Introduction To Basic Accounts_quantus Group
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The Quantus Group™ Elevating you
Pre MBA Programme 2009 Introduction to Accounting
Contents 01 Basic Rules in Accounting 02 Double Entry Accounting 03 Finalization of Accounts 04 Statements of Cash Flows 05 Accounting Ratios
7/31/2009
Content copyrighted by The Quantus Group™, 2009
2
01 Basic Rules in Accounting 7/31/2009
Content copyrighted by The Quantus Group™, 2009
3
Basic Rules of Accounting • • • • •
Assets - things you own. Liabilities - things you owe. Equity - overall net worth. Income - increases the value of your accounts. Expenses - decreases the value of your accounts.
7/31/2009
Content copyrighted by The Quantus Group™, 2009
4
Example • The cash in your bank account is an asset • The house rent that you pay is a liability
• Your pay cheque is income • The cost of dinner last night is an expense (unless
your date picked up the tab!).
7/31/2009
Content copyrighted by The Quantus Group™, 2009
5
Debit vs Credit? • Debits are positive numbers • Assets and expenses normally have debit balances • Credits are negative numbers • Liabilities, fund balance and revenues normally have credit balances
7/31/2009
Content copyrighted by The Quantus Group™, 2009
6
The Basic Accounting Rules Assets - Liabilities = Equity • Furthermore, you can increase your equity through income, and decrease equity through expenses. This makes sense of course, when you receive a paycheck you become "richer" and when you pay for dinner you become "poorer". This is expressed mathematically in what is known as the Accounting Equation: Assets - Liabilities = Equity + (Income - Expenses) • This equation must always be balanced, a condition that can only be satisfied if you enter values to multiple accounts. For example: if you receive money in the form of income you must see an equal increase in your assets. As another example, you could have an increase in assets if you have a parallel increase in liabilities.
7/31/2009
Content copyrighted by The Quantus Group™, 2009
7
The Three Rules of Accounting • To identify the effect of a transaction on a account there are rules: –For Personal Account: •Debit: •Credit:
the receiver the giver
-For Real Account: •Debit: •Credit:
what comes in what goes out
-For Nominal Account: •Debit: •Credit: 7/31/2009
all expenses and losses all incomes and gains Content copyrighted by The Quantus Group™, 2009
8
02 Double Entry Accounting
7/31/2009
Content copyrighted by The Quantus Group™, 2009
9
Double Entry Accounting • The basic accounting equation is the very heart of a double entry accounting system. For every change in value of one account in the Accounting Equation, there must be a balancing change in another. This concept is known as the Principle of Balance. • Double entry accounting serves two purposes. The first is to create an accounting trail, money always has to come from somewhere and go to somewhere. Additionally, double entry accounting historically served to double check the math of an accountant. Because the numbers are entered into multiple accounts simultaneously, there are multiple places to check to make sure the totals match. 7/31/2009
Content copyrighted by The Quantus Group™, 2009
10
Double Entry Accounting (cont.) • Accountants use the terms debit and credit to describe whether money is being transferred to or from an account. Money is recorded in the debit column, which is always the left column, when it is being transferred to an account. Money is recorded in the credit column, which is always the right column, when it is being transferred from an account. Money always flows from the right column of one account to the left column of another account. • The main rule of accounting is this: For every transaction, total debits must equal total credits. This is just another way of repeating the double entry rule, that for each transaction, the amount of money transferred from accounts must equal the amount transferred to other accounts 7/31/2009
Content copyrighted by The Quantus Group™, 2009
11
Important terms in accounting • • • • • • •
Debtors Creditors Assets Liabilities Income Expenses Account
7/31/2009
Content copyrighted by The Quantus Group™, 2009
12
03 Finalization of Accounts 7/31/2009
Content copyrighted by The Quantus Group™, 2009
13
Finalization of Accounts • At the close of every financial year, accounting books have to be “Finalized” as per law • At this juncture “Profit and Loss Account” and “Balance Sheets” are prepared. • All the expenses incurred throughout the year in the business are noted down cumulatively in the P&L Account • The Balance Sheet contains a list of all the assets and liabilities of the firm, as they stand at the end of the year
• This gives an exact picture of the financial condition of the firm at the end of the year. 7/31/2009
Content copyrighted by The Quantus Group™, 2009
14
P&L Account - Sample
7/31/2009
Content copyrighted by The Quantus Group™, 2009
15
Balance Sheet - Sample
7/31/2009
Content copyrighted by The Quantus Group™, 2009
16
04 Statement of Cash Flows
7/31/2009
Content copyrighted by The Quantus Group™, 2009
17
Statement of Cash Flows • What is cash flow statement? • Why cash flow statement? • How to prepare cash flow statement? – Cash from operating activities – Cash from financing activities – Cash from investing activities – Change in cash and cash equivalents
7/31/2009
Content copyrighted by The Quantus Group™, 2009
18
05 Accounting Ratios
7/31/2009
Content copyrighted by The Quantus Group™, 2009
19
Ratio Analysis • Accounting ratios is an expression showing the relationship between two figures of financial statement. Accounting ratios may be expressed in terms of fractions like 1/2 ,1/3 or rates like two times, three times or percentage like 10%, 20%, etc. Many times absolute figures do not help to understand the position of the concern & the final account & financial statements prepared there from may not reveal enough information which will help in decision making. Therefore ratio analysis is employed as a tool to analyze financial position & make logical inferences out of the same. There are three types of ratio:1) Balance Sheet ratios. 2) Revenue Statement ratios. 3) Combined ratios.
7/31/2009
Content copyrighted by The Quantus Group™, 2009
20
Important Ratios Balance Sheet Ratios
Revenue Statement Ratios
Combined Ratios
i) Current ratio ii) Quick ratio iii) Proprietary ratio iv) Debt Equity ratio
i) Gross profit ratio ii) Operating ratio iii) Stock- turnover ratio iv) Net profit ratio
i) Return on Investment ii) Return on Proprietor’s Fund iii) Return of Equity Capital iv) Earning per share v) Price earning ratio vi) Dividend Payout ratio vii) Debt Service ratio viii) Debtor’s turnover ratio ix) Creditors Turnover ratio
7/31/2009
Content copyrighted by The Quantus Group™, 2009
21
Current Ratio • Current ratio = Current Asset/Current Liabilities • It Indicates short term solvency or short term financial strength of company. • It shows whether the company is capable of paying off its short term commitments easily out of its current assets • Too high & too low ratios not desirable. A high current ratio indicates presence of idle funds whereas low ratio indicates inadequacy of funds.
7/31/2009
Content copyrighted by The Quantus Group™, 2009
22
Quick Ratio • Quick ratio = Quick Asset/Quick Liabilities • It Indicates immediate solvency / financial strength of company. • It shows whether the organization is in a position to pay its liabilities within a very short period of time out of assets which can realize money quickly.
7/31/2009
Content copyrighted by The Quantus Group™, 2009
23
Proprietary Ratio • Proprietary Ratio = Share holders Funds / Total Assets • Total Assets = Fixed Assets + Investments + Current Assets. • It Indicates long term solvency or long term financial strength of company. • Proprietors funds should be equal to atleast fixed assets but it may not be possible in all industries.
7/31/2009
Content copyrighted by The Quantus Group™, 2009
24
Debt Equity Ratio • Debt Equity Ratio = Debt Funds / Equity Funds • It Indicates borrowing capacity of organization & emphasizes that more the borrowing, the more is the rate of return for owners. • However there should be a suitable compromise as far as this ratio is concerned. • In earlier years business should have more owned funds whereas after establishment i.e. in subsequent years business should resort to more external funds.
7/31/2009
Content copyrighted by The Quantus Group™, 2009
25
Gross Profit Ratio • Gross Profit ratio = GPX100/ Sales\ • It shows the trading efficiency of management. • It should be sufficient enough to cover operating and nonoperating expenses to assure final profits.
7/31/2009
Content copyrighted by The Quantus Group™, 2009
26
Stock Turnover Ratio • Stock – Turnover Ratio = Cost of goods sold / Average Stock • It shows amount blocked in stock & how fast it can be converted into sales & finally cash. • It indicates efficiency of company in inventory management. • Sometimes too high ratio also indicates a possibility of stock out.
7/31/2009
Content copyrighted by The Quantus Group™, 2009
27
Return on Investment or capital employed • ROI = NP before tax & Interest/ Capital Employed • It Indicates management efficiency in utilizing shareholder’s & borrowed funds. & is a clear index of earning capacity. • Higher ratio indicates higher returns & hence can attract additional funds from lenders. • Higher earning power indicate more punctual repayment of interest & principal amount.
7/31/2009
Content copyrighted by The Quantus Group™, 2009
28
Return on Proprietors Funds • Return on net worth = NP after tax and interest / Net Worth • It indicates profitability on proprietor’s funds and efficiency of company in utilizing shareholder’s fund. • It is used by share holders before investing additional funds into business. • Higher profitability attracts higher funds from shareholders & can also increase market price of shares in anticipation of higher dividends & bonus shares.
7/31/2009
Content copyrighted by The Quantus Group™, 2009
29
Return on Equity Capital • Ret on Eq,Capital = Pt. after tax – Pref Dividend / Equity Capital • It indicates earning for equity holders and management’s efficiency in utilizing equity capital. • Dividend percentage is also determined on the basis of above ratio after taking decisions of retention of some portion of profit for expansion of diversification schemes.
7/31/2009
Content copyrighted by The Quantus Group™, 2009
30
Earnings per share • EPS = (NP after tax - Pref Div) / No. of eq. Shares • It indicates absolute earning per share which affect a market prices of shares. • High EPS encourages prospective investors.
7/31/2009
Content copyrighted by The Quantus Group™, 2009
31
Price Earning Ratio • Price Earning ratio = MPS / EPS • It indicates market price as compared to earning per share. • Lower ratio generally attracts investors for purchase of share.
7/31/2009
Content copyrighted by The Quantus Group™, 2009
32
Dividend Payout Ratio • Dividend – payout ratio = (DPSX100) / EPS • It indicates extent of dividend declared out of earnings. • Lower ratio indicates greater portion kept for self financing. • Short term investors are always interested in higher ratio & vice versa for long terms investors.
7/31/2009
Content copyrighted by The Quantus Group™, 2009
33
Debt service coverage ratio • DSCR = (NP bef int tax and dep) / Interest +Installment due in next year • It indicates ability to meet current interest & instalment due. • It is an index of long term solvency. • Higher ratio indicates more safety for lenders.
7/31/2009
Content copyrighted by The Quantus Group™, 2009
34
Debtor Turnover ratio and collection period • Drs turnover ratio = Sales / Average receivables • It indicates efficiency of company in management of account receivables. • Higher the index, better is the ratio & result.
7/31/2009
Content copyrighted by The Quantus Group™, 2009
35
Creditors turnover ratio and average payment period • Crs Turnover ratio = Purchase / Average Payables • It helps to know creditor’s velocity i.e. average period offered by suppliers for making payment. • Lower the turnover, better is the result as it indicates more period offered by suppliers to make payment.
7/31/2009
Content copyrighted by The Quantus Group™, 2009
36
Importance of Ratios in financial statement analysis • • • •
Liquidity Position and working capital financing Minimum permissible bank finance Profitability ratio ROCE, dividend payout ratio, PE ratio and the investors preferences.
7/31/2009
Content copyrighted by The Quantus Group™, 2009
37
Exercise Class Exercise on Ratios…..
7/31/2009
Content copyrighted by The Quantus Group™, 2009
38
Pre MBA Programme 2009 Introduction to Accounting
Contents 01 Basic Rules in Accounting 02 Double Entry Accounting 03 Finalization of Accounts 04 Statements of Cash Flows 05 Accounting Ratios
7/31/2009
Content copyrighted by The Quantus Group™, 2009
2
01 Basic Rules in Accounting 7/31/2009
Content copyrighted by The Quantus Group™, 2009
3
Basic Rules of Accounting • • • • •
Assets - things you own. Liabilities - things you owe. Equity - overall net worth. Income - increases the value of your accounts. Expenses - decreases the value of your accounts.
7/31/2009
Content copyrighted by The Quantus Group™, 2009
4
Example • The cash in your bank account is an asset • The house rent that you pay is a liability
• Your pay cheque is income • The cost of dinner last night is an expense (unless
your date picked up the tab!).
7/31/2009
Content copyrighted by The Quantus Group™, 2009
5
Debit vs Credit? • Debits are positive numbers • Assets and expenses normally have debit balances • Credits are negative numbers • Liabilities, fund balance and revenues normally have credit balances
7/31/2009
Content copyrighted by The Quantus Group™, 2009
6
The Basic Accounting Rules Assets - Liabilities = Equity • Furthermore, you can increase your equity through income, and decrease equity through expenses. This makes sense of course, when you receive a paycheck you become "richer" and when you pay for dinner you become "poorer". This is expressed mathematically in what is known as the Accounting Equation: Assets - Liabilities = Equity + (Income - Expenses) • This equation must always be balanced, a condition that can only be satisfied if you enter values to multiple accounts. For example: if you receive money in the form of income you must see an equal increase in your assets. As another example, you could have an increase in assets if you have a parallel increase in liabilities.
7/31/2009
Content copyrighted by The Quantus Group™, 2009
7
The Three Rules of Accounting • To identify the effect of a transaction on a account there are rules: –For Personal Account: •Debit: •Credit:
the receiver the giver
-For Real Account: •Debit: •Credit:
what comes in what goes out
-For Nominal Account: •Debit: •Credit: 7/31/2009
all expenses and losses all incomes and gains Content copyrighted by The Quantus Group™, 2009
8
02 Double Entry Accounting
7/31/2009
Content copyrighted by The Quantus Group™, 2009
9
Double Entry Accounting • The basic accounting equation is the very heart of a double entry accounting system. For every change in value of one account in the Accounting Equation, there must be a balancing change in another. This concept is known as the Principle of Balance. • Double entry accounting serves two purposes. The first is to create an accounting trail, money always has to come from somewhere and go to somewhere. Additionally, double entry accounting historically served to double check the math of an accountant. Because the numbers are entered into multiple accounts simultaneously, there are multiple places to check to make sure the totals match. 7/31/2009
Content copyrighted by The Quantus Group™, 2009
10
Double Entry Accounting (cont.) • Accountants use the terms debit and credit to describe whether money is being transferred to or from an account. Money is recorded in the debit column, which is always the left column, when it is being transferred to an account. Money is recorded in the credit column, which is always the right column, when it is being transferred from an account. Money always flows from the right column of one account to the left column of another account. • The main rule of accounting is this: For every transaction, total debits must equal total credits. This is just another way of repeating the double entry rule, that for each transaction, the amount of money transferred from accounts must equal the amount transferred to other accounts 7/31/2009
Content copyrighted by The Quantus Group™, 2009
11
Important terms in accounting • • • • • • •
Debtors Creditors Assets Liabilities Income Expenses Account
7/31/2009
Content copyrighted by The Quantus Group™, 2009
12
03 Finalization of Accounts 7/31/2009
Content copyrighted by The Quantus Group™, 2009
13
Finalization of Accounts • At the close of every financial year, accounting books have to be “Finalized” as per law • At this juncture “Profit and Loss Account” and “Balance Sheets” are prepared. • All the expenses incurred throughout the year in the business are noted down cumulatively in the P&L Account • The Balance Sheet contains a list of all the assets and liabilities of the firm, as they stand at the end of the year
• This gives an exact picture of the financial condition of the firm at the end of the year. 7/31/2009
Content copyrighted by The Quantus Group™, 2009
14
P&L Account - Sample
7/31/2009
Content copyrighted by The Quantus Group™, 2009
15
Balance Sheet - Sample
7/31/2009
Content copyrighted by The Quantus Group™, 2009
16
04 Statement of Cash Flows
7/31/2009
Content copyrighted by The Quantus Group™, 2009
17
Statement of Cash Flows • What is cash flow statement? • Why cash flow statement? • How to prepare cash flow statement? – Cash from operating activities – Cash from financing activities – Cash from investing activities – Change in cash and cash equivalents
7/31/2009
Content copyrighted by The Quantus Group™, 2009
18
05 Accounting Ratios
7/31/2009
Content copyrighted by The Quantus Group™, 2009
19
Ratio Analysis • Accounting ratios is an expression showing the relationship between two figures of financial statement. Accounting ratios may be expressed in terms of fractions like 1/2 ,1/3 or rates like two times, three times or percentage like 10%, 20%, etc. Many times absolute figures do not help to understand the position of the concern & the final account & financial statements prepared there from may not reveal enough information which will help in decision making. Therefore ratio analysis is employed as a tool to analyze financial position & make logical inferences out of the same. There are three types of ratio:1) Balance Sheet ratios. 2) Revenue Statement ratios. 3) Combined ratios.
7/31/2009
Content copyrighted by The Quantus Group™, 2009
20
Important Ratios Balance Sheet Ratios
Revenue Statement Ratios
Combined Ratios
i) Current ratio ii) Quick ratio iii) Proprietary ratio iv) Debt Equity ratio
i) Gross profit ratio ii) Operating ratio iii) Stock- turnover ratio iv) Net profit ratio
i) Return on Investment ii) Return on Proprietor’s Fund iii) Return of Equity Capital iv) Earning per share v) Price earning ratio vi) Dividend Payout ratio vii) Debt Service ratio viii) Debtor’s turnover ratio ix) Creditors Turnover ratio
7/31/2009
Content copyrighted by The Quantus Group™, 2009
21
Current Ratio • Current ratio = Current Asset/Current Liabilities • It Indicates short term solvency or short term financial strength of company. • It shows whether the company is capable of paying off its short term commitments easily out of its current assets • Too high & too low ratios not desirable. A high current ratio indicates presence of idle funds whereas low ratio indicates inadequacy of funds.
7/31/2009
Content copyrighted by The Quantus Group™, 2009
22
Quick Ratio • Quick ratio = Quick Asset/Quick Liabilities • It Indicates immediate solvency / financial strength of company. • It shows whether the organization is in a position to pay its liabilities within a very short period of time out of assets which can realize money quickly.
7/31/2009
Content copyrighted by The Quantus Group™, 2009
23
Proprietary Ratio • Proprietary Ratio = Share holders Funds / Total Assets • Total Assets = Fixed Assets + Investments + Current Assets. • It Indicates long term solvency or long term financial strength of company. • Proprietors funds should be equal to atleast fixed assets but it may not be possible in all industries.
7/31/2009
Content copyrighted by The Quantus Group™, 2009
24
Debt Equity Ratio • Debt Equity Ratio = Debt Funds / Equity Funds • It Indicates borrowing capacity of organization & emphasizes that more the borrowing, the more is the rate of return for owners. • However there should be a suitable compromise as far as this ratio is concerned. • In earlier years business should have more owned funds whereas after establishment i.e. in subsequent years business should resort to more external funds.
7/31/2009
Content copyrighted by The Quantus Group™, 2009
25
Gross Profit Ratio • Gross Profit ratio = GPX100/ Sales\ • It shows the trading efficiency of management. • It should be sufficient enough to cover operating and nonoperating expenses to assure final profits.
7/31/2009
Content copyrighted by The Quantus Group™, 2009
26
Stock Turnover Ratio • Stock – Turnover Ratio = Cost of goods sold / Average Stock • It shows amount blocked in stock & how fast it can be converted into sales & finally cash. • It indicates efficiency of company in inventory management. • Sometimes too high ratio also indicates a possibility of stock out.
7/31/2009
Content copyrighted by The Quantus Group™, 2009
27
Return on Investment or capital employed • ROI = NP before tax & Interest/ Capital Employed • It Indicates management efficiency in utilizing shareholder’s & borrowed funds. & is a clear index of earning capacity. • Higher ratio indicates higher returns & hence can attract additional funds from lenders. • Higher earning power indicate more punctual repayment of interest & principal amount.
7/31/2009
Content copyrighted by The Quantus Group™, 2009
28
Return on Proprietors Funds • Return on net worth = NP after tax and interest / Net Worth • It indicates profitability on proprietor’s funds and efficiency of company in utilizing shareholder’s fund. • It is used by share holders before investing additional funds into business. • Higher profitability attracts higher funds from shareholders & can also increase market price of shares in anticipation of higher dividends & bonus shares.
7/31/2009
Content copyrighted by The Quantus Group™, 2009
29
Return on Equity Capital • Ret on Eq,Capital = Pt. after tax – Pref Dividend / Equity Capital • It indicates earning for equity holders and management’s efficiency in utilizing equity capital. • Dividend percentage is also determined on the basis of above ratio after taking decisions of retention of some portion of profit for expansion of diversification schemes.
7/31/2009
Content copyrighted by The Quantus Group™, 2009
30
Earnings per share • EPS = (NP after tax - Pref Div) / No. of eq. Shares • It indicates absolute earning per share which affect a market prices of shares. • High EPS encourages prospective investors.
7/31/2009
Content copyrighted by The Quantus Group™, 2009
31
Price Earning Ratio • Price Earning ratio = MPS / EPS • It indicates market price as compared to earning per share. • Lower ratio generally attracts investors for purchase of share.
7/31/2009
Content copyrighted by The Quantus Group™, 2009
32
Dividend Payout Ratio • Dividend – payout ratio = (DPSX100) / EPS • It indicates extent of dividend declared out of earnings. • Lower ratio indicates greater portion kept for self financing. • Short term investors are always interested in higher ratio & vice versa for long terms investors.
7/31/2009
Content copyrighted by The Quantus Group™, 2009
33
Debt service coverage ratio • DSCR = (NP bef int tax and dep) / Interest +Installment due in next year • It indicates ability to meet current interest & instalment due. • It is an index of long term solvency. • Higher ratio indicates more safety for lenders.
7/31/2009
Content copyrighted by The Quantus Group™, 2009
34
Debtor Turnover ratio and collection period • Drs turnover ratio = Sales / Average receivables • It indicates efficiency of company in management of account receivables. • Higher the index, better is the ratio & result.
7/31/2009
Content copyrighted by The Quantus Group™, 2009
35
Creditors turnover ratio and average payment period • Crs Turnover ratio = Purchase / Average Payables • It helps to know creditor’s velocity i.e. average period offered by suppliers for making payment. • Lower the turnover, better is the result as it indicates more period offered by suppliers to make payment.
7/31/2009
Content copyrighted by The Quantus Group™, 2009
36
Importance of Ratios in financial statement analysis • • • •
Liquidity Position and working capital financing Minimum permissible bank finance Profitability ratio ROCE, dividend payout ratio, PE ratio and the investors preferences.
7/31/2009
Content copyrighted by The Quantus Group™, 2009
37
Exercise Class Exercise on Ratios…..
7/31/2009
Content copyrighted by The Quantus Group™, 2009
38
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