FINANCIAL MANAGEMENT and

ACCOUNTING METHODS

WE WILL BE COVERING THE FOLLOWING

AREAS:
1. ACCOUNTING PROCESS
2. FINANCIAL STATEMENTS
3. ANALYSIS OF FINANCIAL
STATEMENTS
4. DEBIT CREDIT LEDGER

1. ACCOUNTING PROCESS

WHAT IS ACCOUNTING?

1. PROCEDURES ARE ESTABLISHED TO RECORD FINANCIAL

EVENTS RELATING TO THE INVESTMENT AND FINANCIAL
PRODUCTIVITY OF BUSINESS.
2. PROVIDES FINANCIAL INFORMATION TO ESTABLISH
CONTROLS AND AID IN GUIDING THE VENTURE/ BUSINESS
TOWARDS THE DESIRED FINANCIAL GOALS.
3. ACCOUNTNG IS OFTEN REFERRED TO AS LANGUAGE OF
BUSINESS.

USES OF ACCOUNTING REPORTS

1.

MANAGERS RELY ON ACCOUNTING REPORTS TO MAKE

CORRECT DECISIONS IN ORDER TO IMPROVE THE
CURRENT AND FUTURE FINANCIAL PERFORMANCE OF THE
BUSINESS

2.

ACCOUNTING IS A SOURCE OF PAST FINANCIAL DATA

TYPES OF ACCOUNTING
1.

FINANCIAL ACCOUNTING (GENERAL ACCOUNTING):

FINANCIAL ACCOUNTING DEALS WITH INFORMATION ABOUT

THE FINANCIAL RESOURSES, OBLIGATIONS (LIABILITIES) AND
ACTIVITIES OF AN ORGANIZATION.

DEALS WITH ALL THE EXTERNAL TRANSACTIONS, e.g., between

the firm and its markets, procurement of land, labour , material,
services, sale of products, goods, services, etc.

FINANCIAL ACCOUNTING INFORMATION IS DESIGNED TO HELP

INVESTORS AND CREDITORS IN MAKING DECISIONS WHERE
BEST TO PLACE THEIR INVESTMENT RESOURCES.

FINANCIAL ACCOUNTING INFORMATION IS ALSO USED BY THE

COMPANYS MANAGERS, FOR INCOME TAX RETURNS etc.
6

TYPES OF ACCOUNTING..
2.

COST OR MANAGEMENT ACCOUNTING:

MANAGEMENT ACCOUNTING DEALS WITH ACCOUNTING

INFORMATION USED IN CONTROLLING AND RUNNING THE
BUSINESS

MANAGERS USE THIS INFORMATION IN EVALUATING

PERFORMANCE OF DEPARTMENTS/ COMPANY INDIVIDUALS,
DECIDING TO INTRODUCE A NEW LINE OF PRODUCT OR NOT, etc.

COST ACCOUNTING HELPS PROVIDE THE FOLLOWING

INFORMATION:
TO DETERMINE THE COST OF PRODUCTS/ SERVICES
PROVIDES BASIS FOR PRICING OF GOODS/ SERVICES
PROVIDES MEANS OF CONTROLLING EXPENDITURE

DEALS WITH ALL INTERNAL TRANSACTIONS, i.e., transactions

between various departments dealing with manufacturing are defined as
internal transactions

ACCOUNTING FUNDAMENTALS
1.

ACCOUNTING EQUATION:
ALL ACCOUNTING IS BASED ON THE FUNDAMENTAL ACCOUNTING
EQUATION, WHICH IS:
ASSETS = LIABILITIES + OWNERSHIP

..... (i)

ASSETS

: All things of monetary value which the firm possesses

LIABILITIES: All things of monetary value which a firm owes to others

OWNERSHIP: It is the worth of what the firm owes its stockholders

(also called equity, net worth, etc.)

EXAMPLES of Assets, Liabilities and Ownership?

ACCOUNTING FUNDAMENTALS.
2.

ANOTHER IMPORTANT ACCOUNTING RELATIONSHIP IS:

REVENUES - EXPENSES = PROFIT (or LOSS)

.. (ii)

THIS EQUATION SUMMERISES THE REVENUE AND EXPENSE RESULTING

FROM THE FIRMS OPERATIONS:

REVENUE : IT INCREASES THE OWNERSHIP AMOUNT OF THE FIRM.

It is earned.

EXPENSES : IT DECREASES THE OWNERSHIP AMOUNT OF THE FIRM.

It is incurred.

PROFIT

: IT IS THE INCREASE IN MONEY VALUE RESULTING FROM

A FIRMS OPERATIONS, WHICH IS AVAILABLE FOR
DISTRIBUTION TO THE STOCKHOLDERS.
It, therefore, represents the return on owners capital
investment.
9

ANNUAL RATE OF RETURN:

LIKE ANY SYSTEM, THE EFFICIENCY OF A FIRMS BUSINESS
CAN ALSO BE DETERMINED, AND IS INDICTED BY ITS RATE
OF RETURN.
THE RATE OF RETURN IS GIVEN BY:
PROFIT (i.e. Output)
ANNUAL RATE OF RETURN:
CAPITAL INVESTED ( i.e. Input)

Example:

Rs. 900 (Profit) = 0.3 or 30 %

Rs. 3000 (Capital)
10

2. FINANCIAL STATEMENTS

11

FINANCIAL STATEMENTS
INTRODUCTION:

COMPANIES/ FIRMS ENGAGED IN BUSINESS CARRY ON VARIOUS

FINANCIAL TRANSACTIONS ON REGULAR BASIS, i.e., borrow money
from bank, receive money from its sales, purchase material/ equipment on
credit, pay to its creditors, etc..

THESE TRANSACTIONS ARE CALLED FINANCIAL EVENTS

FINANCIAL EVENTS ARE RECORDED IN FORM OF VARIOUS

FINANCIAL REPORTS/ STATEMENTS FOR ANALYSIS/ EVALUATION, etc.

FINANCIAL REPORTS/ FINANCIAL STATEMENTS, ARE:

1.
2.
3.
4.

BALANCE SHEET
INCOME STATEMENT
STATEMENT OF OWNERS EQUITY
STATEMENT OF CASH FLOWS
12

FINANCIAL STATEMENTS.
1.

BALANCE SHEET:

REPRESENTS A STATEMENT OF THE FINANCIAL POSITION OF THE COMPANY/ FIRM

AT A SPECIFIC/ GIVEN DATE
BY INDICATING:
RESOURCES THAT IT OWNS
THE DEBTS THAT IT OWES
THE AMOUNT OF OWNERS EQUITY IN BUSINESS

ITS FORMAT IS BASED ON THE BASIC ACCOUNTING Eqn. No (i),

Assets = Liability + Ownership

ASSETS:
ARE LISTED ACCORDING TO THEIR RELATIVE DEGREE OF LIQUIDITY:
(i) Cash or Cash equivalents
(ii) Accounts Receivable
(iii) Inventories
(iv) Fixed and Long Term Assets
EXAMPLE OF ASSETS:
CURRENT ASSETS i.e. cash, stock of raw material, cash at bank or
FIXED ASSETS
i.e. land, building, plant , machinery, etc.
13

FINANCIAL STATEMENTS
BALANCE SHEET..
LIABILITY & SHAREHOLDERS EQUITY:
THESE ARE LISTED IN THE ORDER ACCORDING TO THE NEARNESS
WITH WHICH THEY ARE LIKELY TO BE PAID
(i)

CURRENT LIABILITIES: Are payable within one year.

(ii) LONG TERM DEBTS:

Are payable beyond one year

(iii) SHAREHOLDERS EQUITY: Will be paid only through regular cash

dividends.
(iv) RETAINED EARNINGS:

Represent companies cumulative profit

after dividends since the firms inception,
these are the earnings that have been
retained or re-invested in the firm.

14

BALANCE SHEET
as on 30 June, 2010
( in Thousands Rs.)
ASSETS
Cash
Account receivable
Inventories
Prepaid expenses
Accum. tax payments
Current Assets
Fixed Assets at Cost
Less Depreciation
Net Fixed Assets

178
678
1329
21
35
2241
1596
857
739

Investment Long term

65
Other Assets Long Term 205
TOTAL ASSETS:

3250

LIABILITIES&
SHAREHOLDERS EQUITY
Bank Loans & Notes Payables
448
Account Payable
148
Accrued Taxes
36
Other accrued liabilities
191
Current Liabilities
823
Long Term Debts
Share Holders Equity:
Stocks
Paid-in-Capital
Retained earnings
Total Shareholders Equity

TOTAL LIABILITIES AND

SHAREHOLDERS EQUITY

631
421
361
1014
1796

3250

15

FINANCIAL STATEMENTS
2.

INCOME STATEMENT:

THE INCOME STATEMENT SHOWS EARNINGS, OR PROFIT AND

LOSS, i.e., revenues, expenses and net profits FOR A FINANCIAL
PERIOD, GENERALLY ONE YEAR

IT INDICATES THE PROFITABILITY OF THE BUSINESS OVER THE

PRECEEDING YEAR (OR SOME OTHER TIME)

ITS FORMAT IS BASED ON THE BASIC ACCOUNTING EQN. No (ii),

i.e.

Revenue
(Net sales)

Expenses
=
(Cost of Goods sold)

Profit

16

INCOME STATEMENT:YEAR ENDING 30 JUNE 2010

(in Thousands Rs.)
Net Sales
Cost of Goods Sold
Gross Profit
Selling, General &
Administrative Expenses
Earnings before Interest
& Taxes
Interest Expenses (on loans)
Earnings before Taxes
Income Tax
Earning After Taxes
Cash Dividends
Increase in Retained
Earnings

Rs 3992
Rs 2680
Rs 1312
Rs 912
Rs 400
Rs 85
Rs 315
Rs 114
Rs 201
Rs 143
Rs. 58

17

1.

INCOME
NET SALES: STATEMENT.
Amount received or receivable from customers

2.

COST OF GOODS SOLD:

Represents the cost of actually producing the
products that were sold during the period.

3.

GROSS PROFIT:

4.

SELLING, GENERAL AND ADMINISTRATIVE EXPENSES: Are separate from

cost of goods, and not included there.

5.

EARNINGS BEFORE INTEREST AND TAXES: Operating income

6.

INTEREST EXPENSE: Cost of borrowed funds, i.e., interest

7.

EARNING BEFORE TAXES: Taxable income

8.

EARNING AFTER TAXES: Amount earned for stockholders

9.

DIVIDENDS: Amount paid to stockholders

10.

RETAINED EARNINGS: Amount increased in the equity share of the

business

Revenue (sales) Expenses (cost of goods sold)

18

FINANCIAL STATEMENTS
3.

STATEMENT OF OWNERS EQUITY:

THIS FINANCIAL STATEMENT SUMMARIZES THE INCREASES

AND DECREASES DURING THE ACCOUNTING PERIOD IN THE
AMOUNT OF OWNERS EQUITY.

INCREASES RESULT FROM EARNING NET INCOME AND

FROM ADDITIONAL INVESTMENTS BY THE OWNER

DECREASES RESULT FROM NET LOSSES AND FROM

WITHDRAWLS OF ASSET BY THE OWNER.

FOLLOWING EQUATION DESCRIBES THE EQUITY

STATEMENT OF AN INDIVIDUAL:

Ending Equity = Beginning Equity + Investments Withdrawls + Income

19

STATEMENT OF OWNERS EQUITY (EXAMPLE)

Statement of Changes in Owners Equity
For the Month ending 31 Dec, 2009
Mr. XYZ
Rs.
Capital on 01 Dec, 2009
Plus:

Investment by Owner
Net Income
Total

Less: Withdrawl by Owner

Capital on 31 Dec, 2009

Rs.
20,000

30,000
2,400

32,400
52,400
- 600
51,800

20

FINANCIAL STATEMENTS
4.

STATEMENT OF CASH FLOWS:

SUMMARIZES THE CASH RECEIPTS AND CASH PAYMENTS

OF THE BUSINESS OVER THE SAME TIME PERIOD AS
COVERED BY THE INCOME STATEMENT
THE BASIC PURPOSE OF STATEMENT OF CASH FLOWS IS
TO PROVIDE INFORMATION ABOUT THE CASH RECEIPTS
AND CASH PAYMENTS OF A BUSINESS ENTITY DURING
THE ACCOUNTING PERIOD.

IT IS BASICALLY PREPARED AS A FORECAST

ALSO CALLED STATEMENT OF CASH RECEIPTS AND

DISBURSEMENT

21

STATEMENT OF CASH FLOWS (EXAMPLE)

Receipts &
Balances
- SHARES
- SALES
- BALANCE B/F
- BALANCE C/F
- OVERDRAW C/F
Payments &
Balances:
- BUILDINGS
- PLANT & M/C
- FURNITURE
- STOCK
- PURCHASES
- WAGES
- EXPENSES
- BALANCE IN
HAND C/F
- BALANCE B/F

( YEAR ENDING 30 JUNE, 2009)

Jan
Feb
Mar
Apr
(Rs.)
(Rs.)
(Rs.)
(Rs.)
50,000
2,000
10,000
12,000
7,200
4,400

50,000

7,200

20,000
8,000
6,000
7,000
1,000
1,000
800
7,200

6,000
1,000
800
4,400

50,000

7,200

May
(Rs.)
15,000
200

1,400

______

_____

7,800

10,000

12,200

8,000
1,000
800

7,800

10,000
1,000
800
200

10,000

12,000
1,000
800
400
_____
12,200

June
(Rs.)

400
________
15,400

1,000
800
1,600
_______
15,400
22

ANALYSIS OF FINANCIAL STATEMENT

23

ANALYSIS OF FINANCIAL STATEMENT

The purpose of financial statements is to enable the interested
party to evaluate the firm, i.e. evaluate the firms financial
condition and performance.
To evaluate a firms financial condition and performance, the
financial analyst needs to perform check ups on the various
aspects of a firms financial health.
A tool frequently used for these check-ups is financial ratios
or index, which relates two pieces of financial data by dividing
one quantity with the other.

24

FINANCIAL RATIOS
We use financial ratios because this way we get a comparison that is
useful than the raw numbers by themselves.
EXAMPLE:
A firm has a net profit of $ 1 Million.
This looks very profitable?
But if the firm had invested $ 100 Million total assets.
Dividing net profit by total assets, we get: 1/100 = 0.01,
which is the firms return on total assets.
The 0.01 figure means that each dollar of asset invested earns a
1 % return.
A savings account provides a better return on investment than this,
with lesser risk.
In this example, the ratio provides quite a useful information.
25

TYPES OF FINANCIAL RATIOS

Financial ratios are basically of two types:
1.

BALANCE SHEET RATIOS

2. INCOME STATEMENT RATIOS or

INCOME STATEMENT/ BALANCE SHEET
RATIOS

26

BALANCE SHEET RATIOS:

These summarizes some aspect of the firms financial condition at a point in
time, the point at which a Balance Sheet has been prepared. Both the numerator
and the denominator in each ratio come directly from the balance sheet.
2.

Balance sheet ratios can be of the following types:

a) LIQUIDITY RATIO : It provides the basis for answering the question: Does
the firm have sufficient cash or near cash assets to pay its bills on time. It
is given by:
Liquidity Ratio = Current Assets
Current Liabilities
a)

FINANCIAL LEVERAGE ( OR DEBT) RATIO: Shows the extent to which

the firm is financed by debt and is given by:
Financial Leverage (Debt) Ratio =

Total Debt
Shareholders Equity

27

INCOME STATEMENT or INCOME STATEMENT/ BALANCE SHEET RATIOS:

These summarizes some aspect of the firms performance over a period of
time, usually a year. These are:
1. INCOME STATEMENT RATIOS: Compare one flow item from the income
statement to another flow item from the income statement.
2. INCOME STATEMENT/ BALANCE SHEET RATIOS: Compares a flow item
in the numerator (income statement) to an item in the denominator (balance
sheet).
3. These could be of the following types:
a) Coverage Ratio = Earning before Interest and Taxes
Interest Expenses
Relates the financial charges, i.e. payable interest of a firm to its ability
to pay or cover them.
b) Receivable Turnover Ratio = Annual Net Credit Sales
Receivables
c)

Sales to Fixed Asset Ratio =

Sales
Fixed Assets
For (b) and (c), shows how effectively the firm is using its assets.

28

PROFITABILITY RATIOS:
Relates profit to sales and investment. It is given by any of the
Following:
1. Profitability Ratio = Net Sales - Cost of Goods Sold
Net Sales
2. Profitability Ratio = Net Profit after Taxes
Net Sales
3. Profitability Ratio = Net Profit after Taxes
Total Assets
4. Profitability Ratio =

OR

Net Profit After Taxes

Assets - Liabilities
29

End of this lecture.

30

OBJECTIVES OF FINANCIAL ACCOUNTING

1.

PROVIDING A MEANS OF RECORDING AND CLASSIFYING

FINANCIAL DATA

2.

MAKING AVAILABLE TO OWNERS AND MANAGERS

ACCOUNTING INFORMATION USEFUL FOR MAKING
FINANCIAL DECISIONS

31

ACCOUNTING FUNDAMENTALS.
COMBINING EQUATIONS (i) AND (ii), WE GET:

ASSETS = LIABILITIES + BEGINNING + REVENUE EXPENSES ...(iii)

OWNERSHIP
(PROFIT)

32

USE OF FININACIAL STATEMENTS BY OUTSIDERS

INTRODUCTION:

Most outside decision makers use financial statements in

making investment decisions --- that is , selecting companies
in which they will invest or extend credit.
TWO FACTORS OF CONCERN TO CREDITORS AND INVESTORS
ARE THE LIQUIDITY AND PROFITABILITY OF A BUSINESS
ORGANIZATION.
Creditors are interested in liquidity --- the ability of the business to
pay its debts when they come due.
Investors (as well as creditors) are even more interested in its
profitability --- profitable operations increase the value of the owners
equity.
33