COURSE NOTES

FOR

Bachelor Computer Applications

Second Semester

Subject : Financial Accounting & Management

as per syllabus of

Mahatma Gandhi Kashi Vidyapith, Varanasi

Prepared By:Akash

Department of Computer Science

Microtek College of Management & Technology
Varanasi.
 Course Code Syllabus

BCA-S109 Financial Accounting & Management

UNIT-I

Overview - Meaning and Nature of Financial Accounting, Scope of Financial Accounting,

Financial
Accounting & Management Accounting, Accounting concepts & convention, accounting
standards in India.

UNIT-II

Basics of accounting – Capital & Revenue items, Application of Computer in Accounting,

Double Entry
System, Introduction to Journal, Ledger and Procedure for Recording and Posting,
Introduction to Trial
Balance, Preparation of Final Account, Profit & Loss Account and related concepts, Balance
Sheet and related
concept.

UNIT-III

Financial statement analysis: Ratio analysis, Funds flow analysis, concepts, uses,
Preparation of funds flow
statement - simple problems, Cash flow analysis, Concepts, uses, preparation of cash flow
statement- simple
problems, Break – even analysis.

UNIT-IV

Definition nature and Objective of Financial Management, Long Term Sources of Finance,
Introductory idea
about capitalization, Capital Structure, Concept of Cost of Capital, introduction, importance,
explicit & implicit
cost, Measurement of cost of capital, cost of debt.

UNIT-V

Concept & Components of working Capital. Factors Influencing the Composition of working
Capital,
Objectives of working Capital Management – Liquidity Vs. Profitability and working capital
policies.
Theory of working capital: Nature and concepts.

UNIT-VI

Cash Management, Inventory Management and Receivables Management.

 UNIT-I

Overview - Meaning and Nature of Financial Accounting:

Accounting has got a very wide scope and area of application. Its use is not confined to the business world
alone, but spread over in all the spheres of the society and in all professions. Now-a-days, in any social
institution or professional activity, whether that is profit earning or not, financial transactions must take
place. So there arises the need for recording and summarizing these transactions when they occur and the
necessity of finding out the net result of the same after the expiry of a certain fixed period. Besides, the is
also the need for interpretation and communication of those information to the appropriate persons. Only
accounting use can help overcome these problems.
In the modern world, accounting system is practiced no only in all the business institutions but also in
many non-trading institutions like Schools, Colleges, Hospitals, Charitable Trust Clubs, Co-operative
Society etc.and also Government and Local Self-Government in the form of Municipality, Panchayat.The
professional persons like Medical practitioners, practicing Lawyers, Chartered Accountants etc.also adopt
some suitable types of accounting methods. As a matter of fact, accounting methods are used by all who
are involved in a series of financial transactions.

Nature of Accounting:

We know Accounting is the systematic recording of financial transactions and presentation of the related
information of the appropriate persons. The basic features of accounting are as follows:
1. Accounting is a process: A process refers to the method of performing any specific job step by step
according to the objectives, or target. Accounting is identified as a process as it performs the specific task
of collecting, processing and communicating financial information. In doing so, it follows some definite
steps like collection of data recording, classification summarization, finalization and reporting.
2. Accounting is an art: Accounting is an art of recording, classifying, summarizing and finalizing the
financial data. The word ‘art’ refers to the way of performing something. It is a behavioral knowledge
involving certain creativity and skill that may help us to attain some specific objectives. Accounting is a
systematic method consisting of definite techniques and its proper application requires applied skill and
expertise. So, by nature accounting is an art.
3. Accounting is means and not an end: Accounting finds out the financial results and position of an entity
and the same time, it communicates this information to its users. The users then take their own decisions
on the basis of such information. So, it can be said that mere keeping of accounts can be the primary
objective of any person or entity. On the other hand, the main objective may be identified as taking
decisions on the basis of financial information supplied by accounting. Thus, accounting itself is not an
objective, it helps attaining a specific objective. So it is said the accounting is ‘a means to an end’ and it is
not‘an end in itself.’
4. Accounting deals with financial information and transactions; Accounting records the financial
transactions and date after classifying the same and finalizes their result for a definite period for
conveying them to their users. So, from starting to the end, at every stage, accounting deals with financial
information. Only financial information is its subject matter. It does not deal with non-monetary
information of non-financial aspect.
5. Accounting is an information system: Accounting is recognized and characterized as a storehouse of
information. As a service function, it collects processes and communicates financial information of any
entity. This discipline of knowledge has been evolved out to meet the need of financial information
required by different interested groups.

Accounting &Management Accounting:

The process of preparing management reports and accounts that provide accurate and timely financial and
statistical information required by managers to make day-to-day and short-term decisions.
Unlike financial accounting, which produces annual reports mainly for external stakeholders, management
accounting generates monthly or weekly reports for an organization's internal audiences such as
department managers and the chief executive officer. These reports typically show the amount of available
cash, sales revenue generated, amount of orders in hand, state of accounts payable and accounts
receivable, outstanding debts, raw material and inventory, and may also include trend charts, variance
analysis, and other statistics.
Accounting concepts& convention:
Accounting Concepts are the assumptions and conditions on the basis of which financial statements of an
entity are prepared. These are the concepts which are adopted by the organizations in preparation of
financial statements to achieve uniformity in reporting. Accounting concepts are the base for formulation
of accounting principles. Accounting concepts have universal application. Here I’m going to discuss some
basic details about these concepts.
(1) Entity concept :
Entity concept assumes that business Enterprise is separate from its owners. Accounting transactions
should be recorded with this concept only. The main intention of this concept is to keep the business
transactions keep away from the influence of personal transactions of its owners.
(2) Periodicity Concept :
As per going concern concept an entity is assumed to have indefinite life. If we want to measure the
financial performance of an entity then we need to divide the operations of entity for a specific period,
otherwise it’s very difficult to ascertain the performance of business.
Periodicity concept assumes a small but workable fraction of time period for measuring the business
performance. Generally it assumes 1 year is taken for this purpose.
(3) Money measurement concept :
As per this concept transactions which can be measured in monetary terms only are to be recorded in
books of accounts. Any transactions which can not be converted into monetary terms should not be
recorded in books. Since money is the medium of exchange and unit of measurement for showing the
financial performance , it doesn’t accept the transactions other than monetary to record in books of
accounts.
(4) Accrual concept :
As per this concept transactions should be recognized in the books of accounts only when they occur and
not on any cash basis. The main advantage of this concept is that financial Statements prepared as per
this concept inform the users not only about past events involving payment and receipt of cash but also
about obligations to pay cash in the future and resources that represent cash to be received in the future.
(5) Matching concept :
As per this concept all the expenses which can be matched with the revenue of that period only should be
taken into consideration for financial reporting. This concept is based on Accrual concept as it gives
importance to occurrence of an expense which is spent for generating a revenue. This concept leads to
adjustments at the end like outstanding expenses, income and Prepaid expenses , incomes.
(6) Going concern concept :
As per this concept financial statements are prepared on an assumption that enterprise will continue its
operations for the foreseeable future. Thus, it says that enterprise has neither the intention nor the need
to liquidate or curtail the scale of its operations. Valuation of assets of a business entity is dependent on
this assumption.
(7) Cost concept :
As per this concept valuation of assets should be done at historical costs/acquisition cost.
(8) Realisation concept :
This concept says that any change in value of an asset is to be recorded only when the business relaises it.
This concept highly prefers Realisation of the value for which we want to give effect in books of accounts.
(9) Dual Aspect concept :
This concept is base for double entry Accounting.s of a transaction. Under the system, aspects of
transactions are classified into two main types:

1.Debit
2.Credit

Every transaction should have a Debit and credit. Debit is the portion of transaction that accounts for the
increase in assets and expenses, and the decrease in liabilities, equity and income. And credit is the
portion which is a results of decreases the asset, increases the liability, income, gains, equity.
Accounting conventions:
Accounting conventions are the generally accepted guidelines in preparation of financials.They arise from
customs and practical application.They are not legally documented policies.
Following are the accounting conventions:

(1) Conservatism :
As per this concept while Accounting one should not anticipate the income but should provide for all
possible losses. When there are many alternative values to account an asset then we should choose the
lesser value. Inventory valuation is done as per this concept only , as cost or Market value which ever is
lower.
(2) Consistency :

As per this concept the accounting policies followed in preparation and presentation of financial
statements should be consistent from one period to another period. A change in Accounting policy can be
made only when it is required by law , or for better presentation of accounts or change in Accounting
standards.
(3) Materiality :

As per this concept items having significant economic effect on the business of the enterprise should be
disclosed in financial statements and any insignificant item which is not relevant to the users should not
be disclosed in financial statements.

Accounting standards in India:

Accounting is the art of recording transactions in the best manner possible, so as to enable the reader to
arrive at judgments/come to conclusions, and in this regard it is utmost necessary that there are set
guidelines. These guidelines are generally called accounting policies. The intricacies of accounting policies
permitted Companies to alter their accounting principles for their benefit. This made it impossible to make
comparisons. In order to avoid the above and to have a harmonised accounting principle, Standards
needed to be set by recognised accounting bodies. This paved the way for Accounting Standards to come
into existence.

Accounting Standards in India are issued By the Institute of Chartered Accountanst of India (ICAI). At
present there are 30 Accounting Standards issued by ICAI.

Objective of Accounting Standards

Objective of Accounting Standards is to standarize the diverse accounting policies and practices with a
view to eliminate to the extent possible the non-comparability of financial statements and the reliability to
the financial statements.

The institute of Chatered Accountants of India, recognizing the need to harmonize the diversre accounting
policies and practices, constituted at Accounting Standard Board (ASB) on 21st April, 1977.

Compliance with Accounting Standards issued by ICAI

Sub Section(3A) to section 211 of Companies Act, 1956 requires that every Profit/Loss Account and
Balance Sheet shall comply with the Accounting Standards. 'Accounting Standards' means the standard of
accounting recomended by the ICAI and prescribed by the Central Government in consultation with the
National Advisory Committee on Accounting Standards(NACAs) constituted under section 210(1) of
companies Act, 1956.

Accounting Standards Issued by the Institute of Chatered Accountants of India are as below:

• Disclosure of accounting policies:

• Valuation Of Inventories:
• Cash Flow Statements
• Contingencies and events Occurring after the Balance sheet Date
• Net Profit or loss For the period, Prior period items and Changes in accounting Policies.
• Depreciation accounting.
• Construction Contracts.
• Revenue Recognition.
• Accounting For Fixed Assets.
 • The Effect of Changes In Foreign Exchange Rates.
• Accounting For Government Grants.
• Accounting For Investments.
• Accounting For Amalgamation.
• Employee Benefits.
• Borrowing Cost.
• Segment Reporting.
• Related Party Disclosures.
• Accounting For Leases.
• Earning Per Share.
• Consolidated Financial Statement.
• Accounting For Taxes on Income.
• Accounting for Investment in associates in Consolidated Financial Statement.
• Discontinuing Operation.
• Interim Financial Reporting.
• Intangible assets.
• Financial Reporting on Interest in joint Ventures.
• Impairment Of assets.
• Provisions, Contingent, liabilities and Contingent assets.
• Financial instrument.
• Financial Instrument: presentation.
• Financial Instruments, Disclosures and Limited revision to accounting standards.

Disclosure of Accounting Policies: Accounting Policies refer to specific accounting principles and the
method of applying those principles adopted by the enterprises in preparation and presentation of the
financial statements.
Valuation of Inventories: The objective of this standard is to formulate the method of computation of cost
of inventories / stock, determine the value of closing stock / inventory at which the inventory is to be
shown in balance sheet till it is not sold and recognized as revenue.
Cash Flow Statements: Cash flow statement is additional information to user of financial statement. This
statement exhibits the flow of incoming and outgoing cash. This statement assesses the ability of the
enterprise to generate cash and to utilize the cash. This statement is one of the tools for assessing the
liquidity and solvency of the enterprise.
Contigencies and Events occuring after the balance sheet date: In preparing financial statement of a
particular enterprise, accounting is done by following accrual basis of accounting and prudent accounting
policies to calculate the profit or loss for the year and to recognize assets and liabilities in balance sheet.
While following the prudent accounting policies, the provision is made for all known liabilities and losses
even for those liabilities / events, which are probable. Professional judgement is required to classify the
likehood of the future events occuring and, therefore, the question of contingencies and their accounting
arises.

Objective of this standard is to prescribe the accounting of contingencies and the events, which take place
after the balance sheet date but before approval of balance sheet by Board of Directors. The Accounting
Standard deals with Contingencies and Events occurring after the balance sheet date.
Net Profit or Loss for the Period, Prior Period Items and change in Accounting Policies : The objective of
this accounting standard is to prescribe the criteria for certain items in the profit and loss account so that
comparability of the financial statement can be enhanced. Profit and loss account being a period
statement covers the items of the income and expenditure of the particular period. This accounting
standard also deals with change in accounting policy, accounting estimates and extraordinary items.
Depreciation Accounting : It is a measure of wearing out, consumption or other loss of value of a
depreciable asset arising from use, passage of time. Depreciation is nothing but distribution of total cost
of asset over its useful life.
Construction Contracts : Accounting for long term construction contracts involves question as to when
revenue should be recognized and how to measure the revenue in the books of contractor. As the period
of construction contract is long, work of construction starts in one year and is completed in another year
or after 4-5 years or so. Therefore question arises how the profit or loss of construction contract by
contractor should be determined. There may be following two ways to determine profit or loss: On year-to-
year basis based on percentage of completion or On completion of the contract.
Revenue Recognition : The standard explains as to when the revenue should be recognized in profit and
loss account and also states the circumstances in which revenue recognition can be postponed. Revenue
means gross inflow of cash, receivable or other consideration arising in the course of ordinary activities of
an enterprise such as:- The sale of goods, Rendering of Services, and Use of enterprises resources by other
yielding interest, dividend and royalties. In other words, revenue is a charge made to customers / clients
for goods supplied and services rendered.
Accounting for Fixed Assets : It is an asset, which is:- Held with intention of being used for the purpose of
producing or providing goods and services. Not held for sale in the normal course of business. Expected
to be used for more than one accounting period.
The Effects of changes in Foreign Exchange Rates : Effect of Changes in Foreign Exchange Rate shall be
applicable in Respect of Accounting Period commencing on or after 01-04-2004 and is mandatory in
nature. This accounting Standard applicable to accounting for transaction in Foreign currencies in
translating in the Financial Statement Of foreign operation Integral as well as non- integral and also
accounting for For forward exchange.Effect of Changes in Foreign Exchange Rate, an enterprises should
disclose following aspects:

• Amount Exchange Difference included in Net profit or Loss;

• Amount accumulated in foreign exchange translation reserve;
• Reconciliation of opening and closing balance of Foreign Exchange translation reserve;

Accounting for Government Grants : Governement Grants are assistance by the Govt. in the form of cash
or kind to an enterprise in return for past or future compliance with certain conditions. Government
assistance, which cannot be valued reasonably, is excluded from Govt. grants,. Those transactions with
Governement, which cannot be distinguished from the normal trading transactions of the enterprise, are
not considered as Government grants.
Accounting for Investments : It is the assets held for earning income by way of dividend, interest and
rentals, for capital appreciation or for other benefits.
Accounting for Amalgamation : This accounting standard deals with accounting to be made in books of
Transferee company in case of amalgamtion. This accounting standard is not applicable to cases of
acquisition of shares when one company acquires / purcahses the share of another company and the
acquired company is not dissolved and its seperate entity continues to exist. The standard is applicable
when acquired company is dissolved and seperate entity ceased exist and purchasing company continues
with the business of acquired company
Employee Benefits : Accounting Standard has been revised by ICAI and is applicable in respect of
accounting periods commencing on or after 1st April 2006. the scope of the accounting standard has
been enlarged, to include accounting for short-term employee benefits and termination benefits.
Borrowing Costs : Enterprises are borrowing the funds to acquire, build and install the fixed assets and
other assets, these assets take time to make them useable or saleable, therefore the enterprises incur the
interest (cost on borrowing) to acquire and build these assets. The objective of the Accounting Standard is
to prescribe the treatment of borrowing cost (interest + other cost) in accounting, whether the cost of
borrowing should be included in the cost of assets or not.
Segment Reporting : An enterprise needs in multiple products/services and operates in different
geographical areas. Multiple products / services and their operations in different geographical areas are
exposed to different risks and returns. Information about multiple products / services and their operation
in different geographical areas are called segment information. Such information is used to assess the risk
and return of multiple products/services and their operation in different geographical areas. Disclosure of
such information is called segment reporting.
Related Paty Disclosure : Sometimes business transactions between related parties lose the feature and
character of the arms length transactions. Related party relationship affects the volume and decision of
business of one enterprise for the benefit of the other enterprise. Hence disclosure of related party
transaction is essential for proper understanding of financial performance and financial position of
enterprise.
Accounting for leases : Lease is an arrangement by which the lesser gives the right to use an asset for
given period of time to the lessee on rent. It involves two parties, a lessor and a lessee and an asset which
is to be leased. The lessor who owns the asset agrees to allow the lessee to use it for a specified period of
time in return of periodic rent payments.
Earning Per Share :Earning per share (EPS)is a financial ratio that gives the information regarding earning
available to each equiy share. It is very important financial ratio for assessing the state of market price of
share. This accounting standard gives computational methodology for the determination and presentation
of earning per share, which will improve the comparison of EPS. The statement is applicable to the
enterprise whose equity shares or potential equity shares are listed in stock exchange.
Consolidated Financial Statements : The objective of this statement is to present financial statements of a
parent and its subsidiary (ies) as a single economic entity. In other words the holding company and its
subsidiary (ies) are treated as one entity for the preparation of these consolidated financial statements.
Consolidated profit/loss account and consolidated balance sheet are prepared for disclosing the total
profit/loss of the group and total assets and liabilities of the group. As per this accounting standard, the
conslidated balance sheet if prepared should be prepared in the manner prescribed by this statement.
Accounting for Taxes on Income : This accounting standard prescribes the accounting treatment for taxes
on income. Traditionally, amount of tax payable is determined on the profit/loss computed as per income
tax laws. According to this accounting standard, tax on income is determined on the principle of accrual
concept. According to this concept, tax should be accounted in the period in which corresponding revenue
and expenses are accounted. In simple words tax shall be accounted on accrual basis; not on liability to
pay basis.
Accounting for Investments in Associates in consolidated financial statements : The accounting standard
was formulated with the objective to set out the principles and procedures for recognizing the investment
in associates in the cosolidated financial statements of the investor, so that the effect of investment in
associates on the financial position of the group is indicated.
Discontinuing Operations : The objective of this standard is to establish principles for reporting
information about discontinuing operations. This standard covers "discontinuing operations" rather than
"discontinued operation". The focus of the disclosure of the Information is about the operations which the
enterprise plans to discontinue rather than dsclosing on the operations which are already discontinued.
However, the disclosure about discontinued operation is also covered by this standard.
Interim Financial Reporting (IFR) : Interim financial reporting is the reporting for periods of less than a year
generally for a period of 3 months. As per clause 41 of listing agreement the companies are required to
publish the financial results on a quarterly basis.
Intangible Assets : An Intangible Asset is an Identifiable non-monetary Asset without physical substance
held for use in the production or supplying of goods or services for rentals to others or for administrative
purpose
Financial Reporting of Interest in joint ventures : Joint Venture is defined as a contractual arrangement
whereby two or more parties carry on an economic activity under 'joint control'. Control is the power to
govern the financial and operating policies of an economic activity so as to obtain benefit from it. 'Joint
control' is the contractually agreed sharing of control over economic activity.
Impairment of Assets : The dictionary meanong of 'impairment of asset' is weakening in value of asset. In
other words when the value of asset decreases, it may be called impairment of an asset. As per AS-28
asset is said to be impaired when carrying amount of asset is more than its recoverable amount.
Provisions, Contingent Liabilities And Contingent Assets : Objective of this standard is to prescribe the
accounting for Provisions, Contingent Liabilitites, Contingent Assets, Provision for restructuring cost.
Provision: It is a liability, which can be measured only by using a substantial degree of estimation.
Liability: A liability is present obligation of the enterprise arising from past events the settlement of which
is expected to result in an outflow from the enterprise of resources embodying economic benefits.

Financial Instrument: Recognition and Measurement, issued by The Council of the Institute of Chartered
Accountants of India, comes into effect in respect of Accounting periods commencing on or after 1-4-2009
and will be recommendatory in nature for An initial period of two years. This Accounting Standard will
become mandatory in respect of Accounting periods commencing on or after 1-4-2011 for all commercial,
industrial and business Entities except to a Small and Medium-sized Entity. The objective of this Standard
is to establish principles for recognizing and measuring Financial assets, financial liabilities and some
contracts to buy or sell non-financial items. Requirements for presenting information about financial
instruments are in Accounting Standard.

Financial Instrument: presentation : The objective of this Standard is to establish principles for presenting
financial instruments as liabilities or equity and for offsetting financial assets and financial liabilities. It
applies to the classification of financial instruments, from the perspective of the issuer, into financial
assets, financial liabilities and equity instruments; the classification of related interest, dividends, losses
and gains; and the circumstances in which financial assets and financial liabilities should be offset. The
principles in this Standard complement the principles for recognising and measuring financial assets and
financial liabilities in Accounting Standard Financial Instruments:

Financial Instruments, Disclosures and Limited revision to accounting standards: The objective of this
Standard is to require entities to provide disclosures in their financial statements that enable users to
evaluate:

• the significance of financial instruments for the entity’s financial position and performance; and
• the nature and extent of risks arising from financial instruments to which the entity is exposed
during the period and at the reporting date, and how the entity manages those risks.
 UNIT-2

Basics of accounting – Capital & Revenue items:

The main objective of accounting is to ascertain the true profit or loss and to reveal the financial
position of a business at the end of financial year.

To achieve the objectives, the business must take a clear distinction between its capital and revenue
items. The distinction between capital and revenue items is essential for their correct treatment in the final
accounts. Any incorrect treatment of those two items in the final accounts adversely affects the operating
results and financial position of the business.

Capital is the wealth invested by an investor for producing additional wealth. The original figure of wealth
is known as capital. Making of additional wealth with the investment of original capital is known as
revenue. Thus, capital is the source of the basis of revenue. In other words, capital is invested in the
business to earn revenue. For example, a trader has started a business with $ 1,00,000 and earns a profit
of $ 30,000 during the year. The original investment of the trader, i.e $ 1,00,000 is the capital and the
profit of $ 30,000 earned by the investor out of the investment is the revenue.

Capital items concerned with the payment for assets and receipt from the owners and outsiders. It is the
item of the balance sheet. It is of long-term nature and its benefit is long-lasting. In fact, capital items are
assets, liabilities and capital that determine the financial strength of the business.

Revenue item is concerned with the payment for producing or buying goods and receipt from sale
of goods and services. Those revenue incomes and expenditures are the items of trading account
and profit and loss account. It is of short-term nature. Its benefit expires within the year. In fact, revenue
items are incomes and expenses, which determine the operating result (profit or loss) of the business.

The following capital and revenue concepts are relevant for accounting purpose

* Capital and revenue expenditures

* Capital and revenue receipts
* Capital and revenue losses
* Capital and revenue profits
* Capital and revenue reserves

Application of Computer in Accounting:

Computer is very helpful in accounting. All the interested parties of financial statements can easily track
all accounting reports if it is in connected computers. That is the reason, today, all accounting
departments make accounts in computer. Before explaining the application of computer in accounting, we
are providing little introduction to those who are new for understanding this important concept.

Application of Computer in Accounting

1. To Keep Accounting Record of Big Company is Possible

Suppose, you are the accountant of big MNC. What you see in its business. There are millions of clients
from whole world. Is it possible to record all in manual basis. It will be impossible. So, computer and
accounting software in it, it will so easy to keep unlimited accounting records without any risk of
forgetting.

2. Separate Payroll Accounting is Possible

We all know top costly expense in the business is the salary of employees. So, it must be recorded
separately. Computer can help in this. Anytime any edit regarding salary, name or any other adjustment in
payroll is possible.

3. Automation of All Financial Accounts

Just go to any CA office. In its computer system, you will see lots of company's financial statements and
other accounting reports. How can company fastly send its financial statements to CA office for audit.
Answer is very simple. Everything has connected with computer. If accountant will pass voucher entries,
financial accounts will automatically be created by computer software.

4. Graphic Presentation of Accounting Results

Computer can be used for graphic presentation of accounting results. You can see the sale trend graphs,
charts and diagrams. Not only sale trend but you can see anything in accounting area through graphic
way. It will so easy and understandable instead of reading only manual financial results.
5. Updated Fastly

If there is any mistake, we can easily correct. All the accounts will automatically corrected. In manual
accounting, it is not possible. There are lots of options which can help more fastly providing the updated
accounting reports. For example, computer reminder system can send updated debtor balance to the
customer.

6. Best Inventory Control

To record every small item in computer is so easy without keeping big inventory registers. By comparing
computer records of inventory and actual inventory, anytime, we can check the difference and find the
reason behind this difference.

In simple words, single computer has saved the cost of keeping hundred accounts clerks.Without any
errors, computer can records millions of transactions.

Double Entry System:

The double entry system of accounting or bookkeeping means that every business transaction will involve
two accounts (or more). For example, when a company borrows money from its bank, the company's Cash
account will increase and its liability account Loans Payable will increase. If a company pays $200 for an
advertisement, its Cash account will decrease and its account Advertising Expense will increase.

Double entry also allows for the accounting equation (assets = liabilities + owner's equity) to always be in
balance. In our example involving Advertising Expense, the accounting equation remained in balance
because expenses cause owner's equity to decrease. In that example, the asset Cash decreased and the
owner's capital account within owner's equity also decreased.

Introduction to Journal, Ledger and Procedure for Recording and Posting:

In accounting and bookkeeping, a journal is a record of financial transactions in order by date. A journal is
often defined as the book of original entry. The definition was more appropriate when transactions were
written in a journal prior to manually posting them to the accounts in the general ledger or subsidiary
ledger. Manual systems usually had a variety of journals such as a sales journal, purchases journal, cash
receipts journal, cash disbursements journal, and a general journal.
A journal is a sequential record of business transactions. It records all financial transactions of business in
a book in chronological order; however, it does not record transactions relating to a particular subject,
thing or persons into one account. For example, if we want to know the total purchase of business for a
period of three months, we have to go through all journals of three months, which is quite time
consuming and tedious. To overcome the short coming of journal, a ledger account is maintained.

Ledger is a statement prepared to collect and record transactions relating to similar nature or subject into
one place. In other words, a book which records transactions having similar features, nature and subject
into the account is called ledger account. It is a book which contains a classified and summer' zed form of
permanent record of all transactions. Ledger is called the book of secondary entry because it is prepared
from journal.

O.P. Gupta, 'ledger is the principle book of account in which all transactions find their ultimate place
in the shape of account in a classified place form. The book supplied all information regarding
working of business.'

Objective of ledger
A ledger is principal book of account. It is prepared with a view to gathering similar transactions into one
account to show their combined effects. The main objectives of ledger are:

1. To provide information about income and expenditures:

One of the main objectives of preparation of ledger account is to record various incomes and expenditures
of the business. For example, expenses during the period in total. Similarly income like interest received
and receivable is posted to interest account to find total interest earned during the period.

2. To provide information about position of assets and liabilities

A separate ledger account is prepared for individual asset and liability which helps to know its effect on
financial position of business during a particular period. For example: debtor account is prepared to know
the amount receivable during the period.

3. To provide information regarding purchase and sales

In a period, a firm can have several purchase and sales. A purchase account is prepared to know the total
purchase made during the period and similarly, sales account shows the total sales made during the
period. Therefore, ledger is very helpful to know the information about purchase and sales.
4. To help in preparation of trial balance
Since trial balance is prepared on the basic of information provided be ledger account. Thus, ledger
account is immense help for preparing trial balance.

Specimen of ledger
A ledger may be prepared either in T-shape or showing balance after each transaction which is called
a
Ledger account showing running balance i.e. running shape.

T-shape ledger account

This type of ledger account commonly used in book keeping. The ledger is divided into two parts, the
left part of debit and right part for credit. A specimen ruling of ledger accounting is presented below:
1. Date dr.
2. Particular
3. JF
4. Amount rs
5. Date cr.
6. Particular
7. JF
8. Amount rs
Posting
It is the act of transferring recorded in journal into ledger. In other words, the process of recording
transaction into ledger is called posting. The posting in various columns of ledger is done as follows:
1. Date: the date of transaction as mentioned in journal is recorded.
2. Particulars: in this column, the account which was credited in journal is recorded with prefix 'to'.
3. Journal folio (JF): the page number of journal from which the entry is being posted is recorded
here, if available.
4. Amount: in this column, the debit amount of the ledger account is recorded.
5. Date: the date transaction same as in journal is recorded.
6. Particular: in this column, the account was originally debited in journal is recorded with prefixed
"BY".
7. Journal foilo (JF): the page of journal entry is recorded here, if available.
8. Amount; in this column, the credit amount of ledger account is recorded.
Rules for posting
1. First make sure the ledger account being opened.
2. Then, if ledger account being opened is debited in journal, posting should be made in debit side
with opposite account i.e. account credited and
3. If the ledger account being opened is credit in journal, posting should also be made in credit sale
of the account with opposite account i.e. debit account in journal.

Posting of opening entry

To transfer the assets, liabilities and capital of last year to this year, an opening journal entry is
passed. In other words, it recorded the beginning assets, liabilities and capital of business.
Posting without journal entroes

Ledger account can also be maintained without passing journal entries. But transactions should be
journalized in mind and remembered the account to be debited and credited and other procedure is
same. However, instead of journal folio (jf), ledger folio (LF) is recorded since journal entries will not
be passed. For example, salary paid rs. 1000,
Balancing of ledger accounts
After posting transaction journalized into ledger account, all the ledger account must be closed to find
their and posting on the business at the end of certain period. For example, if the ledger has to
determine the amount of cash balance at the end of certain period. Then he has to prepare cash a/c
and debit and credit of the account are totaled. The difference between two sided (i.e. dr, and cr.) is
balance of the account. The process is called balance of ledger accounts.

Balancing of account is done periodically i.e. monthly, quarterly, semi-annually as per requirement.
Normally, monthly balancing is common in practice.

Debit side of an account greater than credit side

In this case, the debit of an account will be greater than credit total. It is known as debit balance of an
account. Here the excess debit in the credit side of the account as by balance C/D and closed the
account in the beginning of next period. The balancing figure is brought down as to balance b/d.

Credit side of an account greater than debit side

In this case, the credit total of an account is greater than debit total. It is knows as credit balance of
an account. Here excess credit amount is entered in the debit side of account as " to balance c/d' and
closed the account. In the next period, the balancing figure is brought down as "By balance b/d".

Introduction to Trial Balance:

Trial Balance is a list of closing balances of ledger accounts on a certain date and is the first step
towards the preparation of financial statements. It is usually prepared at the end of an accounting
period to assist in the drafting of financial statements. Ledger balances are segregated into debit
balances and credit balances. Asset and expense accounts appear on the debit side of the trial balance
whereas liabilities, capital and income accounts appear on the credit side. If all accounting entries are
recorded correctly and all the ledger balances are accurately extracted, the total of all debit balances
appearing in the trial balance must equal to the sum of all credit balances.
Purpose of a Trial Balance
▪ Trial Balance acts as the first step in the preparation of financial statements. It is a working
paper that accountants use as a basis while preparing financial statements.
▪ Trial balance ensures that for every debit entry recorded, a corresponding credit entry has been
recorded in the books in accordance with the double entry concept of accounting. If the totals
of the trial balance do not agree, the differences may be investigated and resolved before
financial statements are prepared. Rectifying basic accounting errors can be a much lengthy
task after the financial statements have been prepared because of the changes that would be
required to correct the financial statements.
▪ Trial balance ensures that the account balances are accurately extracted from accounting
ledgers.
▪ Trail balance assists in the identification and rectification of errors.
Example

Following is an example of what a simple Trial Balance looks like:

ABC LTD
Trial Balance as at 31 December 2011

Debit Credit
Account Title
$ $
Share Capital 15,000
Furniture & Fixture 5,000

Building 10,000
Creditor 5,000

Debtors 3,000
Cash 2,000

Sales 10,000
Cost of sales 8,000

General and Administration Expense 2,000

Total 30,000 30,000

1. Title provided at the top shows the name of the entity and accounting period end for which the
trial balance has been prepared.
2. Account Title shows the name of the accounting ledgers from which the balances have been
extracted.
3. Balances relating to assets and expenses are presented in the left column (debit side) whereas
those relating to liabilities, income and equity are shown on the right column (credit side).
4. The sum of all debit and credit balances are shown at the bottom of their respective columns.

Limitations of a trial balance

Trial Balance only confirms that the total of all debit balances match the total of all credit balances.
Trial balance totals may agree in spite of errors. An example would be an incorrect debit entry being
offset by an equal credit entry. Likewise, a trial balance gives no proof that certain transactions have
not been recorded at all because in such case, both debit and credit sides of a transaction would be
omitted causing the trial balance totals to still agree. Types of accounting errors and their effect on
trial balance are more fully discussed in the section on Suspense Accounts.

Preparation of Final Account, Profit & Loss Account and related concepts:
Final accounts give an idea about the profitability and financial position of a business to its
management, owners, and other interested parties. All business transactions are first recorded in
a journal. They are then transferred to a ledger and balanced. These final tallies are prepared for a
specific period. The preparation of a final accounting is the last stage of the accounting cycle. It
determines the financial position of the business. Under this it is compulsory to make trading account,
profit and loss account and balance sheet.
The term "final accounts" includes the trading account, the profit and loss account, and the balance
sheet. Section 209 of the Companies Act 1956 makes it compulsory for companies to keep certain
books of accounts.

After having checked the accuracy of the books of accounts through preparation of Trial Balance,
businessman wants to ascertain the profit earned or loss suffered during the year and also the
financial position of his business at the end of the year. For this purpose he prepares ‘Final Accounts’
which are also termed as ‘Financial Statement’. These include the following:

1. Trading Account

2. Profit and Loss Account

3. Balance Sheet
Trading Account

Trading account is prepared for calculating the gross profit or gross loss arising or incurred as a result
of the trading activities of a business. In other worlds, it is prepared to show the result of
manufacturing, buying and selling of goods. If the amount of sales exceeds the amount of purchases
and the expenses directly connected with such purchases, the difference is termed as gross profit. On
the contrary, if the purchases, and direct expenses exceed the sales, the difference is called gross
loss. A Trading Account records the amount of purchases of goods and also the expenses which are
incurred in bringing that commodity to a saleable state. IN other words, all expenses which relate to
either purchase of raw material for manufacturing of goods are recorded in the Trading Account. All
such expenses are called ‘Direct Expenses’. According to J.R. Batliboi, “The Trading Account shows the
results of buying and selling of goods. In preparing this account, the general establishment charges
are ignored and only the transaction in goods are included.”

Sometimes, a Trading Account is also called ‘Good A/c’ because all the transaction relating to goods
are recorded in it. Such as (i) Opening Stock, (ii) Purchases, (iii) Purchases Returns, (iv) Sales, (v)
Sales Returns, (vi) Closing Stock, (vii) Expenses incurred on manufacturing of goods, and (viii)
Expenses incurred on purchasing and bringing the goods to the trading place. All such expenses are
summarised and recorded in the Trading Account at the end of the year.

Need and Importance of Trading Account

Preparation of Trading Account serves the following objectives:

1. It provides information about Gross Profit and Gross Loss: It informs of the gross profit or
gross loss as a result of buying and selling the goods during the year. The percentage of
Current Year’s gross profit on the amount of sales can be calculated and compared with those
of the previous years. Thus, it provides data for comparison, analysis and planning for a future
period.

2. It provides information about the direct expenses: All the expenses incurred on the purchase
and manufacturing of goods are recorded in the trading account in a summarised form.
Percentage of such expenses on sales can be calculated and compared with those of the
previous years. In this way it enables the management to control and rationalise the
expenses.

3. Comparison of closing stock with those of the previous years: closing stock has to be valued
and recorded in a trading account. This stock can be compared with the closing stock of the
previous years and if the stock shows an increasing trend, the reasons may be inquired into.

4. It provides safety against possible losses: If the ratio of gross profit has decreased in
comparison to the preceding year, the businessman can take effective measures to safeguard
himself against future losses. For example, he may increase the sale price of his gods or may
proceed to analyse and control the direct expenses.

Preparation of Trading Account

Trading Account is a Nominal Account and all expenses which relate to either purchase or
manufacturing of goods are written on the Dr. side of the Trading Account.
Item written on the Dr. side of the Trading Account:

1. Opening Stock: The stock of goods remaining unsold at the end of the previous year is
termed as the opening stock of the current year. In other words, the closing stock of the last
year becomes the opening stock of the current year. Opening Stock will include the following:

I. Opening Stock of Raw Material.

II. Opening Stock of Semi-finished goods, and

III. Opening Stock of Finished goods.

2. Purchases and Purchases Returns: Goods which have been bought for resale are termed
as Purchases and goods which are returned to suppliers are termed as purchase returns or returns
outwards. Purchase Account will be given on the debit side of the trial balance and Purchase Return
Account on the credit side of the trial balance. Purchase returns will be shown as a deduction from
Purchases on the debit side of the trading account. Purchases include cash as well as credit
purchases.

3. Direct Expenses: All expenses incurred in purchasing the goods, brining them to
the godown and manufacture of goods are called direct expenses. Direct expenses include the
following:

I. Wages: Wages are paid to workers who are directly engaged in the loading, unloading
and production of goods and as such are debited to the trading account. It should be noted
that:

(i) If the item ‘Wages and Salaries’ is given in the question it will be shown on
the trading account. On the contrary, if ‘Salaries and Wages’ is given it will be
shown on the profit & loss account.

(ii) If wages are paid for bringing a new machine or for its installation it will be added to the
cost of the machine and hence will not be shown in the trading account.

II. Carriage or Carriage Inwards or Freight: These expenses should be debited to

trading account because these are generally paid for bringing the goods to the factory or place
of business. However, if any carriage or freight is paid on bringing an asset, the amount
should be added to the asset account and must not be debited to trading account.

III. Manufacturing Expenses: All expenses incurred in the manufacture of goods are shown on
the debit side of the trading account such as Coal, Gas, Fuel, Water, Power, Factory Rent, Factory
Lighting etc.

IV. Dock Charges: These are the charges levied on ships and their cargo while entering or
leaving docks. If dock charges are paid on import of goods they are shown on the debit side of trading
account. In the absence of specific instructions, these are debited to trading account.

V. Import Duty or Custom Duty: Custom Duty is paid on import as well as on export of
goods. Custom duty when paid on the purchase of goods is charged to trading account. In the absence
of specific instructions, these are debited to trading account.

VI. Octroi: This is levied by the Municipal Committee when the goods enter the city and hence
debited to trading account.
VII. Royalty: This is the amount paid to the owner of a mine or patent for using his right or
patent. Royalty is usually charged to trading account because it increases the cost of production.
However, if it is specifically stated in the question that the Royalty is based on sales, it will be charged
to Profit and Loss account.

Items written on the Cr. Side of the Trading Account:

1. Sales and Sales Returns: Both Cash and Credit sales will be included in sales. The
sales account will be a credit balance whereas, the sales return account or returns inwards
account will be a debit balance. Sales return will be deducted out of Sales on the credit side of
the trading account.

2. Closing Stock: The goods remaining unsold at the end of the year is known as Closing Stock.
It is valued at cost price or market price whichever is less. It includes the closing stock of raw
material, Closing Stock of semi-finished goods and Closing Stock of finished goods.

Normally, the Closing Stock is given outside the Trail Balance. This is so because its valuation
is made after the accounts have been closed. It is incorporated in the books by means of the
following entry:

Closing Stock A/c Dr.

To Trading A/c

(Closing Stock transferred to Trading A/c)

When the above entry is passed, the Closing Stock Account is opened. On the one hand, it will
be posted to the credit side of the trading account and on the other hand, will be shown on the
Assets side of the Balance Sheet, in order to complete the double entry. Sometimes, the
Closing Stock is given inside the Trail Balance. This mean that the entry to incorporate the
closing stock in the books has already been passed. It would imply that the Closing Stock
must have been deducted out of Purchases Account. Hence, in such a case, Closing Stock will
not be shown in the Trading Account but will appear on the Assets side of the Balance Sheet
only.

Closing Entries Relating to Trading Account

The preparation of the Trading Account requires that the balances of all such accounts which are due
to appear in the Trading Account are transferred to it. The entries required for such transfer are
termed as Closing entries. These will be as follows:

1. Purchases Return Account is closed by transferring its balance to Purchase Account. Following
entry is recorded for this purpose.

Purchases Return A/c Dr.

To Purchases A/c

(Transfer of Purchases Return Account to Purchases (Account)

2. Similarly, the Sales Return Account is closed by transferring its balance to the Sales Account
as:

Sales A/ct Dr.

To Sales Return A/c

(Transfer of Sales Return Account to Sales Account)

3. Closing entry for those accounts which are to be transferred to the Dr. side of the Trading
Account:

Trading A/c Dr.

To Opening Stock A/ct

To Purchases A/c

To Wages A/c

To Direct Expenses A/c

To Carriage A/c

To Gas, Fuel & Power A/c

To Freight, Octroi & Cartage A/c

To Manufacturing exp. A/c

To Factory Rent & Lighting A/c

To Custom Duty A/c

To Royalty A/c

(Transfer of above accounts to the Dr. side of the Trading A/c)

4. Closing entry for those accounts which are to be transferred to the Cr. Side of the Trading
Account:

Sales A/c Dr.

Closing Stock A/c Dr.

To Trading A/c

(Transfer of above accounts to the Cr. Side of the Trading A/c)

5. Another Closing entry is needed to close the trading account itself. If the credit side of the
Trading Account exceeds the debit, the difference will be Gross Profit. The Gross Profit will be
transferred to the credit of a newly opened account called profit and loss account:

Trading A/c Dr.

To Profit & Loss A/c

(Transfer of Gross Profit to the Credit side of P & L A/c)

6. If the debt side of the Trading Account exceeds the credit, the difference will be Gross Loss. It
will be transferred to the debit of P & L a/c by means of the following entry:

Profit and Loss A/c Dr.

To Trading A/c

(Transfer of Gross Loss to the Debit side of P & L A/c)

Form of Trading Account

TRADING A/C

(for the year ended……………..)

Dr.
Cr.

Particular Amount Particulars Amount

Rs. Rs.

To Opening Stock By Sales

To Purchases Less: Sales Returns

Less: Purchase Returns or

or Returns inwards

Returns outward By Closing Stock

To Wages By Gross loss

To Wages & Salaries (if any) transferred to Profit

and Loss A/c
To Direct Expenses
(Balancing Figure)
To Carriage, or

To Carriage inwards, or

To Carriage on Purchase

To Gas, Fuel and Power

To Freight, octroi and cartage

To Manufacturing Expenses, or

Productive Expenses

To Factory Expenses, such as:

Factory Lighting

Factory Rent etc.

To Dock Charges and Clearing

charges

To Import Duty or Custom duty

To Royalty

To Gross Profit

Transferred to P & L A/c

(Balancing Figures

Notes: (1) In the heading of the Trading Account the words ‘For the year ended……’ are used.
Because it discloses the position of the business for the full accounting year and not at a
particular point of time.

(2) No separate column for date is prepared in the Final Accounts because the date will be
already mentioned in the heading itself.

(3) No column for L.F. is prepared in Final Accounts because these are prepared from trial
balance and not from ledge accounts directly.

Illustration:

Prepare a Trading Account for the year ended 31st December 2010 from the following balances:

Rs. Rs.

Opening Stock 4,00,000 Purchases Return 1,20,000

Purchases 20,00,000 Sales Return 2,00,000

Sales 50,00,000 Carriage on Purchase 80,000

Freight and Octroi 65,000 Carriage on sales 1,00,000

Wages 3,00,000 Factory Rent 1,20,000

Factory Lighting 1,08,000 Office Rent 75,000

Coal, Gas and Water 22,000 Import Duty 3,20,000

Closing Stock is valued at Rs. 6,00,000.

Solution:

TRADING A/C

(for the year ended……………..)

Dr.
Cr.

Particular Amount Particulars Amount

Rs. Rs.

To Opening Stock 4,00,000 By Sales 50,00,000

To Purchases 20,00,000 Less: Sales 2,00,000 48,00,000

Returns

Less:Purchases Return By Closing 6,00,000

Stock
1,20,000 18,80,000

To Freight and Octroi 65,000

To Wages 3,00,000

To Factory Lighting 1,08,000

To Coal, Gas and

Water 22,000

To Carriage on

Purchase 80,000

To Factory Rent 1,20,000

To Import Duty 3,20,000

To Gross Profit

transferred to

Profit & Loss A/c 21,05,000

54,00,000 54,00,000

Profit And Loss Account

Trading account only discloses the gross profit earned as a result of buying and selling of goods.
However, a businessman has to incur a number of expenses which are not taken to trading account.
Hence, a businessman is more interested in knowing the net profit earned or net loss incurred during
the year. As such, a Profit & Loss Account is prepared which contains all the items of losses and gains
pertaining to the accounting period. According to Prof. Carter, “A Profit & Loss Account is an account
into which all gains and losses are collected, in order to ascertain the excess gains over the losses
orvice-versa”.

Need and Importance of Profit & Loss A/c

1. To Ascertain the Net Profit or Net Loss: A Trading Account only discloses the Gross Profit
earned as a result of trading activities, whereas the Profit & Loss Account discloses the net profit (or
net loss) available to the proprietor and credited to his capital account.

2. Comparison with previous years’ profit: The net profit of the current year can be compared
with that of the previous years. It enables the businessman to know whether the business is being
conducted efficiently or no.

3. Control on Expenses: Profit & Loss Account helps in comparing various expenses with the
expenses of the previous year. Also the percentage of each individual expenses to net profit is
calculated and compared with the similar ratio of previous years. Such comparison will be helpful in
taking concrete steps for controlling the unnecessary expenses.

4. Helpful in the preparation of Balance Sheet: A Balance Sheet can only be prepared after
ascertaining the Net Profit through the preparation of Profit and Loss Account.

Preparation of Profit and Loss Account

A Profit and Loss Account is started with the amount of gross profit or gross loss brought down from
the Trading Account. As such, all those expenses and losses which have not been debited to the
Trading Account are now debited to Profit & Loss Account. These expenses include administrative
expenses, selling expenses, distribution expenses etc. These are called ‘Indirect Expenses’. Profit and
Loss Account is a Nominal Account and as such, all the expenses and losses are shown on its debit
side and all the incomes and gains are shown on its credit side.

Items written on the Dr. side of Profit & Loss Account

1. Gross Loss: If trading account discloses Gross Loss, it is shown on the debit side first of all.

2. Office and Administrative Expenses: Such as salary of office employees, office rent, lighting,
postage, printing, legal charges, audit fee etc.

3. Selling and Distribution Expenses: Such as advertisement charges, commission, carriage

outwards, bad-debts, packing charges etc.

4. Miscellaneous Expenses: Such as interest on loan, interest on capital, repair charges,

depreciation, charity etc.

Items written on the Cr. side of Profit & Loss Account

1. Gross Profit: the starting point of the Cr. side of Profit and Loss Account is the gross profit
brought down from the Trading Account.

2. Other Incomes and Gains: All items of incomes and gains are shown on the credit side of the
Profit & Loss Account, such as income from investments, rent received, discount received,
commission earned, interest received, dividend received etc.

If the credit side of the profit and loss account exceeds that of debit side, the difference is
termed as net profit. On the other hand, the excess of the debit side over the credit side is
termed as net loss. Net profit is added to the capital whereas net loss is deducted from the
capital.

Closing Entries relating to Profit and Loss Account

The preparation of profit and loss account requires that the balances of all concerned items are
transferred to it by passing the following closing entries:

1. Accounts of various items of expenses and losses are transferred to the debit side of Profit
and Loss Account by means of the following entry:

Profit and Loss A/c Dr.

To Salaries A/c

To Rent, Rates and Taxes A/c

To Printing and Stationer A/c

To Postage and Telegrams A/c

To General Expenses etc.

(Transfer of nominal accounts showing Dr. balances to the Debit of P & L A/c)

2. Balances of all the accounts of incomes and gains will be transferred to the credit side of Profit
and Loss Account by means of the following entry:

Interest Received A/c Dr.

Commission Received A/c Dr.

Rent Received A/c Dr.

To Profit and Loss A/c

(Transfer of nominal accounts showing Cr. balances to the Credit of P & L A/c)

3. For the transfer of credit balance of Profit & Loss A/c, known as net profit:

Profit and Loss A/c Dr.

To Capital A/c

(Transfer of net profit to Capital A/c)

4. For the transfer of debit balance of Profit & Loss A/c, known as net loss: Capital
A/c Dr.

To Profit and Loss A/c

(Transfer of net loss to Capital A/c)

Form of Profit and Loss Account

PROFIT AND LOSS A/C

(for the year ending………….)

Dr.
Cr.

Particular Amount Particulars Amount

Rs. Rs.

To Gross Loss b/d (if any) By Gross Profit b/d

(Transferred from Trading (Transferred from Trading A/c)

A/c)
By Rent from Tenant
Office Expenses:
By Rent (Cr.)
To Salaries
By Discount received
To Salaries & Wages
or discount (Cr.)
To Rent, Rates & Taxes
By Commission Received
To Printing & Stationery
By Interest on Investments
To Postage & Telegram
By Dividend on Shares
To Lighting
By Bad-Debts Recovered
To Insurance Premium
By apprentice Premium*
To Telephone Charges
By Profit on sale of Assets
To Legal Charges
By Income from other Sources
To Audit Fees
By Miscellaneous Receipts
To Travelling Expenses
By Net Loss (if any)
To Establishment Expenses
Transferred to Capital A/c
To Trade Expenses

To General Expenses

Selling and Distribution Expenses:

To Carriage Outwards, or

Carriage on Sales

To Advertisement

To Commission

To Brokerage

To Bad-debts

To Export Duty

Packing charges

To Delivery Van Expenses

To Stable Expenses

Miscellaneous Expenses:

To Discount

To Repairs

To Depreciation

To Interest (Dr.)

To Bank Charges

To Entertainment Expenses

To Conveyance Expenses

To Donation and Charity

To Loss on Sale of Assets

To Net Profit:

Transferred to Capital A/c

Notes: (1) Those expenses which are not related to the business are not written in the Profit
and Loss Account such as (i) Domestic and household expenses of the proprietor, (ii)
Income-Tax, and (iii) Life Insurance Premium etc. These expenses are known as
Drawings and deducted from Capital at the liabilities side of the Balance Sheet.

(2) Only those items of expenses and incomes are shown in the Profit & Loss Account
which have not been shown in the Trading Account.

* Income received by providing training to someone is called “Apprentice Premium”.

Illustration:

From the following particulars, prepare a Profit & Loss Account for the year ending 31st December,
2010.

Rs. Rs.

Gross Profit 21,05,000 Discount allowed 30,000

Trade Expenses 20,000 Lighting 7,800

Carriage on Sales 1,00,000 Commission Received 8,400

Office Salaries 1,58,000 Bad-debts 12,000

Postage and Telegram 7,200 Discount (Cr.) 6,000

Office Rent 75,00 Interest on Loan 22,000

Legal Charges 4,000 Stable Expenses 14,000

Audit Fee 16,000 Export Duty 23,000

Donation 11,000 Miscellaneous Receipts 5,000

Sundry Expenses 3,600 Unproductive Expenses 41,000

Selling Expenses 53,200 Travelling Expenses 25,000

Solution:

PROFIT AND LOSS ACCOUNT

for the year ending on 31st December, 2010

Dr.
Cr.

Particulars Amount Particulars Amount

Rs. Rs.

To Trade Expenses 20,000 By Gross Profit 21,05,000

To Carriage on Sales 1,00,000 By Commission Received 8,400

To Office Salaries 1,58,000 By Discount 6,000

To Postage & Telegram 7,200 By Miscellaneous Receipts 5,000

To Office Rent 75,000

To Legal Charges 4,000

To Audit Fee 16,000

To Donation 11,000

To Sundry Expenses 3,600

To Selling Expenses 53,200

To Discount Allowed 30,000

To Lighting 7,800

To Bad-Debts 12,000

To Interest on Loan 22,000

To Stable Expenses 14,000

To Export Duty 23,000

To Unproductive Expenses 41,000

To Travelling Expenses 25,000

To Net Profit transferred to

Capital Account
15,01,600

21,24,400 21,24,400

Balance Sheet

After ascertaining the net profit or loss of the business enterprise, the businessman would also like to
know the exact financial position of his business. For this purpose a statement is prepared which
contains all the Assets and Liabilities of the business enterprise. The statement so prepared is called a
Balance Sheet because it is a sheet of balances of ledger accounts which are still open after the
transfer of all nominal accounts to the Trading and Profit & Loss Account. Balances of all the personal
and real accounts are grouped as assets and liabilities. Liabilities are shown on the left hand side o the
Balance Sheet and assets on the right hand side.

Definitions: A Balance Sheet has been defined as follows:

In the words of Karlson, “A business form showing what is owed and what the proprietor is worth, is
called a Balance Sheet.”

According to A. Palmer, “The Balance Sheet is a statement at a particular date showing on one side
the trader’s property and possessions and on the other hand the liabilities.”

According to J.R. Batliboi, “A Balance Sheet is a statement prepared with a view to measure the exact
financial position of a business on a certain fixed date.”

Need and Importance of Preparing a Balance Sheet

The purposes of preparing a Balance Sheet are as follows:

1. The main purpose of preparing a Balance Sheet is to ascertain the true financial position of
the business at a particular point of time.
2. It helps in ascertaining the nature and cost of various assets o the business such as the
amount of Closing Stock, amount owing from Debtors, amount of fictitious assets etc.

3. It helps in determining the nature and amount of various liabilities of the business.

4. It gives information about the exact amount of capital at the end of the year and the addition
or deduction made into it in the current year.

5. It helps in finding out whether the firm is solvent or not. The firm is solvent if the assets
exceed the external liabilities. It would be insolvent if opposite is the case.

6. It helps in preparing the Opening Entries at the beginning of the next year.

Drafting a Balance Sheet

Characteristics of Balance Sheet:

1. A Balance Sheet is a part of the Final Account. This is the reason that the Trading and Profit
&Loss Account and the Balance Sheet are together called ‘Final Accounts’. However, the
Balance Sheet is a statement and not an account. It has no debit or credit side and as such
the words ‘To’ and ‘By’ are not used before the names of the accounts written therein.

2. A Balance Sheet is a summary of the Personal and Real Accounts, which are still open and
have not been closed by transfer to the Trading and Profit & Loss Account. Debit balances of
all Personal and Real Accounts are put on the right hand side known as Assets side, whereas
the credit balances are put on the left hand side known as Liabilities side.

3. The totals of the two sides of the Balance Sheet must be equal. If the totals are not equal,
there will be an error somewhere.

4. Balance sheet is prepared on a particular date and not for a fixed period. As such, it discloses
the financial position of a business on a particular date and not for a period. It is True only for
the date on which it is prepared because even a single transaction would cause a change in
the assets and liabilities.

5. It shows the financial position of the business according to the going concern concept.

Grouping and Marshalling of Assets and Liabilities in Balance Sheet

The Assets and Liabilities shown in the Balance Sheet are properly grouped and presented in a
particular order. The term ‘grouping’ means showing the items of similar nature under a common
heading. For example, the amount owing from various customers will be shown under the heading
‘Sundry Debtors’. Similarly, under the heading ‘Current Assets’, the balance of Cash, bank, debtors,
stock etc. will be shown.

‘Marshalling’ is the arrangement of various assets and liabilities in a proper order. Marshalling can be
made in one of the following two ways:

1. In the Order of Liquidity: According to this method, an asset which is most easily convertible
into Cash such as Cash in hand is written first and then will follow those asses which are
comparatively less easily convertible, so that the least liquid asset such as goodwill, is shown last.
In the same way, those liabilities which are to be paid at the earliest will be written first. In other
words, current liabilities are written first of all, then fixed or long-term liabilities and lastly, the
proprietor’s capital.

Generally, sole proprietors and partnership firms prepare their Balance Sheet in the order of
liquidity. Proforma of a Balance Sheet in the order of liquidity will be as follows:

BALANCE SHEET

as on or as at………………….

Particular Amount Particulars Amount

Rs. Rs.

Current Liabilities: Current Assets:

Bank Overdraft Cash in Hand

Bill Payable Cash at Bank

Sundry Creditors Bills Receivable

Outstanding Expenses Short Term Investments

Unearned Income Sundry Debtors

Fixed Liabilities: Closing Stock

Long Term Loans Prepaid Expenses(3)

Reserves: Accrued Income

Capital: Fixed Assets:

Add: Net Profit Furniture

Less: Drawings Loose Tools

Less: Income Tax Motor Vehicle

Less: Life Insurance Premium Long Term Investments

Plant and Machinery

Land and Buildings

Patents

Goodwill

Notes: (1) The words ‘As at’ or ‘As on’ are used in the heading of the Balance Sheet. Because it is
true only for the date on which it is prepared.
 (2) The total of both the sides of the Balance Sheet is always equal.

(3) Prepaid expenses are treated as current assets. Though Cash cannot be realised from
prepaid expenses, the service will be available against these without further payment.

2. In the Order of Permanence: This method is exactly the reverse of the first method discussed
above. Assets which are most difficult to be converted into cash such as Goodwill are written first and
the assets which are most liquid such as Cash in hand are written last. Similarly, those liabilities which
are to be paid last, will be written first. In other words, the proprietor’s capital is written first of all,
then fixed or long term liabilities and lastly, the current liabilities. Joint stock companies are required
under the Companies Act to prepare their Balance Sheet in the order of permanence.

It is essential to understand the classification of various assets and liabilities before preparing a
Balance Sheet.

Classification of Assets

According to the nature of assets, these may be classified into the following:

1. Fixed Assets: Fixed assets are those which are acquired for continued use and last for many
years such as Land & Building, Plant and Machinery, Motor Vehicles, Furniture etc. According
to Finney & Miller, “Fixed Assets are assets of a relatively permanent nature used in the
operations of business and not intended for sale.”

As the purpose of keeping such assets is not to sell but use them, changes in their market
values are ignored and these are always shown in the Balance Sheet at cost less depreciation.

2. Current Assets: Current assets are those which are either in the form of cash or can be
easily converted into cash within one year of the date of Balance Sheet. In the words of Hovard &
Upton, “The current assets are usually defined as those assets which are convertible into cash through
the normal course of business within a short time ordinarily in a year.”

Current assets include Cash, Bills Receivable, Short Term Investments, Debtors, Prepaid
Expenses, Accrued Income, Closing Stock etc. While valuing these assets, Closing Stock is
valued at cost or realisable value whichever is less and a reasonable provision for doubtful
debts is deducted out of Sundry Debtors.

3. Liquid Assets: Liquid assets are those which are either in the form of Cash or can be quickly
converted into cash, such as Cash, Bills Receivable, Short Term Investments, Debtors, Accrued
Income etc. In other words, if Prepaid Expenses and Closing Stock are excluded from Current Assets,
the balance will be Liquid Assets.

4. Fictitious or Nominal Assets: These are the assets which cannot be realised in Cash or no
further benefit can be derived from these assets. Such assets include Debit balance of P & L A/c and
the expenditure not yet written off such as Advertisement Expenses etc. These assets are not really
assets but are shown on the Assets side only for the purpose of transferring them to the Profit & Loss
Account gradually over a period of time.

5. Wasting Assets: These are the assets which are exhausted or consumed over a period of
time such as mines and oil wells. Their value reduces through being worked. These also include
Patents and the properties taken on lease for a defi9nite period of time.
6. Tangible and Intangible Assets: Tangible asses are those which have a physical existence
or which can be seen and felt like Plant and Machinery, Building, Furniture, Stock, Cash etc. Intangible
assets are those which do not have any physical existence or which cannot been seen or felt such as
the Goodwill, Trade Marks, Patents etc. Intangible assets are as much valuable as tangible assets
because they also help the firm in earning profits. For example, Goodwill helps in attracting customers
and patents are actually the know-how which help in producing the goods.

Classification of Liabilities

According to their nature, the liabilities may be classified as follows:

1. Fixed or Long-term Liabilities: Those liabilities which are to be repaid after one year or more
are termed as long-term liabilities. These include Public Deposits, Long-term Loans,
Debentures etc.

2. Current or Short-term Liabilities: Those liabilities which are expected to be paid within one
year of the date of the Balance Sheet are termed as current or short-term liabilities. These
include Bank Overdraft, Creditors, Bills Payable, Outstanding expenses etc.

3. Contingent Liabilities: These are the liabilities which will become payable only on the
happening of some specific event, otherwise not. Such as:

(i) Liabilities for bill discounted: In case a bill discounted from the bank is
dishonoured by the acceptor on the due date, the firm will become liable to the bank.

(ii) Liability in respect of a suit pending in a court of law: This would become an
actual liability if the suit is decided against the firm.

(iii) Liability in respect of a guarantee given for another person: The firm would
become liable to pay the amount if the person for whom guarantee is given fails to
meet his obligation.

Contingent liabilities are not shown in the Balance Sheet: They are, however, shown as a footnote just
below the balance sheet so that their existence may be revealed.

Difference between Trial Balance and Balance Sheet

S.No. Basis of Trial Balance Balance Sheet

Difference

1. Object It is prepared to check the It is prepared to know the true

arithmetical accuracy of the books financial position of the firm.
of accounts.

2. Information It is not possible to have Since net profit or loss is recorded

about profit or information about net profit or net in the Capital shown in Balance
Sheet, it is possible to have the
 loss information about net profit or net
loss from a Balance Sheet.

3. Necessity Though desirable, its preparation is It is necessary to prepare a

not necessary. Balance Sheet.

4. Headings The headings of its two columns The headings of its two sides are
are debit and credit. assets and liabilities.

5. Period It is normally prepared every It is normally prepared half-yearly

month or whenever needed. or yearly at the end of the
accounting period.

6. Types of All types of accounts whether Only personal and real accounts
Accounts personal, real or nominal must be are included in it.
written in it.

7. Closing Stock Normally, it does not contain the It contains the item of Closing
item of Closing Stock. Stock.

8. Adjustments It can be prepared without making It cannot be prepared without

adjustments for outstanding making adjustments for
expenses, prepaid expenses, outstanding expenses, prepaid
accrued incomes etc. expenses, accrued incomes etc.

9. Evidence It is not accepted by the court as It is accepted by the court as

documentary evidence. documentary evidence. It is also
helpful while making payment of
income-tax and sales-tax.

Following points should be noted for preparing Final Accounts:

1. If a trial balance is not given in the question, it is better to prepare a Trial Balance first of all.
If there is a difference in the Trial Balance, the difference is placed to a ‘Suspense A/c’ and shown in
the Balance Sheet.

2. It should be remembered that all items which appear in the Trial Balance should be shown
only once whereas items which appear outside the Trial Balance, known as adjustments, have to be
shown at two places.

3. The items which appear on the debit side of the Trial Balance should be shown either on the
debit side of the Trading or Profit and Loss A/c or on the Assets side of the Balance Sheet.

4. The items which appear on the credit side of the Trial Balance should be shown either on the
credit side of the Trading or Profit & Loss A/c or on the Liabilities side of the Balance Sheet.

5. All accounts relating to Goods such as Purchases, Sales, Purchase Returns and Sales Returns
are written in the Trading Account. In addition to these, the Trading Account will also be debited with
all expenses which are directly related to either purchase or manufacturing of goods. All the remaining
expenses or the balances of the Nominal Accounts are shown in the Profit & Loss Account.
6. The balances of Personal and Real Accounts are always shown in the Balance Sheet.

7. If the expenses in respect of ‘Rent’ and ‘Lighting’ are clearly stated as having been incurred in
respect of factory, these will be shown in the Trading Account, otherwise these will be shown in Profit
& Loss Account. For example, if ‘Factory Rent’ is given in the question, it will be shown in Trading
Account. Instead, if ‘Rent’ is given, it will be shown in Profit & Loss Account.

8. If a trial balance is not given in the question, and it is not clearly stated whether a particular
item is expense or income, it will be treated as expense such as Discount, commission,
Brokerage or Rent etc.

9. The total of both sides of the Balance Sheet will always be equal.

Illustration:

From the following balances of Siya Ram, Prepare a Balance Sheet as on 31st December, 2010.

Particulars Amount (Dr.) Amount (Cr.)

Plant and machinery 8,00,000

Land and Building 6,00,000

Furniture 1,50,000

Cash in Hand 20,000

Bank Overdraft 1,80,000

Debtors and Creditors 3,20,000 2,40,000

Bills Receivable and Bill Payable 1,00,000 60,000

Closing Stock 4,00,000

Investments (Short-term) 80,000

Capital 15,00,000

Drawings 1,30,000

Net Profit 6,20,000

26,00,0000 26,00,0000

Solution:

BALANCE SHEET

as on 31st December, 2010

Liabilities Amount Assets Amount

Rs. Rs.
Bank overdraft 1,80,000 Cash in Hand 20,000

B/P 60,000 B/R 1,00,000

Creditors 2,40,000 Investments (Short- 80,000

term)

Capital Debtors 3,20,000

Add: Net Profit 15,00,000 Closing Stock 4,00,000

6,20,000 Furniture 1,50,000

21,20,000 Plant & Machinery 8,00,000

Less:Drawings 1,30,000 19,90,000 Land & Building 6,00,000

24,70,000 24,70,000

Illustration:

From the following Trial Balance of Radhe Shyam Trading and Profit and Loss A/c for the year ending
31st December, 2010 and Balance Sheet as on that date. The Closing Stock on 31st December, 2010
was valued at Rs. 2,50,000.

Debit Balances Amount Credit Balance Amount

(Rs.) (Rs.)

Stock (1-1-2010) 2,00,000 Sundry Creditors 1,50,000

Purchases 7,50,000 Purchases Return 30,000

Sales Return 80,000 Sales 25,00,000

Freight and Carriage 75,000 Commission 33,000

Wages 3,65,000 Capital 17,00,000

Salaries 1,20,000 Interest on Bank Deposit 20,000

Repairs 12,000 B/P 62,000

Trade Expenses 40,000

Rent and Taxes 2,40,000

Cash in Hand 57,000

B/R 40,000

5,50,000

Plant and Machinery 16,00,000

Withdrawals (Drawings) 1,66,000

Bank Deposit 2,00,000

44,95,000 44,95,000

Solution:

TRADING AND PROFIT & LOSS ACCOUNT

for the year ending 31st December, 2010

Liabilities Amount Assets Amount

Rs. Rs.

To Opening Stock 2,00,000 By Sales 25,00,000

To Purchases 7,50,000 Less: Sales 80,000 24,20,000

Return

Less:Purchases Return By Closing 2,50,000

Stock
30,000 7,20,000

To Freight & Carriage 75,000

To Wages 3,65,000

To Gross Profit c/d 13,10,000

26,70,000 26,70,000

To Salaries 1,20,000 By Gross 13,10,000

Profit b/d

To Repairs 12,000 By 33,000

Commission

To Trade Expenses 40,000 By Interest 20,000

on Bank

Deposit

To Rent & Taxes 2,40,000

To Net profit transferred

to Capital A/c

9,51,000

13,63,000 13,63,000
 BALANCE SHEET

as on 31st December, 2010

Liabilities Amount Assets Amount

Rs. Rs.

B/P 62,000 Cash in Hand 57,000

Sundry Creditors 1,50,000 B/R 40,000

Capital 17,00,000 Sundry Debtors 5,50,000

Add: Net Profit 9,50,000 Closing Stock 2,50,000

26,51,000 Bank Deposit 2,00,000

Less:Drawings 1,66,000 24,85,000 Plant & Machinery 16,00,000

26,97,000 26,97,000

Note: The heading of Trading A/c and Profit & Loss A/c is put collectively as ‘Trading and Profit &
Loss A/c’. The first part of this Account is Trading A/c, whereas the second part is Profit & Loss A/c.
Trading Account, in fact, is apart of Profit & Loss Account.

Illustration:

From the following balances prepare a Trading, Profit & Loss Account and Balance Sheet.

Rs. Rs.

Carriage on Goods Purchased 80,000 Cash in Hand 25,000

Carriage on Goods Sold 35,000 Banker’s A/c (Cr.) 3,00,000

Manufacturing Expenses 4,20,000 Motor Car 6,00,000

Advertisement 70,000 Drawings 80,000

Freight and Octroi 44,000 Audit Fees 27,000

Lighting 60,000 Plant 15,39,000

Customer’s A/c 8,00,000 Repairs to Plant 22,000

Supplier’s A/c 6,10,000 Stock at the end 7,60,000

Duty and Clearing Charges 52,000 Purchase Less Returns 16,00,000

Postage and Telegram 8,000 Commission on Purchases 20,000

Fire Insurance Premium 36,000 Incidental Trade Exp. 32,000

Patents 1,20,000 Investments 3,00,000

Income Tax 2,40,000 Interest on Investments 45,000

Office Expenses 72,000 Capital A/c 10,00,000

Sales Less Returns 52,00,000

Rent 1,20,000

Discount Paid 27,000

Discount on Purchases 34,000

Solution:

TRADING AND PROFIT & LOSS ACCOUNT

for the year ending ……………………

Rs. Rs.

To Purchases Less Returns 16,00,000 By Sales Less Returns 52,00,000

To Commission on Purchases 20,000

To Carriage on goods Purchased 80,000

To Manufacturing Expenses 4,20,000

To Freight and Octroi 44,000

To Duty & Clearing Charges 52,000

To Gross Profit c/d 29,84,000

52,00,000 52,00,000

To Carriage on Goods Sold 35,000 By Gross Profit b/d 29,84,000

To Advertisement 70,000 By Interest on Investments 45,000

To Lighting 60,000 By Discount on Purchases 34,000

To Postage & Telegram 8,000

To Fire Insurance Premium 36,000

To Office Expenses 72,000

To Audit Fees 27,000

To Repair to Plant 22,000

To Incidental Trade Expenses 32,000

To Rent 1,20,000

To Discount Paid 27,000

To Net Profit Transferred to

Capital A/c 25,54,000

30,63,000 30,63,000

Note: If Closing Stock appears inside the Trial Balance, it will be shown only at one place, i.e., only
on the assets side of the Balance Sheet.

Illustration:

From the following balances prepare Final Accounts as on 31st December, 2010.

Rs. Rs.

Opening Stock 1,53,100 Capital 25,00,000

Purchase 8,24,000 Drawings 4,80,000

Sales 25,60,000 Sundry Debtors 5,70,000

Returns (Dr.) 40,000 Sundry Creditors 1,40,000

Returns (Cr.) 24,000 Depreciation 42,000

Factory Rent 1,80,000 Charity 5,000

Custom Duty 1,15,000 Cash Balance 44,600

Coal, Gas and Power 60,000 Bank Balance 40,000

Wages & Salary 3,66,000 Bank Charges 1,800

Discount (Dr.) 75,000 Establishment Expenses 36,000

Commission (Cr.) 12,000 Plant 4,20,000

Bad-Debts 58,500 Leasehold Building 15,00,000

Bad-Debts Recovered 20,000 Goodwill 2,00,000

Apprentice Premium 48,000 Patents 1,00,000

Productive Expenses 26,000 Trade Marks 50,000

Unproductive Expenses 50,000 Loan Cr. 2,50,000

Carriage 87,000 Interest on Loan 30,000

The value of Closing Stock on 31st December, 2010 was Rs. 2,54,000.

Solution:

TRADING AND PROFIT & LOSS ACCOUNT

for the year ending 31st December, 2010

Rs. Rs.

To Opening Stock 1,53,100 By Sales 25,60,000

To Purchases 8,24,000 Less:Returns 40,000 25,20,000

(Dr.)

Less: Returns (Cr.) 24,000 8,00,00 By Closing Stock 2,54,000

To Factory Rent 1,80,000

To Custom Duty 1,15,000(1)

To Coal, Gas and

Power
60,000

To Wages & Salary 3,66,000

To Productive 26,000
Expenses

To Carriage 87,000

To Gross Profit c/d 9,86,900

27,74,000 27,74,000

To Discount 75,000 By Gross Profit 9,86,900

b/d

To Bad-Debts 58,500 By Commission 12,000

To Unproductive By Bad Debts

Expenses Recovered
50,000 20,000

To Depreciation 42,000 By Apprentice 48,000(2)

Premium

To Charity 5,000

To Bank Charges 1,800

To Establishment
 Expenses 36,000

To Interest on Loan 30,000

To Net Profit
transferred to
7,68,600
Capital A/c

10,66,900 10,66,900

BALANCE SHEET

as on 31st December, 2010

Liabilities Amount Assets Amount

Rs. Rs.

Sundry Creditors 1,40,000 Cash Balance 44,600

Loan 2,50,000 Bank Balance 40,000

Capital 25,00,000 Sundry Debtors 5,70,000

Add: Net Profit 7,68,600 Closing Stock 2,54,000

32,68,600 Plant 4,20,000

Less:Drawings 4,80,000 27,88,600 LeaseholdBuilding 15,00,000

Patents 1,00,000

Trade Marks 50,000

Goodwill 2,00,000

31,78,600 31,78,600

Balance Sheet and related concept:

The balance sheet, sometimes called the statement of financial position, lists the company's assets,
liabilities,and stockholders' equity (including dollar amounts) as of a specific moment in time. That
specific moment is the close of business on the date of the balance sheet. A balance sheet is like a
photograph; it captures the financial position of a company at a particular point in time. The other two
statements are for a period of time. As you study about the assets, liabilities, and stockholders' equity
contained in a balance sheet, you will understand why this financial statement provides information
about the solvency of the business.
The Balance Sheet

If an error is found on a previous year's financial statement, a correction must be made and the
financials reissued.

The balance sheet is a formal document that follows a standard accounting format showing the same
categories of assets and liabilities regardless of the size or nature of the business. Accounting is
considered the language of business because its concepts are time-tested and standardized. Even if
you do not utilize the services of a certified public accountant, you or your bookkeeper can adopt
certain generally accepted accounting principles (GAAP) to develop financial statements. The strength
of GAAP is the reliability of company data from one accounting period to another and the ability to
compare the financial statements of different companies.

Balance Sheet Formats

Standard accounting conventions present the balance sheet in one of two formats: the account form
(horizontal presentation) and the report form (vertical presentation). Most companies favor the
vertical report form, which doesn't conform to the typical explanation in investment literature of the
balance sheet as having "two sides" that balance out.
Whether the format is up-down or side-by-side, all balance sheets conform to a presentation that
positions the various account entries into five sections:

Assets = Liabilities + Equity

1. Current assets (short-term): items that are convertible into cash within one year

2. Non-current assets (long-term): items of a more permanent nature

3. Current liabilities (short-term): obligations due within one year

4. Non-current liabilities (long-term): obligations due beyond one year

5. Shareholders' equity (permanent): shareholders' investment and retained earnings.

 UNIT-3
Ratio analysis:
Financial ratios are mathematical comparisons of financial statement accounts or categories.
These relationships between the financial statement accounts help investors, creditors, and
internal company management understand how well a business is performing and of areas
needing improvement.

Financial ratios are the most common and widespread tools used to analyze a business' financial
standing. Ratios are easy to understand and simple to compute. They can also be used to
compare different companies in different industries. Since a ratio is simply a mathematically
comparison based on proportions, big and small companies can be use ratios to compare their
financial information. In a sense, financial ratios don't take into consideration the size of a
company or the industry. Ratios are just a raw computation of financial position and
performance.

Ratios allow us to compare companies across industries, big and small, to identify their
strengths and weaknesses. Financial ratios are often divided up into seven main categories:
liquidity, solvency, efficiency, profitability, market prospect, investment leverage, and coverage.

Liquidity Ratios:
Liquidity ratios analyze the ability of a company to pay off both its current liabilities as they become due
as well as their long-term liabilities as they become current. In other words, these ratios show the cash
levels of a company and the ability to turn other assets into cash to pay off liabilities and other current
obligations.

Liquidity is not only a measure of how much cash a business has. It is also a measure of how easy it will
be for the company to raise enough cash or convert assets into cash. Assets like accounts receivable,
trading securities, and inventory are relatively easy for many companies to convert into cash in the short
term. Thus, all of these assets go into the liquidity calculation of a company.

Quick Ratio:
The quick ratio or acid test ratio is a liquidity ratio that measures the ability of a company to pay its
current liabilities when they come due with only quick assets. Quick assets are current assets that can be
converted to cash within 90 days or in the short-term. Cash, cash equivalents, short-term investments or
marketable securities, and current accounts receivable are considered quick assets.
Short-term investments or marketable securities include trading securities and available for sale
securities that can easily be converted into cash within the next 90 days. Marketable securities are
traded on an open market with a known price and readily available buyers. Any stock on the New York
Stock Exchange would be considered a marketable security because they can easily be sold to any
investor when the market is open.

Formula:
The quick ratio is calculated by adding cash, cash equivalents, short-term investments, and current
receivables together then dividing them by current liabilities.

Current Ratio:
The current ratio is a liquidity and efficiency ratio that measures a firm's ability to pay off its short-term
liabilities with its current assets. The current ratio is an important measure of liquidity because short-
term liabilities are due within the next year.
This means that a company has a limited amount of time in order to raise the funds to pay for these
liabilities. Current assets like cash, cash equivalents, and marketable securities can easily be converted
into cash in the short term. This means that companies with larger amounts of current assets will more
easily be able to pay off current liabilities when they become due without having to sell off long-term,
revenue generating assets.

Formula

The current ratio is calculated by dividing current assets by current liabilities. This ratio is stated in
numeric format rather than in decimal format. Here is the calculation:
Working Capital Ratio:
The working capital ratio, also called the current ratio, is a liquidity ratio that measures a firm's ability to
pay off its current liabilities with current assets. The working capital ratio is important to creditors
because it shows the liquidity of the company.
Current liabilities are best paid with current assets like cash, cash equivalents, and marketable securities
because these assets can be converted into cash much quicker than fixed assets. The faster the assets
can be converted into cash, the more likely the company will have the cash in time to pay its debts.

The reason this ratio is called the working capital ratio comes from the working capital calculation.
When current assets exceed current liabilities, the firm has enough capital to run its day-to-day
operations. In other words, it has enough capital to work. The working capital ratio transforms the
working capital calculation into a comparison between current assets and current liabilities.

Formula

The working capital ratio is calculated by dividing current assets by current liabilities.

Funds flow analysis, concepts, uses, Preparation of funds flow statement:

Funds flow statement is a statement which discloses the analytical information about the different

sources of a fund and the application of the same in an accounting cycle. It deals with the transactions

which change either the amount of current assets and current liabilities (in the form of decrease or

increase in working capital) or fixed assets, long-term loans including ownership fund.

It gives a clear picture about the movement of funds between the opening and closing dates of the

Balance Sheet. It is also called the Statement of Sources and Applications of Funds, Movement of Funds
Statement; Where Got—Where Gone Statement: Inflow and Outflow of Fund Statement, etc. No doubt,

Funds Flow Statement is an important indicator of financial analysisand control. It is valuable andalso
helps to determine how the funds are financed. The financial analyst can evaluate the future flows of a

firm on the basis of past data.

The significance and importance of Funds Flow Statements may be summarized as:
(a) Analysis of Financial Statement:
The traditional financial statements, viz. Profit and Loss Account and Balance Sheet, exhibit the result of

the operation and financial position of a firm. Balance Sheet presents a static view about the resources

and how the said resources have been utilized at a particular date with recording the changes in

financial activities. But Funds Flow Statement can do so, i.e., it explains the causes of changes so made

and effect of such change in the firm accordingly.

(b) Highlighting Answers to Various Perplexing Questions:

Funds Flow Statement highlights answers of the following questions:

(i) Causes of changes in Working Capital;

(ii) Whether the firm sells any Non-Current Asset; if sold, how were the proceeds utilized?

(iii) Why smaller amount of dividend is paid in spite of sufficient profit?

(iv) Where did the net profit go?

(v) Was it possible to pay more dividend than the present one?

(vi) Did the firm pay-off its scheduled debts? If so, how, and from what sources?

(vii) Sources of increased Working Capital, etc.

(c) Realistic Dividend Policy:

Sometimes it may so happen that a firm, instead of having sufficient profit, cannot pay dividend due to

lack of liquid sources, viz. cash. In such a circumstance, Funds Flow Statement helps the firm to take

decision about a sound dividend policy which is very helpful to the management.
(d) Proper Allocation of Resources:
Resources are always limited. So, it is the duty of the management to make its proper use. A projected

Funds Flow Statement helps the management to take proper decision about the proper allocation of

business resources in a best possible manner since it highlights the future.

(e) As a Future Guide:

A projected Funds Flow Statement acts as a business guide. It helps the management to make provision

for the future for the necessary funds to be required on the basis of the problem faced. In other words,
the future needs of the fund for various purposes can be known well in advance which is a very helpful

guide to the management. In short, a firm may arrange funds on the basis of this statement in order to

avoid the financial problem that may arise in future.

Cash flow analysis, Concepts, uses, preparation of cash flow statement:

A cash flow statement is one of the most important financial statements for a project or business. The
statement can be as simple as a one page analysis or may involve several schedules that feed
information into a central statement.

A cash flow statement is a listing of the flows of cash into and out of the business or project. Think of it
as your checking account at the bank. Deposits are the cash inflow and withdrawals (checks) are the
cash outflows. The balance in your checking account is your net cash flow at a specific point in time.

A cash flow statement is a listing of cash flows that occurred during the past accounting period. A
projection of future flows of cash is called a cash flow budget. You can think of a cash flow budget as a
projection of the future deposits and withdrawals to your checking account.

A cash flow statement is not only concerned with the amount of the cash flows but also the timing of
the flows. Many cash flows are constructed with multiple time periods. For example, it may list monthly
cash inflows and outflows over a year’s time. It not only projects the cash balance remaining at the end
of the year but also the cash balance for each month.

Format of Cash Flow Statement:

Break – even analysis:

The point at which total of fixed and variable costs of a business becomes equal to its total revenue is
known as break-even point (BEP). At this point, a business neither earns any profit nor suffers any loss.
Break-even point is therefore also known as no-profit, no-loss point or zero profit point. Calculation of
break-even point is important for every business because it tells business owners and managers how
much sales are needed to cover all fixed as well as variable expenses of the business or the sales volume
after which the business will start generating profit. The computation of sales volume required to break-
even is known as break-even analysis. The concept explained above can also be presented as follows:

Computation of break-even point:

(1). Use of equation method:
The application of equation method facilitates the computation of break-even point both in units and in
dollars. As we have already described that the sales are equal to total variable and fixed expenses at
break-even point, the equation can therefore be written as follows:
Sp × Q = Ve × Q + Fe
Or
SpQ = VeQ + Fe
Where;
Sp = Sales price per unit.
Q = Number (quantity) of units to be manufactured and sold during the period.
Ve = Variable expenses to manufacture and sell a single unit of product.
Fe = Total fixed expenses for the period.
Notice that the left hand side of the equation represents the total sales in dollars and the right hand side
of the equation represents the total cost. If the information about sales price per unit, variable expenses
per unit and the total fixed expenses is available, we can solve the equation for ‘Q’ to find the number of
units to break-even. The break-even point in units can then be multiplied by the sales price per unit to
calculate the break-even point in dollars. Suppose, for example, you run a manufacturing business that
is involved in manufacturing and selling a single product. The annual fixed expenses to run the business
are $15,000 and variable expenses are $7.50 per unit. The sale price of your product is $15 per unit. The
number of units to be sold to break even can be easily calculated using equation method:
Sp × Q = Ve × Q + Fe
15 × Q = 7.5 × Q + 15,000
15 Q = 7.5 Q + 15,000
15Q – 7.5Q = 15,000
7.5Q = 15,000
Q = 15,000 / 7.5
Q = 2,000 units
The break-even point in units is 2,000 units and the break-even point in dollars can be computed as
follows:
= (2,000 units) × ($15)
= $30,000
(2). Use of contribution margin method:
The method described above is known as equation method of calculating break-even point. Some
people use another method called contribution margin method (read about contribution margin and its
calculation). Under this method, the total fixed expenses are divided by contribution margin per unit.
Consider the following computations:
Total fixed expenses / Contribution margin per unit
= 15,000 / 7.5*
= 2,000 units
or
= (2,000 units) × ($15)
= $30,000
*$15 – $7.5
A little variation of this method is to divide the total fixed expenses by the contribution margin ratio (CM
ratio). Doing so results in break-even point in dollars. It is shown below:
Total fixed expenses / Contribution margin ratio
 = $15,000 / 0.5*
= $30,000
*($15 – $7.5)/$15
Graphical presentation (Preparation of break-even chart or CVP graph):

Explanation of the graph:

1. The number of units have been presented on the X-axis (horizontally) where as dollars have been
presented on Y-axis (vertically).
2. The straight line in red color represents the total annual fixed expenses of $15,000.
3. The blue line represents the total expenses. Notice that the line has a positive or upward slop that
indicates the effect of increasing variable expenses with the increase in production.
4. The green line with positive or upward slop indicates that every unit sold increases the total sales
revenue.
5. The total revenue line and the total expenses line cross each other. The point at which they cross each
other is the break-even point. Notice that the total expenses line is above the total revenue line before
the point of intersection and below after the point of intersection. It tells us that the business suffers a
loss before the point of intersection and makes a profit after this point. The break-even point in the
above graph is 2,000 units or $30,000 that agrees with the break-even point computed using equation
and contribution margin methods above.
6. The difference between the total expenses line and the total revenue line before the point of
intersection (BE point) is the loss area. The loss area has been filled with pink color. Notice that this area
reduces as the number of units sold increases. It means every additional unit sold before the break-even
point reduces the loss.
7. The difference between the total expenses line and the total revenue line after the point of intersection
(BE point) is the profit area. The profit area has been filled with green color. Notice that this area
increases as the number of units sold increases. It means every additional unit sold after the break-even
point increases the profit of the business.
 UNIT -5

Definition nature and Objective of Financial Management:

Financial Management means planning, organizing, directing and controlling the financial activities such
as procurement and utilization of funds of the enterprise. It means applying general management
principles to financial resources of the enterprise.

Objectives of Financial Management:

The financial management is generally concerned with procurement, allocation and control of financial
resources of a concern. The objectives can be-

1. To ensure regular and adequate supply of funds to the concern.

2. To ensure adequate returns to the shareholders which will depend upon the earning capacity,
market price of the share, expectations of the shareholders.
3. To ensure optimum funds utilization. Once the funds are procured, they should be utilized in
maximum possible way at least cost.
4. To ensure safety on investment, i.e, funds should be invested in safe ventures so that adequate
rate of return can be achieved.
5. To plan a sound capital structure-There should be sound and fair composition of capital so that a
balance is maintained between debt and equity capital.

Functions of Financial Management:

1. Estimation of capital requirements: A finance manager has to make estimation with regards to
capital requirements of the company. This will depend upon expected costs and profits and future
programmes and policies of a concern. Estimations have to be made in an adequate manner which
increases earning capacity of enterprise.
2. Determination of capital composition: Once the estimation have been made, the capital
structure have to be decided. This involves short- term and long- term debt equity analysis. This
will depend upon the proportion of equity capital a company is possessing and additional funds
which have to be raised from outside parties.
3. Choice of sources of funds: For additional funds to be procured, a company has many choices
like-
a. Issue of shares and debentures
b. Loans to be taken from banks and financial institutions
c. Public deposits to be drawn like in form of bonds.

Choice of factor will depend on relative merits and demerits of each source and period of
financing.

4. Investment of funds: The finance manager has to decide to allocate funds into profitable
ventures so that there is safety on investment and regular returns is possible.
5. Disposal of surplus: The net profits decision have to be made by the finance manager. This can
be done in two ways:
a. Dividend declaration - It includes identifying the rate of dividends and other benefits like
bonus.
b. Retained profits - The volume has to be decided which will depend upon expansional,
innovational, diversification plans of the company.
6. Management of cash: Finance manager has to make decisions with regards to cash management.
Cash is required for many purposes like payment of wages and salaries, payment of electricity and
water bills, payment to creditors, meeting current liabilities, maintainance of enough stock,
purchase of raw materials, etc.
 7. Financial controls: The finance manager has not only to plan, procure and utilize the funds but
he also has to exercise control over finances. This can be done through many techniques like ratio
analysis, financial forecasting, cost and profit control, etc.

Long Term Sources of Finance

There are various sources of finance such as equity, debt, debentures, retained earnings, term loans,
working capital loans, letter of credit, euro issue, venture funding etc. These sources are useful in
different situations. They are classified based on time period, ownership and control, and their source of
generation.

As the name suggests, Long term financing is a form of financing that is provided for a period of more
than a year. Long term financing services are provided to those business entities that face a shortage of
capital.There are various long term sources of finance.

It is different from short term financing which is normally used to provide money that has to be paid back
within a year. The period may be shorter than one year as well.

Examples of long-term financing include – a 30 year mortgage or a 10-year Treasury note.

Equity is another form of long-term financing, such as when a company issues stock to raise capital for a
new project.

Purpose of Long Term Finance:

▪ To finance fixed assets.

▪ To finance the permanent part of working capital.
▪ Expansion of companies.
▪ Increasing facilities.
▪ Construction projects on a big scale.
▪ Provide capital for funding the operations. This helps in adjusting the cash flow.

Factors determining Long-term Financial Requirements:

▪ Nature of Business
▪ Nature of Goods produced
▪ Technology used

Types of Long Term Financing:

The kind of long term financing that is provided to a particular company depends on its type. For
example, the long term financing that is provided to a solo proprietorship is different from the one
received by a partnership firm.

Uses of Long Term Financing:

Long term financing is used in separate ways by different types of business entities. The business entities
that are not corporations are only supposed to use long term financing for the purpose of debt. However,
the corporations can use long term financing for both debt and equity purposes.

Sources of Long Term Financing:

Following are the various sources of long term finance are as follows –

Shares: These are issued to the general public. The holders of shares are the owners of the business.
These may be of two types:
Equity shares and
Preference shares.
Debentures: These are also issued to the general public. The holders of debentures are the creditors of
the company.
Public Deposits: General public also likes to deposit their savings with a popular and well established
company which can pay interest periodically and pay-back the deposit when due.
Retained Earnings: The company may not distribute the whole of its profits among its shareholders. It
may retain a part of the profits and utilize it as capital.
Term Loans from Banks: Many industrial development banks, cooperative banks and commercial
banks grant medium term loans for a period of 3-5 years.
Loan from Financial Institutions: There are many specialized financial institutions established by the
Central and State governments which give long term loans at reasonable rates of interest.
Long Term Financing Products: The following products are provided as part of long term financing
services.

Introductory idea about capitalization:

The term capital structure refers to the percentage of capital (money) at work in a business by type.
Broadly speaking, there are two forms of capital: equity capital and debt capital. Each has its own benefits
and drawbacks and a substantial part of wise corporate stewardship and management is attempting to
find the perfect capital structure in terms of risk / reward payoff for shareholders. This is true for Fortune
500 companies and for small business owners trying to determine how much of their start-up money
should come from a bank loan without endangering the business.

Let's look at each in detail:

• Equity Capital: This refers to money put up and owned by the shareholders (owners). Typically,
equity capital consists of two types: 1.) contributed capital, which is the money that was originally
invested in the business in exchange for shares of stock or ownership and 2.) retained earnings,
which represents profits from past years that have been kept by the company and used to
strengthen the balance sheet or fund growth, acquisitions, or expansion.

Many consider equity capital to be the most expensive type of capital a company can utilize
because its "cost" is the return the firm must earn to attract investment. A speculative mining
company that is looking for silver in a remote region of Africa may require a much higher return
on equity to get investors to purchase the stock than a firm such as Procter & Gamble, which sells
everything from toothpaste and shampoo to detergent and beauty products.

• Debt Capital: The debt capital in a company's capital structure refers to borrowed money that is
at work in the business. The safest type is generally considered long-term bonds because the
company has years, if not decades, to come up with the principal, while paying interest only in the
meantime.

Other types of debt capital can include short-term commercial paper utilized by giants such as
Wal-Mart and General Electric that amount to billions of dollars in 24-hour loans from the capital
markets to meet day-to-day working capital requirements such as payroll and utility bills. The cost
of debt capital in the capital structure depends on the health of the company's balance sheet -
a triple AAA rated firm is going to be able to borrow at extremely low rates versus a speculative
company with tons of debt, which may have to pay 15% or more in exchange for debt capital.

• Other Forms of Capital: There are actually other forms of capital, such as vendor
financing where a company can sell goods before they have to pay the bill to the vendor, that can
drastically increase return on equity but don't cost the company anything. This was one of the
secrets to Sam Walton's success at Wal-Mart. He was often able to sell Tide detergent before
having to pay the bill to Procter & Gamble, in effect, using PG's money to grow his retailer. In the
case of an insurance company, the policyholder "float" represents money that doesn't belong to
the firm but that it gets to use and earn an investment on until it has to pay it out for accidents or
medical bills, in the case of an auto insurer.
 Concept of Cost of Capital:

A firm raises funds from various sources, which are called the components of capital. Different sources of

fund or the components of capital have different costs. For example, the cost of raising funds through

issuing equity shares is different from that of raising funds through issuing preference shares. The cost of

each source is the specific cost of that source, the average of which gives the overall cost for acquiring

capital.

The firm invests the funds in various assets. So it should earn returns that are higher than the cost of

raising the funds. In this sense the minimum return a firm earns must be equal to the cost of raising the

fund. So the cost of capital may be viewed from two viewpoints—acquisition of funds and application of

funds. From the viewpoint of acquisition of funds, it is the borrowing rate that a firm will try to minimize.

On the other hand from the viewpoint of application of funds, it is the required rate of return that a firm

tries to achieve. The cost of capital is the average rate of return required by the investors who provide

long-term funds. In other words, cost of capital refers to the minimum rate of return a firm must earn on

its investment so that the market value of company’s equity shareholders does not fall.

Measurement of cost of capital:

Measurement of cost of capital is totally related with the risk level of business. In above screenshot, you can

see, when the risk is very very low. We will pay low cost of capital. Our measuring tool will show also low rate

of this cost. Both cost of debt and cost of equity will low. If we have to simplify, we may calculate the weighted

average cost of capital. It will also be very low if risk are at low level. But when the risk level of business will

increase, we have to pay more cost of capital and rate angle will move to right side in measurement tool.

Because, we have explained all the formulae for calculating cost of capital, so this content, we will explain

some examples of measuring cost of capital.

1. Cost of Debt Measurement

B Ltd issues $ 1,00,000 9% debentures at a premium of 10%. The cost of flotation are 2%. The tax rate

applicable is 60%. Measure cost of debt capital.

Kda = Interest /NP X (1-t)

NP = (1,00,000 + 10,000) - (1,10,000 X 2/100) = 1,10,000 - 2,200 = 1,07,800

t = Tax rate

= 1,00,000 X 9% / 1,07,800 X ( 1- 0.6) = 3.34%

2. Cost of Preference Share Capital Measurement

A company issues 1000 7% preference shares of $ 100 each at a premium of 10% redeemable after 5 years at

par. Measure the cost of preference capital

Kpr = D + 1/n ( MV - NP ) / 1/2 ( MV + NP) X 100

D = 100,000 X 7 % = 7,000

MV = 1,00,000

NP = 1,00,000 + 1,00,000 X 10% = 1,10,000

n = 5 years

= 7,000 +1/5 ( 1,00,000 - 1,10,000

3. Cost of Equity Share Capital Measurement

A company is considering an expenditure of $ 60 lakhs for expanding its operations. The relevant information is

as follows.

Number of existing equity shares = 10 Lakhs

Market Value of existing share = $ 60

Net Earnings = $ 90 Lakhs

Measure the cost of existing equity share capital of new equity capital assuming that new shares will be issued

at a price of $ 52 per share and the cost of new issue will be $ 2 per share.

Cost of existing equity share capital

Ke = EPS / MP

EPS = Earning per share

= $ 90/ 10 = $ 9

Ke = 9/60 X 100 = 15%

Cost of New Equity Share Capital

Ke = EPS / NP

= 9/ (52-2) X 100 = 18%

4. Cost of Retained Earning Measurement

A company's return available to shareholders is 15%. The average tax rate of shareholders is 40% and it is

expected that 2% is brokerage cost that shareholders will have to pay while investing their dividends in

alternative securities. What is the cost of retained earnings?

Cost of Retained Earnings = Kr = Ke ( 1- t) (1- b)

Ke = rate of return available to shareholders

t= tax rate

b = brokerage cost

Kr = 15% ( 1-0.4) (1- 0.02)

= 15% X 0.6 X 0.98

= 8.82%
 UNIT-5

Concept & Components of working Capital:

The funds invested in current assets are termed as working capital. It is the fund that is needed to run the

day-to-day operations. It circulates in the business like the blood circulates in a living body. Generally,

working capital refers to the current assets of a company that are changed from one form to another in

the ordinary course of business, i.e. from cash to inventory, inventory to work in progress (WIP), WIP to

finished goods, finished goods to receivables and from receivables to cash.

Need for Working Capital:

Working capital plays a vital role in business. This capital remains blocked in raw materials, work in

progress, finished products and with customers.

The needs for working capital are as given below:

i. Adequate working capital is needed to maintain a regular supply of raw materials, which in turn

facilitates smoother running of production process.

ii. Working capital ensures the regular and timely payment of wages and salaries, thereby improving the

morale and efficiency of employees.

iii. Working capital is needed for the efficient use of fixed assets.

iv. In order to enhance goodwill a healthy level of working capital is needed. It is necessary to build a good

reputation and to make payments to creditors in time.

v. Working capital helps avoid the possibility of under-capitalization.

vi. It is needed to pick up stock of raw materials even during economic depression.

vii. Working capital is needed in order to pay fair rate of dividend and interest in time, which increases the

confidence of the investors in the firm.

Importance of Working Capital:

It is said that working capital is the lifeblood of a business. Every business needs funds in order to run its

day-to-day activities.

The importance of working capital can be better understood by the following:

i. It helps measure profitability of an enterprise. In its absence, there would be neither production nor

profit.

ii. Without adequate working capital an entity cannot meet its short-term liabilities in time.

iii. A firm having a healthy working capital position can get loans easily from the market due to its high

reputation or goodwill.

iv. Sufficient working capital helps maintain an uninterrupted flow of production by supplying raw

materials and payment of wages.

v. Sound working capital helps maintain optimum level of investment in current assets.

vi. It enhances liquidity, solvency, credit worthiness and reputation of enterprise.

vii. It provides necessary funds to meet unforeseen contingencies and thus helps the enterprise run

successfully during periods of crisis.

Classification of Working Capital:

Working capital may be of different types as follows:
(a) Gross Working Capital:

Gross working capital refers to the amount of funds invested in various components of current assets. It

consists of raw materials, work in progress, debtors, finished goods, etc.

(b) Net Working Capital:

The excess of current assets over current liabilities is known as Net working capital. The principal

objective here is to learn the composition and magnitude of current assets required to meet current

liabilities.
(c) Positive Working Capital:

This refers to the surplus of current assets over current liabilities.

(d) Negative Working Capital:

Negative working capital refers to the excess of current liabilities over current assets .

(e) Permanent Working Capital:

The minimum amount of working capital which even required during the dullest season of the year is

known as Permanent working capital.

(f) Temporary or Variable Working Capital:

It represents the additional current assets required at different times during the operating year to meet

additional inventory, extra cash, etc.

It can be said that Permanent working capital represents minimum amount of the current assets required

throughout the year for normal production whereas Temporary working capital is the additional capital

required at different time of the year to finance the fluctuations in production due to seasonal change. A

firm having constant annual production will also have constant Permanent working capital and only

Variable working capital changes due to change in production caused by seasonal changes.
 UNIT-6

Cash Management:

Cash management refers to a broad area of finance involving the collection, handling, and usage of cash.
It involves assessing market liquidity, cash flow, and investments.
In banking, cash management, or treasury management, is a marketing term for certain services related
to cash flow offered primarily to larger business customers. It may be used to describe all bank accounts
(such as checking accounts) provided to businesses of a certain size, but it is more often used to describe
specific services such as cash concentration, zero balance accounting, and automated clearing
house facilities. Sometimes, private banking customers are given cash management services.

Inventory Management:

Inventory is an idle stock of physical goods that contain economic value, and are held in various forms by
an organization in its custody awaiting packing, processing, transformation, use or sale in a future point
of time.

Any organization which is into production, trading, sale and service of a product will necessarily hold
stock of various physical resources to aid in future consumption and sale. While inventory is a necessary
evil of any such business, it may be noted that the organizations hold inventories for various reasons,
which include speculative purposes, functional purposes, physical necessities etc.

From the above definition the following points stand out with reference to inventory:

▪ All organizations engaged in production or sale of products hold inventory in one form or other.
▪ Inventory can be in complete state or incomplete state.
▪ Inventory is held to facilitate future consumption, sale or further processing/value addition.
▪ All inventoried resources have economic value and can be considered as assets of the
organization.

Different Types of Inventory:

Inventory of materials occurs at various stages and departments of an organization. A

manufacturing organization holds inventory of raw materials and consumables required for
production. It also holds inventory of semi-finished goods at various stages in the plant with
various departments. Finished goods inventory is held at plant, FG Stores, distribution centers etc.
Further both raw materials and finished goods those that are in transit at various locations also
form a part of inventory depending upon who owns the inventory at the particular juncture.
Finished goods inventory is held by the organization at various stocking points or with dealers
and stockiest until it reaches the market and end customers.

Besides Raw materials and finished goods, organizations also hold inventories of spare parts to
service the products. Defective products, defective parts and scrap also forms a part of inventory
as long as these items are inventoried in the books of the company and have economic value.
Types of Inventory by Function

INPUT PROCESS OUTPUT

Raw Materials Work In Process Finished Goods

Consumables required for Semi Finished Production in Finished Goods at Distribution

processing. Eg : Fuel, various stages, lying with Centers through out Supply
Stationary, Bolts & Nuts etc. various departments like Chain
required in manufacturing Production, WIP Stores, QC,
Final Assembly, Paint Shop,
Packing, Outbound Store etc.

Maintenance Production Waste and Scrap Finished Goods in transit

Items/Consumables

Packing Materials Rejections and Defectives Finished Goods with Stockiest

and Dealers

Local purchased Items Spare Parts Stocks & Bought

required for production Out items

Defectives, Rejects and Sales

Returns

Repaired Stock and Parts

Sales Promotion & Sample

Stocks

Receivables Management:

Receivables, also termed as trade credit or debtors are component of current assets. When a firm sells its product in

credit, account receivables are created.

Account receivable are the money receivable in some future date for the credit sale of goods and services at present.

These days, most business transactions are in credit. Most companies, when they face competition, use credit sales

as an important tool for sales promotion. As a sales promotion tool, credit sale enhances firm's sales revenue and

ultimately pushes up the profitability. But after the credit sale has been made, the actual collection of cash may be

delayed for months. As these late payments stretch out over time, they may cause substantial drop in a company's

profit margin. Since the extension of credit involves both cost and benefits, the firm's manager must be able to

measure them to determine the ultimate effect of credits sales. In this prospective, we define the receivable

management as the aspect of a firm's current assets management, which is concerned with determining optimum

credit policy associated to a firm, such that the benefit from extension of credit is greater than the cost of maintaining

investment in accounts receivables.

Significance And Purpose Of Receivable Management

The basic purpose of firm's receivable management is to determine effective credit policy that increases the efficiency

of firm's credit and collection department and contributes to the maximization of value of the firm. The specific

purposes of receivable management are as follows:

1. To evaluate the creditworthiness of customers before granting or extending the credit.

2. To minimize the cost of investment in receivables.

3. To minimize the possible bad debt losses.

4. To formulate the credit terms in such a way that results into maximization of sales revenue and still maintaining

minimum investment in receivables.

5. To minimize the cost of running credit and collection department.

6. To maintain a trade off between costs and benefits associated to credit policy.