MANAGEMENT ACCOUNTING

Limitation of Financial accounting:

1. It is only a post mortem report
2. It does not consider the price level changes
3. It provides a holistic view. (not providing information for individual analysis)
4. It gives only a static position. No dynamic analysis is possible.

Financial Accounting Cost Accounting Management Accounting MIS ERP

Management Accounting: It is an accounting system designs to provide information

to management for facilitating their decision making process.

Cost Cost Ascertainment

Accounting Cost Control

Costing Methods – Cost Ascertainment

Costing Techniques – Cost Control

Costing Methods (for ascertaining cost) Costing Techniques (for controlling cost)

1. Unit / Output Costing 1. Marginal Costing

2. Operation Costing 2. CVP Analysis
3. Operating Costing 3. Standard Costing
4. Process Costing 4. Budgetary Control
5. Job Order Costing
6. Batch Order Costing
7. Service Costing
8. Activity Based Costing

Providing information to management to facilitate decision making.

Financial Statements:
1. Income Statement
2. Position Statement
3. Statement of Appropriations
4. Statement of Changes in WC Position Statement of Changes in
5. Statement of Changes in Cash Position Financial Position

Financial Statement Analysis

Horizontal Analysis
- Analysis of Financial data across year
eg: trend analysis
- It is also known as dynamic analysis
Vertical Analysis
- It is also known as static analysis/
structural analysis
- Compare/ relate the performance of
one financial variable with other
variable in the same statement or not.
Eg: Ratio Analysis

Classification of Financial Analysis

1. Ratio Analysis
2. Comparative Statements
3. Common size Statements ( component percentage or 100% statements)
4. Fund flow statement
5. Cash flow statement
6. CVP Analysis
7. Trend Analysis
Ratios

Solvency Ratios Coverage Ratios Turnover Ratios Profitability Ratios

Inventory Gross Profit Ratio

Internal Turnover Net Profit Ratio
Short Term Long Term Coverage Ratio Operating Profit
Solvency Solvency Ratio Receivables Ratio
(Liquidity (Stability/ Dividend Turnover Ratio EPS
Ratios) Financial Coverage Creditors DPS
Ratios) Ratio Turnover P/E Ratio
Debt Service Ratio Dividend Yield
Coverage Working Dividend Payout
Capital Return on
Current Debt-Equity Turnover Ratio Capital
Ratio Ratio Fixed Assets Employed
Quick Capital Turnover Ratio Return on Asset
Ratio Gearing Cash Turnover
Super Ratio Ratio
Quick Proprietary
Ratio Ratio
I. Solvency Ratios
i) Short term solvency – Liquidity Ratios:
 a) Current Ratio= CA ; 2:1
CL

b) Quick Ratio= QA ; 1:1 QA= (CA-Stock+ Prepaid Expenses)

QL QL= (CL-Bank OD)

(Or)

QA
CL
c) Super Quick Ratio = Cash, Bank and Marketable Securities
25% of CA Receivables 2.5:1
50% of CA Net Working Capital

ii) Long term solvency Ratios – Stability Ratios

a) Debt-Equity Ratios = Long Term Debt

Shareholders Fund

b) Capital Gearing Ratio = Fixed Cost Fund

Equity Shareholders Fund

c) Proprietors Ratio = Shareholders Fund

Total Tangible Assets

II. Coverage Ratios

Coverage Ratios determines whether the profit of the company is sufficient to

cover their financial charges.

a) Interest Coverage Ratios = EBIT

Interest Charges

b) Dividend Coverage Ratios = EAT

Annual Preference Dividend

c) Debt- Service Coverage Ratio = EBIT

Interest + Annual Principal Repayment
1-t

III. Turnover Ratios/ Activity Ratios

 Activity Ratios are used to measure the efficiency of the management in utilisation of
assets.
a) Inventory Turnover Ratio = Cost of Goods Sold
(Stock Velocity Ratio) Average Stock

Inventory Period = Days / Months in a year

ITR

b) Receivables Turnover Ratio = Net Annual Credit Sales

Average Receivables
(Higher Ratio is favourable)
c) Creditors Turnover Ratio = Net Credit Purchases
Average Payables
(Lower Ratio is favourable)
d) Working Capital Turnover Ratio = Sales
Working Capital

e) Fixed Assets Turnover Ratio = Sales

Fixed Assets

f) Cash Turnover Ratio = Cash Operating Expenses

Cash Balance
IV. Profitability Ratios

a) GP Ratio = GP x 100
Sales

b) NP Ratio = NP x 100
Sales

(Difference between GP and NP Ratio indicates percentage of establishment cost or

overhead cost or indirect cost)

c) Operating Ratio = Operating Expenses x 100

Sales

d) 1 – Operating Ratio = Operating Profit Ratio

(Difference between NP Ratio and Operating Profit Ratio indicates Percentage of non
operating expenses in total sales)

e) EPS = Earnings after Tax

No. of shares Outstanding
f) DPS = Total Dividend
No. of Shares Outstanding

g) P/E = MPS
EPS

Higher P/E Indicates risky investment.

Higher P/E - Glamour Stock – Risky
Lower P/E – Value Stock

h) Dividend Yield = DPS

MPS

i) Dividend Payout = DPS

EPS

j) Return on Capital Employed / Return on Investment / Overall Profitability

Measure

ROI = Operating Profit x 100

Capital Employed

Capital Employed = shareholder’s funds + reserves + surplus +Long term loan –

[Fictitious Asset + Non Business Asset]

k) Return on Shareholder’s Fund = EAT

Shareholder’s Fund

l) Return on Equity = PAT +Preference Dividend

Equity Shareholders’ fund

m) Return on Total Asset = EAT

Total Asset

EAT + Interest
Total Asset

EAT +Interest
Total Assets (Excluding Fictitious Assets)
Tobin Q Ratio:
 Tobin’s Q ratio is a popular method of estimating a stock’s fair value and can
be practically used by market participants to make informed decisions. It is also
known as Q ratio or general equilibrium theory or Q theory. It is so called in honour
of US Nobel laureate James Tobin who proposed this ratio.
It is the ratio between replacement cost and market value.
Tobin’s Tax: Tax on foreign currency conversion.
Du Pont Analysis:
By using two ratios we can find third dimension.
A DuPont analysis is used to evaluate the component parts of a company's
return on equity (ROE). This allows an investor to determine what financial activities
are contributing the most to the changes in ROE. An investor can use analysis like this
to compare the operational efficiency of two similar firms.
This analysis was developed by the DuPont Corporation in the year 1920.

Asset Turnover x Net Profit Overall Efficiency

Sales x EAT
TA Sales
ROI = EAT
TA
Because, Operating Profit is just sufficient to pay its fixed financial charges.
Sales level at which Earnings After Tax=Financial Charges(Interest) Financial BEP
EBIT
Int + Principal Instalment
(1-t)
Fund Flow Analysis and & Cash Flow Analysis.
Commonly known as dynamic analysis.
Ratio Analysis - Static Analysis
Fund Flow Analysis – Not Compulsory
Cash Flow Analysis – Compulsory (AS 3)
- Exact Cash Profit Position

II. Fund Flow Analysis

Fund means working Capital.

Change in CA or Change in CL Leads to change in W C

Creditors
Outstanding Expenses
Income Received in advance Spontaneous Sources
Bills Payable
All other Liabilities
Bank Overdraft Negotiated Sources
Long Term Liabilities

C A – Spontaneous Liabilities = W C gap

C A – CL = W C
There is intra head transaction & Inter head Transaction.

I. Intra head transactions – will not affect the Fund Flow.

II. Inter head Transactions – May affect the fund position .
(Not all inter head transaction)
I. Inter head:
a) Horizontal Transactions – will not affect the WC position.
Eg: Non CA – CL (F A & Long term Debt)
C A & CL

Working Capital Change

Increase in W C Decrease in W C
Increase in C A or Increase in C L or
Decrease in CL Decrease in C A

Provision for Tax Treated as noncurrent Liabilities

Proposed Dividend

In Fund Flow Statement

1. Changes in W C Position – Schedule of changes in W C
2. Compute funds from operations

Depreciation:
Depreciation is neither a source nor an application. Depreciation is semi
variable cost. It gives tax advantages and leverages.
Deferred Tax – Tax savings through depreciation.

Fund From Operations:

Profit – Non operating Income
Profit on sale of Investment
Interest income received

Non operating expenses Charity

Donations
Loss on sale of assets
 Non cash Expenses:
-Depreciation
-Amortisation of Goodwill
-Preliminary Expenses
-Discount on issue of shares
Provisions & appropriations:
-Provision for Taxation
-Provision for doubtful debts.

Fund from Operations:

Profit XXXX
- Non operating Income XXX
+ Non operating Expenses XXXX
- Provisions and appropriations XXXX
+ Non Cash Expenses XXX
Fund From Operations XXXX

Sources Applications
Issue of shares Redemption of shares
Issue of debentures Redemption of debentures
Bank borrowings Repayment of borrowings
Sale of assets Dividend paid
Sale of investments Purchase of assets
Dividend income received fund from operations Income tax paid
Decrease in W C Loss from operations
Increase in W C

Impairment of loss: Writing off assets which found non-productive &non

revenue generating.

III. Cash Flow Analysis

Cash means cash or cash equivalent items.

i) Cash from operations
ii) Cash flow statement
- When entire transactions are cash transaction.
Cash from operations = Net Profit (Assuming there will be no non operating
items)
- When transactions are non cash transaction

Cash from operations =

Fund From Opearations XXXX

- Increase in Debtors XXX
 - Increase in Stock XXX
- Increase in outstanding income XXX
/accrued income
- Increase in prepaid expenses XXX

- Decrease in creditors XXX

- Decrease in outstanding expenses XXX
XXXX
+ Decrease in debtors XXX
+ Decrease in stock XXX
+ Decrease in prepaid expenses XXX

+ Increase in creditors XXX

+ Increase in payables XXX
+ Increase in outstanding expenses XXX
Cash from operations XXXX

As per AS -3, Cash flows are classified in to three:

1. Cash flow from operating activity
2. Cash flow from investing activity
3. Cash flow from financing activity

I. cash flow from operating activity

a) Cash receipt for sale of goods and rendering of services

b) Cash receipt from royalty fees commission and other revenue.
c) Cash payment to supplier of goods & services
d) Cash payment to employees
e) Cash receipt and payment of an insurance enterprise for premiums
claims and annuity.
f) Cash payment or refund of income tax ( unless they can be identified
with investing & financing activities)
g) Cash receipts and payments relating to derivatives contract for trading
purpose.
II. Cash flow from investing activity.

a) Cash payment to acquire capital assets

b) Cash receipts from the sale of capital assets
c) Cash payment to acquire shares, debentures, etc in other enterprise.
d) Cash receipts from disposal of above items.
e) Cash advances and loans to third parties (other than by a financing
company)
f) Cash receipts from the repayment of above.
 g) Cash receipts or payment from derivative contracts other than for trading
purpose or classified as financing activity.

III. Cash flow from financing activity.

a) Cash receipts from issue of securities and long term loans.

b) Cash payment of amount borrowed.

- Cash from operations: (Net Profit + Increase in outstanding expenses, Net

Profit + Increase in Debtors, Net profit +increase in stock)

WC Cash
Purchase of goods for cash No Change +
Purchase of buildings against loan payment No Change No Change
Bonus paid in the form of fully paid up shares No Change No Change

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