Chapter-1

ROOM SALES
ACCOUNTING

1.1 Performa and Use of Visitors Tabular Ledger and

Guest Weekly Bill
1.2 Allowances and visitors paid outs
1.3 Difference between allowances and VPO
1.1 Performa and Use of Visitors Tabular Ledger and Guest
Weekly Bill

Guest Weekly Bill

A guest is registered at the "Reception" desk of the hotel, after which the
cashier opens the guest folio, which is also normally referred to as the
hotel credit bill or guest weekly bill. Guest accounts are created by
opening guest folios for each resident guest at the front office - against
reservations of rooms, for recording transactions between the resident
guest and the hotel. It is referred to as the "Hotel Credit Bill" because of
the normal practice in hotels to provide credit to the guest for the number
of days they stay in the hotel.
The average stay of guests in hotels in India is considered to be of about 7
days and therefore, from the time the guest checks in his room charges,
food charges, room charges, and other luxury tax, expenditure tax and
service charges are accumulated in the front office guest bill till his
checkout from the hotel and the same is recovered at the time of his
checkout. Therefore this bill is also referred to as priest Weekly Bill.
City Ledger:
It is a ledger in which accounts of the local customers of the city
are maintained, especially for restaurant charges and banquets,
including accounts of some large organizations that may open
accounts with hotels in various cities for the convenience and
benefit of their executive and representatives.
This ledger may also contain accounts of persons residing in the
City, but also of those residing outside the city, and who wish
to use the facilities of the hotel regularly. Thus, non-resident
guest's accounts are created, by opening of accounts in the city
ledgers, for recording actions between the non-resident guests
and the hotel. Accounts of resident guests who check out
without settling their bills, may also be transferred to city
ledger, on request, if approved by the hotel management.
Master Folio:
In case of group bookings, instead of preparing separate folio for
each member of the group, one common folio is usually
opened in the name of the group or the group leader wherein
all transactions with the group are recorded in this folio called
Master Folio.
Visitors Tabular Ledger
It is prepared at the front office, showing all residential guest
accounts at a glance. It is prepared in such a way as to reveal
all information in respect of all type charges incurred by each
guest independently on a daily basis. It reveals the accounts of
all guests residing in the hotel. It gives the appearance as
though, all the guest folios, have been arranged besides each
other.
It provides a very convenient form of guest record, at the front
office and helps in tallying and cross tallying the front office
records, of guest charges for effective control. It serves a
purpose of a Sales book on one hand, and the personal account
of each registered guest on the other hand. However, in the big
hotels, this purpose can be served , by a computerized system.
Advantages of Visitors' Tabular Ledger

The following are the advantages of Visitors tabular ledger

1) All individual guest accounts, can be viewed at any time

with their respective details
2) It reveals at a time and glance, incomes of all the selling
outlets of the hotel.
3) In small hotels, it is convenient to maintain and serves a
useful purpose.
4) Department summary sheets can be conveniently prepared
Disadvantages of Visitors' tabular Ledger

The following are the disadvantages of visitors' tabular ledger

1) In big hotels, viewing all guest accounts becomes

inconvenient and difficult
2) In big hotels, it is inconvenient to maintain, and hence, does
not serve any useful purpose
3) In big hotels, it becomes a big store of details with too many
columns, which are at times untidy and confusing
4) Mistakes are difficult to locate.
1.2 Allowances and visitors paid outs
Allowance-
It is a practice in hotels to credit the guest account by way of
concessions to relieve the guests of certain charges, considered
to be improperly, or incorrectly levied. Such charges or
concessions arise on account of wrong charges, difference in
rates charged, wrong amounts charged or amount charged to
the wrong guest, adjustments due to change of rooms,
defective or dissatisfactory food served or services rendered,
the charges which are disapproved and disputed by the guest
as incorrect, improper, unjust or unfair. Hence, such charges
may be partly, or entirely eliminated by crediting the disputed
charges to the guest who demands such deletion of charges,
and is called an "Allowance".
Visitor's Paid Out (V.P.O)

Visitor's paid out are amounts paid out by hotel to some third party
on behalf of its resident guests, which is subsequently charged to
respective P.O. guest bill for recovering it from them at the time
of their check-out. Such payments are normally made on account
of guest taxi hire, theatre tickets, flowers, and post-parcels, etc. as
per the guidelines of the hotel's management.
These payments, made on behalf of the guest are debited to the
guest by charging to the respective guest folios at the front office,
and the employee who makes the payment is reimbursed by the
chief cashier. This is done by the use of vouchers called V PO
vouchers, which are sent to the cashier by the paying department,
for the sake of posting to the concerned guest folio and also, for
entering it into the petty cash book.
Visitor's disbursements are not a part of the hotel revenue
but merely recoveries of payments made by he hotel The
V.PO. amount will be debited to guest weekly bill through
the petty cash book and petty cash will be credited.
1.3 Difference between allowances and VPO
 Assignment-1
Draw a following formats-( No computer
work, should be handmade)

1. Visitors Tabular Ledger

2. Guest Weekly Bill
3. Allowances Voucher
4. visitors paid out voucher
 Assignment-2
1. What is Audit ?

2. What is Night Audit at front office ?

3. What are the duties of Night Auditor ?

 Assignment-3
1. What is basic concept of cost ?

2. What are the advantages of Cost accounting ?

3. Difference between Cost accounting and

financial accounting .
 Assignment-4
Classification chat of cost & types of cost

Explain material, labour and other

expenses.

What is cost sheet ?

 Assignment-5
1. Meaning , importance and objective of
financial management .

2. Explain the following terms-

i. Capital budget
ii. Rate of interest
iii. Net present value
iv. Discounted pay back
v. Investment
Chapter-2

CONTROL IN HOTEL
CATERING INDUSTRIES

2.1 Internal Control, meaning, objectives and types

of Internal Control
2.2 Internal Audit and Tools of Internal Audit
2.3 Night Audit, Duties of Night Auditor, Functions
of Night Auditor
2.2 Internal Audit and Tools of Internal Audit
Internal auditing is a catalyst for improving an
organization's governance, risk management and
management controls by providing insight and
recommendations based on analyses and assessments of
data and business processes The Institute of Internal
Auditors (IIA) defines Internal Auditing as: The internal
audit activity helps an organization accomplish its
objectives by bringing a systematic, disciplined approach
to evaluate and improve the effectiveness of risk
management, control and governance processes
Some of the benefits of having a good system of internal
controls are:
 Helping protect assets and reduce the possibility of fraud.

 Improving efficiency in operations

 Increasing financial reliability and integrity.

 Ensuring compliance with laws and statutory regulations.

 Establishing monitoring procedures.

Tools of Internal Audit

A tool of practical guide to evaluating risks and control-

Internal Audit is a tool based theoretical knowledge to practical
situations. It helps to improve the day to day working functions in
the Hotel Industry.

Technique for findings and actions –

a collaborative approach Internal Audit provides a clear structure for
approaching weaknesses in the task and contains many tips that will
help to ensure success.
Assurance mapping and co-ordination –
An assurance map (AMAP) is a tool of Internal Audit to ensure key
risks are assured across the Hotel Industry. It provides a thorough
understanding of the principles and practical application of AMAPs.
Audit report writing –
Internal Audit helps to create reports that are clear, logical and
convincing, have an impact, and add value to the organization.
Improving audit efficiency-
Internal Audit is a technique to improve working efficiently as a
team and help improve the value and business relevance of
team work.
Lean auditing - delivering added value
Lean auditing refers to the use of 'lean' principles to streamline
internal audit activities. It acts as a tool and technique to
eliminate waste, maximize impact and add value.
Techniques for effective testing's-
Internal audit is techniques to design testing activities that are
efficient, effective and appropriate.
2.2 Internal Audit and Tools of Internal Audit

Night Auditor- Night Audit / End of Day process in Hotels

The Front office Audit is usually referred as Night Audit because

hotels generally perform it during the late evening hours. Before
the implementation of automated front office systems, The most
convenient time to perform the audit was during the late evening
and early morning hours, This helps the front office personal to
work with minimal interruption and also most of the hotel
outlets and revenue centres are closed during this time.
The audit is a daily review of guest account transactions recorded
against revenue centre transactions. The routine helps guarantee
the accuracy, reliability and thoroughness of office accounting.
Night audit is generally comprised with the
below functions: Shift Commencement:

Taking the shift handover from the evening shift.

Counting and tallying the cash float.
Printing essential Shift reports.
Opening the Night audit Cashier.
Reading the Log book and also listing down any
pending tasks / follow ups from the evening shifts.
Look for any unclear traces for the day and take
necessary actions.
Balance Food and Beverage outlets:

 The Outlets will close their day, hand over the Check copy and
drop the cash collection at front desk

 Print the Outlet wise sale report from the Front office software
( PMS) and tally balance the revenues with similar report from
the Point of Sale ( POS ) software. This will ensure that all
revenues generated at the POS has been captured by the PMS.

 If there is any missing checks then the same has to be posted

manually, Like wise any duplicate postings has to be voided. –

 Tally the cash posting in PMS and print the cash receipt for the
dropping done by restaurant team.
 Check if there is any Tips for the restaurant staff on credit
card, Handover the same after making the corresponding paid
out entry on the system.

 Once all restaurants had dropped their cash check out the
Payment Master room (PM) for Cash. Credit Card and City
Ledger (Eg: 9001, 9010, 9015 etc.)

 Check the lost posting PM to see if there is any lost interface

posting lying on the folio.

 Check-out the Lost posting PM room after taking any

corrective / allowance.
Duties of Night Auditor

Working as a night auditor in a hotel or in any other hospitality

facility, your duties and responsibilities center around making
sure that guests are taken care of from the reservation process
to check-out, as well as assisting with basic accounting tasks.
For example, you might help with a customer's reservation,
perform the check in of guests, and later prepare the bill for
that guest before checkout time.
Working as a night auditor requires that you are a flexible person
and that you have good customer service, organizational, math
and communication skills, and that you are able to work
overnight hours. This entry-level hospitality career can be a
good fit, if you like having a broad variety of job tasks.
Chapter-3

INTRO TO BASIC COST

CONCEPTS
3.1 Concepts of cost, costing, cost accounting & cost
accountancy
3.2 Origin, objectives & features of cost accounting
3.3 Advantages & limitations of cost accounting
3.4 Difference between Financial and cost accounting
3.5 Conceptual analysis of cost unit & cost centre
3.1 Concepts of cost, costing, cost accounting &
cost accountancy
Concept of Cost-
The cost concept of accounting states that all acquisition of items
(such as assets or things needed for expending) should be
recorded and retained in books at cost. Thus, if a balance sheet
shows an asset at a certain value it should be assumed that this
is its cost unless it is categorically stated otherwise
The cost of an item may well be different from its true value but
since ascertainment of true value would be judgmental and
therefore subjective, stating assets at historical cost is generally
accepted as fair way of maintaining records Following the cost
concept means that unless there are special reasons for doing
otherwise, cost of an item should be assumed to be its true
value and that all accounting entries should be made at cost.
Costing-
System of computing cost of production or of running a business, by
allocating expenditure to various stages of production or to different
operations of a firm The proposed or estimated cost of producing or
undertaking something "the obtained costing for manual
keyboarding of the records" the process of calculating a costing
.Costing is any system for assigning costs to an element of a business.
Costing is typically used to develop costs for any or all of the following:-
Customers
Distribution channels
Employees
Geographic regions
Products
Product lines
Processes Subsidiaries
Entire companies
Costing may involve only the assignment of variable costs,
which are those costs that vary with some form of activity
(such as sales or the number of employees). This type of
costing is called direct costing.
For example, the cost of materials varies with the number of
units produced, and so is a variable cost.

Costing can also include the assignment of fixed costs, which

are those costs that stay the same, irrespective of the level of
activity. This type of costing is called absorption costing.
Examples of fixed costs are rent, insurance, and property taxes.
Costing is used for two purposes:-

Internal reporting.
Management uses costing to learn about the cost of operations,
so that it can work on refining operations to improve
profitability. This information can also be used as the basis for
developing product prices.

External reporting.
The various accounting frameworks require that costs be
allocated to the inventory recorded in a company's balance
sheet at the end of a reporting period. This calls for the use of
a cost allocation system, consistently applied
Cost Accounting -A method of accounting in which all costs
incurred in carrying out an activity or accomplishing a purpose
are collected, classified, and recorded. This data is then
summarized and analyzed to arrive at a selling price, or to
determine where savings are possible. Cost accounting is the
process of recording, classifying, analyzing, summarizing, and
allocating costs associated with a process, and then developing
various courses of action to control the costs.
Cost Accountancy- Cost accountancy is the application of
costing and cost accounting principles, methods and
techniques to the science, art and practice of cost control and
the ascertainment of profitability as well as the presentation of
information for the purpose of managerial decision making .
Following are the objects of Cost Accountancy:
-Ascertainment of Cost and Profitability
-Determining Selling Price
-Facilitating Cost Control
-Presentation of information for effective managerial decision
-Provide basis for operating policy
-Facilitating preparation of financial or other statements
 3.2 Origin, objectives & features of cost accounting
It is a process via which we determine the costs of goods and services. It involves the
recording, classification, allocation of various expenditures, and creating financial
statements. This data is generally used in financial accounting.
This helps us calculate the costs of the various goods. It also involves a suitable
presentation of this data for the purposes of cost control and guidance to the 
management.
It deals with the cost of every unit, job, process, order, service, etc, whichever is
applicable and includes the cost of production, cost of selling and cost of
distribution.
Meaning of Costing
Costing is essentially a technique via which we assign or costs to various elements
of the business. It is a system of ascertaining costs.
We follow certain rules and principles to guide us in this ascertaining of costs.
Some such methods of costing to ascertain these costs are historical costing,
standard costing, etc.
Assigning variable costs according to the activity levels is direct costing
And assigning fixed costs irrespective of activity levels is known as absorption
costing
Features of Cost Accounting
 It is a sub-field in accounting. It is the process of accounting
for costs
 Provides data to management for decision making and
budgeting for the future
 It helps to establish certain standard costs and budgets.
 provides costing data that helps in fixing prices of goods and
services
 Is also a great tool to figure out the efficiency of a unit or a
process. It can disclose wastage of time and resources
Standard Accounting
Standard costing is a technique where the firm compares the
costs that were incurred for the production of the goods and
the costs that should have been incurred for the same.
Marginal Costing
This type of costing is based on the principle of dividing all
costs into fixed cost and variable cost.
Fixed costs are unrelated to the levels of production. As the
name suggests these costs remain the same irrespective of the
production quantities.
Variable costs change in relation to production levels. They
are directly proportionate. The variable cost per unit, however,
remains the same.
Importance and Objectives of Cost Accounting
 Classification of Cost
 Cost Control
 Price Determination
 Fixing of Standards
 Measuring and Improving Efficiency
 Identification of Unprofitable Activities
 Fixing Prices
 Price Reduction
 Control over Stock
 Evaluates the Reasons for Losses
 Aids Future Planning
3.3 Advantages & limitations of cost accounting
Calculate Cost of product or service
One of the primary objectives of cost accounting is to calculate the cost of a
product or service. The cost accountant will separate all costs into a variable
cost, fixed cost, and production overhead. Each type of them has different
characteristics and behavior, and it will impact to product’s price and company
profit in different patterns. For example, variable cost will increase as the
production increase, but it stays the same per unit of production. Fixed cost
will be the same, even the production quantity decrease or increase.
Calculate the selling price
When we know precisely the total cost of the product, it will be more precise to
set the correct selling price. The management needs an internal report that
shows the relationship between selling price, cost per unit, profit margin, and
net income.
To Manage cost
One of the main objectives of the business is to obtain a high profit, and there
are two options in which we could archive this. One is by increasing the selling
price; however, it will impact the selling quantity that eventually will reduce
the profit. So the second method is to reducing cost.
Assist Management Decision
In business operations, management may face some situations such as make or buy
decisions, discontinue a product line, discontinue operation, …etc.  In order to solve
these problems, managements need more information besides the financial statements,
and it required the management report from cost accountant.
Prepare Business Budget
The company will require to prepare annual budget to set the target for each
department. So cost accountant plays an important role in ensuring that all the targets
are achievable and there is no budget slack. As we already know, cost accountant
understands precisely how the cost and revenue relation, so if the company sets target
revenue, we will be able to calculate the variable cost and fixed cost which will co
respond with the target revenue. The production department may raise some additional
cost to represent the wastage and error, which is subjective to be discussed and find a
reasonable acceptant rate.
Access Management performance
As we know, financial statements very subjective, and the result can be easily
manipulated by assumption and accounting estimation. So in order to access company
performance, we require to have more internal reports such as the comparison between
budget and actual sale, budget and actual cost, and profit. Again, cost accountant plays
an important role here as they have more information and understand the connection
between all relevant data.
Disadvantages or Limitations of Cost Accounting
The limitations or disadvantages of cost accounting are listed below:
1. Only past performances are available in the costing records but the management
is taking
2. The cost of previous year is not same in the succeeding year. Hence, cost data
are not decision for future.
3. The cost is ascertained on the basis of full utilization of capacity. If capacity is
partly utilized, the cost may not be true.
4. Financial character expenses are not included for cost calculation. Hence, the
calculated cost is not correct always.
5. In cost accounting, costs are absorbed on pre-determined rate. It leads to over
absorption or under absorption of overheads.
6. Cost Accounting fails to solve the problems relating to work study, time and
motion study and operation research.
7. Installation of Cost Accounting System requires the maintenance of many
costing records .If results in heavy expenditure.
8. Delay in receiving costing information does not result in taking quality decision
by the management
9. Rigid Cost Accounting System does not serve all purposes.
 Chapter-4

ELEMENTS OF COST AND COST

SHEET

4.1- Material, Labour and other Expenses

4.2- Classification of Cost & Types of Costs
4.3- Preparation of Cost Sheet (Problems Only)Material
4.1- Material, Labour and other Expenses

Direct materials are those materials and supplies that are consumed
during the manufacture of a product, and which are directly identified
with that product. Items designated as direct materials are usually
listed in the bill of materials file for a product.
Direct materials are those materials and supplies that are consumed
during the manufacture of a product, and which are directly identified
with that product Items designated as direct materials are usually listed
in the bill of materials file for a product. The bill of materials itemizes
the unit quantities and standard costs of all materials used in a product,
and may also include an overhead allocation.
 Labour
labour involved in production rather than administration,
maintenance, and services
labour employed by the authority commissioning the work, not by a
contract or other support Employees or workers who are directly
involved in the production of goods or services Direct labor costs
are assignable to a specific product, cost center, or work order.
Overheads (Expenses)
Overheads are also very important cost element along with direct
materials and direct labor. Overheads are often related to
accounting concepts such as fixed costs and indirect costs.
Overhead expenses are all costs on the income statement except
for direct labor, direct materials, and direct expenses.
Expense directly associated with the production of goods or services,
such as for lighting. maintenance, and rent of a business
premises.
Indirect Overheads
(Expenses)In the hotel industry, indirect expenses are, hence,
divided into two different categories: Fixed Charges:
Examples might include rent, insurance, property taxes, and
interest Undistributed Expenses: Examples might include
electricity, energy, and water expenses.
4.2- Classification of Cost & Types of Costs

Classification of cost means, the grouping of costs according to their

common characteristics. The important ways of classification of costs
are: By Nature or Traceability: Direct Costs and Indirect costs. Fixed
Costs remain fixed irrespective of changes in the production volume
in given period of time. A direct cost is a price that can be completely
attributed to the production of specific goods or services.
The following points highlight the five main types of classification of
costs.
The types are:
1. Cost Classification by Nature
2. Cost Classification in Relation to Cost Centre
3. Cost Classification by Time
4. Cost Classification for Decision Making
5. Cost Classification by Nature of Production Process.
Cost Classification by Nature
The cost can be differentiated by its nature or the purpose for
which it has occurred.
It can be treated as an expense under this category and the
expenses so incurred is divided as follows:
Cost Classification in Relation to Cost Centre
Cost Classification by Relation to Cost Centre
Another basis of differentiating the costs is categorizing them by
their allocation in the production process of goods or services.
The points as mentioned earlier under the cost classification by
nature are used under this category to further sub-categorise
the elements of this category. To get a better understanding of
it, let us read below:
Direct Cost: Direct cost is the significant cost immediately
associated with a production process. It can be seen as a prime
cost for any business. It is sub-divided into direct material cost,
direct labour cost and other direct expenses.
Indirect Cost: Indirect cost is the cost which cannot be
directly allocated to a particular process of production. It is a
secondary cost and is majorly seen as of three types – indirect
material cost, indirect labour cost and other indirect expenses.
Cost Classification by Time
The nature, importance and liability of a cost vary as per the time
it takes place or has been assessed.
A cost which is a priority today, may not be that important
tomorrow or a cost which has been overlooked today, may be
considered as a relevant cost tomorrow.
Historical Cost: Any actual cost ascertained and evaluated
after it has been incurred, is termed a historical cost. It can be
committed either on the production of goods and services or
asset acquisition.
Pre-determined Cost: The cost which can be identified and
calculated before the production of goods and services based
on the cost factors and data is called a pre-determined cost. It
can be either a standard cost or an estimated cost.
Standard Cost: An actual cost which is pre-determined as per
certain norms and guidelines to provide as a base for cost
control, is termed as a standard cost.
Estimated Cost: The cost of business operation presumed on
the grounds of experience is known as an estimated cost. It is
merely based on assumptions and therefore considered to be
less accurate to determine the actual cost.
Cost Classification for Decision Making
Cost is not just a price paid to generate some value, but it is also
used as a tool by the management for decision making.
Managerial decisions are framed depending upon the following
types of cost involved in carrying out of business:
Marginal Cost: Marginal cost is the cost of producing an additional unit and
its impact on the total cost of production.
Differential Cost: When there is an increment or decrement in the cost of
bulk production, the change in the cost of a single unit is also determined
which is known as differential cost.
Opportunity Cost: The value of one or more products given up to acquire
the desired product or service is known as opportunity cost. For instance;
while choosing green tea, a person has to give up the value he must have
derived from coffee or regular tea.
Replacement Cost: When machinery or any other asset becomes obsolete or
involve high maintenance cost, and simultaneously a better asset is available
in the market which can replace it, then the cost involved in such substitution
is known as replacement cost. For example; a transportation company needs
to replace its trucks from time to time to avoid excessive repairing expenses.
Sunk Cost: The cost which has been born by the organisation in the past and
cannot be recovered at any stage of the business process is termed as a sunk
cost. Freight inwards paid at the time of buying machinery has to be written
off at the time of selling it.
Normal Cost: The routine cost associated with the
manufacturing of goods or services under usual circumstances
is called a normal cost. It includes all direct expenses such as
salary, material, rent, etc.
Abnormal Cost: The cost that arises suddenly and
unknowingly under unfavourable situations is known as
abnormal cost. For instance; workers go on strike, theft or
robbery, fire in the premises, etc.
Avoidable Cost: Such costs are under the control of
management and can be prevented as per the organisational
need. For example; an enterprise upgrades its technology by
installing self-operative machines to avoid the labour charges it
pays.
Unavoidable Cost: The cost which is pre-determined and
inevitable is called an unavoidable cost.
Cost Classification by Nature of Production Process.
This basis of cost classification is significantly applicable in the
manufacturing industries or factories where goods are
produced.
All production or manufacturing activities involve different types
of costs. According to the nature of the production process,
these costs can be classified as below:
Batch Cost: The cost incurred while producing a whole lot comprising of identical
products (batch) is known as batch cost. Each batch differs from the other, and the units
lying under a batch are identified by their batch number. Pharmaceuticals, automobiles,
electronic products are some of the examples.
Process Cost: The cost incurred on performing different operations in a streamlined
production process is termed as a process cost. By dividing the total cost of a process
with the number of units produced, we can derive the process cost of a single unit or
product.
Operation Cost: The cost involved in a particular business function contributing to the
production process is known as operation cost. It helps in regulating the mechanism of
business activities by monitoring the cost incurred on each business operation.
Operating Cost: Operating cost refers to the day to day expenses incurred by an
organisation to ensure uninterrupted functioning of the business is known as an
operating cost.
Contract Cost: The cost of entering into a contract with a buyer or seller by mutually
agreeing to the terms and conditions so mentioned is called a contract cost. It includes a
bidding contract, price escalation contract, tenders, etc.
Joint Cost: The combined cost involved in the production of two or more useful
products simultaneously is known as the joint cost. For example; the cost of processing
milk to get cottage cheese and buttermilk.
4.3- Preparation of Cost Sheet (Problems Only)Material
Format of Cost Sheet
A cost sheet is a statement prepared at periodical intervals of time,
which accumulates all the elements of the costs associated with a
 product or production job. It is used to compile the margin earned
on a product or job and forms the basis for the setting of prices on
similar products in the future.
 Cost Sheet depicts the following facts:
Total cost and cost per unit for a product.
The various elements of cost such as prime cost, factory cost, 
production cost, cost of goods sold, total cost, etc.
Percentage of every expenditure to the total cost.
Information to management for cost control
Calculate and summarize the total cost of the product.
Cost Sheet format
 C h a p t e r- 6
CONCEPTS RELATED TO FINANCIAL
MANAGEMENT

6.1 - Meaning, Importance and Objectives of Financial

Management. Time Value of Money, Types of Financing.

6.2. Ratio Analysis: Meaning of Ratio, Necessity and

Advantages

6.3. Investment Decisions. Capital Budgeting - Meaning,

6.1 - Meaning, Importance and Objectives of
Financial Management. Time Value of Money,
Types of Financing.

Meaning of Financial Management Financial Management

means planning, organizing, directing and controlling the
financial activities such as procurement and utilization of funds
of the enterprise. It means applying general management
principles to financial resources of the enterprise.
Financial management may be defined as planning, organizing,
directing and controlling the financial activities of an
organization. According to Guthman and Dougal, financial
management means, "the activity concerned with the planning,
raising, controlling and administering of funds used in the
business."
Objectives of Financial Management-
The financial management is generally concerned with
procurement, allocation and control of financial resources of a
concern. The objectives-
1. To ensure regular and adequate supply of funds to the
concern.
2. To ensure adequate returns to the shareholders which will
depend upon the earning capacity, market price of the share,
expectations of the shareholders.
3. To ensure optimum funds utilization. Once the funds are
procured, they should be utilizedin maximum possible way at
least cost.
4. To ensure safety on investment, i.e. funds should be invested
in safe ventures so thatadequate rate of return can be achieved.
5. To plan a sound capital structure-There should be sound and
 Functions of Financial Management

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 capitalstructure 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 possessingand 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 likea Issue of shares
and debentures b. Loans to be taken from banks and financial
institutionsc. Public deposits to be drawn like in form of bonds.
Choice of factor will depend on relative merits and demerits of
each source and periodof financing
4. Investment of funds: The finance manager has to decide to
allocate funds into profitableventures 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 managerThis can be done in two ways a.
Dividend declaration - It includes identifying the rate of
dividends and other benefits like bonusb. Retained profits -
The volume has to be decided which will depend innovational,
diversification plans of the company
6. Management of cash: Finance manager has to make
decisions with regards to cashupon expansional,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, maintenance 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
manytechniques like ratio analysis, financial forecasting, cost
and profit control, etc.
6.2. Ratio Analysis: Meaning of Ratio, Necessity and Advantages
Ratio Analysis- A ratio analysis is a quantitative analysis of information
contained in a company's financial statements. Ratio analysis is used to
evaluate various aspects of a company's operating and financial
performance such as its efficiency, liquidity, profitability and solvency
Over the years, investors and analysts have developed numerous
analytical tools, concepts and techniques to compare the relative
strengths and weaknesses of companies. These tools, concepts and
techniques form the basis of fundamental analysis.
Ratio analysis is a tool that was developed to perform quantitative analysis
on numbers found on financial statements. Ratios help link the three
financial statements together and offer figures that are comparable
between companies and across industries and sectors. Ratio analysis is
one of the most widely used fundamental analysis techniques. However,
financial ratios vary across different industries and sectors and
comparisons between completely different types of companies are often
not valid. In addition, it is important to analyze trends in company ratios
instead of solely emphasizing a single period's figures.
Asset turnover-Asset turnover measures how efficiently a company uses its
total assets to generate revenues . A low asset turnover ratio may mean that
the firm is inefficient in its use of its assets or that it is operating in a capital-
intensive environment. Additionally, it may point to a strategic choice by
management approach use a more capital-intensive (as opposed to a more
labor-intensive)
Liquidity Ratios- Liquidity ratios are some of the most widely used ratios,
perhaps next to profitability ratios They are especially important to creditors.
These ratios measure a firm's ability to meet its short-term obligations The
level of liquidity needed varies from industry to industry Certain industries
are more cash-intensive than others. For example, grocery stores will need
more cash to buy inventory constantly than software firms, so the liquidity
ratios of companies in these two industries are not comparable to each other.
It is also important to note a company's trend in liquidity ratios over time.
 Current ratio -The current ratio measures a company's current assets
against its current liabilities. The current ratio indicates if the company can
pay off its short-term liabilities in an emergency by liquidating its current
assets Current assets are found at the top of the balance sheet and include line
items such as cash and cash equivalents, accounts receivable and inventory.
Cash ratio-The most conservative liquidity ratio is the cash ratio,
which is calculated as simply cash and short-term marketable
securities divided by current liabilities. Cash and short-term
marketable securities represent the most liquid assets of a firm.
Short-term marketable securities include short-term highly liquid
assets such as publicly traded stocks, bonds and options held for
less than one year. During normal market conditions, these
securities can easily be liquidated on an exchange.
Solvency Ratios -Solvency ratios measure a company's ability to
meet its longer-term obligations. Analysis of solvency ratios
provides insight on a company's capital structure as well as the
level of financial leverage a firm is using Some solvency ratios
allow investors to see whether a firm has adequate cash flows to
consistently pay interest payments and other fixed charges. If a
company does not have enough cash flows, the firm is most likely
overburdened with debt and bondholders may force the company
into default.
 Debt-to-assets ratio The debt-to-assets ratio is the most basic
solvency ratio, measuring the percentage of a company's total
assets that is financed by debt. The ratio is calculated by
dividing totalliabilities by total assets. A high number means
the firm is using a larger amount of financial leverage, which
increases its financial risk in the form of fixed interest
payments. Debt-to-capital ratioThe debt-to-capital ratio is very
similar, measuring the amount of a company's total capital
(liabilities plus equity) that is provided by debt (interesting
bearing notes and short- and long- term debt). Once again, a
high ratio means high financial leverage and risk. Although
financial leverage creates additional financial risk by increased
fixed interest payments, theit does not dilute ownership. In
Interest coverage ratio-The interest coverage ratio, also known
as times interest earned, measures a company's cash flows
generated compared to its interest payments. The ratio is
calculated by dividing EBIT (earnings before interest and taxes)
by interest
Profitability ratios are arguably the most widely used ratios in
investment analysis. These Profitability Ratios include the
ubiquitous "margin" ratios, such as gross, operating and net
profit margins. These ratios measure the firm's ability to earn an
adequate return.
Gross profit margin -Gross profit margin is simply gross
income (revenue less cost of goods sold) divided by net
revenue. The ratio reflects pricing decisions and product costs.
The 50% gross margin for the company in our example shows
that 50% of revenues generated by the firm are used to pay for
the cost of goods sold.
6.3. Investment Decisions. Capital Budgeting -
Meaning, Techniques of Capital Budgeting.

INVESTMENT DECISIONS-
Efficient use and allocation of capital are the most important
functions of financial management Practically, this function
involves the decision of the firm to commit its funds in long-
term assets together with other profitable activities
Generally, investment decisions fall under two broad categories:
(i) Investment in own business, and
(ii) (ii) Investment in outside business, i.e., in securities and other
companies.
Therefore, investment in own business is justified only when the
return for the same in the will be at least equal to the estimated
return resulting from the investment by way of relevant cost of
capital.
In other words, investment in own business is desirable provided the
return from such enterprise is higher than the estimated return
on the relevant cost of capital. The primary purpose, of course,
of investment funds in business assets is to produce future
economic benefits in such a manner which will cover not only
the cost of capital and operating expenses but also will leave a
sufficient margin in order to cover the risk which is involved in
it.
CAPITAL BUDGETING-
Capital budgeting (also known as investment appraisal) is the
process by which a company determines whether projects
(such as investing in R&D, opening a new branch, replacing a
machine) are worth pursuing. A project is worth pursuing if it
increases the value of the company.

Meaning of Capital Budgeting-Capital Budgeting is the process

of making investment decision in fixed assets or capital
expenditure. Capital Budgeting is also known as investment,
decision making, planning of capital acquisition, planning and
analysis of capital expenditure etc.
 Objectives of Capital Budgeting

The following are the objectives of capital budgeting.

 To find out the profitable capital expenditure.

 To know whether the replacement of any existing fixed
assets gives more return than earlier
 To decide whether a specified project is to be selected or
not.
 To find out the quantum of finance required for the
capital expenditure.
 To assess the various sources of finance for capital
expenditure.
 To evaluate the merits of each proposal to decide which
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