Introduction of Accounting to MBA

By Narain

Accounting : Information needs of the users
• The process of identifying, measuring and communicating economic information to permit informed judgements and decisions by the users of accounts. • Is the language of the business

Goals of Accounting
 Financial Accounting
 To satisfy information needs of the external users i.e. investors, creditors, employees, customers  For attracting capital for the company

 Management Accounting
 To satisfy information needs of the internal users i.e. management  For informed decision making

 Tax Accounting
 To satisfy information needs of the tax

Assignment Problem
1. A company issues 50K shares of Rs. 10 face value equity stock at par value for cash. 2. Acquires Land & Building costing Rs. 225K with the payment of 50K cash and balance settled through 8% Mortgage for 20 years. 3. Purchases a used JCB for Rs. 13200 cash. 4. Acquires raw material costing Rs. 8600 on account. 5. Returns defective raw material

Assignment cont……..
6. Pays the supplier in (4) and (5) the amount due, less a 2% discount for the prompt payment. The firm treats cash discount as a reduction in the purchasing cost of raw material. 7. Obtains a fire insurance policy providing Rs. 500K coverage beginning next month. It pays the one year premium of Rs. 4950. 8. Issues a cheque for Rs. 1800 for 3

Assignment cont………
9. Purchases a Patent on a machine process for Rs. 90K cash. 10. Purchases office equipment for Rs. 2700, making a down payment of Rs. 250 and agreeing to pay the balance in 30 days. 11. Pays Rs. 825 to Express Transportations Co. for delivering the equipment purchased in (10) 12. The company makes sale of Rs. 16K.

Solution to Exercise 1
Balance Sheet of …..
as on …….
Liabilities Creditors 8% Mortgage Equity Shares Profit & Loss A/C Assets 2,450 Land & Building 1,75,0 Equipments 00 5,00,0 Patent 00 -14,29 Cash 6 6,63,1 54 2,25,0 00 16,725 90,000 3,31,4 29 6,63,1 54

Solution to Exercise 1
Income Statement
for the period ending …. Revenue Purchase of Raw Material less: Returns less: Cash Discount Insurance Rent 8,600 (900) (154) 7,546 4,950 1,800 0

Profit/Loss

14,296

Solution to Exercise 1
Cash Flow Statement
for the period ending … Cash generated from operations payment to creditors payment to insurer payment for rent Net cash outflow from operations Cash generated from investments Land & Building bought JCB bought with transportation Patent bought Office Equipment bought Net cash outflow from investments 2,25,0 00 14,025 90,000 250 3,29,275 7,546 4,950 1,800 14,296

Solution to Exercise 1
Continued ……. Cash generated from financing activities Issue of Equity Shares Raising 8% Mortgage Loan Net cash inflow from financing Increase in cash balance Cash balance at the beginning of the period Cash balance at the end of the period 5,00,0 00 1,75,0 00 6,75,000 3,31,429 0 3,31,429

Initial Problem
Accounting Equation Approach
LIABILITI + EQUITY ES Cash Equipment Debtor Bank Capital Earnings s Loan 1. +10,000 +10,000 2. +3,000 3. -5,000 4. +8,000 5. -9,000 6. -1,000 6,000 5,000 4,000 3,000 10,000 +5,000 +4,00 0 +12,000 -9,000 -1,000 +2,000 +3,000 ASSETS =

Illustration
1. A company issues 50,000 shares of Rs. 10 face value Equity Shares at par value for cash. 2. The company acquires Land & Building costing Rs. 2,25,000 with the payment of Rs. 50,000 in cash and the balance is settled by raising 8% Mortgage for 20 years. 3. Purchases a used JCB for Rs. 13,200 cash.

Illustration
5. Returns defective Raw Material purchased above and costing Rs. 900 to the supplier . The account has not yet been paid. 6. Pays the supplier in (4) and (5) the amount due, less a 2% discount for the prompt payment. The firm treats this cash discount as a reduction in the purchasing cost of Raw Material.

Illustration
7. Obtains a fire insurance policy providing Rs. 5,00,000 coverage beginning next month. It pays the Insurance Premium of Rs. 4,950 for the current year. 8. Pays Rs. 1,800 for 3 month Rent in advance for office space. 9. Purchases a Patent on a machine process for Rs. 90,000 cash .

Illustration
10. Purchases Office Equipment from Mr. R for Rs. 2,700 making a down payment of Rs. 250 and agreeing to pay the balance in 30 days. 11. Pays Rs. 825 to Express Transportation Co. for delivering the equipment purchased in (10). 12. The company makes sales of Rs. 16,000 out of which only Rs. 12,000 could be Realised from Mr. Y

Cash Flow Statement
• Profit ≠ Cash
– As P & L a/c is prepared on Accrual basis

• The term cash mean & include –
1.Cash in Hand 2.Demand deposit with banks 3.Cash Equivalents

Cash Flow Statement
• Cash Flow Statement reflects the movement of cash from three Activities of the firm
– Operating Activities – Investing Activities – Financing Activities

Preparation of CFS
• Direct Method
– Comparatively more useful – Disclose gross receipts & gross payments

• Indirect Method
– Profit & Loss a/c is adjusted for the effects of transaction of non – cash nature

CFS: Indirect Performa
• Classify the extraordinary items based on the Activities • Tax flow also to be classified based on the Activities • Do not disclose the non – cash transactions
– Like acquisition of fixed assets by issuing shares – Conversion of debt into equity

Steps to Prepare CFS
• Information needed for its preparation –
1. Comparative Balance Sheet 2. Income Statement 3. Additional information

• Steps to prepare CFS
– Analyse the Non – Current Accounts – Analyse the profit & loss figure – Chart the cash flow statement

Financial Analysis
Financial analysis is the process of identifying the financial strengths and weaknesses of the firm by property establishing relationships between the item of the balance sheet and the profit and loss account.

Users of Financial Analysis
• • • • Trade creditors Lenders Investors Management

Nature of Ratio Analysis
A financial ratio is a relationship between two accounting numbers. Ratios help to make a qualitative judgement about the firm’s financial performance.

Standard of Comparison
• • • • Time series analysis Inter-firm analysis Industry analysis Proforma financial statement analysis

Types of Financial Ratios
• • • • • Liquidity ratios Solvency ratios Turnover ratios Profitability ratios Equity-related ratios

Liquidity Ratios
• Liquidity ratios measure a firm’s ability to meet its current obligations.= Current assets Current ratio
Current liabilities Current assets – Inventories Quick ratio = Current liabilities Cash + Marketable securities Cash ratio = Current liabilities

IntervalMeasure=

Currentassets- Inventory Averagedaily operating expenses Net working capital NetWorking CapitalRatio = Net assets

Solvency Ratios
• Solvency ratios measure the dependence of a firm on borrowed Debt funds. ratio  Debt-equity
Equity (Net Worth) Debt Debt Debt ratio   Debt  Equity Capital employed Earnings before interest and tax Interest coverage  Interest

• Treatment of –
– Preference Shares

Turnover Ratios
• Turnover or activity ratios measure the firm’s efficiency in utilising its assets.sold or net sales Cost of goods

Average (or closing) inventory Number of days in the year (say, 360) Days of inventory holding = Inventory turnover Credit sales or net sales Debtors Turnover = Average (or closing) debtors Number of days in the year (say, 360) Collection period = Debtors turnover

Inventory Turnover =

Turnover Ratios
Current assets turnover  Net sales Current assets Net sales Net current assets turnover  Net current assets Net sales Fixed assets turnover  Net fixed assets Net sales Net assets turnover  Net assets or capital employed

Profitability Ratios
• Profitability ratios measure a firm’s overall efficiency and effectiveness in generating profit. and tax (PBIT) Profit before interest
Margin  Net sales Profit after tax (PAT) Net margin  Net sales

PBIT Net assets Profit after tax Return on equity  Equity (net worth) Before tax return on investment 

Equity-related Ratios
• Equity-related ratios measure the shareholders’ return and value.
Profit after tax Number of ordinary shares Dividends DPS  Number of ordinary shares DPS Dividends Payout ratio   EPS Pr ofit after tax DPS Dividend yield  Market value per share EPS 

Equity-related Ratios
EPS Earnings yield  Market value per share Market value per share P / E ratio = EPS Net worth Book value per share  Number of ordinary shares Market value per share M B value  Book value per share Market value of assets Tobin ' s q  Economic value of assets

DuPont Analysis
DuPont Analysis integrates the important ratios to analyse a firm's profitability. PBIT Sales PBIT RONA=   Net Assets Net Assets Sales PAT Sales PBIT  PAT Net Assets  ROE      Net Worth Net Assets Sales  PBIT Net Worth  ROE  Assets turnover × Margin × Leverage

ISPAT INDUSTRIES LIMITED RATIO ANALYSIS Liquidity ratios Current ratio 1.47 1.24 Quick ratio 0.05 0.06 Activity ratios Sales/TA 0.30 Sales/FA Sales/Debtors Sales/Inventory Leverage ratios Debt/Equity Debt/TA PBIT/Interest Profitability ratios PBIT/Sales Net profit/Sales PBIT/TA Net profit/NW 0.81 5.75 8.70 2.85 0.74 1.90 29.41% 13.96% 8.68% 15.87% 1.25 5.69 5.49 2.50 0.71 1.04 7.30% 0.26% 1.59% 0.21%

0.22

INFOSYS Balance Sheeet as at March 31 in Rs. 2,001 SOURCES OF FUNDS SHAREHOLDERS FUNDS Share capital Reserves and surplus Capital Employed APPLICATION OF FUNDS FIXED ASSETS Original cost Less: Depreciation Net book value Add: Capital work-in-progress INVESTMENTS CURRENT ASSETS, LOANS AND ADVANCES Sundry debtors Cash and bank balances Loans and advances Less: Current liabilities Provisions NET CURRENT ASSETS Net Assets 3,023,702,417 3,850,610,285 4,302,793,623 11,177,106,325 1,349,181,176 1,849,320,275 7,978,604,874 13,896,391,988 1,361,781,253 4,317,935,730 2,101,277,161 7,780,994,144 671,506,459 988,195,960 6,121,291,725 8,333,028,248 6,311,444,025 2,441,315,982 3,870,128,043 1,706,504,250 5,576,632,293 341,154,821 2,840,305,143 1,336,520,594 1,503,784,549 569,603,505 2,073,388,054 138,348,469 330,792,085 13,565,599,903 13,896,391,988 330,755,000 8,002,273,248 8,333,028,248 2,000

INFOSYS Profit and Loss Account for the year ended March 31 in Rs. 2001 INCOME Software development services and products Overseas Domestic Other income EXPENDITURE Software development expenses Administrative and other expenses Provision for investments Provision for contingencies Provision for e-inventing the company 11,510,136,229.00 Operating profit (PBIDT) Interest Depreciation Profit before tax and extraordinary item Provision for tax earlier years current year Profit after tax before extraordinary item Extraordinary item -- transfer of intellectual property right (net of tax) -- provision no longer required Net profit after tax and extraordinary item AMOUNT AVAILABLE FOR APPROPRIATION 6,288,136,341.00 6,288,136,341.00 14,000,000.00 713,100,000.00 6,233,192,341.00 54,944,000.00 75,670,846.00 2,935,156,665.00 2,935,156,665.00 2,400,000.00 394,600,000.00 2,859,485,819.00 1,128,945,152.00 6,960,292,341.00 532,327,389.00 3,256,485,819.00 8,089,237,493.00 9,581,766,650.00 1,775,470,971.00 152,898,608.00 33,300,000.00 35,000,000.00 5,425,834,860.00 3,788,813,208.00 4,662,684,578.00 694,850,282.00 18,740,266,421.00 265,392,386.00 593,714,915.00 19,599,373,722.00 8,696,980,931.00 126,256,042.00 391,411,095.00 9,214,648,068.00 2000

INFOSYS Financial Ratios 2001 Activity Ratios Income/Assets Income/Debtors Current Ratios CA/CL CA/Assets NCA/Assets Profitability Ratios Margin PBDIT/Income PBIT/Income PAT/Income Return on Investment PBDIT/Assets PBIT/Assets PAT/NW 1.41 6.48 3.49 0.80 0.57 2000 1.11 6.77 4.69 0.93 0.73

41.27% 41.12% 35.51% 35.34% 31.80% 31.03% 58.21% 45.47% 50.09% 39.08% 44.85% 34.32%

SBU PROFIT & LOSS ACCOUNT, YTD 2002 USD in '000 YTD Tota l Re ve nue Onsite re ve nue Offshore re ve nue Se rvice Cre dit - Onsite Re ve nue % CONTROLLABLE COSTS CGS A Sa la rie s & Re la te d Costs: Onsite Sa la rie s Offshore Sa la rie s GRP Alloca te d Offshore Sa la rie s Othe r Sa la ry Ove rhe a ds Subcontra ctor Costs Sa la rie s-Onsite Sa la rie s-Offshore Fore ign Tra ve l Ince ntive s Proje ct Ince ntive s SBU Spe cia l Ince ntive s Da ta Communica tion Cha rge s Le ga l Immigra tion Fe e s Othe r Profe ssiona l Fe e s Tota l CGS A Cost CGS B Da ta Communica tion Cha rge s Me dica l Insura nce De pre cia tion: CGS Othe rs CGS Tota l CGS B Cost TOTAL CGS A + CGS B Costs Gross Ma rgin 14850 12600 2250 85% % of Re v. 100.0% 84.8% 15.2%

6375 0 840 34 0 0 250 0 0 0 333 0 7832 90 300 223 0 613 8445 6405

42.9% 0.0% 5.7% 0.2% 0.0% 0.0% 1.7% 0.0% 0.0% 0.0% 2.2% 0.0% 52.7% 0.6% 2.0% 1.5% 0.0% 4.1% 56.9% 43.1%

Utility of Ratio Analysis
• Assessment of the firm’s financial conditions and capabilities. • Diagnosis of the firm’s problems, weaknesses and strengths. • Credit analysis • Security analysis • Comparative analysis • Time series analysis

Cautions in Using Ratio Analysis
• • • • • • Standards of comparisons Company differences Price level Different definition Changing situations Past data

ThankQ

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