First Module: Definition and scope of Management accounting

1. What is Management Accounting?

Management accounting or managerial accounting is concerned with the provisions and use of
accounting information to managers within organizations, to provide them with the basis to make informed
business decisions that will allow them to be better equipped in their management and control functions.
Management accounting is the process of identifying, measuring, analyzing, interpreting, and
communicating information in pursuit of an organizations goals Ronald W. Hilton
According to the Chartered Institute of Management Accountants (CIMA), Management Accounting is
"the process of identification, measurement, accumulation, analysis, preparation, interpretation and
communication of information used by management to plan, evaluate and control within an entity and to
assure appropriate use of and accountability for its resources. Management accounting also comprises the
preparation of financial reports for non-management groups such as shareholders, creditors, regulatory
agencies and tax authorities"(CIMA Official Terminology).

The Institute of Management Accountants (IMA) recently updated its definition as follows:
"management accounting is a profession that involves partnering in management decision making,
devising planning and performance management systems, and providing expertise in financial reporting
and control to assist management in the formulation and implementation of an organization's strategy".

2. Management accounting is helpful in decision making- discuss the statement. Or Management accounting
is helpful in decision making do you support this? Give arguments and mention the tools of decision
making.
Management accounting is the process of identifying, measuring, analyzing, interpreting, and
communicating information in pursuit of an organizations goals. So, Management accounting helps in
decision making in the following ways:i.
Defining the problems: First steps of decision making are to determine the problems. In business
organization, to taking decision first to identify the problem. If problem is determine then to
identify the solution of the problem. Management accounting provides the information about the
organization and base on these information problems is determined.
ii.
Helping the problem analysis: The second steps to take decision are to analysis the problem.
Management accounting provides the various information to analysis the problem and how to
solve the problem.
iii.
Helping the searching or developing alternatives: To solve the problems of an organization, first
to setup the how many alternatives ways have? Base on the management accounting information
determine the several alternatives.
iv. Selecting the best alternatives: Then selecting the best alternative to solve the problem base on
the managerial accounting information
v. Putting decision into action: Then taking different steps to implement the action.
vi.
Helping the following up decisions: Finally, managerial accounting provide the information to
follow up the decision action plan and if deviation, take necessary step to solve the problem.

03. Discuss the goal or objectives of Managerial Accounting.

Managerial accounting is an integral part of the management process and managerial accountants
are important strategic partners in an organizations management team. In pursuing goals, an organization
acquires resources, hires people, and then engages in an organized set of activities. It is up to the
management team to make the best use of the organizations resources, activities, and people in achieving
the organizations goals. Managerial accounting activity adds value to an organization by pursuing
five major objectives:
Providing information for decision making and planning, and proactively participating as
part of the management team in the decision making and planning processes.
Assisting managers in directing and controlling operational activities.
Motivating managers and other employees toward the organizations goal.
Measuring the performance of activity, subunits, managers and other employees within the
organization.
Assessing the organizations competitive position, and working with other managers to
ensure the organizations long term competiveness in its industry.
04. Narrate the functions of Managerial Accounting.
Managerial accounting is an integral part of the management process and managerial accountants
are important strategic partners in an organizations management team. In pursuing goals, an organization
acquires resources, hires people, and then engages in an organized set of activities. It is up to the
management team to make the best use of the organizations resources, activities, and people in achieving
the organizations goals. The day-to-day work of the management team comprises basic four activities:
i.
Decision making
ii.
Planning
iii.
Directing operational activities and
iv. Controlling.
Others Activities are Modification of date.
Analysis and interpretation of data.
Facilitating management control.
Use of qualitative information.
Identifying the problems.
05. Discuss the planning, controlling and directing & motivating the management accounting.
Planning:
Planning involves establishing a basic strategy, selecting a course of action, and specifying how the action
will be implemented. An important part of planning is to identify alternatives and then to select from
among the alternatives the one that best fits the organizations strategy and objectives. All important
alternatives considered by management in the planning process impact revenues or costs, and management
accounting data are essential in estimating those impacts.
Controlling
Controlling involves ensuring that the plan is actually carried out and is appropriately modified as
circumstances change. Management accounting information plays a vital role in these basic management
activitiesbut most particularly in the planning and control functions. In carrying out the control function,
managers seek to ensure that the plan is being followed. Feedback, which signals whether operations are on
track, is the key to effective control. This feedback is provided by various detailed reports. One of these
reports, which compares budgeted to actual results, is called a performance report. Controlling are- (1)
Budgetary control, (2) Standard Costing and (3) CVP Analysis.
Directing and Motivating

Directing and motivating involves mobilizing people to carry out plans and run routine operations.
In addition to planning for the future, managers oversee day-to-day activities and try to keep the
organization functioning smoothly. This requires motivating and directing people. Managers assign tasks to
employees, arbitrate disputes, answer questions, solve on-the-spot problems, and make many small
decisions that affect customers and employees. In effect, directing is that part of a managers job that deals
with the routine and the here and now. Managerial accounting data, such as daily sales reports, are often
used in this type of day-to-day activity.
06. Discuss the role of managerial accounting in efficient and effective management or management
accounting is useful in banking operation- comment
1) Forecasting
2) Planning
3) Organizing
4) Motivation
5) Co-ordination
6) Controlling
7) Communication
8) Decision making.
07. Distinguish between Management accounting and financial accounting.
Management accounting is the process of identifying, measuring, analyzing, interpreting, and
communicating information in pursuit of an organizations goals and financial accounting is the use of
accounting information for reporting to parties outside the organization. Management accounting differs in
several ways from Financial accounting process. There are also some important differences are SL
No
1
2

Dimension

Management Accounting

Financial accounting

Verities according to the use of information

Whatever is useful to the management

Uniform structure
GAAP is a statutory obligations

Optional
Historical and estimates to the future

Statutory
Historical

5
6

Structure
Source
of
principle
Need
Time
orientation
Report entity
Purpose

Responsibility centers
A means to the end of assisting Management

Users

Relatively small group: Known identity

Monetary and non-monetary

Many approximately

Few approximately

Varies with the purpose: Mostly monthly and

weekly
Report issued promptly after the end of period
covered
Virtually none

Quarterly and annually

13

Information
centers
Information
perception
Report
frequency
Report
timeliness
Liability
potential
Report to

Overall organization
External reporting / statement for the
outside users
Relatively large group: mostly unknown
identity
Primary Monetary

Reports to those inside the organization for:

Planners
Directors and motivators
Controllers
Performance evaluators

Reports to those outside the organization:

Owners
Lenders
Tax authorities
Regulators

14

Emphasizes

Emphasizes decisions affecting the future.

Emphasizes relevance.

Emphasizes financial consequences of past

activities.

3
4

9
10
11
12

Delay of weeks and even month

Few lawsuits and tread is always present

Emphasizes timeliness.
Emphasizes detailed segment reports about departments,
products, customers, and employees.

15
16

GAAP
External report

Need not follow GAAP.

Not mandatory.

Emphasizes objectivity and verifiability.

Emphasizes precision.
Emphasizes summary data concerning the
entire organization.
Must follow GAAP.
Mandatory for external reports

08. Comparison between Management accounting and financial accounting.

Management accounting is the process of identifying, measuring, analyzing, interpreting, and
communicating information in pursuit of an organizations goals and financial accounting is the use of
accounting information for reporting to parties outside the organization. Comparison between management
accounting and financial accounting area. Relevance of Data: Financial accounting data should be objective and verifiable and Managerial
accounting should be flexible enough to provide whatever data are relevant for a particular decision.
b. Less Emphasis on Precision: Making sure that dollar amounts are accurate down to the last dollar or
penny takes time & effort and managerial accountants often place less emphasis on precision than
financial accountants do.
c. Segments of an Organization: Financial accounting is primarily concerned with reporting for the
company as a whole. By contrast, managerial accounting focuses much more on the parts, or
segments, of a company. These segments may be product lines, sales territories, divisions,
departments, or any other categorization that management finds useful. Financial accounting does
require some breakdowns of revenues and costs by major segments in external reports, but this is a
secondary emphasis. In managerial accounting, segment reporting is the primary emphasis.
d. Generally Accepted Accounting Principles (GAAP): Financial accounting statements prepared for
external users must comply with generally accepted accounting principles (GAAP). External users
must have some assurance that the reports have been prepared in accordance with a common set of
ground rules. These common ground rules enhance comparability and help reduce fraud and
misrepresentation, but they do not necessarily lead to the type of reports that would be most useful
in internal decision making. Managerial accounting is not bound by GAAP. Managers set their
own rules concerning the content and form of internal reports. The only constraint is that the
expected benefits from using the information should outweigh the costs of collecting, analyzing,
and summarizing the data. Nevertheless, as we shall see in subsequent chapters, it is undeniably true
that financial reporting requirements have heavily influenced management accounting practice.
e. Managerial AccountingNot Mandatory: Financial accounting is mandatory; that is, it must be
done. Managerial accounting, on the other hand, is not mandatory.
09. Distinguish between Management accounting and Cost Accounting.
Management accounting is the process of identifying, measuring, analyzing, interpreting, and
communicating information in pursuit of an organizations goals and the cost accounting system is a part of
the basic accounting system that accumulates cost date for use in both managerial and financial accounting.
Management accounting differs in several ways from the cost accounting process. There are also some
important differences are
1. Production Cost: Production cost date typically is used in helping managers set prices, which is a
managerial accounting use. However, production cost data also are used to value inventory on a
manufacturers balance sheet, which is a financial accounting use.
2. Objective: The objective of the managerial accounting is to supply the information to take
decision and cost accounting is to determine the production cost and control it.

3. Accounting method: Management accounting does not follow the cost expenditure method and it
analysis and interpretation the information. Cost accounting follows the double entry system of accounting
and cost ledger.
4. Time: Managerial accounting is implemented in future time and cost accounting is implemented
in current time.
5. Determining method: Managerial accounting follows the several strategy and methods and Cost
accounting follows the pre-determining method and strategy.

10. Importance Role or service of managerial accounting.

Listed below are the primary tasks/ services performed by management accountants. The degree of
complexity relative to these activities is dependent on the experience level and abilities of any one
individual.
Rate and volume analysis
Business metrics development
Price modeling
Product profitability
Geographic vs. Industry or client segment reporting
Sales management scorecards
Cost analysis
Costbenefit analysis
Cost-volume-profit analysis
Life cycle cost analysis
Client profitability analysis
IT cost transparency
Capital budgeting
Buy vs. lease analysis
Strategic planning
Strategic management advice
Internal financial presentation and communication
Sales forecasting
Financial forecasting
Annual budgeting
Cost allocation
11. Role or Function or importance or service of cost and managerial accounting.
i.
Collection, classification, analysis and presentation of financial date.
ii.
Ascertainment, reduction and control of costs.
iii.
Product pricing
iv. Preparation of statement of cost and other necessary statement.

v. Preparation of master plan or development of industry.

vi.
Role of cost and managerial accounting is financial management in industry.
vii.
Efficiency analysis
viii.
Planning and decision making.
12. Management accounting is considered as a very useful tool for decision making-Discuss in short four
management accounting tools that can effectively applied in management decision making process by
banks with example.
Managerial accounting follows the various method and strategy to determine the future action plan
base on the organization current information. Managerial accountings method and strategy means the
evaluation method that analysis, interpret, explicate, supply information to the accounting. So, a single
method does not the management need. For this, several method or strategy need. For example- Need for
long and short term funds and statement of collected fund from the various sources is the tools of
management. If production is changed, then variable cost is changed on the basis of marginal cost. For that,
in short time only marginal cost is changed not fixed cost- this is the strategy of marginal cost strategy. So,
base on these strategies monument take decision for future action.
Tools of management accounting arei. Financial Planning
ii. Fund Flow and cash Flow statement
iii.
Standard costing
iv. Budgetary control.
13. State in short the relationship between management accounting and management information system
(MIS).
i.
Management accounting helps to prepare the plan, direct, coordinate and control the organization
for future action and MIS helps to supply this information to take decision.
ii.
Management accounting helps to set up the short and long term forecasting and planning to meet
the organizational objectives and MIS helps to supply this information to take decision.
iii.
MIS helps to supply this information to take decision to meet the vast managerial arena.
iv. Management accounting analysis interpreted and evaluates the MIS information to determine the
future course of action.
v. Management accounting follows the additional method and strategy in which MIS follows the
formal method and strategy.
14. Discuss the utility of Management accounting over the financial accounting.
i. Related to past activities and past data.
ii.
Helping the usable time.
iii.
Presentation of suitable media
iv. Helping the consideration of alternatives
v. Helping in field of application
vi. Helping in failure to solve critical problem.
15. Discuss the necessity of management accounting to a banker.
i. Collection, classification, analysis and presentation of financial data.
ii.
Systematic and reliable planning
iii.
Ascertainment, reduction and control of costs
iv. Product pricing
v. Measurement of work performance
vi. Preparation of statement of cost and other necessary statement.
vii.
Preparation of master plan or development of industry

viii.
Role of financial management in industry.
ix. Forward working
x. Efficiency analysis
xi. Helping the decision making
16. What are the three major activities of a bank manager?
i. Collection of data
ii.
Modification of raw data into information
iii.
Planning and forecasting.
Module-B: Costing and pricing
01

Define cost Accounting.

Cost accounting is an approach to evaluating the overall costs that are associated with conducting
business. Generally based on standard accounting practices, cost accounting is one of the tools that
managers utilize to determine what type and how much expenses is involved with maintaining the
current business model.
Cost accounting is the branch of managerial accounting that systematically assists managers in the
internal balancing of spending and profits, as well as assessing operational costs and budget analyses. Cost
accounting will first measure and record these costs individually, then compare input results to output or
actual results to aid company management in measuring financial performance.
The Cost accounting system is a part of the basic accounting system that accumulates cost date for
use in both managerial and financial accounting-Ronald W. Hilton.
Cost accounting is that branch of accounting dealing with the classification, recording, allocation,
summarization and reporting current and prospective costs- E.L. Kohler.
Cost accounting may be defined as that part of accounting system of an organization which is
devoted to ascertaining in as precise a manner as possible, the cost of particular process, batch , job,
services or unit of industrial activity not as an end in itself but as a means of controlling all the factors
which influence costs-ICMA
02.
Write the cost, expense and costing.
Cost: An amount that has to be paid or given up in order to get something. In business, cost is usually
a monetary valuation of (1) effort, (2) material, (3) resources, (4) time and utilities consumed, (5) risks incurred, and
(6) opportunity forgone in production and delivery of a good or service. All expenses are costs, but not all costs (such
as those incurred in acquisition of an income-generating asset) are expenses. A cost is the value of money that has
been used up to produce something, and hence is not available for use anymore.
Expenses. Expenses are the cost of assets consumed or services used in the process of earning
revenue. They are decreases in owners equity that result from operating the business.
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.
03.

Discuss the objective of cost accounting.

i.
Ascertain cost
ii.
Controlling cost
iii.
Pricing of product
iv.
Benefit of budgetary control and standard costing
v.
Making decision
vi.
Ascertaining profit and loss department of product-wise.
vii.
Output and profit planning

viii.
ix.
x.

Cost reduction by elimination of waste, inefficiencies and benefits of responsibility accounting.

Employee benefit
Benefit of investors, creditors and public.

04. Narrate the function of cost accounting or discuss the importance of cost accounting to a banker or discuss
the importance of cost accounting to a banker.
i. Recording cost data
ii.
Classification of cost data
iii.
Ascertaining cost
iv. Budgeting cost
v. Reducing cost
vi. Controlling cost
vii.
Helping management in decision making.
05. Give the classification of cost of different bases.
(1) Classification on the basis of elements of costs
i. Direct material cost: The materials that go into the final product are called raw materials.
This term is somewhat misleading, since it seems to imply unprocessed natural resources
like wood pulp or iron ore. Actually, raw materials refer to any materials that are used in the
final product; and the finished product of one company can become the raw materials of
another company
ii.
Direct labor cost: Direct labor consists of labor costs that can be easily (i.e., physically and
conveniently) traced to individual units of product. Direct labor is sometimes called touch
labor, since direct labor workers typically touch the product while it is being made.
iii.
Direct cost: A direct cost is a cost that can be easily and conveniently traced to a specified
cost object.
iv. Indirect cost/ overhead cost: An indirect cost is a cost that cannot be easily and conveniently
traced to a specified cost object. These are three types- (1) Manufacturing overhead, the
third element of manufacturing cost, includes all costs of manufacturing except direct
materials and direct labor. Manufacturing overhead includes items such as indirect materials;
indirect labor; maintenance and repairs on production equipment; and heat and light,
property taxes, depreciation, and insurance on manufacturing facilities. A company also
incurs costs for heat and light, property taxes, insurance, depreciation, and so forth,
associated with its selling and administrative functions, but these costs are not included as
part of manufacturing overhead (2) administrative costs. Administrative costs include all
executive, organizational, and clerical costs associated with the general management of an
organization rather than with manufacturing or selling and (3) Selling costs include all costs
that are incurred to secure customer orders and get the finished product to the customer.
These costs are sometimes called order-getting and order-filling costs.
(2) Classification on the basis of variability or cost behavior of costs.
i. Fixed costs: Cost that remains the same in total regardless of changes in the activity
level. A fixed cost does not change in total as activity changes.
i. Variable cost: Cost that vary in total directly and proportionately with changes in the
activity level.
ii. Semi variable or Mixed cost: Costs that contain both a variable and a fixed cost
element and change in total but not proportionately with changes in the activity level.
A semi variable or mixed cost has both a fixed and a variable component.

iii.

Step cost: A step cost is nearly variable but increases in small steps instead of
continuously. The range of the activity index over which the company expects to
operate during the year is not fixed and this change of cost is called Step cost.

(3) Classification on the basis of controllability of costs

i. Controllable cost: The cost that is managed in different action is called controllable cost.
ii.
Uncontrollable cost: The cost that is not managed in different action is called controllable
cost.
(4) Classification on the basis of department of costs
i. Production department cost: Production department costs are those departments which are
directly engaged in the process of production of goods.
ii.
Service department cost: Service department costs are those departments which are not
directly involved in production process but they provide services to production cost centers.

06.

07.

(5) Classification on the basis of time period of costs

i. Product cost: For financial accounting purposes, product costs include all costs involved in
acquiring or making a product. In the case of manufactured goods, these costs consist of
direct materials, direct labor, and manufacturing overhead. Product costs attach to units of
product as the goods are purchased or manufactured and they remain attached as the goods
go into inventory awaiting sale. Product costs are initially assigned to an inventory account
on the balance sheet.
ii.
Period cost: Period costs are all the costs that are not product costs. For example, sales
commissions and the rental costs of administrative offices are period costs. Period costs are
not included as part of the cost of either purchased or manufactured goods; instead, period
costs are expensed on the income statement in the period in which they are incurred using
the usual rules of accrual accounting.
(6) Classification on the basis of Function of costs
i. Production cost:
ii. Administration cost:
iii.
Marketing cost:
iv. Research and development cost:
Discuss the method of costing.
i. Job-order costing: A job order costing is used in situation where many different productions
are produced each period. It is used in large scale production and service industries. It is two
types- (1) Batch costing and (2) Contract costing.
ii.
Process costing: Process costing is most commonly used in industries the produce
essentially homogenous (i.e. uniform) products on a continuous basis, such as bricks,
cornflake or paper. Process costing is particularly used in companies that convert basic raw
materials into homogeneous products. A process costing system is used in situations where
the company produces many units of a single product for long periods. It is several types(1) Single output costing, (2) Departmental costing, (3) Operating costing and (4) Assemble
costing and multiple costing or composite costing.
iii.
Firm Costing: Firm costing in mostly commonly used in agriculture, fishing, mining etc. It is
consider as a general firming costing.
What do you mean by cost statement or what is cost sheet? Discuss its uses. Why and how makes to
prepare it?

Cost statement or cost sheet is the combination of related cost that determines the production cost.
A cost statement or cost sheet is a breakdown of all costs incurred, which is comprised of direct and
indirect expenses. While the statement can be prepared to calculate the cost of any item from attending a
university to a development project, it is most commonly used for goods. The cost statement is the largest
expense on the income statement and shows the cost of the product. The cost for retailers and wholesalers
is the amount paid during the period. The process for calculating the cost for manufacturers is more
complex and has many components: direct material, direct labor, factory and administration overheads, and
selling and distribution overheads. A cost statement often falls under the managerial accounting section of a
company's financial reporting activities. It contains several different pieces of information for certain
activities.
Why or use of cost sheet or statement:
i. Determine the detail product cost.
ii.
Determine the classification of cost.
iii.
Determine the direct and indirect cost
iv. Knowing the production cost, prime cost and total cost of a product.
v. Knowing the single unit costing
vi. Determining the profit by using the cost statement.
vii.
Determining the selling cost and amount.
viii.
Coordinate with other costs.
ix. Reducing the additional cost.
x. Take necessary action if excess cost is involved.
How to prepare:
First step: First step of preparing the cost statement or sheet is to determining the prime cost. Prime
cost equal to direct raw material + direct labor + direct expenses.
Second step: Second step of preparing the cost sheet is to determining the factory cost. Factory cost
is equal to Prime cost plus factory overhead cost.
Third step: Third step of preparing the cost sheet is to determining the total cost. Total cost is equal
to Factory overhead cost + Administration cost + marketing cost.
Final step: Final step of preparing the cost sheep is to determining the selling cost. The selling cost
is equal to total cost plus profit.
08.

Define margin of safety and discuss its implications.

The margin of safety is the excess of budgeted (or actual) sales dollars over the break-even volume of sales

dollars. It is the amount by which sales can drop before losses are incurred. The higher the margin of safety,
the lower the risk of not breaking even and incurring a loss.
The formula for its calculation is:
Margin of safety = Total budgeted ( or actual ) sales - Breakeven sales
The margin of safety can also be expressed in percentage form by dividing the margin of safety in dollars
by total dollar sales:
Margin of safety percentage = Margin of safety in dollars /Total budgeted (or actual) sales in dollars
Implications arei. Forecasting
ii.
Controlling
iii.
Budgeting
iv. Pricing.

09.

What is the meaning of breakeven Analysis and point? Describe three approaches of break
even analysis (May, 2012). Discuss the usefulness and assumptions of Break-even-point Analysis.
What are the limitation of BEP analysis?
Breakeven Analysis:
Break-Even Analysis, one of the tools of Cost-Volume-Profit Analysis, determines the break-even
sales which is the units and/or sales dollars where total sales equals total costs (expenses).
Break even analysis is a technique of profit planning that has been used for many years by
accountants, business executives and some economists. It is essential a device for integrating costs,
revenues and output of the firm in order to illustrate the probable effects of alternative courses of action
upon net profits. It is an aid to profit planning. It has been defined a chart which shows the profitability or
otherwise of an undertaking at various level of activity and as a result indicates the point at which neither
profit nor loss is made. The Break Even Chart therefore, depicts the following information at various levels
of an activity:
I.
Variable costs, fixed costs and total costs.
II.
Sales Value
III.
Profit or loss
IV. Breakeven point, i.e. the point at which total costs just equal or break even with sales. This
is the activity point at which neither profit is made nor loss is incurred.
Breakeven point:
The breakeven point is the volume of activity at which an organizations revenues and expenses are
equal- Harold W. Hilton.
Breakeven point of an organization/enterprise/firm is a pint where total revenue/sales proceeds/sale
or output equals total cost. It indicates that the level of output / sales / sales proceeds / revenue at which the
firm recovers all its costs and neither neither earns a profit nor incurs loss. In other words, this is a point of
zero profitability. Once the firm/enterprise cross its breakeven point, its starts earning profit.
Breakeven point can be seen from the following example:
Output
Total Cost
Total Revenue/sales/Sales proceeds
200 units
TK-700.00
Tk-600.00
300 units
TK-900.00
TK-900.00
400 units
TK-1100.00
TK-1200.00

Profit
-100
0 (BEP)
+100

No firm/ enterprise can remain satisfied with this level of output. Each firm/enterprise would like to
move as far from this point as possible. Similarly, a firm/ enterprise which is lower than the breakeven
point would like to devise strategies firs for reaching the breakeven point and thereafter crossing this point
at the earlier. Because of a firm operates below the breakeven point it cannot survive for a longer time, as it
will then be functioning only with a drain on its aim of any firm/enterprise is to earn more and more profit
each concern would like to operate at the margin of safely and the lower the profit above breakeven point,
the lower is margins of safety. At breakeven point the margin of softy is nil.

Three approaches of break even analysis

i.

Contribution Margin Approach

The contribution margin approach to calculate the breakeven (i.e. the point of zero profit or loss) is
based on the CVP analysis concepts known as contribution margin and contribution margin ratio.
Contribution margin is the difference between sales and variable costs. Contribution margin is the
difference between sales and variable costs. When calculated for a single unit, it is called unit contribution
margin. Contribution margin ratio is the ratio of contribution margin to sales.
BEP in Sales Units:
We learned that, at break-even point, the CVP analysis equation is reduced to: px = vx + FC,
Where p is the price per unit, x is the number of units, v is variable cost per unit and FC is total
fixed cost.
Solving the above equation for x (i.e. Break-even sales units)
Break-even Sales Units = x = FC ( p v)
Since unit contribution margin (Unit CM) is equal to unit sale price (p) less unit variable cost (v),
So, Unit CM = p v
Therefore, Break-even Sales Units = x = FC Unit CM,
BEP in Sales DollarsBreak-even point in dollars can be calculated via: Break-even Sales Dollars = Price per Unit
Break-even Sales Units; or Break-even Sales Dollars = FC CM ratio.
Example
Calculate the break-even point in units and in sales dollars when sales price per unit is $35, variable
cost per unit is $28 and total fixed cost is $7,000.
Solution
Contribution Margin per Unit = ( $35 $28 ) = $7
Break-even Point in Units = $7,000 $7 = 1,000
Break-even Point in Sales Dollars = 1,000 $35 or $7,000 20% = $35,000
ii.
Graphical Approach
The graphical approach has an X-axis (horizontal) that represents Units (volume) and a Y-axis (vertical)
that represents Dollars and contains lines for:
I.
Sales
II.
Variable costs (Expenses)
III.
Total Costs ( Expenses)
The point on the graph where the Sales and Total Cost (Expense) Lines intersect is the breakeven point.
Another graph that is often used to compare how alternatives on pricing, variable costs, or fixed costs
may affect net income (profit) as volume changes is called a P/V Chart or Profit-Volume Graph.
iii.

Equation Approach
An alternative approach to finding the breakeven point is based on the profit equation. Income (or
Profit) is equal to sales revenue minus expenses. If expenses are separated into variable and fixed expenses,
the essence of the income (profit) statement is captured by the following equation.
Sales revenue-variable expenses-fixed expenses= profit
This equation can be restated as follows:
{(Unit sales price) (sales volume in units) }-{(Unit variable expense) (Sales volume in
units)}=Profit.

{(Unit sales price) (sales volume in units) }-{(Unit variable expense) (Sales volume in
units)}- (Fixed expenses) = BEP.
The usefulness of Break-even Analysis.
Breakeven analysis provides useful information to management and lending institutions (banks) in most
lucid and precise manner. It is an effective and efficient reporting tool of financial management. The
usefulness or importance of breakeven analysis can be enumerated as under:
i.
ii.

iii.

iv.

v.

Fair knowledge about the breakeven analysis can be help the banking to examine loan
proposal of a firm/enterprise.
Breakeven analysis helps the bankers in assessing working capital requirement of a unit; it
comes in handy to measure the future cost and revenue relationship and also helps to
determine the level of production. As and when this level is known, the enterprise can also
play its future working capital requirements for the enterprises.
This analysis helps in revealing clear projections of profit planning of an enterprise at
different production level visavis the financial needs. It also helps to find rate of return on
investment of capital at varying levels of production.
It helps the banker in studying the projection cost of production and profitability statement
of a unit prepared to show net position at a given level of output. Below breakeven point, the
average loss per unit increases as the volume of output declines. When the unit functions
above breakeven point they can maintain their profitability and be in a position to meet their
commitments and debt obligations. In other words, when once a unit breakeven from the
onwards repayments of debt may begin for the terms loans granted by them. Usually, till a
unit reaches the breakeven level of production repayment holding is granted by banks.
Breakeven analysis is a useful diagnostic tool. It indicates the management the causes of
increasing breakeven point and falling profit. The analysis of these causes will reveal to
management what action should be taken. As a practical matter, a knowledge of where
breakeven lies can be quite useful to management in determining the need for action.

The assumptions of Break-even Analysis.

Break even analysis is based on certain assumption. These are as follows:
i.
Fixed Costs will tend to remain constant. In other words, there will not be any change in cost factor,
such as, change in property tax rate, insurance rate, salaries of staff etc. or in management policy.
ii.
Price of variable cost factors, i.e. wage rates, price of materials, supplies, services etc. will remain
unchanged so that variable costs are truly variable.
iii.
Product specification and methods of manufacturing and selling will not undergo a change.
iv. Operating efficiency will not increase or decrease.
v. There will not be any change in pricing policy due to change in volume, competition etc. In other
word, selling prices will remain unchanged as the volume expands.
vi.
The number of units of sales will coincide with the units produced so that there is no closing or
opening stock. Alternatively, the changes in opening and closing stocks are insignificant and that
they are valued at the same price, or at variable cost.

Limitation of breakeven analysis

Breakeven analysis is a simple and useful concept. But, it is based on certain assumptions which have
been discussed earlier. These assumptions may lit the utility and general applicability of breakeven
analysis. Therefore, the analysis should recognize these limitations and adjust the date wherever possible to
get meaningful results. Breakeven analysis suffers from the following limitations:
i.
It may be difficult to segregate cost into fixed and variable components.
ii.
It is not correct to assumption that total fixed cost into fixed and variable components.
iii.
The assumptions of content unit variable cost are not valid.
iv. Selling price may not remain unchanged over a period of time.
v. Breakeven analysis is a short run concept and has a limited use in long range planning.
Although breakeven analysis suffers from a number of limitations, yet are still remains as an important
tool of profit planning. What is needed is that the financial analysis should understand the underlying
assumptions and their corresponding limitations and adjust his / her data appropriately to suit his or her
need.
10. Definition of cost-volume-profit analysis. Uses and assumptions of CVP analysis. Discuss the CVP
analysis as on aid to the management and what are the limitations of CVP analysis have.
Cost-volume-profit (CVP) analysis is a powerful tool that helps managers understand the
relationships among cost, volume, and profit. CVP analysis focuses on how profits are affected by the
following five factors:
1.
Selling prices.
2.
Sales volume.
3.
Unit variable costs.
4.
Total fixed costs.
5.
Mix of products sold.
Because CVP analysis helps managers understand how profits are affected by these key factors, it is
a vital tool in many business decisions. These decisions include what products and services to offer, what
prices to charge, what marketing strategy to use, and what cost structure to implement. CVP analysis is
based on a simple model of how profits respond to prices, costs, and volume.
CVP analysis is a study of the relationships between sales volume, expenses, revenue and profit.
(Ronald W. Histon.)
Uses of CVP arei. Planning: CVP analysis uses to determining the production, sales and mixed product
planning.
ii. Ability of earning profit: analysis the cost-amount-profit determines the ability to
earn profit.
iii.
Controlling: CVP analysis control the additional cost by using several methods.
iv. Stability of earning profit.
v. Decision making.
A number of assumptions commonly underlie CVP analysis:
1. Selling price is constant. The price of a product or service will not change as volume changes.
2. Costs are linear and can be accurately divided into variable and fixed elements. The variable element is constant
per unit, and the fixed element is constant in total over the entire relevant range.
3. In multiproduct companies, the sales mix is constant.
4. In manufacturing companies, inventories do not change. The number of units produced equals the number of units
sold.
Aid to the management:

i.
ii.
iii.
iv.
v.
vi.
vii.
viii.
ix.

Reducing the additional cost and maintain the lowest expenses.

Determining the amount of sales to earn profit.
Changing the cost, expense and amount determine the changing the profit.
Changing the sales and mixed determining the changing the profit.
Changing the sales, expense and amount determining the breakeven point.
Changing the sales mixed determining the breakeven point.
Determining the new equipment and technology affects the cost-amount-profit.
Determining what product or service is more profitable.
Determining what product or service is stopped in production.

Limitation of CVP analysis:

i. It may be difficult to segregate cost into fixed and variable components.
ii.
It is not correct to assumption that total fixed cost into fixed and variable components.
iii.
The assumptions of content unit variable cost are not valid.
iv. Selling price may not remain unchanged over a period of time.
v. CVP analysis is a short run concept and has a limited use in long range planning.
vi. Unchanged of production technology uses.
vii.
If a single unit is change may not determining the change of CVP.
viii.
Selling and production is same.
ix. All cost is determining the fixed and variable cost.
x. Target scale of production of fixed cost is unchanged.

Module-c : Budgeting and expenditure

01.

What do you mean by budget?

A budget is a monetary and / or quantitative expression of business plans and policies, prepared in advance,
to be pursued in the future period of time.
According to certified institute of management accountants, A budget is a financial and / or quantitative
statement prepared prior to a defined period of time, of the policy to be pursued during that period for the purpose of
attaining the objective.
A budget is quantitative plan for acquiring and using resources over a specified time period-Garrison,
Noreen and brewer.
In brief, it is a systematic plan for utilization of manpower and other resources. It acts as a barometer of a
business as it measures the success from time to time, against the standard set for achievement.
Budgeting is a technique for formulating budget.

02.

What are the Characteristics of a budget?

The main characteristics of a budget arei
ii
iii
iv
v
vi
vii

03.

A comprehensive business plan showing what the enterprise wants to achieve .

Prepared in advance
For a definite period of time
Expressed in quantitative form, physical or monetary terms or both
For achieving a given objective
A proper system of accounting is essential
System of proper fixation of authority and responsibility has to be in place.

What are the benefits of budgeting?

Organizations realize many benefits from budgeting including Budget communicates managements plans throughout the organization.

04.

Budget force managers to think about and plan for the future. In the absence of the necessity to prepare a
budget, many managers would spend all of their time dealing with daily emergencies.
The budgeting process provides a means of allocating resources to those parts of the organization where they
can be used most effectively.
The budgeting process can uncover potential bottlenecks before they occur.
Budgets coordinate the activities of the entire organization by integrating the plan of its various parts.
Budgeting helps to ensure that everyone in the organization is pulling in the same direction.
Budgets define goals and objectives that can serve as benchmarks for evaluating subsequent performance.

What are the principles of budgeting?

State the principles of budgeting:
i
ii
iii

Management sponsorship
Organization structure
Budget center

iv
v
vi
vii
viii
ix
x
xi
xii

05.

Budget period
Reality
Flexibility
Fulfillness
Consultative Direction
Economy
Limiting factor
Rectification
Training

Narrate the steps of budgeting or what are the steps involved in the construction of a cash budget?
i
ii
iii
iv
v
vi
vii

Setting up objectives and principles

Preparation of forecast
Preparation of draft budget
Approved of draft budget
Preparation of final budget
Approved of the budget and
Order issuance

06.
Define of the cash budget. Discuss the utility of cash budget as a tool of the cash
management.
A cash budget is an estimate of cash receipts and disbursements during a future period. The anticipated cash
receipts from various sources are taken into account. Similarly, the amount to be spent on various heads, both
revenue and capital, are taken into cash budget. In short, it is a summary of cash intake and outlay.
Cash budget is the forecasting the future cash flow Van Horne.
Cash budget is the comparative forecasting of cash receipts and disbursement of specific time period Gohen & robins.

Cash budget is a tool of the cash management:

i.
Cash budget provides the information when it is need.
ii.
Cash budget indicate the product life cycle and management takes proper action for future
action.
iii.
Cash budget estimates the taxes amount, dividend amount, Loan amount, Preference share
capital amount and pension funds.
iv.
At a certain time, organization can know the fund for short or long term investment or other
activities.

07.

State the differences between cash budget and cash flow statement.
A cash budget is an estimate of cash receipts and disbursements during a future period. The anticipated cash
receipts from various sources are taken into account. Similarly, the amount to be spent on various heads, both
revenue and capital, are taken into cash budget. In short, it is a summary of cash intake and outlay.
A cash flow statement is a statement, which describes the inflows (sources) and outflows (uses) of cash and
cash equivalents during a specified period. It is a summary of cashbook. A cash flow statement explains the causes of
changes in cash position of a business enterprise between two dates of balance sheets. Cash flow statement is a tools
that is available to the management to assess, monitor and control the liquidity available in the enterprise. Conversion
of cash into cash equivalents and vice versa does not constitute cash flows because they are not part of operating,
financing and investing activities. Cash management includes the investment of cash into cash equivalents and vice
versa. A cash flow statement may be defined as a financial statement that summarizes the cash receipts and
payments and net changes resulting from operating, financing and investing activities of an enterprise during a given
period of time.

08.

What do you understand by Master Budget? How a master budget can be used as a control tool?
In an organization, the term master budget refers to a summary of a companys plans including specific
targets for sales, production, and financing activities. The master budget which culminates in a cash budget, a
budgeted income statement, and a budgeted balance sheet-formally lays out the financial aspects of managements
plans for the future and assists in monitoring actual expenditures relative to those plans.

Budgets are used for two distinct purposes- planning and controlling. Planning involves developing goals
and preparing various budgets to achieve those goals. Control involves the steps taken by management to increase the
likelihood that all parts of the organization are working together to achieve the goals set down at the planning stage.
To be effective, a good budgeting system must provide for the both planning and control. Good planning without
effective control is a waste of time and effort.
A master budget can be used as a control tooli
Prepare planning
ii
Use as a standard
iii
Actual result
iv
Comparative analysis
v
Coordinate and control.

09.

What is budgetary control?

Budgetary control is the process of determining various budgeted figures for the enterprise and then
comparing the actual performance with the budgeted figures for calculating the variances, if any. In this process, first
budgets are to be prepared. Second, actual results are to be recorded. Third, comparison is to be made between the
actual with the planned action for calculating the variances. Once the discrepancies are known, remedial measures
are to be taken, at proper time. Then only, planned results can be achieved. A budget is a means and budgetary
control gives the end result.
The establishment of budgets relating to the responsibilities of executives to the requirements of a policy,
and the continuous comparison of the actual with the budgeted result, either to secure by individual action the
objective of the policy or to provide a basis its revision The Chartered Institute of Management Accountants,
London.
Thus, establishment of budgetary control involves the following:
i
Establishment of budgets.
ii
Continuous comparison of actual with the budgets for achievement of targets and fixing the
responsibility for failure to achieve the budget figures.
iii
Revision of budget in the light of changed circumstances.

10.

Objectives of budgetary control.

The main objectives of budgetary control are as underi
To coordinate the activities of different department
ii
To operate various cost centers and departments with efficiency and economy.
iii
Fixation of responsibility of various individuals in the organization.
iv
To ensure a system for correction of deviations from established standards.
v
To centralize the control system and
vi
To ensure planning for future by setting up various budgets.

11.

Requisites for successful budgetary control system

The following requites are essential for effective budgetary control system.
i
Determination of the objectives: There should be clear perspective of the objectives to be achieved
through the budgetary control system. In most of the cases , the basic objective is to achieve
desired/increased profits. To achieve, the following problems are to be sorted out. (1) Laying down

ii

iii
iv

vi

the plan for implementation to achieve the objectives and (2) Bringing coordination amongst the
different department and controlling each function so as to bring the best possible results.
Proper delegation of authority and responsibility: The first step is to have clear organization chart
explaining the authority and responsibility of each individual executives. There should be no
uncertainty regarding the point when the jurisdiction of one authority ends and that another begins.
Proper communication system: The flow of information should be quick so that the budgets are
implemented. Two way communications is important.
Participation of all employees: Budget preparation and control are done at the top level. However,
involvement of all persons, including at the lower level, is necessary in framing the budget and its
implementation for the success of budgetary control.
Flexibility: Future is uncertain. Despite the best planning and foresight, still there may be
occurrences that may require adjustment. Budgets should work in the charged circumstances.
Flexibility in budgets is required to make them work under changed circumstances.
Motivation: Budgets are executed by human beings. There should be incentive in achieving the
required targets. All persons should be motivated to improve their working to achieve the goals set in
the budgets.

12.

Essential steps for installation of budgetary control systems.

In order to have effective budgetary control system, it is appropriate to take the following steps:
i.
Budget Manual: This is a written document specifying the objectives and procedures of budgetary
control. It helps out the duties and responsibilities of executives. The budget manual defines the
sanctioning powers of the various authorities.
ii.
Budget centers: A budget center is that part of organization for which the budget is prepared. Budget
center can be a department, section of a department or any other part of department. Budget centers
are necessary for the purpose of ascertaining cost, performance and its control.
iii.
Budget committee: In a large concern, all the functional heads are the members of the budget
committee. They discuss their respective budgets and finalize the budget, after collective decisions.
The committee is responsible for its execution and achievement of the goals set.
iv.
Budget officers: The chief executive appoints some person as the budget officer. As the convener of
the budget committee, his function is coordination to ensure the achievement of the budgeted targets.
v.
Budget period: A budget period is the length of the period for which budget is prepared.
vi.
Determination of key factor: Budgets are prepared for all the functional areas such as production,
sales, purchases, finance, human resources and research & development and so the budgets are. A
factor, which influences all other budgets, is known as key factor or principal factor.

13.

What is the importances or advantages of budgetary control? Discuss briefly the importance of

budgetary control system with special reference to banking organization.

Budgetary control acts as an important tool for the management to economize costs and maximize profit. The
system helps the management to set the goals. The current performance is compared with the pre-planned
performance to ascertain deviations so that corrective measures are taken. Well at the right time. In this way,
budgetary control system acts as a friend, philosopher and guide to the management. The following are the
advantages of budgetary control system.
i.
Profit maximization: The resources are put to best possible use, eliminating wastage. Proper control
is exercised both on revenue and capital expenditure. To achieve this, proper planning and
coordination of various function is undertaken. So, the system helps in reducing losses and
increasing profits.
ii.
Coordination: the budgets of various departments have a bearing with each other, as activities are
inter-related. As the size of operations increases, coordination amongst the different departments for
achieving a common goal assumes more importance. This is possible through budgetary control
system.

iii.

iv.

v.

vi.

vii.

viii.
ix.
x.

14.

15.

Communication: A budget serves as a means of communicating information throughout the

organization. A sales manager for a district knows what is expected of his performance. Similarly,
production manager knows the amount of material, labor and other expenses that can be incurred by
him to achieve the goal set to him. So, every department knows the performance expectation and
authority for achieving the same.
Tools for measuring performance: Budgetary control system provides a tool for measuring the
performance of various departments. The performance of each department is reported to the top
management.
Economy: Planning at each level brings efficiency and economy in the working of the business
enterprise. Resources are put to optimum use to achieve economy. All this leads to elimination of
wastage and achievement of overall efficiency.
Determining weaknesses: Actual performance is compared with the planned performance,
periodically, and deviations are found out. This shows the variances highlighting the weakness,
where concentration for action is needed.
Consciousness: Budgets are prepared in advance. So, every employee knows what is expected of him
and they are made aware of their responsibility. They do their job uninterrupted for achieving what is
set to him to do.
Timely corrective action: The deviations will be reported to the attention of the top management as
well as functional heads for suitable corrective action, in time.
Motivation: Success is measured by comparing the actual performance with the planning
performance.
Management by exeception: The management is required to exercise action only when there are
deviations. So, long as the plans as achieved, management need not be alerted. This system enables
the introduction of management by exception for effective delegation and control.

Mention the limitations of budgetary control.

i.
Uncertainty of future.
ii.
Problem of coordination
iii.
Not a substitute for management
iv.
Discourages efficiency
v.
Timely revision required
vi.
Conflict among different departments
vii.
Depends upon support of top management.

Define capital budgeting. What are the importance features of Capital budgeting? Discuss the use of
the time value of money in capital budgeting.
A capital expenditure may be defined as an expenditure, the benefit of which is spending over a
period exceeding one year. The main feature of a capital expenditure is that the heavy expenditure is
incurred at one period of time while the benefits of the expenditure are spread at different points of time, in
future.
The investment decisions of a firm are generally known as capital budgeting or capital expenditure
decisions. The capital budgeting is concerned with allocation of the firms scarce financial resources in the
long-term projects, the benefits occur over a future period. Capital budgeting may be defined as the firms
decision to invest current funds in long-term assets to get the benefits over the years.

Capital budgeting is a process of evaluating selection among proposed capital investment-Kolb A.

Barton.
Characteristics:
i. Cost of long term capital
ii.
Forecasting
iii.
Large volume of investment
iv. Considering Assets
v. Cash flow
vi. Risk
The use of the time value of money in capital budgeting:
Investment decisions are of great importance to any concern. These decisions involve commitment
of a large sum of money. They affect the profitability of the enterprise, greatly. These decisions are difficult
to make. The need, significance or importance of these decisions is due to the following reasons:
i. Large investments: Funds are limited and opportunities are abundant. Capital expenditure
decisions involve commitment of large sums of money. If funds are committed to one
project, other projects are denied. So, a great deal of planning is necessary before the capital
expenditure.
ii.
Growth and profitability: The direction of growth is set by the capital expenditure. If the
expenditure goes in the right direction, the organization gets a boost in the profitability. If
the decision is wrong, it is fatal for its growth or at times, even the profitable concern may
suffer due to their heavy financial implications.
iii.
Irreversible nature: Most investment decisions are irreversible. Once these assets are
acquired, their disposal is difficult as there is no ready market and, often, results in heavy
losses. Due to this long term implications, decisions are taken after careful planning. More
often, the decisions cannot be reversed, without substantial loss.
iv. Difficulties of investment decisions: The impact of investment decision is not limited for
one year. Its influence spreads over a series of years. Future is uncertain and so it is difficult
to forecast its impact over the period of the life of the assets. It is difficult to estimate the
future cash flows, accurately; economic, political, social and technological forces cause the
uncertainty of the cash flows.
v. Risk: Long term commitment of funds changes the risk profile of the firm. Adoption of a
profitable investment increases the earnings per share but causes a change in the earning
pattern. As future is uncertain, there is no guarantee for the continuation of the same earning,
positively. Thus, investment decisions shape the basic character of the firm.
15.

Discuss the techniques of capital budgeting.

Capital budgeting techniques are, broadly, divided into two categories. They are discounted and nondiscounted techniques.
(1) Discounted techniques:
i. Net present value (NPV)
ii. Internal rate of return (IRR)
iii.
Profitability Index (PI)
iv. Discounted payback period (DPP)
(2)Non-discounted techniques:
i. Payback period (PB)
ii. Accounting rate of return (ARR)

How we can achieve control of business operations of a bank through budget and standard costing
techniques?
Net present value (NPV): the best method for evaluation of investment proposals is
the net present value method or discounted cash flow technique. The net present value
technique explicitly recognizes the time value of money. This technique recognizes the cash
flows, arising at different time periods, differs in value and is comparable only when their
present values are found out. It is the measure of firms profitability. It increases the value of
the firms share price and contributes to the maximization of the shareholders wealth.
Internal rate of return method: The internal rate of return (IRR) method is another
discounted cash flow technique which takes into account the magnitude and timing of cash
flows. IRR is simple to understand, in case of one-period project. In IRR technique, the future
cash flows are discounted in such a way that their total present value is just equal to the
present value of the total cash flows. The time schedule of occurrence of the future cash
flows is known, but the discount rate is not known. The discount rate is present ascertained
by the trial and error method, where the present value of future inflows is equal to the
present value of outflows, which is known as internal rate of return.

Profitability Index (PI) is a measure of investment efficiency. It is a good tool for ranking projects
because it allows you to clearly identify the amount of value created per unit of investment, thus if you are
capital constrained you wish to invest in those projects which create value most efficiently first.
Profitability Index = (Net Present Value + Initial Investment) / Initial Investment ... where the Initial
Investment is the Net Cost at installation (year 0)
Profitability Index = Present Value of Future Cash Flows Generated by the
Project/Initial Investment in the Project.

A discounted payback period: A capital budgeting procedure used to determine the profitability of
a project. In contrast to an NPV analysis, which provides the overall value of an project, a discounted
payback period gives the number of years it takes to break even from undertaking the initial expenditure.
Future cash flows are considered are discounted to time "zero." This procedure is similar to a payback
period; however, the payback period only measure how long it take for the initial cash outflow to be paid
back, ignoring the time value of money.
Payback period method:
The payback period method (PB) is one of the most popular and widely recognized
traditional methods of evaluating investment proposals. Payback method is defined as the
number of years required to recover the original cash outlay invested in a project. If the
project gives constant annual cash flows, the payback period can be calculated by dividing
cash outlay by the annual cash inflow. The formula for calculation of payback period, when
the cash inflows are constant is as follows:
Payback period= initial investment annual cash inflow.

The accounting rate of return:

The accounting rate of return is used in capital budgeting to estimate whether you should proceed
with an investment. The calculation is the accounting profit from the project, divided by the initial
investment in the project. You would then accept a project if the measure yields a percentage that exceeds a
certain hurdle rate used by the company as its minimum rate of return
The formula for the accounting rate of return is = Average annual accounting profit / Initial
investment
The accounting rate of return (ARR) is a very simple (in fact overly simple) rate of
return. Accounting rate of return (ARR) = average profit average investment.

Basic formulae =

What types of proposals or project for capital budgeting:

i
ii
iii
iv
v

Replacement
Expansion
Diversification
Research and development
Miscellaneous.

Discuss the steps of capital budgeting process.

i
ii

Project generation
Evaluate the finance

What is liquidity? Or define liquidity.

The ability of an asset to be converted into cash quickly and without any price discount is called
liquidity. Liquidity refers to how quickly and cheaply an asset can be converted into cash. Money (in the
form of cash) is the most liquid asset. Assets that generally can only be sold after a long exhaustive search
for a buyer are known as illiquid.
Definition of Liquidity is:

The degree to which an asset or security can be bought or sold in the market without affecting the
asset's price. Liquidity is characterized by a high level of trading activity. Assets that can be easily
bought or sold are known as liquid assets.
2 The ability to convert an asset to cash quickly. Also known as "marketability".
There is no specific liquidity formula; however, liquidity is often calculated by using liquidity ratios.
In accounting, liquidity (or accounting liquidity) is a measure of the ability of a debtor to pay their
debts as and when they fall due. It is usually expressed as a ratio or a percentage of current liabilities
( How the liquidity position can be measured? Or how do the way of liquidity condition measured?)
For a corporation with a published balance sheet there are various ratios used to calculate a measure of
liquidity. These include the following:
i The current ratio, which is the simplest measure and is calculated by dividing the total current assets
by the total current liabilities. A value of over 100% is normal in a non-banking corporation.
However, some current assets are more difficult to sell at full value in a hurry.
ii The quick ratio - calculated by deducting inventories and prepayments from current assets and then
dividing by current liabilities - gives a measure of the ability to meet current liabilities from assets
that can be readily sold. A better way for a trading corporation to meet liabilities is from cash flows,
rather than through asset sales, so;
iii The operating cash flow ratio can be calculated by dividing the operating cash flow by current
liabilities. This indicates the ability to service current debt from current income, rather than through
asset sales.
What is liability management?
Use and management of liabilities, such as customer deposits, by a bank in order to facilitate
lending and allow for balanced growth. Management of money accepted from depositors as well as funds
secured from other institutions constitute liability management. It also involves hedging against changes in
interest rates and controlling the gap between the maturities of assets and liabilities.
In banking, asset and liability management (often abbreviated ALM) is the practice of managing
risks that arise due to mismatches between the assets and liabilities (debts and assets) of the bank. This can
also be seen in insurance.
Banks face several risks such as the liquidity risk, interest rate risk, credit risk and operational risk.
Asset liability management (ALM) is a strategic management tool to manage interest rate risk and liquidity
risk faced by banks, other financial services companies and corporations.
Banks manage the risks of asset liability mismatch by matching the assets and liabilities according
to the maturity pattern or the matching of the duration, by hedging and by securitization.
Modern risk management now takes place from an integrated approach to enterprise risk
management that reflects the fact that interest rate risk, credit risk, market risk, and liquidity risk are all
interrelated.

What types of sources can use of liability management?- Narrate in short.

ii
iii
iv
v

Time certificate of deposit: In America from the 1960 the main sources of the liability
liquidity management is time certificate of deposit of commercial banks. It is salable and
transferable. This certificate is 90 days or 1 year and interest rate is determined comparing
the treasure bills and other instrument.
Loan from other commercial bank: The second liability is the loan from other commercial
banks.
Loan from the central bank.
Issue shares.
Loan from the reserve fund.

What do you mean by ratio analysis?

Definition of 'Ratio Analysis'
A tool used by individuals to conduct a quantitative analysis of information in a company's financial
statements. Ratios are calculated from current year numbers and are then compared to previous years, other
companies, the industry, or even the economy to judge the performance of the company. Ratio analysis is
predominately used by proponents of fundamental analysis.
There are many ratios that can be calculated from the financial statements pertaining to a company's
performance, activity, financing and liquidity. Some common ratios include the price-earnings ratio, debtequity ratio, earnings per share, asset turnover and working capital.

What do you mean by financial analysis?

The term financial analysis is also known as analysis and interpretation of financial statement.
Financial analysis is the process of identifying the financial strengths and weaknesses of the firm, by
properly establishing the relationships between the items contained in balance sheet and profit and loss
account-CA.C. Rama Gopal.
Financial analysis (also referred to as financial statement analysis or accounting analysis or Analysis of
finance) refers to an assessment of the viability, stability and profitability of a business, sub-business or
project. It is performed by professionals who prepare reports using ratios that make use of information
taken from financial statements and other reports. These reports are usually presented to top management as
one of their bases in making business decisions.
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vi

Continue or discontinue its main operation or part of its business;

Make or purchase certain materials in the manufacture of its product;
Acquire or rent/lease certain machineries and equipment in the production of its goods;
Issue stocks or negotiate for a bank loan to increase its working capital;
Make decisions regarding investing or lending capital;
Other decisions that allow management to make an informed selection on various alternatives in the
conduct of its business.

The goals of the financial analysts often assess the following elements of a firm:
1

Profitability - its ability to earn income and sustain growth in both the short- and long-term.
A company's degree of profitability is usually based on the income statement, which reports
on the company's results of operations;

Solvency - its ability to pay its obligation to creditors and other third parties in the longterm;

Liquidity - its ability to maintain positive cash flow, while satisfying immediate obligations;

Stability - the firm's ability to remain in business in the long run, without having to sustain
significant losses in the conduct of its business. Assessing a company's stability requires the
use of the income statement and the balance sheet, as well as other financial and nonfinancial indicators.

The method of financial analysts often compares financial ratios (of solvency, profitability, growth, etc.):
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Past Performance - Across historical time periods for the same firm (the last 5 years for example),
Future Performance - Using historical figures and certain mathematical and statistical techniques,
including present and future values, This extrapolation method is the main source of errors in
financial analysis as past statistics can be poor predictors of future prospects.
Comparative Performance - Comparison between similar firms.

These ratios are calculated by dividing a (group of) account balance(s), taken from the balance sheet
and / or the income statement, by another, for example :
Net income / equity = return on equity (ROE)
Net income / total assets = return on assets (ROA)
Stock price / earnings per share = P/E ratio

What are the comparison of financial and ratio analysis?

Comparing financial ratios is merely one way of conducting financial analysis. Financial ratios face several
theoretical challenges:
i
ii

They say little about the firm's prospects in an absolute sense. Their insights about relative
performance require a reference point from other time periods or similar firms.
One ratio holds little meaning. As indicators, ratios can be logically interpreted in at least two ways.
One can partially overcome this problem by combining several related ratios to paint a more
comprehensive picture of the firm's performance.

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iv

Seasonal factors may prevent year-end values from being representative. A ratio's values may be
distorted as account balances change from the beginning to the end of an accounting period. Use
average values for such accounts whenever possible.
Financial ratios are no more objective than the accounting methods employed. Changes in
accounting policies or choices can yield drastically different ratio values.

What is cash flow statement?

In financial accounting, a cash flow statement, also known as statement of cash flows or funds flow
statement, is a financial statement that shows how changes in balance sheet accounts and income affect
cash and cash equivalents, and breaks the analysis down to operating, investing, and financing activities.
Essentially, the cash flow statement is concerned with the flow of cash in and out of the business. The
statement captures both the current operating results and the accompanying changes in the balance sheet.
As an analytical tool, the statement of cash flows is useful in determining the short-term viability of a
company, particularly its ability to pay bills. International Accounting Standard 7 (IAS 7 ) is the
International Accounting Standard that deals with cash flow statements.
People and groups interested in cash flow statements include:

Accounting personnel, who need to know whether the organization will be able to cover
payroll and other immediate expenses

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v

Potential lenders or creditors, who want a clear picture of a company's ability to repay
Potential investors, who need to judge whether the company is financially sound
Potential employees or contractors, who need to know whether the company will be able to
afford compensation
Shareholders of the business

The cash flow statement was previously known as the flow of Cash statement. The cash flow statement
reflects a firm's liquidity.
The balance sheet is a snapshot of a firm's financial resources and obligations at a single point in time, and
the income statement summarizes a firm's financial transactions over an interval of time. These two
financial statements reflect the accrual basis accounting used by firms to match revenues with the expenses
associated with generating those revenues. The cash flow statement includes only inflows and outflows of
cash and cash equivalents; it excludes transactions that do not directly affect cash receipts and payments. These noncash transactions include depreciation or write-offs on bad debts or credit losses to name a few. The cash flow
statement is a cash basis report on three types of financial activities: operating activities, investing activities, and
financing activities. Non-cash activities are usually reported in footnotes.

The cash flow statement is intended to-

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Provide information on a firm's liquidity and solvency and its ability to change cash flows in future
circumstances.
Provide additional information for evaluating changes in assets, liabilities and equity.
Improve the comparability of different firms' operating performance by eliminating the effects of different
accounting methods.
Indicate the amount, timing and probability of future cash flows.

The cash flow statement has been adopted as a standard financial statement because it eliminates allocations,
which might be derived from different accounting methods, such as various t imeframes for depreciating fixed

assets.
Cash flow activities.
The cash flow statement is partitioned into three segments, namely: 1) cash flow resulting from
operating activities; 2) cash flow resulting from investing activities; and 3) cash flow resulting from
financing activities.
The money coming into the business is called cash inflow, and money going out from the business is
called cash outflow.
Operating activities.
Operating activities include the production, sales and delivery of the company's product as well as
collecting payment from its customers. This could include purchasing raw materials, building inventory,
advertising, and shipping the product.
Under IAS 7, operating cash flows include:
i Receipts from the sale of goods or services.
ii Receipts for the sale of loans, debt or equity instruments in a trading portfolio.
iii Interest received on loans.
iv
Payments to suppliers for goods and services.
v
Payments to employees or on behalf of employees.

vi

Interest payments (alternatively, this can be reported under financing activities in IAS 7, and US
GAAP).
vii Buying Merchandise.
Items which are added back to [or subtracted from, as appropriate] the net income figure (which is
found on the Income Statement) to arrive at cash flows from operations generally include:

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Depreciation (loss of tangible asset value over time).

Deferred tax.
Amortization (loss of intangible asset value over time).
Any gains or losses associated with the sale of a non-current asset, because associated cash
flows do not belong in the operating section.(unrealized gains/losses are also added back from
the income statement).

Investing activities
Examples of investing activities are-

Purchase or Sale of an asset (assets can be land, building, equipment, marketable securities,
etc.)
ii Loans made to suppliers or received from customers.
iii Payments related to mergers and acquisitions.
iv Dividends Received.
Financing activities
Financing activities include the inflow of cash from investors such as banks and shareholders, as well as the
outflow of cash to shareholders as dividends as the company generates income. Other activities which
impact the long-term liabilities and equity of the company are also listed in the financing activities section
of the cash flow statement.
Under IAS 7i Proceeds from issuing short-term or long-term debt.
ii Payments of dividends.
iii Payments for repurchase of company shares.
iv Repayment of debt principal, including capital leases.
v For non-profit organizations, receipts of donor-restricted cash that is limited to long-term
purposes.
Items under the financing activities section include:

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Dividends paid
Sale or repurchase of the company's stock
Net borrowings
Payment of dividend tax

Disclosure of non-cash activities

Under IAS 7, non-cash investing and financing activities are disclosed in footnotes to the financial
statements. Under US General Accepted Accounting Principles (GAAP), non-cash activities may be disclosed in a
footnote or within the cash flow statement itself. Non-cash financing activities may includei
Leasing to purchase an asset.
ii
Converting debt to equity.
iii
Exchanging non-cash assets or liabilities for other non-cash assets or liabilities.
iv
Issuing shares in exchange for assets.
Preparation methods
The direct method of preparing a cash flow statement results in a more easily understood report. The indirect
method is almost universally used, because FAS 95 requires a supplementary report similar to the indirect method if a
company chooses to use the direct method.
Direct method
The direct method for creating a cash flow statement reports major classes of gross cash receipts and payments.
Under IAS 7, dividends received may be reported under operating activities or under investing activities. If taxes
paid are directly linked to operating activities, they are reported under operating activities; if the taxes are directly
linked to investing activities or financing activities, they are reported under investing or financing activities.
Indirect method
The indirect method uses net-income as a starting point, makes adjustments for all transactions for non-cash items,
then adjusts from all cash-based transactions. An increase in an asset account is subtracted from net income, and an
increase in a liability account is added back to net income. This method converts accrual-basis net income (or loss)
into cash flow by using a series of additions and deductions.

Complementing the balance sheet and income statement, the cash flow statement (CFS), a
mandatory part of a company's financial reports since 1987, records the amounts of cash and cash
equivalents entering and leaving a company. The CFS allows investors to understand how a company's
operations are running, where its money is coming from, and how it is being spent. Here you will learn how
the CFS is structured and how to use it as part of your analysis of a company.
The cash flow statement is distinct from the income statement and balance sheet because it does not include the
amount of future incoming and outgoing cash that has been recorded on credit. Therefore, cash is not the same as net
income, which, on the income statement and balance sheet, includes cash sales and sales made on credit. (For
background
reading,
see
Analyze
Cash
Flow
The
Easy
Way.)
Cash flow is determined by looking at three components by which cash enters and leaves a company: core
operations, investing and financing.

Operations
Measuring the cash inflows and outflows caused by core business operations, the operations component of
cash flow reflects how much cash is generated from a company's products or services. Generally, changes
made in cash, accounts receivable, depreciation, inventory and accounts payable are reflected in cash from
operations.
Cash flow is calculated by making certain adjustments to net income by adding or subtracting
differences in revenue, expenses and credit transactions (appearing on the balance sheet and income
statement) resulting from transactions that occur from one period to the next. These adjustments are made
because non-cash items are calculated into net income (income statement) and total assets and liabilities
(balance sheet). So, because not all transactions involve actual cash items, many items have to be reevaluated
when
calculating
cash
flow
from
operations.

For example, depreciation is not really a cash expense; it is an amount that is deducted from the total value
of an asset that has previously been accounted for. That is why it is added back into net sales for calculating
cash flow. The only time income from an asset is accounted for in CFS calculations is when the asset is
sold.

Changes in accounts receivable on the balance sheet from one accounting period to the next must also be
reflected in cash flow. If accounts receivable decreases, this implies that more cash has entered the
company from customers paying off their credit accounts - the amount by which AR has decreased is then
added to net sales. If accounts receivable increase from one accounting period to the next, the amount of
the increase must be deducted from net sales because, although the amounts represented in AR are revenue,
they are not cash.

An increase in inventory, on the other hand, signals that a company has spent more money to purchase
more raw materials. If the inventory was paid with cash, the increase in the value of inventory is deducted
from net sales. A decrease in inventory would be added to net sales. If inventory was purchased on credit,
an increase in accounts payable would occur on the balance sheet, and the amount of the increase from one
year
to
the
other
would
be
added
to
net
sales.
The same logic holds true for taxes payable, salaries payable and prepaid insurance. If something has been
paid off, then the difference in the value owed from one year to the next has to be subtracted from net
income. If there is an amount that is still owed, then any differences will have to be added to net earnings.
Investing
Changes in equipment, assets or investments relate to cash from investing. Usually cash changes from
investing are a "cash out" item, because cash is used to buy new equipment, buildings or short-term assets
such as marketable securities. However, when a company divests of an asset, the transaction is considered
"cash
in"
for
calculating
cash
from
investing.
Financing
Changes in debt, loans or dividends are accounted for in cash from financing. Changes in cash from
financing are "cash in" when capital is raised, and they're "cash out" when dividends are paid. Thus, if a
company issues a bond to the public, the company receives cash financing; however, when interest is paid
to bondholders, the company is reducing its cash.

Mention the characteristics of cash flow statement.

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v

It is a periodical period.
It is combined the beginning and inter-balance.
It is combined the consequences several balance sheets, profit and loss account and inner
analysis statement.
Cash flow statement cannot prepare in a single stage. It is prepared by the different event of
the organization.
It shows the financial changes of the organization.

Narrate the objective of cash flow statement.

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It is prepared the financial policy for using directing, financing and investing of the
organization.
It ensures the necessary cash flow statement of the organization.
It ensures not to break the liquidity position of the organization for shortage of cash.
It ensures the capacity to pay the dividend.
Is analysis the different years statement and take necessary action for the betterment of the
organization.

How cash flow statement can help the bankers to forecast the liquidity position of a firm?
Liquidity is a prime concern in a banking environment and a shortage of liquidity has often been a
trigger for bank failures. Holding assets in a highly liquid form tends to reduce the income from that asset
(cash, for example, is the most liquid asset of all but pays no interest) so banks will try to reduce liquid
assets as far as possible. However, a bank without sufficient liquidity to meet the demands of their
depositors risks experiencing a bank run. The result is that most banks now try to forecast their liquidity
requirements and maintain emergency standby credit lines at other banks. Banking regulators also view
liquidity as a major concern.
(The statement of cash flows is important analytical tools for creditors, investors and other users of
financial statement-explain. Or narrate the importance of cash flow statement.)
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vii

Getting an idea of future cash position

Correction of deviation
Picture of liquidity position
Framing long-term planning
Searching for solution to various
More important than fund flow statement
Useful to outside interested parties.

Mention the importance of cash flow statement for the bank officers.
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viii

It helps to analysis the cash position of the organization.

It helps to analysis the estimated cash flow and actual cash flow of the organization for a
specific time.
It helps the analysis the liquidity position of the organization.
Correction of deviation
Picture of liquidity position
Framing long-term planning
Searching for solution to various
More important than fund flow statement

ix

Useful to outside interested parties.

Distinguish a cash flow statement from a fund flow statement or state the differences between the
cash budget and cash flow statement.
Cash flow statement is prepared from the transactions affecting cash and cash equivalents only.
Taking in to account all sources and uses of cash, it starts with the opening balance of cash and cash
equivalents and reaches the closing balance of cash and cash equivalents,. Cash flow statements are useful
to identify the current liquidity problems which are to be corrected.
Fund flow statement analyses the sources and application of funds of long term nature and the
changes in working capital. It tallies funds generated from various sources with various uses to which they
are put. It is based on accrual accounting system and very useful for long range financial planning.
The distinguish between the two areSl
Difference
Cash Flow Statement
Fund flow statement
subjects
1
foundation
It works on the base of cash It works on the base of current
changing position of a working capital changing position
organization.
of a organization.
2
Beginning surplus It works with the beginning It does not work with the
surplus.
beginning surplus.
3
Process
of It does not prepared the current It is prepared the current active
working
active capital statement.
capital statement.
4
Utility
It helps to determine short It helps to determine the Long term
term the capacity of loan capacity of loan payment or
payment or investment.
investment.
5
Main source
The main source of cash The main source of Fund inflow is
inflow is selling price of the net profit
goods

Distinguish a cash flow statement from cash budget.

In financial accounting, a cash flow statement, also known as statement of cash flows or funds flow
statement, is a financial statement that shows how changes in balance sheet accounts and income affect
cash and cash equivalents, and breaks the analysis down to operating, investing, and financing activities.
Essentially, the cash flow statement is concerned with the flow of cash in and out of the business. The
statement captures both the current operating results and the accompanying changes in the balance sheet.
As an analytical tool, the statement of cash flows is useful in determining the short-term viability of a
company, particularly its ability to pay bills. International Accounting Standard 7 (IAS 7 ) is the
International Accounting Standard that deals with cash flow statements.
People and groups interested in cash flow statements include:

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ii
iii
iv
v

Accounting personnel, who need to know whether the organization will be able to cover
payroll and other immediate expenses
Potential lenders or creditors, who want a clear picture of a company's ability to repay
Potential investors, who need to judge whether the company is financially sound
Potential employees or contractors, who need to know whether the company will be able to
afford compensation
Shareholders of the business

Definition of 'Cash Budget':

An estimation of the cash inflows and outflows for a business or individual for a specific period of
time. Cash budgets are often used to assess whether the entity has sufficient cash to fulfill regular
operations and/or whether too much cash is being left in unproductive capacities. A cash budget is
extremely important, especially for small businesses, because it allows a company to determine how much
credit it can extend to customers before it begins to have liquidity problems. For individuals, creating a
cash budget is a good method for determining where their cash is regularly being spent. This awareness can
be beneficial because knowing the value of certain expenditures can yield opportunities for additional
savings
by
cutting
unnecessary
costs.
A cash budget is an estimation of a person's or a company's cash inputs and outputs over a specific
period of time. Cash budgets are mostly used to estimate whether or not a company has a sufficient amount
of cash to fulfill regular operations. You can also use it to determine whether too much of a companys cash
is being spent in unproductive ways.
What is considered to be cash?
Cash is the amount of assets that a company has available to spend immediately. These include bank
balances, bank account deposits, and more. Liquidity is another word for cash.
Why should I have a cash budget?
A cash budget is very important, especially for smaller companies. It allows a company to establish the
amount of credit that it can extend to customers without having problems with liquidity. A cash budget
helps you avoid having a shortage of cash during periods of numerous expenses. If you cannot pay your
expenses because you have a cash shortage, you must resolve this problem right away by bringing in more
revenue, deferring or eliminating some of your costs or being approved for a larger loan from your bank.
What is fund flow statement?
Fund flow statement is the study of the flow of funds into the business unit and the uses for which
such funds flow out during the same given time period. Fund flow statement showing changes in inflow &
outflow of cash during the period.
Methods of cash flow:
1.Direct Method : presenting information in Statement ofA. operating Activities
B. Investment Activities
C.Financial Activities

2.
Indirect
Method
:
uses
net
income
adjustments to that income (cash & non-cash) transactions.

Mention the importance or utility of fund flow statement.

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To management
To shareholders
To short term creditors and bankers
To investors

Narrate the objective of fund flow statement.

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v

To show total inflow and outflow of fund

To show the sources of fund
To show the applications or uses of funds
To show increase or decrease in working capital
To help preparing budgets and policies.

What are the methods of preparing fund flow statement?

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ii
iii

Statement of changes in working capital

Statement of changes in non-working capital
Statement of sources and application of fund

Narrate the statement of sources and application of fund.

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ii

Fund from operations

Fund from other sources

as

base

&

make

Module-E: working capital management

What is the working capital?
Working capital may be regarded as the lifeblood of a business enterprise. It is, closely, related to
the day-to-day operations of the business. Every business needs funds for two purposes such as Long and
short term finance. This finance is converted into cash and again, cash is converted into current assets. So,
working capital is also called revolving or circulating capital. The assets change the form, on a continuous
basis. In other words, working capital refers to that part of the firms capital, which is required for financing
short-term or current assets such as cash, debtors, inventories and marketable securities etc. The term
working capital refers to (1) those current assets, which are convertible into cash, within a period of one
accounting year and (2) those funds needed for meeting day-to-day operations.
A measure of both a company's efficiency and its short-term financial health. The working capital
ratio is calculated as:
Positive working capital means that the company is able to pay off its short-term
liabilities. Negative working capital means that a company currently is unable to meet its short-term
liabilities with its current assets (cash, accounts receivable and inventory). Also known as "net working
capital", or the "working capital ratio". In general, companies that have a lot of working capital will be
more successful since they can expand and improve their operations.

What's the right level of working capital?

The right level of working capital depends on the industry and the particular circumstances of the business.
For example: Businesses that only sell services, and do not need to pay cash for inventory need a lower
level of working capital. Businesses that take a substantial amount of time to make of sell a product will
need a higher level of working capital. It is important you work out the right level of working capital you
will need. If the working capital is too: high - your business has surplus funds which are not earning a
return; and low - may indicate that your business is facing financial difficulties.

(Describe in brief the various factors which are taken into account in determining the working
capital needs of a firm or discuss the importance of various factors determining of working capital.)
There are no set rules or formulae to determine the working capital requirement. The factors that
influence the requirement vary from time to time. They cannot be ranked in the order of importance as the
importance of each factor differs, over time. However, the following is the description of the factors, which,
generally, influence the requirement of working capital.
1 Nature or character of business: Working capital requirement, basically, depends on the nature
of business. Public utility undertaking like railways, water supply and electricity firms deal in
supply of services, not product, so they do not require any investment in inventory. So, their
working capital is limited.
2 Size of business / scale of operations: The working capital requirements are largely determined
by the size of the unit of operation. If the enterprise is big, the requirements are large and to a
small firm, the requirements are low.
3 Sales and demand conditions: The working capital needs of a firm are directly related to
sales. The firm has to build the inventory, before the sales are expected. It is a normal feature to
see heavy piles of stock before the festival season. During the festive season, demand is large
and to meet the anticipated demand, firms plan building up stock, in advance. So, the firms need
more working capital, when the sales are more and demand for the product is high.
4 Technology and manufacturing policy: In manufacturing business, the requirement of
working capital is in direct proportion to the length of the manufacturing process. If the
manufacturing process is long, the requirement of working capital is more. Non-manufacturing
and service industries do not have manufacturing cycle and so their working capital requirement
is uniform, normally, throughout the year, if they are not engaged in seasonal products.
5 Credit Policy: The credit policy influences the level of debtors. Where a firm buys on cash and
extents credit to its customers, the requirement of working capital would be substantial. In
certain industry, credit is must. They buy on credit and saleon credit. Their need for working
capital would not be too high as they enjor and extend credit.
6 Availability of credit: When the firm is confident of raising additional finance from the banks,
they manage with lower amount of working capital, in contrast to those firms not enjoying that
type of facility or support. Similarly, firms enjoying liberal credit may not require much
working capital. They can sell on cash, enjoying credit.
7 Operating efficiency: Firms may not able to control the prices of raw materials and wages of
labor, but are certainly capable of utilizing the resources, efficiently, without wastage of material
and idle labor. Efficient firms can manage with the working capital.
8 Seasonal business: In certain industries, the business is seasonal. The classical example is
firecrackers and need more working capital.
9 Variable production competencies: When the industry is able to develop alternative product, it
can manufacture its main product during the period of increasing demand and other product
during the non-peak season to use the production capacities.
10 Business cycles: Business cycles alternate to general expansion and contraction of business
activity, generally. During periods of boom, sales increase and situation demands higher
working capital.
11 Price level change: When the prices of raw materials increase, same level of assets need
increased investment in current assets.

12 Working capital cycle: The working capital cycle commences with purchase of raw materials
and ends with the realization of cash, in a manufacturing enterprise. The raw materials move
into work-in-process and, finally, to finished product.

Discuss the importance of working capital of a firm or describe in brief the various factors which are
taken into account in determining the working capital need of a firm.
Cash inflows and outflows are never synchronized. Cash inflows occur with the realization of
current assets, such as stock and debtors. Their realizations are highly unpredictable as the inflows depend
on outsiders action. Outflows are related with the payments to creditors, bills payable and outstanding
expenses. To meet the gap between the cash inflows and outflows, working capital is needed. The more
these cash inflows are predictable, lesser amount is needed for working capital. If the cash flows are
uncertain, higher amount of working capital is essential for the enterprise. The importance of working
capital of a firm or in brief the various factors which are taken into account in determining the working
capital need of a firm arei Continuous accomplishment of working.
ii Using the full capacity of machinery
iii Repayment capacity of loan
iv Increasing the financial goodwill
v Earning profit
vi Increasing the working capacity and development of morale
vii Increasing the liquidity position and reducing the all kinds risks
viii Ensuring the full employment of production
ix Working capital level or ratio.
x Working capital should be a judicious mix.
Discuss about the working capital concepts or discuss the classification of working capital concept.
How to optimize the investment in current assets.
i Gross working capital concept: Gross working capital refers to the firms investment in total
current assets of the enterprise. Current assets are those, which can be converted into cash,
within an accounting year or operating cycle. They include cash, debtors, bills receivable,
stock and marketable securities etc. In a border sense, working capital refers to gross
working capital.
ii Net working capital concept: In the narrow sense, working capital refers to net working
capital. Net working capital is the difference between current assets and current liabilities.
Current liabilities are those claims of outsiders, which are expected to mature for payment,
within an accounting period. They include creditors, bills payable, bank overdraft/cash credit
account and outstanding expenses.
iii Fixed working capital concept: Fixed working capital is that part of working capital which
is consider as a fixed assets.
iv Temporary working capital concept: In the up and down stage or time, enterprise needs
temporary working capital to run the business.
v Operating cycle concepts: Working capital is need at different operating cycle of working
capital.
There are two danger points in respect of working capital, excessive or inadequate investment in
current assets. Both are equally dangerous. The basic objective of working capital management is to
manage firms current assets and current liabilities, in such a way, that working capital are maintained, at a

satisfactory level. Then, what is satisfactory level? The working capital should be neither more nor less, but
just adequate. Cash is tied in current assets and funds involve costs. If investment in current assets is
excessive, profitability will be greatly affected. If investment in current assets is inadequate, firm
experiences difficulty, in meeting the current obligations, as and when they fall due. Inadequate working
capital threatens the solvency of the firm, due to inability to pay current obligations, in time. Both
profitability and solvency are equally important. So, the management should be prompt to initiate the
necessary action to keep working capital, adequate to the changing needs of business.
Moreover, different components of working capital are to be balanced. If inventory level is too high
in the total current assets, due to slow moving stocks; it does not provide any cushion in the form of
liquidity. Similar is the case with the high proportion of accounts receivable, which are difficult to recover.
If cash and bank balance are more in total current assets, they are idle and do aggregate, as well as their
individual proportion.
Mentions the working capital policies of an industrial firm or discuss the necessity of working capital
for firm.
Industrial firms need short term working capital as well as long term working capital. Otherwise, no
industrial firm can sun smoothly. If an industrial firm uses any working capital but it has several policies.
This arei A conservative approach or policy: The owners or managerial committees of the
organizations face more risk and that organizations depend on the conservative approach or
policy. The main theme of this policy is the fixed capital, temporary fixed working capital
and a part of capital is collected from the long term sources of funds and temporary working
capital is collected from the short term sources of funds. This policy is depended on long
term source of funds and meets the firms liquidity position.
ii An aggressive approach or policy: The owners or managerial committees of the
organizations face less risk and that organizations depend on the aggressive approach or
policy. The main theme of this policy is the fixed capital and a part of capital is collected
from the long term sources of funds and a part of fixed working capital and temporary
working capital is collected from the short term sources of funds. This policy is depended on
short term source of funds and meets the firms liquidity position and increases the firms
profit more.
iii Matching approach: Collecting the capital by adopting the coordination of the conservative
and aggressive policy. The main theme of this policy is the fixed capital and a part of fixed
working capital is collected from the long term sources of funds and temporary working
capital is collected from the short term sources of funds. This policy is depended on short
term source of funds and meets the firms best liquidity position and increases the firms
profit more.
Design a sound working capital policy for an industrial undertaking.
Matching approach is a sound working capital because of collecting the capital by adopting the
coordination of the conservative and aggressive policy. The main theme of this policy is the fixed capital
and a part of fixed working capital is collected from the long term sources of funds and temporary working
capital is collected from the short term sources of funds. This policy is depended on short term source of
funds and meets the firms best liquidity position and increases the firms profit more.
Define the working capital management.

The working capital management is a managerial accounting strategy focusing on

maintaining efficient levels of both components of working capital, current assets and current liabilities, in
respect to each other. Working capital management ensures a company has sufficient cash flow in order to
meet its short-term debt obligations and operating expenses.
Decisions relating to working capital and short term financing are referred to as working capital
management. These involve managing the relationship between a firm's short-term assets and its short-term
liabilities. The goal of working capital management is to ensure that the firm is able to continue
its operations and that it has sufficient cash flow to satisfy both maturing short-term debt and upcoming
operational expenses.
Guided by the above criteria, management will use a combination of policies and techniques for the
management of working capital. The policies aim at managing the current assets (generally cash and cash
equivalents, inventories and debtors) and the short term financing, such that cash flows and returns are
acceptable.
i
ii

iii
iv

Cash management. Identify the cash balance which allows for the business to meet day to day
expenses, but reduces cash holding costs.
Inventory management. Identify the level of inventory which allows for uninterrupted production
but reduces the investment in raw materials - and minimizes reordering costs - and hence increases
cash flow. Besides this, the lead times in production should be lowered to reduce Work in Process
(WIP) and similarly, the Finished Goods should be kept on as low level as possible to avoid over
production - see Supply chain management; Just In Time (JIT);Economic order
quantity (EOQ); Economic quantity
Debtors management. Identify the appropriate credit policy, i.e. credit terms which will attract
customers, such that any impact on cash flows and the cash conversion cycle will be offset by
increased revenue and hence Return on Capital (or vice versa); see Discounts and allowances.
Short term financing. Identify the appropriate source of financing, given the cash conversion cycle:
the inventory is ideally financed by credit granted by the supplier; however, it may be necessary to
utilize a bank loan (or overdraft), or to "convert debtors to cash" through "factoring".

Define working capital cycle or what is the working capital cycle?

The working capital cycle is the working capital cycle measures the time between paying for goods
supplied to you and the final receipt of cash to you from their sale. It is desirable to keep the cycle as short
as possible as it increases the effectiveness of working capital. The working capital cycle is made up of four
core components: Cash (funds available), Creditors (accounts payable), Inventory (stock on hand) and
Debtors (accounts payable)

Diagram of the working capital cycle

The key to successful cash management is to be in control of each step in the cycle. If you can
quickly convert your trading operations into available cash, you will be increasing the liquidity in your

business and will be less reliant on cash from customers, extended terms from suppliers, overdrafts, and
loans.

4.1

What do you mean by profitability? How profitability can be improved?

Profitability is the ability to earn a profit. The state or condition of yielding

a financial profit or gain. It is often measured by price to earnings ratio. A class of financial metrics that are
used to assess a business's ability to generate earnings as compared to its expenses and other relevant costs
incurred during a specific period of time. For most of these ratios, having a higher value relative to a
competitor's ratio or the same ratio from a previous period is indicative that the company is doing well.
Increasing profitability is one of the most important tasks of the business managers. Managers
constantly look for ways to change the business to improve profitability. These potential changes can be
analyzed with a pro forma income statement or a Partial Budget. Partial budgeting allows you to
assess the impact on profitability of a small or incremental change in the business before it is implemented.
Profitability is measured with an income statement. This is essentially a listing of income and
expenses during a period of time (usually a year) for the entire business. Decision Tool Income Statement
- Short Form, is used to do a simple income statement analysis. An Income Statement is traditionally used
to measure profitability of the business for the past accounting period. However, a pro forma income
statement measures projected profitability of the business for the upcoming accounting period. A budget
may be used when you want to project profitability for a particular project or a portion of a business.
A variety of Profitability Ratios (Decision Tool) can be used to assess the financial health of a
business. These ratios, created from the income statement, can be compared with industry benchmarks.
Also, Income Statement Trends (Decision Tool) can be tracked over a period of years to identify emerging
problems.

Module-F: working capital management

What do you mean by lease financing or lease contract?
A lease represents a contractual arrangement whereby the lessor grants the lessee the right to use an
asset in return for periodical lease rental payment. While leasing of land, buildings, and animals has been
known from times immemorial, the leasing of industrial equipment is a relatively recent phenomenon,
particularly on the Bangladeshi sense.
In ordinary parlance, leasing or lease refers to the renting out of immovable property by the owner
(lessor) to the tenant (lessee) on a specified rent for a specific period on terms that may be mutually agreed
upon. In financial circles, the term leasing refers to the method of financing equipment and machinery
purchases, as explained in the following paragraphs.
The modus operandi of leasing or leasing is as follows: The prospective lessee indentifies the
equipment (quantity, quality and specifications) that he requires and locates the suppliers. He also
negotiates the price and obtains a quotation. Then he locates a lessor and negotiates a deal with him. A lease
agreement between the two is entered into and the lessor pays the supplier who delivers the goods to the
lessee.
Leasing is sometimes called off-balance sheet finance for obvious reasons. The machinery is owned
by the lessor and as such it does not appear in the books (and balance sheet) of the lease.

Lease contract: the obligations of the lessor and the lessee are clearly defined in the lease contract.
The terms inter alia relate to:
(1) The lease period during which lease is operational,
(2) The timings and amounts of periodic rental payments during the lease period. The rental differs
from the period to period. It is usually higher in the initial period and lower in the later period.
(3) An option to the lessee to renew the lease at an agreed rental or to purchase the asset at an
agreed price or surrender it at the end of the lease period.
(4) Provisions for payment of the costs of maintenance and repairs, taxes, insurance and other
expenses. Usually, these costs are incurred by the lessee.
A lease is contractual arrangement whereby the owner of the property (lessor) allows another party
(lessee) to use the services of the property for a specified period of time- Johnsen & meticher.

Discus the features of leasing.

(1) Rent payment
(2) Net lease
(3) Cancellable lease
(4) Maintenance lease
(5) Non-cancellable lease
(6) Renewal
(7) Purchase options and
(8) Duration.

Discuss its importance as a modern tool of financing.

x Less investment
xi Positive effect on balance sheet.
xii Avoidance of risk
xiii Flexibility
xiv Tax saving
xv Increased liquidity
xvi Absence of restrictive conventions
xvii Avoidance of investment
xviii Short time arrangement
xix Insolvency and
xx Certainty of increased income.
State the advantages of leasing
(1) To lessee: the advantages of lessee are(a) In loan finance, margin money, say 25 to 30 percent of the loan is needed, not so in the case of leasing,
where the entire 100 percent investment in equipment and machinery is made by the leasing company.

Though this arrangement, the lessees can utilize their internal resources so available, for working capital
finance. The need, therefore, for raising additional equity capital to finance capital expenditure is
minimized.
(b) Lease rental is considered as normal business expense debatable to profit and loss account of the lessee,
for example taxation purposes.
(c) The leased equipment ordinarily remains with the lessee and it seldom returns to the lessor at the end of
the lease, if all conditions of the contract are fulfilled.
(d) the leasing company with its wider contract and specialized knowledge is in a better position than the
lessee to purchase quantity equipment on preferential terms including lower price, within a shorter time, in
case the lessee so desires.
(e) The leasing companies claim that leasing finance is an easier and quicker mode of financing than bank
financing where there are a number of procedural delays.
(2) To lessor: the advantages of lessor areA leasing company as investor stands to benefit. Besides the rental, it can claim depreciation on the leased
equipment. As stated in a previous paragraph, the point regarding the claim of the leasing companies in
regard to entitlement of investment allowances not free from doubt. Further, unlike an industrial company,
there is no gestation period. The rental income stars from the date the equipment is leased of the lessee. The
leasing company owns the asset leased and as such its investment is fully secured.

Show the classification of leasing.

An equipment lease transaction can very along the following dimensions: extent to which the risks
and rewards of ownership are transferred, number of parties to the transaction, domiciles of the equipment
manufacturer, the lessor and the lessee, etc. Based on these variations, the following classifications have
evolved:
i Finance lease vs operating lease:
A finance lease, or capital lease, is essentially a form of borrowing. According to the accounting
standard 19 of ICAI, a finance lease is a lease which meets any one of the following requirement.
The lease agreement transfers ownership to the lessee before the lease expires;
The lessee can purchase the asset for a bargain price when the lease expires;
The lease lasts for at least 75 percent of the assets estimated economic life;
The present value of lease payment is at least 90 percent of the assets value. All other lesser
are regarded as operating leases, as far as accounting is concerned.
From an economic point of view, a finance lease results in a substantial transfer of the risks and rewards of
ownership from the lessor to the lessee.
An operating lease can be defined as any lease other than a finance lease. The salient features of an
operating lease are as follows:
The lease term is significantly less than the economic life of the equipment.
The lessee enjoys the right to terminate the lease at short notice without any significant
penalty.
The lessor usually provides the operating know-how and the related services and undertakes
the responsibility of insuring and maintaining the equipment.
ii Sale and lease back vs direct lease:
iii

Single investor lease vs leveraged lease:

iv

Domestic vs international lease:

Narrate the factors of lease contract.

i Term of lease.
ii Lease payment
iii Maintenance of asset
iv Option of purchase
v Securities provision
vi Option to renew
vii Cancelation

(Discuss a brief the methods of lease financing. Or How do the system of lease financing?)
i
Direct leasing
ii Sale and lease back method
iii Leveraged leasing.

Distinguish capital /finance lease from operating lease.

Show the difference between lease and purchase or how does it differ from outright purchase?

Show the difference between lease and loan.

What is Hire purchase (HP)?

A method of buying goods through making installment payments over time. The term hire purchase
originated in the U.K., and is similar to what are called "rent-to-own" arrangements in the United States.
Under a hire purchase contract, the buyer is leasing the goods and does not obtain ownership until the full
amount of the contract is paid.
Hire purchase is the legal term for a contract, in which persons usually agree to pay for goods in
parts or a percentage at a time. A hire-purchase contract allows the buyer to hire the goods for a monthly
rent. When a sum equal to the original full price plus interest has been paid in equal installments, the buyer
may then exercise an option to buy the goods at a predetermined price or return the goods to the owner.
Hire purchase works under a hire purchase agreement, you:
i Purchase goods through installment payments
ii Use the goods while paying for them
iii Do not own the goods until you have paid the final installment.

Standard provisions
To be valid, HP agreements must be in writing and signed by both [parties].They must clearly lay out the
following information in a print that all can read without effort:
1 a clear description of the goods
2 the cash price for the goods
3 the HP price, i.e., the total sum that must be paid to hire and then purchase the goods
4 the deposit
5 the monthly installments (most states require that the applicable interest rate is disclosed and
regulate the rates and charges that can be applied in HP transactions) and
6 a reasonably comprehensive statement of the parties' rights (sometimes including the right to cancel
the agreement during a "cooling-off" period).
7 The right of the hire to terminate the contract when he feels like doing so with a valid reason.
Implied warranties and conditions to protect the hirer. The extent to which buyers are protected varies from
jurisdiction to jurisdiction, but the following are usually present:

1
2
3
4

the hirer will be allowed to enjoy quiet possession of the goods, i.e. no-one will interfere with the
hirer's possession during the term of this contract
the owner will be able to pass title to, or ownership of, the goods when the contract requires it
that the goods are of merchantable quality and fit for their purpose, save that exclusion clauses may,
to a greater or lesser extent, limit the Finance Company's liability
where the goods are let by reference to a description or to a sample, what is actually supplied must
correspond with the description and the sample.

The hirer's rights : The hirer usually has the following rights1 To buy the goods at any time by giving notice to the owner and paying the balance of the HP price
less a rebate (each jurisdiction has a different formula for calculating the amount of this rebate)
2 To return the goods to the owner this is subject to the payment of a penalty to reflect the owner's
loss of profit but subject to a maximum specified in each jurisdiction's law to strike a balance
between the need for the buyer to minimize liability and the fact that the owner now has possession
of an obsolescent asset of reduced value
3 With the consent of the owner, to assign both the benefit and the burden of the contract to a third
person. The owner cannot unreasonably refuse consent where the nominated third party has good
credit rating
4 Where the owner wrongfully repossesses the goods, either to recover the goods plus damages for
loss of quiet possession or to damages representing the value of the goods lost.
The hirer's obligations: The hirer usually has the following obligations1 to pay the hire installments
2 to take reasonable care of the goods (if the hirer damages the goods by using them in a non-standard
way, he or she must continue to pay the installments and, if appropriate, compensate the owner for
any loss in asset value)
3 To inform the owner where the goods will be kept.
4 A hirer can sell the products if, and only if, he has purchased the goods finally or else not to any
other third party.
5 It is pretty much similar to installment but the main difference is of ownership.
The owner's rights: The owner usually has the right to terminate the agreement where the hirer defaults in
paying the installments or breaches any of the other terms in the agreement. This entitles the owner:
1 to forfeit the deposit
2 to retain the installments already paid and recover the balance due
3 to repossess the goods (which may have to be by application to a Court depending on the nature of
the goods and the percentage of the total price paid)
4 to claim damages for any loss suffered.

Narrate the features of hire purchase.

i Installment contract.
ii Payment value
iii Money of installment is consider as the rental
iv Restriction to sale the product by purchaser.
v Cash down payment
vi Ownership
vii Inability to pay the installment
viii Interest
ix Compensation.

Differentiate between general purchase and hire purchase.

A Hire Purchase contract is a type of finance lease where the user has the option to purchase the
asset at the end of the hire period, usually for a nominal sum. In terms of economic effects the differences
between a hire purchase contract and an ordinary finance lease are limited. In both cases the user of the
asset enjoys the risks and rewards of ownership. The differences between a hire purchase contract and a
ordinary or general purchase contract areSL

Differences
subjects

hire purchase contract

general purchase contract

Ownership

The ownership of the product The ownership of

remains to the seller.
transfers to the buyer.

Installment

Installment is consider as the Total installment is paid at present.

rental of the product

Sale
transfer

Value

Value is big because of adding Value is less because of not adding

interest.
interest.

Interest

Interest is added.

Interest is not added.

Return

Can return the product

Cannot return the product.

Payment

Payment is made by several Payment is made by one installment

installment

the

product

or Buyer con not sale or transfer the Buyer can sales or transfers the
product before the last installment product.
is paid.

Differences between hire and cash purchase

The following illustrates the difference between the cash purchase and hire purchase on a 21-inch television
costing $18,000. The installment period chosen for the television is three months.
Cash Purchase
i Go into store with cash, get discount and pay $16,000
ii Leave store same day with new television.
Hire Purchase
i Go into store with down payment.
ii Apply for hire purchase and pay first monthly installment.
iii Wait seven working days before getting product.
iv
Make second monthly payment
v
Make third monthly payment
vi At the end of installment period, pay 2.24% of original price ($18,000).
vii After completing all payment on television, you are now the full owner.

Short notes:
1.
2.
3.
4.
5.
6.
7.
8.
9.

Common misconceptions in pricing

Management report
Types of information and its relevance to bankers
Lease finance vs hire purchase finance
Performance budgeting
Variance analysis
Production and operating cycle.
Financial statement analysis
Short comings of the traditional methods of Credit analysis

10. Cost-volume- profit relationships

The usefulness of Break-even Analysis.

Breakeven analysis provides useful information to management and lending institutions (banks) in most
lucid and precise manner. It is an effective and efficient reporting tool of financial management. The
usefulness or importance of breakeven analysis can be enumerated as under:
i. Fair knowledge about the breakeven analysis can be help the banking to examine loan
proposal of a firm/enterprise.
ii.
Breakeven analysis helps the bankers in assessing working capital requirement of a unit; it
comes in handy to measure the future cost and revenue relationship and also helps to
determine the level of production. As and when this level is known, the enterprise can also
play its future working capital requirements for the enterprises.
iii.
This analysis helps in revealing clear projections of profit planning of an enterprise at
different production level visavis the financial needs. It also helps to find rate of return on
investment of capital at varying levels of production.
iv. It helps the banker in studying the projection cost of production and profitability statement
of a unit prepared to show net position at a given level of output. Below breakeven point, the
average loss per unit increases as the volume of output declines. When the unit functions
above breakeven point they can maintain their profitability and be in a position to meet their
commitments and debt obligations. In other words, when once a unit breakeven from the
onwards repayments of debt may begin for the terms loans granted by them. Usually, till a
unit reaches the breakeven level of production repayment holding is granted by banks.
v. Breakeven analysis is a useful diagnostic tool. It indicates the management the causes of
increasing breakeven point and falling profit. The analysis of these causes will reveal to
management what action should be taken. As a practical matter, a knowledge of where
breakeven lies can be quite useful to management in determining the need for action.
11. Cash flow statement
A cash flow statement is a statement, which describes the inflows (sources) and outflows (uses) of cash and
cash equivalents during a specified period. It is a summary of cashbook. A cash flow statement explains the causes of
changes in cash position of a business enterprise between two dates of balance sheets. Cash flow statement is a tools
that is available to the management to assess, monitor and control the liquidity available in the enterprise. Conversion
of cash into cash equivalents and vice versa does not constitute cash flows because they are not part of operating,
financing and investing activities. Cash management includes the investment of cash into cash equivalents and vice

versa. A cash flow statement may be defined as a financial statement that summarizes the cash receipts and
payments and net changes resulting from operating, financing and investing activities of an enterprise during a given
period of time.
12. Factor affecting working capital requirements
13. Objectives ob budgeting
14. Performance budgeting
15. Standard costing
16. Common misconceptions in pricing
17. Management report
18. Types of information and its relevance to bankers
19. Lease finance vs hire purchase finance
20. Cash flow statement vs cash budget
A cash budget is an estimate of cash receipts and disbursements during a future period. The anticipated cash
receipts from various sources are taken into account. Similarly, the amount to be spent on various heads, both
revenue and capital, are taken into cash budget. In short, it is a summary of cash intake and outlay.
A cash flow statement is a statement, which describes the inflows (sources) and outflows (uses) of cash and
cash equivalents during a specified period. It is a summary of cashbook. A cash flow statement explains the causes of
changes in cash position of a business enterprise between two dates of balance sheets. Cash flow statement is a tools
that is available to the management to assess, monitor and control the liquidity available in the enterprise. Conversion
of cash into cash equivalents and vice versa does not constitute cash flows because they are not part of operating,
financing and investing activities. Cash management includes the investment of cash into cash equivalents and vice
versa. A cash flow statement may be defined as a financial statement that summarizes the cash receipts and
payments and net changes resulting from operating, financing and investing activities of an enterprise during a given
period of time.
21.
22.
23.
24.
25.

Performance budgeting
Variance analysis
Production and operating cycle.
Production and operating cycle
Different forms of Bank credit

26. Assumptions of Break-even analysis

The following assumptions underlie each CVP analysis.

1. The behavior of both costs and revenues is linear throughout the relevant range of the activity index.
2. Costs can be classified accurately as either variable or fi xed.
3. Changes in activity are the only factors that affect costs.
4. All units produced are sold.
5. When more than one type of product is sold, the sales mix will remain constant.
That is, the percentage that each product represents of total sales will stay the same. Sales mix
complicates CVP analysis because different products will have different cost relationships. In this chapter
we assume a single product. When these assumptions are not valid, the CVP analysis may be inaccurate.
27.
28.
29.
30.
I.

Variable working capital vs permanent working capital

Planning for profits
Implication of costing to bankers
Hire purchase finance.