announcement by the Finance Minister the perquisite tax has been removed.

Tax is now payable

only at time of sale of shares as capital gains. Since perquisite tax has been removed employers
are not liable for tax deduction at source, thus removing administrative inconvenience.

For the company:

As per SEBI guidelines listed companies have to account for ESOP by treating the same
as an expense. As yet there is no clarity whether this expense will be allowed as deductible
expense by the Income Tax authorities.

______________________________________________________________________________
UNIT III

Part - A

1. What is the difference between current ratio and quick ratio? (Dec 2017)
The current ratio and quick ratio are both designed to estimate the ability of a business to
pay for its current liabilities. The difference between the two measurements is that the quick ratio
focuses on the more liquid assets, and so gives a better view of how well a business can pay off
its obligations.
Thus, the difference between the two ratios is the use (or non-use) of inventory.

______________________________________________________________________________
2. What is the meaning of Funds from Operation?(Dec 2017)

Funds from operations are the cash flows generated by the operations of a business. The term
is most commonly used in relation to the cash flows from real estate investment trusts (REITs).
This measure is commonly used to judge the operational performance of REITs, especially in
regard to investing in them. Funds from operations do not include any financing-related cash
flows, such as interest income or interest expense. It also does not include any gains or losses
from the disposition of assets, or any depreciation or amortization of fixed assets.

______________________________________________________________________________
3. What do you mean by Acid test ratio? (Dec 2016)
The acid test ratio is similar to the current ratio except that Inventory, Supplies, and
Prepaid Expenses, In other words, the acid test ratio compares the total of the cash, temporary
marketable securities, and accounts receivable to the amount of current liabilities.
______________________________________________________________________________
4. State the limitations of the ratio analysis?(Jan 2016) (Dec 2016)
 A single ratio in itself does not indicate favorable or unfavorable conditions.
 Ratio analysis gives only quantified relationships, which by themselves cannot give
qualitative aspects.
 Ratios suffer from the inherent weakness of the accounting system itself, which is the
source of data.
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  The formula calculating each ratio is not well standardized.
 In Ratio analysis, arithmetical window-dressing is possible and firms may be successful
in concealing the real position.
______________________________________________________________________________
5. Define cash flow statement. (Jan 2014)(Dec 2016)

CFS is a statement which describes the inflows (sources) and outflows (uses) of cash and
cash equivalents in an enterprise during a specified period of time. Such a statement enumerates
net effects of the various business transactions on cash and its equivalents and takes into account
receipts and disbursements of cash. A cash flow statement summarizes the causes of changes in
cash position of a business enterprise between dates of two balance sheets.
______________________________________________________________________________
6. Define Fund flow Statement. (Jan 2016)
A funds flow statement is a consolidated statement of the entire cross transactions over the
period for which the flow is being analysed.
Cross Transactions i.e. transactions involving a current account and a non-current account
bring about a change in the fund or working capital. Some bring about an increase in fund and
others bring about a decrease in the available fund (working capital).
The cross transactions presented in the funds flow statement are classified/grouped into two as,
i. Sources/Inflows of funds
Transactions which bring about an increase in the available fund (working capital)
ii. Applications/Outflows of funds
Transactions which bring about a decrease in the available fund (working capital)
______________________________________________________________________________
7. Name the various tools used for financial statement analysis. (Jan 2015)
 Ratio analysis
 Fund flow statements
 Cash flow statements
 Comparative statements
 Common size statements
 Trend analysis
______________________________________________________________________________
8. Give the meaning of 'flow of funds'. (Jan 2015)
It refers to the sources (inflow) of funds and application (outflow) of funds.
______________________________________________________________________________
9. Define the term Fund. (June 2014)

All the financial resources of a firm, such as cash in hand, bank balance, accounts
receivable. Any change in these resources is reflected in the firm's financial position.
______________________________________________________________________________

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 10. Write a short note on operating ratio. (Jan 2014)

Operating ratio establishes the relationship between cost of goods sold and other
operating expenses on the one hand and the sales on the other. In other words, it measures the
cost of operations per rupee of sales.

Cost of goods sold + operating expenses

Operating ratio = x 100
Net Sales
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11. What are financial statements?(June 2013)

Financial statements may be defined as “the report prepared for the purpose of the
purpose of presenting a periodical review of the performance and the financial position of a
business enterprise”. Financial statements are the organized summaries of detailed information
about the financial position and performance of the concern. They are income statement or profit
and loss account and balance sheet.
______________________________________________________________________________
12. What are the sources of cash inflows? (June 2013)
1. Cash from operations
2. Issue of new shares
3. Raising long term loans
4. Short-term borrowings
5. Sale of fixed assets
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1. What are the objectives of financial statements?(Jan 2012)
(i) To provide reliable financial information about economic resources and obligations of a
business firm.
(ii) To provide other needed information about changes in such economic resources and
obligations.
(iii) To provide reliable information about changes in net resources (resources less
obligations) arising out of business activities.
_____________________________________________________________________________
2. What does ratio analysis mean?(Jan 2012)
Ratio analysis is a technique of analysis and interpretation of financial statements. It is
the process of establishing and interpreting various ratios for helping in making certain decisions.
It is only a means of better understanding of financial strengths and weaknesses of a firm.
___________________________________________________________________________
3. What is ‘Financial analyses?
The term ‘Financial analysis’, also known as analysis and interpretation of financial
statements, refers to the process of determining financial strengths and weakness of the firm by
establishing strategic relationship between the items of the balance sheet, profit and loss account
and other operative data. According to Metcalf and Titard, “Financial analysis is a process of
82
evaluation the relationship between component parts of a financial statement to obtain a better
understanding of a firm’s position and performance”.
___________________________________________________________________________
16.What are the types of financial analysis?
(i) External analysis: This analysis is done by outsiders who do not have access to the
detailed internal accounting records of the business firm.
(ii) Internal analysis: This analysis is done by outsiders who do not have access to the
internal accounting records of a business firm is known as internal analysis.
(iii) Horizontal analysis: It refers to the comparison of financial data of a company for
several years.
(iv) Vertical analysis: It refers to the study of relationship of the various items in the
financial statements of one accounting period.

_______________________________________________________________________
17.Define the term ‘Ratio’.
A Ratio is a simple arithmetical expression of the relationship of one number to
another. A Ratio is an expression of the quantitative relationship between two numbers”.

- Kell and Bedford.

___________________________________________________________________________
18. What are the managerial uses of Ratio analysis?
(i) It helps in making decisions from the information provided in financial
statements.
(ii) It helps in forecasting and planning.
(iii) Ratios help in communication and enhance the value of the financial statements.
(iv) Ratios even help in coordination which is of utmost importance in effective
business management.
(v) Ratio analysis helps in making effective control of the business.
______________________________________________________________________________
19. What are the components of current assets?

1. Cash in hand
2. Cash at bank
3. Marketable securities (short-term)
4. Short-term investments
5. Bills receivable
6. Sundry Debtors
7. Inventories (stocks)
8. Work-in-progress
9. Prepaid expenses
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 20. What re the components of current liabilities?
1. Outstanding expense/Accrued expenses
2. Bills payable
3. Sundry Creditors
4. Short-term advances
5. Income-tax payable
6. Dividends payable
7. Bank overdraft (if not a permanent arrangement)
______________________________________________________________________________
21. Name three current assets movement ratios.

These ratios are otherwise known as efficiency ratios, activity ratios because they
measure the efficiency or effectiveness with which a firm manages its resources or assets. These
ratios are also called turnover ratios because they indicate the speed rate at which the funds
invested in inventories are converted into sale.

(i) Inventory / Stock turnover ratio

(ii) Debtors turnover ratio
(iii) Creditors / Payable turnover ratio
(iv) Working capital turnover ratio
______________________________________________________________________________
22. Write a brief note on Debt-Equity Ratio.
Debt-Equity Ratio, also known as external – internal equity ratio is calculated to,
measure the relative claims of outsiders and the owners (i.e., shareholders) against the firm’s
assets. This ratio indicates the relationship between the external equities or the outsider funds
and the internal equities or the shareholder’s funds.
Outsiders’ funds
Debt-Equity Ratio = ___________________
Shareholder funds
______________________________________________________________________________
23. What is mean by Capital gearing ratio?
The term, ‘Capital gearing’ is used to describe the relationship between equity share
capital including reserves and surpluses to preference share capital and other fixed interest-
bearing loans. If preference share capital and other fixed interest bearing loans exceed the equity
share capital including reserves, the firm is said to be highly geared. The firm is said to be in low
gear if preference share capital and other fixed interest-bearing loans are less than equity capital
and reserves.
Fixed interest bearing securities
Capital gearing ratio = __________________________
Equity shareholder’s funds
______________________________________________________________________________

84
 24. What are the various methods or tools or devices of financial statement analysis?
(i) Comparative statements
(ii) Trend analysis
(iii) Common-size statements
(iv) Fund flow analysis
(v) Cash flow analysis
(vi) Ratio analysis
(vii) Cost-Volume-Profit analysis
____________________________________________________________________________
25. State any four characteristics of financial statements.
1. The information contained in the financial statements should be such that a true and
correct idea taken about the financial position of the concern.
2. The financial statements should be presented in a simple and lucid way so as to make
them easily understandable.
3. Financial statements should be relevant to the objectives of the enterprise.
4. The financial statements should be prepared in such a way that important information is
underlined so that it attracts the eye of the reader.
26. Define Management Accounting.
“Management Accounting is concerned with accounting information that is useful to
management”. – R.N.Anthony.

“Management Accounting is the presentation of accounting information in such a way as

to assist management in the creation of policy and in the day-to-day operations of an
undertaking”.
______________________________________________________________________________
27. State any four objective of management accounting.
1. To assist the management in promoting efficiency. Efficiency includes best possible
services to the customers, investors and employees.
2. To prepare budgets covering all functions of a business.
3. To analyze monetary and non-monetary transaction.
4. To compare the actual performance with plan for identifying deviations and their causes.
______________________________________________________________________________
28. Describe term ‘Capital employed’.
The term ‘Capital employed’ refers to the total investments made in a business and can
be defined in number of ways.
(i) Gross capital employed: sum total of all assets whether fixed or current.
(ii) Net capital employed: sum total of fixed and current assets less current liability.
(iii) Proprietor’s capital employed: Fixed Assets + Current Assets – outside
liabilities (both long term and short term)
(iv) Total of long term funds employed in the business. i.e. (share capital + reserves
and surpluses + long term loans) – (non business assets + fictitious assets)
______________________________________________________________________________
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 29. What are the uses of preparing a cash flow statement?
 Since a cash flow statement is based on the basis of accounting, it is very useful in the
evaluation of cash position of a firm.
 A projected cash flow statement can be prepared in order to know the future cash position
of a concern so as to enable a firm to plan and coordinate its financial operations
properly.
 A comparison of historical and projected cash flow statements can be made so as to find
the variations and efficiency or otherwise in the performance so as to enable the firm to
take immediate and effective action.
 CFS helps in planning the repayment of loan, replacement of fixed assets and other
similar long-term planning of cash. It is also significant for capital budgeting decisions.
______________________________________________________________________________
30. Give any two limitations of cash flow statement.
1. A cash flow statement is based on cash basis of accounting; it ignores the basic
accounting concept of accrual basis.
2. Some people feel that as working capital is wider concept of funds, a funds flows
statement provides a more complete picture than cash flow statement.
3. Cash flow statement is not suitable for judging the profitability of a firm as non-cash
charges are ignored while calculating cash flows from operating activities.

31. How will you calculate cash from operation?

The net profit shown by the Profit and Loss account will have to be adjusted for non-fund
items for finding out funds from operations. By adding the increase in current liabilities and the
decrease in current assets and deducting the increase in current assets and decrease in current
liabilities with the funds from operations, that amount is called cash

______________________________________________________________________________

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 PART - B

1. The Balance sheets of X Ltd. As on 31st March 2015 and 31st March 2016 are as
follows. (Dec 2017)

Liabilities 2015 2016 Assets 2015 2016

Share Capital 500000 700000 Land and Buildings 80000 120000

Profit and Loss A/c 100000 160000 Plant and Machinery 500000 800000

General Reserve 50000 70000 Stock 100000 75000

Sundry Creditors 163000 200000 Sundry Debtors 140000 150000

Bills Payable 30000 40000 Prepaid expenses 14000 12000

Outstanding 7000 5000 Cash at bank 16000 18000

Expenses

Total 850000 1175000 Total 850000 1175000

Additional information

1. Rs. 50000 depreciation has been charged to plant and machinery during the year
2016.
2. A piece of machinery was sold for Rs. 8000 during 2016. It had cost Rs. 12000,
depreciation of Rs. 7000 has been provided on it.

Prepare a Cash Flow Statement from the above details.

Ans: Class Work

______________________________________________________________________________

2. The summarized balance sheet of K Ltd. As on 31st March, 2015 and 31st March
2016 are as follows: (Dec 2017)

Liabilities 2015 2016 Assets 2015 2016(Rs)

(Rs) (Rs) (Rs)

Share Capital 1200000 1500000 Buildings 800000 760000

14% Debentures 600000 400000 Machinery 500000 720000

P&L A/c 100000 150000 Short term Investments 300000 450000

General Reserve 300000 350000 Inventories 400000 470000

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Creditors 490000 560000 Debtors 670000 530000

Proposed Dividends 120000 180000 Cash at Bank 220000 330000

Provision for 100000 130000 Prepaid Expenses 20000 10000

Taxation

Total 2910000 3270000 Total 2910000 3270000

Additional Information:

i) Debentures were redeemed at a premium of 10%.

ii) Taxed paid during the year amounted to Rs. 140000.
iii) A machine which appeared at a WDV of Rs. 80000 was sold for Rs. 130000; and a
new machines worth Rs. 360000 were acquired during the year.

Prepare a statement of sources and applications of funds, showing changes in the

working capital.

Ans: Class work

______________________________________________________________________________

3. A company supplies the following information: (Dec 2017)

Liabilities 2015 (Rs) Assets 2015 (Rs)

Share Capital 200000 Good will 120000
Reserves and Surplus 58000 Plant and Machinery 150000
Debentures 100000 Stock 80000
Creditors 40000 Debtors 45000
Bills Payable 20000 Cash 17000
Other current Liabilities 2000 Miscellaneous Current Assets 8000
Total 420000 Total 420000
Sales for the year (credit) Rs. 400000

Gross Profit Rs. 160000

Calculate:

i) Current Ratio.
ii) Quick and Liquid Ratio.
iii) Inventory Turnover.
iv) Average Collection Period.
v) Proprietor’s funds to liabilities.
Ans: Class work

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 4. Calculate the following ratios from the given balance sheet. (Dec 2016)
(i) Current ratio
(ii) Fixed assets to net worth ratio.
(iii) Debt equity ratio
(iv) Return on capital employed.

Liabilities Amount Assets Amount

600 shares of Rs. 100 each 60000 Land 40000

General reserve 35000 Plant 20000
Dividend equalization Reserve 5000 Machine 27500
Long term loans 20000 Investments 25000
Bills payable 30000 Inventories 30000
Provision for tax 5000 Bills receivable 13500
Profit and loss account: Cash and bank 12000
Balance 1000 Preliminary expenses 8000
Current year 20000 21000
_______ ________

176000 176000

Ans: refer class work note

______________________________________________________________________________

5. Explain the uses of cash flow statement. Distinguish between Fund flow
statement and Cash flow statement.(Dec 2016)
Uses of cash flow statement
 Cash flow statement helps to identify the sources from where cash inflows have
arisen within a particular period and also shows the various activities where in the
cash was utilized.
 Cash flow statement is significant to management for proper cash planning and
maintaining a proper matching between cash inflows and outflows.
 Cash flow statement shows efficiency of a firm in generating cash inflows from
its regular operations.
 Cash flow statement reports the amount of cash used during the period in various
long-term investing activities, such as purchase of fixed assets.
 Cash flow statement reports the amount of cash received during the period
through various financing activities, such as issue of shares, debentures and
raising long-term loan.
 Cash flow statement helps for appraisal of various capital investment programs to
determine their profitability and viability.

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 Basis of
Fund flow statement Cash flow statement
Distinction
It is based on a wider concept of It is based on a narrower concept
1. Basis of concept
funds i.e., working capital of funds i.e., cash
It is based on accrual basis of It is based on cash basis of
2. Basis of Accounting
accounting accounting
Schedule of changes in working
3. Schedule of changes capital is prepared to show the No such schedule of changes in
in working capital changes in current assets and working capital is prepared
current liabilities.
It is prepared by classifying all
FFS reveals the sources and
cash inflows and outflows in
application of funds. The net
terms of operating, investing and
difference between sources and
4. Method of preparing financing activities. The net
applications of funds represents
difference represents net
net increase or decrease in
increase or decrease in cash or
working capital.
cash equivalents.
It is useful in planning It is more useful in short term
5. Basis of usefulness intermediate and long term analyses and cash planning of
financing. the business.

6. What is meant by analysis and interpretations of financial statements? Explain

the various methods used for the analysis and interpretations of financial
statements. (June 2013)

Methods/ Techniques of financial statement analysis

I. Comparative Financial Statement
Comparative Financial Statements are those statements which have been designed in a
way so as to provide time perspective to the consideration of various elements of financial
position embodied in such statements. In these statements figures for two or more periods are
placed side by side to facilitate comparison.
These statements render comparison between two periods of time and exhibit the
magnitude and direction of historical changes in the operating results and financial status of a
business. Financial statements of two or more firm may also be compared for drawing
inferences. This is known as inter-firm comparison.
(i) Comparative Income Statement
The Income Statement discloses Net Profit/Net Loss on account of operations. A
comparative Income Statement will show the absolute figures for two or more periods, the
absolute change from one period to another and if desired the change in terms of percentages.
Since the figures for two or more periods are shown side by side, the reader can quickly ascertain

90
whether sales have increased or decreased, whether cost of sales has increased or decreased etc.
Thus, only a reading of data included in comparative Income Statements will be helpful in
deriving meaningful conclusions.
(ii) Comparative Balance Sheet
Comparative balance sheet as on two or more different dates can be used for comparing
assets and liabilities and finding out any increase or decrease in those items. Thus, while in a
single balance sheet the emphasis is on present position, it is on change in the comparative
balance sheet. Such a balance sheet is very useful in studying the trends in an enterprise.

II. Common – Size Financial Statements

Common-size Financial Statements are those in which figures reported are converted into
percentages to some common base. In the Income Statement the sale figure is assumed to be 100
and all figures are expressed as a percentage of sales. Similarly in the balance sheet and the total
of assets or liabilities is taken as 100 and all the figures are expressed as a percentage of this
total.
III. Trend Percentages
Trend Percentages are immensely helpful in making a comparative study of the financial
statements for several years. The method of calculating trend percentages involves the
calculation of percentage relationship that each item bears to the same item in the base year.
Any year may be taken as the base year. It is usually the earliest year. Any intervening year
may also be taken as the base year. Each item of the base year is taken as 100 and on that basis
the percentages for each of the items of each of the years are calculated. However, trend
percentages are not calculated for all of the items in the financial statements. They are usually
calculated only for major items since the purpose is to highlight important changes.
While calculating trend percentages should be taken regarding the following matters:
 The accounting principles and practices followed should be constant throughout the
period for which analysis is made. In the absence of such consistency, the comparability
will be adversely affected.
 The base year should be carefully selected.

IV. Fund Flow Analysis

Fund Flow Analysis has become an important tool in the analytical kit of financial
analysts, credit granting institutions and financial managers. This is because the balance sheet of
a business reveals its financial status at a particular point of time. It does not sharply focus those
major financial transactions which have been behind the balance sheet changes.
For example, if a loan of Rs.2, 00,000 was raised and paid during the accounting year, the
balance sheet will not depict this transaction. However, financial analysts must know the
purpose for which the loan was utilized and the source from which it was obtained. This will
help him in making a better estimate about the company’s financial position and policies.
Fund Flow Analysis reveals the changes in working capital position. It tells about the
sources from which the working capital was obtained and the purposes for which it was used. It

91
brings out in open the changes which have taken place behind the balance sheet. Working
capital being the life blood of the business, such an analysis is extremely useful.

V. Ratio Analysis
This is the most important tools available to financial analysts for their work. An
accounting ratio shows the relationship in mathematical terms between two interrelated
accounting figures. The figures have to be interrelated (E.g.: Gross Profit and Sales, Current
Assets and Current Liabilities) because no useful purpose will be served if ratios are calculated
between two figures which are not at all related to each other, E.g.: sales and discount on issue of
debentures. A financial analyst may calculate different accounting ratios for different purposes.

7. Discuss the importance of financial statements. (Jan 2012)

Financial Statements
Financial statements are those statements which include the income statement, balance
sheets, statement of retained earnings and the statement of sources and uses of funds. The
income statement includes the trading account and the profit & loss account of the business
concern and the balance sheet includes the assets and liabilities of the business.
The financial statement provides the vital information relating to the profitability, liquidity and
solvency of the business. The main aim of the financial statement is to provide reliable
information relating to the economic resources, business obligations, changes in net resources
etc.

Need or Importance of Financial Statements.

The need or importance of financial statement is to satisfy the needs of the users of the
financial statements and which provides relevant information's about the business to the
interested parties like Government, management, creditors, share holders etc. The importance of
Financial statements are as follows:-

1. Importance to Management
In the competitive business environment, it is difficult to sustain the business without any
advanced planning or forecasting. The financial statements help the management to know about
the current position of the business as up to date, accurate and systematic information relating to
the business. It enables the management to identify the current position, progress of the business
and the business prospectus which leads the managers to take necessary remedies and plans to
develop the business environment.

2. Importance to Share holders.

In the case of companies, management is separated from the ownership of the
organisation and the share holders are not authorized to take part in the day to day business
activities of the concern. But in the Annual General Meeting, the results and activities of the
concern will be reported to the shareholders in the form of financial statements. This financial
92
statement enables the shareholders to know about the performance of the management and it will
give the relevant information of the effectiveness, efficiency and the current financial position of
the business also.

3. Importance to Leaders or Creditors

The financial statements provide the useful information or guide to the suppliers or the
creditors of the company. This is done with the help of critical evaluation of the financial
statements and which provides the clear idea about the liquidity, profitability and the solvency of
the business enterprises.
4. Importance to Labour
The financial statement provides the profit and loss account of the business. This enables
the staff to identify the profit condition of the business and helps to negotiate for the better salary
because the profit of the company depends on the salary for the staffs.

5. Importance to the public

Every business is a social entity which includes the co- operation of the various groups
which includes lawyers, trade unions, financial analysts, teachers, research scholars etc. These
groups are intended to know the financial position of the business and this will be available only
through the financial statements.

6. Importance to National Economy

The economic development of a country is highly depends on the growth and
development of business environment. Financial statement discloses the relevant details of the
business to the needy and this is importance to the tax authorities and other statutory aspects in
the country.
______________________________________________________________________________
8. What is Financial Statement Analysis? What are the various Financial
Statements?

A financial statement is an organized collection of data according to logical and consistent

accounting procedures. Its purpose is to convey an understanding of some financial aspects of a
business firm.

Thus, the term financial statements generally refer to two basic statements:

(i) The Income Statement, and

(ii) The Balance Sheet.

1. Income Statement

The income statement (also termed as Profit and Loss A/c) is generally considered to be
the most useful of all financial statements. It explains what has happened to a business as a
result of operations between two balance sheet dates. For this purpose, it matches the revenues
93
and cost incurred in the process of earning revenues and shows the net profit earned or loss
suffered during a particular period.
2. Balance Sheet
It is a statement of financial position of a business at a specified moment of time. It
represents all assets owned by the business at a particular moment of time and the claims of the
owners and outsiders against those assets at that time.
3. Statement of Retained Earnings
The term retained earnings means the accumulated excess of earnings over losses and
dividends. The balance shown by the income statement is transferred to the balance sheet
through this statement, after making necessary appropriations. It is, thus, a connecting link
between the balance sheet and the income statement.
4. Statement of changes in Financial Position
The balance sheet shows the financial condition of the business at a particular moment of
time while the income statement discloses the results of operations of business over a period of
time. However, for a better understanding of the affairs of the business, it is essential to identify
the movement of working capital or cash in and out of the business. This information is
available in the statement of changes in financial position of the business. The statement may
emphasize any of the following aspects relating to change in financial position of the business:
 Change in the firm’s working capital.
 Change in the firm’s cash position.
 Change in the firm’s total financial position.
______________________________________________________________________________
9. What is Ratio Analysis? What are the importance and limitations of ratio
analysis?
Ratio Analysis is defined as the systematic use of ratio to interpret the financial statements so
that the strengths and weaknesses of a firm as well as its historical performance and current
financial condition can be determined.
Importance of Ratio Analysis
 Ratio act as an index of efficiency of a firm.
 They serve as an instrument of management control.
 They are useful in evaluating performance.
 They facilitate and help in forecasting future events.
 They help management in exercising effective decisions.
 They help management to take corrective actions.
 They facilitate intra firm comparisons.
 They play effective role for easy and clear communications.
 They ensure secrecy.
 They facilitate inter-firm comparisons.

Limitations of Ratio Analysis

 Limitations of Accounting Records
94
  Lack of proper standards
 No allowances for price level changes
 Changes in Accounting Procedure
 Qualitative factors are ignored
 Limited use of single ratio.
 Limited Use
 Personal Bias
 Arithmetical window dressing
______________________________________________________________________________
10. What are the differences between Fund Flow Statement and Income Statement?
Fund Flow Statement Income Statement

 There is no prescribed format for  It is prescribed in a prescribed

preparing a Fund Flow Statement. form.
 While preparing the statement both
capital and revenue items are
considered.  Only revenue items are considered.
 Income statement helps the
preparation Fund Flow Statement.
It is complementary to income  Income statement is not prepared
statement. from Fund Flow Statement.
 It highlights the changes in the
financial position of a business and
indicates the various means by 
It does not reveal the inflows and
which funds were obtained during outflows of funds but depict the
a particular period and the ways to items of expenses and income
which these funds were employed. arrives at the figure of profit or
loss.
______________________________________________________________________________

11. How to calculate cash from operations?

For preparing cash flow statement, we need to calculate cash from operations or cash
operating profits. It is main inflow of cash which can be used for working capital. Generally, net
profit of business is inflow of cash and net loss is outflow of cash. But it does not mean that cash
from operation will always be equal to net profit. Net cash operating profits or loss may be less
or more than net profit or loss. It may be possible that company suffered net loss but at that time,
company may get net cash operating profits. Main reason of this is some non cash items which
we did debit or credit in profit and loss account.

Steps to Calculate Cash from Operations:

There are two main methods of calculating cash from operation:

95
1st Method: Calculating Cash from operation from cash sales

If we have the information of sales, we can calculate cash from trading operations. Its formula is
given below :

Cash from operation = Cash sales - (Cash purchase + Cash operating expenses)
Or
Cash from operation = Total sales - credit sales - (total purchase - credit purchase) - (total
expenses - non operating expenses - non cash operating expenses)

2nd Method: Calculation of cash from operation from Net profit or net loss

Under this method, we can calculate cash operating profits or loss with the help of our profit
and loss account's net profit or net loss. For this, we have to make a statement for calculating of
cash from operations

96
97
If you have to use second method, following points must be noted:

i) Outstanding / Accrued Expenses (Current Year)

Outstanding expenses are those which is payable. So, there is not cash payment of such
expenses. So, there is no cash outflow but it is shown in debit side of profit and loss account.
That is the reason; we will add it in net profit for calculating cash operating profits. We will add
only current year o/s expenses because previous year o/s expenses will be paid current year. So,
there is no need to add previous year o/s expenses.

ii) Prepaid Expenses (Previous Year)

We also add prepaid expenses (Previous year) in net profit because it is paid in advance in
previous year and profit and loss account debited this current year. But according to rule of cash
operating profit, this prepaid expense already was shown as outflow of cash in previous year.
That is the reason; we will add it in net profit.
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12. Prepare a fund flow statement.

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 13. From the information provided in the following profit and loss account, find out
the Funds from Operations.

Dr Profit and Loss a/c Cr

Particulars Amount Particulars Amount

3,42,000
To Salaries and Wages
1,24,000
To Rent and Rates
76,000
To Interest
1,32,000
To Provision for Taxes
87,000
To Depreciation on Machinery
39,000 By Gross Profit 12,50,000
To Depreciation on Furniture
91,000 By Commission 2,80,000
To Loss on Sale of Motor Car
42,000 By Miscellaneous Income 1,54,000
To Reserve for Bad Debts
1,25,000 By Profit on Sale of Asset 64,000
To General Reserve
75,000
To Special Reserve
To Goodwill Written off
50,000
To Discounts on issue of Shares
40,000
To Net Profit
5,25,000

16,84,000 16,84,000

Finding/Calculating Funds from Operations

Statement for Calculation of Funds from Operations
Particulars Amount Amount
Profit and loss Appropriation a/c:
Closing Balance –

Less: Opening Balance –

Current Period Profit 5,25,000

Add: Losses/Appropriations debited to Profit/Loss a/c

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1)Provision for Taxes 1,32,000
2) Depreciation on Machinery 87,000
3) Depreciation on Furniture 39,000
4) Loss on Sale of Motor Car 91,000
5) General Reserve 1,25,000
6) Special Reserve 75,000
7) Goodwill Written off 50,000
8) Discounts on issue of Shares/Debentures 40,000

6,39,000
11,64,000
Less: Gains and Adjustments credited to Profit/Loss a/c
1) Profit on Sale of Asset 64,000
Funds From Operations 11,00,000
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14. From the data calculate:
(i) Gross Profit Ratio (ii) Net Profit Ratio (iii) Return on Total Assets
(iv) Inventory Turnover (v) Working Capital Turnover (vi) Net worth to Debt
Sales 25,20,000 Other Current Assets 7,60,000
Cost of sale 19,20,000 Fixed Assets 14, 40,000
Net profit 3,60,000 Net worth 15,00,000
Inventory 8,00,000 Debt. 9,00,000
Current Liabilities 6,00,000

Solution:
1. Gross Profit Ratio = (GP/ Sales) * 100 = 6
Sales – Cost of Sales Gross Profit
25,20,000 – 19,20,000 = 6,00,000
2. Net Profit Ratio = (NP / Sales)* 100 = 3
3. Inventory Turnover Ratio = Turnover / Total Assets) * 100= 1920000/800000= 2.4 times
Turnover Refers Cost of Sales
4. Return on Total Assets = NP/ Total Assets = (360000/3000000)*100 = 12%
FA+ CA +inventory [14, 40,000 + 7, 60,000 + 8, 00,000] = 30, 00,000
5. Net worth to Debt = Net worth/ Debt= (1500000/900000)* 100 = 1.66 times
6. Working Capital Turnover = Turnover/Working capital
Working Capital = Current Assets – Current Liabilities
= 8, 00,000 + 7, 60,000 – 6, 00,000
15, 60,000 – 6, 00,000= 9, 60,000
Working Capital Turnover Ratio = 19, 20,000 = 2 times.
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