CHAPTER 4 COST AND MANAGEMENT ACCOUNTING - THEORITICAL BACKGROUD

Transcription

1 CHAPTER 4 COST AND MANAGEMENT ACCOUNTING - THEORITICAL BACKGROUD Sr. No. Contains Page No Introduction Cost Accounting Cost and Management Accounting Financial Statement Analysis Ratio Analysis Cash Flow Analysis Fund Flow Analysis Working Capital Management Budget and Budgetary Control Cost Control and Cost Reduction Uniform Costing and Inter-firm Comparison Capital Structure and Cost of Capital Pricing of Services 63 33

2 CHAPTER 4 COST AND MANAGEMENT ACCOUNITNG - THEORITICAL BACKGROUND INTRODUCTION:- This chapter takes brief review of the theoretical aspect of the following topics covered under the Cost and Management Accounting. 4.1 Cost Accounting 4.2 Cost and Management Accounting 4.3 Financial Statement Analysis 4.4 Ratio Analysis 4.5 Cash Flow Analysis 4.6 Fund Flow Analysis 4.7 Working Capital Management 4.8 Budget and Budgetary Control 4.9 Cost Control and Cost Reduction 4.10 Uniform Costing and Inter-firm Comparison 4.11 Capital Structure and Cost of Capital 4.12 Pricing of services 34

3 4.1 COST ACCOUNTING INTRODUCTION:- Cost accounting is the subject, which is immensely useful in all economic activities. It is a natural instinct with all of us to measure the pros and cons of everything. A prudent housewife who goes for shopping considers the quality and price of each product before she buys it. In short, each economic activity, if rationally viewed, has two aspects- firstly, the cost involved in it and secondly, the benefits obtained out of it. This analysis is technically known as cost-benefit analysis. Cost Accounting is only a branch of accounting in general and cannot be divorced from Financial Accounting DEFINITION:- The terminology of Cost Accountancy published by the Institute of Cost and Management Accountants of England defines: - Costing is defined as, the technique and process of ascertaining costs. Cost Accounting is defined as, the process of accounting for cost which begins with the recording of income and expenditure or the bases on which they are calculated and ends with the preparation of periodical statements and reports for ascertaining and controlling costs. Cost Accountancy is defined as, the application of costing and cost accounting principles, methods and techniques to the science, art and practice of cost control and the ascertainment of profitability. It includes the presentation of information derived there from for the purpose of managerial decision making OBJECTIVES OF COST ACCOUNTING:- The main objectives of Cost Accounting includes ascertainment of cost, determination of selling prices, cost control and cost reduction, ascertaining the profit of each activity and assisting management in decision-making DIFFERENCE BETWEEN FINANCIAL ACCOUNTING & COST ACCOUNTING The main function of financial accounting is classification, recording and analysis of business transaction in a subjective manner according to nature of expenditure so as to facilitate preparation of profit and loss account and balance sheet. Financial Accounts perform the function of portraying a true and fair but overall picture of the results or activities carried on by an institution during a period and its financial position at the end of the year. To the extent, Financial Accounting helps to assess the overall progress of a concern, its strength and weakness, provides the figures relating to several years are studied. Financial Accounts suffer various limitations which includes that financial accounts do not provide information for forecasting and planning, decision making and 35

4 for control and assessment. The Cost Accounting provides necessary information required for these purposes. Cost accounting is a branch of accounting which has been developed because of the limitation of Financial Accounting from the point of view of management control and internal reporting COST ACCOUNTING AND MANAGEMENT ACCOUNTING:- The cost accounting now a day is not mere recording and cost finding but an effective instrument for managerial control. Management Accounting is designed to give utmost assistance to management in formulating policies and controlling their current business operations. The objectives of cost accounting are similar to those of management accounting and management accounting employs all techniques of cost accounting, such as standard costing, budgetary control, marginal costing, breakeven and cost-volume analysis, inter-firm comparison, ratio analysis, internal audit and capital project assessment and control. Management accounting utilizes the principles and practices of both cost accounting and financial accounting in the best interest of business. Management accounting is thus an extension of the managerial aspects of cost accounting IMPORTANCE OF COST ACCOUNTING TO BUSINESS CONCERNS:- Management of business concerns expects from Cost Accounting detailed cost information and reports required for Planning, Scheduling, Controlling and Decision-making. To be more specific management expects from cost accounting - information and reports to help them in the discharge of the various functions namely ascertainment of cost, control on material, labour and overheads, measuring efficiency, budgeting, price determination, curtailment of loss during the off seasons, expansion and arriving at decision ADVANTAGES OF A COST ACCOUNTING SYSTEM:- Important advantages of a cost accounting system includes identifying unprofitable activities, losses or inefficiencies, continuous efforts for finding out new and improved methods for reducing costs, providing information for making decisions, price fixation, variance analysis, cost control, uniform costing and Inter-firm comparison, information for the use of Government, Wage Tribunals and other bodies, cost of idle capacity, preventing manipulation and fraud in the organization FACTORS TO BE CONSIDERED BEFORE INSTALLING COST ACCOUNTING Before setting up a system of cost accounting various factors should be studied. These factors includes objectives of installing the system, nature of business, nature of the entire industry and it s salient features, nature of the products and services, technical aspects, organization layout, significant variables of the organization, reconciliation of cost and financial account, forms standardization, accuracy of data and forms, involvement and cooperation of staff, simplicity of the system, economic factors and management by exception. 36

5 4.1.9 ESSENTIALS OF A GOOD COST ACCOUNTING SYSTEM:- A good Cost Accounting System should possess various important features. This includes that Cost Accounting System should be tailor-made, practical, simple and capable of meeting the requirements of a business concern. The data to be used by the Cost Accounting System should be accurate; otherwise it may distort the output of the system. Necessary cooperation and participation of executives from various departments of the concern is essential for developing a good system of Cost Accounting. The cost of installing and operating the system should justify the results. The system of costing should not sacrifice the utility by using network analysis for the introduction of the system. Management should have faith in the Costing System and should also provide a helping had for its development and success. 4.2 COST AND MANAGEMENT ACCOUNTING INTRODUCTION:- Management is the art of getting things done. Decision-making is one of the important functions of Management. It is defined as a process of selecting a course of action out of two or more alternative courses. Management cannot avoid decision making, even if the decision is to do nothing in a particular situation. An efficient management decision should be both effective and efficient and consume minimum amount of resources to achieve the desired goal. Cost and Management Accounting is the subject, which provides data for comparison, to take effective and efficient decision for cost control, ascertainment of profitability and internal and external reporting OBJECTIVES OF ACCOUNTING SYSTEM:- Accounting is the process of identifying, measuring and communicating economic information to permit informed judgments and decisions by users of information. An effective accounting system has three broad objectives which includes, a) Internal reporting at appropriates levels of management for planning and control purposes, b) Internal reporting at the appropriate levels for management making special decisions and the formulation of overall policies and long term plans. and c) External reporting to shareholders, Government agencies and other parties for satisfying the various information requirements under the provisions of relevant laws, rules and regulations. The Financial Accounting is mainly concerned with third objectives of accounting system. The Management Accounting, on the other hand, measures past economic changes that occurred in any segment of a business by assigning revenues and expenses to 37

6 those segments. It helps the management in decision-making by providing the relevant information in the required form to make decision much easier and simpler MANAGEMENT ACCOUNTING:- The International Federation of Accountants (IFAC) has defined Management Accounting, 1 as the process of identification, measurement, accumulation, analysis, preparation, interpretation and communication of information both financial and operating used by the management to plan, evaluate and control with an organization and to assure use of end accountability for its resources. Chartered Institute of Management Accounting (CIMA) has defined it as an integral part of management concerned with identification of presenting and interpreting information used for Formulating strategy, Planning and controlling activities, Decision making, Optimizing the use of resources, Disclosures to shareholders and others external to the entity, Disclosure to employees and Safeguarding assets. Management Accounting is not composed of fixed set of rules. Organizations have different goals and are composed of different members; therefore no universal rules of management accounting exist. Management accounting therefore is not a static process. Instead, it adapts to organizational change. There are basically three forces namely technological changes, Globalization and Customers which in turn churn the basics of management accounting OBJECTIVE OF MANAGEMENT ACCOUNTING:- The objective of Management Accounting is to provide appropriate information to the management to help them in taking better decision. Management Accounting involves application of appropriate techniques and concepts, which help management in establishing a plan for reasonable economic objectives. Any workable concept or technique, whether it is drawn from financial accounting, cost accounting, economics, mathematics and statistic, can be used in management accountancy. It employs all those techniques such as working capital management, capital budgeting, ratio analysis, fund flow and cash flow technique, standard costing, budgetary control, marginal costing, break-even and cost-volume-profit analysis, uniform costing and inter firm comparison etc. in formulation policy, fixation of plans, control of their execution and measurement of their performance. Therefore, it is particularly concerned with supply of information, which is useful in the management in decision making for efficient running of the business and thus in maximizing profits. 1 ICWAI, (Oct 1999), Management Reporting and the Management Accountant The Management Accountant student edition, Vol. 2, No

7 4.2.5 SCOPE OF MANAGEMENT ACCOUNTING:- Management accounting permeates the whole organization. It is primarily concerned with provision of information to people within the organization to help them make better decisions. Management accounting focuses on accomplishment of organization objectives by removing dysfunctional inter- department conflict. It concerns long-range decisionmaking or strategic decision-making. It specifies the organization objectives. Then it attempts to search a range of possible course of action, which might enable the objectives to be achieved normally covered by cost accounting and are concern of lower-level managers. The management accounting concerns strategic decisions having profound effect on company s future position CONTEMPORARY FUNCTIONS OF MANAGEMENT ACCOUNTING:- The functions evolved in response to the new environment from the field of management accounting includes evaluation of performance and efficiency of organization, pricing decisions, estimation and quotation, budgeting, operational control, product and customer costing, cost reduction and cost control, capital budgeting decision, expansion projects, diversification project, manpower planning and usage, management control, strategic control, quality control, inventory management and control, capacity planning, planning and control THE MANAGEMENT PROCESS & COST AND MANAGEMENT ACCOUNTS:- The management process involves series of activities leading to definite end. It involves the deliberate selection of a specific course of action amongst the various alternative course of action available in light of desired corporate objectives. The management in any organization is concerned with the various functions namely planning, controlling, organizing, communicating and motivating. In planning process, management accountant helps in formulation of plans by providing useful information on such matters. In control process it provides performance reports that compare the actual outcome with the planned outcomes for each responsibility center. In organizing function, Management accounting performs a staff function. It provides line managers and other staff managers with a specialized information service, which assist them in decision making planning and control activities. Management accountant helps in tailoring of interval reporting system. Alternatively a more appropriate organizational system is suggested to management. Management accounting helps the communication function by installing and maintaining an effective communication and reporting system. The management accountant assists in motivating personnel by providing them budget and the performance reports and other details about potential problem areas and thereby provides a supportive system to enable managers to control their activities more effectively. 39

8 4.2.8 BENEFIT OF A SOUND SYSTEM OF COST & MANAGEMENT ACCOUNTING:- The benefits of a sound system for cost and management accounting facilitate inter-firm comparison and hence enable good control over operation, inculcate Cost consciousness throughout the organization, enable optimal allocation of resources, improve the quality of management decision, cost reduction and cost control MANAGEMENT ACCOUNTING IS AN EXTENSION OF COST ACCOUNTING:- Recent developments in management techniques and management related technology have significantly popularized management accounting, which is basically an extension of cost accounting. Management accounting out rightly starts with management objective. It goes beyond usage of cost accounting. Other disciplines, especially economic, computer science, and engineering have stimulated management accounting. Management accounting is called extension of cost accounting. Cost accounting concerns short-term decision-making and operational level of management. Management accounting serves the key management with focus on overall organizational objective MANAGEMENT ACCOUNTING IN SERVICE ORGANISATION:- The main characteristics of service organizations includes that there is no product cost, almost all costs are period cost. The out put at the service organizations is difficult to measure. Major inputs and outputs in the service organization cannot be stored. Service organizations are labour intensive and incur very few variable costs. These units deal in personalized services with no reasonable degree of homogeneity, and as a result, it is difficult to measure quantity, efficiency or effectiveness through accounting system. Further, almost all costs are fixed in nature and the share of direct expenses is very negligible. The basic principle of the management accounting have been so evolved that they are equally applicable to all types of organizations, therefore almost all service organizations are subject to control techniques, which are similar the those used to control the manufacturing units. Managers in service companies have historically used management accounting information far less intensively than manager in manufacturing companies. The reason for this was because of many service organizations operated in beginning, non-competitive markets, either highly regulated or government owned such as national rail, roads, airlines, postal services and telecommunications. In these non competitive environments, managers of service companies were not under great pressure to lower costs, improve the quality or efficiency of operations, introduce new products that made profit, or eliminate products or services that made losses. Since managers were not making such decisions were virtually non-existent. Situations are radically different today. The major changes in the demand for management accounting information experienced by the manufacturing companies in recent years have also occurred virtually in all types of service organizations. Service organizations have 40

9 existed for hundred of years; their importance in modern economies has increased substantially during this new century. Even some of the power companies in India, telecom circles and hospitals, which have become competitive, have commissioned Activity Based Costing projects. Some leading banks in India have also started Activity Based Costing exercises. Since these service companies are, made up of business process, which are one hundred percent activity oriented, ABC becomes a valuable exercise. 4.3 FINANCIAL ANALYSIS INTRODUCTION:- A business organization prepares its final accounts. However, these statements do not disclose all the information necessary for ascertaining the financial strengths and weaknesses of an enterprise. It is necessary to analyze the data depicted in the financial statement. Financial information is needed to predict, compare and evaluate the organization s financial performance. It also helps for planning and decision-making. There are various tools of financial analysis namely ratio analysis, fund flow analysis and cash flow analysis which helps financial managers in the financial analysis and planning FINANCIAL APPRIASAL AND FINANCIAL STATEMENT ANALYSIS:- Financial appraisal is a scientific evaluation of the profitability and financial strength of any business concern. It is the process of scientifically making a proper, critical and comparative evaluation of the profitability and financial health of a given concern through the application of the techniques of financial statement analysis. Financial statement analysis is a preliminary step towards the final evaluation of the results drawn by the analyst or management accountant. Financial appraisal begins where financial analysis ends and financial analysis starts where the summarization of financial data in the form of profit and loss account and balance sheet ends. The appraisal of analysis spotlights the significant facts and relationships concerning managerial performance, corporate efficiency, financial strength and weakness and credit worthiness MEANING OF FINANCIAL STATEMENT:- In simple words the term financial statement is defined as 2 a statement that contains financial information. In India, the term financial statement means Balance Sheet and Profit And Loss Account. Financial statements also contain notes and schedules and other information. 2 BOS, Course material for CA Final (old course) Advanced Accounting, The Institute of Chartered Accountant of India, New Delhi. 41

10 4.3.4 OBJECTIVES OF FINANCIAL STATEMENTS:- The objective of financial statements is to provide information about the financial position performance and changes in financial position of an enterprise that is useful to a wide range of users in making economic decisions PARTIES DEMANDING FINANCIAL INFORMATION:- There are various parties interested in financial information includes present and potential investors, employees, lenders, suppliers, and other trade creditors, government and their agencies and the public who use financial statements for taking economic decisions. Although, all the above persons are interested in the financial information and operating results of an enterprise, the type of financial analysis varies according to specific needs of user NATURE OF FINANCIAL ANALYSIS:- The process of financial analysis consists of the application of financial analytical tools and techniques to financial statement and data in order to derive from them measurements relationship that are significant and useful for decision making. In the financial analysis user-oriented approach has been adopted for these purposes instead of following the traditional proprietary approach. The traditional view is that financial statements are prepared for the proprietors and accounting just aids the stewardship function MEANING OF FINANCIAL STATEMENT ANALYSIS:- It is the process of identifying the financial strength and weakness of a firm from the available accounting data and financial statement. The analysis is done by properly establishing the relationship between the items of Balance Sheet and Profit and Loss Account. Financial Statement Analysis refers to draw meaningful interpretation of financial statement for the parties demanding financial information. It is the judgmental process that aims to evaluate the current and past financial position and the results of operations of an enterprise with the primary objectives of determining the best possible estimates and prediction about future condition and performance. Financial analysis is purposive and not necessarily comprehensive to cover all possible uses OBJECTIVES OF FINANCIAL STATEMENT ANALYSIS:- The primary use of financial statement are evaluating past performance and predicting future performance and both these are facilitated by comparison. Therefore, the focus of financial analysis is always on the crucial information contained in the financial statements. The purpose of evaluating such financial statements is different from person to person depending upon its relationship. In other words, even though the business unit itself and shareholders, debenture holders, investors all undertake the financial analysis, the purpose, means and the extent of such analysis differs. The object, scope, extent and means of any 42

11 financial analysis vary as per the specific needs of the analyst. Thus financial statement analysis is purposive and not necessarily comprehensive to cover all possible uses TYPES OF FINANCIAL STATEMENT ANALYSIS:- The main objective of financial analysis is to determine the financial health of a business enterprise. The analysis may be of the external analysis, internal analysis, horizontal analysis, vertical analysis, trend analysis, ratio analysis, funds flow statement, break even analysis TECHNIQUES OF FINANCIAL STATEMENT ANALYSIS:- In the analysis of the financial statements the analyst uses variety of tools. First technique is Cross Sectional Techniques under which Common size statements and Financial Ratio Analysis techniques are used. Second technique is Time Series Techniques under which Simple Comparison and Trend Analysis, Financial Ratio Analysis techniques are used. The third category includes Variability Measure. Fourth technique is Combination of Financial and Non Financial Information technique which include Product Market and Capital Market Information STAPES INVOLVED IN FINANCIAL STATEMENT ANALYSIS:- The focus of financial analysis is on key figures in financial statements and the significant relationship that exists between them. Various steps followed in Financial Analysis are; 1) The first task is to select the information relevant to the decision under consideration from the total information relents to the financial statement. 2) The second step is to arrange the information in a way to highlight significant relationship. Usually instead of the twocolumn (T-Form) statements as ordinarily prepared, the statements are prepared in single vertical column form.3) The final step is to interpretation of ratio and drawing of inferences and conclusion. In brief, financial analysis is the process of selection, relation and evaluation. 4.4 RATIO ANALYSIS INTRODUCTION:- Ratio measures relationship between two data. It is a statistical yardstick that provided a measure of relationship between two data / figures. Absolute comparison between two figures does not convey much sense. When expressed in terms of ratio, it becomes much penetrating and meaningful. Not for comparison only, ratios convert the data in precise form for easy understanding. However, one needs to be careful in his choice and interpretation of ratios. There should be some relationship between the variable selected for ratios; otherwise you cannot come up with any meaningful interpretation of the resulting figures. 43

12 4.4.2 MEANING AND DEFINITION OF RATIO ANALYSIS:- The term ratio is refer to the relationship expressed in mathematical terms between two individual figures or groups of figures connected with each other in some logical manner and are selected from financial statement of the concern. A ratio calculated using at least one financial variable defined as financial ratio. Financial ratio is an index, which relates two accounting numbers and is obtained by dividing one number by the other. If a ratio is calculated taking numerators and denominator from the books of accounts then such ratio can be called as accounting ratio. Ratio Analysis: It is defined as the systematic use of ratio to interpret the financial statements so that the strengths and weakness of a firm as well as its historical performance and current financial condition can be determined. It is a process of determining, interpreting and presenting numerical relationship of items and groups of items in the financial statement FORMS OF RATIO:- The ratios are customarily presented in the different forms namely pure ratios, in the form of rate, and percentage IMPORTANCE OF RATIO ANALYSIS:- The importance of the ratio analysis lies in the fact it presents facts on a comparative basis and enables the drawing of inferences regarding the performance of the firm. Ratio analysis is relevant in assessing the performance of a firm in respect of the various aspects. It facilitates understanding of financial statements. It helps in Inter-firm and Intra-firm comparison, planning business operations, management by exception. It helps to measure liquidity position and long-term financial viability and efficiency in the management and the utilization of its assets. Ratio analysis enables a firm to find out the trend of operational performance STANDARDS FOR COMPARISON:- For making a proper use of ratios, it is essential to have fixed standards for comparison. A ratio provides clues and symptoms of underlying conditions. A computation of ratios is relatively an easy exercise. A ratio by itself has very little meaning unless it is compared to some appropriate standard. Selection of proper standards of comparison is a most important element in ratio analysis. The most common standards used in ratio analysis are absolute, historical, horizontal and budgeted LIMITATIONS OF RATIO ANALYSIS:- In case of organization with diversified product lines ratio calculated on the basis of aggregate data cannot be used for Inter firm comparisons. Financial data are badly distorted by inflation so also the financial ratios. Seasonal factors may also influence 44

13 financial data. To give a good shape to the popularly used financial ratios the business may make some year end adjustment (Window Dressing). Different Accounting Policies and Accounting Period make the accounting data of two firms non comparable as also the accounting ratios. There is no standard set of ratios against which a firm s ratios can be compared. It is very difficult to generalize whether a particular ratio is good or bad. A single ratio may not be conclusive indicator. Financial ratios provide clues but not conclusion. Accounting Ratios may be worked out for any two figures even if they are not significantly related Accounting ratios can be only as correct as the data on which they are based. There is scope for diversity of opinion as to what constitute share holders equity, current assets, quick assets, profits and so on. Ratio devoid of absolute figures may prove dangerous as ratio analysis is primarily a quantitative analysis and not a qualitative analysis. In brief ratio analysis suffers from serious limitations. The analyst should not be carried away by its simplified nature, easy computation with a high degree of precision. Nevertheless, they are important tool of financial analysis CLASSIFICATION OF ACCOUNTING RATIOS:- Various ratios used for analysis and interpretation of financial statements can be classified according to main three bases namely classification according to sources or placement, purpose and important or approach. The ratios according source includes Balance Sheet Ratios, Income statement ratios or Revenues Statement Ratios and Balance Sheet and income Statement ratio. The classification of ratios according to purpose include Profitability Ratios, Liquidity Ratios, Capital Structure Ratios, Ratio showing use of assets / productivity, Investment Analysis, and Management Efficiency. The classification of ratios according to importance or approach includes Primary Ratio and Supporting ratio / Secondary Ratios SOME IMPORTANT FINANCIAL RATIOS:- With reference to co-operative bank the some important ratios are cited in Table CASH FLOW ANALYSIS INTRODUCTION:- The Balance Sheet and Profit and Loss Account constitute the basic financial statements of any business organization and contains summary of items relating to income and expenditure during a particular period of time. However, none of them shows the nature of transactions entered into during the period of time. Financial planning of any organization is always involve the analyzing of the financial flows of the firm as a whole, i.e. forecasting and estimating the impact of investment made in the past and of those which are planned to be invested in the coming future. It also involves of weighing the various 45

14 alternatives of financing and investment and their likely impact so that the business is not adversely affected at any time in future due to lack of funds CONCEPT OF FUNDS:- The concept of funds can be defined in various ways. The two most common usages of the term fund are cash and working capital. If viewed in this sense, statement of changes in financial position would explaina. The changes in the firm s cash position (popularly known as cash flow statement); and b. The changes in the firm s working capital position (popularly known as sources or uses statement or funds flow statement) MEANING OF CASH FLOW STATEMENT:- One of the important tools with the management accountant and finance manager for ascertaining the changes in balance of cash in hand and bank is the Cash Flow Statement. This statement shows the inflows and outflows of cash i.e., sources and applications of cash during particular period. Cash flow statement analyses the reasons for change in balance of cash in hand at bank between two accounting period. All those transactions, which have no effect on cash, are excluded from this statement OBJECITVE OF CASH FLOW STATEMENT:- Information about the cash flows of an enterprise is useful in providing users of financial statements with a basis to assess the ability of the enterprise to generate cash and cash equivalents and the needs of the enterprise to utilize those cash flows. The economic decisions that are taken by users require an evaluation of the ability of an enterprise to generate cash and cash equivalents and the timing and certainty of their generation. The institute of Chartered Accountants of India (ICAI) has issued Accounting Standard (AS 3) (Revised) on, Cash Flow Statement in Revised AS 3 is mandatory w.e.f to Level I enterprises, which includes the following enterprises a) which has turnover more than Rs. 50 crores in a financial year, b) Listed Companies. Level I enterprise includes Banks (including Co-operative Banks) and this AS is applicable to banks and auditors are duty bound while discharging attest function to ensure the AS issued and made mandatory by the ICAI are implemented ADVANTAGES / BENEFITS OF CASH FLOW STATEMENT:- It is helpful in short term planning of the business unit by indicating in advance as to how much funds are needed in future and how much of these can be raised internally and how much should be arranged from outside. It is helpful in making capital budgeting decisions by indicating the availability of funds or otherwise during the period under consideration. It is helpful to management by enabling it to know the magnitude, direction and causes of 46

15 variation of the firm, liquidity position during an accounting period. It is helpful to management in planning replacement of assets and in formulating dividend policies. It enables users to evaluate the changes in net assets of an enterprise, its financial structure (including its liquidity and solvency) and its ability to affect the amounts and timing of cash flows in order to adapt to changing circumstances and opportunities. It is useful in assessing the ability of the enterprise to generate cash and cash equivalents and enables users to develop models to assess and compare the present value of the future cash flows of different enterprises. It also enhances the comparability of the reporting of operating performance by different enterprises because it eliminates the effects of using different accounting treatments for the same transactions and events. Historical cash flow information is often used as an indicator of the amount, timing and certainty of future cash flows. It is also useful in checking the accuracy of past assessments of future cash flows and in examining the relationship between profitability and net cash flow and the impact of changing prices LIMITATIONS OF CASH FLOW STATEMENT:- Limitation of cash flow statement include that it fails to reveal the true liquidity position by excluding many important transactions, which are of non-cash variety, but affecting the change of financial position. It can be very easily manipulated by the management by postponing payment to creditors etc PREPARATION OF A CASH FLOW STATEMENT: - Cash flow statement should report cash flows during the period classified by operating, investing and financing activities. Sum of these three types of cash flow reflects net increase or decrease of cash and cash equivalents. Operating activities are the principal revenue-producing activities of the enterprise and other activities that are not investing or financing activities. The activities of acquisition and disposal of long-term assets and other investments not included in cash equivalents are investment activities. The activity that results in change in size and composition of owner s capital and borrowings of the organization are financing activities METHODS OF CASH FLOW STATEMENT:- As per Accounting Standard (AS) 3, an enterprise should report cash flows from operating activities using either Direct method or Indirect Method ANALYSIS OF CASH FLOW STATEMENT: - Cash flow statement is an important tool for short-term analysis. Like the other financial statements, the statement of cash flows can be analyzed to reveal significant relationships. Two areas, analysts examine while studying a cash flow statement are cash generating efficiency and free cash flow. 47

16 4.6 FUND FLOW STATEMENT INTRODUCTION:- The Final Accounts does not fulfil all the objectives of management though these statements provide highly significant information. The usefulness of the statement is limited for analysis, planning and control purpose. There is certain other fruitful relationship between the Balance Sheet at the commencement and at the end of the accounting period on which traditional package fails to throw any light. The financial executive must know the fund flows underlying the balance sheet changes. The statement of sources and uses of funds serves this end. Law does not prescribe this statement, though a number of organizations now days voluntarily publish this statement as part of the annual accounts. This statement is known by various name viz. where got where gone statement, sources and application of funds, employment and deployment of funds, inflow and outflow of funds, Money provided and its disposition, Funds received and disbursed, Change in financial position, change in working capital etc MEANING OF FUND FLOW STATEMENT: - Another important tool in the hands of finance manager and management accountant for ascertaining the changes in financial position of the firm between two accounting period is known as fund flow statement. The Accounting Standard Board established by the Institute of Chartered Accountants of India defines it as, 3 a statement, which summaries for the period covered by it the changes in financial position including the sources form which the funds were obtained by the enterprise and the specific uses to which the funds were applied IMPORTANCE OF FUNDS FLOW STATEMENT:- The balance sheet and profit and loss account failed to provide the information, which is provided by funds flow statement i.e., changes in financial position of and enterprise. This statement indicates the changes, which have taken, place between two accounting dates. It gives details of sources and uses of funds during a given period which are of great help to the users of financial information. It is also a very useful tool in the hands of management for judging the financial and operating performance of the company. It also indicates the working capital position, which helps the management in taking policy decisions regarding dividend etc. The projected fund flow statement can also be prepared and thus budgetary control and capital expenditure control can be exercised in the organization. 3 Saxena and Vashist, (2000) Cost and Management Accounting, 3rd Edition, Sultan &Chand Sons, Educational Publishers, New Delhi , Chapter 3, Fund Flow Analysis, Page no

17 4.6.4 CONCEPT OF FUNDS AND FLOW:- The term Fund has variety of meanings. The most common interpretation of funds is working capital or net current assets. Many analysts assume that the basic purpose of the fund flow statement is to account for the changes in working capital during the period covered by the statement. The concept of funds as working capital has gained wide acceptance as to make some people believe that the title change in working capital is preferable. The word Flow is interpreted as a Movement or a Change. Thus a movement of funds presented in a statement is interpreted as Funds Flow Analysis. The flow of funds is of two types, a) Sources or inflow of funds and b) Application or outflow of funds USES OF FUND FLOW STATEMENT:- Fund flow statement determines financial consequences of business operations. It provides valuable information that help at the time of financing through borrowing form financial institutions. The basic purpose of this statement is to indicate on a historical basis from where cash come from and when it was used ANALYSIS OF FUNDS FLOW STATEMENT:- Fund flow statement is useful for long-term analysis. Such an analysis is of great help to management, shareholders, creditors, brokers. It helps to know the profitability, utilization of profit, liquidity, financial stability. It helps in working capital management, projection of funds and uses of funds ADVANTAGES AND BENEFITS:- Fund Flow statement helps a firm to plan its financial operations properly. It is helpful in estimating the budgets or the amount of funds required in future for modernization and expansion programs. It leads to improvement in the rate of profit on assets by directing the flow of funds to those activities with higher margins. It helps in the planning of dividend payouts to the shareholders and interest to the debentures holders or creditors in such a way that the working capital of the organization is not adversely affected. It helps in avoiding the situations of running out of funds by obtaining additional working capital when required. It also helps in planning the temporary investment of idle funds and in planning the repayment schedules of long-term debts. It helps in assessing the relative points of strength and weakness of that organization. By studying past flow; the finance manager can evaluate future flows by means of funds statement based on forecast. The statement prepared for the previous year compared with the budget prepared before the year commenced will show to what extent the resources of the company or the firm were used according to plan an to what extent the utilization was unplanned and improper. Since it 49

18 gives the figure of cash inflow from operations, it gives much more reliable picture of the results of operations than the usual profit and loss account LIMITATIONS:- This statement does supply information not otherwise available in the conventional statement but ignores non-fund transactions. It does not provide the original evidence in support of financial status or change but merely rearranges the data appearing elsewhere in the accounts in a special manner. Sometimes a study of changes in cash is more important than a study of changes in funds. In such a case, fund flow statement does not serve the purpose, and cash flow statement has to be prepared. Fund flow statement is expected to deal with only those transactions, which cause movement of funds. Where a transaction involves the exchange of one source of funds for another, these transactions are not reflected in the statement. Fund flow statement cannot take the place of the final accounts, the Balance sheet and the Profit and Loss Account, but it is a very useful supplementary statement CONSTRUCTION OF FUND FLOW STATEMENT:- Based on the interpretation of the term, Funds, the statement of changes in financial position can be prepared on working capital basis, total resources basis, and Cash basis. Three approaches can be made to carry out adjustments in net profit/loss for the period for determining funds from operations. These are Direct method, Add back method and Adjusted P& L a/c method. 4.7 WORKING CAPITAL MANAGEMENT INTRODUCTION:- One of the most important areas in the day to day management of the firm is the management of working capital. It is concerned with management of the level of individual current assets as well as the management of total working capital MEANING OF WORKING CAPITAL:- Working capital refer to the funds invested in the current assets i.e. investment in stocks, sundry debtors, cash and other current assets. The management of working capital includes the management of these assets and liabilities such as accounts payable, wages payable and other current liabilities. The working capital management helps to decide how much the cash balance should be kept by the organization. It also helps to decide the level of inventories, credit period to be offered to customers, composition of current assets and current liabilities. 50

19 4.7.3 CONCEPTS OF WORKING CAPITAL:- In working capital management, two concepts are followed. First concept is Gross working capitals which represent the total of all current assets and is also referred to as circulating capital. Second concept is Net working capita which represent excess of total current assets over total current liabilities OBJECTIVES OF WORKING CAPITAL MANAGEMENT:- The objective of working capital management is to minimize the amount of capital employed in financing the current assets. This will also lead to an improvement in the Return on capital employed". Secondly to manage the current assets in such a way that the marginal return on investment in these assets is not less than the cost of capital acquired to finance them. This will ensure the maximization of the value of the business unit. Third to maintain the proper balance between the amount of current assets and the current liabilities in such a way that the firm is always able to meet its financial obligations, whenever due. This will ensure the smooth working of the unit without any production held ups due to paucity of funds. Thus we see that, in short, the objectives is to ensure the maintenance of satisfactory level of working capital in such a way that it is neither inadequate not excessive. It should not only be sufficient to cover the current liabilities but ensure a reasonable margin of safety also IMPORTANCE OF ADEQUATE WORKING CAPITAL: - Whatever be the size of a business, working capital is lifeblood and controlling nerve center of every business. Thus, working capital management is significant facet of financial management. Both excessive as well as inadequate working capital positions are dangerous from the firm's point of view. Excessive working capital means idle fund, which earns no profits for the enterprise. Paucity of working capital not only impairs profitability but also results in production interruptions and inefficiencies. An over all control over working capital can ensure functioning of the business operations SOURCES OF WORKING CAPITAL:- The various sources for financing the working capital requirements are trade credit, bank credit, current provision and non banking short term borrowing; and long term sources, i.e. equity share capital, preference share capital and other long-term borrowings. The relative importance of these vary from unit to unit but these sources can be further divided into two broad groups, namely short term and long term source of funds. Short term sources of funds are generally available at comparatively lower costs but theoretically these funds can be called back any moment and therefore it is more appropriate to meet at least two thirds of the permanent working capital requirements from the long term sources. 51

20 4.7.7 WORKING CAPITAL FORECASTS:- An adequate amount of working capital is essential for the smooth running of a business enterprise. The finance manager should forecast working capital requirement carefully to determine an optimum level of investment in working capital. While forecasting working capital requirements, it should be borne in mind that working capital requirements are to be determined on an average basis and not at any specific point of time. The important methods used for forecasting working capital requirements are estimation of components of working capital, percentage sales and operating cycle approach FACTORS TO BE CONSIDERED WHILE DETERMINING WORKING CAPITAL REQUIREMENT:- There are various factors which need to consider while determining the requirement of working capital like production polices, nature of business, credit policy, inventory policy, abnormal factors, market conditions, conditions of supply, business cycle, growth and expansion, level of taxes, dividend policy, price level changes and operating efficiency WORKING CAPITAL MANAGEMENT:- Working capital management is usually concerned with the administration of all the current assets and current liabilities. It is basically concerned with determining the need for working capital, determining the optimum levels in investment in various current assets and examining the salient points regarding each element of working capital. 4.8 BUDGET AND BUDGETORY CONTROL INTRODUCTION:- The management in any organization consists of the various functions namely, planning, controlling, organizing, communicating and motivating. Controlling function implies implementation of the planning decisions and performance evaluation so that feedback can be used for attainment of objectives. It involves a comparison of actual performance with plans so that deviations from plans can be identified and corrective action taken. This process enables the management to assess whether or not the objectives included in the long-term plan are likely to be achieved. If these are unlikely to be achieved, the control process gives warning of potential problems and long term plans to be changed before any serious damage to the company occurs. For effective running of a business, management must know: Where it intends to go, i.e. organizational objectives, How it intends to accomplish its objectives i.e. plans, whether individual plans fit in the overall organizational objectives, i.e. coordination and, whether operations conform to the plan of 52

21 operations relating to that period i.e. control. Budgetary control is the device that a company uses for all these purposes BUDGET:- A budget is defined in the CIMA terminology as 4, "A plan expressed in money. It is prepared and approved prior to the budget period and may show income, expenditure and the capital to be employed, may be drawn up showing incremental effects on former budgeted or actual figures, or be complied by zero based budgeting" BUDGETARY CONTROL: - The Institute of Cost and Management Accountants of England and Wales defines Budgetary Control as," The establishment of budgets relating the responsibilities of executives to the requirements of a policy, and the continuous comparison of actual with budgeted results either to secure by individual action the objectives of that policy or to provide a base for its revision". Broadly speaking it is a system of achieving the firm's objectives with minimum possible cost OBJECTIVES OF BUDGETARY CONTROL:- The objectives of a Budgetary Control system are determining the targets of performance for each section or department of the business. Laying down the responsibility of each of the executives and other personnel so that every one knows what is expected of him and how he will be judged. Budgetary control is one of the few ways in which an objective assessment of executives or department is possible. It provides a basis for the comparison of actual performance with the predetermined targets and investigation of deviation, if any, of actual performance and expenses from the budgeted figures. This naturally helps in adopting corrective measures. It ensures the best use of all available resources to maximize profit or production, subject to the limiting factors WORKING OF A BUDGETARY CONTROL SYSTEM:- The responsibility for successfully introducing and implementation of a Budgetary Control System rests with the Budget Committee acting through the Budget Officer. The Budget should be composed of all functional heads and a member from the Board to preside over and guide the deliberations. The main responsibilities of the Budget Officer are to assist in the preparation of budgets, to forward the budget to the individuals who are responsible to adhere them, to guide them in overcoming any practical difficulties in its working; to prepare the periodical budget reports for circulation to the individual concerned; to follow up action to be taken on the budget reports; to prepare periodical reports for the Board meeting and comparing the budgeted profit and loss account and balance sheet with the actual results. 4. BOS, Cost and Management Accounting, ICWAI, Colkatta.Page No