Accounting For Accounting For ManagersManagers

Dr Vikas MadhukarDr Vikas Madhukar ProfessorProfessor

Amity Business School, ManesarAmity Business School, ManesarGurgaonGurgaon

madhukar_vikas@yahoo.commadhukar_vikas@yahoo.com, , vmadhukar@absm.amity.eduvmadhukar@absm.amity.edu

Financial Reporting – who Financial Reporting – who are the users?are the users?

Our focusOur focus ShareholdersShareholders LendersLenders ManagersManagers Potential employeesPotential employees AcquirersAcquirers

But alsoBut also Statutory – tax, company houseStatutory – tax, company house Customers & suppliersCustomers & suppliers competitorscompetitors

What is Accounting?What is Accounting?

Accounting is a Accounting is a LanguageLanguage of of Business.Business.

Key Functions Based on Key Functions Based on Financial StatementsFinancial Statements

Planning/BudgetingPlanning/Budgeting ControlControl Decision MakingDecision Making Investment AnalysisInvestment Analysis ValuationValuation

In other words….In other words…. Accounting is an art as well as a science of:Accounting is an art as well as a science of: Recording,Recording, ClassifyingClassifying SummarisingSummarising the business transactions and events, the business transactions and events,

which are, in part at least of financial which are, in part at least of financial nature, express in terms of money andnature, express in terms of money and

Interpreting the results thereof, andInterpreting the results thereof, and Communicating the results to persons who Communicating the results to persons who

must make decisions or form judgements.must make decisions or form judgements.

RecordingRecording JournalJournal ClassifyingClassifying LedgerLedger SummarisingSummarising Trial BalanceTrial Balance InterpretationInterpretation Profit & Profit &

Loss a/c Loss a/c and Balance Sheetand Balance Sheet

Classification of Classification of AccountingAccounting

Financial Accounting: primary concern is to Financial Accounting: primary concern is to preparation of profit & loss a/c and balance sheet preparation of profit & loss a/c and balance sheet and to provide various business information to all and to provide various business information to all stakeholders.stakeholders.

Cost Accounting: concern with analysis and Cost Accounting: concern with analysis and ascertainment of cost, its classification, ascertainment of cost, its classification, accumulation, allocation and absorption so as to accumulation, allocation and absorption so as to calculate the unit cost of a product/process or a calculate the unit cost of a product/process or a cost centre and to facilitate cost reduction and cost centre and to facilitate cost reduction and cost control.cost control.

Management Accounting: emphasize on Management Accounting: emphasize on managerial decision making, which take data managerial decision making, which take data from financial and cost records.from financial and cost records.

Accounting ConceptsAccounting Concepts

Are the necessary assumptions and Are the necessary assumptions and conditions upon which accounting is conditions upon which accounting is based, some important concepts are:based, some important concepts are:

Business Entity ConceptBusiness Entity Concept Going Concern ConceptGoing Concern Concept Dual Aspect ConceptDual Aspect Concept Money Measurement ConceptMoney Measurement Concept Accounting Period ConceptAccounting Period Concept Accrual ConceptAccrual Concept Matching of Cost and Revenue ConceptMatching of Cost and Revenue Concept

Accounting ConventionsAccounting Conventions

are the traditions, usage and are the traditions, usage and customs which are in use since long. customs which are in use since long. The most important conventions are:The most important conventions are:

Full DisclosureFull Disclosure ConsistencyConsistency ConservatismConservatism MaterialityMateriality

Dual Aspect ConceptDual Aspect Concept Modern accounting system, which is Modern accounting system, which is

known as ‘double entry book-keeping known as ‘double entry book-keeping system’ is based on dual aspect concept.system’ is based on dual aspect concept.

It says, every ‘debit’ has a ‘credit’ and It says, every ‘debit’ has a ‘credit’ and every ‘credit’ has a ‘debit’every ‘credit’ has a ‘debit’

It is because of this concept that the total It is because of this concept that the total claims of outsiders and owners are always claims of outsiders and owners are always equal to total assets. i.e.equal to total assets. i.e.

Total Liabilities = Total Assets orTotal Liabilities = Total Assets orCapital + Liabilities = Total Assets, this is Capital + Liabilities = Total Assets, this is

also known as ‘Accounting Equation’also known as ‘Accounting Equation’

Types of AccountsTypes of Accounts

Personal A/c: related with Personal A/c: related with Natural persons e.g. Suresh a/c Natural persons e.g. Suresh a/c Artificial persons e.g. IBM a/cArtificial persons e.g. IBM a/cRepresentative persons e.g. capital a/cRepresentative persons e.g. capital a/c

Real A/c: related with assets e.g. Real A/c: related with assets e.g. building a/cbuilding a/c

Nominal A/c: related with expenses & Nominal A/c: related with expenses & losses, income & gains e.g. Rent a/c, losses, income & gains e.g. Rent a/c, wages a/c, interest a/cwages a/c, interest a/c

Rules of Double Entry Rules of Double Entry SystemSystem

   Dr.Dr. Cr.Cr.

Personal a/cPersonal a/c ReceiverReceiver GiverGiver

Real a/cReal a/c In the businessIn the business

Out from Out from the the

businessbusiness

Nominal a/cNominal a/cExpenses & Expenses &

LossesLossesIncome & Income &

GainsGains

Balance SheetBalance Sheet

Is a statement consisting two sides, the Is a statement consisting two sides, the right hand side is know as ‘Assets’ and right hand side is know as ‘Assets’ and left hand side is known as ‘Liabilities’. left hand side is known as ‘Liabilities’. The B/S shows the financial position of The B/S shows the financial position of business.business.

Assets: any property own by the business Assets: any property own by the business e.g. cash, land, building, machinery etce.g. cash, land, building, machinery etc

Liabilities: a liability is a claim of an Liabilities: a liability is a claim of an outsider on the assets of a business, outsider on the assets of a business, e.g. bank loan, creditors etce.g. bank loan, creditors etc

Started business with an investment of Rs 5,00,000/-Started business with an investment of Rs 5,00,000/- Machinery purchased worth Rs 20,000/-Machinery purchased worth Rs 20,000/- Computer purchased Rs 30,000/-Computer purchased Rs 30,000/- Goods purchased on credit worth Rs 10,000/-Goods purchased on credit worth Rs 10,000/-

LiabilitiesLiabilities AmountAmount AssetsAssets AmountAmount

CapitalCapital 5,00,0005,00,000 CashCash 5,00,0005,00,000

5,00,0005,00,000 5,00,0005,00,000

Balance Sheet

Started business with an investment of Rs 5,00,000/-Started business with an investment of Rs 5,00,000/- Machinery purchased worth Rs 20,000/-Machinery purchased worth Rs 20,000/- Computer purchased Rs 30,000/-Computer purchased Rs 30,000/- Goods purchased on credit worth Rs 10,000/-Goods purchased on credit worth Rs 10,000/-

LiabilitiesLiabilities AmountAmount AssetsAssets AmountAmount

CapitalCapital 5,00,0005,00,000 CashCash

MachineryMachinery4,80,0004,80,000

20,00020,000

5,00,0005,00,000 5,00,0005,00,000

Balance Sheet

Started business with an investment of Rs 5,00,000/-Started business with an investment of Rs 5,00,000/- Machinery purchased worth Rs 20,000/-Machinery purchased worth Rs 20,000/- Computer purchased Rs 30,000/-Computer purchased Rs 30,000/- Goods purchased on credit worth Rs 10,000/-Goods purchased on credit worth Rs 10,000/-

LiabilitiesLiabilities AmountAmount AssetsAssets AmountAmount

CapitalCapital 5,00,0005,00,000 CashCash

MachineryMachinery

ComputerComputer

4,50,0004,50,000

20,00020,000

30,00030,000

5,00,0005,00,000 5,00,0005,00,000

Balance Sheet

Started business with an investment of Rs 5,00,000/-Started business with an investment of Rs 5,00,000/- Machinery purchased worth Rs 20,000/-Machinery purchased worth Rs 20,000/- Computer purchased Rs 30,000/-Computer purchased Rs 30,000/- Goods purchased on credit from Satish & Sons worth Rs 10,000/-Goods purchased on credit from Satish & Sons worth Rs 10,000/-

LiabilitiesLiabilities AmountAmount AssetsAssets AmountAmount

CapitalCapital

Creditors/PayablesCreditors/Payables

(Satish & Sons)(Satish & Sons)

5,00,0005,00,000

10,00010,000CashCash

MachineryMachinery

ComputerComputer

StockStock

4,50,0004,50,000

20,00020,000

30,00030,000

10,00010,000

5,10,0005,10,000 5,10,0005,10,000

Balance Sheet

JournalJournal

Journal is the original books of business Journal is the original books of business where transactions are first recorded.where transactions are first recorded.

DateDate ParticularsParticulars L.L.F.F.

Amount Amount (Dr)(Dr)

Amount Amount (Cr)(Cr)

Cash a/c Cash a/c Dr.Dr.

To Capital a/cTo Capital a/c

(Being Business Started with (Being Business Started with cash)cash)

Machinery a/c Machinery a/c Dr. Dr.

To Cash a/cTo Cash a/c

(Being machinery purchased (Being machinery purchased worth)worth)

5,00,0005,00,000

20,00020,000

5,00,0005,00,000

20,00020,000

LedgerLedger

It is an account where entries are It is an account where entries are transferred from the journal and this transferred from the journal and this process is known as POSTING.process is known as POSTING.

DatDatee

ParticularsParticulars J.F.J.F. AmountAmount DateDate ParticularsParticulars J.F.J.F. AmountAmount

To Capital To Capital a/ca/c

5,00,005,00,0000

By Machinery By Machinery a/ca/c

20,00020,000

Dr. Cr.

Trial BalanceTrial BalanceDebit balanceDebit balance AmounAmoun

ttCredit balanceCredit balance AmountAmount

ExpensesExpenses

LossesLosses

AssetsAssets

IncomeIncome

GainsGains

LiabilitiesLiabilities

EqualEqual EqualEqual

Financial StatementsFinancial Statements

Trading A/c: To calculate gross Trading A/c: To calculate gross profit/gross lossprofit/gross loss

Profit & Loss A/c: To calculate net Profit & Loss A/c: To calculate net profit/net lossprofit/net loss

Balance Sheet: To reflect financial Balance Sheet: To reflect financial position of the business.position of the business.

Ratio AnalysisRatio Analysis

A ratio is simple arithmetical A ratio is simple arithmetical expression of relationship of one expression of relationship of one number to another. number to another.

1.1. Liquidity RatioLiquidity Ratio

2.2. Solvency Ratio or Leverage RatioSolvency Ratio or Leverage Ratio

3.3. Activity RatioActivity Ratio

4.4. Profitability RatioProfitability Ratio

Liquidity RatioLiquidity Ratio

1.1. Liquid ratio = Current assets/current Liquid ratio = Current assets/current liabilitiesliabilitiescurrent assetscurrent assets = cash, bank, = cash, bank, debtors/receivables + stock and short debtors/receivables + stock and short term marketable securities.term marketable securities.current liabilitiescurrent liabilities = bank overdraft + = bank overdraft + creditors/accounts payables + short term creditors/accounts payables + short term loansloans

2.2. Quick Ratio = quick assets/ current Quick Ratio = quick assets/ current liabilitiesliabilitiesquick assetsquick assets = current assets - stock = current assets - stock

Solvency Ratio or Solvency Ratio or Leverage RatioLeverage Ratio

Debt-equity ratioDebt-equity ratio = External equity/internal = External equity/internal equityequity

Funded debt to total capitalization ratio = Funded debt to total capitalization ratio = funded debt/ total capitlaisation x 100funded debt/ total capitlaisation x 100

Ratio of long term debt to shareholder’s fundsRatio of long term debt to shareholder’s funds= = long term debt/shareholder’s fundslong term debt/shareholder’s funds

Fixed assets to long-term funds ratioFixed assets to long-term funds ratio = = fixed assets (after depreciation)/long term debt fixed assets (after depreciation)/long term debt

Current assets to shareholder’s fundsCurrent assets to shareholder’s funds = = current assets/shareholder’s fundscurrent assets/shareholder’s funds

Interest coverage ratioInterest coverage ratio = EBIT/fixed interest = EBIT/fixed interest chargecharge

Activity RatioActivity Ratio

Stock turnover ratioStock turnover ratio = cost of goods = cost of goods sold/average inventory sold/average inventory

Debtors turnover ratioDebtors turnover ratio = net credit = net credit sales/average debtorssales/average debtors

Creditors turnover ratioCreditors turnover ratio = net credit = net credit purchases/average creditorspurchases/average creditors

Working capital turnover ratioWorking capital turnover ratio = = cost of sales/net working capitalcost of sales/net working capital

Profitability RatioProfitability Ratio Net-profit ratioNet-profit ratio = (net profit/sales) x 100 = (net profit/sales) x 100 Gross-profit ratioGross-profit ratio = (gross profit/sales) x 100 = (gross profit/sales) x 100 Operating profit ratioOperating profit ratio = (operating profit/net = (operating profit/net

sales) x 100sales) x 100 Earning per shareEarning per share = net profit after tax and = net profit after tax and

preference dividend/number of equity sharespreference dividend/number of equity shares Dividend yield ratioDividend yield ratio = dividend per = dividend per

share/earning per shareshare/earning per share Price earning ratioPrice earning ratio = market price per equity = market price per equity

share/earning per shareshare/earning per share

Cash Flow Cash Flow Statement Statement

Cash Flows StatementCash Flows Statement

From From OPERATINGOPERATING ACTIVITIES ACTIVITIES From From INVESTINGINVESTING ACTIVITIES ACTIVITIES From From FINANCINGFINANCING ACTIVITIES ACTIVITIES

Which do you think is most important Which do you think is most important in assessing the firm’s prospects? in assessing the firm’s prospects? Why?Why?

Defining these activities may help Defining these activities may help answer the question...answer the question...

EquityFinancing

DebtFinancing

Investment in Producing

Assets

Goods &Services

NetEarnings

OperatingActivities

InvestingActivities

FinancingActivities

Reinvested

DebtPayment

Dividends

Businesses are like Fruit Trees…Businesses are like Fruit Trees…

Roots

BranchesTrunk &

Fruit

The 3 basic activities involved in conducting a business are:The 3 basic activities involved in conducting a business are:

• Financing activities (Roots): Financing activities (Roots): - Owners contribute cash and receive equity shares in return. - Creditors loan cash in return for the promise of interest and principal payments.

• Investing activities (Trunk and branches):Investing activities (Trunk and branches): Once the capital is collected it is invested in producing assets, like buildings, equipment, machinery and vehicles.

• Operating activities (Fruit): Operating activities (Fruit): The assets are operated to produce goods & services which are sold to customers.

The Net IncomeNet Income of these sales can be used in three ways:

1. Reinvested in the producing assets

2. Returned to the creditors in the form of debt payments

3. Returned to the owners in the form of dividends

Operating Activities Operating Activities include:include:

Delivering or producing goods for Delivering or producing goods for sale and providing servicessale and providing services

The cash effects of transactions and The cash effects of transactions and other events that enter into the other events that enter into the determination of incomedetermination of income

Examples: cash flows resulting from Examples: cash flows resulting from sales of goods, purchase of sales of goods, purchase of inventories, payment of operating inventories, payment of operating expensesexpenses

Investing Activities Investing Activities includeinclude

Acquiring/disposing of securities Acquiring/disposing of securities that are not cash equivalentsthat are not cash equivalents

Acquiring/disposing of productive Acquiring/disposing of productive assetsassets

Lending money/collecting on loansLending money/collecting on loans

Financing Activities Financing Activities includeinclude

Borrowing from creditors/repaying Borrowing from creditors/repaying the principalthe principal

Obtaining resources from ownersObtaining resources from owners Providing owners with a return on Providing owners with a return on

investmentinvestment

The three basic activities of businesses and their The three basic activities of businesses and their financial flowsfinancial flows::

Operating revenuesOperating costs

Sale of assetsPurchase of assets

Operatingactivities

Investingactivities

Financingactivities

Equity, debtDividends, debt payments

Financial boundaries of the corporation

The Statement of Cash FlowsThe Statement of Cash Flows

The statement of cash flows is a summary of the financial flows into and out of a

company’s cash account. (Note that accounting flows are not necessarily cash flows)

Operating activities + Cash collection

− Cash paid

= Net cash increase (decrease) from operating activities (1)

Investing activities − Purchases of securities or property

+ Sales of securities or property

= Net cash increase (decrease) from investing activities (2)

Financing activities + raised capital from issuing equity or entering debt

− Dividends or debt payments

= Net cash increase (decrease) from financing activities (3)

(1) + (2) + (3) = Increase (decrease) in cash balance

+ Beginning cash balance

= Ending cash balance

The cash balance provides important information on a company’s solvency.

Cash Cash FlowsFlows

Funds Flow StatementFunds Flow Statement

Meaning of fundsMeaning of funds Procedure of preparing FFSProcedure of preparing FFS

Schedule of changes in working capitalSchedule of changes in working capital Calculation of funds from operationCalculation of funds from operation Preparing fund flow statementPreparing fund flow statement

Meaning of FundsMeaning of Funds

Here, funds means all financial resources, Here, funds means all financial resources, specifically in context of FFS, funds means specifically in context of FFS, funds means Working Capital. Working Capital.

The flow of funds occurs when a transaction The flow of funds occurs when a transaction changes on the one hand a non-current changes on the one hand a non-current account and on the other hand a current account and on the other hand a current account and vice – verse.account and vice – verse.

FFS is a statement which indicates various FFS is a statement which indicates various means by which the funds have been obtained means by which the funds have been obtained during a certain period and the ways to which during a certain period and the ways to which these funds have been used during that period.these funds have been used during that period.

Statement of Changes in Statement of Changes in Working CapitalWorking Capital

ParticularsParticulars PreviouPrevious years year

Current Current yearyear

IncreIncrease in ase in WCWC

DecreDecrease in ase in WCWC

(A) Current Assets:(A) Current Assets:

Total (A)Total (A)

(B) Current Liabilities:(B) Current Liabilities:

Total (B)Total (B)

Working capital (A – B )Working capital (A – B )

Income StatementIncome Statement

SalesSales

Less: Cost of Goods SoldLess: Cost of Goods Sold

Gross ProfitGross Profit

Less: Operating ExpensesLess: Operating Expenses

Operating ProfitOperating Profit

Add/Less: Non Operating Income or/and Add/Less: Non Operating Income or/and ExpensesExpenses

EBITEBIT

Less: InterestLess: Interest

PBTPBT

Less: TaxLess: Tax

PATPAT

Fund Flow StatementFund Flow StatementSourcesSources AmounAmoun

ttApplicationsApplications AmountAmount

Funds from operationFunds from operation

Issue of share capitalIssue of share capital

Issue of debentures and Issue of debentures and raising long term loansraising long term loans

Sales of non-current Sales of non-current assetsassets

Non-trading receiptsNon-trading receipts

Decrease in WCDecrease in WC

Funds lost in operationFunds lost in operation

Redemption of Redemption of preference sharespreference shares

Repayment of long Repayment of long term loans and term loans and redemption of redemption of debenturesdebentures

Purchase of non-Purchase of non-current assetscurrent assets

Payment of dividend Payment of dividend and taxand tax

Non – trading Non – trading paymentspayments

EqualEqual EqualEqual