Accounting For Managers

Accounting For Managers

Dr Vikas Madhukar Professor Amity Business School, Manesar Gurgaon [email protected], [email protected]

Financial Reporting – who are the users? 

Our focus Shareholders  Lenders  Managers  Potential employees  Acquirers But also  Statutory – tax, company house  Customers & suppliers  competitors 

What is Accounting?

Accounting is a Language of Business.

Key Functions Based on Financial Statements     

Planning/Budgeting Control Decision Making Investment Analysis Valuation

In other words….     

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Accounting is an art as well as a science of: Recording, Classifying Summarising the business transactions and events, which are, in part at least of financial nature, express in terms of money and Interpreting the results thereof, and Communicating the results to persons who must make decisions or form judgements.

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Recording Classifying Summarising Balance Interpretation a/c Balance Sheet

Journal Ledger Trial Profit & Loss and

Classification of Accounting 

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Financial Accounting: primary concern is to preparation of profit & loss a/c and balance sheet and to provide various business information to all stakeholders. Cost Accounting: concern with analysis and ascertainment of cost, its classification, accumulation, allocation and absorption so as to calculate the unit cost of a product/process or a cost centre and to facilitate cost reduction and cost control. Management Accounting: emphasize on managerial decision making, which take data from financial and cost records.

Accounting Concepts

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Are the necessary assumptions and conditions upon which accounting is based, some important concepts are: Business Entity Concept Going Concern Concept Dual Aspect Concept Money Measurement Concept Accounting Period Concept Accrual Concept Matching of Cost and Revenue Concept

Accounting Conventions

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are the traditions, usage and customs which are in use since long. The most important conventions are: Full Disclosure Consistency Conservatism Materiality

Dual Aspect Concept Modern accounting system, which is known as ‘double entry book-keeping system’ is based on dual aspect concept.  It says, every ‘debit’ has a ‘credit’ and every ‘credit’ has a ‘debit’  It is because of this concept that the total claims of outsiders and owners are always equal to total assets. i.e. Total Liabilities = Total Assets or Capital + Liabilities = Total Assets, this is also known as ‘Accounting Equation’ 

Types of Accounts 

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Personal A/c: related with Natural persons e.g. Suresh a/c Artificial persons e.g. IBM a/c Representative persons e.g. capital a/c Real A/c: related with assets e.g. building a/c Nominal A/c: related with expenses & losses, income & gains e.g. Rent a/c, wages a/c, interest a/c

Rules of Double Entry System   Personal a/c Real a/c

Nominal a/c

Dr.

Cr.

Receiver In the business

Giver Out from the business

Expenses & Losses

Income & Gains

Balance Sheet Is a statement consisting two sides, the right hand side is know as ‘Assets’ and left hand side is known as ‘Liabilities’. The B/S shows the financial position of business. Assets: any property own by the business e.g. cash, land, building, machinery etc Liabilities: a liability is a claim of an outsider on the assets of a business, e.g. bank loan, creditors etc 

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

Balance Sheet Liabilities Capital

Amount 5,00,000

5,00,000

Assets Cash

Amount 5,00,000

5,00,000

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

Balance Sheet Liabilities Capital

Amount 5,00,000

5,00,000

Assets Cash Machinery

Amount 4,80,000 20,000

5,00,000

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

Balance Sheet Liabilities Capital

Amount 5,00,000

5,00,000

Assets Cash Machinery Computer

Amount 4,50,000 20,000 30,000

5,00,000

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

Balance Sheet Liabilities Capital Creditors/Payables (Satish & Sons)

Amount

Assets

Amount

5,00,000 Cash 10,000 Machinery Computer Stock

4,50,000 20,000 30,000 10,000

5,10,000

5,10,000

Journal 

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

Date

Particulars Cash a/c Dr. To Capital a/c (Being Business Started with cash)

L. F.

Amount (Dr)

Amount (Cr)

5,00,000 5,00,000

20,000 Machinery a/c Dr. To Cash a/c (Being machinery purchased worth)

20,000

Ledger 

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

Dr. D ate

Particulars To Capital a/c

J.F.

Amount 5,00,00 0

Date

Particulars By Machinery a/c

J.F.

Amount 20,000

Trial Balance Debit balance

Amount

Expenses Losses Assets

Credit balance

Amount

Income Gains Liabilities

Equal

Equal

Financial Statements 

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Trading A/c: To calculate gross profit/gross loss Profit & Loss A/c: To calculate net profit/net loss Balance Sheet: To reflect financial position of the business.

Ratio Analysis A ratio is simple arithmetical expression of relationship of one number to another. 3. 4. 5. 6.

Liquidity Ratio Solvency Ratio or Leverage Ratio Activity Ratio Profitability Ratio

Liquidity Ratio 1. Liquid ratio = Current assets/current liabilities current assets = cash, bank, debtors/receivables + stock and short term marketable securities. current liabilities = bank overdraft + creditors/accounts payables + short term loans 2. Quick Ratio = quick assets/ current liabilities quick assets = current assets -

Solvency Ratio or Leverage Ratio    

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Debt-equity ratio = External equity/internal equity Funded debt to total capitalization ratio = funded debt/ total capitlaisation x 100 Ratio of long term debt to shareholder’s funds= long term debt/shareholder’s funds Fixed assets to long-term funds ratio = fixed assets (after depreciation)/long term debt Current assets to shareholder’s funds = current assets/shareholder’s funds Interest coverage ratio = EBIT/fixed

Activity Ratio 

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Stock turnover ratio = cost of goods sold/average inventory Debtors turnover ratio = net credit sales/average debtors Creditors turnover ratio = net credit purchases/average creditors Working capital turnover ratio = cost of sales/net working capital

Profitability Ratio    

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Net-profit ratio = (net profit/sales) x 100 Gross-profit ratio = (gross profit/sales) x 100 Operating profit ratio = (operating profit/net sales) x 100 Earning per share = net profit after tax and preference dividend/number of equity shares Dividend yield ratio = dividend per share/earning per share Price earning ratio = market price per equity share/earning per share

Cash Flow Statement

Cash Flows Statement   

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From OPERATING ACTIVITIES From INVESTING ACTIVITIES From FINANCING ACTIVITIES Which do you think is most important in assessing the firm’s prospects? Why? Defining these activities may help answer the question...

Fruit

Businesses are like Fruit Trees…

Operating Activities

Investing Activities

Financing Activities

Net Earnings

Reinvested

Debt Payment Dividends

Goods & Services

Investment in Producing Assets

Debt Financing Equity Financing

Branches Trunk &

Roots

The 3 basic activities involved in conducting a business are: • 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): Once the capital is collected it is invested in producing assets, like buildings, equipment, machinery and vehicles. • Operating activities (Fruit): The assets are operated to produce goods & services which are sold to customers. The Net Income of these sales can be used in three ways: 2.

Reinvested in the producing assets

3.

Returned to the creditors in the form of debt payments

4.

Returned to the owners in the form of dividends

Operating Activities include: 

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Delivering or producing goods for sale and providing services The cash effects of transactions and other events that enter into the determination of income Examples: cash flows resulting from sales of goods, purchase of inventories, payment of operating expenses

Investing Activities include 

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Acquiring/disposing of securities that are not cash equivalents Acquiring/disposing of productive assets Lending money/collecting on loans

Financing Activities include 

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Borrowing from creditors/repaying the principal Obtaining resources from owners Providing owners with a return on investment

The three basic activities of businesses and their financial flows: Financial boundaries of the corporation Operating costs

Operating activities

Operating revenues

Purchase of assets

Investing activities

Sale of assets

Dividends, debt payments

Financing activities

Equity, debt

The 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 Flows

Funds Flow Statement  

Meaning of funds Procedure of preparing FFS Schedule of changes in working capital  Calculation of funds from operation  Preparing fund flow statement 

Meaning of Funds 

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Here, funds means all financial resources, specifically in context of FFS, funds means Working Capital. The flow of funds occurs when a transaction changes on the one hand a non-current account and on the other hand a current account and vice – verse. FFS is a statement which indicates various means by which the funds have been obtained during a certain period and the ways to which these funds have been

Statement of Changes in Working Capital Particulars

(A) Current Assets: Total (A) (B) Current Liabilities: Total (B) Working capital (A – B )

Previou s year

Current year

Incre Decre ase in ase in WC WC

Income Statement Sales Less: Cost of Goods Sold Gross Profit Less: Operating Expenses Operating Profit Add/Less: Non Operating Income or/and Expenses EBIT Less: Interest PBT Less: Tax PAT

Fund Flow Statement Sources

Amount

Funds from operation Issue of share capital Issue of debentures and raising long term loans Sales of non-current assets Non-trading receipts Decrease in WC

Equal

Applications Funds lost in operation Redemption of preference shares Repayment of long term loans and redemption of debentures Purchase of noncurrent assets Payment of dividend and tax Non – trading payments

Amount

Equal