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 Association, Articles 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.
