Financial Accounting

Dr. Chandra Mohan Patnaik

Associate Professor (Accounts )
School of Management
KIIT University, Odisha
bcmpatnaik@ksom.ac.in, bcmpatnaik@gmail.com
Hello:9668224322
 Brief profile
 Completed Ph.D in Finance from Bareilly University in 2005.
 Best faculty award 4 times including in 2018 from KIIT
University.
 Received Rajiv Memorial Award from Governor of Odisha in
2012 for contribution in Academics excellence.
 Successfully Completed guidance to 14 Ph.D Students and 6
are pursuing under me including 3 foreign scholars.
 Published more than 175 research papers including 40
papers in SCOPUS indexed Journals- World’s Top most
Journals.
 Editor -in -Chief in SAJMMR and reviewer & member of
various international journals.
 Joined in KIIT in 2007, prior to that associated with Modi
Group in Modinagar (UP) and Wilsonia Group in Moradabad (UP)
 Teaching Accounting is my Passion
Assessment process

r
este
sem
End marks
-40

Mid semester-
20 marks

Assignment -10 Marks

( copy and case study)
Class participation-
10 Marks
4 Quiz of 5 marks each
=20 Marks
Class rules/ expectation from
students
 Class time will be 5 minutes buffer at the beginning
and 10 minutes at the end for biometrics.
 After 5 minutes no body will be allowed to enter into
the class and will stay out .
 One hour and 15 minutes will be actual session.
 All are expected to maintain proper register for
Accounting subject. ( 5 marks will be awarded)
 All are expected to participate in class discussion
 The hidden agenda is class disciple is most important
during the session.
 Quiz will be conducted strictly as per examination
condition no relaxation on this part.
Bonus marks (subject to maximum of 60 marks
in internals)
Physical Attendance in Class Bonus marks in Internal out of 60
marks.
100% 10%
95% 7.5%
90% 5%
85% 2.5%
Why Should we study Accounting?
 Management  Creditors
 Employees  Bankers
 Owners
 Investors
 Government
 Researchers
( MEO)  Public
 Consumers
 ( CBI-GR-PC)

Internal Users External Users

Book Keeping Vs Accounting
It is the art of maintaining It includes analyzing and
accounts in a systematic interpreting of financial
manner statements
Can be done by unskilled Can be done by skilled
employee employee
Person deals with this Person deals with this
Known as book keeper known as accountant
No need for separate It needs separate ledger
books for each and every
accounts
Accounting principles
 Conservatism  Money measurement
 Consistency concept
 Business entity concept
 Materiality  The going concern
 Disclosure concept
 Cost concept
 The dual aspect concept
 Realization concept
 Accrual concept
 Matching concept
Periodicity concept
Concepts- Assumptions/ ground
Conventions- Usage and Customs
rules
Basis of Accounting System:

 1.Cash or receipt basis: It is the method of recording

under which revenues, costs, assets and liabilities are
reflected in accounts in the period in which actual
receipts or actual payments are, made. Receipts and
payments A/C in case of clubs societies; hospitals etc.
are the examples of cash basis of accounting.
 2. Accrual or Mercantile basis: It is the method or
recording transactions by which revenues, costs, assets
and liabilities are reflected in accounts in the period in
which they accrue. This basis includes considerations
relating to outstanding, prepaid, accrued and received in
advance.

Capital and Revenue Expenses
 The amount spent for  The amount spent for
acquiring fixed assets day to day operation and
with an intention to any asset purchased,
retain in the business with an intention to re-
and the benefit of which sale them and whose
will be carried forward benefit will be derived in
beyond one accounting the current accounting
period. period.
 Eg. Machinery, Furniture,
 Eg- Salary, rent, printing
building , equipments and purchase of good
etc.

Capital Expenses Revenue Expenses

Pillars of Accounting
Basics

Assets Income

Expense
Liability
s
Income ( Revenue)
 It refers to all the revenue receipts during the
accounting period. It includes sale proceeds,
amount received from services, rent received,
interest received , commission received and all
other receipts which will can be considered as
revenue
Operating and non-operating
revenue

Operating Gross sale proceeds,

●

commission received,
revenue discount received etc.

Non Dividend and interest received

operating
●

from investments, profit on sale of

assets, compensation received etc.
revenue
 Various Incomes
 Sales
 Income from services
 Rent received
 discount received
 commission received
 interest received
 bad debts recovered
 apprentice premium
 income from investment
 Expenses
 Itincludes all the revenue expenses which are
incurred to run the organization. It includes all
the day to day expenses. Like sales expenses,
administrative expenses, Financial charges etc.
This includes operating and non-operating
expenses.
Operating expenses-relating to main
operation of business

Cost of sales, selling

expenses, office
expenses

Salary , commission,
bank charges, lighting

Stationery, printing ,
discount, bad debts
etc.
Non- operating expenses-incidental
or indirect to main operation

depreciation, amortization, interest charges or other costs of

borrowing.

Expenses relating to employee benefits, such as pension

contributions, would also be considered as a non-operating cost.
Various expenses
 Purchases  Stores consumed
 Carriage  Royalty
 Carriage inward  Motive Power
 Freight  Coal, coke
 Freight inward  Water
 Wages  Oil
 Factory expenses  Octroi
 Dock charges
 Custom Duty
Contd.
salary  entertainment
 rent, rate & taxes expenses
 stationary  repairs

 postage and  depreciation

telegram  interest
 audit fees  trade expenses
 legal charges  conveyance
 telephone charges  charity
 insurance premium  bank charges
Assets- (Company owns)
 These are the economic resources of an
organization . This helps to generate the
revenue. The characteristics are
 Having a value
 It should be companies Control
 Have a recordable value.
Various Assets
 Cash in hand  Goods sent on
 Cash at bank
consignment
 Long term investments
 Bills receivable  Trade mark

 Sundry debtors  Patents

 Vehicle
 Closing stock
 Furniture
 Finished goods
 Investments
 Raw materials  Machinery and plant

 Work in progress  Tools

 Land and building
 Stationary
 Goodwill
Non Current Assets- (Body through
which blood circulates)
Tangible assets

Intangible assets

Capital work in progress

Tangible Assets and Intangible
assets

Tangibl ●
Land, building, plant,
furniture, motor vehicle and

e assets tools etc

Intangibl Patents, trade mark, copy rights, goodwill

●

and research and development cost,

e assets
computer software, IPR, Customer relation
etc.
Capital work in progress
 Capital work in progress account

contains all expenses incurred on
the asset until it is
converted into working condition. All these ex
penses will become part of
the cost of that asset. Any construction which
is not completed before financial year.
Current Assets- life blood of the
organisation

Inventor Trade
y receivables

Short term Cash and

advances bank
 Classification of Assets

Current Fixed
Assets Assets

Wasting Fictitious
Assets Assets
Wasting Assets

Assets diminish in value when the assets are taken out of natural
Mines, Ores, oil wells etc.
resources
Fictitious Assets

Preliminary expenses, issue of shares and debenture & formation

Which do not have any concrete value
expenses
Contingent Assets

The existence and value depends upon occurrence and non-occurence

The undecided suit for property
event
Liabilities (Company owes)
 Liabilities
represent money that organization
owes. This is money that it owes because it
was borrowed by the organization. In other
words, liabilities shows the sources of money,
where the organization has received its funds.
Various Liabilities
 Bank overdraft
 Bills payable
 Sundry creditors
 Short term loans
 Bank loans
 Long-term loans
 Incomes received in advance
 Capital
Non- current liability – Payable
beyond one accounting period
Long term liability- long term borrowings

Deferred Tax liability- provision for future taxation

Long term provision- leave encashment, gratuity

and warranty provison
 Current liability- payable within one
Trade
Short
accounting period
term
payables
borrowings

Ot
he
r
cu
rre
nt
lia
bil
ity
an
d
sh
or
t
ter
m
pr
ov
isi
on
s
Contingent liability

Arrears of dividend of cumulative preference shares, liability on bills

Depending upon occurrence of certain event
discounted and suit for damages by third party.
Determinants of cash transaction
 The transactions,  Goods sold for cash
where the terms on Rs1,000
cash or on cheques,  Rent paid by cash
by cash or by Rs 500
cheques, for cash  Salary paid by
or for cheques are cheque Rs 2,000
used are identified  Good are purchased
as cash for cash Rs 6000
transactions.
Contd.
 The transactions  Charges paid Rs200
where in the terms  Shilpi settled her
paid, received, account of Rs1,000
settled, cleared,  Rs2,000 deposited
deposited, in the bank
withdrawn etc is  Mr. Anirban cleared
used are identified his account or
as cash Rs500 by paying
transactions. Rs450
Contd.
 The transactions  Goods sold to
where both cash Sravani for Cash
and personal names Rs1,000
are mentioned are  Goods purchased
termed as cash from Suman for
transactions cash Rs6,000
Credit transactions
 The transactions  Goods sold to
where in personal Sravani Rs1,000
names or name of a  Good returned from
firm is mentioned Sreemoti Rs5,000
are identified as  Goods returned to
credit transactions Sivani Rs1,000
 Goods purchased
from Suman
Rs6,000
Account
 An account is summarized record of relevant
transactions relating to same activity or
particular head that has taken place during a
given period. Separate individual accounts are
opened for every head of expenses, revenue,
asset, liability and capital
Accounts involved
1. Purchased goods for cash Cash, goods
2. Purchased plant Plant ,cash
3. Purchased furniture Furniture, cash
4. Purchased good on credit Goods, creditor
5. Sold goods on credit to X Goods, X
6. Rent received Cash, rent
7. Salary paid Salary, cash
8. Commission received Commission, cash
9. Cash deposited in to bank Bank ,cash
10. Started business with capital Cash, capital

Transactions Accounts involved

Transactions treatment through
Method-I
Accountin
g equation

Cash flow
statement

Balance Income
Sheet statement
 Transactions treatment through
Adjusted
Income
Trial
Method-II
Statement
Balance

B
al
a
n
c
e
S
h
e
et
Accounting equation
Asset= Liabilities + Equity

Asset- Liabilities = Equity

Assets – Equity = Liabilities

Format of Accounting Equation
Transactions Assets Liability Equity
+
Cash Goods Furniture
Furniture purchased

Increase in one asset

Decrease in other asset

Contd.

Cash brought in to
business

Increase in capital

Increase in asset
Contd.

Goods purchased on
credit

Increase in Liability

Increase in assets
Creditors paid by taking a fresh loan

Increase in one liability

Decrease in another liability

Creditor becomes the partner or the
contributor

Increase in capital

Decrease in liability
Capital transferred to loan

Increase in liability

Decrease in capital
Contd.

Increas
e in
capital

Discharge
of liability
at
discount

Decreas Decreas
e in e in
liability assets
Contd.

Increas
e in
assets
Amount
collected
from
debtors at
discount

Decreas Decreas
e in e in
assets capital
Tips for Accounting equation

Whether expenses
paid or outstanding If expenses paid If outstanding it
both the cases the it will reduce from will increase the
capital will be the cash liability
reduced
Contd.

If income received Increase the

Increase the cash
in advance liability
Contd.

Prepaid expenses
If any expenses column will be It will reduce from
paid in advance opened in asset the cash
side
Contd.

For accrued A separate column

income ( income will be opened in Added to the
earned but not the asset side as equity / capital
received) accrued income
Double entry system

One accountEach
in the
transactions
debit sideis
and
recorded
other account
in two places
in the credit side
Debit and Credit

Debit ●
all expenses, losses,
drawings, assets

refers to ●
(left hand side of an account )

Credit incomes, gains, capital and liability,

●

reserves, surplus and provisions

refers to ( Right hand side of an account)

Modern rules of Debit and credit or
rules under accounting equation

Increase in assets, Debit

expenses,
balance
losses and drawings
Contd.

Decrease in assets,Credit
expenses,
balance
drawings and losses
Contd.

Increase in capital,
Credit
liability,
balance income and gain
Contd.

Decrease in capital,
Debitliability,
balance. gain and income
Journal

Records day
Primary
to day
book
transactions
of businessman
chronologically
Accounting Cycle

TrialFinal
Journal
ledger
Balance
Accounts
Balance Sheet
The Balance Sheet presents an enterprise’s
assets, liabilities and equity at a point in time.
It summarizes the resources, and the claim to
those resources by owners and creditors of
the enterprise on a certain date
Balance Sheet

Liabilities +
Assets
equity
Format of Balance Sheet
Items Details Amount

Assets
Office equipments
Stock
Bank
Cash
Building
Total of assets
Liabilities
Creditors
Outstanding expenses
Overdraft
Equity
Share capital
Income Statement or Profit & Loss
Account
 It is a dynamic document which shows the
results of operation of an enterprise for a
particular period of time. In this statement
revenue of a particular period are marched
with the expenses of that period. The excess
of revenue over expenses is known as net
income and excess of expenses over revenue
is known as net loss
Why Profit is important?
 For business profit is like engine of a car. As
the car ends when its engine is separated
from it, similarly identity of business comes
to an end when the word profit is removed
from it. Profit is very important in any
business.
Why Profit & Loss Account is
prepared?
 The answer to this question is simple and
obvious . As the name suggests, this
statement is prepared to find out whether an
organization has made a profit or a loss.
Profit Cycle
Revenue/ Income
Expenses
Profit
Loss Cycle
Loss
Expenses
Income
Profit and Loss
Items Amount
Income
Sales
Income from services ____________
Other receipts
Total Income ____________
Expenses
Cost of sales
Salary
Expenses due
Depreciation
Rent
Total of Income ____________
____________
Profit ( Income – Expenses) / Loss ( Expenses- Income)
Statement of retained earnings
Particulars Amoun
t
Opening retained earnings
Add Profit during the year
Les Dividend paid during the
year
Closing balance of retained
earnings
Capital Expenditure
 It is the amount spent to acquire the assets
not for resale them, it is for generating the
income of the business unit. The benefit of
this is not for one year, it is for the longer
period. For example purchase of land and
building, purchase of plant, brokerage or
commission paid for acquiring the long term
loan etc. These expenses are recorded in
Balance Sheet.
Contd.
Capital
expenditure

Cost of replacing
petrol driven
engine to a diesel
driven engine

Purchase of land,
Amount spent building, plant and
for erecting of machinery, furniture,
vehicle and any other
plant fixed asset.

Expenditure incurred for

increasing the sitting
accommodation in a
auditorium or restaurant.
Revenue expenses
It includes purchasing assets required for
resale at a profit or being made into saleable
goods, maintaining fixed assets in good
working conditions, meeting the day to day
expenses of carrying business, cost of goods,
raw materials and replacements, renewals,
repairs, depreciation of fixed assets, rent
rates, taxes, wages and salaries, carriage,
insurance etc.
Contd.

Revenue
expenses
Revenue expenses becomes capital
expenditure

Repairs to second
hand machine

Legal expenses at the

time of purchase of
fixed assets

Transport charges for

Plant and Machinery
Contd.

Wages paid to work

man for erecting of PM

Development
expenditure for
plantation, Collieries etc,

Interest paid during

construction of
building or plant etc.
Deferred Revenue Expenses
 It is the expenses which would be normally
treated as revenue expenses but it not written
off in one year as its benefit is not exhausted
in one year but over a period of year. The
nature of this is non-recurring and special
nature. It may be spread over a number of
years, a proportionate amount is charged to
profit &loss account every year and the
balance amount is treated as an asset and
shown on the balance sheet asset side
Contd.

Heavy Insurance premium paid the benefit derived beyond the

Huge advertisement expenses for business promotion
accounting period.
Revenue Profit

Profit Income
from sale from
of goods investment

Commission
received, interest
received, discount
received etc.
Capital receipt

capital invested in the business, loans and the proceeds of sale of

Capital receipts
assets etc
Revenue receipt

cash from sales, discount received, commission, interest on investment,

Revenue receipts
transfer fees received etc
Capital loss

Loss while which occurs while selling fixed assets or raising share
Capital Loss
capital
Profit Before Interest and Tax (PBIT)
or operating profit or EBIT
 This is a measure of gross performance of a
company with reference to its total capital
employed. As the term suggests, interest and
tax are not deducted while computing PBIT.
Interest is a reward of borrowed capital and
tax is a compulsory deduction imposed by
law. It is also known as Earnings Before
Interest and Tax ( EBIT). Generally it is used
to measure managerial Performance.
Profit Before Tax (PBT) or EBT
 This is a measure of net profit before
charging tax. Since tax is a compulsory and
non –discretionary charge on the company,
net profit is first presented before charging
tax. By this the users can understand profit
earning ability of the company and the tax
impact separately. This also otherwise known
as Earnings Before Tax (EBT).
Profit After Tax (PAT)
 This is a measure of net profit. This is used to
understand the profit earned after tax charge.
It is otherwise known as Earnings After Tax
(EAT).
Basics
PBIT

PBT

PAT
Basics

PAT + Previous
DISTRUBUTABLE
years undistributed
PROFIT profit.
Basics

Income from investment,

Non- operating
profitincome
on sale of assets etc.
Basics

Loss on sale of Non-

assetsoperating
or loss onexpenses
sale of investments etc.
 Tax
Share holders
Order of Payment

Operating expenses
Cash Flow Analysis
 Explains reasons for changes in cash position
of a concern. Transactions which increase the
cash position of the concern are known as
inflow of cash and those decreases the cash
position are known as out flow of cash.
Cash flow Reporting
Cash flow from OPERATION

Cash flow from INVESTMENT

Cash flow from FINANCING

Operation Activity

●
Receipts from customers for sale of goods and services

Cash inflow
Investing Activity

●
Sale of fixed assets, sale of investments, collection of loans,
interest and dividend received etc.

Cash inflow
Financing Activity

●
Issue of share capital, debentures and other borrowings

Cash inflow
Cash from investing activities
 Sale of fixed assets
 Sale of investment
 Purchase of fixed asset (-)
 Purchase of investment (-)
 Interest received
 Dividend received
 Loans to subsidiaries (-)
 Net cash from investing activities
Cash flow from financing activity
 Issue of shares and debentures
 Proceeds from long-term borrowings
 Repayment of long-term borrowings (-)
 Redemption of preference shares and

debentures (-)
 Dividend paid (-)
 Interest paid (-)
 Net cash from financing activities
Cash Flow Statement
Particulars Details Amount
I. Cash flow from Operating Activities

II. Cash flow from Investing Activities

III. Cash flow from Financing Activities

Net Increase (Decrease) in cash ____________

+ Beginning Balance of Cash ---
End Balance of Cash ----
Trial Balance
 Trial Balance is a statement, prepared with
the debit and credit balances of ledger
accounts to test the arithmetical accuracy of
books of accounts.
Items shown in the trial balance
Debit side Credit side
Cash in hand Capital
Cash at bank Bank overdraft
Bills receivable Creditors
Drawings Sales
Land and building Bills payable
Furniture Loan (credit)
Plant and machinery Mortgage (payable)
Investments Purchase return
Opening stock Discount ,rent, interest (received)
Rent ,rates and taxes Provisions for bad debts
Wages General reserve
Freight Depreciation reserve
Discount allowed Depreciation fund
Export duty Provision for depreciation
Provisions

set aside ,before

ascertaining the net
profits,

charge against profit for

all anticipated losses

reasonably necessary for the

purpose of providing for any
liability or loss, which is likely or
certain to be incurred;
Reserve
Reserve

Reserves are the items of

owners' equity which arise
from retention of profits (an
appropriation of profits, sum
of money set aside from
distributable profits

capital receipts( profit on sale

of fixed assets or issue of
shares at a premium) upward
revaluation of assets( bringing
the assets to current value
from historical cost
amount of money
that is set aside until
that is required for
other purpose
Classification of reserve
General reserve

Specific reserve
Revenu
Capital
e
reserve
reserve
Depreciation
Due to
wear
and tear

Due to out
date of
technolog
y

Decrease
in value of
an asset
Causes of Depreciation
Lapse of
time

Wear and tear due

to constant use

Depletion
Contd.
Exhaustion
of assets

Accident

Obsolescenc
e
Ratio Analysis
 In general words, a ratio is an expression of
relationship of one figure with another. It may
be defined as the relationship, or proportion
that one amount bears to another. It is found
by dividing a figure with another. A ratio may
be expressed in percentage in which the
base, is taken as equal to 100 and the
quotient is expressed as per hundred of the
base
Various ratios
Capital structure or leverage ratio

Liquidity ratios

Activity or turnover ratio

Profitability or profit earning capacity ratios.

Components

Current Cash in hand, cash at bank, debtors, prepaid

●

expenses, short term deposits, bills receivable,

money at call and short notice, stock ,finished

Assets
goods, work in progress stock of raw materials and
sundry supplies

Current Bills payable, income tax payable, creditors.

●

Outstanding expenses, bank overdraft, provision for

taxation, interest due on fixed liabilities, reserve for

Liabilities
unbilled expenses, installment payable on long-term
loans.
Short term ratio

Primarily
It is the short
abilityterm
of the
creditors
firm to meet
interested
shortin
term
liquidity
obligations.
or shortThis
term
solvencymeasures
of the firm.
concerns
Since their
ability
claims
to meet
areshort
to beterm
met in
obligation
the short term.
Short term solvency or liquidity ratios

Current Ratio

Liquid Ratio

Absolute Liquid Ratio

Current ratio or working capital ratio

This ratio establishes relationship

Meaning
●

between current assets and current

liability

Ratio Current assets / Current

●

liabilities

Standard
norm
●
2:1
Liquid Ratio or quick ratio
This ratio establishes relationship between quick assets

Meaning
●

and current liability . Quick assets refer to those current

assets which can be converted into cash immediately or at
a short notice with out a loss of value.

Ratio Quick Assets/ Current liability or

●

●
Quick assets / Quick liability

Standard ●

●
1:1
Note Quick assets are current assets- stock –prepaid

norm
expenses and quick liabilities are current liability-
bank overdraft.
Absolute liquid ratio
Establishes the relationship between absolute liquid

Meaning
●

assets and absolute liquid liabilities or current liabilities .

●
Absolute liquid assets = Cash in hand, cash at bank and
short term marketable securities

Ratio Absolute liquid assets /

●

Absolute liquid liabilities or CL

Standard
norm
●
.5:1
Activity or Turnover ratio
 It measures the effectiveness with which a
firm uses its available resources.
Activity or Turnover ratios
Stock or inventory turnover ratio

Debtors or receivable turnover ratio

Average collection period or debtor velocity

Creditors or payable turnover ratio

Average payment period

Contd.
Total assets turnover ratio

Fixed asset turnover ratio

Current asset turnover ratio

Working capital turnover ratio

Capital or net worth turnover ratio

Total capital turnover ratio

Stock or inventory turnover ratio

 This ratio is an indicator of velocity of flow of

inventory in business. This shows the rate of
conversion of stock in to sales. In fact,
inventory policy of management and liquidity
of firm both may be tested by this ratio. This
is also a measure of marketing capacity of the
firm. No any standard rate or norm can be
determined for this ratio because it based
more on nature of industry and sales policy
of the firm.
Contd.
 Cost of goods sold / Average stock
 Cost of goods sold = opening stock + purchases+
direct expenses – closing stock
 Average stock = opening stock + closing stock / 2
 Note :1. If cost of goods sold cannot be calculated
then sales will be taken as base
 2. if opening and closing stock is not given in that
case closing stock will be treated as average stock
 3 Higher the ratio good for the organization. A low
stock turnover ratio indicates that the goods do
not sell quickly and efficiently, so the maximum
inventory remains lying in the warehouse.
Debtors Turnover ratio or Receivable
Turnover Ratio (DTR)
 This ratio is a qualitative analysis of a firm’s
marketing and credit policy and debtors
realizations. It is calculated to know the
uncollected portion of credit sales in the form
of debtors by establishing relationship
between trade debtors and net credit sales of
the business.
Contd.
 DTR = Net credit sales / Average receivables
 Net credit sales = Total sales – cash sales –

sales return
 Avg. receivables = opening receivable
+closing receivable / 2
 Receivable = Debtors + Bills receivable
 A decrease in this ratio each year is an

indicator of efficiency of marketing and credit

policy of the firm.
Average collection period:

 This period indicates the period taken in the

realization or collection of debtors. In other
words, it represents the average number of
days for which a firm has to wait before its
receivables are converted into cash. The
purpose of calculating this period is to find
out the ratio of cash flow from collection of
debtors
Contd.
 Average collection period or average age of
receivables=
 Trade receivables/ sales per day
 Or
 Trade receivables / net credit sales X 365

days
 Or
 365/ DTR
Contd.
 In this respect, the general rule is that
average collection period should not exceed
the stated credit period on trade terms plus
1/3rd of such period. If average collection
period exceeds 4/3 of stated credit period, it
will indicate either liberal credit policy or
slackness of management in realizing debts.
A higher average collection period also
implies that chances of bad debts are larger.
Creditors Turnover Ratio
 The short-term creditors ( i.e, suppliers of
goods and bankers) are very much interested
in this ratio, as it shows the firm’s trend of
payment to its short-term creditors. This ratio
shows the relationship of credit purchases and
trade creditors. This ratio indicates the velocity
with which the creditors are turned over in
relation to purchases. Higher the creditors
velocity, better it is. A fall in this ratio shows
delay in payment to creditors.
Creditors or payable turnover ratio
 CTR = Net credit purchases / Average
payables (creditor +BP)
 Net credit purchase = Total purchase – cash

purchase – purchase return

 Average payable = opening payable + closing

payable / 2
 Note : if opening and closing is not given

then closing will be considered as average

Average payment period
 While analyzing creditors, usually average
period is also calculated. This period
discloses the time taken by the firm in
making payment to its trade creditors.
 Average disbursement period is compared

with credit period allowed by suppliers of

goods to know promptness or delay in
payment
Contd.
 Average payable / net credit purchase X no.
of month or weeks or days
 Or
 No. of month or week or days / CTR
Total assets turnover ratio
 Cost of goods sold or net sales / Total assets
 Total assets = Fixed assets + current assets –

fictitious assets- depreciation on fixed assets

 This relationship indicates the efficiency of

the utilization of assets to attain the

maximum turnover on sales. A rise in the
ratio indicates more intensive utilization of
assets, while fall in the turnover suggests
under utilization of assets.
Fixed assets turnover ratio
 Cost of goods sold or net sales / net fixed
assets
 Net fixed assets = Fixed assets – depreciation
 If there is an increase in this ratio, it will show

that there is better utilization of fixed

assets .If there is a fall in this ratio, it will
show that investment in fixed has not been
utilized efficiently. Ideal of this in a
manufacturing company is 5:1
Current assets turnover ratio
 Cost of goods sold or net sales / current
assets
 This ratio measures the concern’s efficiency

in utilization of its current assets. This ratio

also indicates the over investment or under
investment position of current assets in a
concern.
Working capital turnover ratio
 Cost of goods sold or net sales / working
capital
 The high ratio indicates efficient use of

working capital in the concern while low

working capital turnover ratio indicates under
utilization of working capital in the concern
Capital or net worth turnover ratio
 Net sales or cost of goods sold / net worth or
share holder’s fund
 It indicates whether the capital employed by

the shareholder’s in a business is used

efficiently or not
Total capital turnover ratio
 Cost of goods sold or net sales / capital
employed
 Capital employed = long term and short term
capital
 By calculating this ratio, efficiency of capital
employed may be known. This ratio shows
how many times capital has been rotated for
generating the sales. The higher the ratio,
better it is for the business concerns. No
ideal standard can be fixed for this ratio.
Capital Structure Ratio or long –term
solvency ratios
 Debt equity ratio
 Solvency ratio
 Proprietary ratio
 Fixed asset ratio
 Capital gearing ratio
 Debt service ratio or interest coverage ratio
Debt Equity Ratio
 Debt equity ratio = Outsider’s fund /
shareholder’s fund
 Alternative:
 Debt equity ratio = long-term debt / share
holders fund or net worth
 Note: in this case current liabilities will be
ignored.
 Standard norm: 2 : 1, however lending
institutions prefer 1:1
 A low ratio signifies a smaller claim of creditors.
More precisely, the greater the debt-equity ratio,
greater the risk to the creditor.
Outsiders fund and share holders
fund

Outside ●
Debt, long-term or short term,
whether in the form of

rs fund mortgage, bills or debentures

Share ●
Preference share capital, equity share

holders capital, capital reserves, retained earnings

and any other reserves representing the
accumulated profit

fund
Proprietary Ratio
 This is also known as equity ratio, net worth
to total assets ratio.
 Proprietary ratio = Share holders fund / Total

assets
 Higher the ratio better is the financial

position of the firm.

Solvency Ratio or debt to total assets
ratio
 Solvency ratio = Total outside liabilities /
total assets
 If the amount is enough to pay the external

liabilities then the company is said to be

solvent.
Fixed Asset Ratio
 Fixed assets ratio = Net fixed assets /
(shareholders fund + long term liability)
 Or
 Fixed asset ratio = Net fixed assets /
Share holders fund
 Standard norm: 1 :1. It is well established
that fixed assets should be financed only out
of long-term funds. This ratio shows whether
this is so.
Capital gearing ratio
 CGR = Share holders fund / out sider’s fund
 Share holder’s fund = Equity capital +
reserve +surplus
 Outsider’s fund = Preference share
capital + Debentures + Other long term
loans.
 Note : If capital gearing ratio is less than 1,
we will call it high gearing of capital and if
gearing ratio is more than 1 then low gearing
of capital is assumed
Debt service ratio or interest
coverage ratio
 Interest coverage ratio =
 Net profit before interest and tax /Interest on

fixed long term loans or debentures.

 Note : This ratio measures the margin of

safety for the lenders. The higher the

number, more secure the lender is in respect
of his periodical interest income. Normally,
fixed interest charges should be covered six
to seven times.
Profitability ratios:
Based on sales
 Gross profit ratio
 Operating ratio
 Expenses ratio
 Operating profit ratio
 Net profit ratio
Gross profit ratio
 Gross profit / net sales X100
 Net sales = Sales – sales return
 Gross profit = net sales – cost of goods sold.
 The gross profit ratio is primarily a test of the
efficiency of purchases and sales
management. No ideal standard is fixed for
this ratio, but the gross profit ratio must be
adequate.
Operating ratio
 Cost of sales + operating expenses / net
sales X 100
 Operating expenses = office and
administrative expenses + selling expenses +
discount allowed + bad debts etc.
Other profitability ratios
Expenses ratio= Particular expenses/ nets sales
X100

Operating profit ratio=Operating profit/net sales

X100

Net profit ratio= Net profit/ net sales X100

Profitability ratios based on capital
 Return on gross capital employed
 Return on net capital employed
 Return on proprietors net capital
 Return on average capital employed
 Return on total assets
Return on gross capital employed
 EBIT / Gross capital employed X100
 Gross capital = Equity share capital +
preference share capital +reserve and surplus
+ all long and short term external loans
 Or
 All net fixed assets + current assets +
including goodwill of the firm but fictitious
assets are not included
Return on net capital
 EBIT / Net capital employed X100
 Net capital employed = Equity share capital +

preference share capital + reserve and

surplus + long term loans
Return on proprietor’s capital
employed
 Net profit after interest and tax / proprietor’s
net capital employed X100
 Proprietor’s net capital = Equity share capital

+ preference share capital + reserves and

surplus – accumulated losses, if any
Return on average capital employed
 Net profit / average capital X100
 Average capital = Opening capital + closing

capital / 2
 Or
 Opening capital +1/2 of current year’s profit
 Or
 Closing capital – ½ of current year’s profit
 Return on capital employed reflects the

overall profitability of the business

Return on total assets
 Net profit / Total net assets X 100
 Total net assets = Total assets – fictitious

assets
Return on proprietor’s fund or equity
or return on net worth
 Net profit / Proprietor’s fund X100
 Proprietor’s fund =Equity share capital +

preference share capital +reserves and

surplus+ undistributed profit – debit balance
of profit & loss if any.
Ratios showing profitability on shares
 Earning per share(EPS)
 Earning Yield Ratio(EYR)
 Dividend Per share (DPS)
 Pay-out Ratio (POR)
 Dividend Yield Ratio (DYR)
 Dividend coverage ratio (DCR)
 Price earning ratio (PER)
Earning per share(EPS)

EPS
Net profit after tax, interest
●

and preference dividend / no

of equity shares

Indicat It indicates the amount of

●

earnings that equity share

or commands.
Earning Yield ratio (EYR)

EYR = EPS / Market price

●

per share X 100

Indicat This
●
ratio indicates the
relationship between earning per

or share and market price per share

Dividend Per Share (DPS)

DPS Dividend for equity share

●

holders/ no. of equity shares

Indicat ●
Higher the ratio, the better is for equity
share holders of the concern. This ratio

or
shows the amount of dividend per share
paid by the management of the company
Pay-out ratio (POR)

POR dividend per equity shares/

●

earning per share X100

Indicat This ratio helps us to calculate the

●

percentage of dividend paid out of earned

or
incomes and the percentage of earned
profits retained in the business concern
Dividend Yield Ratio (DYR)

DYR Dividend per share / Market

●

price per share X100

Indicat Dividend yield ratio helps investors to

●

ascertain the effective return on the amount

or
they invest or intend to invest in the equity
shares of a company
Dividend cover ratio (DCR)

DCR ●
EPS / DPS

indicat ●
This ratio indicates the relationship between
dividend per share and earning per share.

or
This ratio calculated by dividing earning per
share by dividend per share
Price Earning Ratio (PER)

PER ●
MPS /EPS

Indicat This ratio indicates relationship between market

●

price per equity shares and earning per share. In

or
other words, this ratio indicates the number of times
the earning per share is covered by its market price.
Analysis and Interpretation of
Financial Statements
 It is the process of identifying the financial
strengths and weakness of the firm by
properly establishing relationship between
the items of the Balance Sheet and Profit &
Loss Account and other operating data.
Meaning

Analysi It is used to mean the simplification of

●

financial data by methodical classification

s
of the data given in the financial
statements

Interpr ●
It is the explaining the meaning
and significance of the data so

etation simplified.
Comparative Income Statement
 This statement shows the operational results
of the business for a number of accounting
periods so that changes in absolute figures
from one period to another period may be
stated in terms of money and percentage.
Comparative Balance Sheet
 Comparative Balance Sheet analysis is the
study of the trend of the same items, group
of items and computed items in two or more
balance sheets of the same business
enterprise on different dates
Common- Size Statements
 Common-size statements cover up the
shortcomings of the comparative statements
by expressing each item of the statements as
a percentage of total. In common-size
statements relative values of items are
shown.
Common-Size Balance Sheet
 In common-size balance sheets, various
items of assets and liabilities of balance
sheets of two or more years are shown at
their relative values. That is ,each item of the
assets is shown as percentage of total assets
and each item of liabilities as percentage of
total liabilities and capital fund.
Common-Size Income Statement
 In this statement relationship is established
between items of income statement and
volume of sales in percentage form. In other
words, in a common –size income
statement ,each item of income statement is
shown in percentage based on net sales.
Wish you all the Best
Thank you