Thursday, 3 September 2020

Business Finance & Accounts Business Finance (EDP 14 May 2020)

 Business Finance & Accounts Business Finance

1. COST OF PROJECT

(a) Sources of Finance

The provision of finance to a company to cover its short-term WORKING CAPITAL requirements and longer-term FIXED ASSETS and investments.

Sources of finance for business are equity, debt, debentures, retained earnings, term loans, working capital loans, letter of credit, euro issue, venture funding etc. These sources of funds are used in different situations. They are classified based on time period, ownership and control, and their source of generation. It is ideal to evaluate each source of capital before opting for it.

Long-Term Sources of Finance

Long-term financing means capital requirements for a period of more than 5 years to 10, 15, 20 years or maybe more depending on other factors. Capital expenditures in fixed assets like plant and machinery, land and building, etc

Medium Term Sources of Finance

Medium term financing means financing for a period of 3 to 5 years.

Short Term Sources of Finance

Short term financing means financing for a period of less than 1 year.

 

(b) Assessment of Working Capital

Modes of assessment of working capital for different types of business firm, generally followed by the commercial banks, are as:

1. Sales Turnover Method:

Banks usually apply the turnover method to finance the working capital requirement of relatively small and medium enterprises with sales turnover of approximately Rs 250 million. In this method, the working capital credit limits provided by the lending banks is kept at a minimum level of 20% of the projected annual turnover.

2. Cash Budget Method:

In case of seasonal activities, especially in the agro-based sector, the bank finance for working capital is assessed on the basis of monthly cash budget and the relative cash deficiency on a monthly basis. Under this method, all estimated/projected cash receipts (inflow) on a monthly basis is arranged in a tabular form and the monthly cash outflows are also similarly shown against each month. The deficit or surplus of each month is worked out and the peak deficit amount is considered to be the working capital limit to be provided by the bank.

3. Pre-Defined Inventory and Receivables Holding Level Method:

Under this method, the assessing officer of the bank obtains in the prescribed format the projected level of operations of the borrowing firm for the ensuing year along with the figures of actual operation for the last two years for existing business units. For new firms, only the projection for the ensuing two years is obtained. The projected figures of operation begin with the expected sales turnover and the entire range of other figures of projected expenses revolves round the sales.

 

(c ) Product Costing

Product costing is the accounting process of determining all business expenses pertaining the creation of company products. These costs can include raw material purchases, worker wages, production transportation costs and retail stocking fees.

A product costing can be simply defined as the total amount of costs assigned to a particular product based on a specific PURPOSE of the management of the organization.

 

(d) Profitability

Profitability is ability of a company to use its resources to generate revenues in excess of its expenses. In other words, this is a company's capability of generating profits from its operations.

Profitability is ability of a company to use its resources to generate revenues in excess of its expenses. In other words, this is a company’s capability of generating profits from its operations.

Profitability and profit are sometimes considered as the same thing, they are strictly related, but they do have a crucial difference.

Profit is an absolute amount where profitability is regarded as a relative amount. Profits can be determined by deducting all expenses from the company revenue.

Profitability measure efficiency, ultimately it considers the success or failure of a company.

Even if a company has a profit on the income statement, it does not mean that a company is profitable.

Profitability has two elements, namely, income and expenses. Income also called revenue is the earnings from selling products or providing a service.

A company needs to use resources to generate income, resources are used to produce the products that the company sells or to deliver the services.

Cash is also considered a resource, money is used to settle expenses like salaries, utilities and other necessities that could form part of the production process.

 

(e) Break Even Analysis

Break Even Analysis is a technique widely used by production management and management accountants. It is based on categorizing production costs between those which are "variable" (costs that change when the production output changes) and those that are "fixed" (costs not directly related to the volume of production).

Total variable and fixed costs are compared with sales revenue in order to determine the level of sales volume, sales value or production at which the business makes neither a profit nor a loss ("break-even point").

Fixed Costs

Fixed costs are those business costs that are not directly related to the level of production or output. In other words, even if the business has a zero output or high output, the level of fixed costs will remain broadly the same. In the long term fixed costs can alter - perhaps as a result of investment in production capacity (e.g. adding a new factory unit) or through the growth in overheads required to support a larger, more complex business.

Variable Costs

Variable costs are those costs which vary directly with the level of output. They represent : payment output, related inputs such as raw materials, direct labour, fuel and revenue, related costs such as commission etc.

Significance of Break-Even Analysis as a Tool of Financial Decision Making:

Break-even analysis serves as the most useful and important managerial tool to study cost-output-profits relationships at varying levels of output. This will enable the top management to plan its operational strategies. A finance manager can also make use of this analysis while estimating profits at various levels of sales and production.

Finance manager is not only interested to know at what level of activity the operations of the enterprise will break even but is also interested in estimating the level of operation that will yield optimum profits. Analysis of cost-volume relationships will immensely be useful in profit planning programme.

Finance manager may also use cost-output relationship in establishing or reviewing pricing policies. If the management is contemplating to reduce the price of the product, he may use the relationships to determine what changes in volume of sales would be necessary to compensate the price increase is being considered, the break­even analysis will aid in estimating the maximum reduction in volume that the firm can tolerate without upsetting profitability.

Finance manager may also apply this analysis in determining the implications of proposed changes in policies. For example, a 15% increase in wages will definitely raise the break-even point. The break-even chart will clearly portray the approximate increase in output or rise in selling price to obtain the same level of profits before the wage increase. The break-even analysis aids the finance manager in planning the capital structure of his firm.

The analysis provides a good deal of information about the operating risk of the enterprise. Given an estimated break-even point, a finance manager can compare fluctuations in expected future volume with this point to determine the degree of stability of profits. This will enable a finance manager to determine the ability of the firm to service debt.

Such an analysis provides the management with a means to decide whether or not to acquire assets involving additional fixed costs. Finance manager is generally averse to buy an asset requiring additional fixed costs unless sufficient benefits are assured because increase in fixed costs entails the firm in greater operating risk.

 

 

(f) Financial Ratios and Significance

Financial ratios are created with the use of numerical values taken from financial statements to gain meaningful information about a company. The numbers found on a company’s financial statements – balance sheet, income statement, and cash flow statement – are used to perform quantitative analysis and assess a company’s liquidity, leverage, growth, margins, profitability, rates of return, valuation, and more.

Financial ratios are grouped into the following categories:

1. Liquidity Ratios

Liquidity ratios are financial ratios that measure a company’s ability to repay both short- and long-term obligations. Common liquidity ratios include the following:

The current ratio measures a company’s ability to pay off short-term liabilities with current assets:

Current ratio = Current assets / Current liabilities

The acid-test ratio measures a company’s ability to pay off short-term liabilities with quick assets:

Acid-test ratio = Current assets – Inventories / Current liabilities

The cash ratio measures a company’s ability to pay off short-term liabilities with cash and cash equivalents:

Cash ratio = Cash and Cash equivalents / Current Liabilities

 The operating cash flow ratio is a measure of the number of times a company can pay off current liabilities with the cash generated in a given period:

Operating cash flow ratio = Operating cash flow / Current liabilities

2. Leverage Financial Ratios

Leverage ratios measure the amount of capital that comes from debt. In other words, leverage financial ratios are used to evaluate a company’s debt levels. Common leverage ratios include the following:

The debt ratio measures the relative amount of a company’s assets that are provided from debt:

Debt ratio = Total liabilities / Total assets

 The debt to equity ratio calculates the weight of total debt and financial liabilities against shareholders’ equity:

Debt to equity ratio = Total liabilities / Shareholder’s equity

 The interest coverage ratio shows how easily a company can pay its interest expenses:

Interest coverage ratio = Operating income / Interest expenses

 The debt service coverage ratio reveals how easily a company can pay its debt obligations:

Debt service coverage ratio = Operating income / Total debt service

3. Efficiency Ratios

Efficiency ratios, also known as activity financial ratios, are used to measure how well a company is utilizing its assets and resources. Common efficiency ratios include:

The asset turnover ratio measures a company’s ability to generate sales from assets:

Asset turnover ratio = Net sales / Total assets

The inventory turnover ratio measures how many times a company’s inventory is sold and replaced over a given period:

Inventory turnover ratio = Cost of goods sold / Average inventory

The accounts receivable turnover ratio measures how many times a company can turn receivables into cash over a given period:

Receivables turnover ratio = Net credit sales / Average accounts receivable

The days sales in inventory ratio measures the average number of days that a company holds on to inventory before selling it to customers:

Days sales in inventory ratio = 365 days / Inventory turnover ratio

4. Profitability Ratios

Profitability ratios measure a company’s ability to generate income relative to revenue, balance sheet assets, operating costs, and equity. Common profitability financial ratios include the following:

The gross margin ratio compares the gross profit of a company to its net sales to show how much profit a company makes after paying its cost of goods sold:

Gross margin ratio = Gross profit / Net sales

 The operating margin ratio compares the operating income of a company to its net sales to determine operating efficiency:

Operating margin ratio = Operating income / Net sales

 The return on assets ratio measures how efficiently a company is using its assets to generate profit:

Return on assets ratio = Net income / Total assets

 The return on equity ratio measures how efficiently a company is using its equity to generate profit:

Return on equity ratio = Net income / Shareholder’s equity

5. Market Value Ratios

Market value ratios are used to evaluate the share price of a company’s stock. Common market value ratios include the following:

The book value per share ratio calculates the per-share value of a company based on equity available to shareholders:

Book value per share ratio = Shareholder’s equity / Total shares outstanding

 The dividend yield ratio measures the amount of dividends attributed to shareholders relative to the market value per share:

Dividend yield ratio = Dividend per share / Share price

 The earnings per share ratio measures the amount of net income earned for each share outstanding:

Earnings per share ratio = Net earnings / Total shares outstanding

 The price-earnings ratio compares a company’s share price to its earnings per share:

Price-earnings ratio = Share price / Earnings per share

 

2. ACCOUNTING PRINCIPLES, METHODOLOGY

(a) Book keeping

Bookkeeping involves the recording, on a daily basis, of a company’s financial transactions. With proper bookkeeping, companies are able to track all information on its books to make key operating, investing, and financing decisions.

Bookkeepers are individuals who manage all financial data for companies. Without bookkeepers, companies would not be aware of their current financial position, as well as the transactions that occur within the company.

Accurate bookkeeping is also crucial to external users, which includes investors, financial institutions, or the government – people or organizations that need access to reliable information to make better investments or lending decisions. Simply put, the entire economy relies on accurate and reliable bookkeeping for both internal and external users.

 

Examples of Bookkeeping Tasks

·         Billing for goods sold or services provided to clients

·         Recording receipts from customers

·         Verifying and recording invoices received from suppliers

·         Paying suppliers

·         Processing employees' pay and the related governmental reports

·         Monitoring individual accounts receivable

·         Recording depreciation and other adjusting entries

·         Providing financial reports

Importance of Bookkeeping

Proper bookkeeping gives companies a reliable measure of their performance. It also provides information on general strategic decisions and a benchmark for its revenue and income goals. In short, once a business is up and running, spending extra time and money on maintaining proper records is critical.

Many small companies don’t actually hire full-time accountants to work for them because of the cost. Instead, small companies generally hire a bookkeeper or outsource the job to a professional firm. One important thing to note here is that many people who intend to start a new business sometimes overlook the importance of matters such as keeping records of every penny spent.

 

(b) Financial Statements

Financial statements are reports prepared by a company’s management to present the financial performance and position at a point in time. A general-purpose set of financial statements usually includes a balance sheet, income statements, statement of owner’s equity, and statement of cash flows. These statements are prepared to give users outside of the company, like investors and creditors, more information about the company’s financial positions. Publicly traded companies are also required to present these statements along with others to regulator agencies in a timely manner.

What Does Financial Statements Mean?

Financial statements are the main source of financial information for most decision makers. That is why financial accounting and reporting places such a high emphasis on the accuracy, reliability, and relevance of the information on these financial statements.

Example

The balance sheet a summary of the company position on one day at a certain point in time. The balance sheet lists the assets, liabilities, and owners’ equity on one specific date. In a sense, the balance sheet is a picture of the company on that date. Investors and creditors can use the balance sheet to analyze how companies are funding capital assets and operations as well as current investor information.

The income statement shows the revenue and expenses of the company over a period of time. Most companies issue annual income statement, but quarterly and semi-annual income statements are also common. Users can analyze the income statement to see if companies are operating efficiently and producing enough profit to fund their current operations and growth.

The three financial statements are:

(1) The Income Statement,

(2) The Balance Sheet, and

(3) The Cash Flow Statement.

These three core statements are intricately linked to each other and this guide will explain how they all fit together. By following the steps below, you’ll be able to connect the three statements on your own.

 

(c ) Concept of Audit

Auditing is the process of examining the financial statement and information of the entity. In this process, we examine that is the company making profit or not. It is a systematic process in which we analyze the economic condition and actions.

The word “audit” is a very generic word; it essentially means to examine something thoroughly. But we will be learning about auditing as it relates to accounting and the finance world. So audit meaning is the thorough inspection of the books of accounts of the organization.

 

 

 

 

 

Features of an Audit

·         Auditing is a systematic process. It is a logical and scientific procedure to examine the accounts of an organization for their accuracy. There are rules and procedures to follow.

·         The audit is always done by an independent authority or a body of persons with the necessary qualifications. They have to be independent so their views and opinions can be totally unbiased.

·         Once again, an audit is the examination of all the books of accounts and financial information of the company. So it is essentially a verification of the final accounts of the organization, i.e. the profit and loss statement and the balance sheet at the end of the financial year.

·         Auditing is not only the review of the books of accounts but also the internal systems and internal control of the organization.

·         To conduct the audit we need the help of various sources of information. This includes vouchers, documents, certificates, questionnaires, explanations etc. He may scrutinize any other documents he sees fit like Memorandum of AssociationArticles of Associations, vouchers, minute books, shareholders register etc.

·         The auditor must completely satisfy himself with the accuracy and authenticity of the financial statements. Only then can he give the opinion that they are true and fair statements.

 

No comments:

Post a Comment