Financial Management

and Accounting

Dr. Sarbesh Mishra

NICMAR, Hyderabad.
Room For Improvement
70% of projects are:
Over budget
Behind schedule
52% of all projects finish at
189% of their initial budget

And some, after huge

investments of time and
money, are simply never
complete

Source: The Standish Group

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Determination of Profit
To understand the Profit or Loss Position of
the business an account containing the
Incomes and Expenses relating to the
particular period is prepared in two
parts:

(I) Trading Account

(II)Profit and Loss Account

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TRADING ACCOUNT
 Trading account gives overall result of
trading i.e. purchasing and selling of
goods.

 It takes into account cost of goods sold

and value for which they have been sold
away.

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Items in Trading Account
 Stocks (Opening and Closing Stock),
Purchases, Sales, Wages, Customs and
Import Duty, Freight, Carriage, Royalty,
Gas, Electricity, Fuel, Packaging.

 At the end, Trading Account reflects the

Gross Profit or Gross Loss position of the
Organisation.

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PROFIT AND LOSS ACCOUNT
 This account considers the operating
expenses incurred by the business
during the course of running the
business.

 After considering all expenses and

incomes, the net result is shown as
either Net Profit (+) or Net Loss (-).

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Items in Profit And Loss Account
1. Gross Profit or Loss is brought down
(b/d) from Trading Account.

2. Other items include: Salaries, Interest,

Commission, Trade Expenses, Printing
and Stationery, Advt. Bad debts,
Depreciation, Discount

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Preparation of Balance Sheet
Need For Balance Sheet
 Businessman would like to know the Financial
Position of the business, for this purpose he
prepares a statement of Assets (Owns) &
Liabilities (Owes). Such statement is referred
to as “Balance Sheet” & it is the mirror of
the business.

 Balance sheet has two sides, on left hand side

Liabilities of the business & on right hand side
Assets of the business appears.
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Components of Balance Sheet
Liability
Liabilities can be classified in to two categories
1. Current Liabilities
2. Long Term or Fixed Liabilities

Current Liabilities – Payable within a year e.g.

Bills Payable, Trade Creditors, Outstanding
Expenses, Bank Overdraft, Short term Loans
Fixed Liabilities – Which don't become due for
payment in one year e.g. Long term Loans,
Capital etc.

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Contd….
Assets

It means resources acquired by the business from

the funds made available. Assets are of these
categories:

 Current Assets
 Fixed Assets
 Intangible Assets
 Fictitious Assets
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Assets – Contd….
Current Assets - Current assets consists of cash
& other assets which get converted in to cash
during the operating cycle of the firm e.g.
Cash, Sundry Debtors (Accounts Receivable),
Inventories (Stocks), Loans & Advances, Short
term investments, Pre-paid expenses
Fixed Assets – Fixed assets are those assets
which is acquired for relatively long periods for
carrying on the business of the enterprise.
They not meant for resale. E.g. Land &
Building, Machinery, Furniture

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Assets – Contd….
 Intangible Assets – Intangible assets
are those which cannot be seen or
touched. E.g. Goodwill, Patent,
Trademark etc.
 Fictitious Assets – Formation
expenses incurred for establishing a
business such as registration charge
paid to ROC for getting company
incorporated, discount in issue of shares
etc.
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Capital Expenditure (CAPEX)
Expenditure expended for the
purpose of obtaining long term
advantage for the business.
Examples
 Expenditure incurred in increasing the
quality fixed assets e.g. Purchase of
additional furniture, Plant, Building
for permanent use in Business.

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Revenue Expenditure
“An expenditure that arises out of and in
the course of regular business of a
concern is termed as revenue
expenditure”.
Example
Expenditure incurred in the normal course
of running the business e.g. expenses of
administration, maintaining of facilities
viz. Electricity, Telephone etc. cost
incurred in manufacturing & selling the
products, repairs, Depreciation, Interest
on loan.

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Importance of Investment Decision
 Influence the firm’s growth in long-
term
 They affect the risk of the firm
 They involve commitment of large
volume of funds
 They are irreversible, or reversible at
substantial loss
 They are among most difficult
decisions to make.

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Investment Evaluation Criteria
 Estimation of Cash flows.

 Estimation of required rate of

return (Opportunity cost of
capital)

 Application of decision rule for

making the choice

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Cash Flows
 Cash inflows or outflows occur at three
stages of capital investment project
1. Project Initiation (For beginning operations,
Working Capital needs, Replacement of asset)
2. Project Operation (Operating Expenditure,
Addl. Working capital need, inflow of cash generated by
the investment)
3. Final Project Disposal (Cash inflows or
outflows related to investment’s disposal, Cash inflows
from the release of working capital no longer committed
to the investment)

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Investment appraisal Techniques
Traditional Techniques
 Payback Period Method
 Accounting Rate of return Method
Discounted Cash flow Technique
1. Net Present Value method (NPV)
2. Internal Rate of Return Method (IRR)
3. Profitability Index Method (PI)

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Traditional Techniques
Payback Period Method
 Payback is the number of years required to
recover the original cash outlay invested in a
project.

 Payback = Initial Investment

Annual Average Cash Flows

Project would be accepted if its payback period

is less than the maximum or standard payback
period set by management.

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Accounting Rate of Return (ARR)
 This measures the profitability of an
investment.

ARR = Average Income

Average Investment

Projects with higher ARR over the minimum

rate established by the management will be
accepted.

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DCF Techniques
 It explicitly recognizes the time value of
money.

 Cash flows arising at different time periods

differ in their value and are comparable
when their present values are found out.

 The compound interest rate is used for

discounting cash flows is also called as the
discount rate.

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Net Present Value Method (NPV)
 Cash flows of the invested projects should
be forecasted based on realistic
assumptions.
 Appropriate discount rate should
identified to discount the forecasted cash
flows.
 Present value of cash flows should be
calculated using the opportunity cost of
capital as the discount rate.
 Net Present Value is found out by
subtracting present value of cash inflows.
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NPV Formula

n
Ct
NPV = Ʃ - C0
t=1 (1+k)t
C1, C2 ….. Represent cash inflow in year 1,2 ….,
k is the opportunity cost of capital
C0 is the initial cost of investment
n is the expected life of the investment
* k is assumed to be known and is constant

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Acceptance Rule
1. Accept the project when NPV is positive

2. Reject the project when NPV is negative

3. May accept the project when NPV is zero.

Higher the NPV, the better it is.

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 THANK
YOU
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