Financial Managements

Mr. Pankaj Kusum Ramdas Khuspe Page 1

Financial managements

Syllabus

Understanding basic concept of market share, growth, profitability

Basics of balance sheet and profit and loss account

Mr. Pankaj Kusum Ramdas Khuspe

M. Pharmacy (Pharmaceutics)

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SHARE MARKET

A stock market, equity market or share market is the aggregation of buyers and sellers (a loose

network of economic transactions, not a physical facility or discrete entity) of stocks (also called

shares); these may include securities listed on a stock exchange as well as those only traded

privately.

Function and purpose

The stock market is one of the most important ways for companies to raise money, along with

debt markets which are generally more imposing but do not trade publicly.

This allows businesses to be publicly traded, and raise additional financial capital for expansion

by selling shares of ownership of the company in a public market.

The liquidity that an exchange affords the investors enables their holders to quickly and easily

sell securities. This is an attractive feature of investing in stocks, compared to other less liquid

investments such as property and other immoveable assets. Some companies actively increase

liquidity by trading in their own shares.

History has shown that the price of stocks and other assets is an important part of the dynamics

of economic activity, and can influence or be an indicator of social mood.

An economy where the stock market is on the rise is considered to be an up-and-coming

economy.

The stock market is often considered the primary indicator of a country's economic strength and

development.

Rising share prices, for instance, tend to be associated with increased business investment and

vice versa.

Share prices also affect the wealth of households and their consumption.

Therefore, central banks tend to keep an eye on the control and behavior of the stock market and,

in general, on the smooth operation of financial system functions.

Exchanges also act as the clearinghouse for each transaction, meaning that they collect and

deliver the shares, and guarantee payment to the seller of a security.

This eliminates the risk to an individual buyer or seller that the counterparty could default on the

transaction.

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The smooth functioning of all these activities facilitates economic growth in that lower costs and

enterprise risks promote the production of goods and services as well as possibly employment.

In this way the financial system is assumed to contribute to increased prosperity, although some

controversy exists as to whether the optimal financial system is bank-based or market-based.

Recent events such as the Global Financial Crisis have prompted a heightened degree of scrutiny

of the impact of the structure of stock markets (called market microstructure), in particular to the

stability of the financial system and the transmission of systemic risk.

Defining Profitability

“Profitability can be defined as either accounting profits or economic profits.”

Understanding Profitability

Profitability is the primary goal of all business ventures.

Without profitability the business will not survive in the long run. So

measuring current and past profitability and projecting future

profitability is very important.

Profitability is measured with income and expenses.

Income is money generated from the activities of the business.

For example, if crops and livestock are produced and sold, income is

generated.

However, money coming into the business from activities like

borrowing money do not create income.

This is simply a cash transaction between the business and the lender

to generate cash for operating the business or buying assets.

Expenses are the cost of resources used up or consumed by the activities of the business.

For example, seed corn is an expense of a farm business because it is used up in the production

process.

A resource such as a machine whose useful life is more than one year is used up over a period of

years.

Repayment of a loan is not an expense, it is merely a cash transfer between the business and the

lender.

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Profitability is measured with an “income statement”.

This is essentially a listing of income and expenses during a period of time (usually a year) for

the entire business.

Information File Your Net Worth Statement includes - a simple income statement analysis.

An Income Statement is traditionally used to measure profitability of the business for the past

accounting period.

However, a “pro forma income statement” measures projected profitability of the business for

the upcoming accounting period. A budget may be used when you want to project profitability

for a particular project or a portion of a business.

Reasons for Computing Profitability

Whether you are recording profitability for the past period or projecting profitability for the

coming period, measuring profitability is the most important measure of the success of the

business.

A business that is not profitable cannot survive. Conversely, a business that is highly profitable

has the ability to reward its owners with a large return on their investment.

Increasing profitability is one of the most important tasks of the business managers.

Managers constantly look for ways to change the business to improve profitability.

These potential changes can be analyzed with a pro forma income statement or a Partial Budget.

Partial budgeting allows you to assess the impact on profitability of a small or incremental

change in the business before it is implemented.

Accounting Profits (Net Income)

Traditionally, farm profits have been computed by using “accounting profits”.

To understand accounting profits, think of your income tax return.

Your Schedule F provides a listing of your taxable income and deductible expenses.

These are the same items used in calculating accounting profits.

However, your tax statement may not give you an accurate picture of profitability due to IRS

rapid depreciation and other factors.

To compute an accurate picture of profitability you may want to use a more accurate measure of

depreciation.

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Accounting profits provide you with an intermediate view of the viability of your business.

Although one year of losses may not permanently harm your business, consecutive years of

losses (or net income insufficient to cover living expenditures) may jeopardize the viability of

your business.

To help you assess the financial health of your business, Financial Performance Measures allows

you to give your business a check-up and helps you to understand what these performance

measures mean for your business.

PROFIT AND LOSS ACCOUNT

The determination of Gross Profit or Gross Loss is done by preparation of Trading Account. But

it does not reveal the Net Profit or Net Loss of a concern during the particular period. This is the

second part of the income statement and is called as Profit and Loss Account. The purpose of

preparing the profit and loss account to calculate the Net Profit or Net Loss of a concern. Net

profit refers to the surplus which remains after deducting related trading expenses from the Gross

Profit. The trading expenses refer to inclusive of office and administrative expenses, selling and

distribution expenses. In other words, all operating expenses such as office and administrative

expenses, selling and distribution expenses and non-operating expenses are shown on the debit

side and all operating and non operating gains and incomes are shown on the credit side of the

Profit and Loss Account. The difference of two sides is either Net Profit or Net Loss.

Accordingly, when total of all operating and non-operating expenses is more than the Gross

Profit and other non-operating incomes, the difference is the Net Profit and in the reverse case it

is known as Net Loss. This Net Profit or Net Loss is transferred to the Capital Account of

Balance Sheet.

Specimen Proforma of a Profit and Loss Account

The following Specimen Proforma which is used for preparation of Trading, Profit and Loss

Account.

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Balance sheet

In financial accounting, a balance sheet or statement of financial position is a summary of the

financial balances of an individual or organisation, whether it be a sole proprietorship, a business

partnership, a corporation, Private limited company or other organization such as Government or

not-for-profit entity. Assets, liabilities and ownership equity are listed as of a specific date, such

as the end of its financial year. A balance sheet is often described as a "snapshot of a company's

financial condition".

Of the four basic financial statements, the balance sheet is the only statement which applies to a

single point in time of a business' calendar year.

A standard company balance sheet has three parts: assets, liabilities, and ownership equity. The

main categories of assets are usually listed first, and typically in order of liquidity. Assets are

followed by the liabilities. The difference between the assets and the liabilities is known as

equity or the net assets or the net worth or capital of the company and according to the

accounting equation, net worth must equal assets minus liabilities.

Another way to look at the balance sheet equation is that total assets equals liabilities plus

owner's equity.

Looking at the equation in this way shows how assets were financed: either by borrowing money

(liability) or by using the owner's money (owner's or shareholders' equity). Balance sheets are

usually presented with assets in one section and liabilities and net worth in the other section with

the two sections "balancing".

A business operating entirely in cash can measure its profits by withdrawing the entire bank

balance at the end of the period, plus any cash in hand.

However, many businesses are not paid immediately; they build up inventories of goods and they

acquire buildings and equipment.

In other words: businesses have assets and so they cannot, even if they want to, immediately turn

these into cash at the end of each period. Often, these businesses owe money to suppliers and to

tax authorities, and the proprietors do not withdraw all their original capital and profits at the end

of each period.

In other words, businesses also have liabilities.

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ASSET

Definition “Any item of economic value owned by an individual or corporation, especially that which could

be converted to cash.”

Examples are cash, securities, accounts receivable, inventory, office equipment, real estate, a car,

and other property.

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An asset is a resource or property having a monetary/economic value possessed by an individual

or entity, which is capable of producing some future economic benefit. Assets are generally

brought in business to benefit from them and to increase the value of a business. In simple

language, it means anything that a person “owns” say a house or equipment. In accounting

context, an asset is a resource that can generate cash flows. Assets are found on the right-hand

side of the balance sheet and can also be referred to as “Sources of Funds”

Assets are classified into different types based on their convertibility to cash; use in business or

basis their physical existence. Assets are a part of the balance sheet and are generally stated at

cost or market value, whichever is lower.

Classification of Assets

Assets are generally classified in the following three ways depending upon nature and type:

1. Convertibility: One way of classification of assets is based on their easy convertibility into

cash. According to this classification, total assets are classified either into Current Assets or

Fixed Assets.

• Current Assets: Assets which are easily convertible into cash like stock, inventory, marketable

securities, short-term investments, fixed deposits, accrued incomes, bank balances, debtors,

prepaid expenses etc. are classified as current assets. Current assets are generally of a shorter life

span as compared to fixed assets which last for a longer period. Current assets can also be termed

as liquid assets.

• Fixed Assets: Fixed assets are of a fixed nature in the context that they are not readily

convertible into cash. They require elaborate procedure and time for their sale and converted into

cash. Land, building, plant, machinery, equipment and furniture are some examples of fixed

assets. Other names used for fixed assets are non-current assets, long-term assets or hard assets.

Generally, the value of fixed assets generally reduces over a period of time (known as

depreciation).

2. Physical Existence: Another classification of assets is based on their physical existence.

According to this classification, an asset is either a tangible asset or intangible asset.

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Tangible Assets: Tangible assets are those assets which we can touch, see and feel. All fixed

assets are tangible. Moreover, some current assets like inventory and cash fall under the category

of tangible assets too.

• Intangible Assets: Intangible assets cannot be seen, felt or touched physically by us. Some

examples of intangible assets are goodwill, franchise agreements, patents, copyrights, brands,

trademarks etc.

These are also classified under assets because the business owners reap monetary gains with the

help of these intangible assets. A company’s trademark, brand and goodwill contribute to its

marketing and sale of its products. Many buyers purchase goods only by seeing its trademark and

brand in the market.

3. Usage: According to a third way of classification, assets are either operating or non-operating.

This classification is based on usage of the asset for business operation. Assets which are

predominantly used for day-to-day business are classified as operating assets and other assets

which are not used in operation are classified as non-operating.

• Operating Assets: All assets required for the current day-to-day transaction of business are

known as operating assets. In simple words, the assets that a company uses for producing a

product or service are operating assets. These include cash, bank balance, inventory, plant,

equipment etc.

• Non-operating Assets: All assets which are of no use for daily business operations but are

essential for the establishment of business and for its future needs are termed as non-operational.

This could include some real estate purchased to earn from its appreciation or excess cash in

business, which is not used in an operation.

Understanding Total Assets and Net Assets

The meaning of total assets is truly reflected in the accounting equation as the sum total of

liabilities and owner’s equity. While “Net Assets” is a term used to state the difference between

total assets and total liabilities. Consequently, it can be noted that net assets and owner’s equity

are virtually the same i.e. both represent the difference between “Total Assets” and “Total

Liabilities

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Total Assets = Total Liabilities + Owner’s Equity

Net Assets = Total Assets – Total Liabilities

The following table will give you a clear picture of the types of assets:

Current

Asset Fixed Asset Tangible Asset

Intangible

Asset

Operating

Asset

Non-

operating

Asset

Cash Land Land Goodwill Cash Goodwill

Bank Balance Road Road Patents Bank Balance

Patents

Investments Building Building Brand Inventory

Inventory Furniture Furniture Trademark Stocks

Stock Plant Plant

Copyright

Prepaid Exp.

Receivables Machinery Machinery Receivables

Prepaid Exp. Equipments

Equipment Plant

Cash Machinery

Inventory/Stock

LIABILITY

Definition

An obligation that legally binds an individual or company to settle a debt. When one is liable for

a debt, they are responsible for paying the debt or settling a wrongful act they may have

committed.

In the case of a company, a liability is recorded on the balance sheet and can include accounts

payable, taxes, wages, accrued expenses, and deferred revenues. Current liabilities are debts

payable within one year, while long-term liabilities are debts payable over a longer period.

Meaning and Types of Liabilities Liability is a legal obligation of an individual or a business entity towards creditors arising out of

some transactions. A more clear-cut definition of liability signifies it as a claim by the creditors

against the assets and legal obligations of an individual or entity resulting from the past or

current transactions and events.

Liabilities imply a duty or responsibility to pay on demand or on an occurrence of certain

transaction or event.

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Liabilities also arise from borrowings which may be made to improve business or personal

income and are paid back over an agreed period of an interval, which may be of the short period

or long period.

Liabilities are mentioned on the left-hand side of a Balance Sheet below Equity Capital. Just like

assets, liabilities are also represented in a sequence in the Balance Sheet. Liabilities are grouped

and classified according to their nature and time period. Some common types of liabilities

include current liabilities, long-term liabilities and contingent liabilities. Let us have a look at

them:

Current Liabilities or Short Term Liabilities

Liabilities which are normally due and payable within one year are grouped as current

liabilities. These liabilities are also known as short-term liabilities as they become due within a

shorter period (say within 1 year). Creditors, salaries and wages payable, gratuity or bonus

payable, interest payable, bills payable, sundry creditors, bank overdraft or cash credit,

unclaimed dividends, pre-received incomes, sales tax payable, income tax payable, provisions,

other taxes payable, accrued expenses, instalments due within 1 year for term loans, etc. are all

examples of current liabilities

Long Term Liabilities

Liabilities which are not immediately due but become due after a year or more are classified as

long-term liabilities. Long term bank loans like term loans, debentures, deferred tax liabilities,

mortgage liabilities (payable after 1 year), lease payments examples of long-term liabilities.

Interest payable is also treated as the long-term liability if interest is payable on maturity.

Contingent Liabilities

Certain liabilities are payable on the occurrence of some event or contingency. Contingency

signifies something which may or may not take place. If a liability is due on happening of such

an event, it is termed as the contingent liability. Default in supply, breach of contract, damage to

the environment or to the prestige of some person or entity, an outcome of accidents and other

law-suits, are examples of some such cases where a liability is contingent to occur. Such

liabilities are calculated on the basis of “what if the actual loss occurs” where ever possible and

with an addition of a notional calculation of damage occurred to the person or entity. Generally,

these liabilities are not included in the Balance Sheet but are mentioned separately as a note to

the balance sheet

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Questions asked: 1. Management is art as well as science. (2)

2. Define Balance sheet. (1)

3. Write Performa of profit & loss account & balance sheet. (3/4)*

4. Define Costing. (1)

5. Give formula to calculate retail price of drug. (2)

6. Define Management give its functions. (2)

7. Difference between liabilities & assets. (2)

8. Explain the components of profit & loss account. (4)