Afl - All Five Units

BIM
Executive
Placement 2003
School of Management
Studies Striving towards Excellence
ACCOUNTS AND FINANCE FOR LOGISTICIANS
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
PROBLEMS (U MAY GET PROBLEMS FROM ANY OF

THESE)
COMPARATIVE BALANCE SHEET

COMMON SIZE BALANCE SHEET
COMPARATIVE PROFIT AND LOSS ACCOUNT
COMMON SIZE PROFIT AND LOSS ACCOUNT
TREND PERCENTAGE
RATIO ANALYSIS
BEP, P/V RATIO, MS, REQUIRED SALES AND PROFIT CALCULATION
WORKING CAPITAL REQUIREMENT PROBLEMS
COST OF EQUITY
WEIGHTED AVERAGE COST OF CAPITAL
PAYBACK, ARR, NPV, PI AND IRR
OPERATING, FINANCIAL AND COMBINED LEVERAGE
IN DIVIDEND
Vels University
WALTER MODEL
GORDON MODEL
MM APPROACH
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BIM
Executive
Placement 2003
INSTRUCTIONS
ANSWER ALL THE QUESTIONS

WRITE IN POINTS AND NOT IN PARAGRAPH
IF 5 MARKS, WRITE MINIMUM 2 PAGES
IF 10 MARKS WRITE, WRITE MINIMUM 4 PAGES
CASE STUDY COMPULSORILY ATTEND
IN PPTS, ONLY HINTS ALONE GIVEN, U DEVELOP

ACCORDING TO QUESTIONS
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
SYLLABUS
UNIT I:

Financial Accounting: Meaning of double entry
accounting, Meaning, nature and importance
Accounting cycle, accounting equation. Journal, Ledger
and Trial Balance .Accounting concepts and
conventions, Financial statements- Profit & Loss
account & Balance sheet. Financial statement AnalysisComparative Analysis, Common size & Trend Analysis
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
UNIT II

Financial Statement Analysis - Ratio analysis
Classification of ratios, Advantages & Disadvantages Fund flow statements advantages and disadvantagesMarginal costing Cost Volume Profit analysis Break
Even analysis BEP, P/V ratio, MS

Vels University
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BIM
Executive
Placement 2003
UNIT III:
Introduction to Financial Management Nature of
Financial management Objectives of financial
management -Financial Decisions- Organization of
Finance function Agency Problem
Working capital Concepts Types Determinants
Vels University
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BIM
Executive
Placement 2003
UNIT IV
Sources of capital -Cost of Capital Meaning and
Significance Components Cost of Equity, Cost of
Debt, Cost of Preferred capital, Cost of retained
earnings and weighted average cost of capital. Capital
budgeting meaning Different methods Payback, Net
Present Value, Internal rate of return, Profitability
index and average rate of return

Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
UNIT V

Financial ,Operating and Combined Leverages Meaning
of Capital Structure -Determinants of capital
structure .Dividend decision Dividend policy - Dividend
theories Walter and Gordon modelof dividend
Stability of dividend Share split Buyback of shares.

Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
REFERENCES

1. I.M.Pandey, Financial Management, Vikas publishing
house Ltd., 9th edition, 2007.
2. Prasanna Chandra, Financial Management Theory and
Practice, Tata McGraw Hill, 7th Edition, 2008.
3. Financial and Management accounting by Reddy and
Moorthy
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
UNIT 1
ACCOUNTING:
Accounting is the process of collecting, recording,
classifying summarizing and interpreting financial data
for the needs of management.
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
CLASSIFICATION (OR) BRANCHES OF

ACCOUNTING
FINANCIAL ACCOUNTING
JOURNAL, LEDGER AND TRIAL BALANCE

FINAL ACCOUNTS
TRADING ACCOUNT
PROFIT & LOSS ACCOUNT
BALANCE SHEET
COST ACCOUNTING
COST SHEET
STANDARD COSTING
VARIANCE ANALYSIS
MANAGEMENT ACCOUNTING
- FINANCIAL STATEMENT ANALYSIS COMPARATIVE, COMMON SIZE, TREND ANALYSIS
CAPITAL BUDGETING
RATIO ANALYSIS
FUND FLOW STATEMENT
MARGINAL COSTING
BREAK EVEN ANALYSIS
P/V RATIO
MARGIN OF SAFETY
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
Financial accounting
The main purpose is to ascertain the profit or loss and
to indicate the financial position of the company.
The two important statements prepared in financial
accounting are Profit & loss accounts and Balance
sheet.
Profit & loss accounts to know the profitability of the
company
Balance sheet to know the financial position of the
company on a particular date.
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
Functions/advantages/need/importance/purpose/objective
s/uses of financial accounting
Book keeping functions

Classification of functions
Preparation of financial statements
Segregating financial transactions
Interpretation of financial data
Reporting of information
Providing accurate and reliable information
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
Limitations/disadvantages of financial accounting

Historical data
Financial statements for the enterprise as a whole
It fails to help in price fixation
Not useful in cost control
Evaluation of policies not possible
Actual costs alone are recorded
Does not provide information for strategic decision
making
Complicated and technical subject
Monetary subject
Chances for manipulation or Window dressing
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
Cost accounting
The process of accounting for cost from the point at
which expenditure is incurred or committed to the
company of its ultimate relationship with cost centres
and cost units.
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
Functions/Advantages/need/importance/purpose/objectiv
es/uses of cost accounting
Ascertaining cost
Fixation of selling price
Cost control
Cost reduction
Evaluation of performance
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
Limitations/disadvantages of cost accounting

It involves too many forms and statements.
It involves more clerical work
It is costly to introduce and operate
It depends on financial accounting. If any error in
financial accounting will affect cost accounting too.
It is difficult to ascertain the fully reliable cost
Each cost accountant may use different method which
create confusion
Since different companies use different methods, it is
difficult to compare the companies.
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
Management accounting
Management accounting is the presentation of
accounting information in such a way as to assist
management in the creation of policy and in the day to
day operations of the company.
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
Functions/Advantages/need/importance/purpose/objectiv
es/uses of Management accounting
To help in planning and policy formulation

To help in the interpretation process
To help in decision making
To help in controlling performance
To help in coordinating
To help in organizing
To help in expansion, diversification and strategic business problems
Communication and management policies
To help in motivating employees
Helps in reporting the information
Helps in forecasting
Helps in the achievement of objectives
It uses special tools and techniques
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
Limitations/disadvantages of management accounting
Weakness of source records

Consistent efforts
Management accounting is not a substitute
Mixed discipline
Resistance
Costly installation
Developmental stage
Subjectivity
Vels University
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BIM
Executive
Placement 2003
Users of accounting information

Internal users (Primary Users)of accounting information include the
following:
Management:for analyzing the organization's performance and
position and taking appropriate measures to improve the company
results.
Employees:forassessingcompany'sprofitabilityanditsconsequence
ontheirfutureremunerationandjobsecurity.
Owners:for analyzing the viability and profitability of their
investmentanddetermininganyfuturecourseofaction.
Accountinginformationispresentedtointernalusersusuallyintheform
ofmanagementaccounts,budgets,forecastsandfinancialstatements.
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
Users of accounting information
External users (Secondary Users)of accounting information include the

following:
Creditors:fordeterminingthecreditworthinessoftheorganization.Termsofcreditare
setbycreditorsaccordingtotheassessmentoftheircustomers'financialhealth.Creditors
includesuppliersaswellaslendersoffinancesuchasbanks.
Tax Authorities:fordeterminingthecredibilityofthetaxreturnsfiledonbehalfofthe
company.
Investors:for analyzing the feasibility of investing in the company. Investors want to
makesuretheycanearnareasonablereturnontheirinvestmentbeforetheycommitany
financialresourcestothecompany.
Customers:for assessing the financial position of its suppliers which is necessary for
themtomaintainastablesourceofsupplyinthelongterm.
Regulatory Authorities:for ensuring that the company's disclosure of accounting
information is in accordance with the rules and regulations set in order to protect the
interestsofthestakeholderswhorelyonsuchinformationinformingtheirdecisions.
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
ACCOUNTING CYCLE
JOURNAL
LEDGER
-RECORDING
-CLASSIFYING
TRIAL BALANCE
-SUMMARISING
FINAL ACCOUNTS
- INTERPRETING
TRADING ACCOUNT
PROFIT & LOSS ACCOUNT
BALANCE SHEET
Vels University
FINANCIAL
STATEMENTS
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BIM
Executive
Placement 2003
ACCOUNTING CYCLE
JOURNAL:
Journal is a daily record of business transactions.
It is also called as day book
The process of recording transactions in the journal called
Journalizing
The entries made in journal called journal entries
Vels University
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BIM
Executive
Placement 2003
ACCOUNTING CYCLE
FORMAT OF JOURNAL
S.No
(Rs.)
Vels University
Date
Particulars
L.F
Debit(Rs.)
Name of the A/c

To Name of the A/c
(Narration)
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Credit
BIM
Executive
Placement 2003
ACCOUNTING CYCLE
ADVANTAGES OF JOURNAL:
Vels University
It reduces the possibility of errors

It provides an explanation of the transaction
It provides a chronological record of all transactions
Journal provides records of all business transactions in one place on the time and date basis.
All transactions are recorded on the basis of receipts or bill, so we can check authenticity of each journal entries
with their bills.
There is minimum chance to avoid any particular transaction because in journal transactions are recorded date
basis.
Accountant writes every journal entrys narration bellow of that journal entry, so other auditor can know what the
reason of that journal entry is.
In journal, every transaction is recorded after deep analysis of two accounts on the basis of double entry system, so
there is minimum chance of mistake in journal.
Journal is the basis of posting in ledger accounts. With making of journal, accountant can not make ledger
accounts.
If there is mistake in ledger, we can rectify it with the help of journal or rectify journal entry in journal.
All opening journal entries , closing journal entries and all other transactions which is not recorded in any other
subsidiary books , will be recorded in journal .
Journal is also needed in every type of accounting software . These accounting software can make auto system of
posting journal entries by their automatic processing , but accountant must feed journal entries in journal and
other specific vouchers of journal .
In journal , there is one column of ledger folio . It is very important for checking reference of each account's
posting with its original journal entry .
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BIM
Executive
Placement 2003
ACCOUNTING CYCLE
DISADVANTAGES OR LIMITATIONS OF JOURNAL:
It will be too long if all the transactions are recorded
Difficult to ascertain the balance of each account
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
ACCOUNTING CYCLE
LEDGER:
Ledger provides a summary of similar transactions at one
place.
It is a summary statement of complete transactions relating to
an account.
Ledger is considered as main book of accounts
It is considered to be the principal book of accounts which
helps us in attaining the main objective of accounting.
It provides vital information like
Total sales value periodically
Total purchases periodically
Amount due from individual customers
Amount due to individual suppliers
Amount spent on specific items of expenditure etc
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
ACCOUNTING CYCLE...
DIFFERENCE BETWEEN JOURNAL AND LEDGER
JOURNAL
LEDGER
It is a book of original entry
It is a source of secondary entry
All transactions are recorded in a

chronological order
All transactions pertaining to a particular

account appear at one place
It has greater weightage because it is a book

of source of entry
It is the main source of information
Unit of classification of data is transaction
Unit of classification of data is the account
Process of recording transactions in the

ledger is called as posting
Ledger posting can be done according to

convenience
From the ledger, first the trial balance is
drawn and then final accounts are prepared.
Vels University
Process of recording financial transactions is

called as Journalising
It is a continuous process day after day
Entries are transferred to the ledger
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BIM
Executive
Placement 2003
ACCOUNTING CYCLE...
DIFFERENCE BETWEEN JOURNAL AND LEDGER
Vels University
Journal is the book of prime (first) entry, while Ledger is the book of final entry.
In other words, ledger contains analytical records, while journal contains chronological records.
Narration is required in a journal that is not the case in the ledger.
Transactions are recorded in the sequence of occurrence in the journal, whereas transactions are
classified and recorded in relevant accounts in the ledger.
Data can be classified based on transaction in the ledger, while the basis of classification of data are
accounts in the ledger.
A transaction is firstly recorded in the journal soon after the occurrence of it; it is only then transferred
to the ledger.
Final accounts cannot directly be prepared from journal, but ledgers form the basis for easy
preparation of final accounts.
Accuracy of journal cannot be tested, but accuracy of ledger can be tested to a certain extent using
trial balance.
Journal has two columns for debit and credit, whereas a ledger has two sides of an account one for
debit and the other for credit.
Journals are not balanced at the end of a period, but accounts in the ledger are balanced at the end of
a specific period.
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BIM
Executive
Placement 2003
ACCOUNTING CYCLE..
TRIAL BALANCE:
A statement containing the balances of all ledger accounts, as
at any given date, arranged in the form of debit and credit
columns placed side by side and prepared with the object of
checking the arithmetical accuracy of ledger postings.
Vels University
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BIM
Executive
Placement 2003
ACCOUNTING CYCLE..
IMPORTANCE OR SIGNIFICANCE OF TRIAL BALNCE:
Vels University
Summary of various accounts

Proof of double entry
Ensuring of arithmetical accuracy
Trial balance facilitates preparation of final accounts.
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
It provides a complete picture of each account in the ledger
It supplies in one place ready reference of all the balances of the ledger accounts.
It helps to locate the errors
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BIM
Executive
Placement 2003
ACCOUNTING CYCLE..
LIMITATIONS OF 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.
If avoucheris completed omitted to be entered in a day book
then it will not affect the total of the trial balance.
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
Accounting principles (or) Accounting concepts

Accounting principles are the set of rules and guidelines for the
preparation of financial statements and reports
The accounting concepts are
Business entity concept
Going concern concept
Money measurement concept
Accounting period concept
Dual aspect concept
Cost concept assets in historical cost
Matching concept revenue and expenses matched to know profit
Revenue recognition concept - Inflow and outflow equal
Accrual concept revenue or expenses incurred not received or
paid
Objective evidence concept everything based on evidence
auditor
Vels University
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BIM
Executive
Placement 2003
Accounting conventions
Convention of full disclosure
All information should be revealed
Convention of consistency
Rules, practices and concepts should be used
Convention of materiality
Only required and important items in financial items.
Unimportant should ne left out or merged.
Convention of conservatism
Playing safe. To have accounting alternative for transactions.
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
Difference between Book keeping and Accounting

Bookkeepingis
the
process
of
recording,
in
chronological order, the daily transactions of a business
entity. It forms part of the accounting information
system.
On the other hand,accountingis an information system
includes the process of recording, classifying,
summarizing, reporting, analyzing and interpreting the
financial condition and performance of a business in
order to communicate it to stakeholders for business
decision making.
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
Systems of book keeping

Single entry system
Double entry system
Vels University
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BIM
Executive
Placement 2003
Single entry system

For every transaction there should be one debit and one
credit. This has to be recorded in the journal.
Eg: If Rs. 2000 worth of raw materials purchased by the
company , then Rs. 2000 will be going out of the
company and Rs. 2000 worth of raw material coming in
to the company.
Single entry system is always a incomplete double entry
Vels University
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BIM
Executive
Placement 2003
Single entry system

It does not record the two fold effect of each and every
transaction.
In this single entry, sometimes the business transactions
are recorded in an unsystematic manner by recording only
single aspect, sometimes two fold aspect and sometimes
omitting both.
So, it is called as Single entry double entry or no entry
The accounts maintained in the single entry is not reliable
With this single entry system of accounting, profit & loss
account and balance sheet can not be prepared.
This system is followed in small business
Eg: Sole proprietorship

Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
Double entry system

In double entry system, in every transaction, there will
be one debit and one credit.
An Italian merchant named Luco Pacioli invented the
double entry system of book keeping in 1494 AD.
Vels University
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BIM
Executive
Placement 2003
Advantages of double entry system

It reveals the detailed information
Helps in determining profit & loss
Gives information about financial position
It is based on dual aspect concept ie for every debit
one credit will be there. The information provided in
the double entry system will be accurate.
It helps in preventing frauds and errors.
It satisfies the tax authorities.
It helps in the evaluation of results.
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
Difference between single entry and double entry system

of book keeping.
Single entry is an incomplete and unscientific method of

book keeping where as double entry is a complete and
scientific method of book keeping.
In single entry system, debit and credit do not agree
where as in double entry system, dual aspect concept is
used.
In single entry, only personal and cash accounts are
maintained where as in double entry, Personal account,
real account and nominal account are maintained.
In single entry, Profit and loss and balance sheet cannot
be prepared where as in double entry it can be
prepared.
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
Debit and Credit

Debit:
(Dr)
Benefit receiving aspect
Credit: (Cr)
Benefit giving aspect
In Ledger, Trial balance and Profit & Loss account, the left
hand side is known as debit side and right side know as credit
side.
Vels University
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BIM
Executive
Placement 2003
ALL THE FINANCIAL TRANSACTIONS HAVE TWO ASPECTS

DEBIT BENEFIT RECEIVING ASPECT
CREDIT BENEFIT GIVING ASPECT
DOUBLE ENTRY SYSTEM
Vels University
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BIM
Executive
Placement 2003
NATURE OF ACCOUNT
PERSONAL ACCOUNT
EG: RAMU A/C, GANESH A/C, BANK A/C, RS & CO A/C ETC
REAL ACCOUNT
TANGIBLE ASSETS
EG: MACHINE, LAND, STOCK ETC
INTANGIBLE ASSETS
EG: GOODWILL, PATENTS ETC
NOMINAL ACCOUNT
EXPENSES
EG: SALARY A/C, RENT A/C
INCOME
EG: INTEREST RECEIVED
Vels University
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BIM
Executive
Placement 2003
GOLDEN RULE OF ACCOUNTS
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NATURE OF
ACCOUNT
DEBIT (DR)
CREDIT (CR)
PERSONAL
A/C
THE
RECEIVER
THE GIVER
REAL A/C
WHAT
COMES IN
WHAT GOES
OUT
NOMINAL
A/C
EXPENSES
INCOME AND
AND LOSSES GAINS
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BIM
Executive
Placement 2003
FINANCIAL STATEMENTS
PROFIT AND LOSS ACCOUNT
BALANCE SHEET
Vels University
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BIM
Executive
Placement 2003
Profit & loss account is prepared to ascertain the net profit or net loss of the company in an
accounting period
It is an account into which all gains and losses are collected in order to ascertain the excess of
gains over the losses or vice versa
The left side of the profit and loss account is the debit side (dr) where all the operating and
non operating expenses are mentioned.
The right side of the statement is called as credit side (Cr) where all the operating and non
operating income are mentioned
If income is more than the expenses, then company gets Net profit
If income is less than the expenses, then it is Net loss.
Vels University
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BIM
Executive
Placement 2003

Important expenses
Carriage inwards transport charges paid while bringing the
raw material to the company
Carriage outwards transport charges paid while selling the
products to customers
Bad debts amount which is given as credit but not received
Depreciation
Tax, interest, dividend paid
Salary, wages, rent paid
Discount, commission paid
Vels University
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BIM
Executive
Placement 2003

Important income:
Vels University
Sales
Interest, dividend received
Rent received
Commission, discount received etc
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BIM
Executive
Placement 2003
PROFORMA OF PROFIT AND LOSS ACCOUNT

EXPENSES
Vels University
Purchases
Wages
Salary, rent
Discount
Tax
Interest
Power
Electricity
Carriage inwards
Carriage outwards
Clearing charges
Packing charges
Dock dues
Coal, gas
Factory light
INCOME
Sales
Commission received
Rent received
Interest received
Dividend received
Discount received
Other income
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BIM
Executive
Placement 2003
PROFORMA OF PROFIT AND LOSS ACCOUNT..
Vels University
Dividend paid
Trade charges
Manufacturing expenses
Stationary
Insurance
Repair
Office expenses
Sundry expenses
Establishment expenses
Commission paid
Advertise expenses
Selling and distribution expenses
Audit expenses
Depreciation
Bad debts
Travelling expenses
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BIM
Executive
Placement 2003
BALANCE SHEET
The balance sheet comprises of list of assets and
liabilities of the company on a given date
It presents the financial position of a concern.
It is called as statement of equality.
Vels University
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BIM
Executive
Placement 2003
PROFORMA OF BALANCE SHEET
LIABILITIES
CURRENT LIABILITIES
Creditors
Bills payable
Outstanding expenses
Tax payable
Dividend payable
Bank overdraft
LONG TERM LIABILITIES
EQUITY
Equity share capital
Preference share capital
Reserves & Surplus (Retained Earnings)
DEBT
Debentures
Bank loan
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ASSETS
CURRENT ASSETS
Cash in hand
Cash at bank
Debtors
Bills receivable
Stock
Prepaid expenses
Short term investments
FIXED ASSETS
Land & building
Plant & machinery
Furniture
Loose tools
Motor car
Long term investment
Goodwill
Patents & copyrights
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BIM
Executive
Placement 2003
CURRENT ASSETS AND FIXED ASSETS

CURRENT ASSETS
The asset which can be converted into cash within one

accounting period
Ex
Debtor company gives credit to customers. Customers
will pay later to the company. Till then the customers
are mentioned as Debtors
Bill receivable Same as debtor. The main difference is
that bills receivable is considered as promissory note.
Even if customer cheats, company can take action
against them
Stock or Inventory It may be Raw material or Work in
progress and Finished goods
Prepaid expenses amount paid by the company in
advance
Short term investment company invest their surplus
cash in short time (for period less than one year)
Cash
Current assets are, therefore, very important to cash
flow management and forecasting, because they are
the assets that a business uses to pay its bills, repay
borrowings, pay dividends and so on,
Vels University
FIXED ASSETS
The asset which takes more than one year to

convert into cash
Ex
Land & building
Plant & machinery
Furniture
Loose tools
Motor car
Goodwill
Patents and copyrights
Fixed assets are not held for resale but for the
production, supply, rental or administrative
purposes.
Fixed assets are normally expected to be used for
more than one accounting period which is why
they are part of Non Current Assets of the entity.
Economic benefits from fixed assets are therefore
derived in the long term.
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BIM
Executive
Placement 2003
CURRENT LIABILITIES AND LONG TERM

LIABILITIES
CURRENT LIABILITIES
The liability which has to be paid by the company

within one accounting period
Ex
Creditors credit received by the company from
the suppliers
Bills payable similar to creditors but bills payable
is a promissory note. If company defaults, then
the suppliers will take action against the company
Outstanding expenses expenses not paid by the
company eg: Outstanding rent, outstanding salary
Tax payable
Dividend payable
Bank overdraft company may withdraw more
from their current account above the available
balance and to be repaid within the year
LON TERM LIABILITIES
Vels University
The liabilities which can be paid even after one

year by the company is called as long term
liabilities.
Eg
EQUITY
Equity share capital amount received by the
company by issuing equity share. For this company
pays equity dividend to the equity shareholders.
The dividend rate is not fixed
Preference share capital amount received by the
company by issuing preference share. For this
company pays fixed preference dividend to
preference shareholders
Reserves & Surplus (Retained Earnings) unused
last year profit
DEBT
Debentures amount received by the company by
issuing debentures. For this company pays fixed
interest to the debenture holders
Bank loan
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BIM
Executive
Placement 2003
FINANCIAL STATEMENT
Financial statements refer to formal and original
statements prepared by a business concern to disclose
its financial information
The two major financial statements are
Profit & loss account
Balance sheet
Vels University
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BIM
Executive
Placement 2003
USES OF FINANCIAL STATEMENTS
Prospective investors use financial statements to perform financial analysis, which is a key component in making investment decisions.
A lending institution will examine the financial health of a person or organization and use the financial statement to decide whether or not to lend
funds.
Philanthropies may use financial statements of a non-profit as a component in determining where to donate funds.
Government entities (tax authorities) need financial statements to ascertain the propriety and accuracy of taxes and other duties declared and paid
by a company.
Vendors who extendcreditmay use financial statements to assess the creditworthiness of the business.
Employees also may use reports in making collective bargaining agreements
Managersrequire Financial Statements to manage the affairs of the company by assessing its financial performance and position and taking
important business decisions.
Shareholdersuse Financial Statements to assess the risk and return of their investment in the company and take investment decisions based on their
analysis.
Customersuse Financial Statements to assess whether a supplier has the resources to ensure the steady supply of goods in the future. This is
especially vital where a customer is dependant on a supplier for a specialized component.
Competitorscompare their performance with rival companies to learn and develop strategies to improve their competitiveness.
General Publicmay be interested in the effects of a company on the economy, environment and the local community.
Governmentsrequire Financial Statements to determine the correctness of tax declared in the tax returns. Government also keeps track of
economic progress through analysis of Financial Statements of businesses from different sectors of the economy.
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ESSENTIALS OF GOOD FINANCIAL STATEMENTS
Simplicity:Financial statements should be simple so that concerned individuals can easily understand and interpret them properly. For this, the
statements must be simple and clear.
Right time:These must be prepared at the right time. Any delay in their presentation may decrease their usefulness.
Compliance with legal requirements:Financial statements must be prepared in the form and style as required by the Act. They must have subjectmatter as prescribed and must be presented as stated in the Act.
Adherence of accounting principles:The financial statements must be based on the Generally Accepted Accounting Principles (GAAP) so that they
may have universal acceptance.
Disclosure:The financial statements should disclose all the relevant and material facts. It should be transparent so that the users of accounting
information can draw neat conclusions.
Authentic:The information contained in the financial statements should be authentic supported by evidence.
Relevant to the purpose:Financial statements must be relevant to their purposes. Irrelevant and unnecessary informations should not be included
in these statements.
Complete and accurate informations:Financial statements should include the complete and accurate information about the progress of a business
and its future prospects. Informations should be based on facts. False and incomplete information results in wrong interpretation.
Comparability:Financial statements should be comparable. The comparison can be made between present and past as well as between one business
and the other. It increases the utility of the statements. This can be done when similar accounting principles are adopted for their presentation.
Facilitating the analysis:Decisions can be taken only by proper analysis of the financial statements. Thus, financial statements should be prepared
in such a way that it may facilitate the analysis. For this, the various items should be classified and grouped in a proper manner, so that data can be
obtained easily for analysis.
Systematic arrangement:The information contained in the financial statements should be arranged systematically so that they may be comparable.
Audited:The financial statements should have been presented to the uses after being audited by the competent chartered accountants.
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LIMITATIONS OF FINANCIAL STATEMENTS
Based on traditions and conventions:Financial statements are prepared and based upon traditions and conventions which allow the usage of personal judgments.
Based on historical data:Financial statements are based on historical data while parties are more interested in knowing the present position and future prospects of
the business enterprise.
Scope of manipulations:Financial statements are sometimes prepared according to the needs of the situation or whims of the management. Management can
manipulate financial statements by under-valuation or over-valuation of inventory, under or over charging of depreciation etc.
Sometimes window dressing is resorted to in order to show better financial position of a concern than its real position. So financial statements are not free from bias.
Influenced by personal judgements:Financial statements are influenced by personal judgements of the account. On many issues more than one methods are
permitted. For example, method of depreciation, valuation of stock, valuation of goodwill etc. all depend upon the personal judgements of the policy-maker of the
enterprise.
Ignore qualitative aspects:Financial statements show only those facts which can be expressed in money terms. Qualitative aspects of the business units are omitted
from the books, because they cannot be expressed in money terms. Thus, cordial employer-employee relations, efficiency of management, firm?s ability to develop
new products, customer satisfaction, etc. have a vital role in the profitability of the firm, but here ignored and omitted because these are qualitative in nature.
Ignore inflationary effects:Changes in price level make data meaningless. Financial statements record transactions at historical costs. No account is taken of the
present value.
Ignore the interest of other parties:Financial statements are prepared with a view to take care of the interest of proprietors only and ignore the interests of all
other interested parties like creditors, investors, workers, stock exchanges, taxation authorities, economists, researchers, politicians, etc.
Financial statements are only interim reports:Financial statements are essentially interim reports. They cannot be final. The actual profit or loss of a business can
be determined only when the business is ultimately closed. The existence of contingent assets and liabilities, deferred revenue expenses make the statement less
accurate and more subjective.
Artificial view:Financial statements do not reveal a real and correct picture of the worth of assets and their loss of value. The reason is that they are shown on
historical cost. Thus, these statements provide artificial view. Market or replacement value and the effect of the changes in the price level are completely ignored.
Incapable:Financial statements are incapable of showing profitability, operational efficiency, financial soundness, etc. of the business.
These limitations of financial statements can be removed by efficient analysis and interpretation of the financial statements.
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TECHNIQUES OR TOOLS FOR FINANCIAL

STATEMENT ANALYSIS
COMPARATIVE STATEMENT ANALYSIS (OR) HORIZONTAL ANALYSIS

Comparative financial statement is aanalysis of financial statementsof the company for two years or of
the two companies of similar types. Horizontal analysis is also regarded asDynamic Analysis. It is an
important method of analysis which is used to make comparison between two financial statements. Being
a technique of horizontal analysis and applicable to both financial statements, income statement and
balance sheet, it provides meaningfulinformationwhen compared to the similar data of prior periods.
The comparative statement of income statements enables to review the operational performance and to
draw conclusions, whereas the balance sheets,presentinga change in the financial position during the
period, show the effects of operations on the assets and liabilities. Thus, the absolute change from one
period to another may be determined.
COMPARATIVE BALANCE SHEET
COMPARATIVE PROFIT AND LOSS ACCOUNT
COMMONSIZE STATEMENT ANALYSIS (OR) VERTICAL ANALYSIS
The figures of financial statements are converted to percentages. It is performed by taking the total
balance sheet as 100. The balance sheet items are expressed as the ratio of each asset to total assets and
the ratio of each liability to total liabilities. Thus, it shows the relation of each component to the whole Hence, the name common size.
COMMON SIZE BALANCE SHEET
COMMON SIZE PROFIT AND LOSS ACCOUNT
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STATEMENT ANALYSIS...
TREND ANALYSIS
Trend analysis is the analysis of the trend of the financialratiosof the company over the
years. It is an important tool of horizontal analysis. Under this analysis, ratios of different
items of the financial statements for various periods are calculated and the comparison is
made accordingly. The analysis over the prior years indicates the trend or direction. Trend
analysis is a useful tool to know whether the financial health of a business entity is
improving in the course of time or it is deteriorating.
RATIO ANALYSIS
Ratio analysis is the analysis of the interrelationship between two financial figures. The
most popular way to analyze the financial statements is computing ratios. It is an
important and widely used tool of analysis of financial statements. While developing a
meaningful relationship between the individual items or group of items of balance sheets
and income statements, it highlights the key performance indicators, such as,liquidity,
solvency and profitabilityof a business entity. The tool of ratio analysis performs in a way
that it makes the process of comprehension of financial statements simpler, at the same
time, it reveals a lot about the changes in the financial condition of a business entity.
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STATEMENT ANALYSIS...
FUND FLOW STATEMENT

The objective of this analysis is to extract theinformationrelating to working capital. The
amount of net working capital is determined by deducting the total of current liabilities
from the total of current assets. The statement of changes in working capital provides the
informationin relation to working capital between two financial periods.
CASH FLOW STATEMENT

Cash flow analysis is the analysis of the change in the cash position during a period.
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UNIT 2
RATIO ANALYSIS
A ratio is a mathematical relationship between two items expressed in a
quantitative form.
An accounting ratio can be defined as quantitative relationship between two or
more items of the financial statements connected with each other.
It is a comparison of the numerator with the denominator.
Examples: Liquidity ratios, Profitability ratios, Turnover ratios, solvency ratios.
Analysis and interpretation of financial statements with the help of ratios is
termed as ratio analysis.
It involves the process of computing, determining and presenting the
relationship of items or groups of items of financial statements.
It is an age old technique of financial analysis.
There are three steps in ratio analysis (a) Selection of relevant information (b)
Comparison of calculated ratios (c ) Interpretation and reporting.
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Importance of ratio analysis
Aid to measure general efficiency:

Ratios enable the mass of accounting data to be summarized and simplifies.
They act as an index of the efficiency of the enterprises
As such they serve as an instrument of management control
Aid to measure financial solvency:
Ratios are useful tools in the hands of management and other concerned to evaluate the firms performance over a period of time by comparing past
and present ratios
Aid in forecasting and planning:
Ratio is in invaluable aid to management in the discharge of its basic function such as planning forecasting control
The ratios that are derived after analysing and scrutinising the past results help the management to prepare budgets
To formulate policies and to prepare the future plan of action etc..
Facilitated decision making :
It throws light on the degree of efficiency of the management and utilisation of the assets
Hence it is called surveyor of efficiency
The help in management decision making
Aid in corrective action :
Ratio analysis provides interfirm comparison
They highlight factors associated with successful amd unsuccessful firms
If comparison shows an unfavourable variance corrective action intiated
Act as good communicator:
Ratios are effective means of communication and plays a vital role in informing the progress made by the business concern to the owners and other
interested parties
The communicator by the use of simplified and summarized ratio are more easy to understand
Evaluation of efficiency:
Ratio analysis is an effective instrument which, when properly used is useful to asses important characteristics of business-liquidity, solvency etc
Effective tool:
Ratio analysis helps in making effective control of the business measuring performance control of cost etc.
Effective control is key note of effective management
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Disadvantages or limitations of ratio analysis
Practical knowledge: the analyst should have thorough knowledge and

experience about the firm and industry. otherwise the analysis and
interpretation are of little practical use
Ratio are means: ratios are not an end in themselves but they are means
to achieve a particular purpose or end
Inter relationship: ratios are interrelated and therefore single ratios
cannot convey any meaning. it has to be interpreted with reference to
other related ratios to draw meaningful conculsion
Non availability of standards: ratios will be meaningful if they can be
compared with standard norms. Except for a few financial ratios, other
ratios lack of standards which are universally recognised
Accuracy of financial information: the accuracy of a ratio depends on the
accuracy of information derived from financial statements. If the
statements are inaccurate same will be the results with ratios
Change in price level: ratios analysis become sredundant during periods
of heavy price fluctuations
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Advantages of Ratio analysis
1.Helpful inDecision Making

All our financial statements are made for providing information. But this information is not helpful fordecision makingbecause financial statements provide only raw
information. When we calculate different ratios in ratio analysis, at that time, we get useful information. I can explain it with simple example. Suppose, we calculate
ourinterestcoverage ratio which is 10times but our competitor company's interest coverage ratio is 15 times. It means capacity of the profit of our competitor
company is more than us. By seeing this, we can take decisions for increasing our profitability.
2. Helpful inFinancial Forecastingand Planning
Every year we calculate lots ofaccounting ratios. When we make trend of all these ratios, we can get useful information for our future forecasting and planning. For
example, we can tell five year collection period with following way
From this trend, we know that we are decreasing the days for collection money from ourdebtors. With this information, we can make two plans. One is effective use
of money which we are getting from our debtors more fastly and second we can also check the behavior of our debtors by comparing this with sales trend. Like this,
there are lots of ratios which are also useful for better planning.
3. Helpful in Communication
Ratio analysis are more important from communication point of view. Suppose, we have toappointnew sales agents for our company. At that time, we can
communicate them by using our company's sales and profit related ratios. There is no need of hi-tech for understandingthe meaningof any specific ratio. For
example, ourgross profitin 2010 is 26.6% and in 2011, it is 28.55%. By just telling this ratio, we can understand whether our company is growing or falling.
4. Helpful in Co-ordination
No company has all the strength points. Company'sfinancial resultsshows some strength points and some weak points. Ratio analysis can create co-ordination
between strength points and weak points.
5. Helps in Control
Ratio analysis can also use for controlling our business. We can easily create the standard of each financial item of our balance sheet and profit and loss account. On
this basis, we can also calculate standard ratios. By comparing standard ratios with actualaccounting ratios, we can find variance. These variance may be favorable
and unfavorable. On this basis, we can control our business from financial point of view.
6. Helpful for Shareholder's decisions
For example, I am a shareholder.I want to investin any company's shares. Before buying any company's shares, I will be interested to know company's long term
solvency. So, I have to calculate long term solvency ratios. In which, I have to calculate fixedassetsto net worth ratio, fixed assets tolong term debtratio. On this
basis, I can know the level of fixed assets and its main resource. After checking my money's security, I will be interested to know my return on this investment. ROI,
EPS and DPS are most useful ratios which I can calculate for knowing this.
7. Helpful for Creditors' decisions
Creditorsare those persons who provide goods on credit to company or provides short period loan to company. All the creditors are interested to know whether
company will repay their debt or not. For this, they calculatecurrent ratioand quick liquid ratio andaveragepayment period. On this basis, they take decisions.
8. Helpful for employees' decisions
Every employee wants to increase his salary. He also wants to get more and more incentives from company. For this, he takes help from company's profitability ratios.
Profitability ratios will be helpful for employees to pressure on the company for increasing their salary.
9. Helpful for Govt. decisions
Different companies analyze theiraccounting ratiosand publish on the net and print newspapers. Govt. collects all these information. On this basis, Govt. makes
policies. If ratios will wrong, Govt. policies will become wrong. For example, Govt. collects income data of all companies in different industries for calculation the
national income.
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CLASSIFICATION OF RATIOS
Classification of ratios by purpose or function
These ratios are used for the purpose of assessing profitability, activity or operating efficiency and financial position of a concern.
These ratios are classified as profitability ratios, Turnover ratios, Financial or solvency ratios
Profitability ratios include Return on investment, Net profit ratio, Gross profit ratio, Operating profit ratio etc
Turnover ratios include Stock turnover, Debtor turnover, Creditors turnover, Working capital turnover etc
Financial or solvency ratios include current ratio, liquid ratio, Proprietary ratio, Debt equity ratio etc.
Classification of ratios by importance
This classification is being adopted by the British Institute of Management. These ratios are classified as
Primary ratios Also known as Explanatory ratios which include Return on capital employed, Assets turnover, Profit ratios
Secondary performance ratios Working capital turnover, Stock to turnover, Current assets to fixed assets, Fixed assets to total assets etc
Secondary credit ratios include Creditor turnover, Debtor turnover, Liquid ratio, Current ratio etc
Growth ratios include growth rate in sales, growth rate in net assets.
Classification of ratios by users
Ratios are classified on the basis of parties who use the ratios.
Ratios are classified for management, creditors and shareholders.
The following are the ratios for management viz Operating ratios, Stock turnover ratio, Debtor turnover ratio, Fixed assets turnover ratios,
Creditor turnover ratio, Net profit ratio, Gross profit ratio etc
Ratios for Creditors are Fixed charges cover, Debt service cover, Liquid ratio, Current ratio, Debt equity ratio, Capital gearing ratio, Solvency
ratio etc
Ratios for shareholders are Return on shareholders fund, Payout ratio, Dividend yield ratio, Capital gearing ratio etc.
Classification of ratios by statements
This is the traditional classification of ratios.
Accounting information is obtained mostly from profit & loss account and balance sheet.
Balance sheet ratios Liquidity ratio, Current ratio, Absolute liquidity ratio, Proprietary ratio, fixed assets ratio, Debt equity ratio etc.
Profit & loss account ratios Gross profit ratio, Net profit ratio, Operating profit ratio, Expense ratio etc
Mixed or composite ratios Return on investment, Return on Net worth, Stock turnover, Debtor turnover, Creditor turnover etc.
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Important ratios
1.Debt-to-Equity Ratio
The debt-to-equity ratio, is a quantification of a firms financial leverage estimated by dividing the total liabilities by stockholders
equity. This ratio indicates the proportion of equity and debt used by the company to finance its assets.
The formula used to compute this ratio is
Total Liabilities / Shareholders Equity
2.Current Ratio
The current ratio is a liquidity ratio which estimates the ability of a company to pay back short-term obligations. This ratio is also
known as cash asset ratio, cash ratio, and liquidity ratio. A higher current ratio indicates the higher capability of a company to pay
back its debts. The formula used for computing current ratio is:
Current Assets / Current Liabilities
3.Quick Ratio
The quick ratio, also referred as the acid test ratio or the quick assets ratio, this ratio is a gauge of the short term liquidity of a
firm. The quick ratio is helpful in measuring a companys short term debts with its most liquid assets.
The formula used for computing quick ratio is:
(Current Assets Inventories)/ Current Liabilities
A higher quick ratio indicates the better position of a company.
4.Return on Equity (ROE)
The return on equity is the amount of net income returned as a percentage of shareholders equity. Moreover, the return on equity
estimates the profitability of a corporation by revealing the amount of profit generated by a company with the money invested by the
shareholders. Also, the return on equity ratio is expressed as a percentage and is computed as:
Net Income/Shareholder's Equity
The return on equity ratio is also referred as return on net worth (RONW).
5.Net Profit Margin
The net profit margin is a number which indicates the efficiency of a company at its cost control. A higher net profit margin shows
more efficiency of the company at converting its revenue into actual profit. This ratio is a good way of making comparisons between
companies in the same industry, for such companies are often subject to similar business conditions.
The formula for computing the Net Profit Margin is:
Net Profit / Net Sales
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Important ratios...
6. Inventory turnover ratio:

This ratio is called as Stock velocity ratio (or) Stock turnover ratio. It is calculated to ascertain the efficiency of inventory
management. It shows the relationship between cost of goods sold and average inventory. It helps to evaluate and review inventory
policy. Inventory turnover ratio = Cost of goods sold / Average inventory
Cost of goods sold = Sales Gross profit
Average inventory = (Opening stock + Closing stock) / 2.
7. Debtor and Creditor turnover ratio:
Debtor turnover is also called as Receivables turnover ratio or Debtor velocity
It measures the number of times the receivables are rotated in a year in terms of sales.
It also indicates the efficiency of credit collection and efficiency of credit policy
It helps in determining the operational efficiency of a business
Debtor turnover ratio = Credit Sales / (Debtor + Bills receivable)
Creditor turnover ratio is also known as creditor velocity. Also known as Accounts payable turnover ratio
It indicates the number of times the payables rotate in a year
Creditor turnover ratio = Credit Purchases / (Creditors + Bills Payable)
8. Gross profit ratio
9. Capital Gearing ratio
10. Interest cover ratio
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CURRENT RATIO
Theratioofcurrentassetstocurrentliabilitiesiscalledascurrentratio.
Itisusedtomeasuretheshorttermliquidityorsolvencyofacompany.
Itindicatestheabilityofaconcerntomeetitscurrentobligationasandwhentheyaredueforpayment.
Currentratio=Currentasset/Currentliabilities
CurrentassetsincludeDebtors,Billsreceivable,Stock,Cashinhandandatbanketc
CurrentliabilitiesincludesCreditors,Bankoverdraft,billspayable,Outstandingexpensesetc
Thestandardcurrentratiois2:1
Limitation of current ratio:
Differentratioindifferentpartoftheyear
Changeininventoryvaluationmethod
Currentratioisthetestofquantityandnotquality
Possibilityofmanipulation
Significance and interpretation
Currentratioisausefultestoftheshort-term-debtpayingabilityofanybusiness.Aratioof2:1orhigherisconsidered
satisfactoryformostofthecompaniesbutanalystshouldbeverycarefulwhileinterpretingit.Simplycomputingthe
ratiodoesnotdisclosethetrueliquidityofthebusinessbecauseahighcurrentratiomaynotalwaysbeagreensignal.It
requiresadeepanalysisofthenatureofindividualcurrentassetsandcurrentliabilities.Acompanywithhighcurrent
ratio may not always be able to pay its current liabilities as they become due if a large portion of its current assets
consistsofslowmovingorobsoleteinventories.Ontheotherhand,acompanywithlowcurrentratiomaybeableto
payitscurrentobligationsastheybecomedueifalargeportionofitscurrentassetsconsistsofhighlyliquidassetsi.e.,
cash,bankbalance,marketablesecuritiesandfastmovinginventories.Considerthefollowingexampletounderstand
howthecompositionandnatureofindividualcurrentassetscandifferentiatetheliquiditypositionoftwocompanies
havingsamecurrentratiofigure.
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QUICK RATIO
It is otherwise called as Liquid ratio or Acid test ratio.

Liquid ratio = Liquid assets / Current liabilities
Liquid assets refer to assets which are quickly convertible into cash.
Liquid asset = Current assets Stock Prepaid expenses
CurrentliabilitiesincludesCreditors,Bankoverdraft,billspayable,Outstandingexpensesetc
The ideal liquid ratio is 1 : 1
Comparison of quick ratio with current ratio indicates the inventory hold ups.
Significance and Interpretation
Quick ratio is considered a more reliable test of short-term solvency thancurrent ratiobecause
it shows the ability of the business to pay short term debts immediately.
Inventories and prepaid expenses are excluded from current assets for the purpose of
computing quick ratio because inventories may take long period of time to be converted into
cash and prepaid expenses cannot be used to pay current liabilities.
Generally, a quick ratio of 1:1 is considered satisfactory. Like current ratio, this ratio should
also be interpreted carefully. Having a quick ratio of 1:1 or higher does not mean that the
company has a strong liquidity position because a company may have high quick ratio but slow
paying debtors. On the other hand, a company with low quick ratio may have fast moving
inventories. The analyst, therefore, must have a hard look on the nature of individual assets.
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Inventory turnover ratio
This ratio is called as Stock velocity ratio (or) Stock turnover ratio.
It is calculated to ascertain the efficiency of inventory management
It shows the relationship between cost of goods sold and average inventory
It helps to evaluate and review inventory policy
Inventory turnover ratio = Cost of goods sold / Average inventory
Cost of goods sold = Sales Gross profit
Average inventory = (Opening stock + Closing stock) / 2.
Significance and Interpretation:
Inventory turnover ratio vary significantly among industries. A high ratio indicates fast moving inventories
and a low ratio, on the other hand, indicates slow moving or obsolete inventories in stock. A low ratio
may also be the result of maintaining excessive inventories needlessly. Maintaining excessive inventories
unnecessarily indicates poor inventory management because it involves tiding up funds that could be
used in other business operations.
Users must also observe various factors that can effect inventory turnover ratio (ITR) before interpreting
or making any decision. For example, companies using FIFO cost flow assumption may have a higher ITR
in the days of inflation because latest inventory purchased at higher prices remain in the stock under
FIFO. On the other hand, companies using LIFO cost flow assumption may have comparatively lower ITR
than others because oldest inventory purchased at comparatively lower prices remain in the stock under
LIFO.
Another factor that could influence this ratio is the use of just-in-time inventory method. Companies
using just in time system of inventory management usually have high inventory turnover ratio as
compared to others in the industry.
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Differentiate debtor turnover ratio and creditor

turnover ratio
Debtor turnover is also called as Receivables turnover ratio or Debtor velocity

It measures the number of times the receivables are rotated in a year in terms of sales.
It also indicates the efficiency of credit collection and efficiency of credit policy
It helps in determining the operational efficiency of a business
Debtor turnover ratio = Credit Sales / (Debtor + Bills receivable)
Creditor turnover ratio is also known as creditor velocity. Also known as Accounts payable turnover ratio
It indicates the number of times the payables rotate in a year
Creditor turnover ratio = Credit Purchases / (Creditors + Bills Payable)
Significance of debtor turnover ratio
This ratio is very helpful when used in conjunction with short term solvency ratios i.e.,current ratioand quick
ratio. Short term solvency ratios measure the liquidity of the company as a whole and accounts receivable
turnover ratio measures the liquidity of accounts receivables.
There is no rule of thumb to interpret this ratio. Analysts can compare the ratio with industrys standard.
Generally, a high ratio indicates that the receivables are more liquid and are being collected promptly. A low
ratio is a sign of less liquid receivables and may reduce the true liquidity of the business in the eyes of the
analyst even if the current and quick ratios are satisfactory.
Significance of creditor turnover ratio
Accounts payable turnover ratio indicates the creditworthiness of the company. A high ratio means prompt
payment to suppliers for the goods purchased on credit and a low ratio may be a sign of delayed payment.
Accounts payable turnover ratio also depends on the credit terms allowed by suppliers. Companies who enjoy
longer credit periods allowed by creditors usually have low ratio as compared to others.
A high ratio (prompt payment) is desirable but company should always avail the credit facility allowed by the
suppliers.
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Current assets
A current asset is an item on an entity's balance sheet that is either cash, a cash equivalent, or which can be converted into cash within one year.
Examples of current assets are:
Cash in hand and cash at bank - These assets are literally money in the bank: cold, hard cash
Short term Investments - These represent the next step above cash and equivalents. They normally come into play when a
company has so much cash on hand that it can afford to tie some of it up in bonds lasting less than one year. This money can't
immediately be liquefied without some effort, but it does earn a higher return than plain old cash. Cash and investments give
shares immediate value, and while they're not entirely easy to liquidate, in a pinch they can be distributed to shareholders with
minimal effort.
Prepaid expenses - The company has already paid these expenses to its suppliers. They can be a lump sum paid to an
advertising agency, or a credit for some bad merchandise issued by a supplier. Although these expenditures aren't technically
liquid, since the company does not actually have the money in question in the bank, having bills already paid is a definite plus.
It means that those bills won't have to be paid in the future, allowing more of the revenue for that particular quarter to flow to
the bottom line and become liquid assets.
Accounts receivableor Bills receivable - Normally abbreviated as A/R, these are funds that customers currently owe to a
company. They've received the company's products, but haven't yet paid for those goods or services. Companies routinely buy
goods and services from other companies on credit. Although A/R is almost always turned into cash within a short amount of
time, some customers aren't so diligent. In rare cases, companies have to write off bad accounts receivable if they've shipped
goods or provided services to a customer unwilling or unable to pay.
Inventory or Stock - These are the components and finished products that a company has currently stockpiled to sell to
customers. Not all companies have inventories, particularly if they are involved in advertising, consulting, services, or
information industries. For companies that do sell physical goods, however, inventories are extremely important.
Debtors
These items are typically presented in the balance sheet in their order of liquidity, which means that the most liquid items are shown first. The
preceding example shows current assets in their order of liquidity.
Creditors are interested in the proportion of current assets to current liabilities, since it indicates the short-term liquidity of an entity. In essence,
having substantially more current assets than liabilities indicates that a business should be able to meet its short-term obligations
The main problem with relying upon current assets as a measure of liquidity is that some of the accounts within this classification are not so liquid.
In particular, it may be difficult to readily convert inventory into cash. Similarly, there may be some extremely overdue invoices within the accounts
receivable number, though there should be an offsetting amount in the allowance for doubtful accounts to represent the amount that is not
expected to be collected. Thus, the contents of current assets should be closely examined to ascertain the true liquidity of a business.
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Current liabilities
Current liabilities are what a company currently owes to its suppliers and creditors. These are short-term debts, all due in less
than a year. Paying them off normally requires the company to convert some of its current assets into cash.
The important current liabilities are
Creditors - A creditor may be a bank, supplier or person that has provided credit to a company. In other words, a company
owes money to its creditors. The amounts owed to creditors are reported on the company'sbalance sheetasliabilities.
If a creditor required the company to sign a promissory note for the amount owed, the company will record and report
the amount as Notes Payable. If a creditor is a vendor or supplier that did not require the company to sign a promissory
note, the company will likely report the amounts owed asAccounts Payable. Other examples of creditors include
company's employees (who are owed wages and bonuses), governments (who are owed taxes), and customers (who made
deposits or other prepayments).
Some creditors are known as secured creditors because they have a lien or other legal claim to the company's(debtor's)
assets. Other creditors are often unsecured creditors since they do not have a lien or legal right to specific assets of the
company.
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Bills or Accounts payable - This is the money the company currently owes to its suppliers, partners, and employees -- the
basic costs of business that the company hasn't yet paid, for whatever reason. One company's accounts payable is another
company's accounts receivable, which is why both terms are similarly structured. A company has the power to push back
the due dates on some of its accounts payable. Paying those debts later than expected can often produce a short-term
increase in earnings and current assets.
Bank overdraft - n extension of credit from a lending institution when an account reaches zero. An overdraft allows the
individual to continue withdrawing money even if the account has no funds in it. Basically the bank allows people to
borrow a set amount of money.
Outstanding expenses - Outstanding expenses are those expenses which have been incurred andconsumed during an
accounting period and are due to be paid,but are not paid. Examples include outstanding salary, outstanding rent, etc.
Outstanding expenses are recorded in the books at the end of an accounting period to show true numbers of a business.
Provision for doubtful debts
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Placement 2003
Fund flow statement

This statement is based on the working capital concept
of funds. It measures the inflow and outflow of working
capital resulting from different transactions
Fund flow means change in working capital. Flow of
funds implies any changes in working capital.
Fund flow statement measures and presents in an
analytical manner the summarised version of the
numerous flows of funds for a specified period.
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Importance of fund flow statement
1) it provides detailed analysis and understanding of changes in the

distribution of financial resources between two balance sheet dates.
2)it shows how the funds were obtained and used during a period
3)the sources from which funds were obtained or useful in computation of
cost of capital of the business
4)a detailed analysis of sources of funds in the past acts as a guide for
obtaining funds for future requirements
5)it throws light on the financial consequences of business operations
6)it gives indication of any weakness or strength in the general financial
position of a firm
7)it can be compared with the relevant budgets to assess the usage of
funds as per plan
8)rearrangement of capital structure, formulating long term financial
plans and policies,. Etc. Are facilitated by funds flow analysis.
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Executive
Placement 2003
Difference between fund flow statement and

balance sheet
Funds flow statement

It shows changes in working capital between two balance sheet dates.
It shows only those items which cause changes in working capital
It aims at presenting flow of funds over a period.
It is a tool for financial analysis, generally useful to the management
It is based on the data forming part of the income statement and the balance sheet.
It is prepared after the financial accounts are completed.
Balance sheet
It shows the position of assets and liabilities on a specific date.
It shows the real and personal accounts of a business, reflected in the assets and liabilities.
It aims at depicting the financial position of a business
It is the culmination of the accounting process of a period. It is meant for general purpose and
usage of various stakeholders.
It is based on the trial balance and additional information relating to a firm
It is prepared after the income statement is completed.
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Advantages of Funds Flow Statement:
Funds flow statement presents the following advantages:
(a) Fund Generating Capacity:

With the help of cash flows from operating activities, a Funds Flow Statement helps to understand the fund generating capacity of the
firm which, ultimately, provides valuable information to the management for taking future courses of action.
(b) Changes in Working Capital Position:

A Funds Flow Statement presents either the increase in Working Capital or Decrease in Working Capital with the help of A Statement
of Exchanges in Working Capitalwhich helps us to know from which sources the additional Capital has been procured, or the
application of such funds.
(c) Projected Funds Flow Statement:

A firm can prepare its expected inflows and outflows of cash for future with the help of a Projected Funds Flow Statement.
(d) Highlights the Causes of Changes:

A Funds Flow statement highlights the significant causes of changes in Working Capital position between two accounting periods
revealing the effect for the same on the liquidity and solvency position of a firm.
(e) Evaluation of Credit-Worthiness:

Credit Granting Agencies, after careful analysis of a Funds Flow Statement, can evaluate the creditworthiness of a firmwhich helps
them to understand the liquidity position.
(f) Highlight the Causes of the Following Contradictions:

(i) Adequate Cash Reserve but insufficient profit
Or,
(ii) Sufficient profit, inadequate cash reserves.
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Disadvantages (or) Limitations of fund flow

statement
(A funds flow statement cannot present a continuous change of financial activities including the
changes of working capital.
Since it is based on financial statement (i.e. Income Statement and Balance Sheet), it is not a
original statement.
A projected Funds Flow Statement does not always present very accurate estimates about the
financial position since it is a historic one.
It is not a substitute of financial statements, i.e. Income Statement and Balance Sheet. It
simply supplies information about the change of Working Capital position which, again, depends
on the data presented by the financial statements.
Cash Flow Statement, i.e. changes in cash position, is more important or more informative than
the changes in working capital which is presented by a Funds Flow Statement.
It is historical in nature. It shows what happened in the past. So, necessarily, its value is limited
from the point of view of future operations.
It is nothing but second data. The information in financial accounts is rearranged and
presented. So, its accuracy and reliability depend on the accounting department.
It is a summarised presentation of figures and cannot provide information about changes on a
continuous basis.
The effect of transactions between current assets and liabilities is not shown in the statement
It also ignores transactions between long term and liabilities.
It is not generally considered as a sophisticated technique of financial analysis.
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Format of fund flow statement
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Executive
Placement 2003
Cost Volume Profit analysis ( CVP) analysis

Cost-Volume-Profit (CVP) analysis is a managerial
accounting technique that is concerned with the effect
of sales volume and product costs on operating profit of
a business. It deals with how operating profit is
affected by changes in variable costs, fixed costs,
selling price per unit and the sales mix of two or more
different products.
CVP analysis has following assumptions:
All cost can be categorized as variable or fixed.
Sales price per unit, variable cost per unit and total
fixed cost are constant.
All units produced are sold.
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Executive
Placement 2003
Important concepts in cost volume profit

analysis
Fixed costs it is the total of all those costs termed as Period costs or
Time costs. They do not depend on the volume of production and sales.
Eg: Office rent, Managers salary etc
Variable costs these costs which increase or decrease in proportion to
the output and sales. It is also known as Product costs or Marginal costs.
They vary in direct proportion to the output. They include all direct costs.
Contribution it is the difference between sales and marginal costs. It is
the contribution towards fixed cost and profit. It is used to find the
profitability of products, processes, departments and divisions.
Profit Volume ratio (P/V ratio) this is the ratio of contribution to sales. It
is an important ratio analysing the relationship between sales and
contribution. High P/V ratio indicates high profitability and low value
means low profitability. It helps to compare profitability of various
products.
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Placement 2003
P/V ratio
This is the ratio of contribution to sales. It is an important ratio analysing the relationship
between sales and contribution. High P/V ratio indicates high profitability and low value means
low profitability. It helps to compare profitability of various products.
Every organization should try to increase P/V ratio. It can be increased by
Decreasing the variable costs by effectively utilising materials, machines and men
Selecting most profitable product mix for production and sales
Increasing the selling price per unit
P/V Ratio = Contribution x100

Sales
P/V Ratio = Change in Profit x100
Change in Sales
Significance of P/V ratio
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Useful in Break even analysis

It helps in determining sales, net profit, variable costs etc
It helps to make comparative study in lines of products, individual factors, sales areas , separate
companies
It helps in management to estimate sales, profit, and variable costs of future operations
It is extensively used in determining price policy and other managerial policies where there is any key
factor or limiting factor.
Operating results of a firm may be improved by considering various alternative. Alternative results are
contrasted and assessed through P/V ratio.
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Executive
Placement 2003
Break even point (or) Break even analysis
It determines at what level cost and revenue are in equilibrium

It refers to a system of determination of that level of activity where total sales are just equal to total costs. This level is known
as Break even point (BEP)
Also known as No profit, no loss point
Uses:
Total costs, variable costs and fixed costs can be determined.
Break even sales units and value can be ascertained
CVP relationship can be analysed thoroughly which is useful for the management in decision making
Helps in inter firm comparison
Helps in profit forecasting and planning
Profitability of various levels of activity, products divisions and departments can be analysed through break even analysis
Helps in cost control
Total profits can be determined by aggregating the contribution of different products or divisions and reducing the fixed
cost from the total.
Limitations:
Clear classification of costs into fixed and variable costs not possible
Selling price may not remain constant in practice
Detailed cost information cannot be known
Significance of opening and closing stock is ignored by valuing them at marginal costs
Different product and sales mixes cannot be studies since only one sales mix is analysed usually
Capital employed, market aspects, impact of Govt policy are ignored
It assumes constant business conditions which is not practical.
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Formulae
1.
2.
3.
4.
Sales-Marginal cost = Contribution

Contribution = Fixed costs + Profit
Fixed cost = Contribution Profit
P/V Ratio = Contribution x100
Sales
5. P/V Ratio = Change in Profit x100
Change in Sales
6. Break even point in units = Fixed costs
Contribution per unit
7.Break even point in Rs = Fixed costs
P/V ratio
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8. Contribution per unit = Selling price per unit Variable cost per unit
9. Sales required = Fixed costs+ Required Profits
Contribution = Sales X P/V ratio
P/V Ratio
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Marginal costing
Definition:
The ascertainment of marginal costs and of the effect on profit of changes in volume or type of output by differentiating
between fixed costs and variable costs.
Advantages of Marginal costing
Automation investments:Marginal costing is useful to determine how much a firm stands to gain or lose by automating some
function. The key costs to take into consideration are the incremental labor cost of any employees who will be terminated versus the
new costs incurred from equipment purchase and subsequent maintenance.
Cost reporting:Marginal costing is very useful for controlling variable costs, because you can create a variance analysis report that
compares the actual variable cost to what the variable cost per unit should have been.
Customer profitability:Marginal costing can help determine which customers are worth keeping and which are worth eliminating.
Internal inventory reporting: Since a firm must include indirect costs in its inventory in external reports, and these can take a long
time to complete, marginal costing is useful for internal inventory reporting.
Profit-volume relationship:Marginal costing is useful for plotting changes in profit levels as sales volumes change. It is relatively
simple to create a marginal costing table that points out the volume levels at which additional marginal costs will be incurred, so that
management can estimate the amount of profit at different levels of corporate activity.
Outsourcing:Marginal costing is useful for deciding whether to manufacture an item in-house or maintain a capability in-house, or
whether to outsource it.
Cost control:Marginal costing makes it easier to determine and control costs of production. By avoiding the arbitrary allocation of
fixed overhead costs, management can concentrate on achieving and maintaining a uniform and consistent marginal cost.
Simplicity:Marginal costing is simple to understand and operate and it can be combined with other forms of costing (e.g. budgetary
costing and standard costing) without much difficulty.
Elimination of cost variance per unit:Since fixed overheads are not charged to the cost of production in marginal costing, units have
a standard cost.
Short-term profit planning:Marginal costing can help in short-term profit planning and is easily demonstrated with break-even charts
and profit graphs. Comparative profitability can be easily assessed and brought to the notice of the management for decision-making.
Accurate overhead recovery rate:This method of costing eliminates large balances left in overhead control accounts, which makes it
easier to ascertain an accurate overhead recovery rate.
Maximum return to the business:With marginal costing, the effects of alternative sales or production policies are more readily
appreciated and assessed, ensuring that the decisions taken will yield the maximum return to the business.
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Disadvantages of marginal costing:
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Classifying costs:It is very difficult to separate all costs into fixed and variable costs clearly, since all
costs are variable in the long run. Hence such classification sometimes may give misleading results.
Furthermore, in a firm with many different kinds of products, marginal costing can prove less useful.
Accurately representing profits:Since the closing stock consists only of variable costs and ignores fixed
costs (which could be considerable), this gives a distorted picture of profits to shareholders.
Semi-variable costs:Semi-variable costs are either excluded or incorrectly analyzed, leading to
distortions.
Recovery of overheads:With marginal costing, there is often the problem of under or over-recovery of
overheads, since variable costs are apportioned on an estimated basis and not on actual value.
External reporting:Marginal costingcannotbe used in external reports, which must have a complete
view of all indirect and overhead costs.
Increasing costs:Since it is based on historical data, marginal costing can give an inaccurate picture in
the presence of increasing costs or increasing production.
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Executive
Placement 2003
Application of marginal costing
1. Key factor or limiting factor

2. Make or buy decisions
3. Fixation of selling prices
4. Export decision
5. Sales mix decision
6. Product elimination decision
7. Plant merger decision
8. Plant purchase decision
9. Further processing decision
10. Shut down decision
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DIFFERENT TYPES OF COMPANIES
SOLE PROPRIETORSHIP
PARTNERSHIP COMPANY
PRIVATE LIMITED COMPANY
PUBLIC LIMITED COMPANY
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BALANCE SHEET
LIABILITIES
CURRENT LIABILITIES
Creditors
Bills payable
Outstanding expenses
Tax payable
Dividend payable
Bank overdraft
LONG TERM LIABILITIES
EQUITY
Equity share capital
Preference share capital
Reserves & Surplus (Retained Earnings)
DEBT
Debentures
Bank loan
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ASSETS
CURRENT ASSETS
Cash in hand
Cash at bank
Debtors
Bills receivable
Stock
Prepaid expenses
Short term investments
FIXED ASSETS
Land & building
Plant & machinery
Furniture
Loose tools
Motor car
Goodwill
Patents & copyrights
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FINANCE
Finance Definition:
Finance is the process of conversion of accumulated funds to productive
use
Finance may be defined as the administrative area or set of
administrative functions in an organization which relate with the
arrangement of cash and credit so that the organization may have the
means to carry out its objectives as satisfactorily as possible.
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FINANCIAL MANAGEMENT
Financial management is a managerial activity which is

concerned with the planning and controlling of the
firms financial resources
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Executive
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OBJECTIVES (OR) GOALS OF

FINANCIAL MANAGEMENT
PROFIT MAXIMISATION
MAXIMISING PROFIT AFTER TAXES
MAXIMISING EPS
SHAREHOLDER WEALTH MAXIMISATION(SWM)
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VARIOUS SOURCES OF FINANCE
Short term finance

Trade credit
Open account
Notes payable
Trade acceptance
Accrued expenses
Deferred income
Bank finance
Overdraft
Cash credit
Bills discounting
Factoring
Medium term finance
Loan from financial corporation
Rights or public debentures
Public deposits
Loans from commercial banks
Long term finance
Share
Equity share
Preference share
Debenture
Non convertible debentures(NCDs)
Fully convertible debentures (FCDs)
Partially convertible debentures(PCDs)
Term loans
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BASIC FINANCIAL DECISIONS

(OR)
SCOPE OF FINANCIAL MANAGEMENT
(OR)
EXPLAIN RAISING OF FUNDS, ALLOCATING AND MANAGING OF FUNDS
(OR)
Key decisions in financial management are a part of an integrated framework . Discuss
(OR)
Finance function performs facilitory , reconciliatory and control functions in
organisation . Discuss.
FINANCING DECISIONS (OR) CAPITAL MIX DECISIONS (OR)

CAPITAL STRUCTURE DECISIONS
INVESTMENT DECISIONS (OR) LONG TERM ASSET MIX DECISIONS
(OR) CAPITAL BUDGETING DECISIONS
DIVIDEND DECISIONS (OR) PROFIT ALLOCATION DECISONS
LIQUIDITY DECISIONS (OR) SHORT TERM ASSET MIX DECISIONS
(OR) WORKING CAPITAL DECISIONS (OR) CURRENT ASSET
MANAGEMENT
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FUNCTIONS OR EMERGING ROLE

OF FINANCE MANAGER
FUND RAISING
FUND ALLOCATION
PROFIT PLANNING
UNDERSTANDING CAPITAL MARKETS
ROUTINE FUNCTIONS
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AGENCY PROBLEM
(OR)
Agency conflicts are direct outcome of the multiplicity of stake holders in a firm and their
resolutions lies in the convergence of the interests of varied stakeholders. Analyze.
RELATIONSHIP (OR)PROBLEM BETWEEN SHAREHOLDERS(OWNERS) AND MANAGERS

Managers act according to management and neglects dividend payment to shareholders
and this creates problem between shareholders and managers.
To overcome this problem management should do
Monitoring managers performance
Performance based Incentives to managers
Periodically audit financial statements and limit managers roles
Provide shares to managers (Stock option)
RELATIONSHIP (OR) PROBLEM BETWEEN SHAREHOLDERS(OWNERS) AND CREDITORS
Creditors have fixed claim on company resources in the form of long term debt,
bank loans, leases etc
Creditors have fixed return whereas shareholders have variable returns. This
creates problem between shareholders and creditors
Sometimes in loan covenants creditors restrict dividend payment to
shareholders and getting new debt.
These agency problem lead to agency cost and affect the long survival of the
firm
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ORGANISATION OF FINANCE FUNCTION
OR
HOW FINANCE DEPARTMENT IS ORGANISED
OR
ORGANISATION CHART OF FINANCE FUNCTION
FUNCTIONS OF TREASURER
FUNCTIONS OF CONTROLLER
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BOARD OF
DIRECTORS
MD
P - MANAGER
TREASURER
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HR MANAGER
F - MANAGER
CONTROLLER
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M -MANAGER
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Executive
Placement 2003
TREASURER
Under him auditing, credit management,
retirement benefits, cost control etc
He takes care of the liability side of the balance
sheet
CONTROLLER
Under him planning & budgeting, inventory
management, performance evaluation,
accounting etc.
He takes care of the asset side of the balance
sheet.
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RELATIONSHIP BETWEEN FINANCE

AND OTHER DEPARTMENTS
FINANCE AND ECONOMICS

FINANCE AND ACCOUNTING
FINANCE AND MARKETING
FINANCE AND PRODUCTION
FINANCE AND HR
FINANCE AND SYSTEM
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RELATIONSHIP BETWEEN RISK AND

RETURN
RETURN = RISK FREE RATE + RISK
PREMIUM
Risk free rate is the compensation for time
Risk premium is the compensation for risk
A balance between risk & return should be maintained
and that balance is called as risk return trade off
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RELATIONSHIP BETWEEN RISK AND RETURN AND FINANCIAL DECISIONS
FINANCIAL DECISIONS
INVESTMENT
DECISIONS
FINANCING
DECISIONS
DIVIDEND
DECISIONS
LIQUIDITY
DECISIONS
RISK RETURN TRADE OFF
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While taking all these financial decisions, the finance manager should
maintain a balance between risk and return and these decisions should
increase the shareholders wealth by maximizing the market value of
the share www.velsuniv.org
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TIME VALUE OF MONEY OR TIME

PREFERENCE OF MONEY
A sum of money received today is more worth than if
the same amount is received after sometime
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REASONS FOR TIME VALUE OF MONEY

RISK
CONSUMPTION PREFERENCE
INVESTMENT OPPORTUNITIES
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Concepts of time value of money

Future value of money PROCESS CALLED AS
COMPOUNDING
Present value of money PROCESS CALLED AS
DISCOUNTING
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Future value of money

Future value is defined as the sum of initial principle amount
expected to grow over a period of n years with interest rate of r%
per year
The process of finding out the future value is called as
compounding
FOR SINGLE CASH FLOW
FV(r,n) = PV (1 + r)n = PV x CVF (r,n)

FOR ANNUITY
FV(r,n) = PV
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(1+r)n 1
r
= PV X CVFA (r,n)
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Executive
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Present value of money

Present value is the current value of the future
amount
The process of converting future value to
present value is called as Discounting
FOR SINGLE CASH FLOW
PV(r,n) = FV(r,n)
(1 + r)n
= FV x PVF (r,n)
FOR ANNUITY
PV (r,n)
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= FV x PVFA (r,n)
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OWNERS OF RESIDUE
Equity shareholders or Ordinary shareholders are called
as owners of residue. Equity shareholders being the
owners of the company, bear the risk of ownership.
Equity shareholders will be given dividend only after
satisfying the claims of others. Even when the company
wound up, ordinary shareholders can claim on assets of
the firm at last only. So, they are called as owners of
residue.
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PROFITABILITY LIQUIDITY TRADE OFF

Investment in current assets affects the firms
profitability and liquidity. Firm should not
invest more in current assets or less in current
assets. If more fund invested in current assets
the affects the profitability of the company. If
less funds are invested in current assets that
affects the liquidity position of the company.
So, a proper balance has to be maintained
between profitability and liquidity and this is
called as profitability liquidity trade off.
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DIFFERENCE BETWEEN EQUITY SHARE AND

PREFERENCE SHARE
Ordinary share is otherwise called as Equity share. A person purchasing a

equity share is called as equity shareholder. Equity shareholders do not
receive fixed percentage of dividend, so equity share is called as variable
income security. Equity shareholders receive only the residual income so
they are called as Owners of residue. Equity shareholders have voting
rights.
Preference share: It is called as a hybrid security because it has both the
features of equity shares and debentures. The dividend rate is fixed for
preference share. It has no voting rights. It can be redeemable or
irredeemable preference share.
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Equity share
Ordinary share is otherwise called as Equity share. A
person purchasing a equity share is called as equity
shareholder. Equity shareholders do not receive fixed
percentage of dividend, so equity share is called as
variable income security. Equity shareholders receive
only the residual income so they are called as Owners
of residue. Equity shareholders have voting rights.
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Preference share
Preference share: It is called as a hybrid security
because it has both the features of equity shares and
debentures. The dividend rate is fixed for preference
share. It has no voting rights. It can be redeemable or
irredeemable preference share.
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Debenture
Debenture is a long term promissory note for raising
loan capital. If the investors purchase debenture then
they are called as debenture holders and they receive
fixed percentage of interest from the company.
Debenture holders are the creditors of the company. It
may be Non convertible debenture (NCD), Partly
convertible debenture (PCD) and Fully convertible
debenture(FCD)

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Ordinary share (or) Equity share & its features

Ordinary shares (or) Common share (or) Equity share
represent ownership position in a company.
The holders of equity share is called as equity
shareholders.
They are the legal owners of the company
Ordinary share is the source of permanent capital since
they do not have maturity period.
The shareholders get dividend and the dividend rate is
not fixed.
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This share is otherwise called as Variable income
security.
Being the owners of the company, the equity
shareholders bear the risk of ownership.
When the company wound up, the equity shareholders
get the claims at last, so they are called as Owners of
residue
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Features of equity share (or) Ordinary share:
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Claim on income
Claim on assets
Right to control
Voting rights
Pre emptive rights
Limited liability
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Advantages of equity share to the company
Permanent capital
Borrowing base
Dividend payment discretion
Disadvantages of equity share to the company
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High floatation of cost

Risk
Earnings dilution
Ownership dilution.
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Preference shares & its features

Preference share is a hybrid security because it has
features of both ordinary shares and debentures.
They have fixed dividend rate
No voting rights.
They do not share in the residual earnings.
Preference dividend are not deductible fax tax
purposes.
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Preference shares & its features..

Features of Preference shares:
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Claim on income and assets.

Fixed dividend
Cumulative dividends
Redemption
Sinking fund
Call feature
Participation feature
Voting rights
convertibility
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Preference shares & its features..

Advantages of Preference shares
Riskless leverage advantage

Dividend postponability
Fixed dividend
Limited voting rights
Disadvantages of Preference shares

Non deductibility of dividends
Commitment to pay dividend
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Placement 2003
Debenture & its features

A debenture is a long term promissory note for raising
loan capital.
The firm promises to pay interest and principal as
stipulated.
The purchasers of debentures are called as debenture
holders.
Debenture is otherwise called as bond.
When public sector company issues, it is called as bond
and when private sector company issues it is called
debenture.
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Features of debentures:
Longterm,fixedincomefinancialsecurity.
Debentureholdersarethecreditorsofthefirm.
Theparvalueofadebentureisthefacevalueappearingonthedebenture
certificate
Interestrateisfixed
Debentureshavedefinitematuritydate
Redemption
Sinkingfund
Buybackprovision
Indentureordebenturetrustdeed
Security
Yield
Claimonassetsandincome
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Type of debentures:
Non convertible debentures (NCDs)
Fully convertible debentures (FCDs)
Partly convertible debentures (PCDs)
Advantages of debentures
Less costly
No ownership dilution
Fixed payment of interest
Reduced real obligation
Disadvantages of debentures
Obligatory payments
Financial risk
Cash outflows
Restricted covenants
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
WORKING CAPITAL
THE CAPITAL WHICH IS REQUIRED FOR DAY TO DAY
BUSINESS OPERATIONS
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
CONCEPTS OF WORKING CAPITAL

GROSS WORKING CAPITAL
It refers to the firms investment in current assets.
Current assets are the one which can be converted in cash within
one accounting period.
The major current assets are cash in hand, cash at bank, stock, bills
receivables, Debtors, prepaid expenses etc
NET WORKING CAPITAL

It is the difference between current assets and current liabilities
The major current liabilities are creditors, bills payable,
outstanding expenses, bank overdraft atc.
Current liabilities are the one which needed to repaid by the firm
within one accounting year.
WORKING CAPITAL = CURRENT ASSET CURRENT

LIABILITIES
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
FORMS OR TYPES OF WORKING CAPITAL

PERMANENT WORKING CAPITAL
It is the fixed working capital

It is the minimum level of required current assets
It is similar to firms fixed assets
Depending upon the changes in production and sales, the need
for working capital over and above permanent working capital
will fluctuate
TEMPORARY WORKING CAPITAL

It is the variable working capital
It is the extra working capital needed to support the changing
production and sales activities of the firm.
Both permanent and temporary working capital are needed for
the firm.
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
WORKING CAPITAL CYCLE
CASH
CUSTOMERS (Debtors)
RAW MATERIALS
FINISHED GOODS
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
BALANCED WORKING CAPITAL

HUGE INVESTMENT IN CURRENT ASSETS is NOT GOOD
LESS INVESTMENT IN CURRENT ASSETS is also NOT

GOOD
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
DANGERS OF EXCESSIVE AND INADEQUATE WORKING

CAPITAL
DANGERS OF EXCESSIVE WORKING CAPITAL
It results in unnecessary accumulation of inventory which leads to inventory waste
and losses
It is an indication of defective credit policy and slack in collection period
Excessive working capital degenerates into managerial inefficiency
Tendencies of accumulating inventories tend to make speculative profits grow.
DANGERS OF INADEQUATE WORKING CAPITAL

It stagnates growth
It becomes difficult for the firm to undertake project for non availability of working
capital
It becomes difficult for the firm to implement operating plans
Difficult to meet day to day commitments
Fixed assets will not be efficiently utilized for the lack of working capital funds
Scarcity of working capital funds render the firm unable to avail attractive credit
opportunities
The firm loses its reputation when it is not in a position to honour its short term
obligations.
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
METHODS OF FINANCING WORKING CAPITAL

LONG TERM FINANCING EQUITY SHARE CAPITAL,
PREFERENCE SHARE CAPITAL, DEBENTURES, R & S AND
LONG TERM LOANS
SHORT TERM FINANCING WORKING CAPITAL LOAN
FROM BANKS, PUBLIC DEPOSITS, COMMERCIAL
PAPER(CP), FACTORING OF RECEIVABLES
SPONTANEOUS FINANCING TRADE CREDITORS AND
OUTSTANDING EXPENSES
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
DETERMINANTS OF WORKING CAPITAL (OR)

FACTORS INFLUENCING WORKING CAPITAL
NATURE OF BUSINESS
MARKET AND DEMAND CONDITIONS
TECHNOLOGY AND MANUFACTURING POLICY
CREDIT POLICY
AVAILABILITY OF CREDIT FROM SUPPLIERS
OPERATING EFFICIENCY
PRICE LEVEL CHANGES
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
METHODS OF CALCULATING WORKING CAPITAL NEEDS

The most appropriate method of calculating the working
capital need of a firm is the concept of operating cycle.
Other methods are
Current assets holding period
This can be done by relating the current assets with

the cost based on the companys experience in the
previous years
This method is based on operating cycle concept.
Ratio of sales
This is by the ratio between sales and assumed current

assets
Ratio of fixed investments
Based on a percentage of fixed investment.

Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
COMPONENTS OF WORKING CAPITAL MANAGEMENT

INVENTORY MANAGEMENT
RECEIVABLES OR CREDIT MANAGEMENT
CASH MANAGEMENT
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
INVENTORY (OR) STOCK
RAW MATERIAL
WORK IN PROCESS
FINISHED GOODS
MOTIVES OF HOLDING INVENTORY

TRANSACTION MOTIVE
PRECAUTIONARY MOTIVE
SPECULATIVE MOTIVE
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
OBJECTIVES OF INVENTORY MANAGEMENT
TO MAINTAIN A LARGE SIZE OF INVENTORIES OF RAW
MATERIALS AND WORK IN PROCESS FOR EFFICIENT
AND SMOOTH PRODUCTION OF FINISHED GOODS FOR
UNINTERRUPTED SALES OPERATIONS
TO MAINTAIN A MINIMUM INVESTMENT IN INVENTORIES
TO MAXIMISE PROFITABILITY
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
INVENTORY MANAGEMENT TECHNIQUES
ECONOMIC ORDER QUANTITY (EOQ):

ABC ANALYSIS
JUST IN TIME (JIT) SYSTEMS
OUTSOURCING
COMPUTERIZED INVENTORY CONTROL SYSTEMS.
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
EOQ AND EBQ

Economic Ordering Quantity (EOQ) is the optimum quantity which the firm
has to order each time when raw materials are required. This reduces the
Ordering cost and carrying cost.
EOQ = 2AO/c
Where
A = annual demand of material
O = ordering cost
C = carrying cost per unit.
Economic batch quantity (EBQ) is the optimum quantity which balances the
advantages of larger batches and the disadvantages of larger inventory.
EBQ = 2 US / C
Where U = Annual demand of the product
S = Setting up and order processing cost per batch
C = Carrying cost
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
ORDERING AND CARRYING COST

Ordering cost
It includes the entire costs of acquiring raw materials
It includes cost of requisitioning, purchase ordering, transporting,
receiving, inspecting and storing of raw materials
Ordering cost increases in proportion to the number of orders placed.
Carrying cost
Costs incurred for maintaining a given level of inventory are called as
carrying costs.
It includes storage, insurance, taxes, detorioration, and obsolescence
costs.
The storage costs includes cost of storage space (warehousing cost),
stores handling costs, clerical and staff service costs incurred in
recording and providing special facilities such as fencing, lines, racks
etc.
Carrying cost vary with inventory size.
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
LEAD TIME (or) REORDER PERIOD

Lead time is the time normally taken in replenishing
inventory after the order has been placed.
Lead time = Reorder point / Average usage.
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
REORDER POINT
Reorder time is the inventory level at which an order to
be placed to replenish the inventory.
To determine the Reorder point Lead time, average
usage and EOQ is needed.
Reorder point = Lead time X Average usage.
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
SAFETY STOCK
Normally reorder point is computed under the assumption
of certainty.
It is difficult to predict the annual usage and lead time
accurately
The demand may vary as well as the lead time may also
vary.
If the demand increases and delivery delayed then the firm
face the problem of stock out which is costly for the firm.
In order to guard against stock out, the firm should
maintain safety stock.
Reorder point = Lead time X average usage + safety stock
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
TRADE CREDIT
Trade credit happens when the firm sells its products or
services on credit and does not receive the cash
immediately.
Trade credit creates bills receivable and debtors
Debtor forms a substantial portion in current asset.
Advantages:
Easy availability
Flexibility
Informality
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
COMMERCIAL PAPER
Commercial Paper (CP) is an important money market instrument.
It is issued in a form of unsecured promissory note to raise short term
funds by the firms.
The cost of commercial paper include discount, rating charges, stamp
charges and issuing and paying agent charges.
Merits
It is an alternate source of raising short term finance
It is the cheaper source of finance in comparison to bank credit
From an investors point of view, it provides an opportunity to make a safe, short
term investment of surplus funds
Demerits
It is an impersonal method of financing

It is always available to the financially sound highly rated companies
The amount of loanable funds available in the commercial paper market is limited
It cannot be redeemed until maturity
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
SHORT TERM SOURCE OF FINANCE

Short term finance
The funds available for a period of one year or less are called as short term finance. It is used for
financing working capital
It can be in different forms
Trade credit
Open account
Notes payable
Trade acceptance
Accrued expenses
Deferred income
Bank finance
Overdraft
Cash credit
Bills discounting
Factoring
The sale of bills receivable to a company that is specialized in buying
receivables to acquire short term financing is called as factoring. The types of
factoring are (a) Full service non-recourse (b) Full service recourse factoring
(c) Bulk / agency factoring (d) Non-notification factoring.
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
CREDIT POLICY VARIABLES
The 3 credit policy variables are

Credit standards and analysis
It is the criteria the firm should follow in selecting customers for the
purpose of credit extension
Customers character, capacity and condition is analyzed through Numerical
credit scoring, Ad hoc approach, Simple and multiple discriminant analysis
Credit terms
Once the creditworthiness of the customers are analyzed, the company
decides to grant or not to grant the credit.
The stipulation under which the firm sells on credit to customers is called
as credit terms. It includes credit period and cash discounts.
Credit period is the length of time for which credit is extended to the
customers.
Collection policy and procedures
Collection policy is needed because all the customers do not pay the bills
in time.
Some customers are slow payers and some are non payers.
The firm should offer cash discount for prompt payment.
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
FACTORS DETERMINING SIZE OF RECEIVABLES

Level of sales
Credit policies
Terms of trade
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
CASH MANGEMENT
Cash is an important current asset for the operations of
the business.
Facets of cash management
Vels University
Cash planning
Managing the cash flows
Optimum cash levels
Investing surplus cash
www.velsuniv.org
BIM
Executive
Placement 2003
CASH MANAGEMENT
MOTIVES OF HOLDING CASH
The transaction motive
The precautionary motive
The speculative motive
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
TECHNIQUES TO ACCELERATE CASH COLLECTIONS

The techniques are
Vels University
Decentralized collection
Lock box system
Concentration banking
Delaying payments
www.velsuniv.org
BIM
Executive
Placement 2003
FLOAT AND ITS TYPES

The difference between the available balance and the
ledger balance is called as Float
There are 2 types of float
Disbursement float
Cheques issued by a firm to create disbursement float

Disbursement float = Available balance book balance
Collection float
Cheques received by a firm lead to collection float.

Net float is the sum of disbursement float and collection float. If is
is positive then the available balance is greater than the book
balance and vice versa.
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
CASH MANAGEMENT
MODELS IN CASH MANAGEMENT (OR) CASH MAANGEMENT
MODELS
BAUMOLS MODEL
THE MILLER ORR MODEL
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
CASH MANAGEMENT
BAUMOLS MODEL
It is the formal approach for determining a firms

optimum cash balance under certainty
It considers cash management similar to an inventory
management problem
Assumptions :
Vels University
The firm is able to forecast its cash needs with certainty

The firms cash payments occur uniformly over a period of time.
The opportunity cost of holding cash is known and it does not change over
time
The firm will incur the same transaction cost whenever it converts
securities to cash.
www.velsuniv.org
BIM
Executive
Placement 2003
CASH MANAGEMENT
BAUMOLS MODEL
Holding cost can be calculated using k(C/2)
Transaction cost can be calculated using c(T/C)
The total annual cost of the demand for cash will Total cost =
k(C/2) + c(T/C)
The optimum cash balance C* = 2cT/k
Where C* = optimum cash balance

c = cost per transaction
T = total cash needed during the year
k = opportunity cost of holding cash balance
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
CASH MANAGEMENT
The limitation of the Baumol model is that it does not allow
the cash flows to fluctuate.
Firms do not use their cash flows uniformly and not able to
predict daily cash inflows and outflows
The Miller Orr model overcomes this and allows for daily cash
flow variation
It assumes that net cash flows are normally distributed with
zero value of mean and a standard deviation.
The Miller Orr model provides two control limits.
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
CASH MANAGEMENT
The upper control limit and the lower control limit as well as a
return point.
If the firms cash flows fluctuate randomly and hit the upper
limit, then it buys sufficient marketable securities to come
back to a normal level of cash balance (the return point).
If the firms cash balance hit the lower limit, then it sells the
sufficient marketable securities to bring the cash balance to
the normal level (the return point)
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
CASH MANAGEMENT
The firm sets the lower control limit as per the requirement of
maintaining minimum cash balance.
The difference between upper control limit and lower control
limit depends on the following viz the transaction cost (c ),
the interest rate (i) and the standard deviation of net cash
flows (sigma)
The formula to calculate the distance between upper and
lower control limit (Z) is
Z = (3/4 X Transaction cost X Cash flow variance / Interest per
day)1/3
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
CASH MANAGEMENT
The upper control limit is three times above the lower control
limit and the return point lies between the upper and lower
control limits.
Upper limit = Lower limit +3Z
Return point = Lower limit + Z
Average cash balance = Lower limit + 4/3Z
The Miller Orr model is realistic and allows variation in cash
balance with upper and lower limit.
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
Factoring
Credit management is a specialized activity.
A company can assign its credit management and
collection to specialist organizations called factoring
organizations.
Factoring is a popular mechanism of managing,
financing and collecting receivables in developed
countries like USA and UK.
Factoring is a unique financial innovation.
It is defined as a contract between the suppliers of
goods and services and the factor.
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
Factoring..
The factor provides the following three basic services
to clients
Sales ledger administration and credit management
Credit collection and protection against default bad debt losses
Financial accommodation against the assigned book debts.
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
Factoring..
Costs of factoring
The factoring commission or service fee
Interest on advance granted by the factor to the firm
Benefits of factoring
Helps the firms management to concentrate on manufacturing
and marketing
Helps the firm to save cost of credit administration due to the
scale of economics and specialization.
Types of factoring
Vels University
Full service non recourse

Full service recourse
Bulk or agency factoring
Non notification factoring
www.velsuniv.org
BIM
Executive
Placement 2003
COST OF CAPITAL - DEFINITION
It is the minimum required rate of

return on funds committed to the
project, which depends on the
riskiness of its cash flows
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
Significance (or) Importance of cost of capital

1. Evaluating investment decisions
2. Designing a firms debt policy
3. Appraising the financial performance of top management
4. DESIGNING THE CAPITAL STRUCTURE
5. CAPITAL BUDGETING DECISIONS
6. COMPARATIVE STUDY OF SOURCES OF FINANCING
7. EVALUATION OF FINANCIAL PERFORMANCE OF TOP MANAGEMENT
8. KNOWLEDGE OF FIRMS EXPECTED INCOME AND INHERENT RISK
9. FINANCING AND DIVIDEND DECISIONS.
10. Designing a firms debt policy, and
11. Appraising the financial performance of top management.
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
COST OF DEBT
(a) Irredeemable debt (without maturity period)
Before tax
INT
Kd =
Bo
After tax
= Kd (1 T)
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
COMPONENTS OF COST OF CAPITAL (OR) VARIOUS

CONCEPTS OF COST OF CAPITAL
COST OF DEBT
COST OF PREFERENCE SHARE (OR) PREFERRED CAPITAL
COST OF EQUITY SHARE (OR) EQUITY CAPITAL
COST OF RETAINED EARNINGS
WEIGHTED AVERAGE COST OF CAPITAL (WACC) (OR)
OVERALL COST OF CAPITAL (OR) COMPOSITE COST OF
CAPITAL
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
COST OF DEBT
A company can raise debt by borrowing funds from
financial institutions or from public either in the form
of public deposits or debentures.
These are borrowed for specific period of time at a
certain rate of interest.
A debenture or bond may be issued at par or at discount
or at premium.
Interest should be calculated on the par value or face
value of bond or debenture.
Debt may be redeemable and irredeemable.
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
COST OF DEBT
Redeemable debt (with maturity period)
Before tax
INT + (Bn Bo) / n

Kd =
(Bn + Bo) / 2
After tax
= Kd (1 T)
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
COST OF DEBT
Where,
INT = Annual interest
Bo = Issue price (or) Net value (or) Present value
(or) current value of bond or debenture
Kd = cost of debt
N = No. of years
Bn = Par value (or) maturity value (or) face value
T = tax rate
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
In preference capital, payment of dividend is not

legally binding on the firm and even if dividends are
paid, it is not a charge on earnings rather it is a
distribution or appropriation of earnings to preference
shareholders.
The cost of preference capital is a function of the
dividend expected by investors.
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
(a) Irredeemable Preference share (without maturity

period)
PDiv
Kp =
Vels University
Po
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BIM
Executive
Placement 2003
COST OF PREFERENCE SHARE (OR) PREFERRED

CAPITAL.
Redeemable Preference share (with maturity period)
PDiv + (Pn Po) / n
Kp =
Vels University
(Pn + Po) / 2
www.velsuniv.org
BIM
Executive
Placement 2003
Where,
PDIV = Preference dividend
Po = Issue price (or) Net value (or) Present value
(or) current value of Preference share
Kp = cost of preference share
n = No. of years
Pn = Par value (or) maturity value (or) face value
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
COST OF EQUITY SHARE (OR) COST OF EQUITY CAPITAL
Firms may raise equity capital internally by retaining

earnings or they distribute the entire earnings to equity
shareholders and raise equity capital externally by
issuing new shares.
In both the cases shareholders are giving funds to the
firm.
In external equity, the firm has to incur floatation
costs, so the cost of external equity is more than the
cost of internal equity.
The equity dividend rate is not fixed.
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
COST OF EQUITY SHARE (OR) COST OF EQUITY

CAPITAL
1. Normal (or) constant growth
Div1
Ke =
+ g
Po
2. Ke =
Vels University
EPS1
Po
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BIM
Executive
Placement 2003
COST OF EQUITY SHARE (OR) COST OF EQUITY

CAPITAL
If EPS, g, Div1 values not given, then it can be
calculated as below
Net earnings or net profit

EPS1 =
No. of shares outstanding
g = ROE X b
DIV1 = EPS1 X Dividend ratio
Dividend ratio = 1 retention ratio
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
COST OF EQUITY SHARE (OR) COST OF EQUITY CAPITAL
Where,
Ke = cost of equity
Div1 = Dividend
Po = Present value or current value of equity
share
g = growth rate
EPS1 = Earnings per share
ROE = Return on equity
b = retention ratio
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
Cost of Retained earnings

This is the internal equity of the firm
The opportunity cost of retained earnings is the rate of
return foregone by equity shareholders.
The shareholders normally get dividend and capital gain
from the investment.
The cost of retained earnings is determined by dividend
valuation model under normal , zero growth and super
normal growth.
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
Weighted Average cost of capital (WACC) (or) Overall cost

of capital (or) Composite cost of capital
Companies not depend on single source of finance.

They get finance by debt, preference share, equity
share and retained earnings.
So it is important for the company to calculate WACC
It is otherwise called as Overall cost of capital or
composite cost of capital
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
Weighted Average cost of capital (WACC) (or) Overall cost

of capital (or) Composite cost of capital
WACC should be calculated on after tax cost basis.

It can be calculated based on book value as weight and
market value as weight.
Steps in calculating WACC:
Calculate the cost of specific source of fund
Multiply the cost of each source by its proportion in the
capital structure
Add the weighted component cost to get WACC
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
WHAT IS BOND? IS IT SAME AS DEBENTURE?

Bond is a financial security issued by companies to raise
fund. It bears a fixed interest rate.
Both bond (or) debenture are same, except bond is
issued by Government owned companies while
debenture is issued by private companies.
Bond (or) debenture may be issued at par, at premium
or at discount.
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
Capital budgeting or Capital expenditure decisions or Investment

decisions (or) Long term asset mix decisions.
Definition:
The firms decision to invest their current funds in long
term assets in anticipation of future benefits over a series
of years.
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
Significance (or) Importance of investment

decisions (OR) Capital budgeting
It influences the firms growth in the long run

It affects the risk of the firm
It involves commitment of large amount of funds
They are irreversible
They are the most difficult decision to make
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
Types of investment decisons

Expansion and diversification
A company may add capacity to its existing product
lines to expand existing operstions.
Related diversification
A firm may increase its existing product line. Eg. Gujarat State
Fertilizer company may increase its plant capacity to manufacture
more urea.
Unrelated diversification
A firm may expand its activities in a new business apart from the
existing products. Eg. A packaging company starting a ball bearings
manufacturing company.
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
Types of investment decisions

Replacement and modernization
Otherwise called as cost reduction investments
Main objective to improve operating efficiency and reduce costs.
Assets become obsolete and outdated and company need to replace
and modernize due to technological changes.
Mutually exclusive investment (OR) Projects

They serve for the same purpose and compete with each other.
If one investment undertaken, other investment have to be excluded.
Eg. A company may use a more labour intensive , semi automatic
machine or use more labour intensive, fully automatic machine for
production.
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
Types of investment decisions

Independent investments
They serve for different purposes and do not compete with each other.
Eg. Heavy engineering company may consider expansion of its plant
capacity to manufacture additional excavator for its new product light
commercial vehicle.
Depending on the profitability and availability of funds, the company
can undertake both the investments.
Contingent investments
They are dependent projects.
The investment in one leads to investment in other investment.
Eg. If a company decides to build a factory in a remote, backward
area, then it may have to invest in houses, roads, hospitals, schools
etc for its employees.
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
Methods of capital budgeting (or) Techniques of capital budgeting

(or) Investment evaluation criteria
General methods
Traditional methods
Payback period (PB)
Average rate of return (ARR)
Discounted cash flow (DCF) methods
Net present value(NPV)
Profitability index (PI)
Internal rate of return (IRR)
Risk analysis methods
Risk adjusted discount rate
Probability assignment
Sensitivity analysis
Standard deviation
Coefficient of variation
Certainty equivalent approach
Decision tree approach``
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
General methods in capital budgeting

General methods
Traditional methods
1. Payback period (PB)

2. Average rate of return (ARR)
Discounted cash flow (DCF) methods
1. Net present value(NPV)

2. Profitability index (PI)
3. Internal rate of return (IRR)
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
General methods in capital budgeting

Traditional methods:
1. Payback period:
It is the number of years required to recover the
amount invested in a project
Even cash inflow:
Payback = Initial investment
Annual cash inflow

Uneven cash inflow:
Payback can be calculated by cumulative method
Acceptance rule:
The project with shortest payback can be selected
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
General methods in capital budgeting contd

Payback contd
Advantages
Simplicity
cost effective
Short term effects
Risk shield
liquidity
Disadvantages
Vels University
Cash flows after payback not considered

Not an appropriate method to measure the profitability of project
Fails to consider the cash flow pattern
Administrative difficulties
Inconsistent with the shareholder value
www.velsuniv.org
BIM
Executive
Placement 2003

2. Average rate of return (or) Accounting rate of
return (ARR)
Also known as Return on Investment (ROI)
It is the ratio of average annual cash inflows and
average investment
ARR = Average annual cash inflow X 100
Initial investment / 2
Acceptance rule:
In two projects, project with highest ARR is selected
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003

Advantages of ARR:
Simplicity
Accounting data
Accounting profitability
Disadvantages of ARR:
Cash flows ignored
Time value ignored
Arbitrary cut-off
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003

Discounted cash flow methods(DCF):
1. Net Present value (NPV)
It is the difference between present value of cash
inflow and present value of cash outflow
NPV = PV of cash inflow PV of cash
outflow
Acceptance rule:
If NPV > 0 = accept the project
If NPV = 0 = may or may not accept the project
If NPV < 0 = reject the project
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003

Advantages of NPV:
It recognizes the time value of money

Measure of true profitability
It gives value additivity
It helps in shareholder value maximization
Disadvantages of NPV:
Vels University
Difficult to estimate cash flow

Difficult to measure discount rate
Should be useful if used in mutually exclusive projects
Ranking of projects using NPV is not independent of discount
rate.
www.velsuniv.org
BIM
Executive
Placement 2003

2. Profitability Index (PI)
Also called as Benefit Cost Ratio (BCR)
It is the ratio of present value of cash inflow and
present value of cash outflow
Profitability index = PV of cash inflows
PV of cash outflows
Acceptance rule:
If PI > 1 = accept the project
If PI = 1 = may or maynot accept the project
If PI < 1 = reject the project
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003

Advantages of PI
Recognizes the time value of money
Value maximization
Relative profitability
Disadvantages of PI
Difficult to estimate cash flow
Difficult to measure discount rate
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003

3. Internal rate of return( IRR)
It is the rate at which the present value of cash
inflows and present value of cash out flows
IRR = PV of cash inflows = PV of cash
outflows
Factor F = I / C
I = Initial investment,
C = Average annual cash inflow
Acceptance rule:
If IRR > k = accept
If IRR = k = may or may not accept
If IRR < k = reject the project
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003

Advantages of IRR:
It recognizes the time value of money

Measure of true profitability
It helps in shareholder value maximization
Acceptance rule same as NPV
Disadvantages of IRR:
Multiple rates
Mutually exclusive projects
Value additivity
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
CAPITAL RATIONING
It is the ability of the firm to accept more profitable
projects depending on the investment amount
available.
In this the firm chooses profitable investments by
ranking the projects using NPV and IRR.
Projects above the cutoff point will be funded while
projects below the cutoff points will be rejected.
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
CAPITAL RATIONING
Cut off point is determined based on number of projects,
objectives of the firm, availability of finance etc.
Capital rationing may arise due to external factors or internal
constraints imposed by the management.
There are 2 types of capital rationing.
External capital rationing
It mainly occurs on account of the imperfections in the capital
markets.
Imperfections may be caused by deficiencies in market information.
Internal capital rationing

It is caused by self imposed restrictions by the management.
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
Differences between profits and cash flows
Cashflowisasimpleandobjectivelydefinedconcept.
Itissimplythedifferencebetweenrupeesreceivedandrupeespaidout
Cashflowisnotthesameasprofits.
Profit,asmeasuredbyanaccountant,isbasedonaccrualconcept.
CashflowCashinflowisrecognizedwhenitisearned,ratherthancashis
received.Cashoutflowisrecognizedwhenitisincurredratherthanwhencashis
paid.
Profitsincludescashrevenuesandreceivablesandexcludescashexpensesand
payables.
Profit=RevenuesExpensesDepreciation
Cashflow=RevenuesExpensesCapitalexpenditure.
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
Salvage value and Scrap value

Salvage value:
This is the most common example of terminal cash flows.
It is defined as the market price of an investment at the time
of its sale.
The effects of salvage value of existing and new assets.
Salvage value of the new asset will increase the cash inflow in the
terminal period of the new investment.
Salvage value of the existing asset now will reduce the initial cash outlay
of the new asset.
Salvage value of the existing asset at the end of its normal life will
reduce the cash flow of the new investment of the period in which the
existing asset is sold.
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
SCRAP VALUE:
scrap value is defined as the expected or estimated
value of the asset at the end of its useful life. Scrap
value is also referred to as an assets salvage value or
residual value
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
Phases in capital budgeting or Steps in Capital

budgeting:
Identification of potential investment opportunities

Assembling of proposed investments
Decision making
Preparation of capital budget and appropriations
Implementation
Performance review
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
Par value or Face value

Par value is otherwise called as face value.
This is the value stated on the face of the bond or
share.
It is the amount the firm borrows and promises to repay
at the time of maturity.
Usually the par value or face value for bond is Rs. 100
or Rs. 1000 etc
For share, it is 1 or 2 or 5 or 10 etc
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
Is equity capital free of cost

Sometimes it is argued that the equity capital is cost
free because it is not legally binding for the firms to
pay dividend to equity shareholders.
The dividend rate is also not fixed.
It is assumed as the equity capital is cost free
In general the cost of equity capital is not cost free
because the firm has to pay dividend to the
shareholders
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
Capital structure
Capital structure
The mix of debt and equity capital structure
Optimum capital structure
Optimum capital structure is the one in which
the weighted average cost of capital is
minimum that maximizes the market value of
ordinary share and value of the firm.
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
Difference between PBT and PAT

PBT Profit Before Tax. Also known as EBT (Earnings
Before Tax)
PAT Profit After Tax. Also known as EAT (Earnings After
Tax)
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
Theories of capital structure

Relevant theory:
1. Net Income approach (NI)
Irrelevant theory:
1. Net Operating Income approach (NOI)
2. Modigliani Miller approach (MM)
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
Relevant theory of Capital structure

Net Income approach (NI)
Suggested by Durand
According to this theory, capital structure decision is
relevant to the valuation of firm. So, it is called as relevant
theory.
If financial leverage changes, overall cost of capital and
total value of the firm also changes.
(ie) If financial leverage increases, weighted average cost
of capital decreases and total value of the firm & market
value of ordinary share increases
Or
If financial leverage decreases, weighted average cost of
capital increases and total value of the firm & market value
of ordinary share decreases.
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
Net Income approach (NI)

contd.
Assumptions of NI approach:
There are no taxes
Cost of debt is less than cost of equity
The use of debt does not change the risk
perception of the investors
Operating profit (EBIT) is constant
If no debt, financial leverage is zero, so overall
cost of capital is equal to equity capitalisation
rate or cost of equity.
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
NI approach
To calculate value of the firm and overall cost of capital:

Net operating income (EBIT)
(-) Interest on debt
Profit before tax (PBT) x

(-) Tax x
Profit after tax (PAT)
Equity capitalization rate or cost of equity (Ke)

Market value of Equity (E = PAT / Ke)
Market value of Debt (D) x

Total value of firm (V = E + D) x
Overall or weighted avg cost of capital (Ko = EBIT / V)
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
Irrelevant theories of capital structure

1.Net Operating income (NOI) approach
2. Modigliani Miller (MM) approach
1. Net Operating Income (NOI) approach:
Opposite to NI approach
Change in financial leverage does not change the
overall cost of capital, total value of the firm and
market value of ordinary share
So, it is called as irrelevant theory
All capital structure are optimum capital
structure
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
Net Operating Income (NOI) approach

contd
Assumptions of NOI approach:
Overall capitalization rate of firm remains
constant
Value of equity can be determined by deducting
total value of debt from total value of firm
Equity capitalization rate or cost of equity
increases with the degree of leverage
Cost of debt has two parts (a) Explicit cost (b)
Hidden cost.
The use of debt does not change the risk
perception of the investors
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
NOI approach
To calculate total value of the firm and equity
capitalization rate:
Net operating income (EBIT)
Overall or weighted avg cost of capital Ko

Total value of firm V = EBIT / Ko
Market value of Debt D x

Market value of Equity E = V D
Equity capitalization rate or cost of equity

Ke = (EBIT interest - tax) / E x
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
MM APPROACH
This is an irrelevant theory of capital structure
Assumptions of MM approach:
Vels University
Perfect capital market

Rational investors and managers
Homogenous expectations
Equivalent expectations
No taxes
www.velsuniv.org
BIM
Executive
Placement 2003
MM approach
Criticism of MM approach
It is suitable only if the market is perfect
Firms are liable to pay taxes on their income
Bankruptcy cost can be quite high
Agency costs may arise because of the conflict managers and
shareholders and between shareholders and creditors.
Managers seem to have a preference for a certain sequence of
financing
Informational asymmetry exists because managers are better
than investors.
Personal leverage and corporate leverage are not perfect
substitutes.
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
MM approach
Value of Unlevered firm:
PBT ( 1 t )
Vu =
Ke
Value of Levered firm:
VL = Vu + Dt
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
MM approach
Vels University
Where,
Vu = Value of unlevered firm
PBT = Profit before tax
t = tax rate
Ke = Equity capitalisaztion rate or cost of equity
VL = Value of levered firm
D = value of debt
www.velsuniv.org
BIM
Executive
Placement 2003
MM APPROACH
Proposition I
The value of a firm is equal to its expected operating income
divided by the discount rate appropriate to its risk class. It is
independent of its capital structure
Proposition II
An increase in financial leverage increases the expected
earnings per share but not the share price.
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
ELEMENTS OF CAPITAL STRUCTURE
CAPITAL MIX
MATURITY AND PRIORITY
TERMS AND CONDITIONS
CURRENCY
FINANCIAL INNOVATIONS
FINANCIAL MARKET SEGMENTS
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
EBIT EPS ANALYSIS

It is an important tool to analyze the impact of alternative
financial plans on the shareholders income and its variability
The firm should consider the possible fluctuations in EBIT
and examine its impact on EPS under different financial
plans
It is realized that the EBIT EPS analysis is the first step in
deciding about the firms capital structure
It suffers from certain limitations and does not provide
unambiguous guide in determining the level of debt in
practice.
EPS is one of the most widely used measures of a companys
performance.
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
EBIT EPS ANALYSIS
Sales
(-) Variable cost
Contribution
(-) Fixed cost
EBIT (or) OP (Earnings before interest & tax or
Operating profit)
(-) Interest
PBT (Profit before tax)
(-) Tax
PAT (Profit after tax)
(-) Preference dividend
Net profit
EPS = PAT (or) Net profit / No. of equity shares
ROE = PAT (or) Net profit / Value of equity Shares
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
FACTORS INFLUENCING CAPITAL STRUCTURE (OR) DETERMINANTS OF

CAPITAL STRUCTURE (OR) PRACTICAL CONSIDERATION IN PLANNING
CAPITAL STRUCTURE
Assets
Growth opportunities
Debt and non debt tax shields
Financial flexibility and operating strategy
Loan covenants
Financial slack
Sustainability and feasibility
Control
Marketability and timing
Issue costs
Capacity of raising funds
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
LEVERAGE
Assets can be financed either by debt or equity.

The mix of debt and equity is called as capital structure
If only equity used unlevered firm
If debt and equity used levered firm
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
Leverage types
Operating leverage
Financial leverage
Combined leverage or composite leverage
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
Operating leverage
Operating leverage =
Contribution
EBIT (or) Operating profit
If fixed operating cost exists, then operating leverage arises

If no fixed cost, then no OL
If OL is more, then return also high and risk also high and
vice versa
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
Operating leverage
If fixed operating cost exists, then operating leverage arises

OL will be more if the firm has to pay more fixed costs and less
variable cost and vice versa
If no fixed cost, then no OL
If OL is more, then return also high and risk also high and
vice versa
Operating leverage = C / EBIT (or) OP
Where C = contribution = sales variable cost
EBIT = Earnings before interest and tax
OP = Operating profit
EBIT (or) OP = Contribution Fixed cost
Implications of OL:
If sales changes 1% then EBIT will change more than 1%.
If fixed cost increases OL will also increases
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
Financial leverage
The use of fixed charges sources of funds such as

debt and preference capital along with owners
equity in the capital structure is called as financial
leverage
It is also called as Gearing or trading on equity
Financial leverage = EBIT or OP / PBT
Implications:
If EBIT changes 1% then PBT changes more than 1%
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
Financial leverage
The use of fixed charges sources of funds such as debt
and preference capital along with owners equity in the
capital structure is called as financial leverage
It is also called as Gearing or trading on equity
Financial leverage =
Vels University
EBIT or Operating profit

PBT
www.velsuniv.org
BIM
Executive
Placement 2003
Sales
(-) Variable cost
Contribution
(-) Fixed cost
EBIT (or) OP (Earnings before interest & tax or Operating profit)
(-) Interest
PBT (Profit before tax)
(-) Tax
PAT (Profit after tax)
(-) Preference dividend
Net profit
EPS = PAT (or) Net profit / No. of equity shares
ROE = PAT (or) Net profit / Value of equity Shares
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
Combined or composite leverage
It shows the relationship between

contribution and PBT
Composite leverage = Financial leverage X Operating leverage
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
Indifference point
Otherwise called as EBIT EPS break even point
It is the point at which EPS is same regardless of the
level of financial leverage
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
DIVIDEND DECISIONS
DIVIDEND
The return given to shareholders on purchase of share is called
as dividend
PAYOUT RATIO (OR) DIVIDEND RATIO

The percentage of earnings given as dividend to shareholders
RETENTION RATIO
The percentage of earnings retained by the company is called
as retention ratio
CAPITAL GAIN
The gain the shareholders receive while selling the shares is
called as capital gain
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
DIVIDEND DECISIONS:
It is the decision taken by the company to determine
the amount of earnings to be given as dividend and
the amount of earnings to be retained by the
company.
Optimum payout ratio:
It is the best payout ratio that the company can give to the
shareholders which should try to maximise the value of the
shareholders
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
THEORIES OF DIVIDEND
1.RELEVANT THEORY
WALTER MODEL
GORDON MODEL
According to walter and gordon, the dividend
decision affects the market price of the share. So
the both the theories are called as relevant theory
2.IRRELEVANT THEORY
MM HYPOTHESIS
According to MM, the dividend decision does not
affect the market price, so it is called as irrelevant
theory
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
RELEVANT THEORY OF DIVIDEND

WALTER MODEL
ASSUMPTIONS
Vels University
Only internal financing

r and k are constant
100 percent payout or retention
Constant EPS and dividend
The firm has infinite life
www.velsuniv.org
BIM
Executive
Placement 2003
WALTER MODEL contd

Formula
P0 = Div + (EPS DiV) (r/k)

k
Where,
P0 = Market price of share
Div = Dividend per share
EPS = Earnings per share
r = rate of return (or) internal rate of return (or)
productivity of retained earnings
K = cost of capital (or) discount rate (or)
capitalization rate (or) requires rate of return
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
WALTER MODEL contd

If r > k , then it is a Growth firm, the optimum payout
ratio is 0%
If r = k, then it is a normal firm, the optimum payout
ratio is not applicable
If r < k, then it is a declining firm, the optimum payout
ratio is 100%
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
WALTER MODEL contd

Criticism or disadvantages of walter model:
No external financing
Constant return
Constant cost of capital
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
RELEVANT THEORY OF DIVIDEND

GORDON MODEL:
ASSUMPTIONS
Vels University
Only internal financing

r and k are constant
All equity firm
Perpetual earnings
No taxes
Constant retention
K is greater than g , growth rate
www.velsuniv.org
BIM
Executive
Placement 2003
GORDON MODEL:
Formula
P0 = EPS ( 1 b)
k - br
Where,
P0 = Market price of share
EPS = Earnings per share
r = rate of return (or) internal rate of return (or)
productivity of retained earnings
K = cost of capital (or) discount rate (or)
capitalization rate (or) requires rate of return
b = retention ratio
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
GORDON MODEL:
If r > k , then it is a Growth firm, the optimum payout

ratio is 0%
If r = k, then it is a normal firm, the optimum payout
ratio is not applicable
If r < k, then it is a declining firm, the optimum payout
ratio is 100%
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
IRRELEVANT THEORY OF DIVIDEND

MM hypothesis: (Modigliani Miller)
Assumptions:
Vels University
Perfect capital market

No taxes
Fixed investment policy
No risk
r=k
www.velsuniv.org
BIM
Executive
Placement 2003
MM hypothesis
Formula to calculate market price of share
P1 = P0 ( 1 + Ke) Div1
Where
Vels University
P1 = market price of the share

P0 = current market price of the share
Ke= cost of equity capital
Div1 = dividend per share
www.velsuniv.org
BIM
Executive
Placement 2003
MM hypothesis
According to MM hypothesis, a firm can pay dividend
and if they require any additional capital for
investments that can be get by retained earnings or by
issue of new shares to the shareholders.
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
MM hypothesis
The number of new shares to be issued can be
found out
mP1 = I (X nDiv1)
Where
Vels University
m= no. of new shares to be issued

P1 = price of the share when dividend is declared
I = investment amount required
X= netprofit
n= no. of outstanding shares
Div1= dividend per share
www.velsuniv.org
BIM
Executive
Placement 2003
Dividend policy
Dividend policy of the firm affects the firms investment
opportunities as well as wealth of the shareholders of that firm
If firm earns profit, that has to be divided into two parts: dividend
and retained earnings.
Retained earnings are used to finance long term investment
opportunities of the firm
Dividends are given to shareholders as cash
Both dividend and retained earnings result in cash outflow.
If more dividends are given , then retained earnings will be low.
For future investments the firm again has to issue new shares or
has to go for debt.
So, Dividend policy of the firm affects the firms investment
opportunities as well as wealth of the shareholders of that firm
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
Dividend policy
The following questions are related to the dividend
policy of the firm
Vels University
Firms future investment opportunities and financial needs

Shareholders expectation on dividend
Firms risk in business
Firms constraints in paying dividend
Control of firm
Stable dividend policy of the firm
Form of dividend
Share split
Share buyback
www.velsuniv.org
BIM
Executive
Placement 2003
Different types of Dividend policy
Constant dividend per share

Constant payout
Constant dividend per share plus extra dividend
High payout
Low payout
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
Constraints in paying dividend (or) Factors affecting dividend

(or) determinants of dividend
Legal restrictions
Liquidity
Financial conditions and borrowing capacity
Access to the capital market
Restrictions in loan agreements
Inflation
control
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
Stability of dividend
Types:
Constant dividend per share

Constant payout
Constant dividend per share plus extra dividend
Merits:
Resolution of investors uncertainty

Investors desire for current income
Institutional investors requirement
Raising additional finances
Dangers of stability of dividend:
Once established, cannot be changed

Even if one year without dividend will affect the shareholders a lot
Dividend to be paid even if there is no profit
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
Forms or types of dividend
Cash dividend
Stock dividend or bonus shares
Bond dividend
Scrip dividend
Property dividend
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
Stock dividend or bonus shares
Bonus share or stock dividend is nothing but giving a part as cash dividend
and balance dividend in the form of additional shares
Advantages:
To shareholders:
Tax benefits
Indication of higher future profits
Future dividends may increase
Psychological value
To company
Conservation of cash
Only means to pay dividend during financial difficulty
More attractive share price
Disadvantages:
Shareholders wealth remain unaffected

Costly to administer
Problem of adjusting EPS and P/E ratio
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
Share split or stock split

Share split is a method to increase the number of
outstanding shares through a proportional reduction in
the par value of the share.
Reasons for share split:
To make shares attractive
It is the indication higher future profits
To give higher dividend to shareholders
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
Reverse split
The reduction in the number of outstanding shares by
increasing the par value of the share is called as
reverse split
This is done if the companys share price falls.
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
Share buyback or Equity repurchase (or) Stock repurchase
Buyback of shares
The buyback of shares is the repurchase of its own shares by a
company
Methods of share buyback:

Through authorized brokers
Through tender offer
Vels University
www.velsuniv.org
BIM
Executive
Placement 2003
Share buyback or Equity repurchase (or) Stock repurchase

cond..
Advantages of share buyback
Return of surplus cash to shareholders

Increase in the share value
Increase in the temporarily undervalued shares
Achieving the target capital structure
Consolidating control
Tax savings by companies
Protection against hostile takeover
Not an effective defence against takeover

Shareholders do not like the buyback
Loss to the remaining shareholders
Signal of low growth opportunities
Disadvantages of share buyback
Vels University
www.velsuniv.org

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BIM

ACCOUNTS AND FINANCE FOR LOGISTICIANS

PROBLEMS (U MAY GET PROBLEMS FROM ANY OF

COMPARATIVE BALANCE SHEET

ANSWER ALL THE QUESTIONS

IN PPTS, ONLY HINTS ALONE GIVEN, U DEVELOP

CLASSIFICATION (OR) BRANCHES OF

JOURNAL, LEDGER AND TRIAL BALANCE

Book keeping functions

Limitations/disadvantages of financial accounting

Limitations/disadvantages of cost accounting

To help in planning and policy formulation

Limitations/disadvantages of management accounting

Weakness of source records

Users of accounting information

Users of accounting information

External users (Secondary Users)of accounting information include the

Name of the A/c

It reduces the possibility of errors

It is a book of original entry

It is a source of secondary entry

All transactions are recorded in a

All transactions pertaining to a particular

It has greater weightage because it is a book

It is the main source of information

Unit of classification of data is transaction

Unit of classification of data is the account

Process of recording transactions in the

Ledger posting can be done according to

Process of recording financial transactions is

It is a continuous process day after day

Entries are transferred to the ledger

DIFFERENCE BETWEEN JOURNAL AND LEDGER

Summary of various accounts

Accounting principles (or) Accounting concepts

Difference between Book keeping and Accounting

Systems of book keeping

Single entry system

Single entry system

Eg: Sole proprietorship

Double entry system

Advantages of double entry system

Difference between single entry and double entry system

Single entry is an incomplete and unscientific method of

Debit and Credit

Benefit receiving aspect

ALL THE FINANCIAL TRANSACTIONS HAVE TWO ASPECTS

DOUBLE ENTRY SYSTEM

GOLDEN RULE OF ACCOUNTS

PROFIT AND LOSS ACCOUNT

If income is less than the expenses, then it is Net loss.

PROFIT AND LOSS ACCOUNT

PROFIT AND LOSS ACCOUNT

PROFORMA OF PROFIT AND LOSS ACCOUNT

PROFORMA OF PROFIT AND LOSS ACCOUNT..

PROFORMA OF BALANCE SHEET

CURRENT ASSETS AND FIXED ASSETS

The asset which can be converted into cash within one

The asset which takes more than one year to

CURRENT LIABILITIES AND LONG TERM

The liability which has to be paid by the company

LON TERM LIABILITIES

The liabilities which can be paid even after one