AM Cycle 7 Session 10

PAN African eNetwork Project
Diploma in Business Management (DBM)

Accounting for Managers
Lecture 10
Dr. Adarsh Arora

Copyright Amity University
1
Topics Covered
Budget & Advantages of budgets

Types of budgetary control
Budgetary control methods
Features of a good budget
Types of budget
Cost reduction and control
Financial analysis
Objectives of ratio analysis
Ratio analysis
Liquidity
Acid test
Investment
Financial ratios
Limitations of ratio analysis
Fund flow statement
Components of balance sheet
Sources and uses of working capital
Fund flow statement
Objects of fund flow statement
Preparation of fund flow statement
MCQs
Budgetary Control Methods

a) Budget:
A formal statement of the financial resources set aside for
carrying out specific activities in a given period of time.
It helps to co-ordinate the activities of the organisation.
An example would be an advertising budget or sales force
budget.
b) Budgetary control:
A control technique whereby actual results are compared
with budgets.
Any differences (variances) are made the responsibility of
key individuals who can either exercise control action or
revise the original budgets.
Budgetary control and responsibility centres;

These enable managers to monitor organisational
functions.
A responsibility centre can be defined as any functional
unit headed by a manager who is responsible for the
activities of that unit.
There are four types of responsibility centres:

a) Revenue centres
Organisational units in which outputs are measured in
monetary terms but are not directly compared to input
costs.
b) Expense centres
Units where inputs are measured in monetary terms but
outputs are not.
c) Profit centres
Where performance is measured by the difference between
revenues (outputs) and expenditure (inputs). Interdepartmental sales are often made using "transfer
prices".
d) Investment centres
Where outputs are compared with the assets employed in
producing them, i.e. ROI.
Advantages of budgeting and budgetary control

There are a number of advantages to budgeting and
budgetary control:
Compels management to think about the future, which is
probably the most important feature of a budgetary
planning and control system. Forces management to
look ahead, to set out detailed plans for achieving the
targets for each department, operation and (ideally) each
manager, to anticipate and give the organisation purpose
and direction.
Promotes coordination and communication.
Clearly defines areas of responsibility. Requires
managers of budget centres to be made responsible for
the achievement of budget targets for the operations
under their personal control.

Provides a basis for performance appraisal (variance
analysis). A budget is basically a yardstick against which
actual performance is measured and assessed. Control
is provided by comparisons of actual results against
budget plan. Departures from budget can then be
investigated and the reasons for the differences can be
divided into controllable and non-controllable factors.
Enables remedial action to be taken as variances
emerge.
Motivates employees by participating in the setting of
budgets.
Improves the allocation of scarce resources.

Economises management time by using the
management by exception principle.
Characteristics of a Good budget

A good budget is characterised by the following:
Participation: involve as many people as possible in
drawing up a budget.
Comprehensiveness: embrace the whole organisation.
Standards: base it on established standards of
performance.
Flexibility: allow for changing circumstances.
Feedback: constantly monitor performance.
Analysis of costs and revenues: this can be done on the
basis of product lines, departments or cost centres.
Types of Budget
Firstly, determine the principal budget factor. This is also
known as the key budget factor or limiting budget factor
and is the factor which will limit the activities of an
undertaking. This limits output, e.g. sales, material or
labour.
a) Sales budget: this involves a realistic sales forecast. This
is prepared in units of each product and also in sales
value. Methods of sales forecasting include:
sales force opinions
market research
statistical methods (correlation analysis and examination
of trends)
mathematical models.
b) Production budget: expressed in quantitative terms only

and is geared to the sales budget.
The production manager's duties include:
analysis of plant utilisation
work-in-progress budgets.
If requirements exceed capacity he may:
Subcontract
plan for overtime
introduce shift work
hire or buy additional machinery
The materials purchases budget's both quantitative and
financial.
c) Raw materials and purchasing budget:

The materials usage budget is in quantities.
The materials purchases budget is both quantitative and
financial.
Factors influencing a) and b) include:
production requirements
planning stock levels
storage space
trends of material prices.
d) Labour budget: is both quantitative and financial. This is

influenced by:
production requirements
man-hours available
grades of labour required
wage rates (union agreements)
the need for incentives.
e) Cash budget: a cash plan for a defined period of time. It
summarises monthly receipts and payments. Hence, it
highlights monthly surpluses and deficits of actual cash.
Its main uses are:
to maintain control over a firm's cash requirements, e.g.
stock and debtors

to enable a firm to take precautionary measures and
arrange in advance for investment and loan facilities
whenever cash surpluses or deficits arises
to show the feasibility of management's plans in cash
terms
to illustrate the financial impact of changes in
management policy, e.g. change of credit terms offered
to customers.
Cost Reduction and Control

Control is the process by which management ensures
that the company is confirming to prescribe plans and
policies in working towards the attainment of corporate
objectives.
The central features of control is not coercion as is so
often thought, nor is it the detail study of past mistakes,
but rather the focusing of attention on current and future
activities to ensure that they are performed in
accordance with management wishes.
The existence of a control process enables management
to know from time to time where the company stand in
relation to a predetermined and desirable future position.
Progress towards objectives must be observed,

measured, and directed if these objectives are to be
achieved-this is the function of control.
Control and planning are complementary they are the
two sides of the same coin.
DFFERENCE BETWEEN COST CONTROL AND COST

REDUCTION
Cost Control is concerned with keeping costs at their planned
level (i.e.; confirming in so far as possible with existing
standard and plans).
In contrast, cost reduction is concerned with setting cost
levels at minimum acceptable level by looking as ways of
improving the levels at the minimum acceptable level by
looking at ways of improving the standards that provide the
benchmarks for cost control.
Cost reduction may be achieved by value engineering
techniques, method study, work measurement techniques,
incentive scheme, revised layouts, etc.
If management misguidedly sets cost standards that are

beyond attainable by current methods, etc, this will not
lead to cost reduction: poor morale is a more likely to
outcome, with resultant labour problems.
Conversely, if loose standards are set (i.e.; standards that
can be attained by a poor level of performance) cost
control may be effective, but the overall level of costs will
be at a most inefficient level.
It has been established that control must be exercised over
the level of cost performance, and this require a
consideration of both direct and indirect costs.
Financial Analysis
Assessment of the firms past, present and
future financial conditions
Done to find firms financial strengths and
weaknesses
Primary Tools:
Financial Statements
Comparison of financial ratios to past,
industry, sector and all firms
Objectives of Ratio Analysis

Standardize financial information for
comparisons
Evaluate current operations
Compare performance with past performance
Compare performance against other firms or
industry standards
Study the efficiency of operations
Study the risk of operations
Ratio Analysis
Ratio Analysis
1. Liquidity the ability of the firm to pay its way
2. Investment/shareholders information to enable
decisions to be made on the extent of the risk and the
earning potential of a business investment
3. Gearing information on the relationship between the
exposure of the business to loans as opposed to share
capital
4. Profitability how effective the firm is at generating
profits given sales and or its capital assets
5. Financial the rate at which the company sells its
stock and the efficiency with which it uses its assets
Liquidity
Acid Test
Also referred to as the Quick ratio

(Current assets stock) : liabilities
1:1 seen as ideal
The omission of stock gives an indication of the cash the
firm has in relation to its liabilities (what it owes)
A ratio of 3:1 therefore would suggest the firm has 3
times as much cash as it owes very healthy!
A ratio of 0.5:1 would suggest the firm has twice as many
liabilities as it has cash to pay for those liabilities. This
might put the firm under pressure but is not in itself the
end of the world!
Current Ratio
Current Ratio = Current Assets : Current Liabilities
Ideal level 2 : 1
A ratio of 5 : 1 would imply the firm has 5 of assets to
cover every 1 in liabilities
A ratio of 0.75 : 1 would suggest the firm has only 75p in
assets available to cover every 1 it owes
Too high Might suggest that too much of its assets are
tied up in unproductive activities too much stock, for
example?
Too low - risk of not being able to pay your way
Investment/Shareholder
Earnings per share profit after tax / number of

shares
Price earnings ratio market price / earnings per
share the higher the better generally for company.
Comparison with other firms helps to identify value
placed on the market of the business.
EV / EBITDA Ratio - Enterprise Value / EBITDA
ratio - the higher the better generally for company .
It measures the operational performance of the firm.
Dividend yield ordinary share dividend / market
price x 100 higher the better. Relates the return
on the investment to the share price.
Profitability
Profitability measures look at how much profit

the firm generates from sales or from its capital
assets
Different measures of profit gross and net
Gross profit effectively total revenue (turnover)
variable costs (cost of sales)
Net Profit effectively total revenue (turnover)
variable costs and fixed costs (overheads)
Gross Profit Margin = Gross profit / turnover x 100
The higher the better
Enables the firm to assess the impact of its sales and
how much it cost to generate (produce) those sales.
Net Profit Margin = Net Profit / Turnover

x 100
Net profit takes into account the fixed
costs involved in production the
overheads
Keeping control over fixed costs is
important could be easy to overlook for
example the amount of waste - paper,
stationery, lighting, heating, water, etc.
Return on Capital Employed (ROCE) =

Profit / capital employed x 100
The higher the better
Shows how effective the firm is in using its
capital to generate profit
A ROCE of 25% means that it uses every
1 of capital to generate 25p in profit
Financial Ratio
Assets Turnover
Asset Turnover = Sales turnover / assets
employed
Using assets to generate profit
Asset turnover x net profit margin = ROCE
Stock turnover = Cost of goods sold / stock expressed as times
per year
The rate at which a companys stock is turned over
A high stock turnover might mean increased efficiency?
But: dependent on the type of business supermarkets might have
high stock turnover ratios whereas a shop selling high value
musical instruments might have low stock turnover ratio
Low stock turnover could mean poor customer satisfaction if
people are not buying the goods (Marks and Spencer?)
Liabilities have Credit balance and Assets have Debit

balance
Current Liabilities are those which have either become
due for payment or shall fall due for payment within 12
months from the date of Balance Sheet
Current Assets are those which undergo change in their
shape/form within 12 months. These are also called
Working Capital or Gross Working Capital
Net Worth & Long Term Liabilities are also called Long
Term Sources of Funds
Current Liabilities are known as Short Term Sources of
Funds
Long Term Liabilities & Short Term Liabilities are

also called Outside Liabilities
Current Assets are Short Term Use of Funds
Assets other than Current Assets are Long Term
Use of Funds
Installments of Term Loan Payable in 12 months
are to be taken as Current Liability only for
Calculation of Current Ratio & Quick Ratio.
If there is profit it shall become part of Net Worth
under the head Reserves and if there is loss it will
become part of Intangible Assets.
Investments in Govt. Securities to be treated

current only if these are marketable and due.
Investments in other securities are to be treated
Current if they are quoted. Investments in
allied/associate/sister units or firms to be treated
as Non-current.
Bonus Shares as issued by capitalization of
General reserves and as such do not affect the
Net Worth. With Rights Issue, change takes
place in Net Worth and Current Ratio.
a.
b.
c.
Net Worth : Capital + Reserve = 200

Tangible Net Worth is : Net Worth - Goodwill = 150
Outside Liabilities : TL + CC + Creditors + Provisions = 600
d. Net Working Capital : C A - C L = 350 - 250 = 50

e. Current Ratio : C A / C L
= 350 / 300 = 1.17 : 1
f.
Quick Ratio : Quick Assets / C
L = 200/300 = 0.66 : 1
LIABILITES
ASSETS
Capital
Reserves
180 Net Fixed Assets

20 Inventories
Term Loan
300 Cash
Bank C/C
200 Receivables
Trade Creditors
50 Goodwill
Provisions
50
800
400
150
50
150
50
800
LIABIITIES
ASSETS
Equity Capital
200 Net Fixed Assets
800
Preference Capital
100 Inventory
300
Term Loan
600 Receivables
150
Bank CC (Hyp)
400 Investment In Govt.

Secu.
Sundry Creditors
100 Preliminary Expenses
Total
1400
50
100
1400
Sollution:1. Debt Equity Ratio will be : 600 / (200+100) = 2 : 1

2. Tangible Net Worth : Only equity Capital i.e. = 200
3. Total Outside Liabilities / Total Tangible Net Worth :
(600+400+100) / 200
= 11: 2
4. Current Ratio will be : (300 + 150 + 50 ) / (400 + 100 )
= 1:1
Exercise : Profit to sales is 2% and amount of profit is say Rs.5 Lac.

Then What is the amount of Sales ?
Answer : Net Profit Ratio = (Net Profit / Sales ) x 100
2
= (5 x100) /Sales
Therefore Sales = 500/2 = Rs.250 Lac
Exercise : A Company has Net Worth of Rs.5 Lac, Term Liabilities of
Rs.10 Lac. Fixed Assets worth RS.16 Lac and Current Assets are Rs.25
Lac. There is no intangible Assets or other Non Current Assets.
Calculate its Net Working Capital.
Answer
Total Assets
= 16 + 25 = Rs. 41 Lac
Total Liabilities = NW + LTL + CL = 5 + 10+ CL = 41 Lac
Current Liabilities = 41 15 = 26 Lac
Therefore Net Working Capital = C. A C.L
= 25 26 = (- )1 Lac
Exercise . From the following financial statement calculate (i) Current Ratio (ii) Acid test
Ratio (iii) Inventory Turnover (iv) Average Debt Collection Period (v) Average
Creditors payment period.
C.Assets
Sales
1500
Inventories
125
Cost of sales 1000
Debtors
250
Gross profit
500
Cash
225
C. Liabilities
Trade Creditors
200
(i) Current Ratio : 600/200 = 3 : 1
(ii) Acid Test Ratio : Debtors+Cash /Trade creditors = 475/200 = 2.4 : 1
(iii) Inventory Turnover Ratio : Cost of sales / Inventories = 1000/125 = 8 times
(iv) Average Debt collection period : (Debtors/sales) x 365 = (250/1500)x365 = 61 days
(v) Average Creditors payment period : (Trade Creditors/Cost of sales) x 365
(200/100) x 365 = 73 days
Ratios help to:

Evaluate performance
Structure analysis
Show the connection between activities and
performance
Benchmark with
Past for the company
Industry
Ratios adjust for size differences
Limitations of Ratio Analysis

A firms industry category is often difficult
to identify
Published industry averages are only
guidelines
Accounting practices differ across firms
Sometimes difficult to interpret deviations
in ratios
Industry ratios may not be desirable
targets
Seasonality affects ratios
Fund Flow Statement

It is continuous process. The study and
control of this funds-flow process (i.e., The
uses and sources of funds) is the main
objective of financial management to
assess the soundness of the solvency of
the enterprise.
The funds statement was also known as a
statement of funds flow or a statement of
sources and applications of funds.
This statement was deemed to be

necessary as the balance sheet and
income statement did not present a
complete picture of an entitys economic
activities
The statement was seen as necessary to
summarise investing and financing
activities
Meaning of Fund Flow

The term of Funds Flow has made up
with the two words Funds and Flow of
funds. Let us first we understand these
meaning and then we see how funds flow
statement is prepared.
THE TREM FUND IS USED

IN THREE SENSES
CASH In narrow sense, the term fund is used to

mean only the cash and bank balance.
Working Capital
In popular sense, the term Fund is used to
mean working capital i.e. the excess of
current assets over current liabilities.
Therefore, in this sense, fund flow statement
includes all the transactions affecting current
assets and current liabilities.
COMPONENTS OF
BALANCE-SHEET
1. NON-CURRENT LIABILITIES
These liabilities are not payable within a

year and out of current assets. These
liabilities are generally payable either in
the long-period or at the close of the
business.
2. Current Liabilities:- These liabilities are
payable within a year and out of current
assets. The values of these liabilities
generally changes within one year.
3. Non-current Assets:- Those assets which

are obtained in business for use over a
long period of time for earning purpose are
called non-current assets. These assets
are not purchased for the purpose of
selling and include tangible, intangible and
fictitious.
4. Current Assets:-These assets are equal

to cash or reasonably expected to be
realized in cash or sold or consumed
within one year or during the normal
operating cycle of the business are called
current assets.
Meaning of Flow
The term Flow means changes incoming and
outgoing. When this term is used with funds, it
means the changes taking place in funds during
a certain period. Whenever there is change in
the funds, it is presume that flow in funds has
taken place.
Transactions that bring working capital into the
firm are sources of funds and on the contrary, if
the working capital decreases, it is an
application of funds.
TRANSACTIONS THAT WILL

AFFECT THE FLOW OF FUNDS
The following transactions will bring the change in

the working capital
Current Assets and Non-Current Assets
Current Assets and Non-Current Liabilities
Current Liabilities and Non-Current Liabilities
Current Liabilities and Non-Current Assets
In brief, it can be said that when one aspect is of
non-current category, and the other current
category, there will be flow in funds.
TRANSACTIONS THAT WILL

NOT AFFECT THE FLOW OF FUNDS
1. Current Assets and Current Liabilities

2. Non-Current Assets and Non-Current
Liabilities
3. Non-Current Liabilities or Non-Current
Assets.
Sources and Uses Of

Working Capital
SOURCES
Funds from business Ops
Other Incomes
Sale of non-current assets
Long term borrowings
Issue of additional equity or preference capital.
USES OF WC
Losses from business ops
Purchase of non-current assets
Redemption of debentures/preference shares.
Dividends to shareholders
MEANING OF FUNDS FLOW

STATEMENT
The Funds flow statement (FFS) is a financial
statement which reveals the methods by
which the business has been financed and
how it has used its funds between the
opening and closing Balance-Sheet dates.
It studies from where the funds have been
received and where the funds have been
used.
Objects of Fund
Statements
Following questions are answered by Funds Flow
Statement 1. Where the profit is put up?
2. Why net current assets are low even though
there is an increase in net profit? In other
words, why cash balance has not increased.
3. Why excess dividend was distributed when
there were low profits?
4. How is the amount realized from the sale of
assets used?
5. How were the changes in Working Capital

6. How were the plant and machinery expanded?
7. How was the amount received from the issue of
shares of debentures used?
8. Why the funds were not available for the
purchase of machinery and plant?
Importance of Fund Flow

Statement
1.
2.
3.
4.
5.
6.
7.
Financial Analysis and Control

Financial Planning and Budget preparation
Useful to Bankers and Money Lenders
Helpful in Comparative Study
Knowledge of Managerial Policies
Knowledge of Business Problems
Dividend Policy
Preparation of Fund Flow

Statement
Funds flow statement can be prepared monthly but
usually it is prepared for one, two, three, four or
more years.
The data for the preparation of this statement are
obtained form two balance sheets supplemented by
such other information from the accounts as may
be needed.
It is customary for accompany to use the figures of
the balance sheet for the latest year and those on
the balance sheet as at the beginning of the period
for which this statement is to be prepared.
Preparation of funds flow statement is divided into

three parts.
1. Schedule of Changes in Working Capital;
2. Funds from Operation;
3. Funds Flow Statement
STATEMENT OF CHANGES IN
WORKING CAPITAL
This statement is prepared from current

assets and current liabilities in order to
calculate the increase or decrease in
working capital and is prepared in the
Performa given as under.
STATEMENT OF CHANGES IN WORKING CAPITAL
Particulars
Current Assets :
Previous Current
Changes
Year Fig. Year Fig. in current
Rs.(2008) Rs.(2009) assets
and
liabilities
Increase
Cash
Debtors
Stocks
Bill Receivables
Advance payment
Accrued income
Marketable Securities or
Short-term Investment
Decre
-ase
Contd..
Particulars
Current Liabilities:
Creditors
Previous Current Change in

Year Fig. Year Fig. current and
Rs.(2008) Rs.(2009) liabilities
In.
(+)
Bills Payable
Bank Overdraft
Outstanding Expenses
Short-term
Loan etc.
Increase or
Decrease in Working
Capital
Dec.
(-)
The following rules may be applied to

current assets and current liabilities
for preparing this statement:
1. An increase in current assets, increases

working capital
2. A decrease in current assets, decreases
working capital
3. An increase in current liabilities,
decreases working capital
4. A decrease in current liabilities, increases
working capital
FUNDS FLOW STATEMENT
This statement is usually prepared in T form.

Left-hand side is for sources of funds and
right-hand side for applications of funds. The
items of sources and applications are given
as follows:
Contd.
Sources of Funds:
The following are the sources from which funds
come:
1.Funds from operations
2.Income from investments
3.Issue of shares and debentures
4.Raising a loan
5.Sale of fixed assets and long-term investments
6.Receipt of interest on non-trade investment,
dividend, refund of tax etc.
7.Decrease in working capital etc.
Uses (or Applications) of funds:
The following are the various purposes for

which funds can be used:
1.Funds lost in operations
2.Repayment of long-term loans
3.Redemption of preference shares
debentures
4.Purchase of fixed assets
5.Purchase of long-term investments
and
FUNDS FROM OPERATIONS

It can be calculated in two forms :
Particulars
Net Profit for Current Year
Add : Non fund items
Depreciation
Goodwill, Patents
Preliminary Expenses
Written off
LESS : Non-fund Items and
Non-trading Income
,already Credited to P & L
A/c.
Dividend Recevied
Profit on sale
Funds from
operations
Amount
Rs.
Amount
Rs.
MCQs
Q1 Management accounting analyses accounting data with
the help of:a) Auditors
b) Statutory forms
c) Tools & Techniques
d) None of these
Q2 Management Accounting is suitable for:a) Large industrial & trading concerns

b) small business
c) Co-operative societies
d) Non-profit organizations
Q3. Which of the following can improve the margin of

safety?
a) Lowering the fixed cost
b) lowering the variable cost so as to improve marginal
contribution.
c) increasing volume of sales, if there is available capacity.
d) All (a), (b) & (c) above
Q4. Break even sales is

a) The sales required to earn a particular amount of profit.
b) The sales at which there is neither profit nor loss.
c) The sales equal to amount of fixed expenses incurred by
the company.
d) None of the above.
Q5 Under Resale Price Method price of the product is

determined by:
a) Adding profit margin to selling price for the product.
b) adding an appropriate markup to the cost of the product
c) by subtracting an appropriate gross markup from the
sale price to an unrelated third party
d) none of the above
Q6 Cost Centre is:

a) A responsibility centre in which inputs, are measured in
monetary terms.
b) A responsibility centre in which outputs are measured in
monetary terms.
c) A responsibility centre in which assets employed, are
measured in monetary terms.
d) All of the above
Thank You
Please forward your query
To: aarora@amity.edu
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PAN African eNetwork Project

Diploma in Business Management (DBM)

Dr. Adarsh Arora

Budget & Advantages of budgets

Copyright Amity University

Copyright Amity University

Budgetary Control Methods

Budgetary control and responsibility centres;

Copyright Amity University

There are four types of responsibility centres:

Copyright Amity University

Advantages of budgeting and budgetary control

under their personal control.

Copyright Amity University

Improves the allocation of scarce resources.

Copyright Amity University

Characteristics of a Good budget

Copyright Amity University

b) Production budget: expressed in quantitative terms only

c) Raw materials and purchasing budget:

Copyright Amity University

d) Labour budget: is both quantitative and financial. This is

stock and debtors

Copyright Amity University

Cost Reduction and Control

Progress towards objectives must be observed,

Copyright Amity University

DFFERENCE BETWEEN COST CONTROL AND COST

If management misguidedly sets cost standards that are

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Copyright Amity University

Objectives of Ratio Analysis

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Copyright Amity University

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Also referred to as the Quick ratio

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Copyright Amity University

Earnings per share profit after tax / number of

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Copyright Amity University

Profitability measures look at how much profit

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Net Profit Margin = Net Profit / Turnover

Return on Capital Employed (ROCE) =

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Copyright Amity University

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Liabilities have Credit balance and Assets have Debit

Long Term Liabilities & Short Term Liabilities are

Investments in Govt. Securities to be treated

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Net Worth : Capital + Reserve = 200

d. Net Working Capital : C A - C L = 350 - 250 = 50

180 Net Fixed Assets

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200 Net Fixed Assets

400 Investment In Govt.

100 Preliminary Expenses

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Sollution:1. Debt Equity Ratio will be : 600 / (200+100) = 2 : 1

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Exercise : Profit to sales is 2% and amount of profit is say Rs.5 Lac.

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