Finance addresses the ways in which individuals and organizations raise and allocate monetaryresourcesover time, taking into account therisksentailed in their projects.The wordfinancemay incorporate any of the following: The study ofmoneyand otherassets Themanagementand control of those assets Profiling andmanaging project risks

Fundamental Financial ConceptsArbitrageIneconomicsandfinance,arbitrage/rbtr/is the practice of taking advantage of a price difference between two or moremarkets: striking a combination of matching deals that capitalize upon the imbalance, the profit being the difference between themarket prices. When used by academics, an arbitrage is a transaction that involves no negativecash flowat any probabilistic or temporal state and a positive cash flow in at least one state; in simple terms, it is the possibility of a risk-free profit at zero cost.People who engage in arbitrage are calledarbitrageurssuch as a bank or brokerage firm. The term is mainly applied to trading infinancial instruments, such asbonds, stocks,derivatives,commoditiesandcurrencies.Arbitrage-freeIf the market prices do not allow for profitable arbitrage, the prices are said to constitute anarbitrage equilibriumorarbitrage-freemarket. Arbitrage equilibrium is a precondition for a general economic equilibrium. The assumption that there is no arbitrage is used inquantitative financeto calculate a uniquerisk neutralprice forderivatives.Conditions for arbitrageArbitrage is possible when one of three conditions is met:1. The same asset does not trade at the same price on all markets ("the law of one price").2. Two assets with identical cash flows do not trade at the same price.3. An asset with a known price in the future does not today trade at its future pricediscountedat therisk-free interest rate(or, the asset does not have negligible costs of storage; as such, for example, this condition holds for grain but not forsecurities).Arbitrage is not simply the act of buying a product in one market and selling it in another for a higher price at some later time. The transactions must occursimultaneouslyto avoid exposure to market risk, or the risk that prices may change on one market before both transactions are complete. In practical terms, this is generally possible only with securities and financial products that can be traded electronically, and even then, when each leg of the trade is executed the prices in the market may have moved. Missing one of the legs of the trade (and subsequently having to trade it soon after at a lower price) is called 'execution risk' or more specifically 'leg risk'. In the simplest example, any good sold in one market should sell for the same price in another.Tradersmay, for example, find that the price of wheat is lower in agricultural regions than in cities, purchase the good, and transport it to another region to sell at a higher price. This type of price arbitrage is the most common, but this simple example ignores the cost of transport, storage, risk, and other factors. "True" arbitrage requires that there be no market risk involved. Where securities are traded on more than one exchange, arbitrage occurs by simultaneously buying in one and selling on the other.Examples Suppose that theexchange rates(after taking out the fees for making the exchange) in London are 5 = $10 = 1000 and the exchange rates in Tokyo are 1000 = $12 = 6. Converting 1000 to $12 in Tokyo and converting that $12 into 1200 in London, for a profit of 200, would be arbitrage. In reality, this arbitrage is so simple that it almost never occurs. But more complicated foreign exchange arbitrages, such as the spot-forward arbitrage (seeinterest rate parity) are much more common. One example of arbitrage involves theNew York Stock Exchangeand the Security Futures ExchangeOne Chicago (OCX). When the price of a stock on the NYSE and its correspondingfutures contracton OCX are out of sync, one can buy the less expensive one and sell it to the more expensive market. Because the differences between the prices are likely to be small (and not to last very long), this can be done profitably only with computers examining a large number of prices and automatically exercising a trade when the prices are far enough out of balance. The activity of other arbitrageurs can make this risky. Those with the fastest computers (i.e. lowest latencies to respond to the market) and the most expertise take advantage of series of small differences that would not be profitable if taken individually. Economists use the term "global labor arbitrage" to refer to the tendency of manufacturing jobs to flow towards whichever country has the lowest wages per unit output at present and has reached the minimum requisite level of political and economic development to supportindustrialization. At present, many such jobs appear to be flowing towardsChina, though some that require command of English are going toIndiaand thePhilippines. In popular terms, this is referred to asoffshoring. (Note that "offshoring" is not synonymous with "outsourcing", which means "to subcontract from an outside supplier or source", such as when a business outsources its bookkeeping to an accounting firm. Unlike offshoring, outsourcing always involves subcontracting jobs to a different company, and that company can be in the same country as the outsourcing company.)

Price convergenceArbitrage has the effect of causing prices in different markets to converge. As a result of arbitrage, the currencyexchange rates, the price ofcommodities, and the price of securities in different markets tend to converge. The speed at which they do so is a measure of market efficiency. Arbitrage tends to reduceprice discriminationby encouraging people to buy an item where the price is low and resell it where the price is high (as long as the buyers are not prohibited from reselling and the transaction costs of buying, holding and reselling are small relative to the difference in prices in the different markets).Arbitrage moves different currencies towardpurchasing power parity. As an example, assume that a car purchased in the United States is cheaper than the same car in Canada. Canadians would buy their cars across the border to exploit the arbitrage condition. At the same time, Americans would buy US cars, transport them across the border, then sell them in Canada. Canadians would have to buy American dollars to buy the cars and Americans would have to sell the Canadian dollars they received in exchange. Both actions would increase demand for US dollars and supply of Canadian dollars. As a result, there would be an appreciation of the US currency. This would make US cars more expensive and Canadian cars less so until their prices were similar. On a larger scale, international arbitrage opportunities incommodities, goods,securitiesandcurrenciestend to changeexchange ratesuntil thepurchasing poweris equal.In reality, mostassetsexhibit some difference between countries. These,transaction costs, taxes, and other costs provide an impediment to this kind of arbitrage.RisksExecution riskGenerally it is impossible to close two or three transactions at the same instant; therefore, there is the possibility that when one part of the deal is closed, a quick shift in prices makes it impossible to close the other at a profitable price. However, this is not necessarily the case. Many exchanges and inter-dealer brokers allow multi legged trades.Competition in the marketplace can also create risks during arbitrage transactions. As an example, if one was trying to profit from a price discrepancy between IBM on the NYSE and IBM on the London Stock Exchange, they may purchase a large number of shares on the NYSE and find that they cannot simultaneously sell on the LSE. This leaves the arbitrageur in an unhedged risk position.MismatchAnother risk occurs if the items being bought and sold are not identical and the arbitrage is conducted under the assumption that the prices of the items are correlated or predictable; this is more narrowly referred to as aconvergence trade. In the extreme case this is merger arbitrage, described below. In comparison to the classical quick arbitrage transaction, such an operation can produce disastrous losses.Merger Arbitrage also calledrisk arbitrage, merger arbitrage generally consists of buying/holding the stock of a company that is the target of atakeoverwhileshortingthe stock of the acquiring company.Usually the market price of the target company is less than the price offered by the acquiring company. The spread between these two prices depends mainly on the probability and the timing of the takeover being completed as well as the prevailing level of interest rates.The bet in a merger arbitrage is that such a spread will eventually be zero, if and when the takeover is completed. The risk is that the deal "breaks" and the spread massively widens.Capital asset pricing modelInfinance, thecapital asset pricing model (CAPM)is used to determine a theoretically appropriate requiredrate of returnof anasset, if that asset is to be added to an already well-diversifiedportfolio, given that asset's non-diversifiablerisk. The model takes into account the asset's sensitivity to non-diversifiablerisk(also known assystematic riskormarket risk), often represented by the quantitybeta() in the financial industry, as well as the expected returnof the market and the expected return of a theoreticalrisk-freeasset.Cash flowCash flowis the movement ofmoneyinto or out of a business, project, or financial product. It is usually measured during a specified, limited period of time. Measurement of cash flow can be used for calculating other parameters that give information on a company's value and situation. Cash flow can be used, for example, for calculating parameters: to determine a project'srate of returnor value. The time of cash flows into and out of projects are used as inputs in financial models such asinternal rate of returnandnet present value. to determine problems with a business'sliquidity. Being profitable does not necessarily mean being liquid. A company can fail because of a shortage of cash even while profitable. as an alternative measure of a business's profits when it is believed thataccrual accountingconcepts do not represent economic realities. For instance, a company may be notionally profitable but generating little operational cash (as may be the case for a company that barters its products rather than selling for cash). In such a case, the company may be deriving additional operating cash by issuing shares or raising additional debt finance. cash flow can be used to evaluate the 'quality' of income generated byaccrual accounting. When net income is composed of large non-cash items it is considered low quality. to evaluate the risks within a financial product, e.g., matching cash requirements, evaluating default risk, re-investment requirements, etc.Cash flow is a generic term used differently depending on the subject. It may be defined by users for their own purposes. It can refer to past flows or projected future flows. It can refer to the total of all flows involved or a subset of those flows. Subset terms include net cash flow, operating cash flowandfree cash flow.

Statement of cash flow in a business' financialsThe (total) net cash flow of a company over a period (typically a quarter or a full year) is equal to the change in cash balance over this period: positive if the cash balance increases (more cash becomes available), negative if the cash balance decreases. The total net cash flow is the sum of cash flows that are classified in three areas:1. Operational cash flows: Cash received or expended as a result of the company's internal business activities. It includes cash earnings plus changes toworking capital. Over the medium term this must be net positive if the company is to remain solvent.2. Investment cash flows: Cash received from the sale of long-life assets, or spent oncapital expenditure(investments, acquisitions and long-life assets).3. Financing cash flows: Cash received from the issue of debt and equity, or paid out as dividends,share repurchasesor debt repayments.

Ways Companies Can Augment Reported Cash FlowCommon methods include: Sales - Sell the receivables to a factor for instant cash. (leading) Inventory - Don't pay your suppliers for an additional few weeks at period end. (lagging) Sales Commissions - Management can form a separate (but unrelated) company and act as its agent. The book of business can then be purchased quarterly as an investment. Wages - Remunerate with stock options. Maintenance - Contract with the predecessor company that you prepay five years worth for them to continue doing the work Equipment Leases - Buy it Rent - Buy the property (sale and lease back, for example). Oil Exploration costs - Replace reserves by buying another company's. Research & Development - Wait for the product to be proven by a start-up lab; then buy the lab. Consulting Fees - Pay in shares from treasury since usually to related parties Interest - Issue convertible debt where the conversion rate changes with the unpaid interest. Taxes - Buy shelf companies with Tax Loss Carry Forward's. Or gussy up the purchase by buying a lab or O&G explore co. with the same TLCF.

Discounted cash flow Infinance,discounted cash flow(DCF) analysis is a method of valuing a project, company, orassetusing the concepts of thetime value of money. All futurecash flowsare estimated anddiscountedto give theirpresent values(PVs)the sum of all future cash flows, both incoming and outgoing, is thenet present value(NPV), which is taken as the value or price of the cash flows in question. Using DCF analysis to compute the NPV takes as input cash flows and a discount rate and gives as output a price; the opposite processtaking cash flows and a price and inferring a discount rate, is called theyield. Discounted cash flow analysis is widely used in investment finance,real estate development, andcorporate financialmanagement.

Financial capitalFinancial capitalis money used byentrepreneursandbusinessesto buy what they need to make their products or to provide their services to the sector of the economy upon which their operation is based, i.e. retail, corporate,investment banking, etc.Financial modellingFinancial modellingis the task of building anabstract representation(amodel) of afinancialdecision-makingsituation.[1]This is amathematical modeldesigned to represent (a simplified version of) the performance of a financial asset or portfolio of a business,project, or any other investment.Fixed income analysisFixed income analysisis the valuation offixed incomeor debt securities, and the analysis of theirinterest rate risk,credit risk, and likely price behavior inhedgingportfolios. The analyst might conclude to buy, sell, hold, hedge or stay out of the particular security.Fixed income products are generallybondsissued by various governmenttreasuries, companies or international organizations. Bond holders are usually entitled to coupon payments at periodic intervals untilmaturity. These coupon payments are generally fixed amounts (quoted as percentage of the bond's face value) or the coupons could float in relation toLIBORor anotherreference rate.

Gap financingGap Financingis a term mostly associated withmortgage loansorpropertyloans. It is an interim loan given to finance the difference between thefloor loanand the maximum permanent loan as committed.

Hedge (finance)Ahedgeis an investment position intended to offset potential losses/gains that may be incurred by a companion investment. In simple language, a hedge is used to reduce any substantial losses/gains suffered by an individual or an organization.A hedge can be constructed from many types of financial instruments, includingstocks,exchange-traded funds,insurance,forward contracts,swaps,options, many types ofover-the-counterandderivativeproducts, andfutures contracts.

InvestmentInvestmenthas different meanings infinanceandeconomics.In economics, investment is related tosavingand deferringconsumption. Investment is involved in many areas of theeconomy, such asbusiness managementandfinancewhether for households, firms, or governments.In finance, investment is puttingmoneyinto something with the expectation ofgain, usually over a longer term.Traditional investmentsrefer to theinvestingstocks,bonds, cash, or real estate.Real estateInreal estate, investment money is used to purchasepropertyfor the purpose of holding, reselling or leasing for income and there is an element of capital risk.Residential real estateInvestment in residential real estate is the most common form of real estate investment measured by number of participants because it includes property purchased as a primary residence. In many cases the buyer does not have the full purchase price for a property and must engage a lender such as a bank, finance company or private lender. Different countries have their individual normal lending levels, but usually they will fall into the range of 7090% of the purchase price. Against other types of real estate, residential real estate is the least risky.Commercial real estateCommercial real estate consists of multifamily apartments, office buildings, retail space, hotels and motels, warehouses, and other commercial properties. Due to the higher risk of commercial real estate,loan-to-value ratiosallowed by banks and other lenders are lower and often fall in the range of 5070%.

Analternative investmentis aninvestmentproduct other than thetraditional investmentsofstocks,bonds, cash, or real estate. The term is a relatively loose one and includestangible assetssuch asprecious metals,[1]art, wine, antiques, coins, or stamps[2]and some financial assets such ascommodities,equity, hedge,carbon credits,[3]venture capital, forests/timber,[4][5][6]film production[7]andfinancial derivatives.TheMerrill Lynch/Cap Gemini Ernst & Young World Wealth Report 2003, based on 2002 data, showedhigh net worth individuals, as defined in the report, to have 10% of their financial assets in alternative investments. For the purposes of the report, alternative investments included "structured products, luxury valuables and collectibles, hedge funds, managed futures, and precious metals".[8]By 2007, this had reduced to 9%.[9]No recommendations were made in either report about the amount of money investorsshouldplace in alternative investments.Interest RateAninterest rateis the rate at whichinterestis paid by borrowers for the use of money that they borrow from alender. Specifically, the interest rate (I/m) is a percent of principal (P) paid a certain amount of times (m) per period (usually quoted per annum). For example, a small company borrows capital from a bank to buy new assets for its business, and in return the lender receives interest at a predetermined interest rate for deferring the use of funds and instead lending it to the borrower. Interest rates are normally expressed as apercentageof theprincipalfor a period of one year.Thenominal interest rateis the amount, in percentage terms, of interest payable.For example, suppose a household deposits $100 with a bank for 1 year and they receive interest of $10. At the end of the year their balance is $110. In this case, thenominal interest rateis 10% per annum.Thereal interest rate, which measures thepurchasing powerof interest receipts, is calculated by adjusting the nominal rate charged to takeinflationinto account. If inflation in the economy has been 10% in the year, then the $110 in the account at the end of the year buys the same amount as the $100 did a year ago. Thereal interest rate, in this case, is zero.

Annual percentage rateThe termannual percentage rate (APR), also callednominal APR, and the termeffective APR, also calledEAPR,[1]describes the interest rate for a whole year (annualized), rather than just a monthly fee/rate, as applied on aloan,mortgage loan,credit card, etc. It is a finance charge expressed as an annual rate.[2]Those terms have formal, legal definitions in some countries or legal jurisdictions, but in general:[1] Thenominal APRis the simple-interest rate (for a year). Theeffective APRis the fee + compound interestrate (calculated across a year).

Effective Interest RateTheeffective interest rate,effective annual interest rate,annual equivalent rate (AER)or simplyeffective rateis theinterest rateon a loan or financial product restated from thenominal interest rateas an interest rate with annualcompound interestpayable in arrears.It is used to compare the annual interest between loans with different compounding terms (daily, monthly, annually, or other). The effective interest rate differs in two important respects from theannual percentage rate(APR):[1]1. the effective interest rate generally does not incorporate one-time charges such as front-end fees;2. the effective interest rate is (generally) not defined by legal or regulatory authorities (as APR is in many jurisdictions).[2]By contrast, theeffective APRis used as a legal term, where front-fees and other costs can be included, as defined by local law.The effective interest rate is calculated as if compounded annually. The effective rate is calculated in the following way, whereris the effective annual rate,the nominal rate, andnthe number of compounding periods per year (for example, 12 for monthly compounding):

For example, a nominal interest rate of 6% compounded monthly is equivalent to an effective interest rate of 6.17%. 6% compounded monthly is credited as 6%/12 = 0.005 every month. After one year, the initial capital is increased by the factor (1+0.005)12 1.0617.When the frequency of compounding is increased up to infinity the calculation will be:

The effective interest rate is a special case of theinternal rate of return.If the monthly interest rate j is known and remains constant throughout the year, the effective annual rate can be calculated as follows:

Leverage (finance)Infinance,leverage(sometimes referred to asgearingin the United Kingdom and Australia) is a general term for any technique to multiply gains and losses.Common ways to attain leverage are borrowing money, buyingfixed assetsand usingderivatives.[2]Important examples are: Apublic corporationmay leverage itsequityby borrowing money. The more it borrows, the less equitycapitalit needs, so any profits or losses are shared among a smaller base and are proportionately larger as a result.[3] A business entity can leverage its revenue by buying fixed assets. This will increase the proportion offixed, as opposed tovariable, costs, meaning that a change inrevenuewill result in a larger change inoperating income.

Position (finance)Infinancial trading, apositionis abinding commitmenttobuy or sella given amount offinancial instruments, such as securities, currencies or commodities, for a given price.The term "position" is also used in the context offinancefor the amount of securities or commodities held by a person, firm, or institution, and for the ownership status of a person's or institution's investments.Inderivatives tradingor forfinancial instruments, the concept of apositionis used extensively. There are two basic types of position: alongand ashort.Traded optionswill be used in the following explanations. The same principle applies forfuturesand othersecurities. For simplicity, only one contract is being traded in these examples.

Longposition When a traderbuysan option contract that he has not already written (i.e. sold), he is said to beopeninga long position. When a tradersellsan option contract that he already owns, he is said to beclosinga long position. When a trader is 'long', he/she wins when the price increases, and loses when the price decreases.

Shortposition When a traderwrites(i.e.sells) an option contract that he does not already own, he is said to beopeninga short position. When a traderbuysan option contract that he has written (i.e. sold), he is said to beclosinga short position. When a trader is 'short', he/she wins when the price decreases, and loses when the price increases.The long and the short of it is that: buyers are referred to asthe long; and sellers are referred to asthe short.

Net positionNet position is the difference between total open long (receivable) and open short (payable) positions in a given assets (security, foreign exchangecurrency,commodity, etc...) held by an individual. This also refers the amount of assets held by a person,firm, orfinancial institutionas well as the ownership status of a person's or institution's investments.

Long (finance)n finance, alongpositionin asecurity, such as astockor abond, or equivalentlyto be longin a security, means the holder of the position owns the security and will profit if the price of the security goes up.Going long[1]is the more conventional practice ofinvestingand is contrasted withgoing short. Anoptions investor goes long on theunderlying instrumentby buyingcall optionsor writingput optionson it.Short (finance)In contrast, ashortposition in afutures contractor similarderivativemeans that the holder of the position willprofitif the price of the futures contract or derivative goes down.Market liquidityInbusiness,economicsorinvestment,market liquidityis anasset's ability to be sold without causing a significant movement in thepriceand with minimum loss of value.Liquidityalso refers both to a business's ability to meet its payment obligations, in terms of possessing sufficient liquid assets, and to such assets themselves. An act of exchange of a less liquid asset with a more liquid asset is called liquidation.Money, orcash, is the most liquid asset, and can be used immediately to perform economic actions like buying, selling, or paying debt, meeting immediate wants and needs.Mark-to-market accountingMark-to-marketorfair value accountingrefers to accounting for the "fair value" of an asset or liability based on the currentmarket price, or for similar assets and liabilities, or based on another objectively assessed "fair" value.Mark-to-market accounting can change values on the balance sheet as market conditions change. In contrast,historical costaccounting, based on the past transactions, is simpler, more stable, and easier to perform, but does not represent current market value. It summarizes past transactions instead. Mark-to-market accounting can become inaccurate if market prices fluctuate greatly or change unpredictably.Example: If an investor owns 10 shares of a stock purchased for $4 per share, and that stock now trades at $6, the "mark-to-market" value of the shares is equal to (10 shares * $6), or $60, whereas thebook valuemight (depending on the accounting principles used) only equal $40.Similarly, if the stock decreases to $3, the mark-to-market value is $30 and the investor has lost $10 of the original investment.

MicrofinanceMicrofinanceis usually understood to entail the provision offinancial servicesto micro-entrepreneurs and small businesses that lack access tobankingand related services due to the high transaction costs associated with serving these client categories. The two main mechanisms for the delivery of financial services to such clients are (1) relationship-based banking for individual entrepreneurs and small businesses; and (2) group-based models, where several entrepreneurs come together to apply for loans and other services as a group.

MicrocreditMicrocreditis the extension of very smallloans(microloans) to impoverished borrowers who typically lackcollateral, steady employment and a verifiablecredit history. It is designed not only to support entrepreneurship and alleviate poverty, but also in many cases to empower women and uplift entire communities by extension.

MicropaymentAmicropaymentis afinancial transactioninvolving a very small sum of money and usually one that occursonline.PayPaldefines a micropayment as a transaction of less than 12USD[1]while Visaprefers transactions under 20Australian dollars,[2]and while micropayments were originally envisioned to involve much smaller sums of money, practical systems to allow transactions of less than 1 USD have seen little success.[3]One problem that has prevented the emergence of micropayment systems is a need to keep costs for individual transactions low,[4]which is impractical when transacting such small sums[5]even if the transaction fee is just a few cents.

Reference rateAreference rateis a rate that determines pay-offs in a financial contract and that is outside the control of the parties to the contract. It is often some form ofLIBORrate, but it can take many forms, such as aconsumer price index, a house price index or anunemployment rate. Parties to the contract choose a reference rate that neither party has power to manipulate. E.g. the most common use of reference rates is that of short term interest rates such as LIBOR infloating rate notes,loans,swaps, short term interest ratefutures contracts, etc. The rates are calculated by an independent organisation, such as theBritish Bankers Association(BBA) as the average of the rates quoted by a large panel of banks, to ensure independence.Time Value of MoneyThetime value of moneyis the value of money with a given amount ofinterestearned orinflationaccrued over a given amount of time. The ultimate principle suggests that a certain amount of money today has different buying power than the same amount of money in the future. This notion exists both because there is an opportunity to earn interest on the money and because inflation will drive prices up, thus changing the "value" of the money. The time value of money is the central concept infinance theory.Compounding is the process of investing money as well as reinvesting the interest earned thereon. Discountingis a financial mechanism in which adebtorobtains the right to delay payments to acreditor, for a defined period of time, in exchange for a charge or fee.[1]Essentially, the party that owes money in the present purchases the right to delay the payment until some future date.[2]Thediscount, orcharge, is simply the difference between the original amount owed in the present and the amount that has to be paid in the future to settle the debt.The discount is usually associated with adiscount rate, which is also called thediscount yield. The discount yield is simply the proportional share of the initial amount owed (initial liability) that must be paid to delay payment for 1 year.Discount Yield= Charge" to Delay Payment for 1 year/Debt LiabilityIt is also the rate at which the amount owed must rise to delay payment for 1 year.Since a person can earn a return on money invested over some period of time, most economic and financial models assume the "Discount Yield" is the same as theRate of Returnthe person could receive by investing this money elsewhere (in assets of similarrisk) over the given period of time covered by the delay in payment. The Concept is associated with theOpportunity Cost of not having use of the money for the period of time covered by the delay in payment.

AnnuityInfinance theory, anannuityis a terminating "stream" of fixed payments, i.e., a collection of payments to be periodically received over a specified period of time.[1]The valuation of such a stream of payments entails concepts such as thetime value of money,interest rate, andfuture value.Examples of annuities are regular deposits to a savings account, monthly home mortgage payments and monthly insurance payments. Annuities are classified by the frequency of payment dates. The payments (deposits) may be made weekly, monthly, quarterly, yearly, or at any other interval of time.Annuity ImmediateAnannuityis a series of payments made at fixed intervals of time. If the number of payments is known in advance, the annuity is anannuity-certain. If the payments are made at the end of the time periods, so that interest is accumulated before the payment, the annuity is called anannuity-immediate orordinary annuity or deferred annuity. Mortgage payments are annuity-immediate, interest is earned before being paid.Annuity - dueAnannuity-dueis an annuity whose payments are made at the beginning of each period. Deposits in savings, rent or lease payments, and insurance premiums are examples of annuities due.PerpetuityPerpetuityis an annuity for which the payments continue forever.Present valueThe current worth of a future sum of money or stream ofcash flowsgiven a specified rate of return. Future cash flows are discounted at the discount rate, and the higher the discount rate, the lower the present value of the future cash flows. Determining the appropriate discount rate is the key to properly valuing future cash flows, whether they be earnings or obligations.

Note that this series can be summed for a given value ofn, or whennis .Present value of anAnnuityAn annuity is a series of equal payments or receipts that occur at evenly spaced intervals. Leases and rental payments are examples. The payments or receipts occur at the end of each period for an ordinary annuity while they occur at the beginning of each period for an annuity due.

Present value of a growing annuityIn this case each cash flow grows by a factor of (1+g). Similar to the formula for an annuity, the present value of a growing annuity (PVGA) uses the same variables with the addition ofgas the rate of growth of the annuity (A is the annuity payment in the first period). This is a calculation that is rarely provided for on financial calculators.

Present value of a perpetuity

Present value of a growing perpetuityWhen the perpetual annuity payment grows at a fixed rate (g) the value is theoretically determined according to the following formula. In practice, there are few securities with precise characteristics, and the application of this valuation approach is subject to various qualifications and modifications. Most importantly, it is rare to find a growing perpetual annuity with fixed rates of growth and true perpetual cash flow generation. Despite these qualifications, the general approach may be used in valuations of real estate, equities, and other assets. This is the well knownGordon Growth modelused forstock valuation.Thedividend discount model(DDM) is a method of valuing a company based on the theory that astockis worth the discounted sum of all of its future dividend payments.[1]In other words, it is used to value stocks based on thenet present valueof the futuredividends. The equation most widely used is called theGordon growth model.The variables are:is the current stock price.is the constant growth rate in perpetuity expected for the dividends.is the constant cost of equity for that company.is the value of the next year'sdividends. There is no reason to use a calculation of next year's dividend using the current dividend and the growth rate, when management commonly disclose the future year's dividend and websites post it.

Future valueis the value of an asset or cash at a specified date in the future that is equivalent in value to a specified sum today.Thefuture value(FV) formula is similar and uses the same variables.

Future value of an annuity

Future value of a growing annuity

AccountingAccountancy, oraccounting, is the production of information about anenterpriseand the transmission of that information from people who have it to those who need it.Thecommunicationis generally in the form offinancial statementsthat show in money terms theeconomic resourcesunder the control of management; the art lies in selecting the information that is relevant to the user and is representationally faithful. Theprinciplesof accountancy are applied to business entities in three divisions of practical art, named accounting,bookkeeping, andauditing.TheAmerican Institute of Certified Public Accountants(AICPA) defines accountancy as "...the art of recording, classifying, and summarizing in a significant manner and in terms of money..." transactions and events that are at least partly financial in character, and interpreting the results.The AAA (American Association of Accounting) defines accounting as the process of identifying, measuring and communicating economic information to permit informed judgments and decisions by users of the information.

Branches of Accounting Financial Accounting Cost Accounting Management/Managerial Accounting Auditing TaxationFinancial AccountingIt is the process of recording, classifying, summarising and communicating business information to aid users decision making. Original Form of Accounting Confined to Preparation of Financial Statements Objective is to Calculate Profit / Loss made during the year & to exhibit Financial Position of the BusinessCost Accounting Function of cost accounting is to ascertain the cost of the product and to help the managementin the control of cost. Costing is a technique of ascertaining cost of a particular product or service.Management Accounting It is an accounting for management Provides information to the management (within the organization) It is reproduction of financial accounts in such a way as will enable the management to take decisions & control various activitiesAuditing Examination of books, accounts, vouchers and other records by a practicing Chartered Accountant appointed for the purpose. Reporting to the members / management whether the B/S & P/L A/c as on particular date shows true & fair view of the state of affairs of the businessTaxation Computation of Taxable Income & Tax Payable thereon Reconciliation between accounting profit & taxable profit Statutory complianceFINANCIAL ACCOUNTING

Book KeepingIt is the art of recording business dealings in a set of books.Objectives of Book Keeping: To have date-wise record To have account-wise record To calculate & know yearly profit or loss To know year-end financial position To analyse, interpret & communicate the accounting information

Accounting Concepts

The Entity Concept A business is an artificial entity distinct & separate from its owner. For accounting purposes a business & its owner are two separate persons. Money Measurement Concept For accounting purposes each transaction & event must be expressible in monetary terms. The Cost Concept - Assets such as Land, Buildings, Plant & Machinery etc. and obligations such as Loans, Public Deposits etc. should be recorded at historical cost (acquisition) The Going Concern Concept It is assumed that the business organization would continue its operations for a long time. Periodicity Concept The results of operations of entity are measured periodically i.e. in each accounting period. Calendar Year January to December Fiscal Year April to March. As per Income Tax Act, Accounting Period should always be starting from April March. Accrual Concept Incomes & Expenses should be recognized as and when they are earned and incurred, irrespective of whether the money is received or paid in connection thereof. E.g. Rent paid for 15 months in advance on January 2009. In this case Rent for 3 months should be recognized in FY 08-09 & Rent for 12 months should be recognized in FY 09-10 Concept of Prudence It states that anticipate no profits but provide for all possible losses. Prudence is the inclusion of a degree of caution in the judgment of estimates. Expected losses should be accounted for but not anticipated gains Matching Concept Revenue earned in an accounting year is matched with all the expenses incurred during the same period to generate that revenue. Matching concept suggest that to find out the profitability, the expenses incurred to generate revenue are to be matched against that revenueImportant Terms CAPITAL EXPENDITURE Expenditure for obtaining an asset is known as capital expenditure. It is an expenditure having future benefits. It is an expenditure with long term use (more than 1 year) REVENUE EXPENDITURE Expenditure on obtaining goods and services is known as revenue expenditure. It is expenditure for running the business. It is an expenditure with short term use (1 year or less than 1 year). DEFERRED REVENUE EXPENDITURE To defer means to postpone. It is that expenditure which is carried forward as it will be of benefit over subsequent period e.g. heavy advertisement expenditure to launch a new product. The proportionate cost related to current year is taken as expense. The balance cost is carried forward and written off in next year. CASH DISCOUNT It is concession allowed by the seller to the buyer to encourage him to pay payment promptly. (Recorded in books of accounts) TRADE DISCOUNT It is allowance allowed by a manufacturer or wholesaler to the retailer. (Not recorded in books of accounts)What is an Account An account is defined as a systematic and summarised record of transactions pertaining to one person, one property or one head of expense/loss or gain. It is ledger account opened in a ledger on separate pages.Types of Accounts PERSONAL ACCOUNTS Accounts of all persons like Dena Bank a/c, Garware Institute A/c, Mumbai University A/c, Sachin Tendulkar A/c etc. REAL ACCOUNTS Accounts of all properties & assets like CASH Account, Plant & Machinery A/c, Building A/C etc. NOMINAL ACCOUNTS Accounts of all expenses & losses and Incomes & gains like Telephone charges a/c, Interest Recd A/C, Electricity charges a/c, Salary account etc.Golden RulesPersonal Account: Debit - The Receiver Credit The GiverReal Account: Debit What Comes In Credit What Goes OutNominal Account: Debit All Expenses & Losses Credit All Incomes & GainsSingle Entry System Form of incomplete double-entry system Cash accounts and personal accounts are maintained and impersonal accounts are ignored. Lack of double aspects of transactions does not assure correctness of accounting. Double Entry System Recording of transactions & events follows a definite rule. Each transaction or event has two aspects DEBIT (Dr.) & CREDIT (Cr.) Every Debit has an equal & opposite Credit Every transaction should be recorded in such a way that it affects two sides DEBIT & CREDIT

Accounting Cycle

STEPS:1. SELECTION OF TRANSACTION Select only those transactions which are Financial in nature and Which arise in the course of the business2. ANALYSIS OF TRANSACTION Analyse the transaction to find out Whether the business has received any benefit such as goods, services or assets and in return, any amount is paid in cash or is payable Whether any such benefit has gone out of business and in return any amount is received in cash or is receivable3. CLASSIFICATION OF ACCOUNTS Find out which items or persons are involved in the transaction and classify them in to 3 main types such as Personal A/c Real A/c Nominal A/c4. APPLYING RULES OF DEBIT OR CREDIT - Depending upon the nature of a transaction DEBIT The A/c receiving the benefit or amount CREDIT The A/c giving the benefit or amount5. RECORDING IN JOURNAL OR SUBSIDIARY BOOKS Transactions are recorded as and when they occur, in a daily book called Journal including subsidiary books like Cash Book, Bank Book, Purchase Register, Sales Register etc.

6. POSTING AND TOTALLING OF LEDGER ACCOUNTS - From the journal, the amounts debited or credited are transferred (posted) to the debit and credit of the concerned accounts in a book called Ledger.

Ledger Accounts normally having Dr. and Cr. Balances

7. TRIAL BALANCE At the end of the year trial balance is prepared which shows the closing balances of all accounts in the ledger.

8. PROFIT & LOSS A/C The balances of Income and Expenses accounts at the end of the year are summarized in the P/L A/c. The difference between the income & expenses shows the profit or loss for the year.

9. BALANCE SHEET The balances of assets, liabilities and capital accounts at the end of the year are summarized in the Balance Sheet.Benefits of Financial Accounting Maintaining systematic records Meeting legal requirements Protecting and safeguarding business assets Facilitates rational decision-making Communicating and reportingLimitations of Financial Accounting No clear idea of operating efficiency Weakness not spotted out by collective results Not helpful in price fixation No classification of expenses and accounts No data for comparison for data and decision-making No control on cost No standards to assess the performance Provides only historical information No analysis of losses Inadequate information for reports No answer to certain questionsAccounting Standards It refers to Policy documents issued by recognized accountancy body prescribing various aspects of measurement, treatment presentation and disclosure of accounting transactions. Main objective of accounting standards is to standardize the different accounting policies and practices followed by different business concerns Benefits Reduces variations in accounting treatments of many items such as valuation of stock, depreciation etc. Helps comparison of financial statements Many standards require additional disclosure which help the users to take important decisions Generally Accepted Accounting Principles (GAAP) includes Accounting conventions Accounting rules Accounting Procedures Accounting Standards Accepted accounting practicesCOST ACCOUNTINGTypes of Costing Historical Costing: Determination of costs after they have been actually incurred Standard Costing: Determination of standard costs and applying them for measuring the variations from the standard cost. (To control cost) Uniform Costing: System designed by trade associations and followed by business units. Marginal Costing: It is a system in which total cost is classified into two categories viz. fixed and variable. (Fixed cost is not treated as product cost only variable cost is considered)Functions of Cost Accounting Ascertainment of Cost (Finding out the Cost of the product) Cost Control Reporting or PresentationClassification of CostsOn the basis of behaviour of costFixed Cost: It refers to the portion of cost that remains constant irrespective of output up to capacity limit. It is also referred as standby cost or capacity cost or period cost.Variable Cost: It is the cost that varies according to the output i.e. changes according to the changes in the output. It is also called as product cost.Semi-variable cost: It remains constant up to a certain level and registers change afterwards.On the basis of time: Historic and Pre-determined CostsOn the basis of controllability: Controllable and Non-controllable CostsOn the basis of elements of cost:Direct Cost: Direct Materials, Direct Labour or Wages, Direct ExpensesIndirect Cost: Indirect Materials, Indirect Labour, Indirect Expenses, OverheadsClassification of Overheads (O/H)On the basis of functions Factory O/H, Administrative or Office O/H, Selling and Distribution O/HOn the basis of Behaviour: Fixed, Variable and Semi-variableDivisions of CostPrime Cost (also called Flat cost) = Direct Materials + Direct Labour + Direct Expenses Works Cost (factory cost or cost of manufacture) = Prime Cost + Factory O/HCost of Production = Factory or Works Cost + Administrative or Office O/HTotal Cost = Cost of Production + Selling and Distribution O/HSelling Price = Total Cost + Profit (- Loss)Marginal CostingIt ascertainment of marginal costs and the effect on profit, changes in volume or type of output by differentiating between fixed and variable costs. Marginal CostIneconomicsandfinance,marginal costis the change in thetotal costthat arises when the quantity produced changes by one unit. That is, it is the cost of producing one more unit of a good.Concept of Profit:Profit (P) = Contribution (C) - Fixed Cost (F)Contribution (C) = Sales (S) Variable Cost (V)Profit / Volume Ratio (P-V ratio): Expresses the relationship between contribution and sales.P-V ratio = [C/S] * 100Break-Even Point (B.E. point) Total revenue equals total costB.E.P = Fixed Cost / Contribution per unit (in terms of output)B.E.P = Fixed Cost / P-V Ratio (in terms of sales value)Margin of Safety (M/s): It is the excess of present sales value over the break-even salesM/s = Sales units Break-even unitsM/s = Profit / P-V RatioCost Volume Profit (CVP) AnalysisCost-Volume-Profit is a simplified model, useful for elementary instruction and forshort-run decisions.

Cost-volume-Profit (CVP) analysis expands the use of information provided bybreakeven analysis. A critical part of CVP analysis is the point where total revenues equal total costs (both fixed and variable costs). At this breakeven point (BEP), a company will experience no income or loss. This BEP can be an initial examination that precedes more detailed CVP analysis. The components of Cost-Volume-Profit Analysis are:

Level or volume of activity Unit Selling Prices Variable cost per unit Total fixed costs Sales mixCVP assumes the following: Constant sales price Constant variable cost per unit Constant total fixed cost Constant sales mix Units sold equal units produced

Benefits of Cost Accounting1) Classification and Subdivision of Costs2) Adequacy or Inadequacy of Selling Prices: Unit cost of production, administration and safe made possible by cost accounting aids management in deciding the adequacy or inadequacy of selling prices i.e. neither too high detracting business, nor too low resulting in losses to the concern.

In period of depressions, slumps, or in case of competition management forced to lower prices even below cost of production and sale. In such circumstances, cost accounting will help management in deciding the proper reduction.

3) Disclosure of profitable Products: Cost Accounting will disclose activities, departments, products and territories, which bring profit and those that result in losses. Management will use this information to decide which products are making profits or loss thus making a decision which one to be kept and which ones are to be excluded.4) Control of Material and Supplies: In a good costing system materials and supplies must be accounted for in terms of departments, jobs, units of production or service. This will eliminate altogether or reduce to the minimum misappropriations, embezzlements, deterioration, obsolescence, and losses from defective, spoiled, scrap and out of date materials and supplies.

5) Maintenance of Proper Investment in Inventories: A costing system will help in the maintenance of various inventory items of materials and supplies in line with production and sale requirements. If these quantities are too small, production may stop or sales may be lost. On the other hand, if quantities of such materials and supplies are in excess of the production and sales requirements, too much working capital may unnecessarily tie up in inventories. The detailed quantity information furnished by the cost accountant at all times will go a long way in reducing or eliminating this possibility.

6) Correct Valuation of Inventories:Cost Accounting plays a basic role in the correct valuation of inventories of finished goods, work in process, materials and supplies. The book inventory method (as opposed to physical inventory method) made possible by cost accounting system will involve the operation of the various inventory control accounts in such a manner that the balances of these accounts will be inventory valuations required for periodic financial statements. This enables the preparation of monthly financial statements without the trouble and expense of taking monthly physical inventories.

7) Whether to Manufacture or Purchase from Outsiders: Cost records furnish information regarding the cost of manufacturing of different finished parts, which assist management in making a decision whether to purchase these parts from outside manufacturers or manufacture them in the factory.

8) Control of Labour Cost:Orders, jobs, contracts, departments, processes, or services record cost of labour. In many manufacturing enterprises, daily time reports are prepared showing the number of hours and minutes spent and the wage rate for each worker per job or operation. This enables management to compare the current cost of labour per job or operation with some previously incurred or determined cost thus measuring the efficiency or inefficiency of the labour force and assigning the work to employees best suited for it.

9) Use of Company-wide Wage Incentive Plans:When labour cost is accounted for by jobs and operations, it is possible to use effectively wage incentive plans or bonus schemes for the remuneration of labour force. Carefully planned and administered incentive schemes are an effective means of enforcing superior performance and cost reduction. Workers are more co-operative, responsive and productive when some form of incentive offered to them for surpassing stipulated standards of perfection and performance10) Controllable and Uncontrollable Cost:Cost accounting exhibits at each stage of production and sale the controllable and uncontrollable items in the manufacturing, selling and administrative cost thus enabling management to concentrate attention on those costs, which can reduced or eliminated. 11) Use of Standards for Measuring Efficiency: A complete cost accounting system, generally, has a well-developed plan of standards to measure the efficiency of the organization in the use of materials, incurrence of labour and other manufacturing cost. 12) Reduction of Losses Due to Seasonal Conditions:Cost accounting provides data for making a complete analysis of losses due to idle plant and equipment or due to the use of plant and equipment beyond normal capacity, irregular employment of labour, wastes in the use of materials. It indicates cost variations between active and inactive periods and seasonal conditions in the business or industry. 13) Budgeting:In a good cost accounting system, preparation of various budgets periods in advance of actual production and sale of goods is necessary. These budgets include budgeted statement of profits, budgeted cost of plant improvements, budgeted cost of production, budgeted cash receipts and payments, and so forth. These budgets show the plans of the management for future periods and they reflect the expected results of these plans. In other words, budgeting, inculcates the habit of thinking and calculations before taking decisions.

14) Reliable Check on General Accounting:Finally, an efficient and proper system of cost accounting is a most reliable and independent check on the accuracy of the financial accounts. Limitations of Cost Accountinga) Based on estimates: Indirect costs are not charged fully to a product or process. It is charged to all the products and processes on the basis of estimates. Actual cost varies from estimated cost. Due to these limitations, all cost accounting results are taken as mere estimates.b) Lack of uniformity: Procedures of cost accounting followed by different organisations are different for different products. There is no uniformity. There is also possibility of difference in pricing material issues for production. All these lead to different cost results for the same operation.c) Many conventions: There are many conventions for classification of costs, pricing of material issues, apportionment of indirect costs, adoption of marginal or standard cost, etc. These create difficulty in determining the exact cost, because no one type of cost is suitable for all purposes and in all circumstances.d) Expensive: Cost accounting is expensive. It involves lots of clerical won for maintaining various costing records for different purposes. For medium and small size concern, the benefit derived from costing system may not justify the cost involved.e) Result requires reconciliation: Information and results provided by financial accounting and cost accounting may be different for the given activity. This requires reconciliation to find out correctness of the two before taking any decision.f) Dependent: It is not an independent system of accounting. It depends on other accounting systems.g) Does not include all items of expense and income: Items of purely financial nature such as interest, financial charges, discount and loss on issue of shares and debentures, etc. are not taken into consideration in Cost Accounting.h) Not an exact science: Like other accounting system, it is not an exact science but an art that has developed through theories and practices.

Management AccountingManagement accountingormanagerial accountingis concerned with the provisions and use ofaccountinginformation to managers within organizations, to provide them with the basis to make informed business decisions that will allow them to be better equipped in their management and control functions.It is the process of measuring and reporting information about economic activity within organisations to be used by managers in planning, performance evaluation and operational control.Management accounting information is proprietary. This means that it is not mandatory for public companies to disclose management accounting data or many specifications about the systems that generate this information. Usually, companies disclose very little management accounting information to investors and analysts beyond what is contained in the financial reporting requirements. A company discloses such kind of essential information like unit sales by major product category or product costs or product type only when the management is sure about the fact that the voluntary disclosure of this information will be viewed as good news by the marketplace.

Scope of Management AccountingPlanningPerformance EvaluationOperational Control

In addition, the management accounting system usually feeds into the financial accounting system. In particular, the product costing system is generally used to determine inventory Balance Sheet amounts and the cost of sales for the income statement. Management accounting information is usually financial in nature and Rupee denominated, although increasingly, management accounting systems collect and report nonfinancial information as well.

Budgetary ControlThere are two types of control, namely budgetary and financial. Budgetary control is defined by the Institute of Cost and Management Accountants (CIMA)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 objective of that policy, or to provide a basis for its revision".

Budgetary Control Method1. Budget A formal statement of the financial resources is reserved 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.

2. Budgetary control It is 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.

3. 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: Revenue centers: Organisational units in which outputs are measured in monetary terms but are not directly compared to input costs Expense centers: Units where inputs are measured in monetary terms but outputs are not. Profit centers: Units where performance is measured by the difference between revenues (outputs) and expenditure (inputs) Investment centers: Where outputs are compared with the assets employed in producing them, i.e. ROI

Advantages of Budgeting and Budgetary Control It compels the management to weigh the future, which is probably the most important feature of a budgetary planning and control system. It promotes coordination and communication. It clearly defines areas of responsibility. Such a control provides a basis for performance appraisal (variance analysis). Control is provided by comparisons of actual results against budget plan.

Problems in Budgeting Budgets can be seen as pressure devices imposed by management, thus resulting in - Bad labour relations Inaccurate record keeping Departmental conflict arises due to - Disputes over resource allocation Departments blaming each other if targets are not attained

Steps in Budget Preparation Selecting a budget period Setting or ascertaining the objectives Preparing basic assumptions and forecasts Understanding the need to consider any limiting factor Finalizing forecasts Implementing the budget Reviewing forecasts and plans

Type of BudgetsSales budget: A sales budget is a detailed plan showing the expected sales for the budget period. The sales budget is the starting point in preparing the master budget. All other items in the master budget, including production, purchase, inventories and expenses depend on it in one way or another. The sales budget is constructed by multiplying the budgeted sales in units by the selling price.

Production budget: The production budget is prepared after the sales budget. Theproduction budget lists the number of units that must be produced during each budget period to meet sales needs and to provide for the desired ending inventory.

Purchase budget: Manufacturing firms prepare production budget but Purchase budget shows the amount of goods to be purchased during the period. The format of Purchase Budget is as under:

Labour Budget: The direct labor budget is developed from the production budget. Direct labor requirements must be figured out so that the company will know whether sufficient labor time is available to meet the budgeted production needs.

Cash budget: Cash budget is a meticulous plan showing how cash funds will be acquired and used over some specific time. Cash budget is composed of four major sections. Receipts Disbursements Cash excess or deficiency FinancingThe cash receipts section consists of a listing of all of the cash inflows, except for financing, expected during the budgeting period. Generally, the major source of receipts will be from sales. The disbursement section consists of all cash payment that is planned for the budgeted period.

Master Budget: The master budget is a summary of company's plans that setsspecific targets for sales, production, distribution and financing activities. It generally concludes into cash budget, a budgeted income statement and a budgeted Balance Sheet. In short, this budget represents a widespread expression of management's plans for future and of how these plans are to be accomplished.The components or parts of master budget are as under: Sales Budget Production Budget Material Budgeting/Direct Materials Budget Labour Budget Manufacturing Overhead Budget Ending Finished Goods Inventory Budget Cash Budget Selling and Administrative Expense Budget Purchases Budget for a Merchandising Firm Budgeted Income Statement Budgeted Balance Sheet

Zero-based budgetingZero-based budgetingis an approach to planning and decision-making which reverses the working process of traditionalbudgeting. In traditional incremental budgeting (Historic Budgeting), departmental managers justify only variances versus past years, based on the assumption that the "baseline" is automatically approved. By contrast, in zero-based budgeting, every line item of the budget must be approved, rather than only changes.[1]During the review process, no reference is made to the previous level of expenditure. Zero-based budgeting requires the budget request be re-evaluated thoroughly, starting from the zero-base. This process is independent of whether the total budget or specific line items are increasing or decreasing.The term "zero-based budgeting" is sometimes used in personal finance to describe "zero-sum budgeting", the practice of budgeting every dollar of income received, and then adjusting some part of the budget downward for every other part that needs to be adjusted upward.Zero based budgeting also refers to the identification of a task or tasks and then funding resources to complete the task independent of current resourcing.

Comparison of Financial, Cost and Management Accounting

Financial Accounting

External Vs. Internal:Afinancial accounting system produces information that is used by parties external to the organization, such as shareholders, bank and creditors.

Time span:Financial accountingstatements are required to be produced for the period of 12 months.

Objectives:The main objectives of financial accounting are :i) to disclose the end results of the business, and ii) to depict the financial condition of the business on a particular date.

Accounting process:Follows a full process of recording, classifying, and summarising for the purpose of analysis and interpretation of the financial information.

Centreof importance:the financial accounting , the origin of preservation of knowledge gives emphasis on recording keeping on a whole firm basis for the purpose of decisions by all the users of accounting information, both external and internal.

Cost Accounting

External Vs. Internal:CostAccountingis thatbranchof accountinginformation system which records, measures and reportsinformation about costs.

Time span:CostAccountingemphasizes on the preservation of current years costingreports.

Objectives:The primary purpose of the Cost Accountingis cost ascertainment and its use in decision-making performanceevaluation.

Accounting process:CostAccountingpreserves cost accounts by maintaining double-entryaccountingprocess if felt necessary. Cost Ledger is used under it.

Centreof importance:CostAccountingis mainly concerned with the costing and provision of more accurate cost data to the management. The main focus of costaccountingis costing, cost assignment, cost variance analysis, costingreports, budgeting, etc.

Management Accounting

External Vs. Internal:A management accounting system produces information that is used within an organization, by managers and employees.

Time span:No specific time span is fixed for producing financial statements.

Objectives:The main objectives of Management Accountingare to help management by providing information that used by management to plan, evaluate, and control.

Accounting process:Cost accounts are not preserved under ManagementAccountingbut analyses necessary data from financial statements and cost ledgers.

Centreof importance:Managementaccountinguses cost data for provision of information for strategicmanagement decisions. It is mainly concerned with the provision of help to the managers to asses them in the process of decision making anddesign businessstrategies.

FINANCIAL ANALYSISFinancial Statements Financial statements are summarized reports of accounting transactions They are P & L Statement, Balance Sheet Statement, Cash Flow Statement, Funds Flow Statement FS are the indicators of PROFITABILITY and FINANCIAL SOUNDNESS of enterpriseAnalysis of FS means a systematic and specialized treatment of the information found in the financial statements so as to derive useful conclusions on the profitability and solvency of the business concernedUse of Financial Statements

Objectives of Financial Statements To communicate quantitative and objective information to the interested users Financial statements provide base for tax assessments To provide reliable information about the earnings of business & ability to operate at a profit at future Providing information for predicting the future earning power of the enterprise Provides information regarding changes in economic resources Intended to meet specialized needs of conscious creditors & investors

Type of Financial Analysis

Intra Firm Analysis Analysis of performance of the organization over number of years Inter Firm Analysis Comparison of two or more organizations in terms of various financial variables. Standard Analysis Only one set of financial statements of an organization is analyzed on the basis of standard set for the firm or industry Horizontal Analysis Comparison of figures of two or more consecutive accounting period Vertical Analysis Comparing figures in the financial statements of a single period. Figures are converted to a common unit by expressing them as percentage of a key figureCharacteristics / Features of Financial Statements Internal Audience FS are intended for those who have an interest in a given enterprise. They have to be prepared on the assumption that the user is generally familiar with business practices & meaning & implication of the terms used in that business Articulation The basic FS are interrelated and therefore are said to be articulated. Balance in P/L A/c is transferred to B/S Historical Nature FS generally report what has happened in the past Legal & Economic Consequences FS reflect elements of both economics & law.

Technical Terminology Since the FS are products of a technical process called accounting, they involve the use of technical terms Summarization & Classification Volume of business transactions are so vast that only summarization & classification will help in understanding the FS Money Terms All business transactions are quantified, measured and related in monetary terms Valuation Methods Valuation methods are not uniform for all items found in a balance sheet e.g. Stocks at cost or market price whichever is low, fixed assets at cost less depreciation, cash at current exchange value etc. Accrual Basis Most financial statements are prepared on accrual basis i.e. considering all incomes due but not received and all expenses due but not paid Estimates & Judgments In many circumstances, the facts & figures in the FS are based on estimates, personal opinions and judgments Verifiability It is essential that the facts presented thru FS are susceptible to objective verification, so that the reliability of these statements can be improved Conservatism Estimates should be based on a conservative basis to avoid any possibility of overstating the assets and income Qualities of Ideal Financial Statements Clarity Simplicity Independence (Neutrality) Emphasis on Materiality Accuracy and Brevity Systematic Classification of heads & items ConsistencyMethods / Devices used in Financial Statement Analysis Comparative Financial Statements Common Size/Measurement Statements Trend Percentages Accounting Ratios Statement of Changes in Working Capital Funds Flow Statements Cash Flow Statements Specialized Analysis

Limitations of Financial Statements Absence of complete set of principles Accounting principles does not comprise a complete and consistent body of guidelines that would guarantee solution to any problem an accountant might have to face. In fact rules are based on specific topics about which controversy arose at sometime or other in the past Lack of agreement on principles Interpretation of accounting principles differ from country to country & from accountants to accounting bodies Difference in application of principles In case of stock valuation, depreciation methods etc. different alternative treatments are permitted as per GAAP. Tax regulations too may influence the method of disclosed reporting. Hence much of the information in financial statements are based on personal judgments, management policy, legal & tax regulations etc. Accounting statements are necessarily monetary Financial statements limit themselves to information that can be expressed in terms of money. They fail to disclose certain significant non monetary events like prolonged strike, death of an able executive which may affect the business performance etc. FS do not show possible impacts of future contingent events such as pending law suit & sometime the amount involved may not be possible to estimate FS fail to reveal the strength, adequacy or otherwise scarcity of working capital Lack of general utility FS since prepared for the use of an average reader do not satisfy the requirements of varied users, for special purposes like merchant bankers, collaborators, Investment analysis etc The financial position of a business concern is affected by several factors-economic, social and financial, but financial factors are being recorded in these financial statements. Economic and social factors are left out. Thus the financial position disclosed by these statements is not correct and accurate. Facts which have not been recorded in the financial books are not depicted in the financial statement. Only quantitative factors are taken into account. But qualitative factors such as reputation and prestige of the business with the public, the efficiency and loyalty of its employees, integrity of management etc. do not appear in the financial statement. Balance sheet is only a historical document The values of assets contained in the balance sheet do not reflect the current values. The balance sheet is not affected by falling value of rupee & this has serious effects on the quality of information FS are essentially Interim Reports An enterprise is considered to be a continuing entity i.e. its life is indefinite. It exists for a long time. Financial statements are however, prepared periodically for interim periods and cannot be considered final. The exact position and profitability of a business enterprise can be known only after a reasonable length of time. Omission of special information FS do not show the effect of discovery, values of minerals and value of manpower resources Sacrifice of Simplicity As FS are prepared to disclose the results of diverse economic activities of the business, high degree of summarization is involved. In this process, simplicity, clarity and comprehensiveness are lost Choice of accounting year may also influence the accounting information. E.g. highly seasonal industry like sugar, if the B/S is prepared during off season, the FS may show good liquidity position. But if the accounting date coincides with the cutting crop season, it will show an adverse liquid position, due to large investment in inventories.Balance SheetThe balance sheet, also known as the statement of financial condition, offers a snapshot of a company's health. It tells you how much a company owns (its assets), and how much it owes (its liabilities). The difference between what it owns and what it owes is its equity, also commonly called "net assets" or "shareholders equity". The balance sheet tells investors a lot about a company's fundamentals: how much debt the company has, how much it needs to collect from customers (and how fast it does so), how much cash and equivalents it possesses and what kinds of funds the company has generated over time.State of finances at a snapshot in timeVertical Form of Balance Sheet

Components of Balance Sheet

Income Statement (Profit or Loss Statement)The income statement shows how much money the company generated (revenue), how much it spent (expenses) and the difference between the two (profit) over a certain time period. When it comes to analyzing fundamentals, the income statement lets investors know how well the companys business is performing - or, basically, whether or not the company is making money.Changes to finances over a particular period

Components of Income Statement

Differences between Balance Sheet and Income Statement While income statement reflects current years performance of the company, balance sheet contains information from the start of the business up to the financial year ended. Income statement tells current profit and loss whereas balance sheet reflects the financial health of the company telling its overall assets and liabilities.New formats of Balance Sheet and Income Statement

Connecting the Income Statement and Balance SheetWhen an accountant records a sale or expense entry using double-entry accounting, he or she sees the interconnections between the income statement and balance sheet. A sale increases an asset or decreases a liability, and an expense decreases an asset or increases a liability.Therefore, one side of every sales and expense entry is in the income statement, and the other side is in the balance sheet. You cant record a sale or an expense without affecting the balance sheet. The income statement and balance sheet are inseparable, but they arent reported this way.The following figure shows the lines of connection between income statement accounts and balance sheet accounts. When reading financial statements, in your minds eye, you should see these lines of connection.

Heres a quick summary explaining the lines of connection in the figure, starting from the top and working down to the bottom: Making sales (and incurring expenses for making sales) requires a business to maintain a working cash balance. Making sales on credit generatesaccountsreceivable. Selling products requires the business to carry an inventory (stock) of products. Acquiring products involves purchases on credit that generate accounts payable. Depreciation expense is recorded for the use of fixed assets (long-term operating resources). Depreciation is recorded in the accumulated depreciation contra account (instead decreasing the fixed asset account). Amortization expense is recorded for limited-life intangible assets. Operating expenses is a broad category of costs encompassing selling, administrative, and general expenses: Some of these operating costs are prepaid before the expense is recorded, and until the expense is recorded, the cost stays in the prepaid expenses asset account. Some of these operating costs involve purchases on credit that generate accounts payable. Some of these operating costs are from recording unpaid expenses in the accrued expenses payable liability.Borrowing money on notes payable cause interest expense.A portion (usually relatively small) of income tax expense for the year is unpaid at year-end, which is recorded in the accrued expenses payable liability.Earning net income increases retained earnings.Cash Flow StatementIt is afinancial statementthat shows how changes inbalance sheetaccounts and income affectcash and cash equivalents, and breaks the analysis down to operating, investing, and financing activities. Essentially, the cash flow statement is concerned with the flow of cash in and out of the business. In simple words it shows the changes in the cash position of an organization between two periods. (It records the amounts of cash and cash equivalents entering and leaving a company)Cash would include cash in hand and savings, current a/c balances with banks & cash equivalents.Cash equivalents are short term & highly liquid investments that are readily convertible into cash. An investment would normally be called a cash equivalent only when it has a short term maturity of say 3 months or less from the date of acquisition. (Credit and debit card receivables often are included in cash equivalents)The main reason for the preparation of the Cash Flow Statement is that the income statement of an enterprise is always prepared on an Accrual basis and it may show profits in the income statement but the cash received out of these profits may be low to run the business or vice-versa.As per AS-3 the cash flow statement should report cash flows during the period classified by:Operating Activities The cash flows generated from major revenue producing activities of the entities are covered under this head. Cash flow from operating activities is the indicator of the extent to which the operations of the enterprise have generated sufficient cash to maintain the operating capability to pay dividend, repay loans & make new investments.Investing Activities These are the acquisition and disposal of long term assets and other investments not included in cash equivalents. This represents the extent to which the expenditures have been made for resources intended to generate future incomes & cash flows. Usually cash changes from investing are a "cash out" item, because cash is used to buy new equipment, buildings or short-term assets such as marketable securities. However, when a company divests of an asset, the transaction is considered "cash in" for calculating cash from investing.Financing Activities Financing activities are the activities that result in changes in the size and composition of the owners capital and borrowings of the enterprise. Changes in debt, loans or dividends are accounted for in cash from financing. Changes in cash from financing are "cash in" when capital is raised, and they're "cash out" when dividends are paid. Thus, if a company issues a bond to the public, the company receives cash financing; however, when interest is paid to bondholders, the company is reducing its cash.

Major Cash Inflows Issue of new shares for cash Receipt of short term & long term loans from banks, financial institutions etc Sale of assets & investments Dividend & Interest received Cash generated from operations Major Cash Outflows Redemption of preference shares Purchase of fixed assets or investments Repayment of long term and short term borrowings Decrease in deferred payment liabilities Loss from operations Payment of tax, dividend etc.Benefits of a Cash Flow Statement Efficient Cash Management manage the cash resources in such a way that adequate cash is available for meeting the expenses Internal Financial Management useful for internal financial management as it provides clear picture of cash flows from operations Knowledge of change in Cash Position It enables the management to know about the causes of changes in cash position Success or Failure of Cash Planning Comparison of actual & budgeted cash flow helps the management to know the success or failure in cash management It is a supplement to fund flow statement as cash is a part of fund Cash Flow Statement is a better tool of analysis for short term decisionsLimitations of Cash Flow Analysis Misleading Inter Industry Comparison - Cash flow does not measure the economic efficiency of one company in relation to another company Misleading Inter Firm Comparison - The terms & conditions of purchases & sales of different firms may not be the same. Hence inter firm comparison becomes misleading. Influence of Management Policies Management policies influence the cash easily by making certain payments in advance or by postponing certain payments. Cannot be equated with Income Statement Cash flow statement cannot be equated with income statement. Hence net cash flow does not mean income of the business. CFS cannot substitute the B/S & Funds FlowConnecting Balance Sheet Changes with Cash FlowsThe numbers in thestatementofcashflowsare derived from the changes in a businesss balance sheet accounts during the year. Changes in the balance sheet accounts drive the amounts reported in the statement of cash flows.The lines of connection between changes in the businesss balance sheet accounts during the year and the information reported in the statement of cash flows are shown in the following figure. Note that the $155,000 net increase in retained earnings is separated between the $405,000 net income for the year and the $250,000 cashdividendsfor the year:$405,000 net income $250,000 dividends = $155,000 net increase in retained earnings

Balance sheet account changes are the basic building blocks for preparing a statement of cash flows. These changes in assets, liabilities, and owners equity accounts are the amounts reported in the statement of cash flows, or the changes are used to determine the cash flow amounts (as in the case of the change in retained earnings, which is separated into its net income component and its dividends component).Note in the cash flow from operating activities section in the figure that net income is listed first and then several adjustments are made to net income to determine the amount of cash flow from operating activities. The assets and liabilities included in this section are those that are part and parcel of the profit-making activity of a business.For example, theaccountsreceivableasset is increased (debited) when sales are made on credit. The inventory asset account is decreased (credited) when recording cost of goods sold expense. The accounts payable account is increased (credited) when recording expenses that havent been paid.The rules for cash flow adjustments to net income are: An asset increase during the period decreases cash flow from profit A liability decrease during the period decreases cash flow from profit An asset decrease during the period increases cash flow from profit A liability increase during the period increases cash flow from profitFollowing the third listed rule, the $191,000 depreciation expense for the year is a positive adjustment, or add-back to net income. Recording depreciation expense reduces the book value of the fixed assets being depreciated.To be more precise, recording depreciation increases the balance of the accumulated depreciation contra account that is deducted from the original cost of fixed assets. Recording depreciation does not involve a cash outlay. The cash outlay occurred when the business bought the assets being depreciated, which could be years ago.Working Capital ManagementWorking capital(abbreviatedWC) is a financial metric which representsoperating liquidityavailable to a business, organization or other entity, including governmental entity. Along with fixed assets such as plant and equipment, working capital is considered a part of operating capital. Net working capital is calculated ascurrent assetsminuscurrent liabilities.A company can be endowed withassetsandprofitabilitybut short ofliquidityif its assets cannot readily be converted into cash. Positive working capital is required to ensure that a firm is able to continue its operations and that it has sufficient funds to satisfy both maturing short-term debtand upcoming operational expenses. Decisions relating to working capital and short term financing are referred to asworking capital management. These involve managing the relationship between a firm'sshort-term assetsand itsshort-term liabilities (i.e. involves managing inventories, accounts receivable and payable, and cash). The goal of working capital management is to ensure that the firm is able to continue itsoperationsand that it has sufficient cash flow to satisfy both maturing short-term debt and upcoming operational expenses.Management will use a combination of policies and techniques for the management of working capital.Cash management: Identify the cash balance which allows for the business to meet day to day expenses, but reduces cash holding costs.Inventory management: Identify the level of inventory which allows for uninterrupted production but reduces the investment in raw materials - and minimizes reordering costs - and hence increases cash flow. Besides this, the lead times in production should be lowered to reduce Work in Process (WIP) and similarly, the Finished Goods should be kept on as low level as possible to avoid over production - see Supply chain management; Just In Time (JIT); Economic order quantity (EOQ); Economic quantityDebtors management: Identify the appropriate credit policy, i.e. credit terms which will attract customers, such that any impact on cash flows and the cash conversion cycle will be offset by increased revenue and hence Return on Capital (or vice versa)Short term financing: Identify the appropriate source of financing, given the cash conversion cycle: the inventory is ideally financed by credit granted by the supplier; however, it may be necessary to utilize a bank loan (or overdraft), or to "convert debtors to cash" through "factoring".Working Capital Changes Increase in Current Assets Increase in Working Capital Increase in Current Liabilities Decrease in Working Capital Decrease in Current Assets Decrease in Working Capital Decrease in Current Liabilities Increase in Working CapitalCash conversion cycle(CCC) measures how long a firm will be deprived of cash if it increases its investment in resources in order to expand customer sales. It is thus a measure of theliquidity riskentailed by growth. However, shortening the CCC creates its own risks: while a firm could even achieve a negative CCC by collecting from customers before paying suppliers, a policy of strict collections and lax payments is not always sustainable.The aim of studying cash conversion cycle and its calculation is to change the policies relating to credit purchase and credit sales. The standard of payment of credit purchase or getting cash from debtors can be changed on the basis of reports of cash conversion cycle.

Important

Taking these four transactions in pairs, analysts draw attention to five important intervals, referred to asconversion cycles(orconversion periods): theCash conversion cycleemerges as interval CD (i.e.disbursing cash collecting cash). thePayables conversion period(or "Days payables outstanding") emerges as int