Module - 6

Balance sheet

• Balance sheet is a statement of assets and

liabilities which helps us to ascertain the financial
position of a concern on a particular date, on a
date when financial statements or final accounts
are prepared or books of accounts are closed.
• Balance sheet is basically a historical report
showing the cumulative effect of past transactions.
• It is often described as a detailed expression of the
following fundamental accounting equation.
 Assets
• Assets represents everything which a business
owns and has money value. In other words,
asset includes all rights or properties which a
business owns.
• Cash, investments, bills receivable, debtors,
stock of raw materials, work in progress and
finished goods, land, building, machinery,
trademarks, patent, rights etc. are some
example of assets.
 Liabilities

• Liabilities refer to the financial obligations of a

business. These denote the amounts which a
business owes to others.
• E.g loans from banks or other persons, bank
overdraft etc.
 Basic Accounting Terms
Debtors:
• A person who receives a benefit without giving
money or moneys worth immediately, but liable
to pay in future course of time is a debtor.
• The debtor are shown as an asset in the balance
sheet.
E.g Mr. Arul bought goods on credit from Mr. babu
for Rs. 10,000. Mr Arul is a debtor to Mr. Babu till
he pays the value of the goods.
Creditors:
A person who gives a benefit without receiving money or moneys
worth immediately but to claim in future , is a creditor.
In the above example Mr. Babu is a creditor to Mr. Arul till he
receives the value of the goods.
Purchases:
Purchase refers to the amount of goods bought buy a business for
resale or for use in the production. Goods purchased for cash are
called cash purchase. If it is purchased on credit, it is called as credit
purchase. Total purchase include both cash and credit purchase.
Sales:
Sales refers to the amount of goods sold that are already bought
or manufactured by the business. When goods are sold for cash,
they are cash sales but if goods are sold and payment is not received
at the time of sale, it is credit sales. Total sales include both cash and
credit sales.
 Characteristics of Balance sheet
Balance sheet is the position statement which shows
the position of assets and liabilities . It has got the
following features.
• Balance sheet is a statement
• Prepared on a specific date
• Knowledge of financial position
• Knowledge about the nature of assets and
liabilities
• Assets and liabilities tally each other.
 Preparation of Balance sheet
All the permanent accounts, i.e accounts of assets, liabilities
and capital are shown in the balance sheet.
All those accounts which are still not closed after the
preparation of trading and profit and loss account are taken to
balance sheet.
A balance sheet has two sides the left hand side and the right
hand side.
Accounts of capital and liabilities are shown on the left hand
side known as liabilities side.
Assets and other debit balances are shown on the right hand
side called assets side.
Each side of the balance sheet must be equal the other. and
hence called as balance sheet.
Items to be shown on liabilities side
of Balance sheet
Long term liabilities:
Liabilities which are repayable after a long period of time are known as long term
liabilities. E.g capital, long term loans etc.
Fixed Liabilities:
These are long term liabilities which are payable only on the termination of
business such as capital, which is a liability to the owner.
Current Liabilities:
Current liabilities are those which are repayable with in a year.
e.g creditors for goods purchased, short term loans etc.
Net Profit:
Net profit is the amount earned by the owner and it is always added to the capital.
As capital is the liability of the firm, net profit is also shown on the liability side of the
balance sheet.
Drawings:
The amount withdrawn by the proprietor is termed as drawings and has the effect
of reducing the balance on his capital account.
 Items to be shown on assets side of Balance
sheet
Fixed assets:
Assets which are permanent in nature having long period of life and
cannot be converted into cash in a short period are termed as fixed
assets.
Fixed assets may be classified as follows:
• Tangible fixed assets: Which can be seen and touched. E.g Land and
buildings, plant and machinery etc.
• Intangible fixed assets: Which cannot be seen and touched. E.g
goodwill, patents, trademarks etc.
Current assets:
Current assets are those in which either in the form of cash or which
can be converted into cash within a year. They include the following
• Cash in hand & cash at bank
• Bills receivable
• Sundry debtors
• Closing stock
• Prepaid expenses ( Expenses paid in advance
for services to be received future)
• Accrued Income ( Income which has been
earned but has not yet been received)
Investments:
Investments represents the funds invested in
government securities, share of a company etc.
 Proforma of Balance sheet

Liabilities Amount Amount Assets Amount

Current liabilities Current assets
Bank overdraft XXX Cash in hand XXX
Bills payable XXX Cash at bank XXX
Outstanding expenses XXX Bills receivable XXX
Sundry creditors XXX Sundry debtors XXX
Income received in Prepaid expenses XXX
advance XXX Accrued Income XXX
Closing stock XXX
Long term Liabilities
Loans from banks XXX Investments XXX
Debentures XXX
Fixed assets
Fixed Liabilities Goodwill XXX
Capital XXX Patents XXX
Add Net profit XXX Trademarks XXX
XXX Furniture XXX
Less drawings XXX XXX Plant & Machinery XXX
Land & Buildings. XXX

XXX XXX
 Objectives of Balance sheet
• The function of the correctly prepared balance
sheet is to exhibit the true and correct view of
the state of affairs of any concern.
• In a balance sheet as the assets and liabilities
are shown in details after being properly
valued, a trader can judge the position of his
business from it.
 Need for the balance sheet

The need for preparing balance sheet is as

follows.
• To Know the nature and value of assets of the
business
• To ascertain the total liabilities of the business
• To know the position of owners equity.
 Forecasting
• A key to successful business operations, planning and
strategy is the use of business forecast.
• Since business planning and strategy involve decisions
or actions at the present time which will have
consequences in the future, useful forecasts about
future uncertain events are essential.
• The need for business forecasting is found in all areas
and at all levels of business.
• Forecasting forms the basis of planning the activities of
an organization.
 Definition of forecasting
• “Forecasting an be defined as an estimate of future
events that can be obtained by systematically combining
past and present data in a predetermined way and
arrive at the future data”
• Demand forecasting and production forecasting etc are
examples of different types of forecasting.
• Forecasting begins with demand forecast ( estimate of
demand in future) and is followed by production forecast (
estimation of quantity and quality of work) and forecast
for costs, finance, purchase, profit or loss etc.
• Forecast help to determine the amount of inventory to be
kept on hand, how much raw material should be
purchased and how much of a product should be made.
 Sources of forecasting data
Sources of data can be classified as follows.

 Primary Data:
Primary source of data is the first hand original data collected by the
investigator through observation, interview, questionnaire,
experimentation and surveys.
Primary data presents the current scenario of the situation, therefore it
is more effective in taking business decisions.

 Secondary data:
Secondary data is the data which is already collected by other
institutions such as annual reports, sales data, customer records and
survey, client databases, payment records, reports of marketing research
companies, trade association data and reports, company websites etc.
 Demand forecasting
• Every organization needs the market for selling their product or
services. These sales depend on demand.
• The demand for a product or service depends upon customer
requirements and needs and it can change.
• Demand forecasting is the method of accurate determination of
the demands of sales.
• It estimates the quantity of production on the basis of
forecasted demand.
• The estimation of future demand of a product manufactured by
an industrial organizations will be done on the basis of present
and past data of the demand of the product.
• Forecasting not only plans the quantity of production and
demand but also is necessary to plan material requirements,
schedule of production , operations and manpower etc.. So that
full capacity utilization of resources is possible.
 Purpose of demand forecasting
Demand forecasting is essential because the reasons mentioned
below.
• It determines the volume of production and the production
rate.
• It forms basis for production budget, labour budget, material
budget etc.
• It suggests the need for plant expansion
• It suggests the need for changes in production methods.
• It helps establishing pricing policies.
• It helps deciding the extent of advertising, product
distribution etc.
• It helps to train the personnel so that manpower
requirements can be met.
 Limitations

• Lack of efficient and experienced forecasters

• Lack of demand history
• Change in consumers needs , fashion and style
etc.
• Complex psychology of consumers
 Essential of a good sales forecasting system

• Simplicity - It should be simple not complicated.

• Accuracy - Marketing planning should be accurate and reliable.

• Availability- It cannot be prepared in time if the required data are not easily available.

• Stability - It should be prepared in such a way that there should be no scope of

changes.

• Economy – There should be minimum involvement of time & labour.

 Factors affecting sales forecasting
• General business condition
General economic condition of the country, population, distribution of income and
wealth in the country, general traditions and customs, fashion, seasonal fluctuations,
per capita income, government policy etc.

• Conditions with the industry

Design of product, quality of product, price policy, product line of the enterprise, stage
of competition within the industry, expected improvements in the product etc.

• Internal factors of the enterprise

Plant capacity of the enterprise, quality of the product, price of the product,
advertisement and distribution policies of the enterprise etc.

• Factors affecting export trade

Import and export controls, terms & conditions of export, international policy etc.

• Market behavior
It is required to consider the market behavior which brings about changes in demand.
 Sales forecasting Methods
The various methods used to forecast demand trend can be
categorized into two ways:

 Opinion or judgmental /Qualitative method

 Time series forecasting/Quantitative method

Qualitative Method
• Jury of executive opinion
• The Delphi Method
• Sales force opinion
• Survey of customers buying

Quantitative method
• Time series forecasting
 Opinion and judgmental methods or
Qualitative methods
Jury of executive opinion:
The views of executives or experts from sales, production, finance, purchasing and
administration are averaged to generate a forecast about future sales as they are well
informed about the company's market position, capabilities, competition and market
trend.
Using this method, the demand forecasts can be made relatively quickly and cheaply.

Delphi Method:
Delphi method is similar to jury of executive opinion. In this method a panel of
experts is asked to respond to a series of questionnaire.
The responses are tabulated and opinions of the entire group are made known to each
of the other panel members so that they may revise their previous forecast response.
forecast can be made quickly and economically using this method. Delphi method is a
reliable method because estimates are made on the Basis of knowledge and
experience of sales expert.
Sales force opinion:
Under this method, the salesmen estimate the expected sales
in their respective territories on the basis of previous experience.
Then demand is estimated after combining the individual
forecasts of the salesman. So more accurate estimate is possible.

Survey of customers buying:

In this method, market surveys are conducted regarding
specific consumer purchases.
Surveys may consist of telephone contacts, personal interviews,
or questionnaires as a means of obtaining data. The results are
likely to be more accurate. But it is expensive and time
consuming.
 Time series forecasting or Quantitative
methods
• A trend of company's or industry's demand is
obtained with the help of historical data relating
to demand which are collected, observed or
recorded at successive intervals of time. Such
data is generally referred to as time series.
• The study may show that the demand
sometimes are increasing and sometimes
decreasing, but a general trend in the long run
will be either upward or downward.
 Business financing
• Finance is essential for a business operation,
development and expansion.
• Funds can be procured from different sources and
therefore procurement is always considered as a
complex problem by business concerns.
• Funds procured from different sources have different
characteristics in terms of cost, risk and control.
• It is crucial for business to choose the most
appropriate source of finance for its several needs as
different sources have its own benefits and costs.
 Sources of finance
• A company can have two main sources of funds that
is internal and external.
• Internal sources refer to sources from within the
company such as funds raised from retained
earnings or the saving of the company and personal
capital.
• External sources refer to outside sources consisting
of equity finance (Share capital) and debt finance
(debenture capital, loans and advances etc)
Short term sources of finance are those that are available
for a period of less than one year/ up to 1 year.
It consist of trade credit and bank overdraft.

Medium term source of finance are those that are available

for more than 1 year but less than 5 years/ up to 5 years.
It consist of public deposits and loan from banks

Long term sources of finance are those that are repayable

over a longer period of time, generally for more than 5 year.
It consist of shares and debentures.
Shares:
The capital of a company is divided into a number of very small units called shares.
The person who holds a share is a share holder he is a debtor of a company i.e he is liable to
all the assets and liabilities of that company.

Debentures:
A debenture is an acknowledgement stating the debt of a company. A holder of a
debenture is a creditor of the company.
When the company is being wound up the debtors should be given first preference during
the repayment of capital.
The return on investment of a debenture is interest. Interest is fixed to a particular
percentage.
A debenture holder cannot participate in the management of the company. A debenture
holder cannot vote during the company meetings.

Retained Earnings:
A company generally does not distribute all its earnings amongst the shareholders as
dividends( the return on investment of a share is dividend).
The portion of the profits which is not distributed among the shareholders but is retained
and is used in business is called retained earnings or ploughing back of profits.
Bank overdraft:
Sometimes commercial banks allow overdraft facilities to their reliable and
credit worthy customers. Commercial banks allow such customers to withdraw
more money than they actually deposited in the bank.
Overdraft is granted against security of goods or sometimes on persona
security of the customer. The bank charges penal rate of interest on the
amount over due.

Trade Credit:
For many businesses, trade credit is an essential tool for financing
growth. Trade credit is the credit extended to you by suppliers who let you buy
now and pay later. Any time you take delivery of materials, equipment or other
valuables without paying cash on the spot, you're using trade credit.
The volume and period of credit extended depends on factors such as
reputation of the purchasing firm, financial position of the seller, volume of
purchases, past record of payment and degree of competition in the market
etc.
 Financial market
• Financial market is the market that facilitates
transfer of funds between investors/lenders and
borrowers/users.
• It consists of individual investors, financial
institution and other intermediaries for trading
the various financial assets and credit
institutions.
• Financial market can be classified into two
money market and capital market.
 Money market
• The money market in that part of a financial market which
deals in the borrowing and lending of short term loans
generally for a period of less than or equal to one year. It is
a mechanism to clear short term monetary transactions in
an economy.
• money market instruments have the characteristics of
quick conversion into money, minimum transaction cost
and low loss in value.
• Some of the instruments used in the money markets are
certificates of deposits, bills of exchange, promissory notes,
commercial paper, treasury bills, etc.
 Capital Market
• Capital market may be defined as a market for
borrowing and lending long term capital funds
required by business enterprises.
• Capital market offers an ideal source of external
finance. It refers to all the facilities and the
institutional arrangements for borrowing and lending
medium term and long term funds.
• The government body like any market , the capital
market is also composed of who demand funds
( borrowers) and those who supply funds (lenders).
 Foreign Direct investment (FDI)
• The surplus of income over expenditure results in savings and
savings generate investments. Investment may be in physical
assets such as land ,building and factory, or it may be in financial
assets like bank deposits, shares, debentures and bonds.
• Investments made across the national boundaries are known as
international investments.
• When such an international investment is used to set up and
operate production or service facilities in other countries, it is
referred to as foreign Direct Investment.
• Various software companies like IBM India which is initially
based in Unites States but has opened its subsidiaries in
different part of India. Maruti suzuki is yet another example in
which suzuki of japan had joint ventured with Maruti Udyog ltd.
 Advantages to Home country
• Improves the availability of raw materials
• Improves the Balance of payments(BOP)
• It creates more revenue
• It creates more employment
• Better political relations
• Gets better investment opportunity.
 Foreign Institutional investor (FII)
• Foreign institutional investor means an institution
established or incorporated outside India which
proposes to make investment in securities in India.
• FIIS are regulated by SEBI (Securities and Exchange
Board of India). Foreign entities/Funds such pension
funds, mutual funds, charitable trusts can be as
registered as FII.
• A FII may invest on shares, debentures of
companies, Mutual funds and Government
securities.
 Foreign portfolio Investor (FPI)
• Foreign Portfolio Investment is investment by non
residents in Indian securities including shares,
government bonds, corporate bonds, convertible
securities, infrastructure securities etc.
• Foreign Portfolio Investor should satisfy the
eligibility criteria prescribed by the Government
regulatory body, SEBI regulations 2014. Any
foreign company invests in the shares of Infosys
( based in India) is an example of FPI.
 Taxation
• Taxes are the most important sources of
government income.
• Dr. Dalton defined a tax as “compulsory
contribution imposed by a public authority
,irrespective of the exact amount of securities
rendered to the tax payer in return”
 Features of tax
Compulsory payment:
It is a compulsory contribution imposed by the government on the people residing in
the country. Since it is a compulsory payment, a person who refuses to pay the tax is
liable to punishment.

Public welfare:
A tax is that the revenue received through it is spent for public welfare. It does not
benefit any single individual in particular, rather entire society gets benefited by it.

No direct service:
The tax payer does not get any direct service in return for a tax.
Payment of taxes is personal responsibility of an individual

Legal procedure:
Another feature of tax is that it is imposed legally and properly. Taxes are levied
according to legal procedure.
 Canons of tax/ characteristics of a good tax
system
A good tax system depends on the level of government expenditure,
role of the government and the level of economic development.

Canon of Equity:
Every person should be taxed according to his ability to pay that is
the rich should pay more and poor should pay less so that taxes
should be progressive in nature.

Canon of certainty:
The amount, time and method of tax should be clear and certain.
Canon of convenience:
While imposing tax, the time and method of tax payment should be
convenient to the tax payers.

Canon of economical:
A good tax system should be economical to the government in the sense that
the cost of collection of taxes should be small in proportional to the revenue
from them.

Canon of elasticity:
The tax system should be elastic. The government expenditure increases every
year. The tax revenue may be increased or decreased according to the need of
the government.

Canon of productivity:
A good tax system should be such as to bring in sufficient revenue in the
treasury.
 Taxes on Income/ Direct Tax
Taxes may be direct or indirect
 Direct Tax:
Direct tax is one that is collected directly from the people. In
the case of direct tax, the man who pays it is also intended to bear
the burden of it i.e impact and incidence are on the same person.
The person from whom it is collected cannot shift its burden to
anybody else.
The tax payer knows what to pay , why to pay and when to pay the
direct tax.
e.g income tax, wealth tax, property tax, corporate tax etc.
In case of direct tax, relationship between the tax payer and the
authorities are direct and personal.
 Merits of Direct Tax
• Economy
• Certainty
• Elastic
• Equity
• Public spirit

Demerits of Direct Tax

• Unpopular
• Inconvenient
• Evasion of taxes
• Narrow coverage
 Taxes on commodity/ Indirect taxes
• Taxes on commodities are generally called indirect taxes.
• When we buy a TV from the market, we have to pay the sales tax to
the shopkeeper in addition to the price of TV.
• In this way the government collects the tax from the shopkeeper
and the shopkeeper collects it from the customer (Buyer).
• Thus, the buyer has to pay the tax indirectly to the government,
through the shopkeeper . Such taxes are called indirect tax.
• E.g sales tax, VAT etc.
• In the case of indirect tax, Impact and incidence are on different
persons. i.e impact is on the sellers and incidence is on the buyers.
• Indirect taxes are on goods and services and so they are sometimes
known as output taxes, since they are paid only when certain
purchases are made.
• How much a person pays indirect taxes depends on the extend to
which he uses taxed goods and services.
 Merits of Indirect Tax
• Convenient
• Less evasion
• Wide coverage
• Elastic
• Universality
• Social welfare

Demerits of Indirect Tax

• Regressive
• Evasion
• High cost of collection
• Uncertainty
 Classification of tax
Taxes are classified into as follows.
Proportional Tax:
If the tax is imposed at the same rate on the persons
of different income level, it is called proportional tax.
In this tax, the tax revenue increases in proportion to
increase in income.
Proportional tax implies that the rate of tax does not
change with the change in income.
A fixed portion of income is levied as tax from all people.
 Rate of tax

Income

Income Percent ( Rate) Amount (Rs)

Rs. 1000 10 100
Rs. 2000 10 200
Rs. 3000 10 300
 Advantages

Proportional taxation system is easy to

understand, easy to pay, simplicity and continuity
of same level of distribution of income.

Disadvantages

• It is against the principle of equity because its

burden falls heavily on the poor than rich.
• It does not add adequate revenue to the
government.
 Progressive Tax
• A progressive tax is a tax by which the tax rate
increases as the taxable income amount increases.
• The principle of progressive tax is higher the
income higher tax rate.
• All countries has adopted progressive method as it
is more equitable and reasonable.
• Progressive taxation also allows the government to
have a stable income even in times of depression.
 Rate of tax

Income

Income Percent ( Rate) Amount (Rs)

Rs. 1000 10 100
Rs. 2000 15 300
Rs. 3000 25 750
 Advantages

• The system of progressive taxation is reasonable

because it takes into consideration canon of ability.
i.e the rich should pay more & the poor should pay
less.
• Progressive taxation is economical because a raise
in tax rate yields larger revenue without additional
expenditure.
Disadvantages

• There is no definite principle of fixing rate of

taxation.
• They leads to evasion of tax.
 Regressive Tax
• A tax is said to be regressive, when its burden falls heavily
on poor than rich.
• It is the opposite of a progressive tax.
• The income of a person increases, the tax rate increases &
vise versa. i.e a person with high income pays less tax than
a low income person.
• No civilized government impose a tax in which, as income
increases, rate of tax is lowered.
• But there are several taxes on commodities whose burden
rest mainly on poor.
• So these tax is impracticable, injustice & inappropriate in
poor countries.
 Rate of tax

Income

Income Percent ( Rate) Amount (Rs)

Rs. 1000 10 100
Rs. 2000 8 160
Rs. 3000 6 180
 Impact & incidents of taxation
These are two terms used by the economist to analyse the burden of
tax.
• Impact of taxation refers to the person from whom the government
receives the amount of tax. i.e it is the first resting place of a tax.

• Incidents of taxation refers to the person who bears the final burden
of taxation or who will have to pay the taxes finally. It is the final
resting place of a tax.

• E.g If we buy a musuc system from an shopkeeper, we pay the sales

tax to the shopkeeper. The shopkeeper will pay it to the government.
Technically it may said that the incidence of the sales tax will be on the
customer and its ipact will be on the shopkeeper.

• If the impact & incidents of tax remains on the same person, i.e if
there is no shifting, then that tax is called direct tax.

• If the impact can be passed on to another , i.e if shifting is possible

then that tax is called as Indirect tax.
 Shifting of tax
• Taxes are not always born by the people who pays them in
the first instance. They are sometimes shifted.
• Shifting of tax refers to the process by which the money
burden of a tax is transferred from one person to another.
The burden of tax can be shifted through change in price.
• E.g the government impose tax on the manufacture of
cloth & collects the amount of tax from the manufacturer.
The manufacturer will add this tax to the cost of
production of the cloth & thus will raise its cost. Therefore
the manufacturer will also recover the tax from the
consumer in addition to the price of cloth. The producer
has shifted the burden. Practically every tax can be passed
on from one buyer to the next until it is paid by the
consumer.
 Sales tax
• A sales tax is the tax charged at the point of purchase for goods
and service. The tax is usually se t as a percentage by the
government. Ideally, a sales tax is charged exactly once on one
time. These sales tax attempts to achieve by charging the tax
only on the final end user.

Value Added Tax (VAT)

E.g if a dealer purchases goods for Rs. 100/- from another dealer
and a tax of Rs. 10% has been charged in the bill. He sells the
goods for Rs. 120/- ( Rs 20/- being profit to him) on which the
dealer will charge a tax of Rs 12/- instead of 10%. Thus the dealer
has paid the tax at 10%, on Rs. 20/-be the value addition in his tax.
 Tax Evasion
• Tax evasion is the efforts that are made by trusts, individuals,
firms and various other entities to avoid paying taxes by
illegal and unfair means.
• The evasion of tax usually takes place when taxpayers
intentionally hide their incomes from the tax authorities in
order to reduce their liability of tax.
• The level of evasion tax depends on the chartered
accountants and tax lawyers who help companies, firms,
individuals evade paying taxes.
• Tax evasion is a crime in all major countries and the guilty
parties are subjected to imprisonment and fines.
 Methods of Tax Evasion
Smuggling
People export or import foreign goods through routes that are
unauthorized.
Customs duty evasion
The importers avoid paying customs duty by false declarations of
the description of the product and its quantity.
Value added tax evasion
The producers collect value added tax from the consumers and
evade paying those taxes to the government by showing less sales
amount.
Illegal tax evasion
Many people earn money by illegal means such as theft, gambling and
drug trafficking and so they do not pay tax on this amount.
 Reasons for tax evasion

• No trust in the government

• High tax rates
• Week tax administration
• General tendency
 Control of tax evasion

• Reducing tax rate

• Strong surveillance system
• Bringing strong corruption laws
• Simplifies tax laws and filling mechanism.