managerial economics financial analysis notes 3

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TRAIL BALANCE

The first step in the preparation of final accounts is the preparation of trail balance. In the double entry system of book keeping, there will be credit for every debit and there will not be any debit without credit. When this principle is followed in writing journal entries, the total amount of alldebits is equal to the total amount all credits.

A trail balance is a statement of debit and credit balances. It is prepared on a particular date with the object of checking the accuracy of the books of accounts. It indicates that all the transactions for a particular period have been duly entered in the book, properly posted and balanced. The trail balance doesn’t include stock in hand at the end of the period. All adjustments required to be done at the end of the period including closing stock are generally given under the trail balance.

DEFINITIONS:          SPICER AND POGLAR :A trail balance is a list of all the balances standing on the ledger accounts and cash book of a concern at any given date.

J.R.BATLIBOI:

A trail balance is a statement of debit and credit balances extracted from the ledger with a view to test the arithmetical accuracy of the books.

Thus a trail balance is a list of balances of the ledger accounts’ and cash book of a business concern at any given date

PROFORMA FOR TRAIL BALANCE:

Trail balance for MR……………………………………  as on …………

NO	NAME OF ACCOUNT (PARTICULARS)	DEBIT AMOUNT(RS.)	CREDIT AMOUNT(RS.)

FINAL ACCOUNT

In every business, the business man is interested in knowing whether the business has resulted in profit or loss and what the financial position of the business is at a given time. In brief, he wants to know (i)The profitability of the business and (ii) The soundness of the business.

The trader can ascertain this by preparing the final accounts. The final accounts are prepared from the trial balance. Hence the trial balance is said to be the link between the ledger accounts and the final accounts. The final accounts of a firm can be divided into two stages. The first stage is preparing the trading and profit and loss account and the second stage is preparing the balance sheet.

1.      Trading account

2.      Profit and loss account

3.      Balance sheet.

Trading account

Trading account is a part of profit and loss account . trading account is prepared for ascertaining Gross profit  or gross loss. The difference between the sales and the cost of the goods sold is gross profit. Cost of good sold can be ascertained by adding opening stock , purchases, direct expenses for purchase of goods and deduction there from  closing stock and sales.

PROFORMA OF TRADING ACCOUNT

Trading account of ------------- for the year ended 31 march ----

Particular	Amount	Particular	Amount
To opening stock To Purchase                                      xxxx Less: purchase return                     xxxx	Xxxx Xxxx	By Sales                                               xxxxx Less; Sales return                          xxxxx	Xxxx
To carriage inwards	Xxx	By closing stock	Xxxx
To wage	Xxxx
To freight , duty clearing charges	Xxxx
To fuel and power	Xxxx
To coal, gas, and water	Xxxx
To motive power	Xxxx
To factory rent	Xxxx
To manufacturing expenses	Xxxx
To direct expenses	Xxxx
To factory lighting	Xxxx
To gross profit	Xxxx
	Xxxxxxx		xxxxxxx

PROFIT AND LOSS ACCOUNT

Profit and loss account is prepared to ascertain the net profit or net loss of the business for a particular period. All indirect expenses such as management and office expenses, financial expenses, selling and distribution expenses are taken on the debit side. Gross profit and other items of incomes such as interest received , discount received, etc. are taken on credit side. The different between two sides is either net profit or net loss which is transferred to capital account.

The business man is always interested in knowing his net income or net profit.Net profit represents the excess of gross profit plus the other revenue incomes over administrative, sales, Financial and other expenses. The debit side of profit and loss account shows the expenses and the credit side the incomes. If the total of the credit side is more, it will be the net profit. And if the debit side is more, it will be net loss.

PROFORMA  OF PROFIT AND LOSS ACCOUNT

Profit and loss of ---------------  for the year ended  31 march xxx

Particular	Amount	Particular	Amount
To Salaries                                                 xxx Add : outstanding salaries                     xxx	Xxx	By gross profit	Xxx
To Rent	Xxx	By Discount receive	Xxx
To Discount  allowed	Xxx	By Interest receive	Xxx
To Office expenses	Xxx	By Commission receive	Xxx
To Rate and tax	Xxx
To Lighting	Xxx
To Printing and stationery	Xxx
To Postage and telegrams	Xxx
To Telephone charges	Xxx
To Legal expenses	Xxx
To Telephone charges	Xxx
To Audit fee	Xxx
To General expenses	Xxx
To Advertisement	Xxx
To Insurance	xxx
To interest on capital	Xxx
To deprecation on assets( machinery , building , furniture, land.etc)	Xxx
To repair	Xxx
To carriage outward	Xxx
To written off bad debts	Xxx
To travelling expenses	Xxx
To interest on loan	Xxx
To net profit	Xxx
	Xxxxxx		xxxxxx

BALANCE SHEET:

The second point of final accounts is the preparation of balance sheet. It is prepared often in the trading and profit, loss accounts have been compiled and closed. A balance sheet may be considered as a statement of the financial position of the concern at a given date.

DEFINITION:  A balance sheet is an item wise list of assets, liabilities and proprietorship of a business at a certain state.

J.R.botliboi: A balance sheet is a statement with a view to measure exact financial position of a business at a particular date.

Thus, Balance sheet is defined as a statement which sets out the assets and liabilities of a business firm and which serves to as certain the financial position of the same on any particular date. On the left-hand side of this statement, the liabilities and the capital are shown. On the right-hand side all the assets are shown. Therefore, the two sides of the balance sheet should be equal. Otherwise, there is an error somewhere.

PROFORMA OF BALANCE SHEET

Balance sheet of Mr.------------------------------ for the year ending on 31 march xxxxx

Liabilities	Amount	Assets	Amount
Capital                                          xxxx Add: interest on capital             xxxx          Net profit                             xxxx                                                       ------                                                        Xxxx Less: drawings                             xxxx           Net loss                               xxxx	Xxx	Plant and machinery                                Xxx Less: depreciation on plant machinery xxx Building                                                      xxx Less : depreciation on building              xxx Land                                                            xxx Less ; depreciation on land                     xxx	Xxx Xxx Xxx
Sundry creditor	xxx	Sundry debtor                                           xxx Less : written of bad debts                     xxx	Xxx
Bank overdraft	Xxx	Cash in  hand	Xxx
Outstanding expenses	Xxxx	Cash at bank	Xxx
Reserves	Xxx	Investment	Xxx
Long term loans	Xxx	Bill receivable	Xxxx
Bill payable	Xxx	Prepaid expenses	Xxx
		Prepaid expenses	Xxx
		Vehicle	Xxx
		Closing stock	Xxx
	Xxxxx		xxxxx

Advantages: The following are the advantages of final balance .

1. It helps in checking the arithmetical accuracy of books of accounts.
2. It helps in the preparation of financial statements.
3. It helps in detecting errors.
4. It serves as an instrument for carrying out the job of rectification of entries.
5. It is possible to find out the balances of various accounts at one place.

FINAL ACCOUNTS -- ADJUSTMENTS

                                               

We know that business is a going concern. It has to be carried on indefinitely. At the end of every accounting year. The trader prepares the trading and profit and loss account and balance sheet. While preparing these financial statements, sometimes the trader may come across certain problems .The expenses of the current year may be still payable or the expenses of the next year have been prepaid during the current year. In the same way, the income of the current year still receivable and the income of the next year have been received during the current year. Without these adjustments, the profit figures arrived at or the financial position of the concern may not be correct. As such these adjustments are to be made while preparing the final accounts.       

The adjustments to be made to final accounts will be given under the Trial Balance. While making the adjustment in the final accounts, the student should remember that “every adjustment is to be made in the final accounts twice i.e. once in trading, profit and loss account and later in balance sheet generally”. The following are some of the important adjustments to be made at the time of preparing of final accounts:-

1. CLOSING STOCK :-

(i)If closing stock is given in Trail Balance: It should be shown only in the balance sheet “Assets Side”.

(ii)If closing stock is given as adjustment  :

1.      First, it should be posted at the credit side of “Trading Account”.

2.      Next, shown at the asset side of the “Balance Sheet”.

           

2.OUTSTANDING EXPENSES :-   

(i)If outstanding expenses given in Trail Balance: It should be only  on the liability side of Balance Sheet.

(ii)If outstanding expenses given as adjustment :

1. First, it should be added to the concerned expense at the                                                                                                     debit side of profit and loss account or Trading Account.
2. Next, it should be added at the liabilities side of the

            Balance Sheet.

3.PREAPID EXPENSES :-

(i)If prepaid expenses given in Trial Balance: It should be shown only in assets side of the Balance Sheet.

 (ii)If prepaid expense given as adjustment    :

1. First, it should be deducted from the concerned expenses at the debit side of profit and loss account or Trading Account.
2. Next, it should be shown at the assets side of the Balance Sheet.

4.INCOME EARNED BUT NOT RECEIVED [OR] OUTSTANDING INCOME [OR] ACCURED INCOME :-

(i)If incomes given in Trial Balance: It should be shown only on the assets side of the Balance Sheet.

(ii)If incomes outstanding given as adjustment:

1. First, it should be added to the concerned income at the credit side of profit and loss account.
2. Next, it should be shown at the assets side of the Balance sheet.

5. INCOME RECEIVED IN ADVANCE: UNEARNED INCOME:-

(i)If unearned incomes given in Trail Balance : It should be shown only on the liabilities side of the Balance Sheet.

(ii)If unearned income given as adjustment    :

1. First, it should be deducted from the concerned income in the credit side of the profit and loss account.
2. Secondly, it should be shown in the liabilities side of the

Balance Sheet.

6.DEPRECIATION:- 

(i)If Depreciation  given in Trail Balance: It should be shown only on the debit side of the profit and loss account.

(ii)If Depreciation  given as adjustment 

1. First, it should be shown on the debit side of the profit and loss account.
2. Secondly, it should be deduced from the concerned asset in the Balance sheet assets side.

7.INTEREST ON LOAN [OR] CAPITAL :-

(i)If interest on loan (or) capital given in Trail balance   :It should be shown only on debit side of the profit and loss account

(ii)If interest on loan (or)capital given as adjustment :    

1.      First, it should be shown on debit side of the profit and loss account.

2.      Secondly, it should added to the loan or capital in

                           the liabilities side of the Balance Sheet.     

8.BAD DEBTS:-

(i)If bad debts given in Trail balance  :It should be shown on the debit side of the profit and loss account.

(ii)If bad debts given as adjustment:

1. First, it should be shown on the debit side of the profit and loss account.
2. Secondly, it should be deducted from debtors in the assets side of the Balance Sheet.

9.INTEREST ON DRAWINGS  :-      

(i)If interest on drawings given in Trail balance: It  should be shown on the credit side of the profit and loss account.

(ii)If interest on drawings given as adjustments :

1. First, it should be shown on the credit side of the profit and loss account.
2. Secondly, it should be deducted from capital on liabilities

            side of the Balance Sheet.

10.INTEREST ON INVESTMENTS  :-          

(i)If interest on the investments given in Trail balance :It should be shown on the credit side of the profit and loss     account.

(ii)If interest on investments given as adjustments       :

1. First, it should be shown on the credit side of the profit and loss account.
2. Secondly, it should be added to the investments on assets side of the Balance Sheet.

Ratio Analysis

Ratio analysis is used to evaluate relationships among financial statement items. The ratios are used to identify trends over time for one company or to compare two or more companies at one point in time. Financial statement ratio analysis focuses on three key aspects of a business: liquidity, profitability, and solvency.

Liquidity ratios

Liquidity ratios measure the ability of a company to repay its short‐term debts and meet unexpected cash needs.

Current ratio. The current ratio is also called the working capital ratio, as working capital is the difference between current assets and current liabilities. This ratio measures the ability of a company to pay its current obligations using current assets. The current ratio is calculated by dividing current assets by current liabilities

This ratio indicates the company has more current assets than current liabilities. Different industries have different levels of expected liquidity. Whether the ratio is considered adequate coverage depends on the type of business, the components of its current assets, and the ability of the company to generate cash from its receivables and by selling inventory.

Acid‐test ratio. The acid‐test ratio is also called the quick ratio. Quick assets are defined as cash, marketable (or short‐term) securities, and accounts receivable and notes receivable, net of the allowances for doubtful accounts. These assets are considered to be very liquid (easy to obtain cash from the assets) and therefore, available for immediate use to pay obligations. The acid‐test ratio is calculated by dividing quick assets by current liabilities.

The traditional rule of thumb for this ratio has been 1:1. Anything below this level requires further analysis of receivables to understand how often the company turns them into cash. It may also indicate the company needs to establish a line of credit with a financial institution to ensure the company has access to cash when it needs to pay its obligations.

Inventory turnover. The inventory turnover ratio measures the number of times the company sells its inventory during the period. It is calculated by dividing the cost of goods sold by average inventory. Average inventory is calculated by adding beginning inventory and ending inventory and dividing by 2. If the company is cyclical, an average calculated on a reasonable basis for the company's operations should be used such as monthly or quarterly.

Profitability ratios

Profitability ratios measure a company's operating efficiency, including its ability to generate income and therefore, cash flow. Cash flow affects the company's ability to obtain debt and equity financing.

Profit margin. The profit margin ratio, also known as the operating performance ratio, measures the company's ability to turn its sales into net income. To evaluate the profit margin, it must be compared to competitors and industry statistics. It is calculated by dividing net income by net sales.

Earnings per share. Earnings per share (EPS) represents the net income earned for each share of outstanding common stock. In a simple capital structure, it is calculated by dividing net income by the number of weighted average common shares outstanding.

Price‐earnings ratio. The price‐earnings ratio (P/E) is quoted in the financial press daily. It represents the investors' expectations for the stock. A P/E ratio greater than 15 has historically been considered high.

Solvency ratios

Solvency ratios are used to measure long‐term risk and are of interest to long‐term creditors and stockholders.

Debt to total assets ratio. The debt to total assets ratio calculates the percent of assets provided by creditors. It is calculated by dividing total debt by total assets. Total debt is the same as total liabilities.