UGC NET MBA Unit-4

Accounting and Financial Management

1. Accounting Principles and Standards

Meaning of Accounting:

Accounting is the process of recording, classifying, summarizing, and interpreting financial transactions to provide useful information for decision-making.

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Basic Accounting Principles (GAAP):

1. Business Entity Concept: Business and owner are separate entities.

2. Going Concern Concept: Business will continue for the foreseeable future.

3. Money Measurement Concept: Only monetary transactions are recorded.

4. Accounting Period Concept: Results are reported for a fixed period (usually one year).

5. Cost Concept: Assets are recorded at their purchase price.

6. Dual Aspect Concept: Every transaction affects two accounts (Debit = Credit).

7. Accrual Concept: Record income and expenses when they occur, not when cash is received or paid.

8. Matching Concept: Match revenues with related expenses in the same period.

9. Conservatism: Recognize expected losses, not profits.

10. Materiality: Only significant information should be disclosed.

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Accounting Standards (AS) and IFRS

• Issued in India by Institute of Chartered Accountants of India (ICAI).

• Ensure uniformity, transparency, and comparability in financial reporting.

• International Standards: IFRS (International Financial Reporting Standards).

• Ind AS: Indian convergence with IFRS.

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🔹 2. Preparation of Financial Statements

Financial Statements show the financial performance and position of a business.

Major Statements:

1. Income Statement (Profit & Loss Account) – shows profitability.

2. Balance Sheet – shows financial position at a point in time.

3. Cash Flow Statement – shows movement of cash.

4. Statement of Changes in Equity (for companies).

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Format of Balance Sheet (Condensed):

Assets = Liabilities + Owner’s Equity

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🔹 3. Financial Statement Analysis

Used to evaluate financial health and assist managerial decision-making.

Techniques of Analysis:

1. Comparative Statement Analysis – compares financial data across years.

2. Common Size Analysis – expresses items as % of total.

3. Ratio Analysis – most common tool.

4. Cash Flow & Funds Flow Analysis.

5. Trend Analysis.

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A. Ratio Analysis

1️⃣ Liquidity Ratios

• Current Ratio = Current Assets / Current Liabilities
  → Ideal = 2:1

• Quick Ratio (Acid-Test) = (Current Assets − Inventory) / Current Liabilities
  → Ideal = 1:1

2️⃣ Solvency Ratios

• Debt-Equity Ratio = Total Debt / Shareholders’ Equity

• Interest Coverage Ratio = EBIT / Interest Expense

3️⃣ Profitability Ratios

• Gross Profit Ratio = (Gross Profit / Sales) × 100

• Net Profit Ratio = (Net Profit / Sales) × 100

• Return on Assets (ROA) = Net Profit / Total Assets

• Return on Equity (ROE) = Net Profit / Shareholders’ Equity

4️⃣ Activity Ratios

• Inventory Turnover = Cost of Goods Sold / Average Inventory

• Debtors Turnover = Credit Sales / Average Debtors

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B. Funds Flow Analysis

Shows changes in working capital between two balance sheets.

Key Terms:

• Fund: Working Capital (Current Assets − Current Liabilities)

• Sources of Fund: Issue of shares, long-term loans, sale of assets.

• Uses of Fund: Purchase of assets, repayment of debt, dividend payment.

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C. Cash Flow Analysis

Prepared as per AS-3, it shows inflows and outflows of cash.

Activities:

1. Operating Activities: Day-to-day operations.

2. Investing Activities: Purchase/sale of assets or investments.

3. Financing Activities: Issue/repayment of capital and loans.

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D. DuPont Analysis

DuPont model breaks Return on Equity (ROE) into three components:

$$\text{ROE}=\text{Net Profit Margin}\times \text{Asset Turnover}\times \text{Equity Multiplier}$$

Helps in understanding how profit, efficiency, and leverage affect ROE.

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🔹 4. Cost Accounting and Cost Sheet

Cost Accounting:
Identifies, measures, and controls costs for cost efficiency.

Cost Sheet:
A statement showing the total cost of production and selling a product.

Format:

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🔹 5. Marginal Costing and CVP Analysis

Marginal Costing:
Costs are divided into Fixed and Variable; fixed costs are not charged to individual products.

Contribution (C):

$$C=\text{Sales}-\text{Variable Cost}$$

Profit = Contribution − Fixed Cost

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Cost-Volume-Profit (CVP) Analysis

Used to study the relationship between cost, volume, and profit.

Key Equations:

• Break-Even Point (BEP):

  $$\text{BEP (units)}=\frac{\text{Fixed Cost}}{\text{Selling Price per Unit – Variable Cost per Unit}}$$

• BEP (Sales ₹):

  $$\text{BEP (₹)}=\frac{\text{Fixed Cost}}{\text{P/V Ratio}}$$

P/V Ratio (Profit-Volume Ratio):

$$\text{P/V Ratio}=\frac{\text{Contribution}}{\text{Sales}}\times 100$$

Margin of Safety (MOS):

$$\text{MOS}=\text{Actual Sales}-\text{BEP Sales}$$

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🔹 6. Standard Costing and Variance Analysis

Standard Costing:
Predetermined cost used as a benchmark for comparison.

Variance:
Difference between standard and actual performance.

Types:

1. Material Variance:

   • Material Cost Variance = (Standard Cost − Actual Cost)

   • Material Price Variance = (SP − AP) × AQ

   • Material Usage Variance = (SQ − AQ) × SP

2. Labour Variance:

   • Labour Cost Variance = (SR × SH) − (AR × AH)

   • Labour Efficiency Variance = (SH − AH) × SR

3. Overhead Variance:

   • Overhead Cost Variance = Standard OH − Actual OH

Purpose:
Control and performance evaluation.

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🔹 7. Financial Management – Concept and Functions

Definition:

Financial Management involves planning, organizing, and controlling financial resources to achieve organizational objectives.

Main Functions:

1. Investment Decision – Capital budgeting.

2. Financing Decision – Sources of funds and capital structure.

3. Dividend Decision – Distribution of profits.

4. Liquidity Decision – Managing working capital.

Objectives:

• Maximize shareholders’ wealth.

• Ensure profitability, liquidity, and solvency.

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🔹 8. Capital Structure and Cost of Capital

Capital Structure:

Combination of debt and equity used for financing business operations.

Capital Structure Theories:

1. Net Income (NI) Theory: More debt → higher firm value (due to low cost).

2. Net Operating Income (NOI) Theory: Value independent of capital structure.

3. Traditional Theory: Moderate debt optimizes value.

4. Modigliani–Miller (M–M) Theory: In perfect market, structure is irrelevant.

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Cost of Capital:

Minimum rate of return expected by investors.

$$\text{Overall Cost of Capital (WACC)}=\frac{E}{V}{K}_e+\frac{D}{V}{K}_d(1-T)$$

Where:
E = Equity, D = Debt, V = Total Capital, Ke = Cost of Equity, Kd = Cost of Debt, T = Tax rate.

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Sources of Finance:

• Long-term: Shares, debentures, loans, retained earnings.

• Short-term: Trade credit, bank loans, commercial paper.

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🔹 9. Budgeting and Budgetary Control

Meaning:

Budgeting = Preparing future financial plans.
Budgetary Control = Comparing actual with budgeted performance to take corrective action.

Types of Budgets:

1. Fixed Budget – For one level of activity.

2. Flexible Budget – For multiple activity levels.

3. Cash Budget – Forecast of cash inflow/outflow.

4. Capital Budget – Long-term investment planning.

5. Zero-Based Budgeting (ZBB):
   Every activity must be justified from zero base (no automatic carry-forward).

Budgetary Process:

1. Define objectives.

2. Prepare budgets.

3. Implement.

4. Compare actual vs. budget.

5. Take corrective actions.

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🔹 10. Leverages and EBIT–EPS Analysis

Leverage:

Leverage measures how changes in sales or EBIT affect profits.

A. Operating Leverage (OL):

$$\text{OL}=\frac{\text{Contribution}}{\text{EBIT}}$$

→ Measures effect of sales change on operating income.

B. Financial Leverage (FL):

$$\text{FL}=\frac{\text{EBIT}}{\text{EBT}}$$

→ Measures effect of EBIT change on EPS.

C. Combined Leverage (CL):

$$\text{CL}=\text{OL}\times \text{FL}$$

Financial Breakeven Point:

$$\text{BEP (financial)}=\text{Fixed Financial Charges (Interest, Preference Dividend)}$$

Indifference Point:
Level of EBIT where EPS remains same for two financial plans (debt vs. equity).

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✅ Quick Summary Keywords:

GAAP, Financial Statements, Ratio Analysis, Cash Flow, DuPont, Cost Sheet, Marginal Costing, Variance, Capital Structure, Budgeting, Leverage, EBIT–EPS, ZBB.