the
funds. The funds should be allocated in such a manner that they are optimally used.
3. Profit Planning
Profit earning is one of the prime functions of any business organization. Profit earning is important
for survival and sustenance of any organization. Profit planning refers to proper usage of the profit
generated by the firm.
Profit arises due to many factors such as pricing, industry competition, state of the economy,
mechanism of demand and supply, cost and output. A healthy mix of variable and fixed factors of
production can lead to an increase in the profitability of the firm.
Shares of a company are traded on stock exchange and there is a continuous sale and purchase of
securities. Hence a clear understanding of capital market is an important function of a financial
manager. When securities are traded on stock market there involves a huge amount of risk
involved. Therefore a financial manger understands and calculates the risk involved in this trading
of shares and debentures.
Fund
A fund is a source of money that is allocated for a specific purpose. A fund can be established for
any purpose whatsoever, whether it is a city government setting aside money to build a new civic
center, a college setting aside money to award a scholarship, or an insurance company setting aside
money to pay its customers’ claims.