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MODULE 1
Financial accounting
Meaning :- financial accounting may be defined as the recording and classifying the
business transactions and prepared summaries of the same for determining the year end of
profit or loss and financial position of the concern.
Function
● Recording of information :- accounting is an art of recording financial facts of a
concern. The information is recorded in journal and other subsidiary books
● Classification of data :- the classification of information means that data of one
nature is placed at one place. This is done in the book called ledger
● Dealing with financial transaction :- only those transactions are recorded which are
measurable in terms of money
● Communicating Results:- financial accounting is not only concerned with recording
of facts and figures but it is also connected with the communication of results.
Limitations of financial accounting
● Historical nature :- financial accounting is historical in nature in the sense that it is a
record of all those transactions which have taken place in the business during a
particular period of time
● Provide information about the concern as a whole:- in financial accounting
information is recorded for the whole concern
● Cost control not possible :- cost control is not possible in financial accounting. The
cost figures are known only at the end of the financial period
● Not helpful in price fixation :- the cost of a product can be obtained only when all
expenses have been incurred
● Only actual cost recorded :- financial accounting records only actual cost figures.
The amount paid for purchasing materials, property or other asset is recorded in
account book
● Quantitative information :- financial accounting records only that information which
can be quantitatively measured
Costing
Meaning:-
It is the technique and process of ascertaining cost, technique means body of principles and
rules by which the cost is ascertained and the process means classification, recording and
allocation of expenditure of the product or service
Definition:-
According to Harley <costing is the study of expenses incurred in manufacturing a product
and conducting a business in such a manner that the expenses are analyse and classified
so as to enable the actual cost of any particular process or unit of production to be
determined with a minimum of error=
Cost accounting
Meaning:- Cost accounting means the process of recording, classifying, allocating and
reporting various costs incurred in the operation of an enterprise. It is also a format system
of recording, analyzing and reporting cost data for the managerial process.
Definition :- According to the Institute of cost and management accounting <cost accounting
is the application of ghosting and cost accounting principlesl,

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methods and techniques to the science, art and practice of cost control and ascertainment of
profitability. It includes the presentation of information drive there from for the purpose of
managerial decision making.”
Features of cost accounting
● It is concerned with presentation of cost for cost reduction and cost control
● It determines the total and per unit cost of products and service
● It is both a science as well as an art
● It is a system which uses budgets,standard cost,marginal cost as a tool for planning
and control
Scope of cost accounting
● Cost ascertainment:- call singer refers to the techniques and processes of
ascertaining cost
● Cost principle
● Cost audit:- according to the official terminology of the ICM a ghost old is the
verification of the characters of cost account and a check on the adherence to the
cost accounting plan
● Budgetary control:- budget control is a system of controlling cost which includes the
preparation of budgets, department and extrapolation responsibilities comparing
actual performance with the budgeted and acting upon result to achieve maximum
profitability
Objectives or functions of cost accounting
● Analysis and ascertainment of cost
● Preparation of cost for cost reduction and cost control
● Planning and decision making
Advantage
@Advantages to management
1. Supply details of cost information
2. Facilitates planning
3. Price-fixing
4. Helps in decision-making
5. Facilitates cost controlling
6. Inter firm comparison
7. Helps in future prospectus
@ advantages to employees
1. To adopt correct page policy
2. To find efficient and inefficient workers
3. Security of job
@Advantages to government
1. To adopt National plans
2. Import and export policy
3. Reliable policy
4. Taxation policy
@Advantages to public
1. Good and services low in price
@ advantages to creditors
1. Shares increases they become happy

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Limitations of cost accounting

● It is not an independent tool
● Problem of a portion in efficient
● Problem of recon selling cost account and financial account
MANAGEMENT ACCOUNTING
Meaning :- Management accounting is comprised of two words management and
accounting. It is the study of managerial aspect of accounting.
Definition :- According to TG Rose "Management accounting is the adaptation and analysis
of accounting information and its diagnosis and explanation in such a way as to assist
management"
Characteristics or nature of Management Accounting
● Providing Accounting information :- the collection and classification of data is the
primary function of accounting department
● Use of special techniques and concepts :- Management Accounting uses special
techniques and concepts to make accounting data more useful
● Taking important decisions :- Management Accounting helps in taking various
important decisions
● Achieving of objectives :- in management accounting the accounting information is
used in such a way that it helps in achieving organisational objectives
● Increase in efficiency :- the purpose of using accounting information is to increase
efficiency of the concern
Scope of Management Accounting
● Financial Accounting :- financial accounting deals with the historical data. The
recorded facts about an organisation are useful for planning the future course of
action.
● Cost accounting:- cost accounting provides various techniques for determining cost
of manufacturing product for cost of providing service
● Financial management:- Financial Management is concerned with the planning and
controlling of the financial resources of the firm
● Budgeting and forecasting:- budgeting means expressing the plans, policies and
goals of the enterprise for a definite period in future. Forecasting is a judgement
where as budgeting is an organisational object
● Reporting to management
● Control procedures and methods
● Internal audit
● Tax accounting
Objectives of Management Accounting
● Planning and policy formulation:- the object of management accounting is to supply
necessary data to the management for formulating plants
● Helpful in controlling performance :- Management Accounting devices like standard
costing and budgetary control are helpful in controlling performance
● Helpful in organising :- organisation is related to the external assessment of
relationship among different individuals in the conserve
● Helpful in making decisions
● Helpful in coordination
● Helpful in tax administration

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Functions of Management Accounting

● Planning and forecasting
● Modification of data
● Financial analysis and interpretation
● Facilitate managerial control
● Communication
● Use of qualitative information
Difference between financial accounting and Management Accounting

Point of distinction Financial accounting Management Accounting

Object The object is to record The main objective is to

various transactions and to provide information to
know the financial position management for formulating
and to find out profit or loss policies and plans
at the end of the financial
year

Subject matter It is concerned with It deals separately with

assessing the results of the different units,departments
business as a whole and cost centres

Legal compulsion The preparation of financial It is not compulsory. it is

accounts is compulsory in only a service function and
certain undertakings while is helpful in administration of
these are necessity in the business
others

Reporting Financial reports are Management Accounting

prepared not only for the reports are meant for
benefit of the concern but internal use only
also for outsiders

Period Financial accounts are Which supplies information

prepared for a particular from time to time during the
period whole year

Description It records only those It uses both monetary and

transactions which can be non-monetary events or
measured in monetary information
terms
Difference between cost and Management Accounting

Point of difference Cost accounting Management Accounting

Object The object of cost The purpose of

accounting is to record the management accounting is
cost of producing a product to provide information to the
or providing a service management for

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planning,coordinating,
decision making and control

Nature Cost accounting uses both It is generally concerned

past and present figures with the projection of figures
for the future

Data used Only quantitative aspect is It uses both quantitative

recorded and qualitative information

Development The development of cost Has developed only in the

accounting is related to last 40 years
industrial revolution

Principles followed Certain principles and No specific rules and

procedures are followed for procedures are followed in
recording cost of different reporting Management
products Accounting
Need and importance of Management Accounting
● Increases efficiency
● Proper planning
● Measurements of performance
● Maximizing profitability
● Effective management control
Limitations of Management Accounting
● Based on accounting information:- Management accounting is based on data
supplied by financial and cost accounting
● Lack of knowledge:- the use of Management Accounting records the knowledge of a
number of related subjects
● Top heavy structure:- the installation of a Management Accounting system needs
and elaborate organisational system
● Evolutionary stage:- Management accounting is only in a developmental stage
● Physiological resistance :- the installation of Management Accounting involves basic
change in organisational setup
Cost accountant
He analyses coast, record and inform management is there is finding any problem. The main
duty to estimates, budget account.
Cost
According to ICMA cost is defined as” the amount of expenditure incurred on or attribute to a
given thing. It represents the source that has been or must be sacrificed to attain a particular
objective”
Expense
The amount spent in the process of earning revenue
Eg:Wages, salary, rent
Expenditure
It is the amount of resource consumed for long period of time.
Elements of cost
1. Direct cost

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2. Indirect cost
Direct cost :-It is refers to these cost which can be clearly or easily traced by identified with
a job, product etc
● Direct material:-it refers to the cost of material used for specific product or service. It
is that material which can be identified in the product and conveniently measured and
charged to the product. Eg: wood in furniture,Cost of sugarcane manufacturing sugar
● Direct labour:-it is defined as the cost of remunerated for employer effort and still
applied directly to the product or service and which can be identified separately in
product cost.eg:Wages paid at the carpenter for manufacturing furniture
● Direct expense:Expenses other than direct material or direct labour which are
specifically occurring for a particular product or known as direct labour. Example,
royalty paid for manufacturing a product, excise duty
Indirect cost :-Indirect cost are those costs which are of a general nature and are not
directly chartable to a particular product. These cannot be identified conveniently with the
output.
● Indirect material:-Material which do not form part of a product or indirect material.
The material is of very small value are also treated as indirect material. example, oil
used in manufacturing of machine Greece lubricants
● Indirect labour:-All human force which is directly spent in the manufacturing of a
product or output comes under the category.eg: salary paid to Clark, remuneration
paid to managers
● Indirect expense:-expenses which are not directly related to product or service or
known as indirect expenses. These cannot be allocated conveniently and whotly any
product or process. Example, insurance premium, water charge, advertisement.
Difference between cost account and financial account

Basis financial account cost account

Coverage It covers business or in the Manufacturing and sale of

commercial activity goods and service

classification They are also considering Controllable, uncontrollable,

income, expenses Fixid, variable

approach After record, analyse all it has forward looking

expenses

stock Valued at market price and always valued at cost price

cost price

inter firm comparison Low Good

entity Particular principles rules Not independent, only

are there (independent ) independent when the
details get from financial
account

Wastage No category Way stages are categorised

as normal, abnormal

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Cost centre
Cost centre is the smallest segment or such unit of an organisation for which cost is
collected separately.
Cost sheet
It is a detailed statement to all these elements of cost. it arranged in a logical order in
different heads in a particular statement.
● Direct material = opening stock + purchase - closing stock
● Direct material + direct labour + direct expenses = prime cost
● Prime Cost + works overhead(indirect labour, indirect material, indirect expenses) =
work cost or factory cost or production cost or manufacturing cost
● Work cost + administrative overhead = cost of production
● Cost of production + selling and distribution overhead = cost of sales
● Cost of sales - sales = profit/ loss
Factory cost
It is also known as work cost, production cost, manufacturing cost. It also refers to the total
cost incurred in the production stage.
Factory cost = Prime cost + factory overhead cost
Factory overhead cost :-cost refers to the cost of indirect material, labour and expenses in a
factory. Example, factory rent, insurance, depreciation etc
Cost of production
It is also known as office cost
Cost of production = factory cost + office and administrative overhead.
Administative overhead
Administrative overhead refers to all costs that are incurred in the management
Eg: maintenance of accounting records, office records.
Cost of goods sold
Cost of good sold = cost of production + cost of opening stock of finished goods -cost of
closing stock of finished goods.
Cost of sales
What is the sum total of goods sold and selling and distribution overhead

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COST BEHAVIOR, MARGINAL COSTING AND BREAK EVEN ANALYSIS

Fixed cost:-fixed cost also refers to unknown variable cost, stand by cost, period cost or
capacity cost are those costs which do not vary you with changes in oldham of output power a
given period of time and within a relevant range of activities.
Fixed cost is further classified into two categories,
● Committed fixed cost:-committed cost of those fixed cost which are caused by
investment in fixed assets such as building a plant or equipment for providing production
facilities
Eg:-depreciation insurance and property taxes
● Discretionary fixed cost:-discretionary cost, also referred to as programmed or managed
cost are those fixed cost the amount of which is decided by the management.
Eg:-research and development cost, advertising cost coma expenses in court on human
resource development, public relations.
Variable costs:-variable cost are those costs which fluctuate in total, in direct proportion to the
volume of output.such cost increase in aggregate as the output increase and decrease in the
same proportion when the output falls.
Semi-variable costs:-semi variable cost are a combination of fixed and variable cost and are,
also known as mixed cost.such cost our nails perfectly variable not absolutely fixit in relation to
changes in the volume of output .'The fixed components of such cost represents the cost of
providing capacity and the variable component is caused by using the capacity.'
Marginal cost
Definition:-according to the terminology of cost accountants of the institute of cost and
Management accountants, London and then marginal cost represents "the amount of any given
volume of output by which aggregate cost are changed if the volume of output is increased by
one unit".
Marginal costing
Definition:-The institute of cost and Management accountants London has defined marginal
costing as" the ascertainment of marginal cost and of the effect on profit of changes in oleum or
type of output by differentiating between fixed cost and variable cost."
Basic characteristics of marginal costing
● All elements of cost-production administration and selling and distribution are classified
into variable and fixed components. Even semi- variable cost are analysed into fixed and
variable.
● The variable cost are regarded as the cost of products
● fixed cost are treated as period cost and are charged to profit and loss account for the
period for which they are incurred
● the stocks of finished goods and work-in-process are valued at marginal cost only.
● Price of determined on the basis of marginal cost by adding contribution which is the axis
of sales of selling price over marginal cost of sales
Assumptions of marginal costing
● All all the elements of cost-production administration and selling and distribution can be
segregated into fixed and variable components
● the selling price per unit remains unchanged or constant at all the levels of activity

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● Fixed cost remain unchanged for constant for the entire volume of production
● the volume of production or output is the only factor which influences the cost
Cost- volume-profit analysis (CVP)
Meaning:-cost hai phone oleum I find profit analysis is a technique for study the relationship
between cost, volume and profit. Profit of an undertaking depend upon a large number of factors
but the most important of these factors are the cost of manufacture of sales and the selling price
of the product.
Definition:-according to Herman C. Heiser "the most significant single factor in profit planning
of the average business is the relationship between the old name of the business, cost and
profit"
Main objectives of cost-volume- profit analysis
● The CVP analysis may be used in determining the break even point
● Fixation of selling prices
● Selecting the suitable product or sales mix
● Determining the optimum level of activity
● Evaluating the performance
Assumptions of CVP analysis
● All elements of cost can be a segregated into fixed and variable components
● Fixed cost remain unchanged for constant for the entire volume of production
● productivity and efficiency of operations are remain constant at various level of operation
● The selling price per unit remains unchanged or constant at all levels of activity
● The volume of production or output is the only factor which influences the cost
● Total cost and total revenue are linear function of output
TECHNIQUES OR ELEMENTS OF COST- VOLUME- PROFIT ANALYSIS
1)contribution margin concept:-contribution is the difference between sales and variable cost
or marginal cost of sales full stop it may also be defined as the excess of selling price over
variable cost per unit. Contribution=Sales - Variable cost
Contribution (per unit)=Selling Price -Variable cost per unit
Contribution=Fixed cost+profit
Advantage of contribution
● It helps the management in the fixation of selling prices
● It assist in determining the break even point
● it helps management in the selection of a suitable product mix for profit maximization
● It helps in taking a decision as regards to adding a new product in the market
2) Marginal cost equation:-
● Sales-Variable cost=Contribution
● Sales=Variable cost+Fixed cost+/-profit/loss
● Sales-Variable cost+Fixed cost+/-profit/loss
S-V=F+/-P
3)Profit/volume ratio(P/V ratio or C/S ratio)
P/V ratio= Contribution
Sales
Since contribution=Sales-Variable cost=Fixed cost+profit
P/V ratio=Sales-Variable cost ie.S-V

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Sales. S
P/V ratio=Fixed cost+Profit ie.F+P
Sales. S
P/V ratio= change in profit or contribution
Change in sales
the ratio can be increased by increasing the contribution. This can be done by
● Increasing the selling price per unit
● Reducing the variable or marginal cost
● Changing the sales mixture and selling more profitable products for which the PV ratio is
higher
4) Break-even analysis
The study of cost-volume profit analysis is often referred to as break-even analysis and the two
terms are used in the charge believed by many.
Assumptions of break even analysis
● Fixed cost elements constant at all volumes of output
● selling price per unit remains unchanged or constant at all levels of output
● Volume of production is the only factor that influences cost
● They will be no change in the general price level
● There is only one product or in case of multi products, the sales mix remain unchanged
● There is synchronisation between production and sales
Break even point
the break even point may be defined as that point of sales emporium at which total revenue is
equal to total cost. It is a point of no profit no loss.the break-even point refers to that level of
output which evenly breaks the cost and revenue and hence the need to stop at this point
contribution sales minus marginal cost, equals the fixed cost and hence this point is often called
critical point or equilibrium point or balancing point.
Sales revenue at break-even point=fixed costs + variable costs
Break-even point = fixed cost
Selling price per unit - variable cost per unit
= fixed cost
Contribution per unit
Assumptions of Break-even chart
● All costs can be separated into fixed and variable All costs can be separated into fixed
and variable cost
● Fixed cost remain constant at all levels of activity
● Selling price per unit remain constant at all levels of activity
● There is no opening or closing stock
● There will be no change in operating efficiency
● Product mix remains unchanged or there is only one product
Advantages or uses of break even chart
● Information provided by the break even chart is in make simple form and is clear and
understandable even to layman
● The break even chart is a managerial tool for control of cost as it shows the relative
importance of fixed costs in the total cost of a product

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● The break even chart can also be used to study the comparative plant efficiency of
business
Margin of safety
Meaning :- the excess of actual or budgeted sales over the break even sales is known as
margin of safety
Managerial uses of marginal costing
● Pricing decisions
● Make or buy decisions
● Problems of key or limiting factor
● Capital investment decisions
● Determination of optimum level of activity
● Effect of changes in sales price
● Exploring new market
Advantages of marginal costing and cvp analysis
● Simple to operate and easy-to-understand
● Helps Management in production planning
● Facility calculation of important factors like BEP
● Helps in cost control
● Profit planning
● Management reporting
Limitations or disadvantages of marginal costing and cvp analysis
● The technique of marginal costing is based upon a number of assumptions which may
not hold good under all circumstances
● All costs are not divisible into fixed and variable
● Variable cost do not always remain constant
● Fixed cost do not remain constant after a certain level of activity
● Fixation of selling prices
● It is difficult to use the cost volume profit analysis for a multi product firm or situation

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BUDGETARY CONTROL
Budget
Meaning :- yeah budget is the monetary aur quantity expression of business plants and policies
to be pursued in the future period of time
Definition:- According to Brown and Howard "a budget is a predetermined statement of
Management policy during a given period which provides a standard for comparison with the
results actually achieved"
Budgeting
Meaning :- budgeting is technique for formulating budgets
Objectives of budgetary control
● To co-ordinate the activities of different departments
● To operate various cost centres and departments with efficiency and economy
● Elimination of wastes and increase in profitability
● To anticipate capital expenditures for future
● To centralise the control system
Characteristics of good budgeting
● The targets of the budget should be a realistic
● A good system of accounting is also essential to make the budgeting successful
● The budgeting system should have a hearted support of the top management
Requisites for a successful budgetary control system
● Clarifying objectives
● Proper delegation of authority and responsibility
● Proper communication system
● Budget education
● Participation of all employees
● Flexibility
● Motivation
Essentials of budgetary control
● Organisation for budgetary control :- a proper organisation is essential for the successful
preparation, maintenance and administration of budgets
● Budget centres :- a budget Centre is that part of the organisation for which the budget is
prepared
● Budget manual:- budget manual is a document which spells out the duties and the also
the responsibility of the various executive concerned with the budgets
● Budget officer :- the chief executive who is at the top of the organisation appoints some
person as budget officer
● Budget period :- budget period is the length of time for which a budget is prepared
Difference between budgeting and forecasting

Budgeting Forecasting

Budgeting begins where forecasting ends Forecasting provides the logical basis for
preparing the budgets

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Budget provides a standard for comparison Focus represent merely a probable event
with the result actually achieved over which no control can be exercised

Budget relates to plant events and is the Forecast are merely well-educated estimates
quantitative expression of Budget relates to or interference about the future probable
plant events and is the quantitative events
expression of business plans and policies to
be pursued in the future
Advantages of budgetary control
● Maximisation of profit
● Proper co-ordination
● Provide specific AIMS
● Tool for measuring performance
● Corrective action
● Reduced cost
Limitations of budgetary control
● Uncertain future
● Revision required
● Problems of coordination
● Depends upon support of top management
Classification and types of budgets

1) classification according to time

❤ Long term budgets :- the budgets are prepared to depict long-term planning of the business.
The period of long term budgets varies between 5 to 10 years
❤ Short term budgets :- these budgets of generally for one or two years and are in the form of
monetary terms
❤ Current budgets :- the period of current budgets is generally of month and weeks.

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2) classification on the basis of functions

❤ Operating budgets :- these budgets related to the different activities or operation of the firm
Sales budget, production budget, production cost budget, purchase budget,raw material
budget, labour budget, plant utilisation budget,manufacturing expenses or work overhead
budget, administrative and selling expenses budget.
The operating budget of a firm is broadly classified into two
● Programme budget :- it consists of expected revenues and the cost of various product
or project that are termed as the major programs of the firm
● Responsibility budget :- when the operating budget of a firm is constructed in terms of
responsibility area it is called the responsibility budget
❤ financial budget :- financial budgets are concerned with cash receipts and disbursement,
working capital capital,expenditure, financial position and results of business operation
❤ master budget :- various functional budgets are integrated master budget. This budget is
prepared by the ultimate integration of separate functional budgets
3) classification on the basis of flexibility
● Fixed budget :- the fixed budget prepared for a given level of activity, the budget is
prepared before the beginning of the financial year
● Flexible budgets :- a flexible a flexible budget consists of a series of budgets for
different level of activity.
Difference between a fixed and variable budget

Basis of distinction Fixed budget Flexible budget

Conditions A fixed budget assumes that This budget is changed if

condition will remain constant level of activity varies

Cost classification In fixed budget cost are not The Costa studied as per
classified according to their their nature
nature

Changes in volume If the level of activity The budget are drafted as

changes then budgeted and per the change the volume
actual resource cannot be and take comparison
compared because of change between budgeted and actual
in basis figures will be possible

Forecasting Forecasting of accurate Flexible but there is clearly

result is difficult shown the impact of
expenses on operations and
it helps in making accurate
forecast

Cost ascertainment Under changed The cost can be easily

circumstances cost cannot be ascertained under different
ascertained levels of activity
Production budget
The production budget is prepared in relation to the sale budget

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The preparation of production budget involves the following stages

● Production planning
● Consideration of plant capacity
● Stock quantity to be held
● Considering sales budget
Cost of production budget
The production budget determines the number of units to be produced.
Cash budget
Hay cash budget Kishan estimation of cash receipts and disbursements during a future period
of time. The cash budget is an analysis of flow of cash in a business over a future, short or long
period of time.

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FINANCIAL STATEMENTS,
Definition
Smith and Ashburne , defines, ‘financial statements as ‘ the end product of financial
accounting is a set of financial statements prepared by the accountant of a business
enterprise – that purport to reveal the financial position of the enterprise, the result of its
recent activities, and an analysis of what has been done with earnings”
Nature of financial statement
[1] Recorded Facts :-
Record is made only of those facts which can be expressed in monetary terms. Facts which
have not been recorded in the financial books are not depicted in the financial statements.
[2] Accounting Conventions :-
In spite of the accounting standards laid down by the various accounting bodies,
management of concerns are free to choose an accounting policy suited to their concern.
[3]Personal Judgment :-
Personal judgment plays a great part while dealing in various questions like method and rate
of depreciation to be adopted, valuation of inventories, provision for bad and doubtful debts,
amortization of fictitious assets, etc.
[4] postulates :-
The accountant makes certain assumptions while making accounting records. One of these
assumptions is that the enterprise is treated as a Going Concern. The assumption is known
as realisation postulate
Objectives of financial statements
● To provide reliable financial information about economic resources and applications
of a business firm
● To provide other needed information about changes in such economic resources and
regulations
● To provide reliable information about changes in net resource arising out of business
activities
● To provide financial information that assist in estimating the To provide financial
information that assist in estimating the earning potentials of business earning
Types of financial statements

1) balance sheet
The American institute of certified public Accountants defines balance sheet as "a tabular
statement of summary of balance carried forward after and actual and constructor closing of
books of account and kept according to principles of accounting".

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The purpose of the balance sheet is to show the resources that the company has its asset
and from where those resources come from its liabilities and investment by owners and
outsiders
2) income statement or profit and loss account
Income statement is prepared to determine the operational position of the concern. It is a
statement of revenues earned and the expenses include for earning that revenue. The
income statement is prepared for a particular period, generally a year.
3) statement of changes in owner's equity
The term owner's equity refers to the claims of the owners of the business against the Asset
of the firm. It consists of two elements
● Paid up share capital
● Retained earnings or reserves and surplus
In most cases, the only owners equity account that change significantly is retained earnings
and hence the statement of changes in owners equity becomes nearly a statement of
retained earnings
4) statement of changes in financial position
The basic financial statement, the balance sheet and the profit and loss account or income
statement of a business review the net effect of the various transactions on the operational
and financial position of the company.
The balance sheet gives a static view of the resources of a business and the use to which
those resource have been put at a certain point of time.
The profit and loss account is a General way indicates the resource provided by operations.
a) fund flow statement :- the fund flow statement is designed to analyse the changes in the
financial condition of a business enterprise between two periods.
b) cash flow statement :- a cash flow statement is a statement which describes the inflows
and outflows of cash and cash equivalent in an enterprise during a specific period of time.
Importance of financial statements
● Management
The financial statements are useful for assessing the efficiency of different cost centres. The
management is able to exercise cost control through these statements.
● Creditors
The trade creditors are to be paid in a short period. This liability is met out of current assets.
The creditors will be interested in currency solvency of the concern.
● Bankers
The banker is interested to see that the loan amount is secure and the customer is also able
to pay the interest regularly. The banker will analyse the balance sheet to determine financial
strength of the concern and profit and loss account will also be studied to find out the
earning position.
● Investors
The investors include both short-term and long term investors. They are interested in the
security of the principal amount of loan and regular interest payments. The investors will
study the long-term solvency of the concern with the help of financial statements.
● Government
The financial statements are used to assess tax liability of business enterprises. The
Government studies the economic situation of the country from these statements.
Limitations of financial statements
● Information shown in financial statements is not precise since it is based on practical
experience and the conventions and rules developed there from.

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● Financial statements do not always disclose the correct financial position of business
concern as they are influenced by the personal opinions, judgment, subjective views
and whims of accountants of each concern.
● Balance Sheets of a concern is a static document as it discloses the financial position
of concern on a particular date.
● Information disclosed by a profit and loss account may not be real profits as many
items shown in the profit and loss account are not real but estimated.
● Financial statements are dumb, because they cannot speak themselves.
● Financial statements of one period may not be comparable as such with statements
of other periods due to differences in conditions and changes in economic situations.
FINANCIAL STATEMENT ANALYSIS
Definition :- in the words of Myers "financial statement analysis is largely a study of
relationship among the various financial factors in the business as disclosed by a single set
of statements, and a study of the trend of these factors are shown in a series of statements"
Objectives and importance of financial statement analysis
a. To interpret the profitability and efficiency of various business activities with the help of a
profit and loss account.
b. To assess the financial position of the firm.
c. To measure managerial efficiency and progress of the firm.
d. To judge the solvency - short-term and long-term solvency of the business.
e. To ascertain earning capacity in the future period.
f. To determine future potential of the concern.
g. To help in making future plans.
Parties interested in financial analysis
● Investor or potential investors
● Management
● Creditors or suppliers
● Bankers and Financial Institutions
● Employees
● Government
● Stock exchanges
● Economist and researches
Types of financial analysis

1) on the basis of material used

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a) external analysis:- this analysis done by outsiders who do not have access to the detailed
internal accounting record of the business firm. These outsiders include investors, potential
investors, creditors or potential creditors, government Agencies, credit Agencies and the
general public.
b) internal analysis :- the analysis conducted by persons who have access to the internal
accounting records of a business firm is known as internal analysis. Such analysis can,
therefore, be performed by executors and employees of the organisation as well as
government Agencies which have statutory powers vested in them.
2) on the basis of modus operandi
a) horizontal analysis :- horizontal analysis refers to the comparison of financial data of a
company for several years. The figures of this type of analysis are presented horizontally
over a number of columns. This type of analysis is also called dynamic analysis the figures
of the various years are combined with standard or base year
b) vertical analysis :- vertical analysis refers to the study of relationship of the various items
in the financial statement of one accounting period. In this types of analysis the figures from
financial statement of a year are combined with a base selected from the same year's
statement. This is also known as static analysis.
3) on the basis of time horizon objective of analysis
a) short term analysis :- short-term analysis measures the liquidity position of a firm. The
short-term paying capacity of a firm or the forms ability to meet its current obligations
b) long term analysis :- long-term analysis involves the study of forms ability to meet the
interest cost and repayment schedule of its long-term obligations. The solvency, stability and
profitability are measured under this type of analysis.
Tools aur method or techniques of financial statement analysis
1. Comparative Financial statement;
2. Common Size or measurement statements;
3. Trend Analysis;
4. Ratio Analysis ;
5. Funds Flow Analysis ;
6. Cash Flow Analysis ; and
7. Cost-Volume Profit Analysis.
Comparative financial statement
Comparative financial statement is a tool of financial analysis used to study the magnitude
and direction of changes in the financial position and performance of a firm over a period of
time.
The comparative statement may show
● Absolute figures
● Changes in absolute figures
● Absolute data in terms of percentage as
● Increase or decrease in terms of percentages
● Comparisons Express in terms of ratios
● Percentage of tortoise
The important objectives of comparative financial statement
● To indicate the trend and direction of financial position and operating result
● To help the management in Planning and forecasting
● To enhance the usefulness of financial reports
The two comparative statements

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a) comparative balance sheet :- comparative balance sheet of an enterprise is prepared to

show different assets, liabilities and capital as on two or more dates so as to compare and
ascertain any increase or decrease in absolute items and also percentage changes.
Advantages of comparative balance sheet
● It helps in forming an opinion about the progress of an enterprise
● It can be used as a tool in analysing and evaluating the financial position of a firm
over a period of number of years
● The comparative balance sheet is more useful than a simple balance sheet.
b) comparative income statement or statement of profit and loss:- the income statement
gives the result of the operation of a business. It shows the net profit or net loss on account
of business operation. The comparative income statement gives an idea of the progress of a
business over a period of time.
The objectives of comparative income statement
● To analyse and evaluate the operating the service of a business
● To enhance the usefulness of an income statement
● To help the management in Planning and forecasting the profits
Trend analysis
The financial statements may be analysed to by computing Trends of series of information.
This method determines the direction upwards or downwards and involves the computation
of the percentage relationship that each statement item to the same item in base year.
Common size statement
The common size statement balance sheet and income statement are shown in analytical
percentages. The figures are shown as percentage of total liabilities and total sales.
a) common size balance sheet:- a statement in which balance sheet items are expressed as
the ratio of each asset to total asset and the ratio of its liability is expressed as a ratio of total
liabilities is called common size balance sheet.
b) common size statement of profit and loss :- the item in statement of profit and loss can be
shown as percentages of revenue from operation to show the relation of each item to sales.
A significant relationship can be exchanged between an item of income statement and
Onam of sale.
Limitations of financial analysis
● It is only a study of interim reports
● It does not control changes in price levels
● Financial analysis is based upon only monetary information and non monetary
factors are ignored
● Changes in accounting procedure by a firm may offer make financial analysis
misleading
● Analysis is only a means and not an end in itself
RATIO ANALYSIS
Meaning :- the relationship of one number to another
Definition :- according to Accountants Handbook by Wixon, Kell and Bedford A ratio "is an
expression of the quantitative relationship between two numbers "
Nature of ratio analysis
Ratio analysis is a technique of analysis and interpretation of financial statements.
Steps involved in the ratio analysis
● Selection of relevant data from the financial statement depending upon the objective
of the analysis
● Calculation of appropriate ratios from the above data

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● Comparison of the calculator ratios with the ratios of the same for in the past or the
ratios developed from projected financial statement for the ratios of some other forms
for the comparison with ratio of the industries to which the firm belongs
● Interpretation of the ratio
Interpretation of ratios
● Single absolute ratio
● Group of ratios
● Historical comparison
● Projected ratios
● Inter firm comparison
Guidelines or precautions for use of ratio
● Accuracy of financial statements :- the ratios are calculated from the data available
in the financial statements
● Objective or purpose of analysis :- the type of ratios is to be calculated will depend
upon the purpose for which these are required
● Selection of ratios :- another precaution in ratio is a proper selection of appropriate
ratios
● Use of standards :- the ratio will give an identification of financial position only when
discussed with reference to certain standards.
Uses and significance of ratio analysis
@ managerial uses of ratio analysis
● Helps in decision making
● Helps in financial forecasting and planning
● Helps in communicating
● Helps coordination
● Helps in control
@ utility to shareholders or investors :- an investor in the company will like to access the
financial position of the concern where he is going to invest
@ utility to creditors :- the creditors or suppliers extend short term credit to the concern
@ utility to government :- government is interested to know the overall strength of the
industry
Limitations of ratio analysis
● Limited use of a single ratio
● Lack of adequate standards
● Change of accounting procedure
● Window dressing
● Price level changes
● Ratio no substitutes
Classification of ratios

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A) traditional classification or statement ratio

@ balance sheet II position statement ratio :- balance sheet ratio deals with the relationship
between two balance sheet items.
@ profit and loss account or revenue or income statement ratio :- this ratio deals with the
relation between to profit and loss account items
B) functional classification of classification according to tests
@ liquidity ratio :- these are the ratios which measure the short term solvency or financial
position of a firm. The various liquidity ratios are current ratio, liquid ratio and absolute liquid
ratio.
@ long term solvency and leverage ratios :- long term solvency ratios convey a firm's ability
to meet the interest cost and repayment schedule of long term application. Eg:- debt equity
ratio and interest coverage ratio.
@ activity or turnover ratio :- activity ratio calculated to measure the efficiency with which the
resources of a firm have been employed. Eg:- debtor turnover ratio
@ profitability ratio :- this ratio measures the results of business operations for overall
performance and effectiveness of the firm. Eg:- gross profit operating ratio or return on
capital employed.
Liquidity ratios
Liquidity refers to the ability of a concert to meet its current application as and when these
become due.
a) current ratio
Current ratio may be defined as the relationship between current assets and current
liabilities

Components of current ratio

@Current asset :- cash in hand, cash at Bank, short term securities, short term investment,
bill receivable,sundry debtors, stock, work in progress as, prepaid expenses
@ current liabilities :- outstanding expenses, bills payable, Sundry creditors,short term
advances, Income Tax payable, dividend payable,bank overdraft
b) quick ratio
The liquidity refers to a ability of a firm to pay its short-term applications as and when they
become due

Components of quick or liquid ratio

@ quick asset
Current investments,bill receivables,sundry debtors,investments provision for doubtful
debts,cash at Bank, cash in hand, short term loan and advances, (other current asset expect
prepaid expenses,advance tax )
@ current liabilities

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Short term borrowings, bills payable, sundry creditors,other current liabilities,short term
provisions ( provision for tax, proposed dividend )
c) absolute liquid ratio

Absolute liquid assets include cash in hand and at bank and marketable securities or
temporary investment. That's up to norms for this ratio is 50 % or 0.5:1 or 1:2.
Solvency ratio
The term solvency refers to the ability of a concern to meet its long-term obligations.
Analysis of long term financial position or test of solvency
a) debt equity ratio
Debt equity ratio also known as external internal equity ratio is calculated to measure the
later claims of out outsiders and the owner against the firm's asset.

b) proprietary ratio
This ratio establishes the relationship between shareholder's fund to total asset of the firm

c) solvency ratio
The ratio indicates the relationship between the total liabilities to outsiders to total asset of a
firm.

d) fixed asset to net worth ratio

Garage exhibitions relationship between fixed assets and shareholders fund

e) fixed asset to total long term fund ratio

Turnover or activity ratios

Funds are invested in various assets in business to make sales and earn profit. Activity ratio
measures deficiency of effectiveness with which a firm manages its resources or assets.
These ratios are also called turnover ratios. They indicate the speed with which assets are
converted or turned over into sales

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a) inventory turnover for stock turnover ratio

Every firm has to maintain a certain level of Inventory of finished goods so as to be able to
meet the requirements of the business
Inventory turnover ratio also known as top velocity is normally calculate as sales or average
Inventory of cost of goods sold By average inventory.

b) debtors or receivable turnover ratio

Trade debtors are expected to be converted into cash within a short period and are included
in current asset
@ debtors turnover ratio:- which indicates the number of times average debtors are turned
over during a year

@ average collection period ratio :- the average collection period presents the average
number of days for which a firm has to wait before its receivables are converted into cash

c) creditors or payable turnover ratio

d) working capital turnover ratio

e) capital turnover ratio

Capital turnover ratio is the relationship between cost of goods sold and the capital
employed.

Profitability ratios
a) gross profit ratio
Gross profit ratio means the relationship of gross profit to net revenue from operation ( net
sales ). Usually representative as a percentage

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b) operating ratio
It measures the cost of operation per rupee of sale.

c) operating profit ratio

Dividing operating profit by sales

d) net profit ratio

The relationship between net profit and revenue from operations.

Analysis of profitability or profitability ratio

a) return on shareholders investment or net worth

b) return on equity capital

c) Earning per share

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d) return on capital employed

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FUND FLOW STATEMENT

Meaning:- the fund flow statement is a statement which shows the movement of funds and is a
report of the financial operation of the business undertaking
The flow means movement and includes both inflow and outflow
Current and noncurrent accounts
Current accounts can either be current asset or current liability
@ current asset :- current assets are those asset which is the ordinary course of business can
be or will be continued into cash within a short period normally one accounting year
@ current liabilities :- current liabilities are those liabilities which are intended to be paid in the
ordinary course of business within a short period of normally one accounting year out of the
current assets or the income of the business
Fund flow statements
Meaning:- fund flow statement is a method by which we study changes in the financial position
of a business enterprise between beginning and ending financial statement dates.
Definition :- according to Antony" the funds flow statement describes the source from which
additional funds were derived and the use to which these source were put"
Difference between funds flow statement and income statement

Fund flow statement Income statement

It is complementary to the income statement. Income statement is not prepared from funds
Income statement helps the preparation of flow statement
funds flow statement

While preparing funds flow statement both Only revenue items are considered
capital and revenue items are considered

There is no prescribed format for preparing a It is prepared in a prescribed format

funds flow statement
Difference between funds flow statement and balance sheet

Funds flow statement Balance sheet

It is a statement of changes in financial It is a statement of financial position on a

position and hence is dynamic in nature particular date and hence is static in nature

It shows the sources and uses of funds in a It depicts the Assets and liabilities at a
particular period of time particular point of time

It is a tool of Management for financial It is not of much help to management in

analysis and helps in making decisions making decisions
Uses or importance of funds flow statement
● Helps in analysis of financial statement
● Helps in the formulation on dividend policy
● Helps in the proper allocation of resources
● Actor se future guide

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● Helps knowing the credit worthiness

Limitations of funds flow statement
● It should be remember that a funds flow statement is not a substitute of an income
statement or a balance sheet
● Cannot review continuous changes
● It is essentially historical in nature and projected funds flow statement cannot be
prepared with much accuracy
● Changes in cash or more important and relevant for financial management than the
working capital
Uses of funds
● Funds lost in operations
● Repayment of loans for redemption of debentures
● Purchase of any non current or fixed asset
● Payments of dividends and tax
● Any other non trading payment
CASH FLOW STATEMENT
Meaning :- cash flow statement is a state of mind which describes the inflow( sources ) and
outflow( uses ) of cash and cash equivalents in an enterprise during a specified period of time
Classification of cash flow
1) cash flows from operating activities:-
Operating activities are the principal revenue proceeding activities of the enterprise and other
activities that are not investing and financial activities
2) cash flows from investing activities :-
Investing activities are the acquisition and disposal of long term Assets and other investments
not included in cash equivalents.
3) cash flows from financing activities :-
Financing activities are activities that result in changes in the size and composition of the
owner's capital and borrowings of the Enterprise.
Objectives of cash flow statement
● To provide the users of financial statements with basis to access the ability of the
Enterprise to generate cash and cash equivalents
● To ascertain the inflows of cash and cash equivalents classified under
operating,investing and financing activities
● To ascertain outflows of cash and cash equivalents
● Net increase or decrease in cash and cash equivalents
Limitations of cash flow statement
● It ignores the basic accounting concept of a accrual basis
● A fund flow statement provides a more complete picture than cash flow statement
● Non cash charges are ignored
● Not a substitute of funds flow statement
● Main give misleading results
Steps for the preparation of cash flow statement
● Step1:- calculate the net cash flow provided operating activities by analysing the profit
and loss, balance sheet and additional information.

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● Step2:- calculate the net cash flow from investing activities

● Step3:- calculating the net cash flow from financing activity
● Step4:- prepare a formal cash flow statement highlighting the net cash flow from
operating,investing and financing activities separately
● Step5:- make an aggregate of net cash flows from the three activities and ensure that
the total net cash flows is equal to the net increase or decrease in cash and cash
equivalents are calculated in step 6
● Step6:- compute net increase or decrease in cash and cash equivalents by making a
comparison of these accounts given in the comparative balance sheet
● Step7:- add to net increase in cash and cash equivalents( as calculated in step 5 ) cash
and cash equivalents in the beginning of the year and the total should be equal to the
amount of cash and cash equivalents at the end of the year
● Step8:- report significant non cash transactions that did not involve cash or cash
equivalents in a separate schedule to the cash flow statement.

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