Business Management Paper V – Financial Management-munotes

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INTRODUCTION TO FINANCIAL
MANAGEMENT
WHAT IS FINANCE?
Finance is the soul of any business concern, and we cannot imagine a
world without Finance. When we say finance, it generally means money
for a layman but it is not only the money, it is a wider conce pt that is
related to money and its flow. The word finance is a French word and it
means ‘Management of Money’.
Finance is such a powerful source that it performs an important role to
operate and co -ordinate the various economic activities of the business.
Like other resources finance is also limited and a business entity needs to
manage its finances efficiently and effectively.
The figure below shows the different perspectives of finance:

Finance is the lifeline of any Business whether large scale, medium scale
or small scale because all the activities depend on finance. For any
business to be successful, business needs to have a sufficient amount of
finance. As a result, it is essential to fully understand the concept of
financ ial management.
WHAT IS FINANCIAL MANAGEMENT?
To understand financial management let’s see some definitions of
Financial Management,
General Finance is the administration of
funds and other valuables that
can be converted into cash. Experts Finance is a simple task of
providing the necessary funds
(money) required by the
business entities like
companies, f irms, individuals and others on the terms that Entrepreneurs Finance is all about money.
This is because every financial
transaction involves cash,
either directly or indirectly. Academicians Finance is the acquisition (to
get, obtain) and effective
(well -planned) use of funds. It
also relates with profits that
adequately compensate for the business costs and risks. munotes.in

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2 “Financial management is the activity concerned with planning, raising,
controlling and administering of funds used in the business.” – Guthman
and Dougal
“Financial management is that area of business management devoted to a
judicious use of capital and a careful selection of the source of capital in
order to enable a spending unit to move in the direction of reaching the
goals.” – J.F. Brandley
“Financial management is an application of general managerial principles
to the area of financial decision -making”. - Howard and Uptron
“Financial management is an area of financial decision making,
harmonizing individual motives and e nterprise goal”. - Weston and
Brighem
“Financial management is concerned with the efficient use of an important
economic resource, namely capital funds” - Solomon Ezra & J. John
Pringle.
“Financial Management is the operational activity of a business tha t is
responsible for obtaining and effectively utilizing the funds necessary for
efficient operations” - Joseph & Massie
“Financial Management is concerned with managerial decisions that result
in the acquisition and financing of long -term and short -term c redits of the
firm. As such, it deals with the situations that require selection of specific
assets (or combination of assets), the selection of specific liability (or
combination of liabilities) as well as the problem of size and growth of an
enterprise. The analysis of these decisions is based on the expected
inflows and outflows of funds and their effects upon managerial
objectives”. - Phillippatus.
Financial Management is a managerial process that is concerned with the
planning, organizing, directing, a nd controlling of financial resources.
Initially, financial management was concerned only with the collection of
funds. Later on, proper utilization of funds also became an important
aspect of Financial Management. In today's world, Financial Management
examines all financial issues of a company.
Financial Management involves functions like
● Fund procurement
● Working capital management
● Capital budgeting and capital structure designing of an organization
● Controlling and managing an organization's financial as sets
● Making strategies related to expansion, diversification, joint venture,
and mergers & acquisitions. munotes.in

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Introduction to Financial Management
3 Financial Management influences both profit -oriented firms and non -
profit firms. Since Financial Management has acquired a vital role in
every type of organization, the financial manager has become an important
constituent of any organization.
The financial manager provides a significant contribution to all business
activities by estimating the requirement of funds, planning the different
sources of fund s, and performing the functions of collection of funds and
their effective utilization.
He must be clear about the financial objectives of the firm and also his
duties and responsibilities about the business activities like production,
purchase, marketing, sales, etc. which include the creation and utilization
of funds.
EVOLUTION OF FINANCIAL MANAGEMENT
The evolution of Financial Management can be divided into two phases
1. Traditional approach
2. Modern approach
Traditional Method
The traditional approach of financial management refers to its subject
matter as a separate branch of academic study in the early stages of its
evolution in academic literature. The term 'corporation finance' was used
to define what is now called as 'financial management' in academia .
Corporation finance, as the name implies, was concerned with the funding
of corporate enterprises. In other words, the traditional approach limited
the finance function to the procurement of funds by companies to meet
their funding requirements. The term "procurement" was used broadly to
encompass the entire process of raising funds from outside sources.
Limitations of the traditional approach
● The traditional approach focuses on the procurement system and the
issues that may arise. It does not provide a system for maximizing the use
of funds obtained.
● The traditional approach considers budgetary allocation as a
contingency for unpredictable incidents, neglecting everyday financial
difficulties that a business enterprise may face. Working capital financing
choices are also kept outside of the purview of a conventional approach.
● The traditional approach's primary focus is on corporate entities.
Non-corporate entities, such as partnership firms, are not covered.
Modern approach –
The modern approach takes a broad view of the term financial
management and provides an analytical and conceptual framework for
financial decision making. As such, the finance function includes both the munotes.in

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4 acquisition and allocation of funds. Apart from the issues involved in
acquiring external funds, the primary goal of financial management is the
efficient and prudent allocation of funds to various uses. In a broader
context, it is regarded as an essential component of overall management.
The new method is an analytical way of looking at a company's financial
problems. What is the total amount of funds that an enterprise should
commit? What specific assets should a company purchase? How should
the necessary funds be raised? These are the main aspects of this method.
Alternatively, the f ollowing are the main components of the modern
approach to financial management:
1. How large should an enterprise be, and how quickly should it grow?
2. In what form should assets be held?
3. How should its liabilities be structured?
The three questions raised above cover the major financial issues
confronting a company. In other words, according to the new approach,
financial management is concerned with the resolution of three major
problems relating to a firm's financial operations, pertaining to the three
questions of investment, financing, and dividend decisions. Thus, financial
management in the modern sense can be divided into three major
decisions such as:
1. the investment decision;
2. the financing decision;
3. the dividend policy decision.
The modern method wi ll make provision for a variety of irregular events.
The main components of this method are as follows:
● Planning your finances
● Continuous operation and appropriate capital budgeting evaluation
● Provision for optimal working capital management
● A broad range of capabilities for measuring a company's performance
As a result, the modern approach contributes to the establishment of a
financial standard for the company's success.
OBJECTIVE OF FINANCIAL MANAGEMENT
Financial management generally deals with procurem ent, allocation and
control of financial resources and the two most widely used objectives are
a) Profit Maximization
b) Wealth maximization munotes.in

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Introduction to Financial Management
5 Profit maximization: Profit maximization is considered as the basic
objective of financial management. It should focus on increasing profit
rather than decreasing profit.
The term 'profit' is used in two senses
1. Owner oriented concept: It means the amount of net profit, which goes
in the form of dividends to the shareholders.
2. Operational concept - It refers to profita bility, which is an indicator of
the economic efficiency of the firms.
Earning profit is the main aim of any business concern and so profit is the
main parameter that is considered to measure the efficiency of the
business concern. Profit maximization obje ctives help to reduce the risk of
the business. To attain the objective of Profit maximization, the enterprise
should consider the assets, projects and decisions that are profitable and
the non -profitable ones shouldn’t be considered. Let us now discuss so me
merits and drawbacks of Profit Maximization.
Benefits of Profit Maximization
1. It is the best criteria for decision making since it helps in judging the
economic performance of the firm.
2. It helps in the efficient allocation of resources so that the firm c an
make maximum profit.
3. It helps the firm to allocate and utilize its available resources in the
best possible manner.
4. It helps in payment of maximum returns on investments in the form of
dividends to the shareholders, regular payment to lenders, higher
wages, increase in jobs, better quality products, and reduce the price of
products which in turn benefits the society at large.
Drawbacks of Profit Maximization
1. The term profit is not clearly stated which can lead to unnecessary
assumptions regarding earnin g habits of the organization. It can be
a. long term or short term
b. total profit or rate of profit
c. net profit before tax or net profit after tax
d. return on total capital employed or total assets or shareholders equity
2. It does not consider the time value of m oney or the net present value of
the cash inflow.
3. It affects the overall operation of the organization since it ignores
internal or external risk factors. munotes.in

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6 Wealth Maximization:
Wealth maximization is also called value maximization or net present
worth max imization. It involves the latest innovations and improvements
in the field of business concern. The term wealth means shareholder
wealth or the wealth of the persons who are involved in the business
concern.
It helps in the better valuation of the organi zation. It takes into account
both the factors i.e. time and risk. It provides efficient allocation of
resources and considers the generation of cash flows and not accounting
for profit. The computation of inflows and outflows of cash is accurate. It
consi ders the time value of money concept. A right financial decision
increases market value whereas poor financial decisions reduce the market
value of the owners’ equity.
The concept of wealth maximization is universally accepted, because it
takes care of th e economic welfare of people who are directly or indirectly
involved in the overall development of the company such as shareholders,
lenders, workers, society, etc.
It eliminates the technical drawbacks of profit maximization therefore it is
considered as the modern objective of Financial Management.
FUNCTIONS OF FINANCIAL MANAGEMENT:
It is concerned with providing solutions to problems like investment,
financing and dividend decisions of the financial activities of an
organization.


Functions
of
Finan
cial
Mana
geme
nt Investment decisions
Financing decisions
Dividend decisions munotes.in

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Introduction to Financial Management
7 1. Investment Decision
It is concerned with the selection of both long -term and short -term assets
in which a firm's funds will be invested. Long -term assets, or fixed assets,
will generate a return over time, whereas short -term assets, or current
assets, are those that can be converted into cash within a financial period,
such as a year.
Capital budgeting refers to long -term investment decisions, while working
capital management refers to short -term investment decisions. Capital
budgeting can also r efer to long -term planning for allocating funds among
various investment options. Risk and uncertainty analysis is a critical
component of capital budgeting decisions. Because the return on
investment proposals can be derived for a longer period of time in the
future, the capital budgeting decision should be weighed against the risk
associated with it. This method aids in determining the assets' 'Net Present
Value.'
The financial manager, on the other hand, is also in -charge of the efficient
management of c urrent assets, also known as working capital
management. Working capital is an essential component of financial
management. These decisions include whether to invest funds in
inventory, cash, bank deposits, or other short -term investments. They have
a dire ct impact on the liquidity and performance of the business.
2. Financing Decision
The second critical function is financial decision -making. It is concerned
with a company's capital – mix, financing – mix, or capital structure. The
proportion of debt capita l and equity capital is referred to as capital
structure. A firm's financing decision is related to the financing – mix.
Finance acquisition decisions must be made by the finance manager.
It must be decided whether the entire required capital should be ra ised in
the form of equity capital or whether the amount should be from the loan
fund. Even the timing of capital acquisition should be well defined. In a
firm's financing decisions, there is a conflict between return and risk. As a
result, the financial m anager must strike a balance between risk and return
by maintaining the proper balance of debt and equity capital. On the other
hand, it is also the financial manager's job to identify an appropriate
capital structure. The ideal capital structure would alw ays maximize
wealth.
3. Dividend Decision
The dividend policy decision is the third major function. Decisions on
dividend policy are concerned with the distribution of a company's profits
to its shareholders. How much of the profits should be distributed as
dividends, specifically, the dividend pay -out ratio.
The decision will be based on the shareholder's preferences, investment
opportunities within the firm, and opportunities for future growth of the munotes.in

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8 firm. The dividend payout ratio must be determined in ligh t of the goal of
increasing the share's market value. As a result, the dividend decision has
become a critical component of the financing decision. Dividend decision -
making must be evaluated with respect to the firm's financing decisions to
decide the part of retained earnings to be used as direct financing for the
company's future expansions.
IMPORTANCE OF FINANCIAL MANAGEMENT
Finance is the lifeblood of a business organization. It needs to meet the
requirements of the business concern. Each and every bus iness concern
must maintain an adequate amount of finance for the smooth running and
achieve the goal of the business concern. The business goal can be
achieved only with the help of effective management of finance. We can’t
neglect the importance of finan ce at any time and at any situation. Some of
the importance of financial management is as follows:
Employees
Efficient financial management helps in profit maximization and also
welfare of the employees by payment of incentives, bonus and increment
in sala ry.
Shareholders
Financial management plays an important role towards dividend payment
to the shareholders by taking correct and timely financial decisions.
Government
Financial management helps the firm to fulfill the duties and
responsibilities towards the government by payment of tax, licence fees,
etc.
Customers
Proper planning of financial matters leads to customers satisfaction by
providing good and quality products and services at reasonable prices.
Management
Efficient Financial management helps th e management in overall image
building, increase in the market share, optimizing shareholders wealth and
profit.
Other departments
Financial management through efficient management of funds has to
ensure that adequate funds are made available to all depart ments like
productions, marketing, etc for their smooth functioning.

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Introduction to Financial Management
9 lenders
lenders rely on effective financial management for safety of their funds,
timely repayment of the principal amount as well as interest on the same.
Helps to study Risk -Return Re lationship
The prospective investors expect higher returns on investment from the
firm, therefore there is a need for Financial Management.
Promoting Savings
Savings are possible only when the business concern earns higher
profitability and maximizes wealt h. Effective financial management helps
to promote and mobilize individual and corporate savings.
Nowadays financial management is also popularly known as business
finance or corporate finances. The business concern or corporate sectors
cannot function wit hout the importance of financial management.
NATURE OF FINANCIAL MANAGEMENT
The nature of financial management includes the following −
Estimates the amount of funds needed
Financial management aids in the planning of funds by estimating the
amount of working and fixed capital required to carry out business
operations. Financial m anagement aids in the estimation of money for the
firm's short, medium, and long term operations.
Determine the capital structure
A proper balance of debt and equity should be achieved in order to reduce
the cost of capital. Financial management determines the appropriate
allocation of various securities like equity and debt.
Select source of fund
Source of funds is one of the crucial decisions in every organization.
Every organization should properly analyze various sources of funds
(shares, bonds, deben tures etc.) and must select appropriate funds which
involve minimal risk.
Fund Management
All cash movements (inflow and outflow) are monitored by the finance
manager to ensure that there are no cash shortages or surpluses.
Suitable to all concern
The fina ncial management concept is relevant to all types of businesses,
whether they are small, medium, or large, profit or non -profit, educational
or corporate, and so on. munotes.in

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10 Goal
Financial management establishes the firm's objectives and goals, as well
as the pat h for achieving current and future objectives.
Decision Making
Financial management assists the firm's top management in making
accurate and timely decisions.
Optimum use of resources
Financial management aids in the efficient and appropriate utilization
of available financial resources, resulting in the firm's success and profit.
SCOPE OF FINANCIAL MANAGEMENT
Financial management is concerned with acquiring finance as well as
utilizing it to the best of one's ability for the firm's growth and
development.
Cash management
The financial manager must manage cash because sufficient cash
availability is required to meet the cash requirements of the firm's various
departments.
Profit maximization
Financial manager has to plan the activities to achieve profit ma ximization
and future prospects of the firm by adopting profit maximization
approach.
Capital budgeting
Financial managers has to study the area of future long term projects and
its profitability through the systematic investment programme, that is
capital budgeting. As per firm’s cash flows and availability of funds
capital budgeting should be essentially done.
Capital structure - Finance manager need to ensure proper and regular
financing for the firm by assuring appropriate capital structure of the firm.
Working capital management
Financial manager has to study the regular working capital changes and
accordingly assigns the finance required as per the changes so as to ensure
adequate liquidity in the firm.
Financial performance evaluation
Management info rmation and control systems (MICS) constantly review
the financial performance of the entire organization and assist in
evaluating how funds have been used in various divisions and what can be
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11 LIMITATIONS OF FINANCIAL MANAGEMENT
It is c ritical that financial management objectives are properly understood.
Organizational leaders must make the necessary efforts to understand
regulatory requirements and develop procedures that meet the standards
without incurring excessive costs. To better u nderstand the limitations of
financial management, let us first take a look at them.
Uncertainty regarding the future
The assumption about the project's future circumstances is a major
drawback of financial management. The nature of the future is
unexpecte d, and things do not always turn out the way we expect them to.
The dependability of financial data is greatly influenced by future
uncertainty.
Rigidity
Financial management contributes to organizational rigidity by
establishing specific criteria for eval uating performance. All of the
standards are set in accordance with a set of criteria. As a result of the
rigidity of standards, it is impossible to meaningfully compare real and
standard performance.
Inaccuracy in the Data Used to Make Decisions
Financial management is the process method of predicting the future based
on past or researched data gathered from various sources. If financial
management data has limitations, the data's foundation is faulty, as the
results purpose of financial planning could be impacted incorrectly.
Because all predictions may be incorrect, the credibility and quality of the
data on which the computations are based are critical.
Criteria standardization and determination
Financial management necessitates the development of perfor mance
criteria for assessing actual performance, which would be a time -
consuming and complex process. There are no appropriate setup
prerequisites for establishing standards, and the standards may be formed
inaccurately.
Rapid changes in the environment an d public policy
Government laws and regulations guiding the economic environment may
change significantly, which can have a significant effect on financial
management. If the strategy does not have the agility to adapt to changing
conditions, it may go fro m being a perfect financial plan to a financial
failure.
Inadequate availability of essential information
Financial records can be altered for a variety of reasons. This is the most
major drawback of financial management. It could, for example, be
presente d in accordance with management's wishes or formed from the munotes.in

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12 viewpoint of shareholders. Profits and financial circumstances, as well as
the rate of profitability, are the only things that are made publicly
available when it comes to financial management.
Warning
Business executives must have systems in place to keep ahead of the
rapidly changing regulatory environment. The employer is responsible for
making changes to company policies to accommodate this change.
Penalties are imposed regardless of whether or not business owners are
aware of the change. To overcome the disadvantages of financial
management, one should always have up -to-date business information.
Costly
For commercial enterprises, financial management is a time -consuming
and costly activity. Fi nancial management comprises the use of various
financial control instruments to manage and measure costs. These tools are
both costly and time -consuming to operate.
A challenge in setting a reasonable price
Financial management is assigned with the primar y responsibility of
generating income streams for the firm. Each time new manufacturing
processes, business models, or customer preferences are introduced, new
needs are created. Financial management's dependability and limitations
are debatable, and its e ffectiveness is strongly questioned.
External Sources Factors
External factors which are not directly involved in your business strategy
but have the potential to have a negative impact on your planning, such as
war, natural disasters, pandemics, and other such events, are extremely
difficult or impossible to predict. To avoid these types of financial
management constraints, you must take appropriate steps, such as
insurance, to minimize the financial loss that can result from such
difficulties.
PREPARATION OF FINANCIAL STATEMENT ADHERING TO
CURRENT SATAUTORY REQUIREMENT
[The below content has been adapted from Institute of Chartered
Accountant of India (ICAI)]
GENERAL INSTRUCTIONS FOR PREPARATION OF BALANCE
SHEET AND STATEMENT OF PROFIT AND LOSS OF A
COMPAN Y
GENERAL INSTRUCTIONS
1. Where compliance with the requirements of the Act including
Accounting Standards as applicable to the companies require any change
in treatment or disclosure including addition, amendment, substitution or
deletion in the head or subh ead or any changes, inter se, in the financial munotes.in

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Introduction to Financial Management
13 statements or statements forming part thereof, the same shall be made and
the requirements of this Schedule shall stand modified accordingly.
2. The disclosure requirements specified in this Schedule are in addit ion
to and not in substitution of the disclosure requirements specified in the
Accounting Standards under the Companies Act, 2013. Additional
disclosures specified in the Accounting Standards shall be made in the
notes to accounts or by way of additional s tatement unless required to
prescribed be disclosed on the face of the Financial Statements. Similarly,
all other disclosures as required by the Companies Act shall be made in
the notes to accounts in addition to the requirements set out in this
Schedule.
3. (i) Notes to accounts shall contain information in addition to that
presented in the Financial Statements and shall provide where required
(a) narrative descriptions or dis -aggregations of items recognized in those
statements; and
(b) information about i tems that do not qualify for recognition in those
statements.
(ii) Each item on the face of the Balance Sheet and Statement of Profit and
Loss shall be cross -referenced to any related information in the notes to
accounts. In preparing the Financial Stateme nts including the notes to
accounts, a balance shall be maintained between providing excessive
detail that may not assist users of financial statements and not providing
important information as a result of too much aggregation.
4. (i) Depending upon the turn over of the company, the figures
appearing in the Financial Statements may be rounded off as given
below: —
Sr.
No. Turnover Rounding off
1 Less than one
hundred crore rupees To the nearest hundreds, thousands, lakhs
or millions, or decimals thereof.
2 One hundred crore
rupees or more To the nearest lakhs, millions or crores, or
decimals thereof.

(ii) Once a unit of measurement is used, it shall be used uniformly in the
Financial Statements.
5. Except in the case of the first Financial Statements laid bef ore the
Company (after its incorporation) the corresponding amounts
(comparatives) for the immediately preceding reporting period for all munotes.in

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14 items shown in the Financial Statements including notes shall also be
given.
6. For the purpose of this Schedule, the ter ms used herein shall be as per
the applicable Accounting Standards.
Note: This part of Schedule sets out the minimum requirements for
disclosure on the face of the Balance Sheet, and the Statement of Profit
and Loss (hereinafter referred to as “Financial S tatements” for the purpose
of this Schedule) and Notes. Line items, sub -line items and sub -totals shall
be presented as an addition or substitution on the face of the Financial
Statements when such presentation is relevant to an understanding of the
compan y’s financial position or performance or to cater to industry/sector -
specific disclosure requirements or when required for compliance with the
amendments to the Companies Act or under the Accounting Standards.
PART I — BALANCE SHEET
Name of the Company………… ………….
Balance Sheet as at ………………………
Particulars Note
No. Figures as at
the end of
current
reporting
period Figures as at
the end of
previous
reporting
period
1 2 3 4
I. EQUITY AND LIABILITIES
(1) Shareholders’ funds
(a) Share capital
(b) Reserves and surplus
(c) Money received against share
warrants

(2) Share application money
pending allotment

(3) Non-current liabilities
(a) Long -term borrowings
(b) Deferred tax liabilities (Net)
(c) Other Long term liabilities
(d) Long -term provisions
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15
(4) Current liabilities
(a) Short -term borrowings
(b) Trade payables
(c) Other current liabilities
(d) Short -term provisions

TOTAL (1+2+3+4)

II. ASSETS
Non-current assets
(1) (a) Fixed assets
(i) Tangible assets
(ii) Intangible assets
(iii) Capital work -in-progress
(iv) Intangible assets under
Develop ment
(b) Non -current investments
(c) Deferred tax assets (net)
(d) Long -term loans and
advances
(e) Other non -current assets

(2) Current assets
(a) Current investments
(b) Invent ories
(c) Trade receivables
(d) Cash and cash equivalents
(e) Short -term loans and advances
(f) Other current assets

TOTAL (1+2)
See accompanying notes to the Financial Statements.

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16 General Instructions f or Preparation of Balance Sheet
1. An operating cycle is the time between the acquisition of assets for
processing and their realisation in cash or cash equivalents. Where the
normal operating cycle cannot be identified, it is assumed to have a
duration of tw elve months.
2. An asset shall be classified as current when it satisfies any of the
following criteria: —
a) it is expected to be realised in, or is intended for sale or consumption in,
the company’s normal operating cycle;
b) it is held primarily for the purpose o f being traded;
c) it is expected to be realised within twelve months after the reporting
date; or
d) it is cash or cash equivalent unless it is restricted from being exchanged
or used to settle a liability for at least twelve months after the reporting
date.
All other assets shall be classified as non -current.
3. A liability shall be classified as current when it satisfies any of the
following criteria: —
(a) it is expected to be settled in the company’s normal operating cycle;
(b) it is held primarily for the p urpose of being traded;
(c) it is due to be settled within twelve months after the reporting date; or
(d) the company does not have an unconditional right to defer settlement
of the liability for at least twelve months after the reporting date. Terms
of a liability that could, at the option of the counterparty, result in its
settlement by the issue of equity instruments do not affect its
classification.
All other liabilities shall be classified as non -current.
4. A receivable shall be classified as a “ trade receivable ” if it is in
respect of the amount due on account of goods sold or services
rendered in the normal course of business.
5. A payable shall be classified as a “ trade payable ” if it is in respect of
the amount due on account of goods purchased or se rvices received in
the normal course of business.
6. A company shall disclose the following in the notes to accounts.
A. Share Capital
For each class of share capital (different classes of preference shares to be
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17 (a) the number and amount of shares authorised;
(b) the number of shares issued, subscribed and fully paid, and subscribed
but not fully paid;
(c) par value per share;
(d) a reconciliation of the number of shares outstanding at the beginning
and at the end of the reporting period;
(e) the rights, preferences and restrictions attaching to each class of shares
including restrictions on the distribution of dividends and the
repayment of capital;
(f) shares in respect of each class in the company held by its holding
company or its ulti mate holding company including shares held by or
by subsidiaries or associates of the holding company or the ultimate
holding company in aggregate;
(g) shares in the company held by each shareholder holding more than 5
per cent. shares specifying the numbe r of shares held;
(h) shares reserved for issue under options and contracts/commitments for
the sale of shares/disinvestment, including the terms and amounts;
(i) for the period of five years immediately preceding the date as at which
the Balance Sheet is prepared:
(A) Aggregate number and class of shares allotted as fully paid -up
pursuant to contract(s) without payment being received in cash.
(B) Aggregate number and class of shares allotted as fully paid -up by way
of bonus shares.
(C) Aggregate number and class of shares bought back.
(j) terms of any securities convertible into equity/preference shares issued
along with the earliest date of conversion in descending order starting
from the farthest such date;
(k) calls unpaid (showing aggregate value of cal ls unpaid by directors and
officers);
(l) forfeited shares (amount originally paid -up).
B. Reserves and Surplus
(i) Reserves and Surplus shall be classified as:
(a) Capital Reserves;
(b) Capital Redemption Reserve;
(c) Securities Premium Reserve;
(d) Deben ture Redemption Reserve; munotes.in

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18 (e) Revaluation Reserve;
(f) Share Options Outstanding Account;
(g) Other Reserves –(specify the nature and purpose of each reserve and
the amount in respect thereof);
(h) Surplus i.e., balance in Statement of Profit and Loss disclo sing
allocations and appropriations such as dividend, bonus shares and
transfer to/ from reserves, etc.;
(Additions and deductions since last balance sheet to be shown under
each of the specified heads)
(ii) A reserve specifically represented by earmar ked investments shall be
termed as a “fund”.
(iii) Debit balance of statement of profit and loss shall be shown as a
negative figure under the head “Surplus”. Similarly, the balance of
“Reserves and Surplus”, after adjusting negative balance of surplus, if
any, shall be shown under the head “Reserves and Surplus” even if the
resulting figure is in the negative.
C. Long -Term Borrowings
(i) Long -term borrowings shall be classified as:
(a) Bonds/debentures;
(b) Term loans:
(A) from banks.
(B) from other partie s.
(c) Deferred payment liabilities;
(d) Deposits;
(e) Loans and advances from related parties;
(f) Long term maturities of finance lease obligations;
(g) Other loans and advances (specify nature).
(ii) Borrowings shall further be sub -classified as secured and unsecured.
Nature of security shall be specified separately in each case.
(iii) Where loans have been guaranteed by directors or others, the
aggregate amount of such loans under each head shall be disclosed.
(iv) Bonds/debentures (along with the rate of interest and particulars of
redemption or conversion, as the case may be) shall be stated in
descending order of maturity or conversion, starting from farthest
redemption or conversion date, as the case may be. Where
bonds/debentures are redeemable by i nstalments, the date of maturity munotes.in

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Introduction to Financial Management
19 for this purpose must be reckoned as the date on which the first
instalment becomes due.
(v) Particulars of any redeemed bonds/debentures which the company has
power to reissue shall be disclosed.
(vi) Terms of repayment of term loans and other loans shall be stated.
(vii) Period and amount of continuing default as on the balance sheet date
in repayment of loans and interest, shall be specified separately in each
case.
D. Other Long -term Liabilities
Other Long -term Liabiliti es shall be classified as:
(a) Trade payables;
(b) Others.
E. Long -term provisions
The amounts shall be classified as:
(a) Provision for employee benefits;
(b) Others (specify nature).
F. Short -term borrowings
(i) Short -term borrowings shall be classified as:
(a) Loans repayable on demand;
(A) from banks.
(B) from other parties.
(b) Loans and advances from related parties;
(c) Deposits;
(d) Other loans and advances (specify nature).
(ii) Borrowings shall further be sub -classified as secured and unsecured.
Nature of security shall be specified separately in each case.
(iii) Where loans have been guaranteed by directors or others, the
aggregate amount of such loans under each head shall be disclosed.
(iv) Period and amount of default as on the balance sheet da te in
repayment of loans and interest, shall be specified separately in each
case.
(v) current investment of long term borrowings shall be disclosed
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20 G. Other current liabilities
The amounts shall be classified as:
(a) Current maturities of fin ance lease obligations;
(b) Interest accrued but not due on borrowings;
(c) Interest accrued and due on borrowings;
(d) Income received in advance;
(e) Unpaid dividends;
(f) Application money received for allotment of securities and due for
refund and inte rest accrued thereon. Share application money includes
advances towards allotment of share capital. The terms and conditions
including the number of shares proposed to be issued, the amount of
premium, if any, and the period before which shares shall be al lotted shall
be disclosed. It shall also be disclosed whether the company has sufficient
authorised capital to cover the share capital amount resulting from
allotment of shares out of such share application money. Further, the
period for which the share ap plication money has been pending beyond
the period for allotment as mentioned in the document inviting application
for shares along with the reason for such share application money being
pending shall be disclosed. Share application money not exceeding the
issued capital and to the extent not refundable shall be shown under the
head Equity and share application money to the extent refundable, i.e., the
amount in excess of subscription or in case the requirements of minimum
subscription are not met, shall be separately shown under “Óther current
liabilities”;
(g) Unpaid matured deposits and interest accrued thereon;
(h) Unpaid matured debentures and interest accrued thereon;
(i) Other payables (specify nature).
H. Short -term provisions
The amounts shall be cl assified as:
(a) Provision for employee benefits.
(b) Others (specify nature).
I. Tangible assets
(i) Classification shall be given as:
(a) Land;
(b) Buildings;
(c) Plant and Equipment; munotes.in

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Introduction to Financial Management
21 (d) Furniture and Fixtures;
(e) Vehicles;
(f) Office equipment;
(g) Ot hers (specify nature).
(ii) Assets under lease shall be separately specified under each class of
asset.
(iii) A reconciliation of the gross and net carrying amounts of each class of
assets at the beginning and end of the reporting period showing additions,
disposals, acquisitions through business combinations, amount of change
due to revaluation (if changes 10% or more in the aggregate in the net
carrying value of each class of tangible assets) and other adjustments and
the related depreciation and impairme nt losses/reversals shall be disclosed
separately.
(iv) Where sums have been written -off on a reduction of capital or
revaluation of assets or where sums have been added on revaluation of
assets, every balance sheet subsequent to date of such write -off, or
addition shall show the reduced or increased figures as applicable and
shall by way of a note also show the amount of the reduction or increase
as applicable together with the date thereof for the first five years
subsequent to the date of such reduction or increase.
J. Intangible assets
(i) Classification shall be given as:
(a) Goodwill;
(b) Brands /trademarks;
(c) Computer software;
(d) Mastheads and publishing titles;
(e) Mining rights;
(f) Copyrights, and patents and other intellectual property rights, services
and operating rights;
(g) Recipes, formulae, models, designs and prototypes;
(h) Licences and franchise;
(i) Others (specify nature).
(ii) A reconciliation of the gross and net carrying amounts of each class of
assets at the beginning and end of the reporting period showing additions,
disposals, acquisitions through business combinations, amount of change
due to revaluation (if changes 10% or more in the aggregate in the net
carrying value of each class of intangible assets) and other adjustments munotes.in

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Financial Management

22 and the related amortization and impairment losses/reversals shall be
disclosed separately.
(iii) Where sums have been written -off on a reduction of capital or
revaluation of assets or where sums have been added on revaluation of
assets, every balance shee t subsequent to date of such write -off, or
addition shall show the reduced or increased figures as applicable and
shall by way of a note also show the amount of the reduction or increase
as applicable together with the date thereof for the first five years
subsequent to the date of such reduction or increase.
K. Non -current investments
(i) Non -current investments shall be classified as trade investments and
other investments and further classified as:
(a) Investment property;
(b) Investments in Equity Instr uments;
(c) Investments in preference shares;
(d) Investments in Government or trust securities;
(e) Investments in debentures or bonds;
(f) Investments in Mutual Funds;
(g) Investments in partnership firms;
(h) Other non -current investments (specify natur e).
Under each classification, details shall be given of names of the bodies
corporate indicating separately whether such bodies are (i) subsidiaries,
(ii) associates, (iii) joint ventures, or (iv) controlled special purpose
entities in whom investments ha ve been made and the nature and extent of
the investment so made in each such body corporate (showing separately
investments which are partly -paid). In regard to investments in the capital
of partnership firms, the names of the firms (with the names of all their
partners, total capital and the shares of each partner) shall be given.
(ii) Investments carried at other than at cost should be separately stated
specifying the basis for valuation thereof;
(iii) The following shall also be disclosed:
(a) Aggregate amount of quoted investments and market value thereof;
(b) Aggregate amount of unquoted investments;
(c) Aggregate provision for diminution in value of investments.

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Introduction to Financial Management
23 L. Long -term loans and advances
(i) Long -term loans and advances shall be classified as:
(a) Capital Advances;
(b) Loans and advances to related parties (giving details thereof);
(c) Other loans and advances (specify nature).
(ii) The above shall also be separately sub -classified as:
(a) Secured, considered good;
(b) Unsecured, considered goo d;
(c) Doubtful.
(iii) Allowance for bad and doubtful loans and advances shall be disclosed
under the relevant heads separately.
(iv) Loans and advances due by directors or other officers of the company
or any of them either severally or jointly with any o ther persons or
amounts due by firms or private companies respectively in which any
director is a partner or a director or a member should be separately
stated.
M. Other non -current assets
Other non -current assets shall be classified as:
(i) Long -term Trade Re ceivables (including trade receivables on
deferred credit terms);
(a) Security Deposits;
(ii) Others (specify nature);
(iii) Long term Trade Receivables, shall be sub -classified as:
(a) (A) Secured, considered good;
(B) Unsecured, considered good;
(C) Doubtful.
(b) Allowance for bad and doubtful debts shall be disclosed under the
relevant heads separately.
(c) Debts due by directors or other officers of the company or any of them
either severally or jointly with any other person or debts due by firms
or private companies respectively in which any director is a partner or
a director or a member should be separately stated.
(iv) For trade receivables outstanding, following ageing schedule shall be
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24 Trade Receivables ageing schedule
(Amount in Rs.)
Particulars Outstanding for following periods from
due date of payment # Total
Less
than 6
months 6
months -
1 year 1-2
years 2-3
years More
than 3
years
(i) Undisputed
Trade receivables
- considered good
(ii) Undisputed
Trade receivables
- considered
doubt ful
(iii) Disputed
Trade receivables
- considered good
(iv) Disputed
Trade receivables
- considered
doubtful

# similar information shall be given where no due date of payment is
specified, in that case disclosure shall be from the date of the transaction.
Unbilled dues shall be disclosed separately
N. Cu rrent Investments
(i) Current investments shall be classified as:
(a) Investments in Equity Instruments;
(b) Investment in Preference Shares;
(c) Investments in Government or trust securities;
(d) Investments in debentures or bonds;
(e) Investments in Mutual Funds;
(f) Investments in partnership firms;
(g) Other investments (specify nature). munotes.in

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Introduction to Financial Management
25 Under each classification, details shall be given of names of the bodies
corporate [indicating separately whether su ch bodies are: (i) subsidiaries,
(ii) associates, (iii) joint ventures, or (iv) controlled special purpose
entities] in whom investments have been made and the nature and extent
of the investment so made in each such body corporate (showing
separately inve stments which are partly paid). In regard to investments in
the capital of partnership firms, the names of the firms (with the names of
all their partners, total capital and the shares of each partner) shall be
given.
(ii) The following shall also be discl osed:
(a) The basis of valuation of individual investments;
(b) Aggregate amount of quoted investments and market value thereof;
(c) Aggregate amount of unquoted investments;
(d) Aggregate provision made for diminution in value of investments.
O. Inventori es
(i) Inventories shall be classified as:
(a) Raw materials;
(b) Work -in-progress;
(c) Finished goods;
(d) Stock -in-trade (in respect of goods acquired for trading);
(e) Stores and spares;
(f) Loose tools;
(g) Others (specify nature).
(ii) Goods -in-transi t shall be disclosed under the relevant sub -head of
inventories.
(iii) Mode of valuation shall be stated.
P. Trade Receivables
(i) For trade receivables outstanding, following ageing schedule shall be
given:



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26 Trade Receivables ageing schedule
(Amount in Rs.)
Particulars Outstanding for following periods from
due date of payment # Total
Less
than 6
months 6
months -
1 year 1-2
years 2-3
years More
than 3
years
(i) Undisputed Trade
receivables - considered
good
(ii) Undisputed Trade
receivables - considered
doubt ful
(iii) Disputed Trade
receivables - considered
good
(iv) Disputed Trade
receivables - considered
doubtful

# similar information shall be given where no due date of payment is
specified, in that case disclosure shall be from the date of the transaction.
Unbilled dues shall be disclosed separately \
(ii) Trade receivables shall be sub -classified as:
(a) Secured, considered good;
(b) Unsecured, considered good;
(c) Doubtful.
(iii) Allowance for bad and doubtful debts shall be disclosed under the
relevant heads separately.
(iv) Debts due by directors or other officers of the company or any of them
either severally or jointly with any other person or debts due by firms or
private companies respectively in which any director is a partner or a
director or a member s hould be separately stated.
Q. Cash and cash equivalents
(i) Cash and cash equivalents shall be classified as:
(a) Balances with banks; munotes.in

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Introduction to Financial Management
27 (b) Cheques, drafts on hand;
(c) Cash on hand;
(d) Others (specify nature).
(ii) Earmarked balances with banks (for exam ple, for unpaid dividend)
shall be separately stated.
(iii) Balances with banks to the extent held as margin money or security
against the borrowings, guarantees, other commitments shall be
disclosed separately.
(iv) Repatriation restrictions, if any, in r espect of cash and bank balances
shall be separately stated.
(v) Bank deposits with more than twelve months maturity shall be
disclosed separately.
R. Short -term loans and advances
(i) Short -term loans and advances shall be classified as:
(a) Loans and adv ances to related parties (giving details thereof);
(b) Others (specify nature).
(ii) The above shall also be sub -classified as:
(a) Secured, considered good;
(b) Unsecured, considered good;
(c) Doubtful.
(iii) Allowance for bad and doubtful loans and advan ces shall be disclosed
under the relevant heads separately.
(iv) Loans and advances due by directors or other officers of the company
or any of them either severally or jointly with any other person or
amounts due by firms or private companies respectively in which any
director is a partner or a director or a member shall be separately
stated.
S. Other current assets (specify nature)
This is an all -inclusive heading, which incorporates current assets that do
not fit into any other asset categories.
T. Conti ngent liabilities and commitments (to the extent not provided
for)
(i) Contingent liabilities shall be classified as:
(a) Claims against the company not acknowledged as debt; munotes.in

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Financial Management

28 (b) Guarantees;
(c) Other money for which the company is contingently liable.
(ii) Commitments shall be classified as:
(a) Estimated amount of contracts remaining to be executed on capital
account and not provided for;
(b) Uncalled liability on shares and other investments partly paid;
(c) Other commitments (specify nature).
U. The amo unt of dividends proposed to be distributed to equity and
preference shareholders for the period and the related amount per share
shall be disclosed separately. Arrears of fixed cumulative dividends on
preference shares shall also be disclosed separately.
V. Where in respect of an issue of securities made for a specific purpose,
the whole or part of the amount has not been used for the specific purpose
at the balance sheet date, there shall be indicated by way of note how such
unutilised amounts have been u sed or invested.
Where the company has not used the borrowings from banks and financial
institutions for the specific purpose for which it was taken at the balance
sheet date, the company shall disclose the details of where they have been
used.
W. If, in t he opinion of the Board, any of the assets other than fixed assets
and non -current investments do not have a value on realisation in the
ordinary course of business at least equal to the amount at which they are
stated, the fact that the Board is of that o pinion, shall be stated.











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Introduction to Financial Management
29 PART II – STATEMENT OF PROFIT AND LOSS
Name of the Company…………………….
Profit and loss statement for the year ended ………………………
Particulars Note
No. Figures as
at the end
of current
reporting
period Figures as at
the end o f the
previous
reporting
period
1 2 3 4
I Revenue from operations
II Other income

III Total Revenue (I + II)

IV Expenses:
Cost of materials
consumed
Purchases of Stock -in-
Trade
Chang es in inventories of
finished goods, work -in-
progress and Stock -in-
Trade
Employee benefits
expense
Finance costs
Depreciation and
amortization expense
Other expenses

Total expenses

V Profit before exceptional
and extraordinary items
and tax (III - IV)

VI Exceptional items munotes.in

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30
VII Profit before
extraordinary items and
tax (V - VI)

VIII Extraordinary items

IX Profit be fore tax (VII -
VIII)

X Tax expense:
(1) Current tax
(2) Deferred tax

XI Profit (Loss) for the
period from continuing
operations (VII -VIII)

XII Profit/(loss) from
discontinuing operatio ns

XIII Tax expense of
discontinuing operations

XIV Profit/(loss) from
Discontinuing operations
(after tax) (XII -XIII)

XV Profit (Loss) for the
period (XI + XIV)

XVI Earnings per equit y
share:
(1) Basic
(2) Diluted
See accompanying notes to the financial statements.
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Introduction to Financial Management
31 General instructions for preparation of Statement of Profit and Loss
1. The provisions of this Part shall apply to the income and expenditure
account referred to in sub -clause (ii) of clause (40) of section 2 in like
manner as they apply to a statement of profit and loss.
2. (A) In respect of a company other than a finance company revenue
from operations shall disclose separately in the notes revenue from —
(a) Sale of products;
(b) Sale of services;
“(ba) Grants or Donations received (relevant in case of section 8
Companies only)”.
(c) Other operating revenues;
Less:
(d) Excise duty.
(B) In respect of a finance company, revenue from operations shall inclu de
revenue
from —
(a) Interest; and
(b) Other financial services.
Revenue under each of the above heads shall be disclosed separately by
way of notes to accounts to the extent applicable.
3. Finance Costs
Finance costs shall be classified as:
(a) Interest expe nse;
(b) Other borrowing costs;
(c) Applicable net gain/loss on foreign currency transactions and
translation.
4. Other income
Other income shall be classified as:
(a) Interest Income (in case of a company other than a finance company);
(b) Dividend Income;
(c) Net gain/loss on sale of investments;
(d) Other non -operating income (net of expenses directly attributable to
such income). munotes.in

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32 5. Additional Information:
i). A Company shall disclose by way of notes additional information
regarding aggregate expenditure and income on the following items: —
(a) Employee Benefits Expense [showing separately (i) salaries and
wages, (ii) contribution to provident and other funds, (iii) expense on
Employee Stock Option Scheme (ESOP) and Employee Stock Purchase
Plan (ESPP), (iv) sta ff welfare expenses].
(b) Depreciation and amortisation expense;
(c) Any item of income or expenditure which exceeds one per cent of the
revenue from operations or Rs.1,00,000, whichever is higher;
(d) Interest Income;
(e) Interest expense;
(f) Dividend in come;
(g) Net gain/loss on sale of investments;
(h) Adjustments to the carrying amount of investments;
(i) Net gain or loss on foreign currency transaction and translation (other
than considered as finance cost);
(j) Payments to the auditor as
(a) auditor ;
(b) for taxation matters;
(c) for company law matters;
(d) for management services;
(e) for other services; and
(f) for reimbursement of expenses;
(k) In case of Companies covered under section 135, amount of
expenditure incurred on corporate social res ponsibility activities;
(l) Details of items of exceptional and extraordinary nature;
(m) Prior period items;
(ii) (a) In the case of manufacturing companies, —
(1) Raw materials under broad heads.
(2) goods purchased under broad heads.
(b) In the case of t rading companies, purchases in respect of goods traded
in by the company under broad heads. munotes.in

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Introduction to Financial Management
33 (c) In the case of companies rendering or supplying services, gross income
derived from services rendered or supplied under broad heads.
(d) In the case of a compan y, which falls under more than one of the
categories mentioned in (a), (b) and (c) above, it shall be sufficient
compliance with the requirements herein if purchases, sales and
consumption of raw material and the gross income from services rendered
is show n under broad heads.
(e) In the case of other companies, gross income derived under broad
heads.
(iii) In the case of all concerns having works in progress, works -in-
progress under broad heads.
(iv) (a) The aggregate, if material, of any amounts set aside or proposed to
be set aside, to reserve, but not including provisions made to meet any
specific liability, contingency or commitment known to exist at the date as
to which the balance sheet is made up.
(b) The aggregate, if material, of any amounts withdra wn from such
reserves.
(v) (a) The aggregate, if material, of the amounts set aside to provisions
made for meeting specific liabilities, contingencies or commitments.
(b) The aggregate, if material, of the amounts withdrawn from such
provisions, as no long er required.
(vi) Expenditure incurred on each of the following items, separately for
each item: —
(a) Consumption of stores and spare parts;
(b) Power and fuel;
(c) Rent;
(d) Repairs to buildings;
(e) Repairs to machinery;
(f) Insurance;
(g) Rates and taxe s, excluding, taxes on income;
(h) Miscellaneous expenses,
(vii) (a) Dividends from subsidiary companies.
(b) Provisions for losses of subsidiary companies
(viii) The profit and loss account shall also contain by way of a note the
following infor mation, namely: — munotes.in

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Financial Management

34 (a) Value of imports calculated on C.I.F basis by the company during the
financial year in respect of —
I. Raw materials;
II. Components and spare parts;
III. Capital goods;
(b) Expenditure in foreign currency during the financial year on a ccount of
royalty, know -how, professional and consultation fees, interest, and other
matters;
(c) Total value if all imported raw materials, spare parts and components
consumed during the financial year and the total value of all indigenous
raw materials, spare parts and components similarly consumed and the
percentage of each to the total consumption;
(d) The amount remitted during the year in foreign currencies on account
of dividends with a specific mention of the total number of non -resident
shareholder s, the total number of shares held by them on which the
dividends were due and the year to which the dividends related;
(e) Earnings in foreign exchange classified under the following heads,
namely: —
I. Export of goods calculated on F.O.B. basis;
II. Royal ty, know -how, professional and consultation fees;
III. Interest and dividend;
IV. Other income, indicating the nature thereof.
(ix) Undisclosed income: The Company shall give details of any
transaction not recorded in the books of accounts that has been
surrendered or disclosed as income during the year in the tax assessments
under the Income Tax Act, 1961 (such as, search or survey or any other
relevant provisions of the Income Tax Act, 1961), unless there is
immunity for disclosure under any scheme and al so shall state whether the
previously unrecorded income and related assets have been properly
recorded in the books of account during the year.
(x) Corporate Social Responsibility (CSR)
Where the company covered under section 135 of the companies act
the following shall be disclosed with regard to CSR activities:
(a)amount required to be spent by the company during the year,
(b) amount of expenditure incurred,
(c) shortfall at the end of the year,
(d) total of previous years shortfall, munotes.in

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Introduction to Financial Management
35 (e) reason for s hortfall,
(f) nature of CSR activities,
(g) details of related party transactions, e.g., contribution to a trust
controlled by the company in relation to CSR expenditure as per relevant
Accounting Standard,
(h) where a provision is made with respect to a l iability incurred by
entering into a contractual obligation, the movements in the provision
during the year should be shown separately.
(xi) Details of Crypto Currency or Virtual Currency
Where the Company has traded or invested in Crypto currency or Virtu al
Currency during the financial year, the following shall be disclosed:
(a) profit or loss on transactions involving Crypto currency or Virtual
Currency
(b) amount of currency held as at the reporting date, deposits or
advances from any
Note: — Broad heads shall b e decided taking into account the concept of
materiality and presentation of true and fair view of financial statements.
Structure for preparing Notes to Account
[The below content has been adapted from Institute of Chartered
Accountant of India (ICAI)]
NOTES TO ACCOUNTS `
1. Share Capital
● Authorised Shares (Par Value per Share:Rs.……….)
● Issued, subscribed, called up & fully paid Shares
● Subscribed but not fully paid Shares
● Less: Calls unpaid
 By Directors by
 By Officers
 By Others
● Forfeited Shares
● Forfeite d Shares reissued
● Reconciliation of Shares Outstanding
2. Reserves and Surplus
● Capital Reserves
● Capital Redemption Reserve
● Securities Premium
● Debenture Redemption Reserve
● Revaluation Reserve munotes.in

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36 ● Share Options Outstanding Account
● Other Reserves
● General Res erves
● Surplus
 Balance b/d
 Add: Profit for Year
 Less: Appropriations
3. Long Term Borrowings
● Bonds / Debentures
● Term Loans
 Term Loans from Banks.
 Term Loans from Other Parties
● Deferred Payment Liabilities
● Deposits
 Public Deposits
 Inter -Corporate Deposi ts
● Loans and Advances from Related Parties.
● Long Term Maturities of Finance Lease Obligations
● Other Loans and Advances
4. Other Long Term Liabilities
● Trade Payables
● Other Payables
 Trade Deposits
 Security Deposits
5. Long Term Provisions
● Provision f or Employee Benefits
● Others
 Provision for Warranties
6. Short Term Borrowings
● Loans Repayable on Demand
 From Banks
 From Other Parties
● Loans and Advances from Related Parties
● Deposits
● Other Loans and Advances munotes.in

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Introduction to Financial Management
37
7. Other Current Liabilities
● Current Mat urities of Long Term Debt
● Current Maturities of Finance Lease Obligations
● Interest Accrued but not Due on Borrowings.
● Interest Accrued and Due on Borrowings
● Income Received in Advance
● Unpaid Dividends
● Application Money Refund and Interest Due
● Unpaid Matur ed Deposits and Interest Accrued thereon
● Unpaid Matured Debentures and Interest Accrued
thereon
● Other Payables
 Calls -in-Advance
 Non-Trade Payables
 Taxes Payable
8. Short Term Provisions
● Provision for Employee Benefits
● Others
 Provision for Tax (Net of tax payments)
9. Tangible Assets
● Land
● Buildings
● Plant and Equipment
● Furniture and Fixtures
● Vehicles
● Office Equipment
● Others (specify nature)
10. Intangible Assets
● Goodwill
● Brands /Trademarks
● Computer Software
● Mastheads and Publishing Titles
● Mining Rights
● Copyrights, Patents, etc. munotes.in

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38 ● Recipes, Formulae. Models, Designs and Prototypes
● Licenses and Franchise
● Others (specify nature)
11. Non -Current Investments
● Investments in Property
● Investment in Equity Instruments
● Investments in Preference Shares
● Investments in Government or Trust Securities
● Investments in Debentures or Bonds
● Investments in Mutual Funds
● Investments in Partnership Firms
● Other Non Current Investments and Advances
12. Long Term Loans and advances
● Capital Advances
● Security Deposits
● Loans and Advances to Related Parties
● Other Loans and Advances
 Advance Tax (Net of provision)
 CENVAT Credit Receivable
 VAT Credit Receivable
 Service Tax Credit Receivable
13. Other Non Current Assets
● Long Term Trade Receivables
● Others
14. Current Inv estments
● Investments in Equity Instruments
● Investments in Preference Shares
● Investments in Government or Trust Securities
● Investments in Debentures or Bonds
● Investments in Mutual Funds
● Investments in Partnership Firms
● Other Investments munotes.in

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39
15. Inventorie s
● Raw Materials
● Work -in-Progress
● Stock -in-Trade
● Stores and Spares
● Loose Tools
● Others
16. Trade Receivables
● Secured, Considered Good
● Unsecured Considered Good
 More than 6 months
 Other
● Doubtful
 Less: Provision for Bad and Doubtful Debts
17. Cash and Ca sh Equivalents
● Balances with Banks
● Cheques, Drafts on Hand
● Cash on Hand
● Others (specify nature)
 Other Bank Balances
 Earmarked (Unpaid Dividend A/c)
 Margin Money Deposit
 Deposits Maturing After 12 Months
18. Short Term Loans and Advances
● Loans and Adva nces to related parties
● Others
● Prepaid Expenses
● Tax Refund Receivable vide A.O.
19. Other Current Assets
● Non-Trade Receivables
● Unamortized Expenditure
● Unbilled Revenue munotes.in

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40
20. Revenue from Operations
● Sale of Products
● Sale of Services
● Other Operating Re venues
 Sale of Manufacturing Scrap
● Less: Excise Duty Collected
21. Other Income
● Interest Income
● Dividend Income
● Net Gain/Loss on Sale of Investments
● Other Non -Operating Income (Net)
 Profit on Sale of Fixed Assets
22.Cost of Materials Consumed
● Raw Mat erials
● Purchased Components
23. Change in Inventories
● Finished Goods
Opening Stock
Less: Closing Stock
● Work -in-progress
Opening Stock
Less: Closing Stock
● Stock -in-Trade
Opening Stock
Less: Closing Stock
24. Employee Benefits Expense
● Salaries and Wages
● Contribution to Provident and Other Funds
● Expense on ESOP and ESPP
● Staff Welfare Expenses
25. Finance Costs
● Interest on Borrowings from Bank
● Interest on Borrow ings from Others
● Interest on Debentures munotes.in

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41 ● Finance Charge on Lease Financing
● Interest by Tax Department
● Other Borrowing Costs
 Commitment Charges
 Amortization of Discount/Premium/Issue Expenses on
Debentures
 Ancillary Charges (Processing/Guarantee / Fac ilitation) 26. Other Expenses
● Consumption of Stores and Spare Parts
● Power and Fuel
● Rent
● Repairs to Buildings
● Repairs to Machinery
● Insurance
● Rates and Taxes excluding, Taxes on Income
● Payment to Auditor
 Payment for Audit Services
 Payment for Taxation Ma tters
 Payment for Company Law Matters
 Payment for Management Services
 Payment for Other Services
● Payment for Reimbursement of Expenses
● Adjustment to Carrying Amount of Investments
● Loss on Foreign Currency Transaction/Translation
● Expenses on CSR Activitie s
● Exceptional (Major) Items
 Costs of Restructuring
 Disposal of Fixed Assets
 Disposal of Long Term Investments
 Effect of Retrospective Legislation
 Legal Settlements
 Reversal of Provisions
 Write Down of Inventory to NRV

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42 ● Extra -ordinary (Major) Items
 Loss from Attachment of Property
 Loss from Earthquake
 Profit from Insurance Claim
 Write -Back of Self -Insurance Reserve
● Prior Period Expenses
● Miscellaneous Expenses
(Higher of 1% of Operating Revenue or 1,00.000)
Contingent Liabilities and Commitments (to the Extent
Not Provided For)
a) Contingent Liabilities
 Claims against the company not acknowledged as debt:  Guarantees;
 Other money for which the company is contingently
liable
b) Commitments
 Estimated amount of contracts remaining to be
executed on capital accoun t
 Uncalled liability on shares and other investments
partly paid
 Other Commitments (non -cancellable)
Note:
Illustration no. 01
The following balances have been extracted from the accounting records
of B. R. Cold storage ltd. as of 31st March,2021.
Partic ulars Rs. (Amt.) Opening Stock of finished goods 3,00,000 Purchase 2,35,000 Net Sales 10,00,000 Closing Stock of finished goods 1,00,000 Interest on Investment 40000 Dividend received 10000 Depreciation on Furniture 20000 General expenses 10000 Salaries 45000 Interest on Bank loan 30000 Income tax 2,00,000 munotes.in

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43 Solution :
B . R . Cold Storage
Profit and loss statement for the year ended 31st March, 2021
Sr.
No. Particulars Note
No. Amt. 1 2 3 4 I Revenue from operations (Net
Sales) 10,00 ,000 II Other income 1 50,000 III Total Revenue (I + II) 10,50,000 IV Expenses: Cost of materials consumed
(Purchase of Finished goods) 2,35,000 Changes in inventories of finished
goods
(Opening - Closing) (3,00,000 -
1,00,000) 2,00,000 Employee benefits expense
(Salaries) 45,000 Depreciation (On Furniture) 20,000 Finance costs (Interest on Bank
loan) 30,000 Other expenses (General expenses) 10,000 Total expenses 5,40,000 V Profit before tax (III - IV) 5,10,000 VI (-) Income Tax 2,00,000 VII Profit / (Loss) for the period (V - VI) 3,10,000


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44 Notes to Accounts
Note
No. Particulars Amt. 1 Other Income a. Interest on Investment 40,000 b. Dividend received 10,000 Total 50,000
Illustration no. 02
From the following ledger balances of Addu and Anshu ltd. as on 31st
March, 2021, you are required to Prepare a balance sheet as on that date as
per the Companies Act, 2013
Debit Bal ance Amt. Credit Balance Amt. Advances to employees 3,00,000 Share Capital 7,50,000 Cash in hand 1,00,000 General reserves 2,50,000 Cash at Bank 50,000 Loan from Bank of
India 1,25,000 Plant and Machinery 2,00,000 Provision for
Employee’s welf are
fund 1,45,000 Building 1,50,000 Provision for
Expense 1,10,000 Copyrights 3,00,000 Short term loan from
Bank 75,000 Expenses on Issue of
Debentures (not written
off) 1,55,000 Unclaimed Dividend 25,000 Debtors 2,00,000 Profit and loss A/c 1,00,0 00 Advance income tax 75,000 Bill payable 50,000 9 % Goverment
Securities 1,00,000 Creditors 50,000 Inventories 50,000 16,80,000 16,80,000 munotes.in

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45 Solution:
Addu and Anshu ltd.
Balance sheet as on 31st March, 2021
0 Particulars Note
No. Amt. 1 2 3 4 I EQUITY AND LIABILITIES 1 Shareholder’s Funds a Share Capital 7,50,000 b Reserves and Surplus 3,50,000 c Money received against share warrants 2 Share application money pending
allotment - 3 Non-Current Liabilities a Long -term borrowings (loan from
bank of India) 1,25,000 b Deferred tax liabilities (Net) c Other Long term liabilities d Long term provisions (Employee’s
welfare) 1,45,000 4 Current Liabilities a Short -term borrowings (Short ter m
loan from Bank) 75,000 b Trade payables 1,00,000 c Other current liabilities (Unclaimed
Dividend) 25,000 d Short -term provisions (Provision for
Expense) 1,10,000 Total (1+2+3+4) 16,80,000 II Assets 1 Non-current assets a Fixed assets i Tangible assets 3,50,000 ii Intangible assets (Copyrights) 3,00,000 b Non Current Investments
(Government securities) 1,00,000 c Other non -current assets (Expenses on
Issue of Debentures (not written off)) 1,55,000 munotes.in

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46 2 Curr ent assets a Inventories 50,000 b Trade receivables (Debtors) 2,00,000 c Cash and Cash equivalents 1,50,000 d Short -term loans and advances
(Advances to employees) 3,00,000 e Other current assets (Advance Income
tax) 75,000 Total (1+2 ) 16,80,000
Notes to Accounts
Note No. Particulars Amt. 1 Reserves and Surplus a. General reserves 2,50,000 b. Profit and loss A/c 1,00,000 Total 3,50,000 2 Trade payable a. Creditors 50,000 b. Bill payable 50,000 Total 1,00,000 3 Tangible Assets a. Plant and Machinery 2,00,000 b. Building 1,50,000 Total 3,50,000 4 Cash and Cash Equivalent a. Cash in hand 1,00,000 b. Cash at Bank 50,000 Total 1,50,000 munotes.in

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Introduction to Financial Management
47 Illustration no. 03
The following are the balances of M/s Ganesh ltd. as on 31st March,
2020
Debit Balance Amt. Credit Balance Amt. land and Building 32,00,000 Equity Share
Capital (Rs. 10) 45,00,000 Plant and Machinery 25,00,000 10% Debentures 15,00,000 Stock 1,50,000 General res erves 2,50,000 Patent 13,50,000 Sales 50,00,000 Sundry Debtors 2,50,000 Creditors 2,00,000 Bank balance 1,50,000 Bills payable 3,50,000 Calls in arrears 50,000 Capital reserves 1,50,000 Purchase 23,50,000 Share issue expenses 1,00,000 Wages 8,00,000 General expenses 75,000 Salaries 3,00,000 Bad Debts 5,00,000 Interest on Debenture 1,75,000 1,19,50,000 1,19,50,000
Adjustments:
1. Stock on 31 -03-2020 was Rs. 1,00,000
2. Depreciation Plant and Machi nery by 10 %
3. Write off Rs. 9,000 from Share issue expenses
4. Create 5 % provision for doubtful debts
5. Provide for Income tax @ 40 %
Prepare Final accounts of the company as per Companies Act , 2013
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48 Solution:
In the Books of M/s Ganesh
Balance shee t as on 31st March, 2020
Particulars Note
No. Amt. 1 2 3 4 I EQUITY AND LIABILITIES 1 Shareholder’s Funds a Share Capital 1 44,50,000 b Reserves and Surplus 2 6,87,100 c Money received against share warrants - 2 Share application money pending
allotment - 3 Non-Current Liabilities a Long -term borrowings (10 %
Debenture) 15,00,000 b Deferred tax liabilities (Net) - c Other Long term liabilities - d Long term provisions - 4 Current Liabilities a Short -term borrowings - b Trade payables 3 5,50,000 c Other current liabilities (Interest on
Debenture) - d Short -term provisions (Income tax) 1,91,400 Total (1+2) 73,78,500 II Assets 1 Non-current assets a Fixed assets i Tangible assets 4 54,50,000 ii Intangible assets (Patent) 13,50,000 b Non Current Investments - munotes.in

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49 c Other non -current assets 5 91,000 2 Current assets a Inventories 1,00,000 b Trade receivables (De btors) 6 2,37,500 c Cash and Cash equivalents (Bank
Balance) 1,50,000 d Short -term loans and advances e Other current assets Total (1+2) 73,78,500
Profit and loss account for the year ended 31st March, 2020
Particulars Note
No. Amt. 1 2 3 4 I Revenue from operations (Sales) 50,00,000 II Other income - III Total Revenue (I + II) 50,00,000 IV Expenses: Cost of materials consumed
(Purchase) 23,50,000 Changes in inventories (Open ing
stock - Closing stock) (1,50,000 -
1,00,000) 50,000 Employee benefits expense 7 11,00,000 Depreciation (On Plant and
Machinery) 2,50,000 Finance costs (Interest on Debenture) 1,75,000 Other expenses 8 5,96,500 Total expe nses 45,21,500 V Profit before tax (III - IV) 4,78,500 VI (-) Income Tax @ 40 % 1,91,400 VII Profit / (Loss) for the period ( V - VI) 2,87,100 munotes.in

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50 Notes to Accounts:
Note No. Particulars Amt. 1 Share Capital
Issued , Subscribed and Paid -up Capital 4,50,000 Equity Shares of Rs. 10 each fully paid up 45,00,000 (-) Calls in arrears 50,000 Total 44,50,000 2 Reserves and Surplus General reserves 2,50,000 Capital reserves 1,50,000 Profit for the year 2,87,100 Total 6,87,100 3 Trade payable Creditors 2,00,000 Bills payable 3,50,000 Total 5,50,000
4 Fixed assets - Tangible land and Building 32,00,000 Plant and Machinery
25,00,000 (-) 10% Depreciation
2,50,000 22,50,000 Total 54,50,000 5 Other Non Current assets Share Issue expenses 1,00,000 (-) Written off 9,000 Total 91,00 0 6 Trade Receivable Sundry Debtors 2,50,000 (-) Provision for Doubtful Debts @ 5 % 12,500 Total 2,37,500 munotes.in

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51 7 Employee Benefits Expenses Wages 8,00,000 Salaries 3,00,000 Total 11,00,000 8 Other Expenses
Bad Debts 5,00,000
(+) Provision for Doubtful Debts @ 5 % 12,500 5,12,500 Share issue expenses 9,000 General Expenses 75,000 Total 5,96,500
References:
1. https://www.managementstudyguide.com/financial -management .htm
2. Satish M. Inamdar (2006). Principles of Financial Management.
Everest Publishing House.ISBN 8176601205
3. CA. C. Rama Gopal (2008). Financial Management (Text cum
suggested answers), New Age International Publishers. ISBN (10)
8122422063
4. https://www.economicsdiscussion.net/financial -
management/introduction -to-financial -management/33281
5. Sudhindra Bhat (2008). Financial Management Principl es and
Practice. Excel books. ISBN 9788174465863.
6. https://www.toppr.com/guides/business -environment/business -
functions/financial -management/

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52 2
ANALYSIS OF FINANCIAL STATEMENTS
Unit Structure
2.0 Learning Objectives
2.1 The Financial Statements
2.2 Need and Importance of Financial Statement
2.3 Analysis and Interpretation
2.4 Balance Sheet
2.5 Income Statement

2.0 LEARNING OBJECTIVES
After stud ying the unit, the students will be able to:
 Understand the objectives and nature of Financial Statements.
 Know the characteristics of Financial Statements.
 Discuss about the qualities of Ideal Financial Statements.
 Interpret the financial statements.
2.1 THE FINANCIAL STATEMENTS
( i ) "Financial Statements” is a set of documents consisting of:
(a) Balance Sheet as on date - shows position of assets and
liabilities as on date.
(b) Profit and loss account - shows profit or loss for the period.
(c) Cash Flow Statement - wherever applicable
(d) Statements and Explanatory Notes – part of balance sheet
(e) Supplementary Schedule and Information
(ii) The financial statements help one to realize,
- the progress made by a business,
- the resources utilized by the business or
- the failure suffered by a business.
(iii) Financial statement does not include
- Report by directors
- Statement by the chairman
- Management discussion & analysis report (MDAR) munotes.in

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53 2.2 NEED AND IMPORTANCE OF FI NANCIAL
STATEMENT
The users of these financial statements need to have an honest assurance
that the statements have been properly
- Compiled,
- Prepared, and
- Presented.
They want a reasonable degree of assurance as regards the reliability and
accuracy of the financial statement.
Limitations of Financial statements
The company releases financial statements, and hence the obvious
limitation is that the information an analyst gets is limited to what the
company wants to show and how it plans to manipulate the information.
Limitations of Financial Statements
Interim
1. Only Interim Reports
The data in financial statements is based on approximation and do not give
a clear picture. The actual results can only be known in condition of sale
or liquidation of business. Generally statements are prepared for different
accounting period say yearly, during the lifetime of concern. Cost and
income be apportioned to different periods with a view to determine
profits etc.
Accountant, on his personal judgement do alloc ation of income and
expenses. The existence of contingent assets and liabilities also make
statements imprecise. So financial statements do not actual picture and at
the most they are interim reports
2. Exact position not known
The financial statements a re expressed in monetary terms, so they tend to
give final and accurate position. The fixed asset value in the balance sheet
neither represents the value for which fixed assets can be sold nor the
amount which will be required to replace these assets. The balance sheet is
prepared on the presumption of a going concern.
So, fixed assets are shown at cost less accumulated depreciation. There are
certain assets in the balance sheet such as preliminary expenses, goodwill,
discount on issue of shares which will realize nothing at the time of
liquidation though they are shown in the balance sheet.
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54 3. Historical cost
The financial statements are prepared on the basis of historical costs or
original costs. The diminishing value in asset is not accounted for. The
statements are not prepared keeping in view the present economic
conditions.
The balance sheet loses the significance of being an index of current
economic realities. Similarly, the profitability shown by the income
statement may not represent the earning c apacity of the concern. The
increase in profits may be due to an increase in prices or due to some
abnormal causes and not due to increase in efficiency. The conclusions
drawn from financial statements may not give a fair picture of the concern
4. Non-mone tary factors impact left unseen
There are certain factors which have a relevance on the financial position
and operating results of the business but they do not become a part of
these statements because they cannot be measured in monetary terms.
Such fact ors may include the management reputation credit worthiness of
the concern, sources and commitments for purchases and sales, co -
operation of the employees, etc. The financial statements only show the
position of the financial accounting for business and no t the financial
position.
5. No precision in Financial Statements
There is no possibility in precision of financial statements because the
statements deal with matters which cannot be precisely stated. The data
are recorded by conventional procedures foll owed over the years. Various
conventions, postulates, personal judgments etc. are used for developing
the data.










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55 USERS AND THEIR PURPOSE





















2.3 ANALYSIS AND INTERPRETATION

(1) Need for Analysis and Interpretation : A typical F inancial Statement
of a company may run into many pages. It normally contains a huge mass
of data and figures. A common user would be at a loss to understand
which figures are important and what is the exact significance of all the
figures shown in the Fin ancial Statements. The Financial Statements are
basically prepared for the owners or managers and outsiders such as
Creditors, Lenders or researchers have re -organise the figures appearing in
the Financial Statements for the purpose of their study.

(2) Me aning of Analysis: 'Analysis' means - to resolve something into
its elements or components, For an outside user, the details in the
Financial Statements signify only raw data or 'raw material'!
This raw material' needs to be re -organised, processed and con verted into
an easy to understand form. The process of breaking up a large mass of
raw data into manageable form is called "analysis' of the Financial
Statements.

(3) Financial Statement Analysis : Financial statement analysis is a
process of evaluating t he relationship between the component parts of a
financial statement to obtain a better understanding of a firm's financial
position and performance (Metcalf and Tigard). Analysis of Profit and
Loss Account, therefore, means breaking down the Profit and Lo ss
Account Government OWNERS
Evaluating
performance
& profitability Lenders and
creditors
Establish
degree of
safety of
money Investors
Making
investment decisions Workers Financial
analysts
Assess
performance
of entity
Management
Decision making purpose Levy taxes & providing
relief to business
organization
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56 into its various components or segments i.e. Gross Sales, Net Sales, Cost
of Goods Sold, Operating Profit and so on. This is done by converting the
T Form Profit and Loss Account into a Vertical Income Statement.
Analysis of Balance Sheet means breaking down or "analysing' the Funds
into Total Funds Available and Total Funds Employed. The Total Funds
Available are further broken down into Owners' Funds and Loan Funds.
The Total Funds employed are broken down into Fixed Assets and
Working Capital. This is done by converting the T Form Balance Sheet
into a Vertical Balance Sheet.
2.4 BALANCE SHEET
ASSETS
Definitions
(1) Expenditure means a payment made by a business to obtain some
benefit i.e., assets, goods or services (Guidance Note - ICAI). Whil e an
expenditure on obtaining goods or services by a concern in the course of
its business activity is known as revenue expenditure, an expenditure in
the course of its investing activity (obtaining an asset) is known as capital
expenditure.
(2) Capital ex penditure means an expenditure carrying probable future
benefits (Guidance Note. ICAl. Capital expenditure gives rise to 'assets'.

Types and Valuation

Following are the different types of assets as defined by the ICAI in its
Guidance Note, and the mode o f valuation:
(1) 'Assets" are tangible objects or intangible rights, owned by a concern,
carrying probable future benefits. Thus, assets include tangible items
(capital assets, current assets) and intangible rights (intangible assets).

(2) 'Capital assets ' means assets including investments not held for sale,
con version or consumption in the ordinary course of business. Capital
assets thus include fixed assets and investments.
(3) 'Capital work -in-progress means expenditure on capital assets which
are und er construction or completion. It is valued at cost incurred till date.
(4) Current assets are cash and other assets that are (i) expected to be
converted into cash or
(in) consumed in the production of goods or rendering of services in the
normal course o f business. Thus, current assets, as opposed to capital
assets, are short -term assets (debtors, stock etc.. Debtors and stocks are
shown at their Net Realisable Value, if and only if, it is lower than cost.
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57
(5) Fixed asset is an asset held for the purpos e of providing or producing
goods or services, and which is not held for resale in the normal course of
business. Fixed assets may be either depreciable assets (machinery etc.) or
wasting assets (mines etc.). Fixed assets are valued at cost incurred upto
installation, i.e. Invoice price + Tax + Delivery charges + Installation cost
+ Cost of trial runs + Initial spares.

(6) Depreciable asset' is a fixed asset which has a limited useful life. These
are valued at the WDV (Cost less Depreciation).

(7) Wasting assets' are natural resources like mine, oil -well etc. which are
exhausted or depleted due to extraction or use. These are valued at WDV
(Cost less amount amortised).
(8) Investment' is expenditure on assets held, not for business operations,
but to earn interest, income, profit or other benefits e.g. shares, debentures,
immovable properties etc. Investments are normally valued at cost.
(9) Intangible asset' is an asset which does not have a physical identity e.g.
goodwill, patent, copyright etc. Intangibl e assets are valued at WDV (cost
less amount amortised).
(10) 'Fictitious asset' is an item shown under assets in the balance sheet
which has no real value (e.g. debit balance of profit and loss account
which indicates accumulated losses)
(In) Hidden asset s do not appear on the balance sheet. Examples are : self
created good will, assets Written off in books but still in use, options on
lease, exclusive trading agreements, secret process or designs and so on.
Hidden assets are like 'secret reserves'
Deferr ed Revenue Expenditure
(1) Meaning: Deferred Revenue Expenditure' is that expenditure which is
carried forward on the presumption that it will be of benefit over
subsequent period(s) (Guidance Note -ICAl. It is also known as "deferred
expenditure'. To defer ' means to postpone. Deferred revenue expenditure
has a mixed nature and has some features of both revenue and capital
expenditure. It may be either a basically revenue expenditure whose
benefits can be enjoyed for a number of years; or a capital expenditu re not
represented by any real asset.

(2) Accounting : The items of expenditure having medium term benefits
(say 3 years) are treated as deferred revenue expenditure. The
proportionate cost (1/3 cost) related to current year is charged as expenses.
The ba lance (unexpired) cost (2/3) is carried forward as "fictitious asset' in
the balance sheet and written off in next years. Such gradual and
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58 (3) Applicable Only to Companies : Earlier, research expenses, heavy
advertisement expenditure, preliminary expenses, expenses on shifting the
business etc. used to be treated as deferred revenue expenditure and
written off over 3 to 5 years. However, Accounting Standard 26
(Intangible Assets) requi res that such items should be treated as revenue
expenses. However, according to the ICAI Guidance Note on Revised
Schedule VI to the Companies Act, a Limited Company may treat the
following as deferred revenue expenditure - (1) Share issue expenses (2)
Discount on issue of Shares (3) Debenture issue expenses (4) Discount on
issue of debentures, and (5) Premium payable on redemption of
debentures. Many companies amortize share issue expenses, discount on
shares etc. over the period of benefit, i.e., normall y 3 to 5 years. Expenses
on issue, discount or premium relating to debentures can be amortized
over the period of debentures. Proportionate amount related to current year
is charged as expenses in the profit and loss statement of the company.
Balance amoun t not yet written off is shown as Unamortized Expenditure'
on the Assets side of the company balance sheet.
LIABILITIES
Definitions
Capital means the amounts in vested in the concern by its owners e.g.
paid-up capital in a corporate enterprise. It is also used to refer to the
interests of the owners in the assets of the enterprise (ICAI). Capital is
refunded to the owners only when the concern finally stops its business
and is closed .
Liability means the financial obligation of an enterprise other than ow ner's
funds (ICAN).
Long term (Non -current) Liability is a liability which does not fall due for
payment in a short period i.e. twelve months (ICAI) Current Liability is a
liability including loans, deposits and bank overdraft which falls due for
payment in a relatively short period, normally not more than 12 months
(ICAL).

Disclosure in Final Accounts
Capital and Liabilities are shown in Balance Sheet. Capital receipt from
sale of asset or
Investment is deducted from the concerned fixed asset or invest ment
shown on the Assets side in the balance
CONVENTIONAL OR T'FORM
The conventional form of Balance Sheet (also called the T form or the
Account form), shows the Assets on the right hand side and the Liabilities
on the left hand side.

In this form the As sets are normally shown in order of Permanence. The
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59 most Liquid assets, ie. the current asses: [Even under cash head, items of
assets are arranged in the order of Permanance e.g. un der Current A sos
stace spears first and Cash & Bank balance which is the most liquid,
appears last]. The Liabilities are shown in order of priority of e -amont.
Permanent Liabilities (e.g. Capital) are shown first followed by long term
Loans and short ter m Loans. Current Liabilities appear last. This form is
used by non. corporates e.g. sole trader or firm. Thus, the Balance Sheet in
conventional form appears like this:
EXHIBIT 1 : BALANCE SHEET IN 'T' FORM

Liabilities ` Assets `
Capital XX Fixed Assets XX
Reserves & Surplus XX Investments XX
Long term Loans XX Current Assets XX
Short term Loans XX Loans and Advances XX
Current Liabilities XX
Provisions XX
XX XX

Note: If the items are shown in order of liquidity, the above sequence is
reversed. On the assets side, current assets are shown first, followed by
fixed assets. On the liabilities side, current liabilities are shown first,
followed by short term loans, long term loans and capital.
NEED FOR VERTICAL FORMAT
The horizontal format o f Balance Sheet is designed from the point of view
of the owner of a concern It enables the owner to know at a glance the
amount of Total Funds Owned (Total Assets) and the amount of Total
Funds Owed (Total Liabilities). It also enables the owner to know w hich
assets will take time to sell (Fixed Assets) and which assets can be realised
quickly (Current Assets). The order of payment of liabilities in the event
of Liquidation can also be ascertained from such a Balance Sheet in
conventional form.
However, t he Conventional Form of Balance Sheet is not suitable for
financial analysis, precisely because.
(1) It is designed for the owner. It does not serve the purpose of the other
users such as a potential investor or lender.
(2) Its presentation and sequence or order of items is relevant only in the
event of Liquidation; it is unsuitable for financial analysis of a 'going
concern'.
munotes.in

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60 Hence, a user or Financial Analyst, generally converts the horizontal
Balance Sheet, into a Vertical Format, which is more suitable for financial
analysis especially in Ratio Analysis. Even the vertical financial
statements for a limited company prepared under Schedule VI of the
Companies Act need to be converted into the following format for
financial analysis. The Balance Sheet in V ertical Format for financial
analysis will appear as follows : -
VERTICAL FORMAT
WORKSHEET 2 : VERTICAL BALANCE SHEET (DETAILED
ITEMS) Particulars ` ` `
I SOURCES OF FUNDS
1 Owner's Funds
A Capital
i Equity Share Capital / Capital of Proprietor or
Partner XX
ii Preference Share Capital Amount Subscribed /
Called -up XX
iii Less : Unpaid Calls / Drawings of Proprietor or
Partner XX
iv Add : Forfeited Shares / Fresh Capital by Prop.
/ Partner XX
v Add : Received Agains t Share Warrants XX XX
B. Reserves and Surplus
i Capital Reserve XX
ii Capital Redemption Reserve XX
iii Share Premium XX
iv General Reserve XX
v Other Reserve XX
vi Profit & Loss A/c - Cr. balance XX
vii Sinking Fu nds / Other Funds XX XX
C. Less : Losses & Fictitious Assets
i Profit & Loss A/c - Dr. balance XX
ii (in) Misc. Expenditure not written off XX
iii Share Issue Expenses XX
iv Discount on Issue of Shares XX
v Debenture Issue Exp enses XX munotes.in

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Analysis of Financial
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61 vi Discount on Issue of Debentures XX
vii Premium Payable on Redemption of
Debentures XX XX
Own Funds or Net Worth (1) (A+B -C) X
X
(Capital + Reserves & Surplus - Losses &
Fictitious Assets)
2 Loan Funds/Borrowed Funds
D. Secured Loans / Long Term Borrowings
Debentures or bonds XX
Loans from Banks XX
Loans from Financial Institutions XX XX
E. Unsecured Loans
Public Deposits XX
Loan from Directors XX XX
Owed Funds (D + E) (Secured Loans +
Unsecured Loans) X
X
Total Funds Available / Capital Employed X
X
(Own Funds + Owed Funds) (1 + 2)

II APPLICATION OF FUNDS
3 Net Fixed / Non -Current Assets
F. Tangible XX
Land and buil ding XX
Leaseholds XX
Plant and Machinery XX
Furniture and Fittings XX
Vehicles XX XX
G. Intangible
Goodwill XX
Patents, copyrights, trademarks and designs XX XX
Total Fixed Assets (F + G) X
X
(Net Tangible Assets + Intangible Assets)
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62 4 Long Term / Non -current Investments
Investments in Government Securities XX
Shares, Debentures etc. XX
Less: Sinking Funds / Other Funds /
Investments XX
Investments in immovabl e properties XX
Investments in Capital of Partnership Firms XX
Long Term Loans given XX X
X
5 Working Capital
H. Quick Assets
a Cash and Bank XX
b Debtors (Net) / Trade Receivables XX
c Bills Receivable XX
d Short Term Loans & Advances Given XX
e Accrued Income XX
f Short -term or Marketable Investments XX
Total Quick or Liquid Assets (a to f) XX
I Non-Current Assets XX
g Inventory XX
h Pre-payments (pre -paid expenses, advance for
goods, advance tax) XX XX
Current Assets (a to h)
Less
:
J. Quick Liabilities
a Creditors / Trade Payables XX
b Bills Payable XX
c Advances Received XX
d Outstanding Expenses XX
e Accrued Interest XX
f Provision for Tax XX
g Unclaimed Dividend XX
h Short Term Loans XX
Total Quick Liabilities (a to h) XX
K. Non-Quick Liabilities munotes.in

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63 i Bank Overdraft XX
j Cash Credit XX
k Incomes received in advance XX
Current Liabili ties (a to k) (XX
)
Net Current Assets or Working Capital (A - B) X
X
Total Assets or Total Funds Employed X
X
(Fixed Assets + Investments + Working
Capital)
(3 + 4 + 5)

Notes
(1) Thus, a Vertical Analytical Balance Sheet differs from a Horizontal
Balance Sheet in following respects

(a) Current Liabilities are deducted from the Current Assets;

(b) Fictitious Assets are deducted from the Owners' Funds.
This should be kept in mind while converting a Horizontal Balance Sheet
into a Vertical Balance Sheet.

(2) At times, Application of Funds (FA and WC) is shown first, followed
by Sources of Funds (OF and LF).

EXPLANATION (MAIN HEADINGS)
The vertical form has two parts - I. Source of Funds and II. Application of
Funds.
I. SOURCES OF FUNDS
A concern has two main sources of funds - 1. Own Funds and 2. Loan
Funds.

1. Proprietors' or Own Funds OF
Proprietors' or Own Funds (or internal sources) mean (a) capital of the
owners (proprietor, partners, or shareholders) and (b) Retained Earning s
(or Reserves & Surplus). To arrive at the Net Worth or Owners' Funds,
Capital and Reserves are added and the accumulated losses and fictitious
assets are deducted. The accumulated losses (Profit and Loss A/c - Dr. munotes.in

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Financial Management

64 balance) and fictitious assets (Misc. Ex penditure Not Written off) reduce
the amount of funds available or attributable to the owners and hence have
to be deducted to ascertain the owners' net worth.
2. Borrowed or Loan Funds [LF]
Borrowed or Loan Funds (Long Term Borrowings) constitute another
major source of funds. Loan funds may be (a) Secured Loans like
Debentures, bonds, Loans from banks, loans from financial
institutions, or (b) Unsecured Loans e.g. public deposits. The total of
Secured Loans and Unsecured Loans give the total amount of Loa n Funds
or 'Owed' funds.
Total Funds Available : The total of Own Funds and Owed Funds is the
total amount of Funds Available to the concern as on date of the Balance
Sheet. How these funds were actually employed or used is shown in the
second part of verti cal Balance Sheet, viz. Application of Funds.
II. APPLICATION OF FUNDS
The Total Funds Available are used to finance 1. Fixed Assets and 2. Net
Current Assets (called Working capital).
1. Fixed Assets [FA]
The Fixed Assets (also known as Non -Current Assets ) may be classified
into Tangible, Intangible and Investments.
A. Tangible Assets have definite physical existence. ('Tangible' means
that which can be 'touched'). Thus Land, Building, Machinery, Veh icle are
tangible fixed assets. These are shown at net co st, i.e. cost less
depreciation.
B. Intangible Assets cannot be seen (or 'touched'), but do earn income for
the concern -such as Goodwill, Trade -mark etc.
Net Fixed Assets mean Fixed Assets less accumulated depreciation
thereon till date (ICAN).
2. Long T erm or Trade Investments
Long term or trade investments are those investments which are intended
to be held for a long term (such as investments in immovable properties)
or those which are held in the normal course of business (e.g. investment
in the capit al of a partnership firm). Investments in Government Securities
shares, bonds, etc. may be Long Term or Short Term depending upon the
circumstances.

3. Working Capital [WC]
Working Capital is represented by. the excess of current assets over
current liabi lities including short -term loans (ICAD). It means the funds
available for conducting the day -to-day operations of the enterprise. munotes.in

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Analysis of Financial
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65 A. Current Assets [CA] : Investments in Fixed Assets is a permanent or
long-term investment. A concern also has circulating f unds, i.e. short -term
assets like stock, debtors, etc. called current assets. These assets keep
getting converted into cash. Those current assets which can be quickly
converted into cash are called Liquid or Quick Assets.
B. Current Liabilities [CL]: Curre nt Liabilities, on the other hand, are
short -term liabilities payable within a year. These arise out of purchase of
goods on credit, outstanding expenses etc. The excess of current assets
over current liabilities is called Net Current Assets or Working Cap ital.
Total Fund or Capital Employed [CE]
Capital Employed means the finances deployed by an enterprise in its Net
Fixed Assets, Investments and Working Capital (ICAI).
The amount of Total Funds used or employed is equal to Net Fixed Assets
+ Working Capit al.
Vertical Balance Sheet structure can be analysed through the following
equations:

(1) Own Funds + Loan Funds = Fixed Assets + Investments + Working
Capital or OF + LF= FA + Inv. + WC

(2) TA (Total Assets) = FA + Inv. + CA = TL (Total Liabilities) = O F +
LF+ CL

(3) CE (Capital Employed) = FA + WC = FA+ (CA - CL) = OF+ LE

(4) OF (Owners' Funds) = TA - CL - LF

The items to be included under each of the above main headings are
described in detail below.
EXPLANATION (DETAILED ITEMS)
I. SOURCES OF FUNDS
1. Proprietors' Funds
A. Capital
Capital refers to the amount invested in an enterprise by its owner. It also
refers to the interest of the owners in the assets of an enterprise (Guidance
Note on Terms used in Financial Statements -ICAl henceforth mentione d
as "GN by ICAI".)
In case of a Proprietor, Capital would be equal to
Opening Balance
Add Profit during year
Additional Capital brought in during year
Less Loss during year
Drawing during year
Closing Balance. munotes.in

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66 In case of a firm, capital would be the total of the closing balances of the
Capital Accounts, determined as above, for all partners.
In case of a Limited Company; Capital would include (i) Equity Share
Capital and (ii) Preference Share Capital. Under each type of share capital,
the amount paid -up is shown. The paid -up amount is equal to Called up
Amount Less Unpaid Calls Plus Forfeited Shares. Money received against
share warrants (to be converted into shares) is also part of shareholders’
funds.

B. Reserv es & Surplus:
Reserves means the profit retained or ploughed back in business and not
distributed as dividends. Reserves are defined as the portion of the
earnings receipts or other surplus of an enterprise (whether capital or
revenue appropriated by the m anagement for a general or specific purpose
(GN by ICAI).
(i) Capital Reserves : Capital Reserves are those reserves of a company
which are not available for distribution as dividend (GN by ICAN. These
are not created out of normal business profits of the c ompany. They are
created out of premium received on issue of shares, profit on sale of fixed
assets. Capital redemption reserve (reserve created on redemption of
preference shares), profit on forfeiture of shares etc. These are not
available for payment of dividends.
(ii) General Reserve : General Reserve is a Revenue Reserve not
earmarked for any specific purpose (GN by ICAD. This represents
undistributed normal profits of the company. Profits may be distributed by
way of dividends or retained by way of res erves.
(iii) Funds : Fund is a Reserve or a Provision represented by specifically
earmarked asset (GN by ICAD. A Fund as Sinking Fund, Provident Fund,
or Staff Benefit Fund denotes that the amount shown under that Fund has
been invested in specific (earmark ed) securities. In a vertical balance
sheet, the amount of such earmarked investments is adjusted against the
amount of Fund and only the net amount (Fund less Investment), is shown
under 'reserves
C. Losses and Fictitious Assets The accumulated losses (Pr ofit & Loss
Account - Dr. balance) and Fictitious Assets, i.e. Misc Expenditure Not
Written off are shown on the Assets side of the conventional balance
sheet. However, in the Vertical balance sheet, these are deducted from the
total of (a) Capital and (b) Reserves & Surplus to determine the net Equity
or net Worth. These include - (i) Profit & Loss A/c - Dr. balance
(ii) Miscellaneous expenses not written off (also known as Unamortized
Expenses) –
(1) Share issue expenses
(2) Discount on issue of Shares
(3) Debenture issue expenses munotes.in

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Analysis of Financial
Statements
67 (4) Discount on issue of debentures, and
(5) Premium payable on redemption of debentures.

Net Worth , also known as Shareholders Funds, means the excess of the
book value of the assets (other than fictitious assets) of an enterpri se over
its liabilities (ICAI). Net worth is the same as Owners Funds or
Proprietors Funds.
Owners' Funds = Capital + Reserves & Surplus - Losses & Fictitious
Assets
2. Loan Funds
Loan or Liability means the financial obligation of an enterprise other than
owner's funds (GN by ICAl). This are the long -term Borrowings.
This is the Second Source of finance for a concern. The distinction
between the Proprietors Funds (own Funds) and the Loan Funds (owed
Funds) is as follows:
EXHIBIT 2: OWN FUNDS VS. OWED FUND S
No. Own Funds Owed Funds
1 Internal source of finance External source of finance.
2 Represents claim of outsiders
on the assets of the concern. Represents claims of owners on the assets of the concern.
3 Own Funds i.e. Capital earns
dividends. Owed F unds, i.e. Loans earn
interest
4 Dividends are paid out of
profits ("appropriations out of
profits') and the rate may vary. Interest is charged against profits (i.e. paid irrespective of profit or
loss), at a fixed rate
5 In liquidation, own funds are
returned
last. Hence Own Funds are
called "Permanent Funds.' In Liquidation, Owed Funds are
repaid before capital. Even
otherwise, loans have to be
repaid according to the terms of the agreement. Hence,
Owed Funds are called
"Semipermanent Funds."
6 Own Fun ds are not 'secured' by charge on assets. Loans may be secured by charge
on Fixed or Current Assets.

A. Secured Loans:
Loans may be for Secured or Unsecured.
Secured loans (also called Fixed Liabilities) consist of: munotes.in

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Financial Management

68 (i) Debentures or Bonds repayable afte r a fixed period.
(ii) Bank Loans
(iii) Loans from Financial Institutions
B. Unsecured Loans:
Public Deposits are deposits kept by public for a fixed period which are
unsecured.All Loans, other than Secured Loans, would be shown as
Unsecured Loans.
(1) Tot al Owed Funds = Secured Loans + Unsecured Loans
(2) Total Funds Available = Own Funds + Owed Funds
I. APPLICATION OF FUNDS
1. Fixed Assets:
Following items are included under Fixed Assets (also known as Non -
Current Assets):
A. Tangible Assets (at cost less depreciation)
(i) Land and Buildings
(ii) Leasehold Property
(iii) Railway Sidings
(iv) Plant & Machinery
(v) Furniture & Fittings
(vi) Development of Property
(vii) Live Stock
(viii) Vehicles etc.
B. Intangible Assets
(i) Goodwill
(ii) Patents, Copyrigh ts, Trade -marks and designs
Fixed Assets = Tangible Assets (net cost) + Intangible Assets
2. Long Term Investments
Investments may be long -term or short -term. If for example, bonds of an
Electricity Undertakinghave to be compulsorily purchased so as to obt ain
power connection, these will be held as long as the concern exists. Hence
these will be Long Term Investments. If any investment represents a Fund
shown under Reserves (e.g., Provident Fund Investment), it is adjusted
against the balance of the Fund. I f the net balance is Debit (i.e., munotes.in

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Analysis of Financial
Statements
69 Investment exceeds Fund), only the net Dr. is shown as Investment; if the
Fund exceeds Investment the net Cr. balance is shown under Reserves.
Short Term Investments are shown as a part of Current Assets.

3. Working Capit al
Working Capital means the net current assets or the excess of Current
Assets over Current Liabilities.
A. Current Assets:
Current Assets (or Floating Assets) mean those assets which move through
the operating cycle of the business viz. through the stage s of purchase of
raw materials (Stock) production of finished goods (Stock) sales of goods
(Cash/Debtors) Realisation of Debtors (cash) and so on. Current assets
mean the assets like stock, debtors and cash which move in a cycle. Thus
stock is converted by sales into debtors, debtors get converted by
realisation of dues into cash, cash is used for buying goods and again the
cycle is repeated. Current assets are short term assets unlike fixed assets
which are long term assets.
The following item are included under Current Assets:
(a) Stock
1. Stores and spare parts
2. Stock -in-trade
(Raw Materials - Finished Goods + Packing Materials)
3. Work -in-progress.
(b) Debtors
Gross amount
Less : Provision for bad & doubtful debts
(c) Cash and Bank
1. Cash on hand
2. Bank balances
3. Cash Equivalents e.g. liquid deposits
(d) Loans & Advances Given
1. to subsidiaries
2. to firms etc.
(e) Marketable Investments i.e. temporary investments made out of
surplus funds. munotes.in

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70 (f) Other Current Assets
1. Interest accrued on investment s
2. Loose tools
3. Bills of exchange
4. Pre -payments (pre - paid expenses, advance for goods, advance tax paid)
5. Balances with customs. Port trust etc. (Payable on demand).
Thus,
Current Assets = Stock + Debtors + Cash and Bank + Loans & Advances+
Market able Investments + Other Current Assets
Quick Assets :
Quick assets are the following items of Current Assets, which are 'quickly
realisable' -
(a) Cash & Bank
(b) Debtors (net) / Trade Receivables
(c) Bills Receivable
(d) Loans
(e) Marketable (Current / Sh ort-term) Investments
(f) Other e.g. Accrued Income
Or
Quick Assets = Current Assets Less Inventories & Pre -payments
(Note: Pre -payments : Pre -paid Expenses, Advances for Goods &
Advance tax)
B. Current Liabilities:
Current Liabilities include the followin g items
(a) Sundry creditors for supply of goods or services (Trade Payables).
(b) Bills Payable
(c) Advances Received
(d) Outstanding expenses
(e) Accrued Interest
(f) Provision for tax
(g) Unclaimed Dividends
(h) Short Term Loans
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Analysis of Financial
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71 Notes :
(1) Current mat urities of long -term debts e.g. Debentures / Loans (whether
Secured or Unsecured) repayable within 1 year should be shown as
Current Liabilities
(2) Dividends proposed but not yet approved by shareholders are shown
by way of a Note toAccounts. No provision is made for proposed
dividends w.e.f. FX. 2016 -17 (vide MCA/ICAIAmended Accounting
Standard 4)
Quick Liabilities :
Quick Liabilities are those current liabilities which are payable in a short
period of time. Bank Overdraft is not, in practice, immediately payable.
So,
Quick Liabilities = Current Liabilities - Bank Overdraft
Working Capital = Current Assets - Current Liabilities
Total Funds Applied = Net Fixed Assets + Investments + Working Capital
This is always equal to Total Funds Available.
2.5 INCOME ST ATEMENT
Vertical Income Statement of ………… for the year ended
………….
Particulars Amount Amount Amount I. Sales
Cash Sales XX
Credit Sales XX
Gross Sales XX
Less: Returns and Allowances (XX)
Net Sales XX
Less:
II. Cost of Goods Sold
Opening Stock XX
Add:
Purchases XX
Direct Expenses XX
Carriage Inward/Freight Inward XX
Octoroi Duties/Import Duties XX
Direct Wages XX munotes.in

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72 Factory lighting XX
Fuel, coal, oil XX
Depreciation on Plan t and
Machinery XX
Depreciation on Factory Premises XX XX
Less:
Closing Stock (XX)
Goods Damaged by fire (XX)
Goods lost by theft (XX) (XX)
Cost of Goods Sold (XX)
III. Gross Margin (III = I - II) XX
Add:
IV. Operat ing Incomes
Discount received (on Purchases) XX
Bad Debts Recovered XX XX
Less:
V. Operating Expenses
A. Office and Administrative
Expenses
Salaries XX
Rent, Rates and Taxes XX
Office Lighting XX
Printing an d Stationery XX
Insurance premium XX
Postage XX
Depreciation on Furniture XX
Depreciation on Office Premises XX
Depreciation on
Computers/Laptops XX
Miscellaneous expenses/General
Expenses XX XX
B. Selling and Distribution
Expenses
Salary sales staff XX
Commission charges XX
Advertising expenses XX munotes.in

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Analysis of Financial
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73 Carriage outward XX
Packing expenses XX
Depreciation on delivery vans XX
*Bad Debts XX XX
C. Finance Expenses
Interest on bank overd raft XX
Interest on cash credit XX
Discount allowed XX
Bank charges XX
Bank commission XX
**Bad Debts XX XX
Total Operating Expenses (XX)
VI. Net Operating Profit (VI = III
+ IV - V) XX
Less:
VII. Interest on Lo ng Term
Borrowings
Interest on Loans XX
Interest on Debentures XX
Interest on Public Deposits XX (XX)
VIII. Net Profit (VIII = VI - VII) XX
Add:
IX. Non -Operating Income
Dividend and interest on
investments XX
Rent received XX
Profit on Sale of Investments/Fixed
Assets XX XX
Less:
X. Non -Operating Expenses
Loss on Sale of Investments/Fixed
Assets XX
Preliminary Expenses written off XX
Loss by fire/Theft/Accident XX (XX)
XI. Net P rofit Before Tax (XI =
VIII + IX - X) XX munotes.in

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74 Less: Provision for Tax (XX)
XII. Net Profit After Tax XX
Add: Opening Balance of Retained
Earnings/P&L A/c (XX)
XIII. Net Profit Available for
Appropriations XX
Less:
XIV. Appropriat ions
Transfer to General Reserve XX
Transfer to Reserves XX
Dividend on Preference
Shares/Equity Shares XX
Interim Dividend XX (XX)
XV. Closing Retained Earnings
(XV = XIII - XIV) XX
*Bad Debts can be alternatively treated as Financial Expenses.
From the above rearrangement of operating statements, thefollowing
accounting equations may be given:
1. Net Sales = Cost of sales + operating expenses + Nonoperating
expenses
2. Gross Profit = Net sales – Cost of goods sold
3. Net ope rating profit = Gross profit – operating expenses
4. Gross Sales:Gross sales also called ‘ Turnover’ is the amountof total
sales of goods and services. This includes both cashand credit sales.
Gross sales = Credit sales + cash sales
5. Cost of Goods Sold: This is the cost of purchases or cost
ofmanufacturing the goods, which are sold during the year.
Cost of Goods Sold = Opening stock + Purchases + Direct
Expenses + Depreciation – less closing stock
6. Gross Profit:
This is the major source of operating inc ome of anorganization. This is the
amount of profit earned on purchases,manufactures and sales of goods and
services.
Gross Profit = Net Sales – Cost of goods sold
7. Operating Expenses:These are the expenses incurred in the course of
normalconduct of busi ness, which are related to the business munotes.in

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Analysis of Financial
Statements
75 activities.Broadly, operating expenses areclassified into the
followingcategories.
a) Administrative Expenses: These are the expenses pertainingto general
office administrative of an organization.
b) Selling and Dist ribution Expenses: These are the expensesincurred for
the purpose of increasing and maintaining thesales, distributing and
delivering the goods.
c) Finance Charges: This includes: Cash discount, Bad debts (Abnormal),
Bank charges, bank Commission.
Operatin g Expenses = Administrative Expenses + Selling & Distribution
Expenses + Finance Expenses
8. Operating Profit: Excess of operating income over operating expenses is
called net operating profit. This is the amount of profit earned during the
normal course o f business.
Operating profit may be:
a) Operating Profit before Interest: Gross Profit - Operating expenses
(Before Interest)
b) Operating Profit After Interest : Operating profit (before Interest) –
Interest
9. Non -operating Income:Income not related to t he ordinary course of
business i.e., Interest on investment is not an operating income to a
company, which is engaged in buying and selling of goods and services of
goods. But for an investment company, interest will be considered as an
operating income.
10. Non -Operating Expenses: These are the expenses, which do not relate
to day -to-day conduct of business operations. These expenses arise due to
certain unusual events and unexpected occurrences.
11. Net Profit: This is the excess of total operating and no noperating
income over the total operating and non -operating expenses. It is
therefore, ultimate profit earned by the organization.
a) Net Profit before Tax = Net operating profit + Net non -operating
Income
b) Net profit After Tax =Net profit before tax - Income tax
12. Retained Earnings: Net profit after tax - dividend
Illustration 01:
Following is the Profit & Loss Account of Leena Ltd. for the year ended
31s March 2020. You are required to prepare Vertical Income Statement
for the purpose of analysis. munotes.in

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Financial Management

76 Particulars Amount Particulars Amount Amount
To Opening Stock 14,00,000 By Sales: To Purchases 18,00,000 Cash 10,40,000 To Wages 3,00,000 Credit 30,00,000 To Factory
Expenses 7,00,000 (-) Return &
Allowance 40,40,000 To Office Salaries 1,00,000 (20,000) 40,20,000 To Office Rent,
Rates & Taxes 78,000 To Postage and
Telegram 40,000 To Audit Fees 12,000 To Salesman
Salaries 24,000 By Dividend
on Investment 1,00,000 To Promotion
Expenses 76,000 By Closing
Stock 14,00,000 To Deliv ery
Expenses 40,000 By Profit on
sale of
Machinery 80,000 To Debenture
Interest 60,000 To Depreciation: - On Office
Furniture 1,00,000 On Plant 1,20,000 On Delivery Van 80,000 To Loss on Sale of
Van 10,000 To Income Tax 3,50,000 To Net Profit 3,10,000 56,00,000 56,00,000 munotes.in

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Analysis of Financial
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77 In the books of Leena Limited
Vertical Income / Revenue Statement as on 31 March 2020
Particulars Amount Amount Amount
SALES Cash 10,40,000 Credit 30,00,000 40,40,000 Less : Returns (20,000) Net sales 40,20,000 Less : Cost of goods Sold Opening stock 14,00,000 Add: purchase 18,00,000 Add: Wages 3,00,000 Add: Factory Expenses 7,00,000 Add: Depreciation on plant 1,20,000 43,20,000 Less: Closing stock (14,00,000) (29,20,000) Gross margin / Gross profit 11,00,000 Add: Operating Income Less: Operating expenses (1) Office & administrative Exp Office salary 1,00,000 Office Rent, Rate & Taxes 78,000 Postage & telegram 40,000 Directors fees 12,000 Depreciation on office furniture 1,00,000 3,30,000 (2) Selling & Distribution Salesmen salary 24,000 Promotion Expenses 76,000 Delivery Expenses 40,000 Dep. On Delivery van 80,000 2,20,000 (3) Finance Expenses - Total Operating Ex penses (5,50,000) Operating Profit 5,50,000 Debenture Interest (60,000) munotes.in

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Financial Management

78 Net Profit 4,90,000 Add:Non -operating Income Dividend on investment 1,00,000 Profit on sale of furniture 80,000 1,80,000 6,70,000 Less: Non -operating exp Loss in Sale of Van (10,000) Net profit before tax 6,60,000 Less: taxation (3,50,000) Net profit after tax 3,10,000
Illustration 02:
Profit & Loss account of Dani Ltd. For the year ended 31st October 2020
Particulars Amount Particulars Amou nt
To Opening Stock 1,98,250 By Sales: 13,26,00
0 To Purchases 8,19,650 Less Returns (26,000) 13,00,00
0 To Wages 18,200 By Closing Stock 2,56,100 To Staff Salaries 52,000 To Sales Salaries 39,780 To Interest 3,120 By Interest on
Debenture 3,900 To Office Rent 7,020 By Dividend on
Shares 15,860 To Printing and
Stationery 6,500 By Profit on sales
of shares 10,140 To Carriage Outward 12,220 To Discount 6,240 To Depreciation 24,180 To Insurance 2,600 To Motor Bill 910 To S alesmen's Travelling
Exp. 5,200 To Bad Debts 8,840 To Telephone Expenses 1,950 munotes.in

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Analysis of Financial
Statements
79 To Legal Charges 5,200 To Director's Fees 11,440 To Income Tax 1,24,800 To Loss on Sale of Bond 9,100 To Provision for claim
for damages 10,400 To Net Profit 2,18,400 15,86,000 15,86,00
0 Convert the above profit & loss A/c. of a company into a vertical revenue
statement.
Solution:
In the books of Dani Limited
Vertical Income / Revenue
Statement as on 31 March 2020
Particulars Amount Amount Amount
Sales 13,26,000 Less: Returns (26,000) Net sales 13,00,000 Less: Cost of goods Sold Opening stock 1,98,250 Add: Purchase 8,19,650 Add: Wages 18,200 10,36,100 Less: Closing stock (2,56,100) (7,80,000) Gross margin / Gross profit 5,20,000 Add: Operating Income - 5,20,000 Less: Operating expenses (1) Office & administrative Exp Staff salaries 52,000 Office Rent 7,020 Printing & Stationery 6,500 Depreciation 24,180 Insurance 2,600 Motor bill 910 Telephone Expenses 1,950 munotes.in

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Financial Management

80 Legal Charges 5,200 Directors Fees 11,440 Carriage outward 12,220 1,24,020 (2) Selling & Distribution Sales salaries 39,780 Salesmen's traveling exp 5,200 44,980 (3) Finance Expenses Interest 3,120 Discount 6,240 Bad Debts 8,840 18,200 (1,87,200) Operating Net profit 3,32,800 Add: Non operating Income Interest on d ebenture 3,900 Dividend on shares 15,860 Profit on sale of shares 10,140 29,900 3,62,700 Less: Non operating expenses Loss in sale of Bonds 9,100 Provision for Claim for Damages 10,400 (19,500) Net profit before ta x 3,43,200 Less: taxation (1,24,800) Net profit after tax 2,18,400
Illustration 03:
The following information regarding Speed Car Ltd, for the year ended 31
March, 2020 is given to you
Particulars Amount Rs.
Sales 37,50,000 Purchases 25,00,000 Opening Stock (1 -4-2014) 2,50,000 Closing Stock (31 -3-2015) 3,75,000 Return Inward 37,500 Carriage Outward 28,500 Carriage Inward 25,000 Return Outward 25,000 Salesman Salary 37,500 Advertising and Publicity 1,26,000 munotes.in

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Analysis of Financial
Statements
81 Salesman Traveling All owance 3,750 Office Salary 2,00,000 Computer Repairs & Maintenance 42,000 Rent, Rates, Taxes 2,000 Printing & Stationery 200 Bad Debts 37,875 Purchases of Computer 20,000 Dividend on Shares (Cr.) 5,000 Staff Welfare Expenses 22,000 Interest (Dr.) 25,000 Loss on Sales of Shares 62,500 Rearrange above information in Vertical Form suitable for analysis.
Solution 03:
Vertical Revenue Statement for the year ending 31st March, 2015
Particulars Amount Amount
Gross Sales 37,50,000 Less: Return Inwar d (37,500) Net Sales 37,12,500 Less: Cost of Goods Sold Opening Stock 2,50,000 Purchases 25,00,000 Less: Return Outward (25,000) Carriage Inward 25,000 Less: Closing Stock (3,75,000) (23,75,000) Gross Profit 13,37,500 Less: Operating Expenses Administration Expenses Office salaries 2,00,000 Rent, rates and taxes 2,000 Staff Welfare 22,000 Printing & Stationery 200 Computer Repairs & Maintenance 42,000 2,66,200 Selling & Distribution Expenses Salaries to salesmen 37,500 munotes.in

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Financial Management

82 Advertisement and Publicity 1,26,000 Traveling Allowances 3,750 Carriage Outward 28,500 Bad Debts 37,875 2,33,625 Total Operating Expenses (4,99,825) Operating Profit before Interest 8,37,675 Less: Inte rest Paid (25,000) Net Profit after Interest 8,12,675 Net Non -operating Income Dividends on shares 5,000 Less: Non -Operating Expenses Loss on Sale -Shares (62,500) Net Non -Operating Income (57,500) Net Profit 7,55,175
Illustr ation 04
Balance sheet of Tanu Ltd. For the year ended 31st March 2020.
(` in '000)
Liabilities Amount Assets Amount 4,200 Trade Investments 1,680 Dividend Equilisation
Reserve 588 Patent 252 General Reserve 924 Land and Building (Cost) 2,688 Profit and Loss Account 1,596 Plant and Machinery (Cost) 5,460 6% Debentures 2,100 Cash and Bank Balance 739 Cash Credit 1,260 Closing Stock 2,604 Sundry Creditors 1,764 Sundry Debtors 1,865 Unpaid Dividend 84 Bills Receivable 252 Bills Payable 504 Short Term Deposit with
Customers 252 Provision for Tax 1,428 Underwriting Commission 504 Provision for Depreciation Preliminary Expenses 252 Land and Building 420 Plant and Machinery 1,680 16,548 16,548 munotes.in

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Analysis of Financial
Statements
83 Solution 04:
Vertical Balance sheet of Tanu Ltd. For the year ended 31st March 2020.
(` in ‘000)
Particulars Amount Amount Amount
SOURCES OF
FUND/EQUITY AND
LIABILITY 1 Shareholders’ Funds Equity Share Capital 4,200 Reserves & Surplus Dividend Equalisation Reser ve 588 General Reserve 924 P & LA/ c 1,596 3,108 Less: Fictitious Assets Underwriting Commission 504 Preliminary Expenses 252 (756) Networth 6,552 2 Loan Funds Secured Loans 6% Debenture s 2,100 Total Sources of Funds 8,652 APPLICATION OF FUNDS/
ASSETS 3 Fixed Assets Tangible Fixed Assets Land & Building 2,688 Less Provision for Depreciation (420) 2,268 Plant & Machinery 5,460 Less Provision for Depreciation (1,680) 3,780 Total Tangible Assets 6,048 Intangible Fixed Assets Patents 252 Total Fixed Assets 6,300 4 INVESTMENTS Trade Investments 1,680 munotes.in

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Financial Management

84 5 CURRENT ASSETS, LO ANS
& ADVANCES Closing Stock 2,604 Liquid Assets Sundry Debtors 1,865 Cash & Bank 739 Bills Receivable 252 Short Term Deposits 252 Total Current Assets 5,712 Less: CURRENT
LIABILITIES &
PROVI SIONS Cash Credit 1,260 Quick Liabilities Sundry Creditors 1,764 Unpaid Dividend 84 Bills Payable 504 Provision for Tax 1,428 Total Current Liabilities (5,040) Working Capital 672 Tota l Application of Funds 8,652
Illustration 05
The following balances appear in the books of M/s. Krushna & Sons. As
on 31st March, 2020. You are required to prepare a Vertical Balance Sheet
for financial analysis.
Particulars Amount (Rs.)
Provision for Income Tax 26,000 Advance Tax 29,250 Marketable Investments 16,250 Profit & Loss Account - Credit Balance 26,000 Equity Share Capital 1,30,000 Bank Overdraft 29,250 Loan from Bank 56,875 Machinery 84,500 munotes.in

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Analysis of Financial
Statements
85 Preliminary Expenses 4,875 Sundry Debto rs 29,250 General Reserve 22,750 Sundry Creditors 13,000 Stock 48,750 Building at Cost Less Depreciation 65,000 Cash and Bank 26,000
Solution 05:
in the books of M/s. Krushna & Sons Balance Sheet as at 31st March,
2014
Particulars Amount Amount Amo unt
A Sources of Funds Shareholders Funds Share Capital Equity Share Capital 1,30,000 (+) Reserves & Surplus Profit & Loss A/c 26,000 General Reserve 22,750 48,750 (-) Fictitious Assets Preliminary Expenses (4,875) Networth 1,73,875 B Borrowed Funds Loan from Bank 56,875 Net Borrowings 2,30,750 Application of Funds C Fixed Assets Building (Less :
Depreciation) 65,000 Machinery 84,500 1,49,500 D Investments NIL E Working Capital Current Assets Advance Tax 29,250 Marketable Investments 16,250 Sundry Debtors 29,250 Stock 48,750 Cash at Bank 26,000 munotes.in

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Financial Management

86 Total Current Asse ts (A) 1,49,500 Less : Current Liabilities Provision for Income
Tax 26,000 Bank Overdraft 29,250 Sundry Creditors 13,000 Total Current Liability
(B) (68,250) Working Capital (A -B) 81,250 Total 2,30,750
Illustration 06
Following are the balances in the books of Hattrick Ltd., for the year
ended 31st March,2020.
Particulars Amount Rs.
11% Preference Share Capital 7,50,000 Administrative Expenses 4,50,000 Cash and Bank 37,500 Marketable Investm ents 3,00,000 Depreciation 2,62,500 Direct Labour 2,81,250 Equity Share Capital 11,25,000 Fixed Assets 52,50,000 Income Tax 6,63,750 Interest Paid 5,40,000 Inventories 22,50,000 Long Term Investments 1,50,000 Other Current Liabilities 75,000 Othe r Direct Expenses 1,80,000 Provision for Expenses 2,43,750 Raw Materials Consumed 29,25,000 Reserves and Surplus 2,62,500 Sales 60,00,000 Secured Term Loans 45,00,000 Selling Expenses 97,500 Trade Payables 12,56,250 Trade Receivables 13,87,500 Unsecured Term Loans 5,62,500 munotes.in

Page 87

Analysis of Financial
Statements
87 You are required to prepare vertical Income Statement for the year ended
31st March, 2020 and vertical Balance Sheet as on that date for analysis.
Solution 06:
Hattrick Ltd. Vertical Income Statement for the year ended 31st Marc h
2020
Particulars Amount Amount
Sales 60,00,000 60,00,000 Less: Cost of Goods Sold
a) Raw Material Consumed 29,25,000
b) Other Direct Expenses 1,80,000
c) Direct Labour 2,81,250
Cost of Goods S old (33,86,250) Gross Profit 26,13,750 Less: Operating Expenses
a) Administration Expenses 4,50,000
b) Depreciations 2,62,500
c) Selling Expenses 97,500
Total Operating Expenses (8,10,000) Operating Profit Before Interest 18,03,750 Less: Interest - Net Profit before tax 18,03,750 Less: Income Tax - Net Profit After Tax 18,03,750




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Financial Management

88 Particulars Amount Amount
SOURCES OF FUND/EQUITY
AND LIABILITY
1 Shareholders Funds
Equity Share Capital 11,25,000
11% Prof. Share Capital 7,50,000 18,75,000 Add : Reserve Supluses 2,62,500 P/LA/c (N.P.) 6,00,000 Share Holders Fund 27,37,500 2 Loan Funds
a) Secured Terms Loan 45,00,000
b) Unsecured Term Loan 5,62,500 50,62,500 Total Sources of Funds 78,00,000 APPLICA TION OF FUNDS/
ASSETS
I. Fixed Assets 52,50,000 II. Investment 1,50,000 III. Working Capital
A Current Assets
Cash and Bank 37,500
Marketable Investment 3,00,000
Inventories 22,50,000
Trade Receivable 13,87,500 39,75,000 B. Less : Current Liabilities
Other Current Liabilities 75,000
Provision for Expenses 2,43,750
Trade Payables 12,56,250 (15,75,000) Working Capital (A - B) 24,00,000 Total Application of Funds 78,00,000



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Analysis of Financial
Statements
89 Illustration 07 (Adjustment based sum)
The following figures are related to the Sara Ltd. for the year ended 31st
March, 2020.
Particulars Amount Particulars Amount
Sales 14,40,000 Staff Salaries 24,000 Net Block 6,00,000 Advertisement Expenses 36,000 Bills Receivable 2,40,000 Warehouse Rent 18,000 Bills Payable 1,20,000 Depreciation on Plant 30,000 Cash Balance 51,000 Interest on Overdraft 18,000 Bank Overdraft 1,20,000 Share Capital 4,80,000 Purchases 10,80,000 Reserves (1 -04-2017) 2,19,000 Other
Administrative
Exp. 24,000 Stock (1 -04-2017) 2,16,000 Legal Charges
(Paid) 18,000 Lap Top Repairs 15,000 Direct Expenses 9,000
Other Information:
i) Make a provision for Income Tax of ` 1,44,000.
ii) Provide final dividend ` 48,000.
iii) Closing stock on 31st March, 2020 is ` 2,40,000.
You are required to prepare Balance Sheet and Income Statement in
vertical form suitable for analysis for the year ended 31" March, 2020.






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Financial Management

90 Solution 07:
Sara Ltd. Vertical Income Statement for the year ended 31st March 2020
Particulars Amount Amount
Sales 14,40,000 Less: Cost of Goods Sold Opening Stock 2,16,000 Add: Purchases 10,80,000 12,96,000 Less: Closing Stock (2,40,000) 10,56,000 Direct Expenses 9,000 Depreciation on Plant 30,000 Cost of Goods Sold (10,95,000) Gross Profit 3,45,000 Less: Administrative Expenses Legal Charges 18,000 Staff Salaries 24,000 Lap Top Repairs 15,000 Other Administrative Expenses 24,000 81,000 Less: Selling and Distribution Expenses Advertising 36,000 Warehouse Rent 18,000 54,000 Total Operating Expenses (1,35,000) Net Profit before Interest 2,10,000 Less: Interest on Overdraft (18,000) Net Profit before Tax 1,92,000 Less: Income Tax (1,44,000) Net Profit after Tax 48,000



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Analysis of Financial
Statements
91 Vertical Balance Sheet as on 31st March 2020
Particulars Amount Amount SOURCES OF FUND/EQUITY AND LIABILITY 1. Shareholders Funds Share Capital 4,80,000 Add: Reserve &Surpluses 2,19,0 00 6,99,000 Total Sources of Fund 6,99,000 APPLICATION OF FUNDS/ ASSETS I. Fixed Assets Net Block 6,00,000 A. Current Assets Bill Receivable 2,40,000 Closing Stock 2,40,000 Cash 51,000 5,31,000 B. Less: Current Liabilities Bills P ayable 1,20,000 Bank Overdraft 1,20,000 Provision for Tax 1,44,000 Bills Payable 48,000 (4,32,000) Net Current Assets (A - B) 99,000 Total Application of Funds 6,99,000 Note: Contingent liability
Proposed dividend ` 48,000
Illustration 08:
From the following balances from the books of Account of Chika Ltd. for
the year ended 31 -03-2020 you are required to prepare vertical Income
statement and vertical Balance Sheet.
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Financial Management

92 Particulars Amount Particulars Amount Advertising 31,250 Sales Return 12,50 0 Interest Received 7,500 Bills Payable 53,750 Sales 15,00,000 10% Pref. Share Capital 1,87,500 Equity Share Capital 11,25,000 Debenture Interest 30,000 Salaries 2,25,000 Wages 2,31,250 Furniture and Fixture 2,50,000 Cash and Bank Balance 1,00,000 Outstanding Expenses 31,250 Debtors 2,50,000 P/LA/c (Credit Balance) 4,86,250 Opening Stock 62,500 Bad Debts 6,250 General Reserve 63,750 Purchases 7,50,000 Creditors 1,25,000 Machinery 9,37,500 8% Debentures 5,00,000 Preliminary Expenses 12,500 Income Tax 12,500 Closing Stock on 31 -03-
2020 1,87,500 Land & Building 8,75,000
Solution 08
Vertical Income Statement for the year ended 31st March, 2020
Particulars Amount Amount
Sales 15,00,000 Less: Returns (12,500) Net Sales 14,87,500 Less: Cost of Goods Sold Opening Stock 62,500 Purchases 7,50,000 Wages 2,31,250 Less: Closing Stock (1,87,500) 8,56,250 GROSS PROFIT 6,31,250 Less: OPERATING EXPENSES a) Administration Expenses Salaries 2,25,000 b) Selling & Distribution Expenses Advertising 31,250 Bad Debts 6,250 37,500 Total Operating Expenses (2,62,500) Operating Profit Before Interest 3,68,750 Less: Interest on Debentures (WN) (40,000) munotes.in

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Analysis of Financial
Statements
93 Net Profit After Interest 3,28,750 Add: Non -operating Income Interest recei ved 7,500 Net Profit Before Tax 3,36,250 Less: Income Tax (12,500) Net Profit After Tax 3,23,750
Vertical Balance Sheet as on 31st March 2020
Particulars Amount Amount
SOURCES OF FUND/EQUITY AND
LIABILITY 1 Shareholders Funds A Share Ca pital Equity Share Capital 11,25,000 10% Pref. Share Capital 1,87,500 13,12,500 B Reserve & Surplus General Reserve 63,750 Profit & Loss A/c - Cr. Balance 4,86,250 5,50,000 C Less: Fictitious Assets Preliminary E xpenses (12,500) Own Fund/Net Worth 18,50,000 2 Loan Funds 8% Debentures 5,00,000 Add: Interest Accrued 40,000 5,40,000 Total Sources of Funds 23,90,000 APPLICATION OF FUNDS 1 Fixed Assets Tangible Assets Land & Buildings 8,75,000 Machinery 9,37,500 Furniture & Fixtures 2,50,000 20,62,500 2 Working Capital A) Current Assets a) Quick Assets Cash and Bank 1,00,000 munotes.in

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Financial Management

94 Debtors 2,50,000 b) Non -Quick Assets Inventory 1,87, 500 Total Current Assets (A) 5,37,500 B. Less: Current Liabilities a) Quick Liabilities Creditors 1,25,000 Bills Payable 53,750 Outstanding Expenses 31,250 Quick / Current Liabilities (2,10,000) Working Capital (A - B) 3,27,500 Total 23,90,000 W.N. 1.
Interest on Debentures: 5,00,000 x 8% = 40,000
Illustration 09:
The following balances are extracted from the financial statements of
Nano Products Ltd.
Balances as on 31st March, 2020
Particulars Amount Particul ars Amount
Bank Loan 4,00,000 Preliminary Expenses
(Not yet w/0) 50,000 9% Preference Share Capital
(R 100) 10,00,000 Stock (Closing) 8,00,000 Investments 5,00,000 10% Debentures 10,00,000 Trade Receivables 8,00,000 Bills Payable 2,00,000 Trad e Payables 6,00,000 Land and Building 20,00,000 Goodwill 5,00,000 Equity Share Capital (R
10 each) 20,00,000 Bills Receivable 5,50,000 Bank Overdraft 1,00,000 Plant and Machinery 12,00,000 Cash and Bank Balance 1,50,000 Profit and Loss A/c (Cr. ) 8,00,000 Furniture 8,00,000 Unclaimed Dividend 40,000 General Reserve 8,50,000 Prepaid Expenses 1,00,000 Advance Tax 4,00,000 Provision for Taxation 6,60,000 Cash Credit 2,00,000
You are required to prepare Balance Sheet in vertical form sui table for
analysis. munotes.in

Page 95

Analysis of Financial
Statements
95 Vertical Balance Sheet of Nano Products Ltd.
Particulars Amount Amount Amount
SOURCES OF FUNDS 1 Owner's Funds A. Capital Equity Share Capital (R 10 each) 20,00,000 9% Preference Share Capital (R
100) 10,00,00 0 30,00,000 B. Reserves and Surplus General Reserve 8,50,000 Profit and Loss A/c (Cr.) 8,00,000 16,50,000 Less : Preliminary Expenses (not
w/o) (50,000) Own Funds or Net Worth 46,00,000 II Loan Funds 10% Debentures 10,00,000 Bank Loan 4,00,000 14,00,000 Capital Employed [1 + 2] 60,00,000 APPLICATION OF FUNDS I Fixed Assets A Tangible Land and building 20,00,000 Plant and Machinery 12,00,000 Furniture 8,00,000 Net Ta ngible Assets 40,00,000 B. Intangible Goodwill 5,00,000 45,00,000 Total Fixed Assets II Investments 5,00,000 III Working Capital A Current Assets Quick Assets Cash and Bank 1,50,000 Trade Receivables 8,00,000 Bills Receivable 5,50,000 Total Liquid Assets 15,00,000 Non-Quick Assets Stock (closing) 8,00,000 Prepaid expenses 1,00,000 munotes.in

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Financial Management

96 Advance tax 4,00,000 Total Illiquid Assets 13,00,000 Total Current Assets (A) 28,00,000 B. Less: Current Liabilities Quick Liabilities Trade Payables 6,00,000 Bills Payable 2,00,000 Provision for Taxation 6,60,000 Unclaimed Dividend 40,000 Total Quick Liabilities 15,00,000 Non-Quick Liabilities Bank Overdraft 1,00,000 Cash Credit 2,00,000 Total Non -Quick Liabilities 3,00,000 Total Current Liabilities (B) (18,00,000) Working Capital (A - B) 10,00,000 Capital Employed [1 + 2] 60,00,000
Illus tration 10:
Balances as on 31st March, 2020
Liabilities Amount Assets Amount
Bills Payable 32,500 Fixed Assets 1,62,500 Sundry Creditors 65,000 Sundry Debtors 65,000 Debentures 1,30,000 Bank Balance 32,500 Reserves 65,000 Inventory 1,62,500 Equity Sha re Capital 65,000 Preference Share Capital 65,000 4,22,500 4,22,500





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Page 97

Analysis of Financial
Statements
97 Profit and Loss A/c for the year ended 31 -3-2020
Particulars Amount Particulars Amount To Opening Inventories 97,500 By Sales 6,50,000 To Purchases 1,95,000 By Closing In ventories 1,62,500 To Manufacturing Expenses 65,000 By Profit on Sale of Shares 32,500 To Direct Wages 1,30,000 To Administration Expenses 32,500 To Selling Expenses 32,500 To Loss on Sale of Asset 35,750 To Interest on Debentures 6,500 To Net Profit 2,50,250 8,45,000 8,45,000
Solution 10:
In the Books of Srivalli Ltd.
Vertical Income Statement for the Year Ended on 31 -3-2020
Particulars Amount Amount Amount
1 Net Sales 6,50,000 2 Less: Cost of Goods Sold : Opening Sto ck 97,500 Add : Purchases 1,95,000 Manufacturing Expenses 65,000 Direct Wages 1,30,000 Less : Closing Stock (1,62,500) Cost of Goods Sold (3,25,000) Gross Profit (1 - 2) 3,25,000 3 Less : Operating Expenses Administration Expenses 32,500 Selling and Distribution Expenses 32,500 (65,000) 4 Operating Profit 2,60,000 5 Less : Interest Paid Interest on Debentures (6,500) 6 Net Profit After Interest 2,53,500 munotes.in

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Financial Management

98 7 Add: Non -operating Income Profit on Sale of Shares 32,500 8 Less: Non -operating Expenses Loss on Sale of Asset (35,750) 9 Net Profit befor Tax 2,50,250
Balance Sheet as on 31st March, 2020
Particulars Amount Amount Amount
SOURCES OF FUNDS 1 Owner's Funds A Capital Equity Share Capital 65,000 Preference Share Capital 65,000 1,30,000 B Reserves and Surplus General Reserve 65,000 Own Funds / Net Worth 1,95,000 2 Loan Funds Debentu res or Bonds 1,30,000 Capital Employed 3,25,000 APPLICATION OF FUNDS 1 Fixed Assets 1,62,500 2 Working Capital A Current Assets Cash and Bank 32,500 Debtors 65,000 Quick Assets 97,500 Stock 1,62, 500 Total Current Assets (A) 2,60,000 B Less : Current Liabilities Creditors 65,000 Bills Payable 32,500 Total Current/Quick Liabilities (B) (97,500) Working Capital (A - B) 1,62,500 Capital Employed 3,25,00 0

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Page 99

Analysis of Financial
Statements
99 Exercise:
True and False
1. Balance sheet shows result of activities F
2. Subscribed capital is the capital subscribed by the investors. T
3. Goodwill is shown under fictitious assets. F
4. Working capital is equal to capital employed. F
5. All curr ent liabilities are quick liabilities. T
6. Fictitious assets can be converted in cash. F
7. For a petrol company, stock of petrol is liquid asset. F
8. Owed funds comes under internal source of Finance. T
9. Unclaimed Dividends are classified as Quick lia bilities in vertical
financial statements. F
10. Advance to suppliers for stock classified as current assets in vertical
statements. T
SHORT NOTES
1. Financial statement’s objectives
2. Users of financial statements
3. Own funds
4. Quick liabilities
5. Working capital
6. Limitations of financial statements
7. Cost of goods sold
8. Operating expenses.
9. Operating profit





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Financial Management

100 Unsolved Illustration
Problem 01:
Following Trial Balance was extracted from the books of M/s. Aisha Pvt.
Limited for the year ended 31st Dec 2020.
Particulars Amount Particulars Amount
Land and Building 1,35,000 Sundry Creditors 45,900 Plant and Machinery 2,48,400 Reserves 22,500 Furniture and fittings 5,400 Profit and Loss A/c -
1/1/2020 37,950 Preliminary Expenses 7,350 Creditors for goods 16,770 Calls in Arrears (20per
share) 3,750 Return Outwards 7,500 Cash in hand 750 Sales 4,61,700 10% Govt. bonds
(F.V.10,000) 14,820 Share Capital 3,00,000 Bills Receivable 34,500 8% Debentures 1,50,000 Delivery Van 4,500 Goodwill 24,00 0 Sundry Debtors 31,200 Purchases 3,60,000 Free sample distributed 3,810 Sales return 10,500 Legal Fees 1,500 Carriage Inwards 5,550 Wages 34,800 Rent Rates and Insurance 4,350 Stock 71,400 Prepaid Expenses 4,200 Require to Furniture 2,250 Repairs to plant and
Machinery 1,290 Inteim Dividend Paid 30,000 Salaries 3,000 10,42,320 10,42,320
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Analysis of Financial
Statements
101 Additional Notes:
You are requied to prepare Profit and Loss A/c and the Balance Sheet in
Vertical Format as per Managemen t Accounting after taking into
consideration the following statements.
(1) Charge 5% depreciation on Plant and Machinery, 7.5% on Furniture
and Fittings and 20% on delivery van.
(2) Closing Stock was Rs.81,300 as on 31st March,2020
(3) The directors have p roposed a final dividend of 6% on paid up share
capital.
(4) Interest on Govt. Bonds and Debentures in due for the year 2020.
Problem 02:
Following information regarding M/s. Savita Ltd. for the year ended 31st
March, 2020 is given.
Particular Amount Parti cular Amount
Sales 15,00,000 Return Inwards 37,500 Opening stock of Raw
material 82,500 Purchases of Raw
material 3,75,000 Staff Salaries 1,12,500 Commission
Allowed 3,750 Salesmen Salaries 18,750 Proposed Dividend 1,12,500 Bank Charges 7,500 Exhibit ion
Expenses 26,250 Freight Inwards 30,000 Repairs of
Computer 3,750 Office Rent & Insurance 33,750 Closing stock of
work -in-progress 30,000 Debenture Interest 37,500 Wages 52,500 Loss on sale of
machinery 7,500 Purchases of
Finished goods 60,000 Printing & Stationery 3,750 Interest received on
Investment 30,000 Direct Expenses 37,500 Provision for
Income Tax 1,50,000 Profit & Loss A/c
(Credit) 1,80,000 Closing stock of
Raw Material 60,000 Depreciation on patterns 7,500 Sale of scrap 15,000 Depre ciation on
machinery 15,000 You are required to Rearrange the above information and prepare vertical
income statement, suitable for analysis. munotes.in

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Financial Management

102 Problem 03:
The following balances appear in the books of M/s. Bhavana Ltd. for the
year ended 31st March, 2020, you are required to prepare a Revenue
statement in vertical form
Dr. Cr.
Particular Amount Particular Amount
Opening Stock 1,06,250 Sales Return 42,500 Net Profit b/f from P.Y. 1,27,500 Profit on Sale of Investment 10,625 Office Rent 10,625 Loss by Fire 10,625 Carriage Inward 42,500 Closing Stock 85,000 General Reserve 85,000 Purchases 4,25,000 Wages 1,53,000 Postage and Telegram 10,625 Octroi 10,625 Provision for Tax 63,750 Office Staff Salaries 85,000 Sales 13,17,500 Audit Fees 42,500 Dividend on Shares Held 53,125 Advertisement 53,125 Carriage Outward 10,625 Finance Expenses 53,125 Warehouse Expenses 10,625 Loss on Sale of Asset 63,750 Import Duty 6,375 Depreciation on: Proposed Dividend 74,375 Plant and Machinery 31,875 Furniture 34,000 Delivery Van 29,750






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Analysis of Financial
Statements
103 Problem 04:
Following is the Profit and Loss Account of Gehna Limited for the year
ended 31st March, 2011.
Particular ` ` Particular ` `
To Opening Stock 7,91,000 By Sales To Purchase 10,17,000 Cash 5,87,600 To Wages 1,69,500 Credit 16,95,000 To Factory Expenses 3,95,500 22,82,600 To Office Salaries
28,250 Less: Returns &
Allowance (22,600) 22,60,000
To Office Rent 44,070 To Postage & Telegram 5,650 To Directors Fees 6,780 By Closing Stock 6,78,000
To Salesman Salaries
13,560 By Dividend on
Investment 11,300
To Advertising
20,340 By Profit on sale
of Furniture 22,600
To Delivery Expenses 22,600 To Debenture Interest 22,600 To Deprec iation On Office Furniture 11,300 On Plant 33,900 On Delivery Van 22,600 67,800 To Loss on Sale of Van 5,650 To Income Tax 1,97,750 To Net Profit 1,63,850 29,71,900 29,71,900

You are required to prepare Vertical Inc ome Statement for purpose of
analysis.
Problem 05:
The following balances are extracted from the financial statements of
Sameer Products Ltd.
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Financial Management

104
Balance Sheet as on 31st March, 2020
Liabilities Amount Assets Amount Bank Loan 1,50,000 Preliminary Expenses 18,750 (10% preference Share) (Net yet written off) Capital (R 100) 3,75,000 Stock (closing) 3,00,000 Investments 1,87,500 10% Debentures 3,75,000 Trade Receivables 3,00,000 Bills Payable 75,000 Trade Payables 2,25,000 Land & Building 7,50,000 Goodw ill 1,87,500 Equity Share Capital « 10 each) 7,50,000 Bills Receivable 2,06,250 Bank Overdraft 1,12,500 Plant & Machinery 4,50,000 Cash & Bank Balance 56,250 Profit & Loss A/c (Cr.) 3,00,000 Furniture 3,00,000 Unclaimed Dividend 15,000 General Reserve 3,18,750 Prepaid Expenses 37,500 Advance Tax 1,50,000 Provision for Taxation 1,72,500 Proposed Dividend 75,000
You are required to Prepare Balance Sheet in vertical form suitable for
analysis.
Problem 06:
From the information given below prepare a Bala nce Sheet in a vertical
form suitable for analysis.
Particulars Amount ( `) Current Account with IDFC Bank 60,000 Land and Building 9,60,000 Advance Payments 74,400 Stock 3,27,600 Creditors 4,87,200 Debtors 6,27,600 Bills Receivable 25,200 Plant and Machinery 6,52,800 8% Debentures 3,00,000 Loan from a Director 62,400 Equity Share Capital 12,00,000 Profit and Loss Account 2,60,400 Trade Investments 24,000 Proposed Dividend 1,03,200 munotes.in

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Analysis of Financial
Statements
105 Advance Tax 1,20,000 Provision for Taxation 3,16,800 Bills P ayable 21,600 General Reserve 1,20,000
Problem 07:
The balance sheet of Diana Ltd. is given for the year 2020. Convert them
into vertical balance sheet.
Balance Sheet as on 31st March, 2004
Liabilities Amount Assets Amount
Equity Shares 4,39,300 Buildi ng 4,60,000 Capital Reserve 1,61,000 Plant and Machinery 1,26,500 Revenue Reserve and
Surplus 69,000 Furniture 46,000 Trade Creditors 92,000 Freehold Property 27,600 Bills Payable 1,38,000 Goodwill 69,000 Bank Overdraft 1,84,000 Cash Balance 46,000 Provisions 46,000 Sundry Debtors 80,500 Inventories 1,31,100 Investment
(Temporary) 96,600 Bills Receivable 46,000 11,29,300 11,29,300








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106 Problem 08:
Following is the Trial balance of M/s. Vanraj Ltd. as on 31" March, 2020.
Trial Balance
Particulars Amount ( `) Amount ( `) Sales - 2,40,000 Fixed Assets 1,20,000 - Bills Receivable & Bills Payable 24,000 18,000 Cash and Bank Balance 6,000 - Opening Stock 12,000 - Bank overdraft - 12,000 Purchases 1,50,000 - Administrative Expenses 3,600 - Legal Expenses 2,400 - Salaries 6,000 - Advertisement 4,800 - Warehouse Rent 2,400 - Depreciation on machinery 6,000 - Interest on Bank overdraft 1,200 - Equity share capital - 72,000 General Reserve - 12,000 Lap Top Repairs 2,400 - Direct E xpenses 2,400 - Investment 4,800 - Debtors and creditors 12,000 6,000 Total 3,60,000 3,60,000
Additional Information:
Closing stock on 31st March 2020 was valued at Rs.6,000
Cash sales were 1/3 of credit sales.
You are required to prepare vertical inc ome statement for the year ended
31st March 2020 and
Vertical balance sheet as on that date for financial analysis.
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107 Problem 09:
From the following Trial Balance of Urmila Ltd. as on 31st March, 2020.
Particulars Amount Rs. Amount Rs. Equity Share Capital - 25,74,000 Plant and Machinery 28,08,000 - Sales - 86,58,000 Purchases 39,78,000 - Sundry Debtors 21,06,000 - Sundry Creditors - 19,89,000 Wages 8,19,000 - Opening Stock 2,80,800 - Salaries 4,21,200 - Advertisement 1,75,500 - Telephone Charges 81,900 - Furniture 4,68,000 - Investment (Long Term) 11,70,000 - Interest Received - 93,600 Loss on Sale of Furniture 46,800 - Commission 1,40,400 - Profit and Loss A/c - 2,80,800 Interim Dividend 1,17,000 - General Reserve - 2,34,000 Cash At Bank 7,48,800 - Bills Receivable 4,68,000 - 1,38,29,400 1,38,29,400 Prepare vertical Revenue statement for the year ended 31st March, 2020
and vertical Balance sheet as on that date after making the necessary
adjustments.

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108 3
COMPARATIVE STATEMENTS,
COMMON SIZE STATEMENTS & TREND
ANALYSIS COMPARATIVE BALANCE
SHEET
Unit Structure
3.0 Learning Objectives
3.1 Introduction to Comparative Statement
3.0 LEARNING OBJECTIVES
After studying this unit, the learners will be able to:
 Analyses the financial statements.
 Understand the limitations of financial statements.
 Solve the practical problems of analyses.
3.1 INTRODUCTION TO COMPARATIVE
STATEMENT
A comparative balance sheet is a statement that shows the financial
position of an or ganization over different periods for which comparison is
made or required. The financial position is compared with 2 or more
periods to portray the trend, direction of change, analyse and take suitable
actions.
Advantages of Comparative Balance Sheet
1. Easy Comparison – It is easy to compare the figures for the current
year with the previous years as it gives both the years’ figures in one
place. It also help in analysing the data of two or more companies or
subsidiaries of one company.
2. Indicates Trend – It shows the company’s trend by putting several
years’ financial figures at one place like an Increase or decrease in current
assets, current liabilities, profit, loans, reserves & surplus, or any other
items that help investors make decision.
3. Ratio Analysis – Financial ratio is obtained from the balance sheet
items. The comparative balance sheet’s financial ratio of two years of two
companies can be derived to analyse the company’s financial status. For
example, the current ratio is obtained with the help of current assets and
current liabilities. If the current ratio of the current year is more than the
last year, it shows the company’s liabilities have been reduced from last
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Comparative Statements,
Common Size Statements & Trend Analysis Comparative Balance Sheet
109 4. Comparison with Industry Performance – Helps to compare one
company’s performance with another company or the industry’s average
performance.
5. Helps in Forecasting – It also helps in forecasting because it provides
the past trend of the company based on which the management can
forecast the company’s financial position.
Limitation/Disadvantages
1.Uniformity in Principles and Policy – If two companies have adopted
different policies and accounting principles while preparing the balance
sheet ,Comparative balance sheet will not give the correct comparison.
2. Inflationary Effect is not Considered – The inflation effect is not
considered, while preparing the comparative balance sheet. Therefore,
only a comparison with other balance sheets will not give the correct
picture of the company’s trend.
3. Market Situation and Political Conditions not Considered – While
preparing the comparative balance sheet, marketing conditions, political
environment, or any factor affecting the company’s business are not
considered. Therefore, it does not give the co rrect picture every time. For
example, suppose the overall economy is going down in the current year,
or the political condition is unstable compared to last year. In that case, it
will decrease the demand, and general company sales will experience de -
grow th, not because of its performance but due to external factors.
4. Misleading Information – Sometimes, it gives misleading information,
thus, misguiding the person who reads the comparative balance sheet.
Illustration 01: Following is the Balance Sheet of M/s Rohan Ltd.
Liabilities 2019 ` 2020 ` Assets 2019 ` 2020 `
Share Capital 5,55,000 5,85,000 Fixed Assets 5,70,000 5,25,000 Reserve and
Surplus 1,50,000 2,10,000 Investment 1,35,000 1,80,000 Current
Liabilities 1,50,000 1,98,600 Current
Asse ts 2,70,000 4,35,000 13 % Debentures 1,20,000 1,46,400
9,75,000 11,40,000 9,75,000 11,40,000
Prepare comparative balance sheet from the above in vertical form.


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110 Solution 01
In the books of M/s Rohan Ltd.
Comparative Balance Sheet
Particulars 2019 2020 Absolute
Increase/
Decrease %
Increase/
Decrease I SOURCES OF FUNDS 1. Owner's Funds Capital Equity Share Capital 5,55,000 5,85,000 30,000 5.41 Reserves and Surplus General Reserve 1,50,000 2,10,000 60,000 40.00 Own Funds or Net Worth 7,05,000 7,95,000 90,000 12.77 2. Loan Funds 13% Debentures 1,20,000 1,46,400 26,400 22.00 Capital Employed (1 + 2) 8,25,000 9,41,400 1,16,400 14.11 ll. APPLICATION OF FUNDS 1 Fixed Assets 5,70,000 5,25,000 (45,000) (7.89 ) 2 Investments 1,35,000 1,80,000 45,000 33.33 3 Working Capital A Current Assets 2,70,000 4,35,000 1,65,000 61.11 B Less: Current Liabilities 1,50,000 1,98,600 48,600 32.40 Working Capital (A - B) 1,20,000 2,36,400 1,16,400 97.00 Capital Employe d (1 + 2+3) 8,25,000 9,41,400 1,16,400 14.11







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Common Size Statements & Trend Analysis Comparative Balance Sheet
111 Illustration 02:
Following are the Balance Sheet of Helly Ltd. as on 31st March 2019 and
2020
Liabilities 2020 ` 2019 ` Assets 2020 ` 2019 `
Equity Share
Capital 1,68,000 1,68,000 Fixed As sets 2,16,000 1,92,000 11 % Preference
share capital 1,44,000 1,20,000 Investment 96,000 1,20,000 General Reserve 57,600 52,800 Current
Assets 76,800 1,36,800 10 % Debentures - 72,000 Prelim inary
Expenses 19,200 24,000 Current Liabilities 38,400 60,000 Total 4,08,000 4,72,800 Total 4,08,000 4,72,800
Solution 02:
Particulars 2019 2020 Absolute
Increase/
Decrease % Increase/
Decrease
I. SO URCES OF FUNDS 1. Shareholder's Fund (a) Equity Share Capital 1,68,000 1,68,000 - -
(b) 11% Preference Share Capital 1,20,000 1,44,000 24,000 20.00 2,88,000 3,12,000 24,000 8.33
(c) Reserve and Surplus: General Reserve 52,800 57,600 4,800 9.09
Owners Funds 3,40,800 3,69,600 28,800 8.45
Less: Preliminary Expenses 24,000 19,200 (4,800) (20.00)
Net Worth 3,16,800 3,50,400 33,600 10.61
2. Loan Fund (a) Secured Loans 10% Debenture 72,000 0 (72,000) (100.00)
TOTAL FUNDS AVAILABLE (A) 3,88,800 3,50,400 (38,400) (9.88)
B APPLICATION OF FUNDS: 1. Fixed Assets 1,92,000 2,16,000 24,000 12.50
2. Investments 1,20,000 96,000 (24,000) (20.00)
3. Working Capital 3,12,000 3,12,000 0 0
(i) Current Assets 1,36,800 76,800 (60,000) (43.86)
(ii) Current Liabilities 60,000 38,400 (21,600) (36.00)
Working Capital (i - ii) 76,800 38,400 (38,400) (50.00)
APPLICATION OF FUNDS (B)
(a + b + c) 3,88,800 3,50,400 (38,400) (9.88)
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112 Illustration 03:
Following are the Profit and Loss Accounts of M /s Pari Enterprises for the
years ended 31st
Profit & Loss Account for the year ended 31st March 2019 and 2020
Particular 2019 ` 2020 ` Particular 2019 ` 2020 `
To Cost of sales 2,70,000 4,05,000 By Sales 4,05,000 5,40,000 To Salaries 27,000 27,000 By In terest 13,500 27,000 To Office Rent 13,500 20,250 To Advertisement Expenses 40,500 16,200 To Travelling Expenses 20,250 40,500 To Income Tax 6,750 13,500 To Net Profit c/d 40,500 44,550 Total 4,18,500 5,67,000 Total 4,18,500 5,67,000 Prepare a comparative Income statement from the above, in vertical form.
Solution 03:
In the books of Helly Ltd.
Comparative Balance Sheet for the year ended:
Particulars 2019 2020 Absolute
Increase/
Decrease %
Increase/
Decrease I SOURCES OF FUNDS 1 Shareholder's Fund (a) Equity Share Capital 1,68,000 1,68,000 - - (b) 11% Preference Share
Capital 1,20,000 1,44,000 24,000 20.00 2,88,000 3,12,000 24,000 8.33 (c) Reserve and Surplus: General Reserve 52,800 57,600 4,800 9.09 Owners Funds 3,40,800 3,69,600 28,800 8.45 Less: Preliminary Expenses 24,000 19,200 (4,800) (20.00) Net Worth 3,16,800 3,50,400 33,600 10.61 2 Loan Fund (a) Secured Loans 10% Debenture 72,000 0 (72,000) (100.00) munotes.in

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Comparative Statements,
Common Size Statements & Trend Analysis Comparative Balance Sheet
113 TOTAL FUNDS
AVAILABLE (A) 3,88,800 3,50,400 (38,400) (9.88) B APPLICATION OF
FUNDS: (a) Fixed Assets 1,92,000 2,16,000 24,000 12.50 (b) Investments 1,20,000 96,000 (24,000) (20.00) (c) Working Capital 3,12,000 3,12,000 0 0 (i) Current Assets 1,36,800 76,800 (60,000) (43.86) (il) Current Li abilities 60,000 38,400 (21,600) (36.00) Working Capital (i - ii) 76,800 38,400 (38,400) (50.00) APPLICATION OF FUNDS
(B) (a + b + c) 3,88,800 3,50,400 (38,400) (9.88)
Illustration 04:
From the following Profit and Loss Account prepare a vertical
compa rative income statement of Ritesh Ltd.
Particular 2017 2018
Opening Stock of Raw Materials 1,60,000 2,40,000 Purchases 6,00,000 16,00,000 Wages 2,00,000 3,20,000 Factory Expenses 1,60,000 2,00,000 Closing Stock of Raw Materials 2,40,000 6,00,000 Salaries 20,000 24,000 Rent 16,000 20,000 Carriage Outward 24,000 20,000 Delivery Expenses 12,000 6,000 Advertisement Expenses 30,000 20,000 Interest Paid 2,000 6,000 Loss on Sale of Asset 26,000 20,000 Tax Paid 76,000 56,000 Sales 12,00,000 20,00,000 Interest Received on Investment 1,000 1,000 munotes.in

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114 Solution 04:
Comparative Vertical Profit & Loss Statement
Particulars as on 2017
` as on 2018
` Absolute
Increase/
Decrease %
Increase/
Decrease
1 Net Sales 12,00,000 20,00,000 8,00,000 66.67 2 Less: Cost of Goods
Sold Opening Stock 1,60,000 2,40,000 80,000 50.00 Purchases 6,00,000 16,00,000 10,00,000 166.67 Factory Expenses 1,60,000 2,00,000 40,000 25.00 Wages 2,00,000 3,20,000 1,20,000 60.00 Less: Closing Stock (2,40,000) (6,00,000) (3,60,000) 150.00 8,80,000 17,60,000 8,80,000 100.00 3 Gross Profit 3,20,000 2,40,000 (80,000) (25.00) 4 Operating Expenses I. Administration
Expenses Salaries 20,000 24,000 4,000 20.00 Rent 16,000 20,000 4,000 25.00 II. Selling and
Distribution Expenses Carriage Outward 24,000 20,000 (4,000) (16.67) Delivery Expenses 12,000 6,000 (6,000) (50.00) Advertisement Expenses 30,000 20,000 (10,000) (33.33) 5 Add: Operating
Expenses 1,02,000 90,000 (12,000) (11.76) 6 Profit Before Interest 2,18,000 1,50,0 00 (68,000) (31.19) 7 Less: Interest Paid 2,000 6,000 4,000 200.00 8 Net Profit After Interest 2,16,000 1,44,000 (72,000) (33.33) 9 Non -Operating Income Interest received on
Investments 1,000 1,000 - - 10 Less: Non -Operating
Expenses Loss on Sale of Asset 26,000 20,000 (6,000) (23.08) 11 Net Profit Before Tax 1,91,000 1,25,000 (66,000) (34.55) 12 Income Tax 76,000 56,000 (20,000) (26.32) 13 Profit After Tax 1,15,000 69,000 (46,000) (40.00)
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Comparative Statements,
Common Size Statements & Trend Analysis Comparative Balance Sheet
115 Illustration 05
CIRCLE and SQUARE are carrying o n partnership business. Their
position as on 31st March 2020 and 2019 is as follows:
(i) The Summarised Balance Sheet
Liabilities 2020 ` 2019 ` Assets 2020 ` 2019 `
Capital Accounts 1,21,975 1,01,150 Fixed Assets 89,250 74,375 Bank Loans 23,800 17,850 Investments 5,950 2,975 Sundry Creditors 65,450 59,500 Stock in Trade 35,700 29,750 Sundry
Debtors 53,550 44,625 Loans and
Advances 23,800 23,800 Cash and Bank 2,975 2,975 Total 2,11,225 1,78,500 Total 2,11,225 1,78,50
0
ii) Summarised Income Statement
Particulars 2020 ` 2019 `
Net Sales 71,400 65,450 Less: Cost of sales 53,550 50,575 Gross Margin 17,850 14,875 Operating Expenses 14,875 11,900 Net Profit before Tax 2,975 2,975






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116 Solution 05:
Comparative Balance Sheet
Particul ars as on
2019 ` as on 2020
` Absolute
Increase/
Decrease %
Increase/
Decrease I SOURCES OF
FUNDS 1 Owner's Funds 1,01,150 1,21,975 20,825 20.59 2 Loan Funds 17,850 23,800 5,950 33.33 Total Funds
Available (1 + 2) 1,19,000 1,45,775 26,775 22.50 II APPLICATION
OF FUNDS 1 Fixed Assets 74,375 89,250 14,875 20.00 2 Investments 2,975 5,950 2,975 100.00 3 Working Capital (A) Current Assets Stock 29,750 35,700 5,950 20.00 Debtors 44,625 53,550 8,925 20.00 Loans & Advances 23,800 23,800 - - Cash/Bank 2,975 2,975 - - (A) 1,01,150 1,16,025 14,875 14.71 (B) Less: Current
Liabilities Creditors 59,500 65,450 5,950 10.00 (B) 59,500 65,450 5,950 10.00 (A - B) 41,650 50,575 8,925 21.43 Total Funds
Employed (1 + 2 + 3) 1,19,000 1,45,775 26,775 22.50

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Comparative Statements,
Common Size Statements & Trend Analysis Comparative Balance Sheet
117 Comparative Income Statement
Particulars as on 2019
` as on 2020
` Absolute
Increase/
Decrease %
Increase/
Decrease 1 Sales 65,450 71,400 5,950 9.09 2 Less: Cost of Sales 50,575 53,550 2,975 5.88 3 Gross Profit (1 - 2) 14,875 17,850 2,975 20.00 4 Less: Operating
Expenses 11,900 14,875 2,975 25.00 5 Net Profit (3 - 4) 2,975 2,975 - -
Illustration 06:
Complete the following Comparative Statement of Barkha Products by
ascertaining the missing figures.
Particular Year Ended
31-03-16 ` Year Ended
31-03-17 ` Increase/
(Decrease) ` % Increase/
(Decrease)
Gross Profit ? ? ? ? Less: Expenses - Administrative 1,12,000 ? 22,400 20.00 - Selling 56,000 67,200 11,200 ? - Financial ? 28,000 5,600 25.00 Operating Net
Profit ? 2,24,000 1,12,000 100.00
Solution 06:
Comparative Statement of Barkha Product
Particular Year Ended
31-03-16 ` Year Ended
31-03-17` Increase/
(Decrease) ` % Increase/
(Decrease)
Gross Profit 3,02,4006 4,53,6005 1,51,2007 50.00 Less: Expenses - Administrative 1,12,000 1,34,4001 22,400 20.00 - Selling 56,000 67,200 11,200 20.002 - Financial 22,4003 28,000 5,600 25.00 Operating Net
Profit 1,12,0004 2,24,000 1,12,000 100.00 munotes.in

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118 Working Note:
1. 1,12,000 + 22,400 = 1,34,400
2. 11,200 ÷ 56,000 x 100 = 20.00
3. 5,600 ÷ 25% or 28,000 – 5,600 = 22,400
4. 1,12,000 ÷ 100% or 2,24,000 - 1,12,000 = 1,12,000
5. 2,24,000 + (1,34,400+67,200+28,000) = 4,53,600
6. 1,12,0004 + (1,12,000+56,000+22,400) = 3,02,400
7. 4,53,600 – 3,02,400 = 1,51,200
8. 1,51,200 ÷ 3,02,400 = 50.00%
Illustration 07:
Particula r 2019 ` 2020 ` Absolute Increase/ (Decrease) % Increase/ (Decrease)
Sales ? ? (+) 4,60,000 (+) 25.00% Cost of Goods Sold Opening Stock 92,000 1,38,000 ? ? Purchases ? ? (+) 2,30,000 (+) 20.00% Wages 2,76,000 5,06,000 ? ? Less: Closing Stock ? 1,84,000 ? ? Cost of Goods Sold ? ? ? ? Gross Profit (A - B) ? ? ? ? Operating Expenses (a) Administrative ? ? (+) 23,000 (+) 20.00% (b) Selling 57,500 69,000 - ? (c) Finance ? ? (+) 5,175 (+) 22.5% Total Operating Expenses ? ? ? ? Net Operating Profit (C - D) ? ? ? ? Add: Non -Operating Income 23,000 1,15,000 ? ? Net Profit Before Tax ? ? ? ? Less: Provision for Tax ? ? ? ? Net Profit After Tax 2,41,500 2,70,825 ? ?
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Comparative Statements,
Common Size Statements & Trend Analysis Comparative Balance Sheet
119 Solution 07:
Particulars 2019 ` 2020 ` Absolute
Increase/
(Decrease) % Incr ease/ (Decrease)
Sales 18,40,0001 23,00,0002 (+) 4,60,000 (+) 25% Cost of Goods Sold Opening Stock 92,000 1,38,000 46,0003 50.00%4 Purchases 11,50,0005 13,80,0006 (+) 2,30,000 (+) 20.00% Wages 2,76,000 5,06,000 2,30,0007 83.33%8 Less: Closing Sto ck 1,38,0009 1,84,000 46,00010 33.33%11 Cost of Goods Sold 13,80,000 18,40,000 4,60,000 33.33% Gross Profit (A - B) 4,60,000 4,60,000 - 0.00% Operating Expenses (a) Administrative 1,15,00012 1,38,00013 (+) 23,000 (+) 20.00% (b) Selling 57,500 69,000 11,50014 20.00%15 (c) Finance 23,00016 28,17517 (+) 5,175 (+) 22.5% Total Operating Expenses 1,95,500 2,35,175 39,675 20.29% Net Operating Profit (C - D) 2,64,500 2,24,825 (39,675) (15.00%) Add: Non -Operating Income 23,000 1,15,000 92,000 400.00% Net Profit Before Tax 2,87,500 3,39,825 52,325 18.20% Less: Provision for Tax 46,000 69,000 23,000 50.00% Net Profit After Tax 2,41,500 2,70,825 29,325 12.14%





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120 Working Notes:
1. 4,60,000 ÷ 25% = 18,40,000
2. 1,840,000 + 4,60,000 =
23,00,000
3. 1,38,000 – 92,000 = 46,000
4. 46,000 ÷ 92,000 = 50%
5. 2,30,000 ÷ 20% = 11,50,000
6. 11,50,000 + 13,80,000
7. 5,06,000 – 2,76,000 =
2,30,000
8. 2,30,000 ÷ 2,76,000 = 83.33%
9. Opening Stock of 2020 is
closing stock of 2019.
10. 1,84,000 – 1,38,000 =
46,000
11. 46,000 ÷ 1,38,000 = 33.33 12. 23,000 ÷ 20% = 1,15,000
13. 1,15,000 + 23,000 =
1,38,000
14. 69,000 – 57,500 = 11,500
15. 11,500 ÷ 57,500 = 20.00%
16. 5,175 ÷ 22.50% = 23,000
17. 23,000 + 5,175 = 28,175
Figures in Bracket indicates negative numbers.
Illustration 08
Complete the following Comparative Statement of H ina Products by
ascertaining the missing figures.
Particular Year Ended
31-03-16 Year Ended
31-03-17 Increase/
(Decrease) ` % Increase/
(Decrease) `
Share Capital 16,25,000 ? 1,00,000 ? Reserve and Surplus 6,25,000 5,00,000 ? ? Debentures 3,75,000 ? (1,25,000) ? Current Assets ? 7,50,000 1,00,000 ? Long Term
Investment ? ? 25,000 10 Current Liabilities ? 5,00,000 (25,000) ? Fixed Assets ? ? ? ?
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Comparative Statements,
Common Size Statements & Trend Analysis Comparative Balance Sheet
121 Solution 08:
Particulars 2019 2020 Absolute Increase/
Decrease % Increase/
Decrease
I SOURCES OF FUNDS 1 Shareholder's Fund a Share Capital 16,25,000 17,25,000 1,00,000 6.15
b Reserves and Surplus 6,25,000 5,00,000 (1,25,000) (20.00) 56,25,000 55,62,500 (62,500) (1.11)
2 Loan Fund Debentures 3,75,000 2,50,000 (1,25,000) (33.33)
3 Capital Employed 60,00,000 58,12,500 (1,87,500) (3.13)
II APPLICATION OF FUNDS 1 Fixed Assets
(CE - Invt. - WC) 22,50,000 19,50,000 (3,00,000) (13.33)
Investments 2,50,000 2,75,000 25,000 10.00
2 Working Capital A Current Assets 6,50,000 7,50,000 1,00,000 15.38
B Less: Current Liabilities 5,25,000 5,00,000 (25,000) (4.76)
Working Capital (A - B) 1,25,000 2,50,000 1,25,000 100.00
3 Capital Employed 26,25,000 24,75,000 (1,50,000) (5.71)

Common Size Statement
A common size income statement is an inc ome statement in which each
line item is expressed as a percentage of the value of revenue or sales. It is
used for vertical analysis, in which each line item in a financial statement
is represented as a percentage of a base figure within the statement.
Use of Common Size Income Statement:
It helps the business owner in understanding the following points
1. Whether profits are showing an increase or decrease in relation to the
sales obtained.
2. Percentage change in cost of goods that were sold during the a ccounting
period.
3. Variation that might have occurred in expense.
4. If the increase in retained earnings is in proportion to the increase in
profit of the business.
5. Helps to compare income statements of two or more periods.
6. Recognises the changes happening in the financial statements of the
organisation, which will help investors in making decisions about
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122
Limitations of Common Size Statement
1. It is not helpful in the decision -making process as it does not have any
approved benchmark.
2. For a business that is impacted by fluctuations due to seasonality, it can
be misleading.
Illustration 09:
Following is the Balance Sheet of Priyanka Ltd. as on 31st March, 2020.
Balance Sheet as on 31st March 2020
Liabilities ` Assets `
Equity Share Capital 1,50,000 Fixed Assets 2,00,000 8% Preference Share Capital 1,00,000 Investments 75,000 General Reserve 10,000 Stock 12,500 Profit and Loss Account 25,000 Debtors` 37,500 10% Debentures 50,000 Bills Receivable 15,000 Creditors 10,000 Cash 7,500 Bills Payable 3,500 Preliminary Expenses 2,500 Outstanding Expenses 1,500
3,50,000 3,50,000 Prepare a Common -size Balance Sheet from the above in vertical form.
Solution 09:
Priyanka LTD.
Particulars 2020 % Incr ease/ Decrease I SOURCES OF FUNDS 1 Owner's Funds A Capital Equity Share Capital 1,50,000 45.11 8% Preference Share Capital 1,00,000 30.08 2,50,000 75.19 B. Reserves and Surplus 0.00 General Reserve 10,000 3.01 Profit and Loss A/c 25,000 7.52 35,000 10.53 Less: Preliminary Expenses (2,500) (0.75) Net Reserves and Surplus 32,500 9.77 munotes.in

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Comparative Statements,
Common Size Statements & Trend Analysis Comparative Balance Sheet
123 Own Funds or Net Worth 2,82,500 84.96 2 Loan Funds 0.00 10% Debentures 50,000 15.04 Capital Employed [1 + 2] 3,32,500 100.00 II APPLICATION OF FUNDS 1 Fixed Assets 2,00,000 60.15 2 Investments 75,000 22.56 3 Working Capital A Current Assets Cash 7,500 2.26 Debtors 37,500 11.28 Bills Receivable 15,000 4.51 Total Liquid Assets 60,000 18.05 Stock 12,500 3.76 Total Current Assets 72,500 21.80 B. Less: Current Liabilities 0.00 Creditors 10,000 3.01 Bills Payable 3,500 1.05 Outstanding Expenses 1,500 0.45 Total Current Liabilities (15,000) (4.51) Working Capital [A - B] 57,500 17.29 Capital Employed [1 + 2 + 3] 3,32,500 100.00
Illustr ation 10:
Following is the Summarised Balance Sheet of M/s. Sana Ltd. as on 31st
March, 2020, prepare a Common Size Balance Sheet in vertical form.
Balance Sheet as at 31st March, 2020
Liabilities Assets Equity Share Capital 2,55,000 Fixed Assets 1,95,000 Reserve Fund 81,000 Investment 85,200 Creditors 42,000 Inventory 42,000 Tax Provision 27,000 Debtors 48,000 Cash 34,800 4,05,000 4,05,000 Prepare a Common -size Balance Sheet from the above in vertical form. munotes.in

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124 Solution 10:
Sana Ltd.
Common -Size Balance Sheet
Particulars Amount Amount % Increase/Decrease I SOURCES OF FUNDS 1 Owner's Funds A Capital Equity Share Capital 2,55,000 75.89 B. Reserves and Surplus Reserve Fund 81,000 24.11 Own Funds or Net Worth 3,36,000 100.00 2 Loan Funds 3 Capital Employed 3,36,000 100.00 II APPLICATION OF FUNDS 1 Net Fixed Assets Net Tangible Assets 1,95,000 58.04 2. Long Term Investments Trade Investments 85,200 25.36 3. Working Capital Current Assets Cash 34,800 10.36 Debtors (Net) 48,000 14.29 Total Liquid Assets 82,800 24.64 Inventory 42,000 12.50 a Current Assets 1,24,800 37.14 Less: Current Liabilities - Creditors 42,000 12.50 Provision for Tax 27,000 8.04 b Total Quick/Current Liabilities (69,000) (20.54) c Working Capital (a - b) 55,800 16.61 4. Capital Employed 3,36,000 100.00



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Comparative Statements,
Common Size Statements & Trend Analysis Comparative Balance Sheet
125 Illustration 11:
Dr. Trading and Profit and Loss Account for the Year Ended 31st
March, Cr.
Particular Particular
To Opening Stock 2,25,000 By Sales 45,00,000 To Purchases 24,07,500 By Closing Stock 2,70,000 To Interest on Debentures 1,12,500 By Dividend 29,250 To Depreciation on Furniture 11,250 To Depreciation on Machinery 22,500 To Administration Expenses 3,30,750 To Selling Expenses 5,64,750 To Carriage Outward 2,36,250 To Loss by Fire 11,250 To Wages 2,25,000 To Provision for Tax 3,26,250 To Net Profit 3,26,250 47,99,250 47,99,250
Solution 11:
Commonsize In come Statement For the Year Ended 31st March 2018
Particulars 2018 Percentage 1 Net Sales 45,00,000 100.00 2 Less: Cost of Goods sold
A Opening Stock 2,25,000 5.00 B Add: Purchases 24,07,500 53.50 Wages 2,25,000 5.00 Depreciation - Mach inery 22,500 0.50 28,80,000 64.00 C Less: Closing Stock (2,70,000) (6.00) D Cost of Sales 26,10,000 58.00 3 Gross Profit (1 - 2) 18,90,000 42.00 4 Less: Operating Expenses
I. Administration Expenses
Depreciation on Furniture 11,250 0.25 Other 3,30,750 7.35 Total Administration Expenses 3,42,000 7.60 I. Selling and Distribution Expenses munotes.in

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126 Carriage Outward 2,36,250 5.25 Other 5,64,750 12.55 Total selling and distribution expenses 8,01,000 17.80 Total Operat ing Expenses (I + I1) 11,43,000 25.40 5 Operating Profit Before Interest (3 - 4) 7,47,000 16.60 6 Less : Interest Paid
Interest on Debentures (1,12,500) (2.50) 7 Net Profit After Interest (5 - 6) 6,34,500 14.10 8 Add : Non -Operating Income
Dividends 29,250 0.65 9 Less: Non -Operating Expense
Loss by Fire (11,250) (0.25) 10 Net Profit Before Tax (7 + 8 - 9) 6,52,500 14.50 11 Less: Income Tax (3,26,250) (7.25) 12 Net Profit After Tax (10 - 11) 3,26,250 7.25
Illustration 12
Following is the Trading and Profit & Loss Account of Daya Ltd. &
Radha Ltd. for the year ended 31st March 2020
Trading and Profit and Loss Account for the Year Ended 31st March,
2020
Particular Daya Radha Particular Daya Radha
To Opening Stock 25,920 1,03,680 By Sales 1,44,000 7,20,000 To Purchases 1,05,120 3,15,360 By Closing
Stock 43,200 2,16,000 To Wages 15,840 95,040 To Carriage Inward 5,760 21,240 To Gross Profit c/d 34,560 4,00,680 1,87,200 9,36,000 1,87,200 9,36,000 To Operating
Expenses 28,800 2,01,600 By Gross
Profit b/d 34,560 4,00,680 To Loss on Sale of
Asset 7,200 43,200 By Interest on
Investment 18,720 29,980 To Income Tax
Provision 2,880 28,240
To Net Profit c/f 14,400 1,74,340 Total 53,280 4,30,660 Total 53,280 4,30,660 munotes.in

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Comparative Statements,
Common Size Statements & Trend Analysis Comparative Balance Sheet
127 Solution 12:
Commonsize Income Statement For the Year Ended 31st March 2020
Particulars Daya Radha
Amount % Amount %
1 Net Sales
1,44,000 100.00
7,20,000
100.00 2 Less : Cost of
Goods sold
A Ope ning Stock 25,920 18.00 1,03,680 14.40 B Add: Purchases 1,05,120 73.00 3,15,360 43.80 Wages 15,840 11.00 95,040 13.20 Carriage Inward 5,760 4.00 21,240 2.95 1,52,640 106.00 5,35,320 74.35 C Less : Closing
Stock (43,200) (30.00) (2,16,000) (30.00) D Cost of Sales 1,09,440 76.00 3,19,320 44.35 3 Gross Profit (1 - 2) 34,560 24.00 4,00,680 55.65 4 Less : Operating
Expenses (28,800) (20.00) (2,01,600) (28.00) 5 Operating Profit 5,760 4.00 1,99,080 27.65 6 Add : Non -
operating Income
Interest on
Investment 18,720 13.00 29,980 4.16 7 Less : Non -
operating Expense 24,480 17.00 2,29,060 31.81 Loss on Sale of
Asset (7,200) (5.00) (43,200) (6.00) 8 Net Profit Before
Tax 17,280 12.00 1,85,860 25.81 9 Less : Income Tax (2,880) (2.00) (28,240) (3.92) 10 Net Profit After
Tax 14,400 10.00 1,57,620 21.89



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128 Illustration 13:
Prepare common size Financial Statement in a form suitable for analysis
Summary Balance Sheet as on 31st March, 2020
Liabilitie s ` Assets `
13,650 Cash 8,775 Oustanding expenses 25,350 Debtors 36,075 Loans 73,125 Prepaid Expenses 71,500 Capital 2,13,850 Stock 32,500 Reserves 32,500 Other Current Assets 3,250 Fixed Assets 2,06,375 3,58,475 3,58,475
Summary Income Sta tement for the Year Ending on 31st March, 2020
Particulars Amount Particulars Amount
To Cost of goods sold 2,31,075 By Net Sales 4,12,425 To Selling Overheads 1,17,000 By Other Income 3,900 To Administration and General
Expenses 29,900 To Tax 11,050 To Loss on sale of Investments 15,600 To Net Income 11,700 4,16,325 4,16,325





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Comparative Statements,
Common Size Statements & Trend Analysis Comparative Balance Sheet
129 Solution 13:
Particulars Amount Percentage I SOURCES OF FUNDS
1 Shareholders Funds
Capital 2,13,850 66.94 Reserves 32,500 10.17 Networth 2,46,350 77.11 2 Loan Funds 73,125 22.89 Total Funds Available 3,19,475 100.00 II APPLICATION OF FUNDS
1 Fixed Assets 2,06,375 64.60 2 Working Capital
A Current Assets
Cash 8,775 2.75 Debtors 36,075 11.29 Other Current As sets 3,250 1.02 Stock 32,500 10.17 Prepaid Expenses 71,500 22.38 Total (A) 1,52,100 47.61 B Less: Current Liabilities 0.00 Creditors 13,650 4.27 Outstanding Expenses 25,350 7.93 Total (B) (39,000) (12.21) (A-B) 1,13,100 35.40 Total Funds Employed (1+2) 3,19,475 100.00


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Financial Management

130 Particulars Amount Percentage 1 Net Sales 4,12,425 100.00 2 Less: Cost of goods sold (2,31,075) (56.03) 3 Gross Profit (1 - 2) 1,81,350 43.97 4 Less: Operating Expenses: (a) Admin & General Expen ses (29,900) (7.25) (b) Selling Overheads (1,17,000) (28.37) Total (4) (1,46,900) (35.62) 5 Other operating Income 3,900 0.95 6 Net Operating Profit (3 - 4 + 5) 38,350 9.30 7 Less: Non -operating Expenses Loss on sale of Investments (15,600) (3.78) 8 Net Profit before Tax (6 - 7) 22,750 5.52 9 Less: Taxes (11,050) (2.68) 10 Net Profit After Tax (8 - 9) 11,700 2.84
Illustration 14:
Complete the following Common Size Income Statement of Babita Ltd.
by ascertaining the missing figures / percentages
Common Size Income Statement as on 31st March, 2020
Particular ` ` % %
Net Sales 5,00,000 Less : Cost of Goods Sold Opening Stock ? 20.00 Purchases ? 60.00 Wages 62,500 ? Factory Overheads ? 12.50 ? 105.00 Less : Closing Stock 1,50,000 ? 30.00 75.00 Gross Profit 1,25,000 25.00 Less : Operating Expenses (a) Administrative
Expenses ? 7.00 (b) Selling Expenses 12,500 2.50 (c) Finance Expenses ? 52,500 ? 10.50 Operating Profit ? ? Add : Non -Operating
Income 12,500 2.50 Less : Non -Operating
Expenses ? 1.00 Net Profit Before Tax 80,000 ? munotes.in

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Comparative Statements,
Common Size Statements & Trend Analysis Comparative Balance Sheet
131 Solution 14:
Common Size Income Statement as on 31st March, 2020
Particular ` ` % %
Net Sales 5,00,000 100.00 Less: Cost of Goods Sold Opening Stock 1,00,000 20.00 Purchases 3,00,000 60.00 Wages 62,500 12.50 Factory Overheads 62,500 12.50 5,25,000 105.00 Less: Closing Stock (1,50,000) (3,75,000) 30.00 75.00 Gross Profit 1,25,000 25.00 Less: Operating Expenses (a) Administrative Expenses 35,000 7.00 (b) Selling Expenses 12,500 2.50 (c) Finance Expenses 5,000 (52,500) 1.00 (10.50) Operating Profit 72,500 14.50 Add: Non -Operating Income 12,500 2.50 Less: Non -Operating Expenses (5,000) (1.00) Net Profit Before Tax 80,000 16.00
Illustration 15:
From the following information of Gabbar Ltd. prepare Common Size
Balance Sheet in Vertical Form as on 31st March 2020.
Particulars `
Fixed Assets 510000 Net Worth 510000 Loan Fund ?
Working Capital 340000 Total Capital Employed 850000 Current Liabilities 340000 munotes.in

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Financial Management

132 Solution 15:
In the books of Gabbar Ltd.
Commonsize Balance Sheet as on 31st March 2020
Particulars as on 2020 ` %
I SOURCES OF FUNDS 1 Shareholders Funds 5,10,000 60.00 2 Loan Fund 3,40,000 40.00 Total Funds Available (1 + 2) 8,50,000 100.00 II APPLICATION OF FUNDS 1 Fixed Assets 5,10,000 60.00 2 Working Capital - A Current Assets 6,80,000 80.00 B Less : Current Liabilities (3,40,000) (40.00) Working Capital (A -B) 3,40,000 40.00 2 Total Funds Employed (1 + 2 ) 8,50,000 100.00
Trend Analysis
Meaning: Trend Analysis treats year 1 as the base year and compares the
figures of all the (year 2/year 3) with those of the base year to find out the
trend in figures. Thus trend analysis ofpurchase will reveal whether as
compared to the base year, i.e. Year 1, the purchase show atrend increase
or decrease in subsequent years, i.e. Year 2, Year 2, Year 3 ..... and so on.
Use: It is useful because: (1) It shows the direction(up or down)of the
changes. (2) Trends areeasy to calculate and interpret. (3) It is a quick
method of analysis.
Advantages:
(1) Trend Analysis helps in analysing the growth in the financial acti vities
of the firm with abrief look.
(2) Graphical presentation of trend line helps the management to take a
quick decision matter.
(3) Trend values also help the management in the controlling process as
well.
(4) Trend analysis proves to be very useful fo r taking rational investment
decisions. munotes.in

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Comparative Statements,
Common Size Statements & Trend Analysis Comparative Balance Sheet
133 Disadvantages:
(1) Choice of Base Year & No. of Years: If different year is chosen as the
base year, the trend may be different. Further, the total number of years
covered should not be too large (say 30 years) or to o small (say 3 years).
Data for a large number of years show large variationsdue to inflation and
figures for a few years are not representative.
(2) Different Accounting Policies: The trend will give a distorted figure, or
a wrong picture ifthe accounting policies in respect of depreciation,
valuation of closing stock etc. have changed.
Illustration 16:
M/s. Henry Ltd. Carrying on business, furnished their position as on 31st
March, 2018, 2019 and 2020.
Particulars 2018
(Amount in `) 2019 (Amount
in `) 2020 (Amount
in `)
Assets
Fixed Assets 60,000 51,000 87,600 Investment 26,000 26,000 36,800 Current Assets 54,000 66,400 37,800 1,40,000 1,43,400 1,62,200
Liabilities
Share Capital 66,000 62,700 82,000 Debentures 54,000 56,700 19,000 Liabilities for expenses 20,000 24,000 61,200 1,40,000 1,43,400 1,62,200
Solution:
In the books of Henry Ltd.
Trend Analysis of Balance Sheet
Particulars Amount Trend %
2018 ` 2019 ` 2020 ` 2018 2019 2020 I SOURCES OF
FUNDS
Share Capital 66,000 62,700 82,000 100.00 95.00 124.00 Debentures 54,000 56,700 19,000 100.00 100.00 35.00 Capital Employed 1,20,000 1,19,400 1,01,000 100.00 99.50 84.00 munotes.in

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134
II APPLICATION
OF FUNDS
1 Fixe d Assets 60,000 51,000 87,600 100.00 85.00 146.00 2 Investments 26,000 26,000 36,800 100.00 100.00 142.00 3 Current Assets 54,000 66,400 37,800 100.00 123.00 70.00 4 Current Liabilities (20,000) (24,000) (61,200) 100.00 120.00 306.00 5 Working Capital
(3 - 4) 34,000 42,400 (23,400) 100.00 125.00 (69.00) 6 Capital Employed 1,20,000 1,19,400 1,01,000 100.00 99.50 84.00
Illustration 17:
From the following balance sheet of Sunny Ltd., prepare Trend Percentage
Statement in V ertical form:
Balance Sheet as on 31st March
Particulars 2018 (Amount in
Rs) 2019
(Amount in Rs) 2020 (Amount
in Rs)
Equity and Liability Equity Share Capital 2,40,000 2,40,000 2,40,000 8% Preferen ce Share
Captial 1,20,000 1,80,000 1,20,000 General Reserve 24,000 26,400 50,400 Debentures 90,000 1,20,000 1,08,000 Bills Payable 6,000 8,400 12,000 Creditors 18,000 12,000 28,800 Total 4,98,000 5,86,800 5,59,200 Assets Fixed Assets 1,80,000 2,40,000 2,40,000 Investment 1,20,000 1,80,000 1,20,000 Cash 60,000 30,000 48,000 Debtors 84,000 72,000 75,600 Stock 48,000 60,000 72,000 Preliminary Expenses 6,000 4,800 3,600 Total 4,98,000 5,86,800 5,59,200 munotes.in

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Comparative Statements,
Common Size Statements & Trend Analysis Comparative Balance Sheet
135 Solution 17:
In the books of Sunny Ltd.
Trend Analysis of Balance Sheet
Particulars Amount Trend % Base year 2018
2018 ` 2019 ` 2017 ` 2,018 2,019 2,017
I SOURCES OF
FUNDS
1 Shareholders'
Funds
a Capital Equity Share Capital 2,40,000 2,40,000 2,40,000 100.00 100.00 100.00
8% Pref. Share
Capital 1,20,000 1,80,000 1,20,000 100.00 150.00 100.00
Capital 3,60,000 4,20,000 3,60,000 100.00 116.67 100.00
b Reserves and
Surplus
General Reserve 24,000 26,400 50,400 100.00 110.00 210.00 3,84,000 4,46,400 4,10,4 00 100.00 116.25 106.88
c Less: Preliminary
Expenses. 6,000 4,800 3,600 100.00 80.00 60.00
2 Own Funds 3,78,000 4,41,600 4,06,800 100.00 116.83 107.62
3 Loan Funds Debentures 90,000 1,20,000 1,08,000 100.00 133.33 120.00
Capital Employed (2
+ 3) 4,68,000 5,61,600 5,14,800 100.00 120.00 110.00
II APPLICATION
OF FUNDS
1 Fixed Assets 1,80,000 2,40,000 2,40,000 100.00 133.33 133.33
2 Investments 1,20,000 1,80,000 1,20,000 100.00 150.00 100.00
3 Working Capital a Current Assets: Cash 60,000 30,000 48,000 100.00 50.00 80.00
Debtors 84,000 72,000 75,600 100.00 85.71 90.00
Stock 48,000 60,000 72,000 100.00 125.00 150.00
Current Assets (a) 1,92,000 1,62,000 1,95,600 100.00 84.38 101.88
Less: Current
Liabilities
Bills Paya ble 6,000 8,400 12,000 100.00 140.00 200.00
Creditors 18,000 12,000 28,800 100.00 66.67 160.00
Current Liabilities (b) 24,000 20,400 40,800 100.00 85.00 170.00
Working Capital (a - b) 1,68,000 1,41,600 1,54,800 100.00 84.29 92.14
Capital Employed
(1+2+3 ) 4,68,000 5,61,600 5,14,800 100.00 120.00 110.00
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136 Illustration 18
Following balances are extracted from the books of Naman Ltd.
Balance Sheet as on 31st March
Particulars 2018
(Amount in
Rs) 2019
(Amount in
Rs) 2020 (Amount
in Rs)
Net Sales 1,00,500 1,34,000 1,67,500 Opening Stock 10,050 16,750 23,450 Purchases 56,950 63,650 67,000 Wages 5,025 10,050 6,700 Carriage Inward 6,700 13,400 13,400 Closing Stock 16,750 23,450 20,100 Office Expenses 3,350 4,020 5,025 Selling Expenses 2,345 3,015 3,350 Finance Expenses 2,010 3,350 6,700 Non-Operating Income 2,680 3,015 3,350 Non-Operating
Expenses 1,675 1,005 1,675 Tax 40% 40% 40%
You are required to prepare vertical trend analysis Income Statement from
the above.








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Comparative Statements,
Common Size Statements & Trend Analysis Comparative Balance Sheet
137 Solution 18:
In the books of Naman Ltd.
Vertical Trend Analysis Income Statement
Particulars Amount Trend % Base year 2015
2015 ` 2016 ` 2017 ` 2015 2016 2017
1 Net Sales 1,00,500 1,34,000 1,67,500 100.00 133.33 166.67 2 Less: Cost of Goods Sold
Opening Stock 10,050 16,750 23,450 100.00 166.67 233.33 Purchases 56,950 63,650 67,000 100.00 111.76 117.65 Wages 5,025 10,050 6,700 100.00 200.00 133.33 Carriage Inward 6,700 13,400 13,400 100.00 200.00 200.00 Less: Closing Stock 16,750 23,450 20,100 100.00 140.00 120.00 Cost of Goods sold 61,975 80,400 90,450 100.00 129.73 145.95 3 Gross Profit I1 - 2] 38,525 53,600 77,050 100.00 139.13 200.00 4 Less: Operating Expenses
Office Expenses 3,350 4,020 5,025 100.00 120.00 150.00 Selling Expenses 2,345 3,015 3,350 100.00 128.57 142.86 Finance Expenses 2,010 3,350 6,700 100.00 166.67 333.33 Operating Expenses 7,705 10,385 15,075 100.00 134.78 195.6 5 5 Net Profit [3 - 4] 30,820 43,215 61,975 100.00 140.22 201.09 6 Non -operating Income 2,680 3,015 3,350 100.00 112.50 125.00 7 Non -operating Expenses 1,675 1,005 1,675 100.00 60.00 100.00 8 Net Profit Before Tax (5+6 -7) 31,825 45,225 63,650 100.00 142.11 200.00 9 Less: Income Tax (40%) 12,730 18,090 25,460 100.00 142.11 200.00 10 Net Profit after Tax [8 - 9] 19,095 27,135 38,190 100.00 142.11 200.00




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Financial Management

138 Illustration 19:
Calculate Trend Percentage from the foll owing information extracted from
financial statement of M/s. Lalita Ltd., after arranging in vertical from.
Balance Sheet as on 31st March
Particulars 2018 (Amount
in Rs) 2019 (Amount in
Rs) 2020 (Amount
in Rs)
Assets Fixed Assets 32,400 34,020 40,500 Investment 2,700 1,350 2,700 Current Assets 36,450 45,306 52,785 71,550 80,676 95,985 Liabilities Share Capital 39,150 45,900 55,350 Bank Loan 8,100 8,100 10,935 Current Liabilities 24,300 26,676 29,700 71,550 80,676 95,985
Income Statements for the year ended 31st Mar ch
Particulars 2018 (Amount
in Rs) 2019 (Amount
in Rs) 2020 (Amount
in Rs)
Net Sales 30,000 33,000 36,000 Less Cost of Sales 22,500 27,000 27,000 Gross Margin 7,500 6,000 9,000 Less: Operating Expenses 3,000 1,500 2,700 Operating Profit 4,500 4,500 6,300


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Comparative Statements,
Common Size Statements & Trend Analysis Comparative Balance Sheet
139 Solution 19
In the books of Lalita Ltd.
Trend Analysis of Balance Sheet
Particulars Amount Trend % Base year 2018
2018 ` 2019 ` 2020 ` 2018 ` 2019 ` 2020 `
I SOURCES OF FUNDS
Share Cap ital 39,150 45,900 55,350 100.00 117.24 141.38 Bank Loan 8,100 8,100 10,935 100.00 100.00 135.00 Capital Employed 47,250 54,000 66,285 100.00 114.29 140.29 II APPLICATION OF FUNDS
1 Fixed Assets 32,400 34,020 40,500 100.00 105.00 125.00 2 Investments 2,700 1,350 2,700 100.00 50.00 100.00 3 Working Capital
a. Current Assets 36,450 45,306 52,785 100.00 124.30 144.81 b Less: Current Liabilities (24,300) (26,676) (29,700) 100.00 109.78 122.22 c Working Capital (a - b) 12,150 18,630 23,085 100.00 153.33 190.00 4 Capital Employed (1 + 2 + 3) 47,250 54,000 66,285 100.00 114.29 140.29
Income Statements for the year ended 31st March
Particulars Amount Trend % Base year 2018
2018 ` 2019 ` 2020 ` 2018 2,019 2,020 Net Sales 30,000 33,000 36,000 100.00 110.00 120.00 Less Cost of Sales 22,500 27,000 27,000 100.00 120.00 120.00 Gross Margin 7,500 6,000 9,000 100.00 80.00 120.00 Less : Operating Expenses 3,000 1,500 2,700 100.00 50.00 90.00 Operating Profit 4,500 4,500 6,300 100.00 100.00 140.00
Illustration 20:
From the following information prepare Vertical Balance Sheet for
financial analysis and Trend analysis of Fenny Products Ltd. For all the
years.
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Financial Management

140 Balance Sheet as on 31st March
Particulars 2018
(Amount in
Rs) 2019 Trend
% 2020
(Amount in
Rs)
Share Capital 1,12,500 120 1,57,500 Reserve and Surplus 22,500 150 45,000 Secured Loans 22,500 100 22,500 Current Liabilities 22,500 150 45,000 Fixed Assets 90,000 110 1,12,500 Investment (Long Term) 22,500 160 45,000 Stock and Debtors 56,250 120 78,750 Bank Balance 11,250 200 33,750
Solution:
Trend Analysis of Balance Sheet
Particulars Amount Trend % Base year 20 18
2018 ` 2019 ` 2020 ` 2018 2019 2020
I SOURCES OF FUNDS
Share Capital 1,12,500 1,35,000 1,57,500 100.00 120.00 140.00 Reserves and Surplus 22,500 33,750 45,000 100.00 150.00 200.00 1 Own Funds 1,35,000 1,68,750 2,02,500 100.00 125.00 150.00 2 Loan Funds
Secured Loan 22,500 22,500 22,500 100.00 100.00 100.00 3 Capital Employed (1 + 2) 1,57,500 1,91,250 2,25,000 100.00 121.43 142.86 II APPLICATION OF FUNDS
1 Fixed Assets 90,000 99,000 1,12,500 100.00 110.00 125.00 2 Long Term Investments 22,500 36,000 45,000 100.00 160.00 200.00 3 Working Capital
a Current Assets
Stock and Debtors 56,250 67,500 78,750 100.00 120.00 140.00 Bank 11,250 22,500 33,750 100.00 200.00 300.00 Current Assets 67,500 90,000 1,12,500 100.00 133.33 166.67 b. Less: Current Liabilities 22,500 33,750 45,000 100.00 150.00 200.00 C. Working Capital (a - b) 45,000 56,250 67,500 100.00 125.00 150.0 0 4 Capital Employed (1 + 2 + 3) 1,57,500 1,91,250 2,25,000 100.00 121.43 142.86 munotes.in

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Comparative Statements,
Common Size Statements & Trend Analysis Comparative Balance Sheet
141 Exercise:
TRUE AND FALSE
1. Comparative statement includes comparative income statement and
balance sheet. T
2. Common size statement is horizontal analysis. F
3. In Vertical Income Statement, preliminary expenses written off will be
shown under Operating Expenses. F
4. Own funds is internal source of finance, whereas Owed funds is an
external source of finance. T
5. Comparative financial statements in which each amou nt is expresses as
a percent of a base amount are called Trend statements. F
6. The managerial accounting system produces information for external
users. F
7. Vertical analysis is a tool to evaluate each financial item or group of
items in terms of a speci fic base amount.
8. Using the common size statement, a company’s net income as a
percentage of sales is 20%therefore , the cost of goods sold as a
percentage of sale must be 80%. F
9. Liquidity is ability of firm to pay, as and when the debts fall dure for
payment. T
10. Currents assets and liabilities are listed in alphabetical order , in
vertical balance sheet for financial analysis. F
SHORT NOTES.
Write short note on -
1. Trend analysis.
2. Inter -firm comparisons
3. Inter -period comparisons
4. Advantages of comparative statements
5. Limitations of comparative statements
6. Common size statements
7. Advantages of trend analysis
8. Use of common size statements
9. Disadvantages of trend analysis
10. Limitations of common size statements.
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142 1. Rearrange the B alance Sheets in Vertical form and calculate the trend
percentage taking 2017 figures as 100 and briefly comment on the same.
Liabilities 2017 ` 2018 ` 2019 ` 2020 ` Assets 2017 ` 2018 ` 2019 ` 2020 `
Equity
Share
Capital 145.00 159.50 174.0 0 174.00 Land &
Building 58.00 58.00 50.75 65.25
12% Pref.
Share
Capital 29.00 14.50 7.25 7.25 Plant &
Machinery 203.00 181.25 159.50 166.75
Reserve &
Surplus 108.75 130.50 174.00 188.50 Furniture &
Fixture 36.25 43.50 36.25 29.00
13%
Debentures 87.00 72.50 36.25 22.00 Current Assets 145.00 166.75 232.00 224.75
Current
Liabilities 72.50 72.50 87.00 94.00
442.25 449.50 478.50 485.75 442.25 449.50 478.50 485.75

Calculate Trend % to full integer (without decimal points - Figures to be
rounded)
2. Rearrange the following summary Balance Sheet in vertical form
suitable for analysis and calculate the trend percentage taking 2017 figures
as 100 and briefly comment on the same.
Balance Sheet as on 31st December
Liablilities 2017 ` 2018 ` 2019 ` 2020 ` Assets 2017 ` 2018 ` 2019 ` 2020 ` Share
Capital 300 300 400 400 Building 250 300 275 400 Reserve 250 225 100 100 Goodwill 250 225 200 200 Surplus 65 160 155 200 Machinery 100 200 215 250 Debentures 50 100 100 150 Stock 25 75 125 25 Secured
Loans 60 40 50 100 Debtors 100 70 75 50 Creditors 30 40 50 15 Cash 25 5 10 75 Bank O/D 5 10 40 20 Preliminary
Expenses 15 10 5 - Other
Liabilities 5 10 10 15
765 885 905 1,000 765 885 905 1,000


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Comparative Statements,
Common Size Statements & Trend Analysis Comparative Balance Sheet
143 3. You are furnished with the follo wing revenue statements of Piya Ltd.
for the year ended March 31st 2020
Particulars 2017 ` 2018 ` 2019 ` 2020 `
Sales 37,50,000 45,00,000 54,00,000 64,80,000 Less : Cost of Sales (24,00,000) (28,50,000) (34,50,000) (42,00,000) Gross Margin 13,50,000 16,50,000 19,50,000 22,80,000 Management Expenses 2,25,000 2,62,500 3,00,000 3,37,500 Sales Expenses 3,75,000 4,50,000 5,40,000 6,48,000 Interest on Borrowings 2,25,000 3,00,000 3,75,000 4,50,000 Total Expenses (8,25,000) (10,12,500) (12,15,000) (14,35,50 0) Net Profit before
Depreciation and
Taxation 5,25,000 6,37,500 7,35,000 8,44,500 Depreciation (3,75,000) (3,37,500) (4,50,000) (4,87,500) Profit before Taxation 1,50,000 3,00,000 2,85,000 3,57,000 Income Tax (60,000) (1,50,000) (1,38,750) (1,80,000) Profit after Tax 90,000 1,50,000 1,46,250 1,77,000
(a) You are asked to prepare trend analysis.
(b) Comment on the same.
4. From the following prepare income statement in vertical form showing
trend percentages of M/S Lakhan Traders and comment on gross profit
trend.
Particulars 2017 ` 2018 ` 2019 ` 2020 `
Sales 5,88,000 7,14,000 7,56,000 8,40,000 Cost of Sales 2,69,500 3,27,250 3,45,800 3,85,000 Administrative Expenses 94,500 94,500 1,05,000 1,05,000 Selling and Distribution
Expenses 58,800 71,400 75,600 84,000 Finance Expenses 28,000 28,000 28,000 28,000 Income tax Provision 41,160 57,855 60,270 71,400 munotes.in

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144
5. Hammu and Pammu are partners of a firm carrying on business
(i) Their position as on 31st December 2018, 2019 and 2020 is as follows
Liabiliti es 2020 ` 2019 ` 2018 ` Assets 2020 ` 2019 ` 2018 `
Partners
Capitals 8,80,000 7,48,000 6,60,000 Fixed
Assets 8,80,000 7,92,000 6,16,000
General
Reserve 2,20,000 2,20,000 2,20,000 Current
Assets - - -
Secured
Loans 1,32,000 1,32,000 1,10,000 Stock 3,52, 000 3,30,000 2,97,000
Unsecured
Loans 3,52,000 3,96,000 3,08,000 Debtors 4,40,000 3,52,000 3,08,000
Sundry
Creditors 3,52,000 1,98,000 99,000 Loans and
Advances 2,20,000 1,76,000 1,32,000
Cash &
Bank
Balances 44,000 44,000 44,000 19,36,00 0 16,94,000 13,97,000 19,36,000 16,94,000 13,97,000

(ii) Summarised Income Statement for the year ended
Particulars 2020 ` 2019 ` 2018 `
Sales 88,00,000 79,20,000 66,00,000 Less: Cost of Sales 61,60,000 52,80,000 44,00,000 Gross Pro fit 26,40,000 26,40,000 22,00,000 Less: Expenses 17,60,000 17,60,000 15,40,000 Net Profit 8,80,000 8,80,000 6,60,000 Prepare Trend Statement



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Comparative Statements,
Common Size Statements & Trend Analysis Comparative Balance Sheet
145 6. Calculate Trend Percentage from the following information extracted
from Financial Statementsof Vinayak Limited Company. Give your
appropriate comments
Particulars 2020 ` 2019 ` 2018 ` 2017 `
Sales 32,802 27,290 19,768 18,224 Cost of Sales 29,956 24,982 17,626 14,864 Expenses 178 268 116 90 Interest 1,006 758 412 202 Profit Before Tax 1,662 1,282 1,614 3,068 Tax 788 396 910 1,640 Profit After Tax 874 886 704 1,428 Fixed Assets (Net) 10,978 10,222 9,554 8,972 Working Capital 10,170 9,774 6,596 5,546 Loans ? ? ? ?
Net Worth 13,382 12,034 11,714 11,908
7. From the following prepare income statement in vertical form showing
trendpercentages of M/S Ferry Traders and comment on gross profit trend.
Particulars 2017 ` 2018 ` 2019 ` 2020 `
Profit and Loss Accounts
Sales 30,000 33,000 36,000 39,000 Cost of Sales 22,500 24,525 26,550 28,575 Expenses 2,400 2,805 3,420 3,861 Interest 675 900 1,125 1,350 Profit Before Tax ? ? ? 5,214 TaX 1,770 1,908 1,962 2,085 Profit After Tax 2,655 ? ? ?

Balance Sheets
Fixed Assets ? ? ? ?
Current Assets 45,000 ? 53,400 ?
Current Liabilities ? 32,700 ? 38,400 Net Working Capital 15,000 16,500 17,850 19,350 Net Worth 3,00,000 32,100 33,300 34,800 Loans (Liabilities) 15,000 18,000 21,000 24,000
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146 8. Prepare a Comparative Revenue Statement in Vertical Form from the
following details
Particular 2019 ` 2020 ` Particular 2019 ` 2020 `
To Opening
Stock 3,60,000 4,80,000 By Sales 72,00,000 96,00,000
To Purchases 36,00,000 51,36,000 By Closing
Stock 4,80,000 5,76,000
To Interest on
Debenture 2,40,000 2,40,000 By Dividend 39,200 62,400
To Depreciation : By Profit on
Sale of
Machinery 18,400
Furniture 24,000 24,000 Machinery 57,600 48,000 To
Administrative
Exp. 4,70,400 7,05,600
To Selling
Expenses 7,29,600 12,04,800
To Carriage
Outward 1,20,000 5,04,000
To Loss by Fire - 24,000 To Wages 3,12,000 4,80,000 To Provision for
Tax 9,12,000 6,96,000
To Net Profit 9,12,000 6,96,000 Total 77,37,600 1,02,38,400 Total 77,37,600 1,02,38,400

9. The income statements of a Nisha Ltd. are given for the years ending on
31st March, 2019 and2020. You are r equired to prepare a comparative
income statement and interpret the changes.
Income Statements for the year ending 2019 and 2020
Particulars 2019 ` 2020 `
Sales 487500 543750 Cost of Sales 318750 375000 Gross Profit 1,68,750 1,68,750 Operating Expenses Selling & Distribution Expenses 45000 56250 General Expenses 18750 30000 Total Operating Expenses 63,750 86,250 Net Profit during the year 1,05,000 82,500 munotes.in

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Common Size Statements & Trend Analysis Comparative Balance Sheet
147 10. From the following balance sheet as on 31 st March, 2019 and 31st
March, 2020 of M/sYahv i Ltd. Prepare Comparative balance sheet for
analysis purpose in vertical form.
Particular 31st March
2019 ` 31st March
2020 `
Assets Cash and Bank balance 8,40,000 2,80,000 Short term investments 2,80,000 12,60,000 Accounts receivable 18,20,000 14,00,000 Inventories 21,00,000 7,00,000 Prepaid Income Tax 3,50,000 2,80,000 Other Current Assets 4,20,000 3,50,000 58,10,000 42,70,000 Land and Building 5,60,000 3,50,000 Machinery 8,40,000 7,00,000 Furniture 2,10,000 1,40,000 Leasehold Land 3,50,00 0 3,50,000 19,60,000 15,40,000 77,70,000 58,10,000 Liabilities: Bills payable 16,80,000 11,20,000 Accounts payable 14,00,000 7,00,000 Accrued compensation and
employee benefit 7,00,000 2,80,000 Income tax payable 2,80,000 1,40,000 40,60,000 22,40,000 Equity Capital 28,00,000 28,00,000 Reserve 9,10,000 7,70,000 37,10,000 35,70,000 77,70,000 58,10,000




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148 11. From the following financial statements of Tappu Limited, prepare
financial statements in Vertical Form.
Balance Sheets as at 31st December
Liabilities 31st March
2019 ` 31st March
2020 ` Assets 31st March
2019 ` 31st March 2020 `
Equity Share
Capital 6,00,000 6,00,000 Land 3,00,000 3,60,000 9% Preference
Share Capital 4,50,000 4,50,000 Factory
Plant &
Buildings 9,00,000 8,10,000 General Reserves 3,00,000 3,67,500 Stocks 3,00,000 4,50,000 Tax Payable 1,50,000 2,25,000 Debtors 3,00,000 4,50,000 Creditors 3,00,000 4,12,500 Cash 1,50,000 2,10,000 17% Debentures 1,50,000 2,25,000 19,50,000 22,80,000 19,50,000 22,80,000
Incom e Statement for Year Ended 31st December
Expenses 31st March
2019 ` 31st March
2020 ` Income 31st March
2019 ` 31st March 2020 `
Cost of goods sold 9,00,000 11,25,000 Sales 12,00,000 15,00,000
Admn. Expenses 45,000 60,000 Selling Expenses 30,000 30,000 Net Profit 2,25,000 2,85,000 12,00,000 15,00,000 12,00,000 15,00,000

Briefly comment on the difference between the stated net profit of 2020
and the increment inGeneral Reserves on 31 -12-2020 assuming that no
amount is paid towards tax in 20 20.Also ascertain the quantum of cash
gross profit of 2020 assuming that no depreciation is provided on Land.
12. From the following Financial statements of Grishma Limited prepare a
common size financialstatement and give your comments on them.


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Common Size Statements & Trend Analysis Comparative Balance Sheet
149 Profit and Loss Account for the year ended 31st March 2020
Particular ` Particular `
To Opening Stock 4,68,000 By Sales 23,40,000 To Purchases 14,04,000 By Closing Stock 7,02,000 To Wages 2,92,500 To Factory Overheads 2,92,500 To G.P. c/d 5,85,000 30,42,000 30,42,000 To Administrative Expenses 87,750 By G.P. b/d 5,85,000 To Selling & Distribution
Expenses 58,500 By Dividend 35,100 To Depreciation 76,050 To Interest on Debentures 23,400 To Net Profit c/d 3,74,400 6,20,100 6,20,100 To Preference Dividend Paid 17,550 By Balance b/d 2,34,000 To Provision for Tax 1,22,850 By Net Profit b/d 3,74,400 To Surplus to Balance Sheet 4,68,000 6,08,400 6,08,400
Balance Sheet as on 31st March 2013
Liabilities ` Assets `
Equity Sh are Capital 11,70,000 Goodwill 5,85,000 Preference Share Capital 5,85,000 Plant and Machinery 5,85,000 General Reserve 1,17,000 Land and Building 9,36,000 P and LA/c Balance 4,68,000 Furniture 1,17,000 Provision for Tax 1,22,850 Stock 5,85,000 Bill Payable 2,28,150 Bill Receivable 93,600 Bank Overdraft 1,17,000 Debtors 2,34,000 Creditors 5,85,000 Bank 2,57,40 0 33,93,000 33,93,000
13. From the following information of Sahani Enterprises prepare the
Common size Revenue Statement with Amountand % for the year ended
on 31st March, 2020 in a vertical form suitable for analysis munotes.in

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150 Particulars % on net sales of Rs.500000 Opening Stock 2 Closing Stock 2.25 Purchases 51 Office Expenses 4.5 Other Administrative Expenses 6.2 Distribution Expenses 5.7 Selling Expenses 4.65 Interest (Dr.) 1.80 Direct Wages 3.30 Provision f or Income tax is to be made @25% on net profit before tax.


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151 4
RATIO ANALYSIS

Unit structure:
4.0 Objectives
4.1 Introduction
4.2 Definition and Meaning
4.3 Importance and limitation of Accounting Ratios
4.4 Classification of Ratios -
4.5 Balance Sheet Ratios
4.6 Revenue Statement Ratios
4.7 Combined Ratios
4.0 OBJE CTIVES:
After studying the unit the students will be able to understand:
 Meaning and definition of ratios
 Advantages of preparing ratios
 Importance of Ratio Analysis
 Limitaions of Ratio Analysis
 Calculate various ratios to assess solvency,liquidity,efficie ncy and
profitability of the firm.
 Apply ratio analysis to evaluate a company’s liquidity, performance
& risks.
 Standardize financial information for comparision.
 Compare present performance with past performance.
 Evaluate current operations

4.1 INTRODUCT ION

The basis for financial analysis, planning and decision making the
financial statements which mainly consist of Balance sheet and profit and
loss account.

The profit & loss account shows the operating activites of the concern
over a period of time an d the balance sheet shows balance activites of
assets and liabilities in other words financial position of an organization at
a particular point of time.

However, the above statements do not disclose all of the necessary and
relevant information. For the purpose of obtaining the material and
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152 weeknesses of an enterprise, it is necessary to analyse the data depicted in
the financial statement.

The financial manager has certain analy tical tools which helps in financial
analysis and planning . One of the main tool is Ratio Analysis let us
discuss the Ratio Analysis in this chapter.

4.2 RATIO DEFINITION & MEANING:

Definition of Ratio
A ratio is defined as “the indicated quotient of tw o mathematical
expressions and as the relationship between two or more things.” Here,
ratio means financial ratio or accounting ratio which is a mathematical
expression of the relationship between two accounting figures.

According to Myers,”Ratio Analysis of financial statements is a study of
relationship amoung various financial factors in a business as disclosed by
a single set of statements and a study of trend of these factors as shown in
a series of statements.”
According to James C. Van Harne“Ratio i s a yardstick used to evaluate
the financial condition andperformance of a firm, relating two pieces of
financial data to each other.”
According to Kohler “The relation of one amountA to another B expressed
as the ratioof A to B”.
“Ratio is the relationshi p or proportion that one amount bears to another,
the first number being the numerator and the later denominator.”
From the above definations we conclude that ratio analysis is gives us idea
about company or firms financial position. It is helpful for inve stors as
well as company also for future better performance also they can use it.

Meaning of Ratio analysis

Ratio -Analysis means the process of computing, determining and
presenting the relationship of related items and groups of items of the
financial statements. They providein a summarized and consise form of
fairly good idea about the financial position of a unit. They are important
tool for financial analysis.

Ratio is the numericl or as arithmatical relationship between two figures.
Ratio is simply one number expressed in terms of another.It is poweful
tools of the financial analysis.

The data given in the financial statement does not have any importance
unless a relationship is established among them . The ratio used to reveal
the relationship of accounting data is called accounting ratio or ratio
analysis.
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153 Ratio may be expressed in terms of -
1) Proportion , pure, simple ratio E.g. Current asset:Current liabilities 2:1
2) Rate or times or days or coefficient e.g 5 times
3) In percentage e.g. %
4) In fraction e.g.1/4th

Sources required for the Ratio analysis -
1) Annual Report
2) Financial statement
3) notes to accounts
4) statement of cash flow statement

Importance of accounting ratios -
1. Understanding financial statements are important for stake holders of
the company. Ratio analysis helps in understanding the comparison of
these numbers: furthermore it helps in estimating numbers from
income statements and balance sheets for the future. For e.g. equity
shareholders looks into the P/E ratio, the d ividend payout ratio etc.
while creditors observe debt to equity ratio, gross margine ratio, debt
to asset ratio etc.

2. Ratio analysis is important in understanding the compamy’s ability to
generate profit. Return of asset, return on equity tells us how muc h
profit the company is able to generate over assets of the firm. While
gross margin and operating margin ratios tell us the company’s ability
to generate profit from sales and operating efficiency.

3. From a managemetn and investor point of view ratio analy sis helps to
understand and estimate the company’s future finacials and operations.
Ratios formed from past finacial statement analysis helps in estimating
future fianacials, budgeting and planning for the future operation of
the company.

4. The company oper ates under various business,market,operations
related risks. Ratio analysis help in understanding these risks and helps
management to prepare and take necessary actios. Leverage ratios help
in preforming sensitivity analysis of various factors affecting th e
company’s profitability like sales, cost, debt, financial leverage ratios
like interest coverage ratio and debt coverage ratio tell how much the
company is dependant on external capital source.

5. Investor as well as the company’s management,makes a compar ison
with competitiors company to understand efficiency, profitability and
market share, ratio analysis is helpful for companies to perfromn
SWOT (strengths, weakness,opportunities and threats) analysis in the
market. It also tells whether the company is a ble to perform growth or
not over a period from past financials and whether the company’s
financials and whether the company’s financial position is improving
or not.
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154 6. A better source of communication with customers, stakeholders, and
other outsider who wa nt to invest in the company.

7. Helps in understanding the profitability of the company for decision
making purpose.

8. Helps in identifying the business risks of the firm to protrect from
furture threats or any losses.

9. Helps in identifying the financial risk s of the company for better
performance of the company or firm.

10. For planning and future forecasting of the firm ratio analysis helps
more.

11. To compare the performance of the firms ratio analysis give brief idea
about current position of the company.

12. Ratio analysis makes comparison easy for the user.one ratio is
compared with another ratio as it shows efficiecy or utilisation of
assets etc.

13. Ratio analysis helps the mangement for future best performance with
help of past performance experience.

Limitation s of Accounting Ratios -
The limitaions of ratio analysis which arise primarily from the nature of
financial statements are as under:

1. Financial statements provide historical information. They do not
reflect current conditions. Hence, it is not useful in pr edicting the
future.

2. Correct and standard ratio can be obtained only if we have true,
comparable or correct data. Lack of true comparison give false
results.

3. Different companies may have differnt accounting methods if two
forms follow differnent accounti ng policies.Different accounting
policies regarding valuation of inventories, charging depreciation etc.
make the accounting ratios of two firms non -comparable.

4. It is essential to have information about the company regarding its
past as well as future tra nsactions to have purposeful analysis. But
ratios give informations only about the past

5. Fixed assets show the position statement at cost only. Hence, it does
not reflcet the changes in price level. Thus, it makes comparison
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155 6. Accounting ratios ar e tools of quantitative analysis only. But it is
quite possible that qualitative aspect may be over quantitative aspects.
So in this case analysis may get distorted.

7. No fixed standards can be laid down for ideal ratios. Some times
ratios may be worked out for insignificant and unrelated figures. Such
ratios will be misleading.e.g. current ratio 2:1

8. It might possible that some firms may manipulate the data to bring
about changes to the ratio for displaying a better picture of the firn,
thus in the ratio an alysis there are scope of window dressing.

9. Ratio analysis may be missinterpret at a time because Profit and loss
acconut is based on actual numbers and balance sheet data is base on
historical so Due to mix of historical and actual numbers it may not
give desired results.

10. Ratios are subject to arithmatical accuracy of the financial statements.
Moreover, financial statements also include estimated data like
provision for depreciation, for bad and doubtful debts etc. hence
results revealed by ratios are su bject to such estimates.

11. Knowledge of ratios alone is meaningless unless their composition is
ascertained.

12. A ratio is a comparison of two figures, a numerator and a
denominator. In comparing ratios, it may be difficult to determine
whether difference ar e due to changes in the numerator, or in the
denominator or in both.

CLASSIFICATION OF RATIOS
The ratios are used for different purposes, for different users and for
different analysis. The ratios can be classified as under:
1. Traditional classification
2. Functional classification
3. Classification from the point of view of users

The above classifications can be elaborated as follows:

 TRADITIONAL CLASSIFICATION

Form this point of view the ratios are classifited as follows:

i. Balance sheet ratios -
This ratio is also known as financial ratios. The ratios which express
relationship between two items or group of items mentioned in the balance
sheet at the end of the year, Some examples of balance sheet ratios are as
follows:
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156 Current ratio
Quick ratio
Propretary rat io
Stock to working capital
Debt equity ratio
Capital gearing ratio

ii. Income statement ratios -
This ratio is also known as Revenue statement ratios which expressed in
relationship between two items or two groups of items which are found in
the income statem ent of the year.

Some examples of income statement ratios are as follows:
Gross profit ratio
Operating cost ratio
Operating profit ratio
Net profit ratio
Stock tournover ratio

iii. Inter statement ratios -
These ratios shows the relationship between two items or two groups of
items of which one is from balance sheet and another from income
statement(trading a/c and profit & loss a/c and balance sheet)
Somr examples of inter statement ratios are as follows:
Return on investment
Return on equity capital ratio
Trade receivable turnover ratio
Trade payabeles turnover ratio
Fixed assets turnover ratio
Earning per share

 FUNCTIONAL CLASSIFICATION
The accounting ratios can also be classified according to their functions as
follows:

i. Liquidity Ratios -
These ratios shows relationship between current assets and current
liabilities:
Some examples of liquidity ratios:
Current Ratio
Quick Ratio

ii. Leverage Ratios/Long term solvency ratios -
These ratios shows relationship between proprietor’s fund and debts used
in finanacing th e assets of the business organization.
Some examples of leverage ratios:
Debt equity ratio
Proprietary ratio
Capital gearing ratio
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157 iii. Activity Ratios/Turnover ratios -
This ratio is also known as turnover or productivity ratio or efficiency and
performance ra tio. These ratio shows relationship between the sales and
the assets. These are designed to indicate the efficiency of the firm or
company in using funds, degress of efficiency, and its standard of
performance of the organization.
Some examples of Activity ratios are as follows:
Stock turnover ratio
Trade receivables turnover ratio
Trade payables turnover ratio
Fixed assets turnover ratio

iv. Profitability ratios -
These ratios show relationship between profits and sales and profit and
investments. It reflects overall performance of the organizations, its ability
to earn return on capital employed and effectiveness of investment policies
Some example of profitability ratios are as follows:
Gross profit ratio
Operating cost ratio
Operating cost ratio
Net proft r atio
Return on investment

v. Coverage ratios -
These ratios show relationship between profit in hand and claims of
outsiders to be paid out of profits.
Some examples of coverage ratios are as follows:.
Dividend payout ratio
Debt service ratio
Debt service co verage ratio

 CLASSIFICATION FROM THE POINT OF VIEW OF USERS
Ratios from the users point of view are classified as follows:

i. Shareholder’s point of view
These ratios are serve the purpose of shareholders. Shareholders, generally
expect the reasonable retur n on their capital.They are interested in the
safety of shareholders investments and interest on it.
Some examples it as follows:
Return of proprietor’s fund
Return on capital
Earning per share

ii. Long term creditors
This ratio provides useful information t o the long term creditors which
include debenture holders,vendors of fixed assets etc. The creditors
interested know the ability of repayment of principle sum and periodical
interest payments as and when they become due.
Some examples of it are as follows:
Debt equity ratio munotes.in

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158 Return on capital employed
Proprietary ratio

iii. Short term creditors
The short term creditors are basically interested to know their repayment
ability of the firm. Therefore, the creditors has important place on the
liquidity aspects of th e company’s assets.
Some examples of it are as follows:
Current ratio
Debtor’s turnover ratio
Stock working capital ratio

iv. Management
Management is interested to use borrowed funds to improve the earnings.
Some examples of its are as follows:
Return on cap ital employed
Turnover ratio
Operating ratio
Expense ratio
Balance sheet Ratios/ Liquidity Ratios/ Short term solvency Ratios
The term ‘liquidity’ and ‘short -term solvency’ are used synonymously.
Liquidity or short -term solvency means ability of the busine ss to pay its
short -term liabiliites.Inability to pay -off short -term liabilities affects its
credibility as well as its credit rating. Continuous default on the part the
business leads to commercial bankruptcy. Eventually such commercial
bankruptcy may lea d to its sickness and dissolution. Short -term lenders
and creditors of a business are very much intersted to know its state of
liquidity because of their finaicial stake. Both lack of sufficient liquidity
and excess liquidity is bad for the organization.
1. Current Ratio - The Currrent Ratio is one of the best known measures
of short term solvency. It is the most common measures of short term
liquidity.

Current ratio measures whether a firm had enough resources to meet its
current obligations.

Formula:
Current Ratio = Current Assets
Current Liabilities

Current Assets= Inventories+Sundry Debtors+Cash and Bank
Balances+Receivables/Accruals+Loans and advances+Disposable
investment+any other current asset.

Current Liabilities= Creditor for goods and service s+Short term
loans+bank overdraft+cash credit+outstanding expenses+provision for munotes.in

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159 taxation+proposed divided+unclaimed dividend+any other current
liabilites.

A generally accepted current ratio is 2:1 But whether or not a specific ratio
is satisfactory depen ds on the nature of the business and the
characteristics of its current assets and liabilities.

Example:
Calculate Current Ratio from the following information

Particulaers Rs.
Inventories 50,000 Trade Receivables 50,000 Advance tax 4,000 Cash and c ash equivalent 30,000 Trade payables 1,00,000 Short term borrowings(bank overdraft) 4,000
Solution:
Current Ratio = Current Assets /Current Liabilities

Current Assets = Inventories+Trade receivables+Advance
tax+Cash and cash equivalents
=Rs. 50,000+Rs.50,000+Rs.4,000+Rs.30,000
=Rs.1,34,000

Current liabilities = Trade payables+short -term borrowings
=Rs.1,00,000+Rs.4,000
=Rs.1,04,000

Current Ratio = Rs.1,34,000 / Rs.1,04,000 =1.29:1


Since, excess of current asset over current liabilities provide a measures of
safety margin available against uncertainty in realisation of current assets
and flow of funds.The ratio should be reasonable.It should be neither be
very high or very low. Both the situations have their inherent
disadvantages. A very high current ratio implies heavy investment in
current assets which is not a good sign as it reflects under utilisation or
improper utilisation of resources. A low ratio dagerous for business an d
put it at risk of facing a situation where it will not be able to pay its short -
term debt on time.Normally, it is safe to have this ratio within range
of 2:1

2. Quick or Liquid ratio - munotes.in

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160 It is the ratio of quick(or liquid) asset to current l iabilities. It is expressed
as :
Quick ratio = Quick Asset:Current Liabilities
Or
Quick Assets
Current Liabilites

Quick assets means those assets which are quickly convertible into cash.
While calculating quick assets we exclude the inventor ies at the end and
other current assets such as prepaid expenses,advance tax etc. from the
current assets. Due to exclusion of non -liquid current assets it is better
than current ratio as a measure of liquididty position of the business. It is
calculated t o serve as a supplimentary check on liquidity position of the
business and is therefore,also known as ‘Acid -Test Ratio’.

Illustration:
Calculate quick ratio from the information given in illustration 1

Solution :
Quick Ratio = Quick Assets
Quick L iabilities
Quick Assets = Current Assets - (Inventories+Advance tax)
= Rs1,34,000 - (Rs.50,000+Rs.4,000)
= Rs 80,000
Quick Liabilities= Rs 1,04,000 – 4,000
Quick Ratio = Rs.80,000 = 0.80:1
Rs. 1,00,000

This Ratio Provides a measures of capacity of the business to meet its
short term obligation without any flaw. Normally, it is advovated to be
safe to have a ratio of 1:1 as unnecessarily low ratio will be very risky and
high ratio suggests unnecessarily deplo yment of resources in otherwise
less profitable short term investments.

3. Proprietary Ratio -
Proprietary ratio express relationship of properietors fund to net assets and
its calculated as follows:
Properietary ratio = Shareholders fund
Capita l employed/ Net assets

OR
Properietary ratio = Proprietary fund
Total Assets
Properietary fund includes equity share capital, preference share capital
and reserves and surplus
Total assets exludes fictitious as sets and losses

This ratio indicates that the proportion of total assets financed by
shareholders. Higher the ratio less risky scenario it shall be
4. Stock Working Capital Ratio - munotes.in

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161 This ratio is calculated as follows:
Stock Working capital ratio = Closing S tock
Working Capital

This ratio indicates the extent of working capital turned over in achieving
sale of the firm

5. Capital Gearing Ratio -
Capital Gearing ratio is calculated to show the proportion of fixed interest
(Dividend) bearing capital to funds belonging to equity shareholders i.e
equity funds or net worth again higher ratio may indicate more risk

Capital Gearing ratio =

Preference share capital + Debentures+Other borrowed funds
___________________________________ _________ ____
Equit y Share Capital+ Reserves and surplus - Losses

6. Debt Equity Ratio -
Debt Equity ratio = Long Term Debt
Shareholder’s Fund
OR
= Total Outside liabilities
Shareholder’s Equity
OR
= Total Debt
Shareholder’s Equity

Where:
Shareholder’s Funds (Equity) = Share capital+ Reserves and Surplus+
Money received against share warrants + Share application money
pending allotment

Share capital = Equity Share capital+ Preference Share capital
OR
Shareholder’s Fund(Equity) = Non Current assets + Working capital –
Non current liabilities

Working Capital = Current As sets- Current liabilities

Not merely Long term debt i.e both current and non current liabilities
Some times only interest bearing, Long term debt used instead of total
liabilities (exclusive of current liabilities)

A high debt to equity ratio means less protection for creditors, a low ratio
on the other hand indicates a wider safety for creditors. The ratio indicates
the proportion of debt fund in relation to equity. The ratio is used for
making capital strucrture decisions such as issue of shares and de bentures,
lenders are also very eager to know this ratio since it shows relative munotes.in

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Financial Management

162 weights of debt and equity. Debt equity ratio is the indicator of firms
financial leaverage.

This ratio measures the degree of indebtedness of an enterprise and gives
an idea to the long term lenders regarding extend of security of the debt.

Illustration :
From the following balance sheet of ABC Co. Ltd as on March 31, 2022
Calculate debt equity ratio

Particulars Amount (Rs)
I. Equity and Liabilities
1. Shareholder’s Fund
(a) Share capital
(b) Reserves and surplus
(c) Money received against share warrants
2. Non current liabilities
(a) Lonag term borrowings
(b) other long term liabilities
(c) long term provisions
3. Current liabilites
(a) Short term borrowings
(b) Trade Payables
(c) Other Current Liabilities
(d) Short Term Provisions
II. Assets
1. Non current Assets
(a) Fixed Assets
(b) Non Current Investments
(c) Long Term Loans and advances
2. Current Assets
(a) Current Investment
(b) Inventories
(c) Trade Receivables
(d) Cash and cash Equiva lents
(e) Short term loans and advances
12,00,000 2,00,000 1,00,000 4,00,000 40,000 60,000 2,00,000 1,00,000 50,000 1,50,000 25,00,000 15,00,000 2,00,000 1,00,000 1,50,000 1,50,000 1,00,000 2,50,000 50,000 25,00,000 munotes.in

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Ratio Analysis

163 Solution:

Debt Equity Ratio = Debts
Equity
Debt = Long term borrowings+other long term liabilities+long term
Provisons
=Rs.4,00,000+Rs.40,000+Rs.60,000
=Rs.5,00,000
Equity =Share capital+Reserves and surplus+Money received against
share warrants
=Rs.12 ,00,000+Rs.2,00,000+Rs.1,00,000
=Rs.15,00,000
Alternatively,
Equity = Non current assets+working capital -non current liabilities
= Rs.18,00,000+Rs.2,00,000 -Rs.5,00,000
=Rs.15,00,000
Working Capital= Current assets -current liabilites
=Rs.7,00,000 -Rs.5,00,000
=Rs.2,00,000

Debt Equity Ratio = 50,000 = 0.33:1
1,50,000

Revenue Statement Ratio
1. Gross Profit Ratio/Gross profit margin -
Gross profit ratio as a percentage of revenu from operations is computed
to have an id ea about gross proft. It measures the percentage of each sale
in rupees remaining after payment for the goods sold.It is calculated as
follows:
Gross profit ratio = Gross profit × 100
Net Revenue of operations
Or
= Gross Profit × 100
Sales
Gross profit margin depends on the relationship between sales price,
volume and costs. A high Gross profit margin is a favourable sign of good
management.

2. Operating Ratio -
It is computed to analyse cost of operation in relat ion to revenun from
operations. Is is calculated as follow:

Operating Ratio=Cost of Revenue from operation+Operating
Expenses
________________________________ ×100
Net Revenue from operation
Operating expenses include office expenses, administrative expenses,
selling expenses, distribution expeses, Depreciation and employee benefit
expenses etc. munotes.in

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Financial Management

164 Cost of operation is determined by excluding non -operating incomes and
expesnses such as loss on sale of assets, interest paid , dividend received,
loss by fire, speculation gain and so on.
Operating Profit Ratio
Operating profit ratio is also calculated to evaluate operating performance
of business or organisation.
Operating Profit Ratio = Operating profit ×100
Sales
Or
= Earning before interest and taxes(EBIT) ×100
Sales
Where as,
Operating profit=Sales -Cost of Goods Sold(COGS) -Operating expenses
Operating profit ratio measures the percentage of each sale in rupees that
remains after the payme nt of all costs and expenses except for interest and
taxes. The ratio is followed closely by analysts because it focuses on
operating results.operating profit is often referred to as earning before
interest and taxes or EBIT

3. Expense ratios -
Based on diffe rent concepts of expenses it can be expressed in different
variants as below:

I. Cost of goods sold(COGS)Ratio = COGS × 100
sales
II. Operating expenses ratio = Administrative exp+selling &
distribution OH × 100
Sales
III. Oper ating Ratio = COGS+ Operarting expenses × 100
Sales
IV. Financial Expenses Ratio = Financial expenses × 100
Sales
*It excludes taxes, loss due to theft, goods destroyed by fire etc.

4. Net profit ratio - Net profit ratio is based on all inclusive c oncept
of profit .It relates revenue from operations to net profit after operational
as well as non -operational expenses and incomes. It is calculated as
under:
Net profit ratio=Net profit/Revene from operations × 100
Or
=Net profit/sales × 100
Or
= Earnings after taxes(EAT)/Sales × 100
Or
Pre-Tax Profit Ratio= Earnings before taxes (EBT)/Sales × 100

Generally, net profit refers to profit after tax (PAT)
It is a measures of net profit margin in relation to revenue from operations.
Besides reveali ng profitability. It is the main variable in computaion of munotes.in

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Ratio Analysis

165 return on investment. It reflects the overall efficiency of the
business,assumes great significance from the point of view of investors.
Net profit ratio finds the proportion of revenue that find i ts way into
profits after meeting all expenses. A high net profit ratio indicates positive
returns from the business.

5. Stock turnover ratio
This ratio is a considerable amount of a company’s capital may be tied up
in the financing of raw materials, work -in-progress and finsihed goods. It
is important to ensure that the level of stocks is kept as low as possible ,
consistent with the need to fulfill customer’s orders in time.
Stock turnover ratio = COGS or Sales
Average I nventory
Average inventory = (Opening Stock+Closing Stock)/2

The highest the stock turnover rate or the lower the stock turnover period
the better, although the ratios will vary between companies.This ratio
measures that how many times stock has been so ld during the year.

Combined Ratios
1. Return on capital employed (ROCE) - It is another variation of
ROI the ROCE is calculated as follow.
ROCE(before tax)= Earnings before interest and taxes(EBIT) ×100
Capital Employed

ROCE (after tax) = EBIT(1 -t) × 100
Capital Employed

Sometimes it also calculated as
= Net profit after taxes (PAT/EAT) × 100
Capital Employed
Where as
Capital Employed = Total assets -Current liabilities
Or
= Fixed assets+Working capital
Or
= Equity+Long term debt

The return on capital employed should be always higher than the rate at
which the company borrows.

Intangible assets should be included in the capital employed.

No fictitious assets should be included in within capit al employed.

If there is information available regarding average capital employed shall
be taken.


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Financial Management

166 2. Return on proprietor’s Fund -
This ratio is important from shareholders point of view in assessing
whether their investment in the firm generates a reasona ble return or not.
It should be higher than the return on investment otherwise it would imply
that company’s funds have not been employed profitability.

A better measure of profitability from shareholders point of view is
obtained by determining return on total shareholder’s funds,it is also
termed as return on shareholder’s fund

Formula:
Return on proprietor’s fund = Profit After Tax × 100
Shareholders funds

3. Return on equity share capital - Return on equity measures the
profitability of equity funds invested in the firm or company. This ratio
shows how profitability of the shareholders have been utilised by the
company. This ratio also measures the percentage of return generated to
equity shareholders

ROE = Net profit after taxes -prefernce di vidend(if any) × 100
Net worth/ equity shareholdre’s funds

4. Debtor’s Turnover Ratio(Debtor’s Velocity) -
This ratio measures whether the amount or resources tied up in debtors, is
reasonable and whether the company has been efficient in converting
debtors into cash.
Formula:
Debtor’s Turnover ratio = Credit Sales × 100
Average Debtores
Debtor’s Velocity Ratio = Average Debtors × 365 days
Credit sales
Average debtors collection period measures how long it takes to collect
amounts from this ratio

5. Earning Per share (EPS)
The profitability of a firm from the point of view of ordinary
shareholder’s can be measured in term of earnings per share basis. It is
calculated as follow:
EPS = Net profit available to equity shar eholders
Number of equity shares outstanding

This ratio is very important from equity shareholders point of view and
also for the share price in the stock market. This also helps comparision
with other to ascertain its reasonableness and capacity t o pay dividend.

6. Dividend Payout ratio -
This ratio measures the dividend paid in relation to net earnings. It is
determined to see to how much extent earnings per share have been
reatined by the management for the business.it is calculated as follows: munotes.in

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Ratio Analysis

167 Dividend payout ratio = Dividend per equity share (DPS)
Earning per share (EPS)

7. Price earning ratio -
The price earning ratio indicates the expectation of equity investors about
the earnings of the firm. It relates earnings to market price and is gener ally
taken as a summary measure of growth potential of an investment, risk
characteristics, shareholders orientation,coperate image and degree of
liquidity. It is calculated as

Price -Earnings per share (P/E Ratio ) = Market price per share (MPS)
Earning per share(EPS)

It indicates the payback period of the investor or prospective investors. A
higher P/E ratio could either mean that a company’s stock is over -valued
or the investors are expecting high growth rate in future

Ratios at a glance
Sr.
no Ratio Formula Interpretation
1 Current Ratio Current Asset
Current Liabilities A simple measure that
estimates whether the
business can pay short term
debts. Ideal ratio is 2:1
2 Quick Ratio Quick Assets
Current Liabilities It measures the ability to
meet current debt
immediately. Ideal ratio is
1:1
3 Proprietary
Ratio Properietary Fund
Total Assets It measures the proportion of
total assets financed by
shareholders.
4 Stock working
capital ratio Closing Stock
Working Capital This ratio indicates th e extent
of working capital turned
over in achieving sale of the
firm
5 Capital gearing
ratio (Preference+Debent
ures+other borowed
funds
(Equity share
capital+Reserves &
Surplus -losses) It shows the proportion of
fixed interest bearing capital
to equity s hareholder’s fund.
It also signifies the advantage
of financial leverage to the
equity shareholders.
6 Debt equity
ratio Long Term Debt
Shareholder’s Fund
OR
Total Outside
Liabilities
Shareholder’s This ratio meas ures the
degree of indebtedness of an
enterprise and gives an idea
to the long term lenders
regarding extend of security
of the debt. munotes.in

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Financial Management

168 Equity
OR
Total Debt
Shareholder’s
Equity
7 Gross profit
ratio Gross profit × 100
Sales This ratio tells us something
about the business’s ability &
consistancy t o control its
production costs or to
manage the margins it makes
on products it buys and sells.
8 Operating ratio COGS+Operating
Expenses × 100
Sales It measures portion of a
particular expenses in
comparison to sales
9 Operating
Profit ratio Operating profit × 100
Sales
OR
Earning before
interestand taxes
(EBIT) × 100
Sales
The ratio is followed closely
by analysts becauseit focuses
operating results. Operating
profitis often referred to as
earni ng before interest and
taxes or EBIT
10 Expense ratio Administrative
exp+selling & Distribution OH × 100
Sales It measures portion of a
particular expenses in
comparison to sales
11 Net profit ratio Net Profit × 100
Sales It measures the relati onship
between net profit and sales
of the business
12 Stock turnover
ratio COGS
Average inventory This ratio measures that how
many times stock has been
sold during the year.
13 Return on
capital
employed Before tax=
EBIT × 100
Capital Employed
Afer Tax =
EBIT (1 -t) × 100
Capital Employed It measures overall
earnings(either before or after
tax) on total capital
employed.
14 Return on
Proprietor’s
Funds Profit after tax×100
Shareholder’s fund A better measure of
profitability from
shareholders po int of view is
obtained by determining munotes.in

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Ratio Analysis

169 return on total shareholder’s funds.
15 Return on
equity share
capital Net profit after
taxes -prefernce
dividend (if any)
× 100
Net worth/ equity
shareholdre’s funds
It indicates earnings available
to equity sha reholder’s in
comparison to equity
shareholder’s net worth.
16 Debtor’s
Turnover ratio Credit sales × 100
Average Debtor’s It measures the efficiency at
which firm is managing its
receivables.
17 Debtor’s
velocity Average Debtor’s × 365days
Credit Sales It measures the velocity of
collection of receivables.
18
Earning per
share Net profit available
to equity
shareholders
Number of equity
shares outstanding EPS measures the overall
profit generated for each
share in existence over a
particular per iod.
19 Dividend
payout ratio Dividend per equity
share(DPS)
Equity per
share(EPS) It measures dividend paid
based on market price of
shares.
20 Price Earning
ratio Market Price Per
Share (MPS)
Earning Per Share
(EPS) At any time, the P/E ratio is
an ind ication of how highly
the market “rates” or
“values” a business. A P/E
ratio is best viewed in the
context of a sector or market
average to get a feel for
relative value and stock
market pricing.

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Financial Management

170 Exercise with solution
1) The following information availab le for the year 2021 -2022
calculate GP ratio:
Revenue from the operatios: Cash 25000 Credit 75000 Purchases Cash 15000 Credit 60000 Carrigae inwards 2000 Salaries 25000 Decrease in inventory 10000 Return outwards 2000 Wages 5000
Solution:
Revenue from operations= Cash revenue from operations+Credit revenue
from operation
=Rs.25,000+Rs.75,000=Rs1,00,00
Net purchases =Cash purchases+credit purchases -Return
outwards
=Rs15000+Rs.60000 -Rs.2000=Rs.7300 0
Cost of revenue from =Purchases+(opening inventory -closing
inventory)+Direct operations expenses
=Purchases+Decrease in inventory+Direct
Expenses
Rs.73000+Rs10000+(Rs2000+Rs5000)
= Rs 90000
Gross profit = Revenue from operations -Cost of revenue from operations
=Rs100000 -Rs90000
= Rs10000
Gross profit ratio= Gross profit/Net revenue from operations 100
= Rs 10000/Rs100000 100
=10%

2) A trader carries an average stock of Rs.80,000. His stock turnover
is 8 times. If he sells goods at profit of 20% on sales. Find out the profit. munotes.in

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Ratio Analysis

171
Solution:
Stock turnover ratio= Cost of goods sold/Average stock
= Cost of goods sold/Rs.80,000

Cost of goods sold = Rs.80,000×8
= Rs.6,40,000

Sales= Cost of goods sold×100/80
= Rs.6,40,000×100/80
= Rs.8,00,000

Gross profit=Sales -Cost of goods sold
=Rs.8,00,000 -Rs.6,40,000
=Rs.1,60,000

3) The total sales (all credit) of a firm are Rs.6,40,000. It has a gross
profit margin of 15 per cent and a current rat io of 2.5 . The firm’s current
liabilities are Rs.96000; inventories Rs.48,000 and cash Rs.16,000.

a) Determine the average inventory to be carried by the firm, if an
inventory turnover of 5 times is expected?(Assume 360 days a year)

b) Determine the av erage collection period if the opening balance of
debtors is intended to be of Rs.80,000?(Assume 360 days a year).

Solution:
a) Inventory turnover = Cost of goods sold
Average inventory

Since gross profit margin is 15 per cent, the cost of goods sold should be
85 per cent of the sales.

Cost of goods sold=0.85×Rs.6,40,000=Rs.5,44,000
Thus, Average inventory = COGS/Inventory Turnover
= 5,44,000 /5
Average inventory = Rs.1,08,000

b) Average collection period= Average receivables ×360 days
Credit sales
Averagte receivables= (opening receivables+closing receivables) /2

Closing balance of receivables is found as follows:

Particulars Rs. Rs.
Current assets(2.5 of current
liabilities) 2,40,000 Less: Inventories 48,000 munotes.in

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Financial Management

172 Cash 16,000 64,000 Closing Receivables 1,76,000
Average receivables =(Rs.1,76,000+Rs.80,000 )/2
=Rs.1,28,000

So, average collection period = Rs.1,28,000 ×360 days
Rs.6,40,000
= 72 days.

4) The following Trading and profit and loss account of fantasy ltd.
For the year 31/03/2022 is given below.

Particulars Rs. Particulars Rs.
To Opening stock 76,250 By Sales 5,00,000 To Purchases 3,15,250 By Closing stock 98,500 To Carriage and Freight 2,000 To Wages 5,000 To Gross profit c/d 2,00, 000 5,98,000 5,98,000 To Administration
Expenses 1,01,000 By Gross profit b/d 2,00,000 To selling and dist
expenses 12,000 By non operating
incomes: Non operating expenses 2,0000 Interest on securities 1,500 Financial expenses 7,000 Dividend on s hares 3,750 Net profit c/d 84,000 Profit on sale of
shares 750 2,06,000 2,06,000

Calculate:
1) Gross profit Margin 2) Expenses ratio 3) Operating ratio 4) Net profit
ratio 5) Operating (net ) profit ratio 6) stock turnover ratio

Solution:

1) Gross profit margin= Gross profit × 100
Sales
= 2,00,000 × 100
5,00,000
= 40%

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Ratio Analysis

173 2) Expenses ratio = Op. Expenses ×100
Net sales
= 1,13,000 × 100
5,00,000
= 22.60%

3) Operating ratio = Cost of good s sold+op. expenses × 100
Net sales
= 3,00,000+1,13,000 × 100
5,00,000
= 82.60%
Cost of goods sold = Op. stock+purchases+carriage and freight+wages -
Closing stock
= 76,250+3,15,250+2,000+5,000 -98,500
= Rs.3,00,000

4) Net profit ratio = Net profit × 100
Net sales
= 84,000 × 100
5,00,000
= 16.8%

5) Operating profit ratio = Operating profit × 100
Net sales
Operating profit= sales -(op exp+admin exp)
87,000 × 100
5,00,000
=17.40%

6) Stock Turnover ratio = Cost of goods sold
Avg stock
3,00,000
87,375

5) The Balance Sheet of Punjab Auto Limited as on 31 -12-2002 was as
follows
Particular Rs. Particular Rs.
Equity Share Capital 40,000 Plant and Machinery 24,000 Capital Reserve 8,000 Land and Building 40,000 Capital Reserve 8,000 Furniture & Fixtures 16,000 8% Loan on Mortage 32,000 Stock 12,000 Creditors 16,000 Debtors 12,000 Bank overdraft 4,000 Investment (Short -term) 4,000 Taxation: Cash in hand 12,000 munotes.in

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Financial Management

174 Current 4,000 Future 4,000 Profit and Loss A/c 12,000 1,20,000 1,20,000
From the above, compute (a) the Current Ratio, (b) Quick Ratio, (c ) Debt -
Equity Ratio, and (d) Proprietary Ratio.

Solution:

(Problem related to Balance Sheet Ratio)
1. Current Ratio = Current Assets
Current Liabilities
Current Assets= Stock+d ebtors+Investment (Short term)+
Cash in hand
Current Liabilities=Creditors+bank overd raft+Provision for
taxation (Current & Future)
CA =12,000+12,000+4,000+12,000 = 40,000
CL=16,000+ 4,000+4,000+4,000 = 28,000
= 40,000
28,000
= 1.43:1

2. Quick Ratio = Quick Assets
Quick Liabilities
Quick Assets = Current Assets -Stock
Quick Liabilities = Current Liabilities - (BOD+PFT future)
QA= 40,000 -12,000
= 28,000
QL = 28,000 -(4,000+4,000)
= 20,000
=28,000
20,000
= 1.40:1

3. Debt -Equity Ratio = Long Term D ebt (Liabilities)
Shareholders Fund
LTL = Debentures + Long term loans
SHF = Eq.Sh.Cap.+ Reserves & Surplus+Preference Sh.
Cap. – Fictitious Assets
LTL =32,000
SHF= 40,000+8,000+12,000
= 60,000
= 32,000
60,000
= 0.53:1
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Ratio Analysis

175 4. Proprietary Ratio = Shareholder’s Funds
Total Assets
SHF=Eq.Sh. Cap.+ Reserves & Surplus + Preference Sh.
Cap.-Fictitous Assets
Total Assets = Total Assets -Fictitious Assets
SHF=40,000+8,000+12,000
= 60,000
TA = 1,20,000
= 60,000
1,20,000
= 0.5:1

6) Cash Purchased ratio Rs.1,00,000 cost of goods sold Rs. 3,00,000
opening stock Rs.1,00,000 and closing stock Rs.2,00,000. Creditors
turnover ratio 3 times. Calculate the opening and closing creditors if the
credit ors at the end were 3 times more than the creditors at the begining.

Solution
Total Purchase = Cost of goods sold + closing stock -opening stock
= Rs.3,00,000+2,00,000 – Rs.1,00,000
= Rs.4,00,000
Credit purchase = Total purchase -cash purchase
= Rs.4,00,000 -1,00,000
= Rs.3,00,000
Creditor Turnover Ratio = Net Credit Purchase / Average Creditor
Average Creditor = Rs. 3,00,000/ 3
= Rs.1,00,000
(Opening Creditor + Clos ing Creditor)/2=Rs.1,00,000
Opening Creditor + Closing Creditor ) = Rs.2,00,000
(Opening Creditor + (Opening Creditor+3 Opening Creditor)
= Rs.2,00,000
Opening Creditor = Rs.40,000
Closing Creditor = Rs.40,000+(3×Rs.40,000)
= Rs.1,60,000

7) Calculate Gross Profit ratio from the following information:
Opening stock Rs. 50,000; closing stock Rs.75,000; cash sale
Rs.1,00,000; credits sales Rs.1,70,000; Returns outwards Rs.15,000;
purchased Rs.2,90,000; advertisement expenses Rs.30,000; carria ge
inwards Rs.10,000

Solution :

Cost of goods sold = Opening stock+net purchase + direct expenses -
closing stock
= Rs. 50,000 + (Rs. 2,90,000 – Rs. 15,000) + Rs. 10,000 -Rs.75,000
= Rs. 2,60,000
Total Sales = Cash Sales + Credits Sales
= Rs.1,00,000+Rs.1,70,000
= Rs. 2,70,000 munotes.in

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176 Gross profit= Total Sales -Cost of goods sold
= Rs.2,70,000 -Rs.2,60,000
= Rs. 10,000
Gross profit Ratio = 10,000×100
2,70,000
= 3.704%

8) M/s. Vinay Ltd. Presents the following Trading and Profit & Loss A/c
for the year ended 31.3.2014 and balance sheet as on that date.
Trading and Profit and Loss account for the year ended 31.3.2014
Particulars Amt Partic ulars Amt
To opening stock 2,00,000 By sales 12,00,000 To purchases 5,00,000 By closing Stock 4,00,000 To Wages 3,00,000 To Gross Profit c/d 6,00,000 16,00,000 16,00,000 To Salaries 1,50,000 By Gross Profit b/d 6,00,000 To Rent 60,000 By Profi t on sale of
Machinery 5,000 To Commission 12,000 By Interest 15,000 To Advertising 20,000 To Interest 83,000 Depreciation 30,000 To Provision for tax 50,000 To Net Proft c/d 2,15,000 6,20,000 6,20,000 To Proposed 80,000 By balance b/f 1,85,000 To Preference 16,000 By Net profit b/d 2,15,000 To Balance c/d 3,04,000 4,00,000 4,00,000
Balance sheet as on 31.3.2014
Liabilities Amt Assets Amt
Equity share capital
(Rs.100) 8,00,000 Land and Building 6,00,000 8% Pref. Sh.Capita l 2,00,000 Plant and
Machinery 5,50,000 Reserve and surplus 3,04,000 Furniture 4,00,000 7% Debentures 5,00,000 Investment 2,70,000 munotes.in

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Ratio Analysis

177 Loan from IDBI 6,00,000 Stock 4,00,000 Creditors 1,50,000 Debtors 2,00,000 Bills Payable 50,000 Bills receivable 1,60,00 0 Provision for tax 50,000 Advance tax 30,000 Dividend Payable 96,000 Prepaid expenses 40,000 Cash in Hand 20,000 Bank Balance 60,000 Dis. On issue of
Debentures 20,000 27,50,000 27,50,000

Additional information :
1) The Market Price of equal ly shares as on 31.03.2014 was Rs. 90.
2) Out of total sales, 30% are cash sales and out of total Purchases,50%
are credit purhases. You are required to calculate the following
Ratios:
a) Return on Capital employed
b) Price earning Ratio
c) Debt Service Ratio
d) Credi tors Turnover Ratio
e) Retu rn of equity capital
208000

Solution:

Return on
capital
employed NOPBIT Capital Employed ×100
NOPBIT



Capital Employed 3,28,000 x 100
24,04,000

6,00,000-1,50,000-60,000
-12,000-20,000-30,000

8,00,000+2,00,000+3,04,0
00+5,0 0,000+6,00.000 13.64%
Creditors
Turnover
Ratio Credit Purchase
Avg Creditors + Bills
payable 2,50,000
2,00,000
1.25
Time

Price Earning
Ratio


EPS MPS
EPS

Net Profit -Pref. Div
No.of Equity Shares 90
24.88

2,15,000 -16,000
8,000 3.62


24.88
Return on NPAT - Pref. Div 2,15,000 - 16,000 × 100 24.875% munotes.in

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178 Equity Capital Eq.Sh Cap 8,00,000
Debit Equity
Ratio NPBIT
Interest 2,15,000+50,000+83,000
83,000 4.19
Times

9) X Co. has made plans for the next year. It is estimated that the
company will employ total assets of Rs.8,00,000; 50% of the assets being
financed borrowed capital at an interest cost of 8% per year. The direct
costs for the year are estimated at Rs. 4,80,000 and all the opera ting
expenses are estimated at Rs.80,000. The goods will be sold to customers
at 150% of the direct costs. Tax rate is assumed to be 50%.

You are required to CALCULATE; (i) Operating profit margin (before
tax) (ii) net profit margin (after tax) (iii) retu rn an assets (an operating
profit after tax); (iv) asset turnover and (v) return on owner’s equity.

Solution:
The net profit is calculated as follows:

Particulars Rs.
Sales (150% of Rs.4,80,000) 7,20,000 Direct costs (4,80,000) Gross profit 2,40,000 Operating expenses (80,000) Profit before interest and Tax (EBIT) 1,60,000 Interest changes (8% of Rs. 4,00,000) (32,000) Profit before taxes 1,28,000 Taxes (@) 50% (64,000) Net profit after taxes 64,000
(i) Operating profit margin = EBIT = Rs. 1,60, 000 =0.2222 or 22.22%
Sales Rs. 7,20,000

(ii) Net profit margin = Net Profit after taxes = Rs.64,000 = 0.089 or 8.9%
Sales Rs.7,20,000
(iii) Return on asset s = EBIT (1 -T) = Rs.1,60,000(1 -0.5) = 0.10 or 10%
Assets 8,00,000
(iv) Asset turnover = Sales = Rs.7,20,000 = 0.90x
Assets Rs.8,00,00 0
(v) Return on equity = Net Profit after taxes = Rs.64,000
Owner’s equity 50% of Rs.8,00,000
= Rs. 64,000 = 0.16 or 16%
Rs 4,00,000 munotes.in

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179
10) From th e following ratios and information given below, prepare
Trading Account, Profit and Loss Account and Balance Sheet of Hibacus
Company.
Fixed Assets Rs. 40,00,000
Closing Stock Rs. 4,00,000
Stock turnover ratio 10
Gross profit ratio 25%
Net profit ratio 20%
Net profit to capital 1/5
Capital to total liabilities 1/2
Fixed assets to capital 5/4
Fixed assets/Total cuurent assets 5/7
Solution:

Workings:
i. Fixed assets = 5
Total current assets 7
Or, Total current assets= Rs 40,00,000×7 =Rs.56,00,000
5
ii. Fixed assets = 5
Capital 4
Or, Capital= Rs.40,00,000×4 = Rs.32,00,000
5
iii. Capital = 1
Total liabilities* 2
Or,Total liabilities = Rs.32, 00,000×2 =Rs 64,00,000
*It is assumed that total liabilities do not include capital.

iv. Net profit = 1
Capital 5
Or, Net profit= Rs.32,00,000×1/5=Rs.6,40,000

v. Net profit = 1
Sales 5
Or, sales =Rs.6,40,000×5= Rs.32,00,000

vi. Gross profit=25% of Rs.32,00,000

vii. Stock Turnover = Cost of goods sold(i.e Sales -Gross profit)
Average Stock
10 = Rs.32,00,000 -Rs.8,00,000
Average Stock
Or, Average stock =Rs.2,40,000
Or, opening stock+Rs.4,00,000 =Rs.2,40,000
2
Or,Openin g stock =Rs.80,000


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180 Trading Account

Particulars Rs. Particulars Rs.
To opening Stock 80,000 By Sales 32,00,000 To Manufactuing
exp/purchases 27,20,000 To Gross profit b/d 8,00,000 By closing stock 4,00,000 36,00,000 36,00,000


Profit and loss account

Particulars Rs. Particulars Rs.
To opening
expenses
(Balancing figure) 1,60,000 By Gross profit c/d 8,00,000 To Net Profit 6,40,000 8,00,000 8,00,000 Balance sheet
Capital and
liabilities Rs. Assets Rs.
Capital 32,00, 000 Fixed assets 40,00,000 Liabilities 64,00,000 Current assets: Closing stock 4,00,000 Other current
assets(bal figure) 52,00,000 96,00,000 96,00,000
Theory Questions
1) Explain what is the ratio analysis?
2) What is the purpose of liquid ratio?
3) “Ratio analysis is the only tool and not a final decision.” Discuss.
4) Whar are the limitations of ratio analysis?
5) Discuss the benefits of ratios.
6) How are the ratio classified from the point of view of users.
7) Write short notes on munotes.in

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181 i. Quick ratio
ii. Debtors turnover r atio
iii. Earning per share
iv. Return on equity


Practice Problems
1) From the following balance sheet and other information, calculate
following ratios:


(i) Debt equity ratio
(ii) Working capital turnover ratio
(iii) Trade receivables turnover ratio
Balance sheet as a march 31, 2021
Additional information:Revenu e from operation Rs. 18,00,000

(Ans. Debt -Equity Ratio 0.63:1,Working capital turnover ratio 1.38 times,
trade receivables turnover ratio 2 times)
Particulars Rs.
1) Equity and liabilities
1) Shareholder’s fund
(a)Share capital
(b)Reserves and surplus
(c)Money re ceived against share warrants
2) Non-current Liabilities
Long term borrowings
3) Current liabilities
Trade payables

2) Assets
1) Non current assets
Fixed assets
-tangible assets
2) Current assets
(a)Inventories
(b)Trade receivable
(c)Cash and cash equivalents 10,00,00 0 7,00,000 2,00,000 12,00,000 5,00,000 36,00,000 18,00,000 4,00,000 9,00,000 5,00,000 Total 36,00,000 munotes.in

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182 2) Cost of revenue from operations is Rs 1,50,000.Operating expenses are
Rs.60,000.Revenue from operations is Rs2,50,000.Calculate operating
ratio.

(Ans. Operating Ratio 84%)

3)From the following information calculate Gross profit ratio, inventory
turnover ratio and trade receivable turnover ratio.

Revenue from operations
Rs.3,00,000
Cost of revenue fr om operations Rs.2,40,000
Inventory at the end
Rs.62,000
Gross profit Rs.60,000
Inventory in the beginning Rs.58,000
Trade receivables Rs.32,000

(Ans:Gross profit ratio 20%, Inventory turnover ratio 4 times, Trade
receivable s turnover ratio 9.375 times.)
4)Compute working capital turnover ratio, debt equity ratio and
proprietary ratio from the following information.

Paid up share capital
Rs.5,00,000
Current assets
Rs.4,00,000
Revenue from operations
Rs.10,00,000
13% Debentures Rs.2,00,000
Current liabilities Rs.2,80,000

(Ans: Working capital ratio 8.33 times, Debt –Equity ratio 0.4:1, and
proprietary ratio 0.71:1)

5)Calculate Debt equity ratio from the following information:

Total as sets Rs.15,00,000
Current liabilities Rs.6,00,000
Total debts Rs.12,00,000

(Ans: Debt -Equity Ratio 2:1)

Multiple choice questions

1. Ratio of net sales to net working capital is a:
(a) Profitability ratio
(b) Liquidity ratio
(c) Current ratio
(d) Working capital turnover ratio munotes.in

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183
2. Long term solvency is indicated by
(a) Debt -equity ratio
(b) Current ratio
(c) Operating ratio
(d) Net profit ratio
3. Ratio of net profit before interest and tax to sales is:
(a) Gross profit ratio
(b) Net profit ratio
(c) Operating ratio
(d) Interest coverage ratio

4. Oberving changes in the financial variables across the year is:
(a) Verticle analysis
(b) Horizontal analysis
(c) Peer-firm analysis
(d) Industry analysis

5. The Receivables -turnover ratio helps managem ent to:
(a) Managing resources
(b) Managing inventory
(c) Managing customer relationship
(d) Managing working capital

6. Which of the following is liquidity ratio?
(a) Equity ratio
(b) Proprietory ratio
(c) Net working capital
(d) Capital gearing ratio

7. Whic h of the following is not a part of Quick assets?
(a) Disposable investments
(b) Receivables
(c) Cash and cash equivalents
(d) Prepaid expenses

8. Capital gearing ratio is the fraction of:
(a) Preference share capital and debentures to equity share capital a nd
reserves and surplus
(b) Equity share capital and reserves and surplus to prefernece share
capital and debentures
(c) Equity share capital to total assets
(d) Total assets to equity share capital

9. From the following information calculate P/E ratio:
Equi ty share capital of Rs.10 each
Rs.8,00,000
9% Preference share capital of Rs. 10 each
Rs.3,00,000 munotes.in

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184 Profit (after 35% tax)
Rs.2,67,000
Depreciation
Rs.67,000
Market price of equit y share Rs.48
(a)15 times
(b)16 times
(c)17 ti mes
(d)18 times

10. A company has average accounts receivable of Rs.10,00,000 and
annual credit sales of Rs.60,00,000. Its average collection period would
be:
(a) 60.83 days
(b) 6.00 days
(c) 1.67 days
(d) 0.67 days

(Ans: 1 (d) 2(a) 3(c) 4(b) 5(d) 6(c) 7(d) 8(a) 9(b) 10(a)


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185 5
SOURCES OF FINANCING
Unit Structure
5.0 Objectives
5.1 Meaning of Finance
5.2 Need for Finance
5.2 Sources of Finance
5.3 Exercises
5.0 OBJECTIVES
After studying this unit you willunderstand:
 Meaning offinance
 Need and Importance of Finance
 Sources of long term finance
 Sources of short termfinance
5.1 MEANING OF FINANCE
Finance is a broad term that describes activities associated with banking,
leverage or debt, credit, capital markets, money, and investments.
Basically, finance represents money mana gement and the process of
acquiring needed funds. Finance also encompasses the oversight, creation,
and study of money, banking, credit, investments, assets, and liabilities
that make up financial systems. It is necessary to raise finance from
various sour ces for implementation of the project. The schemes of finance
will be determined after consideration of various aspects attached to
different sources of finance as following:
a) Share capital –preference shares and equityshares
b) Debentures
c) Term loan from finan cial institutions
d) Unsecured loan -banks, promoters,others.
5.1.1 Promoters Contribution
The persons who are involved in implementation of a project are known as
promoters .An entrepreneur who promotes the project is also required to
participate in the schem e of finance of the project. The extent of munotes.in

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186 promoter’s contribution in the project is a sign of interest of the promoters
in the project. Promoter’s contribution indicates the extent of their
involvement the inthe project. The promoters contribution can be provided
in the form of subscribing to equity and preference shares issued by the
company unsecured loans ,seed capital assistance and internal accrual of
funds .The bank and financial institution normally participate in the
scheme of project finance and t hey ask the promoters to bring in a certain
portion of funds required which is normally between 25% to 50% of the
cost of the project into the equity share capital of the company .The
promoters contribution can be arranged from outside sources like friends
and relatives. For eligibility of the project financing the financial
institution may stipulate minimum promoter’s contribution which is to be
arranged by the promoters.
5.1.2 Margin money
The banks and financial institutions maintain a margin while finan cing the
project cost. They asked the borrowers to bring a certain amount of the
cost of the project cost as margin money to safeguard from the changes in
the value of assets that are being financed and provided as a security. The
quantum of margin money t o depend upon the creditworthiness of the
borrower and nature of security provided to the institution. Margin money
is one of the important factors which are evaluated by the financial
institutions while considering the project for financial assistance. Th e
margin money required for working capital will be provided in the project
cost .The RBI guidelines provide the amount of capital brought by the
promoters in project financing.
5.1.3 Capital Structure
Capital structure refers to the mix of a firm’s capita lization and includes
long-term source of fund such as debentures, preference shares, equity
share, and retained earnings. The decision regarding the forms of
financing their requirements and their relative proportions in total
capitalization are known as capital structure decision. A firm has the
choice to raise capital for financing its project from different sources in
different proportions as follows:
(a) exclusive use of equity capital
(b) Use of equity and preferencecapital
(c) Use of equity and debt capital
(d) Use of equity, preference and debtcapital
(e) Use of a combination of debt, equity and preference capital in
differentproportions.

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187 The choice of combination of these sources is called capital structure mix.
5.1.4 Optimum Capital Structure:
The theory of optimal capital structure deals with the issue of right mix of
debt and equity in the long term capital structure of a firm. This theory
states that if a company takes on debt the value of the firm increases up to
a point, beyond that point if debt continues to in creases then the value of
the firm will start to decrease. if the company is unable to repay the debt
within the specified period, then it will affect the goodwill of the company
in the market . Therefore, the company should select its appropriate capital
structure with due consideration to the factors of debt and equity.
5.1.5 Trading on Equity
The term ‘trading on equity’ is derived from the fact that debts are
contracted and loans are raised mainly on the basis of equity capital. The
concept of trading o n equity provides that the capital structure of a
company should include equity as well as debt. Again the proportion of
debt in the capital structure should also be optimal. Those who provide
debt have a limited share in the firm’s earnings and hence want to be
protected in term of earning and values represented by equity capital.
Since fixed charges do not vary with the firm’s earnings before interest
and tax, a magnified effect is produced on earning per share. The
determination of optimal level of debt is a formidable task and is a major
policy decision .EBIT -EPS analysis is a widely used tool to determine the
level of debt in afirm.
5.2 NEEDS AND IMPORTANCE OF FINANCE
What is the main purpose of business finance? or Why is finance so
important?
1. Estab lishment of Business Enterprises:
The promotion of any establishment or any type of enterprise basically
requires finance.
Finance is required at every stage of the business establishment like
a. During registration of the company,
b. At the incorporation stage,
c. For obtaining the certificate for starting the business and
d. also for obtaining various permissions
Besides, expenditure on these requirements, finance is required for
arranging the Assets such as working place, plant and machinery, and
furniture and equipment, for short term items like working material,
furnishing and salaries of the employees.
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188 Thus, finance is required to complete the initial activities of the business
enterprise.
2. Proficient Operation of Business
Operations of business cannot be efficiently operated without finance. The
activities such as purchase of raw materials, sending of products to the
consumers, conversion of raw materials into finished product and sale
cannot be done without efficient finance.
3. Development and Expansion of Business
Finances are required for the overall development and extension of all
business activities in compatibility with advance technology. With
finances, various commodities can be upgraded with the purchases or sold
or produced. Besides, finance (capital) is also required for the purchasing
of techniques, machinery, and equipment, the establishment of
Laboratories, etc.
4. Sound Business Position
Finance is an important measure by which the position of a business is
measured i.e. whether i t is strong or weak, Few examples of business
transactions like payments to the suppliers, remuneration and facilities to
the Employees and payment of principal amount and interest can be paid
to the lender within due date only when sufficient funds are av ailable.
5. Surviving in the Competition Era
One of the biggest threats to any business units are their competitors.
Performing with an aim to meet the expectations of the customers and
having edge over the competitors requires finance. To gain such edge o ne
organisation has to look in many aspects. So there should be proper
policies and allocation of required funds towards relating advertisement
and publicity, production and distribution of commodities and services,
incentives to the consumers, sale promot ion, providing services and
commodities at a fair price are required, to face present -day competitors.
6. Infrastructural Facilities:
Finance is also required for arranging infrastructural facilities which are
essential for any business entrepreneurship. T he volume of finance
required depends upon the nature of the business organisation i.e.
Proprietary business, may be high or low, according to the coverage of
various Enterprises. Substantial capital is required for all infrastructural
facilities, place, land, office site, plant installation for the establishment of
industries, place for conversion of raw materials into finished products,
water, electricity, telephone, etc.
7. Modernization of Business
In this era there dynamism and ever changing technolog ies, there is always
need for upgradation. Finances are required for technical know -how, munotes.in

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189 research and development, new techniques, new machinery, various new
products, and computerization, which are essential for the upgradation,
modernization and operatio n of the business.
8. Labour Welfare and Social Security
For the success of any business or enterprise, human relations between
employers and workers should be cordial. In order to ensure the same,
entrepreneurs should essentially safeguard the interests o f the employees
and workers. Employer should proper facilities like – that of housing,
primary treatment, health, education, libraries, and reading rooms, travel,
etc. In addition, they are also to be provided provident fund, gratuity,
pension, old age, pe rsonal or group insurance and accidental insurance,
etc. All these need a substantial volume of finance.
5.3 SOURCES OF FINANCE
The sources from which a business meets its financial requirements can be
classified on the basis oftime, ownership and source o f generation as
explained in Figure 5.1.

Figure 1
5.3.1 Long Term Sources of Finance
Long -term financing means capital requirements for a period of more than
5 years to 10, 15 or 20 years or maybe more depending on other factors. munotes.in

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190 Capital expenditures in fixed assets like plant and machinery, land and
building etc. of a business are funded using long -term sources of finance.
Part of working capital which permanently stays with the business is also
financed with long -term sources of f inance. Long term financing sources
can be in form of any of them:
(a) Equity Shares.
(b) Preference Shares.
(c) Debentures
(d) Bonds.
(e) Term Loans.
(f) Venture Funding
(g) Assets Securitization
(h) International Financing
(a) Equity Shares
Equity share is a main source of finance for any company giving investors
rights to vote, share profits and claim on assets. We call it stock, ordinary
share, or shares, all are one and the same.Normally, a company is started
with equity finance as its first source of capital from the owners or
prom oters of that company. The company then finds an investor in the
form of friends, relatives, venture capitalists, mutual funds, or any such
small group of investors and issue fresh equity shares to these investors.A
point comes where the company reaches a very big level and requires huge
capital investment for business growth. It then offers its equity share to the
general public. This is called Initial Public Offer (IPO). More such issues
in future are called Follow -on Public Offer (FPO).
They are categori zed under long -term sources of finance because legally
they are irredeemable in nature. For an investor, these shares are
certificate of ownership in the company by virtue of which investors are
entitled to share the net profits and have a residual claim o ver the assets of
the company in the event of liquidation. Investors have voting rights in the
company and their liability to the company is limited to the amount of
investment.
Types of Equity Shares
There are various types of equity shares classified bas ed on various things:
i Authorized Share Capital: It is the maximum amount of capital which
can be issued by a company. It can be increased from time to time.
Some fee is required to be paid to legal bodies accompanied with some
formalities.
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191 ii Issued Share Ca pital: It is that part of authorized capital which is
offered to investors.
iii Subscribed Share Capital: It is that part of Issued capital which is
accepted and agreed by the investor.
iv Paid Up Capital: It is the part of subscribed capital, the amount of
which is paid by the investor.
Normally, all companies accept complete money in one shot and therefore
issued, subscribed and paid capital becomes one and the same.
Conceptually, paid up capital is the amount of money which is actually
invested in the business.
There are other types of equity shares discussed below:
i Rights Share: These are the shares issued to the existing shareholders
of a company. Such kind of shares is issued to protect the ownership
rights of the investors.
ii Bonus Share: These are the type of shares given by the company to its
shareholders as a dividend. There are various advantages and
disadvantages of bonus shares like dividend, capital gain, limited
liability, high risk, fluctuation in the market, etc.
iii Sweat Equity Share: These shares are i ssued to an exceptional
employees or directors of the company for their exceptional job in
terms of providing know -how or intellectual property rights to the
company.
Various Prices of Equity Shares
i Par or Face Value: It is the value of a share of which it is accounted in
books of accounts.
ii Issue Price: It is the price at which the equity share is actually offered
to the investor. Normally, the issue price and face value of a share are
same in the case of new companies.
iii Share Premium and Share at Discount: When a share is issued at a
price higher than face value, the excess amount is called premium.
Contrary to it, if the share is issued at a price lower than face value, it
is said to be issued at a discount.
iv Book Value: It is the ratio of the total of paid -up capital and reserves
and surplus divided by total no. of shares. This is the balance sheet
value of shares.
v Market Value: In the case of companies listed on stock exchanges, the
market value of the share is the price at which they are sold currently
sold in the market.
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192 Investing and Financing Angle of Equity Shares
When talking about equity shares, there are two angles. One is an
investor’s angle wherein the investor invests in equity shares and second
financing angle where a company accepts the finance in the form of
equity. There are pros and cons of both of these as described below.
ADVANTAGES
i Dividend: An investor is entitled to receive a dividend from the
company. It is one of the two main sources of return on his
investment.
ii Capital Gain: The other source of return on investment apart from
dividend is the capital gains. Gains which arise due to rise in market
price of the share.
iii Limited liability: Liability of shareholder or investor is limited to the
extent of the investment made. If the company go es into losses, the
share of loss over and above the capital investment would not be
borne by the investor.
iv Exercise control: By investing in the company, the shareholder gets
ownership in the company and thereby he can exercise control.
v Claim over Assets and Income: An investor of equity share is the
owner of the company and so is the owner of the assets of that
company. He also enjoys a share of the incomes of the company.
vi Rights Shares: Whenever companies require further capital for
expansion, growth, en tering into new areas etc., they tend to issue
‘rights shares’. By issuing such shares, ownership and control of
existing shareholders are preserved and the investor receives
investment priority over other general investors.
vii Bonus Shares: At times, compani es decide to issue bonus shares to
its shareholders. It is also a type of dividend. Bonus shares are free
shares given to existing shareholders and many times they are given
in lieu of dividends.
viii Liquidity: The shares of the company which is listed on stoc k
exchanges have the benefit of any time liquidity. The shares can very
easily transfer ownership.
ix Stock Split: Stock split means splitting a share into parts. How
should an investor be benefited by this? By splitting of share, the
per-share price reduces in the market which eventually increases the
readability of share. At the end, stock split results in higher volumes
with a number of investors leading to high liquidity of the share.

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193 Disadvantages
i Dividend: The dividend which a shareholder receives is n either fixed
nor controllable by him. The management of the company decides
how much dividend should be given.
ii High Risk: Equity share investment is a risky share compared to any
other investment like debts etc. The money is invested based on the
faith an investor has in the company. There is no collateral security
attached with it.
iii Fluctuation in Market Price: The market price of any equity share has
a wide variation. It is always very difficult to book profits from the
market. On the contrary, there are e qual chances of losses.
iv Limited Control: An equity investor is a small investor in the
company, therefore, it is hardly possible to impact the decision of the
company using the voting rights.
v Residual Claim: An equity shareholder has a residual claim over both
the assets and the income. Income which is available to equity
shareholders is after the payment of all other stakeholders’ viz.
debenture holders etc.
(b) Preference shares:
Preference Shares: Preference shares are one of the special types of share
capital having fixed rate of dividend and they carry preferential rights over
ordinary equity shares in sharing of profits and also claims over assets of
the firm. Preference shares are long -term source of finance for a company.
They are neither completely similar to equity nor equivalent to debt. The
law treats them as shares but they have elements of both equity shares and
debt. For this reason, they are also called ‘hybrid financing instruments’
. Features of Preference Shares Similar to Debt
i Fixed Divide nds: Like debt carries a fixed interest rate, preference
shares have fixed dividends attached to them.But the obligation of
paying a dividend is not as rigid as debt. Non -payment of a dividend
would not amount to bankruptcy in case of preference share.
ii Preference over Equity: As the word preference suggests, these type of
shares get preference over equity shares in sharing the income as well
as claims on assets. Alternatively, preference share dividend has to be
paid before any dividend payment to ordinary equity shares. Similarly,
at the time of liquidation also, these shares would be paid before
equity shares.
iii No Voting Rights: Preference shares holders normally does not have
any voting rights. They are similar to debenture holders and do not
have any say in the management of the company.
iv No Share in Earnings: Preference shareholders can only claim two munotes.in

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194 things. One agreed on percentage of dividend and second the amount
of capital invested. Equity shares are entitled to share the residual
earnings and residua l assets in case of liquidation which preference
shares are not entitled.
v Fixed Maturity: Just like debt, preference shares also have fixed
maturity date. On the date of maturity, the preference capital will have
to be repaid to the preference shareholders . A special type of shares
i.e. irredeemable preference shares is an exception to this. They do not
have any fixed maturity.
Features of Preference Shares similar to Equity Shares:
i Dividend from PAT: Equity share dividend is paid out of the profits
left af ter all expenses and even taxes and same is the case with
preference shares. The preference dividend is paid out of the divisible
profits of the company. Out of the divisible profits, the preference
dividend would be paid first and the remaining profits ca n be utilized
for paying any dividend to equity shareholders.
ii Management Discretion over Dividend Payment: The payment of
preference dividend is not compulsory and is a decision of the
management. Equity shareholders also do not have any right to ask for
dividends, the dividends are paid at the discretion of the management
of the company. Unlike debt, the nonpayment of a dividend of
preference shares does not amount to bankruptcy.
iii No Fixed Maturity: The maturity of a special variant of preference
share is n ot fixed just like equity shares. This variant is popularly
known as irredeemable preference shares.
Types of Preference Shares
There are various Types of Preference Shares with differences in their
structure. Some of these are cumulative, non -cumulative, participating,
non-participating, redeemable, irredeemable, convertible, non -convertible,
callable, adjustable rate preference shares.
i Convertible and Non -Convertible Preference Shares
Convertible preference shareholders possess an option or right whereby
they can be converted into an ordinary equity share at some agreed terms
and conditions. Non -convertible simply does not have this option but has
all other normal characteristics of a preference share.
ii Redeemable and Irredeemable Preference Shares
Redeemab le preference share is very commonly seen preference share
which has a maturity date on which date the company will repay the
capital amount to the preference shareholders and discontinue the dividend
payment thereon. Irredeemable preference shares are lit tle different from
other types of preference shares. It does not have any maturity date.
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195 preference shares can be issued and even the existing irredeemable
preference shares have to be rede emed.
iii Cumulative and Non -Cumulative Preference Shares
If the shares are cumulative preference shares, the dividends are
cumulated and therefore paid when the company makes the profit. In
short, a dividend of cumulative preference shares will have to be pai d as
long as the company earns the profit in any year. Whereas, for non -
cumulative preference shares, a company can skip the dividend in the
year, the company has incurred losses.
iv Preference Shares with Callable Options
These are another innovative prefere nce shares in which the company has
an option to buy the share at a predetermined price and on or before a
certain date.
v Adjustable Rate Preference Shares
These are some of the innovative types of instruments where the rate of
dividend is not fixed and is formulated based on some calculations relating
to the current interest rates etc.
BENEFITS OF PREFERENCE SHARE
There are several benefits of a preference share from the point of view of a
company which is discussed below:
i No Legal Obligation for Dividend P ayment: There is no legal
compulsionfor payment of preference dividend. This dividend is not a
fixed liability like the interest on the debt which has to be paid in all
circumstances.
ii Improves Borrowing Capacity: Preference shares become a part of net
worth and therefore reduces debt to equity ratio. This is how the
overall borrowing capacity of the company increases.
iii No dilution in control: Issue of preference share does not lead to
dilution in control of existing equity shareholders because the voting
rights are not attached to the issue of preference share capital. The
preference shareholders invest their capital with fixed dividend
percentage but they do not get control rights with them.
iv No Charge on Assets: While taking a term loan security needs to be
given to the financial institution in the form of primary security and
collateral security. There are no such requirements and therefore, the
company gets the required money and the assets also remain free of
any kind of charge on them.
DISADVANTAGES OF PR EFERENCE SHARES
i Costly Source of Finance: Preference shares are considered a very
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196 compared with debt as a source of finance. The interest on the debt is a
tax-deductible expense whereas the di vidend of preference shares is
paid out of the divisible profits of the company i.e. profit after taxes
and all other expenses.
ii Skipping Dividend Disregard Market Image: Skipping of dividend
payment may not harm the company legally but it would always crea te
a dent on the image of the company.
iii Preference in Claims: Preference shareholders enjoy a similar situation
like that of an equity shareholder but still gets a preference in both
payment of their fixed dividend and claim on assets at the time of
liquida tion.
(c) Debentures:
A debenture is a debt instrument used by the companies to raise money for
medium to long term at a specified rate of interest. It consists of a written
contract specifying the repayment of the principal and the interest payment
at the fixed rate. Generally, a debenture is not secured by any collateral
and is only backed by the reputation of the issuer.
FEATURES / ATTRIBUTES OF DEBENTURES:
Trust Indenture
It is an agreement which has to be entered into by the ‘Issuing Company’
and the ‘ Trust’ which is involved in taking care of the interest of the
general investors. Normally the trustee is a bank or a financial institution
who is appointed by a debenture trust deed.
Coupon Rate
It is the rate of interest which is promised by the company to pay to the
debenture holder on a regular interval which may vary from case to case.
The rate of interest may be fixed or floating.
Tax Benefit
Most important element from the company point of view is that the
interest paid is a tax deductible expense. E ffectively, the company will get
the tax benefit because the taxable income will be reduced by the extent of
interest paid. Due to this, the effective cost of borrowing gets reduced.
Date of Maturity
For all the debentures, the issuing company has to issu e repayment to the
debenture holders on the date of maturity. This date is also mentioned on
the certificates
Security
Here, we should classify debentures into two – secured debentures and
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197 immovable assets of the company whereas the unsecured assets are issued
based on the general credit of the company. The general legal preference
of debt is available to all types of debentures i.e. in the event of liquidation
debenture will stand prior to preference shares and ordinary equity shares.
Convertibility
Certain types of debentures are issued with the option of conversion into
equity. The ratio of conversion and the time period after which conversion
will take place is mentioned in the agreeme nt of debenture. Debentures
may be fully or partly convertible in nature.
Credit Rating
Normally, an investor would not go and check the credibility and the risk
involved with the debentures. Credit rating agencies are given this task
and they rate the deb entures and the overall company. Involving a rating
agency is compulsory for the issuing company normally in every country.
A debenture is the primary source of long -term capital for companies to
fulfill their financial requirements. Other instruments to r aise long term
capital are bank loans, bonds, and equity shares. Though all these
instruments are used widely in different combinations, they differ from
each other in many ways. The article clarifies how debenture is different
from the bank loan, equity s hares, and bonds respectively.
Types of Debentures:
There are various types of debentures like redeemable, irredeemable,
perpetual, convertible, non -convertible, fully, partly, secured, mortgage,
unsecured, naked, first mortgaged, second mortgaged, the b earer, fixed,
floating rate, coupon rate, zero coupon, secured premium notes, callable,
puttable, etc.
Redeemable and Irredeemable (Perpetual) Debentures:
Redeemable debentures carry a specific date of redemption on the
certificate. The company is legally bound to repay the principal amount to
the debenture holders on that date. On the other hand, irredeemable
debentures, also known as perpetual debentures, do not carry any date of
redemption. However after introduction of Companies Act, 2013, no
irredeema ble debentures can be issued and even the existing irredeemable
debentures have to be redeemed.
Convertible and Non -Convertible Debentures
Convertible debenture holders have an option of converting their holdings
into equity shares. The rate of conversion and the period after which the
conversion will take effect are declared in the terms and conditions of the
agreement of debentures at the time of issue. On the contrary, non -
convertible debentures are simple debentures with no such option of
getting conver ted into equity. Their state will always remain of a debt and
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198 Fully and Partly Convertible Debentures
Convertible Debentures are further classified into two – Fully and Partly
Convertible. Fully convertible debe ntures are completely converted into
equity whereas the partly convertible debentures have two parts.
Convertible part is converted into equity as per agreed rate of exchange
based on an agreement. Non -convertible part becomes as good as
redeemable debentu re which is repaid after the expiry of the agreed
period.
Secured (Mortgage) and Unsecured (Naked) Debentures
Debentures are secured in two ways. One when the debenture is secured
by the charge on some asset or set of assets which is known as secured or
mortgage debenture and another when it is issued solely on the credibility
of the issuer is known as the naked or unsecured debenture. A trustee is
appointed for holding the secured asset which is quite obvious as the title
cannot be assigned to each and eve ry debenture holder.
Registered Unregistered Debentures (Bearer) Debenture
In the case of registered debentures, the name, address, and other holding
details are registered with the issuing company and whenever such
debenture is transferred by the holder; it has to be informed to the issuing
company for updating in its records. Otherwise, the interest and principal
will go the previous holder because the company will pay to the one who
is registered. Whereas, the unregistered commonly known as bearer
debent ure. can be transferred by mere delivery to the new holder. They are
considered as good as currency notes due to their easy transferability. The
interest and principal are paid to the person who produces the coupons,
which are attached to the debenture cer tificate. and the certificate
respectively.
Fixed and Floating Rate Debentures
Fixed rate debentures have fixed interest rate over the life of the
debentures. Contrarily, the floating rate debentures have the floating rate
of interest which is dependent on some benchmark rate say LIBOR etc.
Secured Premium Notes / Debentures
These are secured debentures which are redeemed at a premium over the
face value of the debentures. They are similar to zero coupon bonds. The
only difference is that the discount and p remium. Zero coupon bonds are
issued at the discount and redeemed at par whereas the secured premium
notes are issued at par and redeemed at the premium.
Callable and Puttable Debentures / Bond:
Callable debentures have an option for the company to buyback and repay
to the investors whereas, in the case of puttable debentures, the option lies
with the investors. Puttable debenture holders can ask the company to
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199 (d) Bonds:
Bond is a financial instrumen t whereby the issuer of the bond raises
(borrows) capital or funds at a certain cost for certain time period and pays
back the principal amount on maturity of the bond. Interest paid on bonds
is usually referred to as coupon. In simple words, a bond is a l oan taken at
a certain rate of interest for a definite time period and repaid on maturity.
From a company’s point of view, the bond or debenture falls under the
liabilities section of the balance sheet under the heading of Debt. A bond
is similar to the lo an in many aspects however it differs mainly with
respect to its tradability. A bond is usually tradable and can change many
hands before it matures; while a loan usually is not traded or transferred
freely.
Common features of bonds and the financial terms related to bonds.
1. Issuer: The entities that borrow money by issuing bonds are called as
issuers.
2. Face Value: Every bond that is issued has a face value; which is
usually the principal amount that is borrowed and returned on
maturity. In layman’s ter m, it is the value of the bond on its maturity.
3. Coupon: The rate of interest paid on the bond is called as a coupon.
5. Rating: Every bond is usually rated by credit rating agencies; higher
the credit rating lower will be the coupon required to pay by t he issuer
and vice versa.
5. Coupon Payment Frequency: The coupon payments on the bond
usually have a payment frequency. The coupons are usually paid
annually or semi -annually; however, they may be paid quarterly or
monthly as well.
6. Yield: The effective return that the investor makes on the bond is
called as a return. Assuming a bond was issued for a face value of
1000 and a coupon rate of 10% on initiation. The Price at a later date
may rise or fall and hence the investor who invests at a rate other than
1000 will still receive a coupon payment of 100 (1000 * 10%) but
the effective earning shall be different s ince investment amount is not
1000. That effective return in layman’s term is called as the yield. If
the holding period is considered for a year this is referred to as current
yield and if it is held to maturity it is referred to as yield to maturity
(YTM).
DIFFERENT TYPES OF BONDS
Plain Vanilla Bonds
A plain vanilla bond is a bond without any unusual features; it is one of
the simplest forms of bond with a fixed coupon and a defined maturity and
is usually issued and redeemed at the face value. It is a lso known as a
straight bond or a bullet bond.
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200 Zero Coupon Bonds
A zero coupon bond is a type of bond where there are no coupon payments
made. It is not that there is no yield; the zero coupon bonds are issued at a
price lower than the face value (say 950) and then pay the face value on
maturity ( 1000). The difference will be the yield for the investor. These
are also called as discount bonds or deep discount bonds if they are for
longer tenor.
Deferred Coupon Bonds
This type of bond is a blend of a coupon -bearing bond and a zero coupon
bond. These bonds do not pay any coupon in the initial years and
thereafter pay a higher coupon to compensate for no coupon in the initial
years. Such bonds are issued by corporates whose business model has a
gestatio n period before the actual revenues start. Examples of a company
which may issue such type of bonds include construction companies.
Convertible Bonds
Convertible bonds are a special variety of bonds which have an inbuilt
feature of being converted to equit y shares at a specified time at a pre -set
conversion price.
Foreign currency convertible Bonds
Foreign currency convertible bond is a special type of bond issued in the
currency other than the home currency. In other words, companies issue
foreign currency convertible bonds to raise money in foreign currency.
Difference between Debentures & Bonds
Debenture and bond are used often as interchangeable terms. However,
there are subtle and noteworthy differences between the two instruments:
• Security: A bond is a more secure instrument than a debenture. A
debenture does not have any collateral backing; whereas a bond will
always have collateral attached.
• Rate of Interest: Debenture holders are entitled to a higher rate of
interest in comparison to bond holders . The reason is that debenture is
an unsecured loan and therefore, is riskier than a bond.
• Liability: In a case of a bankruptcy, the company is liable to pay
bondholders on priority, whereas debenture holders are paid later.
• Periodical Payments: Debent ure holders are paid periodical interest on
their loan and the principal is paid back at the completion of the entire
term. Bondholders, on the other hand, are not paid any periodical
payments. They receive the accrued interest and the principal upon the
term completion at one go.
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201 (e) Term Loan:
A term loan provides borrowers with a lump sum of cash upfront in
exchange for specific borrowing terms. Term loans are normally meant for
established small businesses with sound financial statements. In exchange
for a specified amount of cash, the borrower agrees to a certain repayment
schedule with a fixed or floating interest rate. Term loans may require
substantial down payments to reduce the payment amounts and the total
cost of the loan.
Types of Term Loans
Term loans come in several varieties, usually reflecting the lifespan of the
loan. These include:
Short -term loans: These loans are generally for a period of less than a 12
months.
Intermediate -term loans: These loans are generally for a period of one to
three years.
Long -term loans: These loans last anywhere above three to twemty five
years.
(f) Venture Funding:
Venture funding is a funding process in which the venture funding
companies manage the funds of the investors who want to invest in new
business es which have the potential for high growth in future. The venture
capital funding firms provide the funds to start ups in exchange for the
equity stake. Such a startup is generally one that possesses the ability to
generate high returns. However, the risk for venture capitalists is high.
There are five stages of venture funding. They are as follows:
Stage 1: Seed Capital
Stage 2: Startup Capital
Stage 3: Early Stage / Second Stage Capital
Stage 4: Expansion Stage
Stage 5: Bridge / Pre IPO Stage
Stage 1: Se ed Capital
In this first stage of venture funding, the venture or the startup company in
need of the funds contacts the venture capital firm or the investor. The
venture firm shall share its idea of business with the investors and
convince them to invest i n the project. The investor or venture capital firm
shall then conduct research on the business idea and analyze its future
potential. If the expected returns in future are good, the investor (Venture
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202 Stage 2: Star tup Capital
Startup capital is the second stage of venture funding. If the venture is able
to attract the investor, the idea of the business of the venture is brought
into reality. A prototype product is developed and fully tested to know the
actual potent ial of the product. Generally, a person from the venture
capital firm takes a seat in the management of the business to monitor the
operations regularly and keep a check that every activity is done as per the
framed plan. If the idea of business meets the requirement of the investor
and has sufficient market in the trail run, the investor agrees to participate
in the future course of the business.
Stage 3: Early Stage / Second Stage Capital
After the startup capital stage comes the early/first/second stage capital. In
this stage, the investor significantly increases the capital invested in the
venture business. The capital increase is mainly towards increasing the
production of goods, marketing or other expansion say building a network
etc. The company with higher capital inflow moves towards profitability
as it is able to reach a wide range of customers.
Stage 4: Expansion Stage
This is the fourth stage of venture funding. In this stage, the company
expands its business by way of diversification and differen tiation of its
products. This is possible only if the company is earning good profits and
revenue. To reach up to this stage the company needs to be operational for
at least 2 to 3 years. The expansion gives the venture new wings to enter
into untapped mar kets.
Stage 5: Bridge / Pre IPO Stage
This is the last stage of venture funding. When the company has
developed substantial share in the market with its products, the company
may opt for going public. One main reason for going public is that the
investors can exit out of the company after earning profits for the risks
they have taken all the years. The company mainly uses the amount
received by way of IPO for various purposes like merger, elimination of
competitors, research and development, etc.
(g) Ameri can Depository Receipt
American Depository Receipt represents the shares of a foreign company
issued by U.S bank which can be traded in U.S. equity markets.
Meaning of American Depository Receipt
American Depository Receipt (ADR) is a certified negotiable instrument
issued by an American bank suggesting the number of shares of a foreign
company that can be traded in U.S. financial markets. American
Depository Receipts provide US investors with an opportunity to trade in
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203 American Depository Receipt Process
The domestic company, already listed in its local stock exchange, sells its
shares in bulk to a U.S. bank to get itself listed on U.S. exchange.
The U.S. bank accepts the shares of the issuing company. The bank keeps
the shares in its security and issues certificates (ADRs) to the interested
investors through the exchange.
Investors set the price of the ADRs through bidding process in U.S.
dollars. The buying and selling in ADR shares by the investors is possible
only after the m ajor U.S. stock exchange lists the bank certificates for
trading.
The U.S. stock exchange is regulated by Securities Exchange
Commission, which keeps a check on necessary compliances that need to
be complied by the foreign company.
Advantages of American D epository Receipt
The American investor can invest in foreign companies which can fetch
him higher returns.
The companies located in foreign countries can get registered on
American Stock Exchange and have its shares trades in two different
countries.
The benefit of currency fluctuation can be availed.
It is an easier way to invest in foreign companies as there are no
restrictions to invest in ADR.
ADR simplifies tax calculations. Trading in shares of foreign company in
ADR would lead to tax under US jurisd iction and not in the home country
of company.
The pricing of shares of foreign companies in ADR is generally cheaper.
Hence it provides additional benefit to investors.
Disadvantages of American Depository Receipt
Even though the transactions in ADR take place in US dollars, still they
are exposed to the risk associated with foreign exchange fluctuation.
The number of options to invest in foreign companies is limited. Only few
companies feel the necessity to register themselves through ADR. This
limits the choice available to US investor to invest.
The investment in companies opting for ADR often becomes illiquid as
investor needs to hold the shares for long term to generate good returns.
The charges for entire process of ADR are mostly transferred on inves tors
by the foreign companies.
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204 Any violation of compliance can lead to strict action by Securities
Exchange Commission.
Conclusion:
ADRs provide the US investors with ability to trade in foreign companies
shares. ADR makes it easier and convenient for the domestic investors in
US to trade in foreign companies shares. ADR provides the investors an
opportunity to diversify their portfolio by investing in companies which
are not located in America. This eventually leads to investors investing in
companies loc ated in emerging markets, thereby leading to profit
maximization for investors.
(h) Global Depository Receipt
Global Depository Receipt (GDR) is an instrument in which a company
located in domestic country issues one or more of its shares or
convertibles bonds outside the domestic country. In GDR, an overseas
depository bank i.e. bank outside the domestic territory of a company,
issues shares of the company to residents outside the domestic territory.
Such shares are in the form of depository receipt or ce rtificate created by
overseas the depository bank.
Issue of Global Depository Receipt is one of the most popular ways to tap
the global equity markets. A company can raise foreign currency funds by
issuing equity shares in a foreign country.
Global Deposit ory Receipt Example
A company based in USA, willing to get its stock listed on German stock
exchange can do so with the help of GDR. The US based company shall
enter into an agreement with the German depository bank, who shall issue
shares to residents bas ed in Germany after getting instructions from the
domestic custodian of the company. The shares are issued after
compliance of law in both the countries.
Global Depository Receipt Mechanism
The domestic company enters into an agreement with the overseas
depository bank for the purpose of issue of GDR.
The overseas depository bank then enters into a custodian agreement with
the domestic custodian of such company.
The domestic custodian holds the equity shares of the company.
On the instruction of domestic cu stodian, the overseas depository bank
issues shares to foreign investors.
The whole process is carried out under strict guidelines.
GDRs are usually denominated in U.S. dollars
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205 Advantages of GDR
The following are the advantages of Global Depository Receip ts:
GDR provides access to foreign capital markets.
A company can get itself registered on an overseas stock exchange or over
the counter and its shares can be traded in more than one currency.
GDR expands the global presence of the company which helps in getting
international attention and coverage.
GDR are liquid in nature as they are based on demand and supply which
can be regulated.
The valuation of shares in the domestic market increase, on listing in the
international market.
With GDR, the non -residen ts can invest in shares of the foreign company.
GDR can be freely transferred.
Foreign Institutional investors can buy the shares of company issuing
GDR in their country even if they are restricted to buy shares of foreign
company.
GDR increases the shareh olders base of the company.
GDR saves the taxes of an investor. An investor would need to pay tax if
he purchases shares in the foreign company, whereas in GDR same is not
the case.
Disadvantages
The following are the disadvantages of Global Depository Re ceipts:
Violating any regulation can lead to serious consequences against the
company.
Dividends are paid in domestic country’s currency which is subject to
volatility in the forex market.
It is mostly beneficial to High Net -Worth Individual (HNI) investor s due
to their capacity to invest high amount in GDR.
GDR is one of the expensive sources of finance.
(i) Public Fixed Deposits:
Public deposits refer to the unsecured deposits invited by companies from
the public mainly to finance working capital needs. A company wishing to
invite public deposits makes an advertisement in the newspapers.
Any member of the public can fill up the prescribed form and deposit the
money with the company. The company in return issues a deposit receipt.
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206 and conditions of the deposit are printed on the back of the receipt. The
rate of interest on public deposits depends on the period of deposit and
reputation of the company.
A company can invite public deposits for a period of six months to three
years. Therefore, public deposits are primarily a source of short -term
finance. However, the deposits can be renewed from time -to-time.
Renewal facility enables companies to use public deposits as medium -
term finance.
Public deposits of a company cannot exceed 25 per cent of its share capital
and free reserves. As these deposits are unsecured, the company having
public deposits is required to set aside 10 per cent of deposits maturing by
the end of the year. The amount s o set aside can be used only for paying
such deposits.
Thus, public deposits refer to the deposits received by a company from the
public as unsecured debt. Companies prefer public deposits because these
deposits are cheaper than bank loans. The public pre fers to deposit money
with well -established companies because the rate of interest on public
deposits is higher than on bank deposits. Now public sector companies
also invite public deposits. Public deposits have become a popular source
of industrial finan ce in India.
Merits of Public Deposits:
1. Simplicity:
Public deposits are a very convenient source of business finance. No
cumbersome legal formalities are involved. The company raising deposits
has to simply give an advertisement and issue a receipt to each depositor.
2. Economy:
Interest paid on public deposits is lower than that paid on debentures and
bank loans. Moreover, no underwriting commission, brokerage, etc. has to
be paid. Interest paid on public deposits is tax deductible which reduces
tax liability. Therefore, public deposits are a cheaper source of finance.
3. No Charge on Assets:
Public deposits are unsecured and, therefore, do not create any charge or
mortgage on the company’s assets. The company can raise loans in future
against the security of its assets.
5. Flexibility:
Public deposits can be raised during the season to buy raw materials in
bulk and for other short -term needs. They can be returned when the need
is over. Therefore, public deposits introduce flexibility in the compa ny’s
financial structure.
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207 5. Trading on Equity:
Interest on public deposits is paid at a fixed rate. This enables a company
to declare higher rates of dividend to equity shareholders during periods of
good earnings.
Public deposits enable a company to build up contacts with a wider public.
These contacts prove helpful in the sale of shares and debentures in future.
Demerits of Public Deposits:
1. Uncertainty:
Public deposits are an uncertain and unreliable source of finance. The
depositors may not res pond when economic conditions are uncertain.
Moreover, they may withdraw their deposits whenever they feel shaky
about the financial health of the company.
Depositors are entitled to withdraw their deposits at any time after giving
prior notice to the com pany. During times of financial tightness or distress
the depositors may get panicked and wish to withdraw their deposits.
Moreover, if a large number of depositors simultaneously withdraw their
deposits during slump, the company may find it difficult to repay a huge
sum at once. Therefore, public deposits are described as ‘fair weather
friends’.
2. Limited Funds:
A limited amount of funds can be raised through public deposits due to
legal restrictions.
3. Temporary Finance:
The maturity period of publ ic deposits is short. The company cannot
depend upon public deposits for meeting long -term financial needs.
5. Limited Appeal:
Public deposits do not appeal as a mode of investment to bold investors
who want capital gains. Conservative investors may also not like these
deposits in the absence of proper security.
5. Unsuitable for New Concerns:
New companies lacking in sound credit standing cannot depend upon
public deposits. Investors do not like to deposit money with such
companies.
(j) Concept of Secu ritization:
Securitization is a structured process by which a pool of loans and other
receivables are packaged and sold in the form of asset -backed securities to
the investors to raise the required funds from them. By this process
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208 under the broad category termed as structured finance transactions.
Structured finance refers to securities where the promise to repay the
investors is backed by the value of the underlying financial as set or the
credit support of a third party to the transaction or some combination of
the two. Thus, securitization is nothing but liquefying assets comprising
loans and receivables of an institution through systematic issuance of
financial instruments.
(i) The process of securitization starts with identification by the company
(the originator) the loans or bills receivable in its portfolio, to prepare a
basket or pool of assets to be securitized.
(ii) The pool of assets so identified is then sold to a speci fic purpose
vehicle (SPV) or trust. Usually an investment banker performs the task of
an SPV, which is also called an issuer, as it ultimately issues the securities
to investors.
(iii) Once the assets are acquired by SPV, the same are split into individual
shares/securities which are reimbursed by selling them to investors. These
securities are called ‘Pay or Pass Through Certificates’ (PTC) which are
so structured as to synchronize for redemption with the maturity of the
securitized loans or bills.
(iv) Re payments under the securitized loans or bills keep on being
received by the originator and passed on to the SPV. To this end, the
contractual relationship between the originator an d the
borrowers/obligates is allowed to subsist in terms of the pass throug h
transaction; alternatively a separate agency arrangement is made between
the SPV (Principal) and the originator (agent).
(v) Although a PTC could be with recourse to its originator, the usual
practice has been to make it without recourse. Accordingly, a PTC holder
takes recourse to the SPV and not the originator for payment to the
principal and interest on the PTCs held by him. However, a part of the
credit risk, as perceived (and not interest risk), can be absorbed by the
originator, by transferring the assets at a discount, enabling the SPV to
issue the PTCs at a discount to face value.
(vi) The debt to be securitized and the PTC issues are got rated by rating
agencies on the eve of the securitization. The issues by the SPV could also
be guaranteed by ex ternal guarantor -institutions to enhance creditability of
the issues. The PTCs, before maturity, are tradable in a secondary market
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209

(h) Long term financialinstitution:
Long term loans are provided by specify financi al institutions in India.
The following are the specialised financial institution:
(i) The industrial financial corporation inIndia.
(ii) Industrial development bank ofIndia.
(iii) Industrial Reconstruction Corporation in India.
(iv) Small industries development bank ofIndia.
(v) Life insurance Corporation ofIndia.
(vi) State financial corporation.
(vii) Exime book.
Term loans are provided by these institutions at deferent rate of interest
under scheme of financial institution. it is also to be repaid according to a
stipulated repayment sche dule these institution stipulate a number of
condition management and certain and other financial policy of a company
.
Term loan represent secured borrowing. It is the most important source of
finance for new project. They generally carry a rate of intere st inclusive
interest tax depending on the credit rating of the borrower, the perceived
risk of lending. The loan are generally repayable over a period of 60 to 10
years in annul, half yearly or quarterly installment. For last scale project
all India finan cial institution provides the bulk of term finance either
singly or in consortium with other financial institution.

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210 (b) Loan from commercial banks:
The banks’ in India also provide term loans to the companies .banks
normally provides term loans to projects i n the small and medium scale
sectors . The primary role of commercial banks is to cater to the short term
requirement of the industry. However banks have started taking an interest
on term financing of industries in several ways. The proceeds of the term
loan from banks are generally used for fixed assets or for expansion of
plant capacity. Their repayment is scheduled over a period of time. Term
loans proposals involve an element of risk because of changes in the
conditions affecting the borrowers. The ban k making such a proposal has
to access the situation to make a proper appraisal. The decision in such a
situation would depend upon various factors affecting the conditions of the
industry concerned and the earning potential of the borrower.
(c) Retained earni ngs:
Retained earnings are the profits retained in the business. Every company
retains certain portion every year in the form of reserve. Even the balance
of profit after declaration of dividend is also carried forward in the balance
of sheet. It is known as ploughing backs of profits. Such funds belong to
the ordinary shareholder’s and increase the net worth of company. a public
limited company has to plough back a reasonable amount of profit every
year keeping in view the legal requirements and its own ex pansions plans.
However, retained earnings can be used by existing and financially sound
companies. A new company or a loss making company cannot follow this
method. Retained earnings are used as a long -term capital without any
cost.
5.3.2 Short Term Sourc e of Finance
Short -term financing deals with raising of money required forperiods
varying from a few days to one year. It may sometimes exceed for a
period above one year but still be called as short -term finance.
1. Trade Credit
Trade credit is credit rec eived by an business organisation from the
manufacturers or wholesalers or suppliers. It is also known as mercantile
credit. The usual duration of this credit ranges from 30 to 90 days. It is
granted to the company or firm on “Open account” without any sec urity
except that of the goodwill and financial standing of the buyer. Trade
credit does not provide the cash but it facilitates the purchase of materials
without immediate payment. Usually no interest is charged on trade
credits. Trade credit depends upon the buyer’s need for it and also the
willingness of the supplier and factors such as:
The financial resources of the supplier.
His eagerness to dispose of his stock.
Degree of competition in the market.
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211 2. Consumer Credit or Customer Advance
Many times the manufacturers or the suppliers insist on, advance by the
customers particularly in case of special orders or big orders. The
customer advance forms part of the price of the products ordered by him.
Sometimes, the customer a lso tenders the full price. This is an interest free
source of finance. The period of such credit depends upon the time taken
to deliver the goods. The availability of this credit also depends on the
following factors:
Competitive conditions in the market
Customs of the trade and usage.
Reputation of the supplier.
3. Installment Credit
This is also called consumer credit. Retailers for selling consumer durable
generally use it. Here, however, we use the term “Installment credit” to
denote the facility provi ded by the equipment suppliers on easy
installments as this serves to provide capital to a firm in kind. Installment
includes interest on unpaid sums and is suitably spread so as to enable the
purchasing company to meet them out of current cash flows. Comm ercial
banks and financial institutions, now -a-days provide this form of credit on
liberal terms. Hire purchase system is also a modified form of the
installment credit. In the hire purchase system, the title over the machinery
or equipment remains with th e supplier until the full price amount is
settled.
5. Factoring
Under this method, a financing company purchases the account
receivables from the customers or money is advanced on the security of
the accounts receivable. In financial accounting, it is deno ted as Trade
Debtors, and this item appears on the asset side of the Balance Sheet.
Since credit sales are unavoidable in trading transactions, every trader has
always a larger amount locked up in the form of Account Receivables.
This account receivable is a right to property and a right to collect the
amount from the client.
5. Short -term Loans
Commercial banks also provide loans to the business concern to meet the
short -term financial requirements. When a bank makes an advance in
lump sum against some sec urity it is termed as loan. Loan may be in the
following form:
(a) Cash credit: A cash credit is an arrangement by which a bank allows
his customer to borrow money up to certain limit against the security of
the commodity.
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212 (b) Overdraft: Overdraft is an a rrangement with a bank by which a current
account holder is allowed to withdraw more than the balance to his credit
up to a certain limit without any securities.
MONEY MARKET INSTRUMENTS IN INDIA
1. Treasury Bills
T-bills are one of the most popular money market instruments. They have
varying short -term maturities. The Government of India issues it at a
discount for 14 days to 364 days. These instruments are issued at a
discount and repaid at par at the time of maturity. Also, a company, firm,
or person can purchase TB’s. And are issued in lots of Rs. 25,000 for 14
days & 91 days and Rs. 1,00,000 for 364 days.
2. Commercial Bills
Commercial bills, also a money market instrument, works more like the
bill of exchange. Businesses issue them to meet their short -term money
requirements. These instruments provide much better liquidity. As the
same can be transferred from one person to another in case of immediate
cash requirements.
3. Certificate of Deposit
Certificate of deposit or CD’s is a negotiable term deposi t accepted by
commercial banks. It is usually issued through a promissory note. CD’s
can be issued to individuals, corporations, trusts, etc. Also, the CD’s can
be issued by scheduled commercial banks at a discount. And the duration
of these varies between 3 months to 1 year. The same, when issued by a
financial institution, is issued for a minimum of 1 year and a maximum of
3 years.
5. Commercial Paper
Corporates issue CP’s to meet their short -term working capital
requirements. Hence serves as an alternati ve to borrowing from a bank.
Also, the period of commercial paper ranges from 15 days to 1 year. The
Reserve Bank of India lays down the policies related to the issue of CP’s.
As a result, a company requires RBI‘s prior approval to issue a CP in the
market . Also, CP has to be issued at a discount to face value. And the
market decides the discount rate.
Denomination and the size of CP:
Minimum size – Rs. 25 lakhs
Maximum size – 100% of the issuer’s working capital
5. Call Money
It is a segment of the market where scheduled commercial banks lend or
borrow on short notice (say a period of 14 days). In order to manage day -
to-day cash flows. The interest rates in the market are market -driven and munotes.in

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213 hence highly sensitive to demand and supply. Also, the interest rate s have
been known to fluctuate by a large % at certain times.
5.4 EXERCISES:
1 Which of the following is a liability of a bank?
(a) Treasury Bills
(b) Commercial Papers
(c) Certificate of Deposits
(d) Junk Bonds

2. Commercial paper is a type of
(a) Fixed coupon bond
(b) Unsecured short -term debt
(c) Equity share capital
(d) Government bond

3. In India, Commercial Papers are issued as per the guidelines issued by
(a) Securities and Exchange Board of India
(b) Reserve Bank of India
(c) Forward Market Commis sion
(d) None of the above

5.Commercial paper are generally issued at a prices
(a) Equal to face value
(b) More than face value
(c) Less than face value
(d) Equal to redemption value

5. Which of the following is not applicable to commercial paper?
(a) Fa ce Value
(b) Issue Price
(c) Coupon rate
(d) None of the above

6. Which of the following is true with respect to commercial paper (CP)?
(a) These are issued in multiples of 1 lakh
b) The minimum amount to be invested by a single investor is 5 lakhs
(c) Th e minimum maturity period is 30 days
(d) The issuer cannot buy back these instruments
(e) These can be raised up to the extent of 80% of working capital limit

7. Which of the following statements is/are true with respect to Short -term
bank finance
i) Unde r the cash credit arrangement the customer is permitted to borrow
up to a limit called the cash credit limit
ii) Cash credit account operates against security in the form of pledge of
shares and securities.
iii) Under letter of credit agreement the bank as sumes the risk and also
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214 (iv) Security in the form of hypothecation is limited to movable properties
(a) Only (ii) above
(b) Only (iv) above
(c) Both (i) and (iv) above
(d) Both (ii) and (iii) above

8. Which of the following statements is not true with respect to
Commercial Papers (CPs)
(a) These are short -term usance promissory notes with a fixed maturity
period
(b) It is also referred to as Corporate Paper
c) is mostly used to finance the current transactions of a company
(d) it helps to meet the seasonal need for funds
(e) it cannot be issued by body corporate

9. Which of the following statements is true with regard to public deposit
to a company?
(a) The procedure involved in raising public deposit is fairly complex
(b) A public depo sit with maturity period of less than 1 year is also treated
as long term liability
(c) After -tax cost of public deposits will be much less than the after -tax
cost of bank borrowing
(d) Security is offered in the case of public deposit
(e) Public deposit w ill have restrictive covenants in respect of dividends
payments appointment of senior executives

10. The type of collateral (security) used for short -term loan is
(a) Real estate
(b) Plant and Machinery
(c) Stock of good
(d) Equity share capital

Solution
1. C 6. B
2. B 7. C
3. B 8. C
5. C 9. D
5. D 10. E


1. What are the sources of long -term finance?
2. Explain the concept of financial feasibility of aProject?
3. Explain the advantages of equityfinancing? munotes.in

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215 4. What is debenture (debt) financing? Why deben tures are considered
cheaper than equity as a source of long -term finance?
5. Write short notes on the following:
(a) Trading onequity
(b) Promoter’s contribution.
(c) Preference Shares
(d) Money Market Instruments
(e) Loan syndication.



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216 6
SOURCES OF FINANCE AND CASH FLOW
ANALYSIS
Unit Structure:
6.0 Objective
6.1 Introduction to Business Finance
6.2 Classification of Sources of Finance
6.3 Cash Flow Statement
6.4 Classification of Cash Flow Statement
6.5 Uses of Cash Flow statement
6.6 Preparation of Cash Flow Statement Direct and Indirect
6.7 Summary
6.8 Exercise
6.0 LEARNING OBJECTIVES:
After studying this sectionlearners will be able to:
 State the purpose of business finance and classification of business
finance
 State the aim for prep aration ofstatement of cash flowstatement;
 Differentiatetheoperating activities,investing activities andfinancing
activities;
 Make the statementof cash flows usingdirect method;
 Make the cashflow statement usingindirect method.
6.1 BUSINESS FINANCE:
Busine ss Finance refers to the capital funds and the credit funds
capitalized in any type of organization. Business Finance refers to the
funds and credit involved in in any type of organization. Finance is the
basis of a corporate. Finance supplies are to acquis ition assets, goods, raw
materials and for the other movement of financial activities . Let us
comprehend in -depth importance of Trade Finance.AS per the opinion of
Wheeler , “Finance is that business actions which is concerned with
achievement and preservation of capital fund in meeting the
monetaryrequirements and over all purposes of corporate”

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217 The monetary needs of a firm can b e classified into two groups.
(i) Fixed capital requirement
(ii) Working capital requirement
4.2 CLASSIFICATION OF SOURCES OF FINANCE :
(A) Period Basis :
On the basis of time period, a business finance can be categorized in to the
following three sections.
(a) Long Term Fin ance :
Funds which are essential to be invested in a business for a long period of
time that is more than five years are known as long term finance.
(b) Medium Term Finance :
The finance is very for business more than one year but less than five
years is recogni zed as medium term finance.
(c) Short Term Finance :
The finance necessary for a short period up to one year is known as short
term finance.
(B) Ownership Basis:
On the foundation of ownership, the bases can be categorized into
‘owner’s fund’ and ‘borrowed fund’ ,
 Owner Fund :
It denotes to the funds donated by owners as well as the accrued profit of
the corporate this fund remains with the company and it has no liability to
return this fund. e.g., equity shares.
Borrowed Fund :
It mentions to the borrowing of the co rporate. It comprises all funds
obtainable by way of loans and by the way of credit.
(C) Source of Generation Basis :
Another basis of categorizing the sources of funds can be whether the
funds are generated from within the organization internal or from
outsid ebases.
(D) Sources of Finance
Corporates can raise finance from the subsequent methods.
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218 Retained Earning
Retained earnings means undistributed profits after sum earning refers to
of dividend and taxes. It provides the basis of development and growth of
a firm.
Specifications of Retained Earnings
(a) Cushion of safety
(b) Funds for original and pioneering projects
(c) Intermediate and long term finance
(d) Conversion into possession fund
Trade Credit
It refers to a groundwork whereby a producer is granted cre dit from the
dealer of raw materials, inputs spare parts etc. The dealer allow their
customers to pay their unsettled balance, with in a credit period. The
obtainability of trade credit depends upon
(i) Nature of the firm
(ii) Size of the firm
(iii) Status of the firm
(E) Factoring
Factoring is a monetary service under which factor condenses the
following services
(i) Discounting of Bills of Exchange
When goods are sold on credit then a dealer generally draws bills of
exchange upon consumers who are essential to accept the same.
(ii) Providing Information Regarding the Creditworthiness of
Future Clients
Factors gather detailed evidence regarding the financial history of
dissimilar companies which can used by the financier who may lend
money to these corporations.
(F) Lease Financing:
Leasi ng is a contract among lessor and lessee. Whereby the lessor permits
the lessee to use the asset attained by the lessor in return of a payment
named rent. Lessor is titled the owner of the assets and lessee hires the
assets by giving rent. With leasing con tract the lessee can use the assets
without capitalizing a high amount of fund for purchasing it.
(G) Public Deposits :
Public deposits refers to loose deposits requested from the public. A
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219 newspapers. Any member of the public can fill up the arranged form and
deposit money with the company. Dissimilar features of public deposits
are as under.
(i) Unsecured
(ii) Finance of working capital
(iii) Time age
(iv) Simple procedure to raise
(v) Refund
(H) Commercial Papers
Commercial paper is a one type of good source of short finance. The
commercial paper was presented in India for the rust time in 1990. It is an
unsafe promissory note issued by public or private sector Company with a
fixed maturity date, which differs from 3 to 12 months. Since these are
unsecured that is why these are generally issued by companies having a
good repute.
(I) Issue of Shares :
Share is the minimum unit in which owner’s capital of the business is
divided. A share may also be defined as a unit of mea sure of a
shareholder’s interest in the firm.
According to Companies Act, a public company can issue two categories
of shares.
(i) Equity shares
(ii) Preference shares
 Equity Shares
Equity shares is a joint security issued under permanent or owner’s fund
capital. E quity shares are the utmost important source of nurturing long
term capital.In Companies Act authorizing companies to issue two
categories of equity shares.
(i) Equity shares with equal rights.
(ii) Equity shares with differential rights as to divide.
 Preference Sh ares
Preference shares are those shares which get favorite over equity shares in
addition to
(i) The payment of dividend.
(ii) The refund of investment amount during winding up.
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220 (J) Debentures
Debentures are common securities issued below borrowed fund capita l.
Debentures are devices for elevating long time debt capital. Debentures
are called creditor deliver securities because debenture holder are known
as creditors of a company. Different functions of debentures are borrowed
fund
(i) Fixed rate of interest
(ii) Comp ulsory payment of interest
(iii) Security
(iv) Redeemable
(v) No, voting right
(vi) Appointment of trustee
(K) Commercial Banks
Commercial banks occupy a completely crucial role as they offer price
range for exclusive purposes and distinctive durations. Companies of all
sizes can approach commercial banks. Generally, industrial banks offer
short and medium time period loans but now -a-days they've began giving
long term loans in opposition to protection.
(L) Financial Institutions
Public monetary establishments are called lending estab lishments.
Improvement banks or financial institutions, after independence the
government of India found out that for economic development of a rustic
only business banks are not enough. There should be financial institutions
to provide financial help and steering to industries and business
corporations.
(M) International Source of Finance :
After the new financial policy of liberalization or globalization. The doors
of foreign corporations and buyers were opened to make investments
inside the Indian companies. After 1991. The Indian groups tap
international resources of finance for each debt and fairness. The main
securities used by Indian agencies to tap international assets of finance are
given underneath
(i) Loans from Commercial Bank!’;
(ii) International Agencies and Development Bank
(iii) International Capital Market
(a) GDR
(b) ADR
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221 6.3 CASH FLOW STATEMENT :
Introduction:
The cash flow is the inflow i.e. receipt of cash and the outflow means
payment of Cash. Here the Cash means Cash and Cash equi valents. The
cash equivalents include Cash balance, Bank Balance, and the different
types of Marketable Securities. Cash Flow Statement means a statement
that indicates the inflows of cash and the outflows of Cash during the
particular period. Inflows of c ash means those transactions that rises the
Cash and Cash Equivalents. The Cash outflows are those transactions that
reduces the Cash and Cash Equivalents. This statement is arranged in
accordance with the Accounting Standard -3 on Cash Flow Statement. As
per the Accounting Standard -3, cash flows are obtainable under the three
heads i.e. Cash Flow from the Operating Activities, Cash Flow from the
Investing Activities and the Cash Flow from Financing Activities.
Cash plays a reallyimperativepartwithin thefin ancial life of a business . A
firm needs cash to make payments for suppliers, daily operations, to make
payment of salaries, wages, dividend and interest. In short it can be said
that as blood is important in the human body like that cash is important in
the business life. Thus, it is exceptionallyfundamental for a businessto
preserve an adequate balance of cash. For instance , a concern
worksbeneficially but it does not have adequate cash balance to make
payment of dividend , what message does it pass on to the shareholders and
open in common . In this way , managing of cash is remarkablyimportant .
There ought to be focus on drive of cash and its equals . Cash implies , cash
in hand and demand deposits. Cash equalscomprises of bank overdraft,
cash credit, short t erm bank deposits .
Cash Flow Statement compacts with stream of cash which incorporates
cash reciprocals as well as cash. This explanation is an extradata to the
clients of Money related Statements. The articulationappears the
approaching and active of cash . The explanationsurveys the capability of
the endeavor to produce cash and utilize it.Thus a Cash -Flow statement
may be characterized as aoutline of receipts and payment of cash for a
particular period of time. It moreoverclarifies reasons for the changes in
cash position of the firm. Cash streams are cash inflows and outpourings .
Exchanges which increment the cash position of the substance are called
as inflows of cash and those which diminish the cash position as
outpourings of cash.
6.4 CLASSIFICATION O F CASH FLOW STATEMENT
1. Cash Flow -Operating Activities:
The operating activities related to the vitalincome making exercises to a
business which comes under this category. Money Inflows for operating
activitiesincorporates Cash Deals , Collection from Indeb ted individuals
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222 Outpourings from the operating activitiesincorporates Cash Buys ,
Installment to lenders and pay of wages etc.
2. Cash Flow -Investing Activities:
The Investing events incorporatesdeal and buy of long -term fixedresources
as well as ventures . Money Inflows from the ContributingExercises
comprises Pay from deal of fixedassets , Deal of investment , Wage from
Interest and profit . Money Surges from the Contributing Exercises
incorporates the Buy of long term fixedresources i.e. Building, Plant
&Machineries, Furniture and fixtures and Investment etc.
3. Cash Flow from the Financing Activities:
The Financing e xercisesincorporates capital and the other long term fund
generation activities of the ven ture. Money Inflows from the Financing
Exercisesincorporates the continues from Issue of shares , Issue of
Debentures and the Long -term Borrowings i.e. Bonds, Loans, etc.
Whereasmoney Surges from the Financing e xercises comprises
Reimbursement of loan and a dvances , Reimbursement of shares,
Reimbursement of Debentures, The buy -back of the equity shares . The
payment of the interest and the dividend.
Objectives -Cash Flow Statement:
 To define the bases of Cash and Cash Equivalents under operating,
investing a nd financing doings of the organization.
 To define the uses of Cash and Cash Equivalents for operating,
investing and financing doings of the organization.
 To define the net alteration in Cash and Cash equivalents due to cash
arrivals and discharges for operating, investing and financing doings of
the organization that take place among the two balance sheet dates.
6.5 Uses of Cash Flow statement
 To helpful for the Short -term Planning and forecasting:
It assists in planning of savings and assessing the f inancial supplies of the
enterprise based on evidence provided in the declaration about the inflow
and the outflow of Cash and Cash Equivalents.
 To measure Liquidity and Solvency of the organization:
It assists in recognizing the capability of the organi zation to meet its
responsibilities on time.
 To accomplish Cash Efficiently:
It deliversmaterial about the cash location by reflecting whichever
anexcess of cash or a shortfall of cash in the report. This assists the
organization to take decisions about the investment of excess cash and the
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223  To simplifythe Relative Study:
It simplify the evaluation of actual cash flows with the planned cash flows
to recognize whether the arrivals and discharges of cash are moving as per
the schedule or not. Such assessment will also reproduce deviations of the
realarrivals and discharges from the budgeted cash flows for which
essential actions are then occupied by the initiative.
 To validate Cash Situation:
The Cash flow statement is arrang ed to record all the arrivals and
discharges which effect in the extra or deficit of cash for an organization.
Since, all the cash dealings are accessible in the report, it becomes easy to
recognize the items which increase or reductionin the cash balances .
 To assessAdministration Decisions:
This statement categorizes the cash dealings under three separate heads
viz., operating, investing and financing cash. Such arrangementassist the
operators of the statement to evaluate whether the decisions taken by t he
organization are suitable from investing and financing fact of view or not.
 For payment of dividend :
To approve the dividends, every organizationmust comply with the
approved provisions for the payment of dividend. I also helps in
determining how muc h dividend the organization should pay in a specific
year.
Limitations -Cash Flow Statement:
 Non-cash transactions are not shown:
This statement always takes into consideration merely cash arrivals and
cash discharges. Non -cash dealings are not measured for preparation of
cash flow statement.
 Not analternative for a profit and loss statement :
This statement cannot be used as analternative for a profit and loss
statementbecause profit and loss statementis prepared on accrual basis of
accounting while c ash flow statement is prepared on the cash basis. It is
not imaginable to calculate net profit or loss from the statement of cash
flow.
 Not an alternative for Balance Sheet:
This statement cannot be used as an alternative for a financial position
showing statement i.e. the Balance Sheet. Therefore, this statement cannot
be taken as a substitute for Balance Sheet.

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224  Historicby Nature:
This statement is prepared grounded on the cash arrivals and discharges
that have already taken place during the year and hence, it is pastby
nature.
 Valuation of Liquidness:
The Cash flow statement takes into deliberation all the dealings of cash
and cash equivalents. This is just one of the mechanisms in the current
assets which regulate the liquidness position of the org anization.
Therefore, cash flow statement alone cannot help in defining the
liquidness position of the organization.
 Correctness of Cash Flow Statement:
The cash flow statement is arranged from the financial statements of an
organization, correctness of t he same will depend upon how correctly the
monetary statements of the enterprise are arranged.
Expressions used in the Cash Flow Statement:
 Cash:
It comprises Cash in hand and deposit with banks.
 Cash Equivalents:
It comprisesextremely liquid short -term investments that are freely
convertible into cash and that are subject to an unimportant risk of change
in value. It includes bill of exchange, commercial papers, investments etc.
 Disclosure in Cash Flow Statement:
Cash and Cash Equivalent is calculated as under:
` Cash in Hand + Cash at Bank + Cheques + Drafts on Hand + Short -term
Investments (Marketable Securities) + Short -term Deposits in Banks
Classification of the Cash Flows for Cash Flow Statement :
Classification of Cash Flows as per Accounting Standard -3:
This standard on Cash Flow Statement needs that all the inflows and
outflows of the cash and cash equivalent during a specific period should
be categorized under 3 different heads as per the nature of dealings. These
3 heads are explained as below:
(a) Fund from Operating Activities:
These are the principal revenue making activities of an entity. It comprises
all non -investing and non -financing doings. In a cash flow statement, net
result of all the inflows and outflows from functioning activitie s is shown
as Cash Flow from Operating Activities. Subsequent is the list of
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225 (I) Financial Companies:
It comprises all dealingsconnected to: a. acquisition of securities; b. sale of
securities; c. interest on loans; d. interest on loans occupied; e. dividends
on securities; f. salaries and bonus g. income tax paid.
(II) Non-Financial Companies:
It comprises all dealingsconnected to: a. acquisition of goods; b. sale of
goods c. amounts received from trade receivables; d. Trade payables; e.
commission, etc.; f. wages and salaries g. payment of claims h. income
tax
(b) Fund from Investing Activities:
These include all doings related to the purchase and clearance of Long -
term Assets and other investments which are not categorized as cash
equivalen ts. Subsequent is the list of investing activities: a. acquisition of
fixed assets; b. sale of fixed assets; c. acquisition of securities; d. disposal
of securities; e. loans and advances
(c) Fund from Financing Activities:
These are that type of activities that alteration the size and composition of
the owner’s capital as well as borrowings of the firm. Subsequent is the
list of financing doings: a. issue of shares; b. issue of debentures c. loans
and bonds d. short -term borrowings; e. bank overdraft as w ell as cash
credit.
Transactions not regarded as Cash Flow:
These are the dealings that are mere actions in between the items of Cash
and Cash Equivalents. This comprises cash deposited in bank, cash
withdrawn from the bank etc.
Non-cash transactions:
These are the dealings in which the inflow or outflow of Cash does not
take place. So, these non -cash dealings are not deliberated while making
the Cash Flow Statements. These dealingscomprise depreciation, issue of
bonus, etc.
Significance of separate exp ose of cash flows under each activity:
 Operating Activities:
It acts a pointer of the extent to which the business processes successfully
generate cash.
It controls operating efficiency of the business.
It helps in taking dynamic decisions with conne ction with cash for
payment of dividends to shareholders, make new investments, expand
projects, etc. munotes.in

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Financial Management

226 It helps in predicting and projecting upcoming cash flows.
Investing Activities:
It signifies the extent to which expenditure has been experienced to
generate future revenue
Financing Activities:
It contributes in assessing claims on future cash flows by contributors of
funds to the business.
Format of Cash Flow Statement
Extraordinary Items:
All the incomes and expenses that arise from events or tra nsactions that
are clearly separate from the ordinary course of business of the enterprise
are termed as extraordinary items. All such items are not expected to recur
frequently or regularly. It comprises items such as payment to
shareholders in the event of buy back of shares, claim for damages
received, etc.
6.6 PREPARATION OF CASH FLOW STATEMENT
DIRECT AND INDIRECT
Cash Flow from Operating Activities
(A) Cash Flow from Operating Activities:
Indirect Method:
In this method, Cash Flow from Operating Activi ty is considered from
statement of Profit and Loss and Balance Sheet with the help of following
steps:
Step 1:
Calculate the Net Profit before Tax and Extraordinary Items.
Step 2:
Calculate the Operating Profit before Working Capital Changes.
Step 3:
Compute the Cash generated from Operating Activities.
Step 4:
Compute the Cash flow from Operating Activities before Extraordinary
Items.
Step 5:
Compute the Cash flow from (or used in) Operating Activity. munotes.in

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Sources of Finance and Cash Flow Analysis

227 (B) Cash Flow from Investing Activities:
These co mprise all activities related to the acquisition and disposal of
Long -term Assets and other investments which are not categorized as cash
equivalents. All cash inflows and outflows connecting to the fixed assets,
shares and related instruments of other ent erprise including loans and
advances to third parties and their repayments are classified under
Investing Activities.It shows the degree to which investments have been
made for resources that produce revenue and cash flows in future. It is
determined by an alyzing the deviations in fixed assets, long -term
investments in the start and at the end of the year for which particular
accounts can be prepared using the values that are available.
(C ) Financing Activities:
These are those doings that change the size and composition of the
owner’s capital and borrowings of the firm. It is beneficial in estimating
claims on cash flows by lenders of funds in future and therefore, are
shown distinctly. It is calculated by analyzing change in Equity and
Preference Share Capital, Debentures and other borrowings. It also takes
into deliberation the amounts paid on account of interest and dividend. If
shares or debentures are delivered at a premium, Cash Flow Statement
shows total cash received from the issue that comprises both insignificant
value and the premium. Any amount of share issue expenditures and
underwriting commission is a cash outflow from financing activities. o It
does not take into consideration bonus issue as it is just a capitalization of
reserves for which the company does not receive any cash for it. Similarly,
conversion of debentures into new debentures or shares involves no cash
flow and consequently not considered in a cash flow statement.
Preparation of Cash Flow Statement
Steps for Preparing Cash Fl ow Statement:
Step 1:
Compute cash flow from Operating Activities.
Step 2:
Compute cash flow from Investing Activities.
Step 3:
Compute cash flow from Financing Activities.
Step 4:
Adding Step 1, Step 2 and Step 3 above, compute the net increase or
decrease in Cash and Cash Equivalents.

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