Complete Glossory

7/30/2019 Complete Glossory

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Accountancy

The accounting process in a nutshell:

Capture and Record a business transaction. Classify and post transactions to their individual Ledger Accounts.

Summarize and report the balances of Ledger Accounts in financial statements.

The three main financial statements:

Income Statement Balance Sheet Statement of Cash Flows

What are the 3 Golden Rules of Accountancy?

Real Accounts: Debit what comes in Credit what goes out

Personal Accounts: Debit the receiver Credit the giver

Nominal Account: Debit all expenses and losses Credit all incomes and gains

GAAP:

In the United States, Generally Accepted Accounting Principles are accounting rules used toprepare, present and report financial statements for a wide variety of entities, includingpublicly traded and privately held companies, non-profit organizations, and governmentauthorities.

Basic objectives:

Financial reporting should provide information that is:

Useful to present to potential investors and creditors and other users in makingrational investment, credit, and other financial decisions.

Helpful to present to potential investors and creditors and other users in assessingthe amounts, timing, and uncertainty of prospective cash receipts.

About economic resources, the claims to those resources, and the changes in them. helpful for making financial decisions helpful in making long-term decisions helpful in improving the performance of the business useful in maintaining records


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Basic concepts:

To achieve basic objectives and implement fundamental qualities GAAP has four basicassumptions, four basic principles, and four basic constraints.

Assumptions:

Accounting Entity: assumes that the business is separate from its owners or otherbusinesses. Revenue and expense should be kept separate from personal expenses.

Going Concern: assumes that the business will be in operation indefinitely. Thisvalidates the methods of asset capitalization, depreciation, and amortization. Onlywhen liquidation is certain this assumption is not applicable. The business willcontinue to exist in the unforeseeable future.

Monetary Unit principle: assumes a stable currency is going to be the unit of record. The FASB accepts the nominal value of the US Dollar as the monetary unit of record unadjusted for inflation.

The Time-period principle implies that the economic activities of an enterprise can bedivided into artificial time periods.

Principles:

Historical cost principle requires companies to account and report based onacquisition costs rather than fair market value for most assets and liabilities. Thisprinciple provides information that is reliable (removing opportunity to providesubjective and potentially biased market values), but not very relevant. Thus there isa trend to use fair values. Most debts and securities are now reported at marketvalues.

Revenue recognition principle requires companies to record when revenue is

1. realized or realizable and2. earned, not when cash is received.

This way of accounting is called accrual basis accounting.

Matching principle . Expenses have to be matched with revenues as long as it isreasonable to do so. Expenses are recognized not when the work is performed, orwhen a product is produced, but when the work or the product actually makes itscontribution to revenue. Only if no connection with revenue can be established, costmay be charged as expenses to the current period (e.g. office salaries and otheradministrative expenses). This principle allows greater evaluation of actualprofitability and performance (shows how much was spent to earn revenue).Depreciation and Cost of Goods Sold are good examples of application of thisprinciple.

Full Disclosure principle . Amount and kinds of information disclosed should bedecided based on trade-off analysis as a larger amount of information costs more toprepare and use. Information disclosed should be enough to make a judgment whilekeeping costs reasonable. Information is presented in the main body of financialstatements, in the notes or as supplementary information


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Constraints:

Objectivity principle: the company financial statements provided by theaccountants should be based on objective evidence.

Materiality principle: the significance of an item should be considered when it is

reported. An item is considered significant when it would affect the decision of areasonable individual. Consistency principle: It means that the company uses the same accounting

principles and methods from year to year. Conservatism principle: when choosing between two solutions, the one that will be

least likely to overstate assets and income should be picked (see convention of conservatism).

International Financial Reporting Standards:

International Financial Reporting Standards (IFRS) are designed as a common globallanguage for business affairs so that company accounts are understandable and comparableacross international boundaries. They are a consequence of growing internationalshareholding and trade and are particulalrly important for companies that have dealings inseveral countries. They are progressively replacing the many different national accountingstandards.The rules to be followed by accountants to maintain books of accounts which iscomaprable, understandable, reliable and relevant as per the users internal or external.

IFRS began as an attempt to harmonise accounting across the European Union but thevalue of harmonisation quickly made the concept attractive around the world. They aresometimes still called by the original name of International Accounting Standards (IAS). IAS

were issued between 1973 and 2001 by the Board of the International AccountingStandards Committee (IASC). On April 1, 2001, the new IASB took over from the IASC theresponsibility for setting International Accounting Standards. During its first meeting thenew Board adopted existing IAS and Standing Interpretations Committee standards (SICs).The IASB has continued to develop standards calling the new standards InternationalFinancial Reporting Standards (IFRS).

Role of framework:

Deloitte states:

In the absence of a Standard or an Interpretation that specifically applies to a transaction,management must use its judgement in developing and applying an accounting policy thatresults in information that is relevant and reliable. In making that judgement, IAS 8.11requires management to consider the definitions, recognition criteria, and measurementconcepts for assets, liabilities, income, and expenses in the Framework. This elevation of the importance of the Framework was added in the 2003 revisions to IAS 8.


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Objective of financial statements:

A financial statement should reflect true and fair view of the business affairs of theorganization. As statements are used by various constituents of the society / regulators,they need to reflect true view of the financial position of the organization. and it is veryhelpful to check the financial position of the business for a specific period.

IFRS authorize three basic accounting models:

I. Current Cost Accounting, under Physical Capital Maintenance at all levels of inflationand deflation under the Historical Cost paradigm as well as the Capital Maintenancein Units of Constant Purchasing Power paradigm. (See the Conceptual Framework,Par. 4.59 (b).)

II. Financial capital maintenance in nominal monetary units, i.e., globally implementedHistorical cost accounting during low inflation and deflation only under the traditionalHistorical Cost paradigm.(See the original Framework (1989), Par 104 (a))[nowConceptual Framework (2010), Par. 4.59 (a)].

III. Financial capital maintenance in units of constant purchasing power, i.e., ConstantItem Purchasing Power Accounting[5] CIPPA in terms of a Daily Consumer PriceIndex or daily rate at all levels of inflation and deflation (see the original Framework(1989), Par 104 (a)) [now Conceptual Framework (2010), Par. 4.59 (a)] under theCapital Maintenance in Units of Constant Purchasing Power paradigm and ConstantPurchasing Power Accounting CPPA (see IAS 29) during hyperinflation under theHistorical Cost paradigm.

The following are the three underlying assumptions in IFRS:

1. Going concern: an entity will continue for the foreseeable future under the HistoricalCost paradigm as well as under the Capital Maintenance in Units of Constant PurchasingPower paradigm. (See Conceptual Framework, Par. 4.1)

2. Stable measuring unit assumption: financial capital maintenance in nominal monetaryunits or traditional Historical cost accounting only under the traditional Historical Costparadigm; i.e., accountants consider changes in the purchasing power of the functionalcurrency up to but excluding 26% per annum for three years in a row (which would be100% cumulative inflation over three years or hyperinflation as defined in IAS 29) asimmaterial or not sufficiently important for them to choose Capital Maintenance in unitsof constant purchasing power in terms of a Daily Consumer Price Index or daily rateConstant Item Purchasing Power Accounting at all levels of inflation and deflation asauthorized in IFRS in the original Framework(1989), Par 104 (a) [now ConceptualFramework (2010), Par. 4.59 (a)].

Accountants implementing the stable measuring unit assumption (traditional HistoricalCost Accounting) during annual inflation of 25% for 3 years in a row would erode 100%of the real value of all constant real value non-monetary items not maintained constantunder the Historical Cost paradigm.


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3. Units of constant purchasing power: capital maintenance in units of constant purchasingpower at all levels of inflation and deflation in terms of a Daily Consumer Price Index ordaily rate (Constant Item Purchasing Power Accounting)[6] only under the CapitalMaintenance in Units of Constant Purchasing Power paradigm; i.e. the total rejection of the stable measuring unit assumption at all levels of inflation and deflation. See The

Framework (1989), Paragraph 104 (a) [now Conceptual Framework (2010), Par. 4.59(a)]. Capital maintenance in units of constant purchasing power under Constant ItemPurchasing Power Accounting in terms of a Daily Consumer Price Index or daily rate of all constant real value non-monetary items in all entities that at least break even in realvalue at all levels of inflation and deflation - ceteris paribus - remedies for an indefiniteperiod of time the erosion caused by Historical Cost Accounting of the real values of constant real value non-monetary items never maintained constant as a result of theimplementation of the stable measuring unit assumption at all levels of inflation anddeflation under HCA.It is not inflation doing the eroding. Inflation and deflation have no effect on the realvalue of non-monetary items.[2] It is the implementation of the stable measuring unit

assumption, i.e., traditional HCA which erodes the real value of constant real value non-monetary items never maintained constant in a double entry basic accounting model.

Constant real value non-monetary items are non-monetary items with constant real valuesover time whose values within an entity are not generally determined in a market on a dailybasis.

Examples include borrowing costs, comprehensive income, interest paid, interest received,bank charges, royalties, fees, short term employee benefits, pensions, salaries, wages,rentals, all other income statement items, issued share capital, share premium accounts,share discount accounts, retained earnings, retained losses, capital reserves, revaluationsurpluses, all accounted profits and losses, all other items in shareholders equity, tradedebtors, trade creditors, dividends payable, dividends receivable, deferred tax assets,deferred tax liabilities, all taxes payable, all taxes receivable, all other non-monetarypayables, all other non-monetary receivables, provisions, etc.

All constant real value non-monetary items are always and everywhere measured in units of constant purchasing power at all levels of inflation and deflation under CIPPA in terms of aDaily CPI or daily rate under the Capital Maintenance in Units of Constant Purchasing Powerparadigm. The constant item gain or loss is calculated when current period constant itemsare not measured in units of constant purchasing power.

Monetary items are units of money held and items with an underlying monetary nature

which are substitutes for units of money held.Examples of units of money held are bank notes and coins of the fiat currency createdwithin an economy by means of fractional reserve banking. Examples of items with anunderlying monetary nature which are substitutes of money held include the capital amountof: bank loans, bank savings, credit card loans, car loans, home loans, student loans,consumer loans, commercial and government bonds, Treasury Bills, all capital and money


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market investments, notes payable, notes receivable, etc. when these items are not in theform of money held.

Historic and current period monetary items are required to be inflation-adjusted on a dailybasis in terms of a daily index or rate under the Capital Maintenance in Units of ConstantPurchasing Power paradigm. The net monetary loss or gain as defined in IAS 29 is requiredto be calculated and accounted when they are not inflation-adjusted on a daily basis duringthe current financial period. Inflation-adjusting the total money supply (excluding banknotes and coins of the fiat functional currency created by means of fractional reservebanking within an economy) in terms of a daily index or rate under complete co-ordinationwould result in zero cost of inflation (not zero inflation) in only the entire money supply (asqualified) in an economy.

Variable real value non-monetary items are non-monetary items with variable real valuesover time. Examples include quoted and unquoted shares, property, plant, equipment,inventory, intellectual property, goodwill, foreign exchange, finished goods, raw material,etc.

Current period variable real value non-monetary items are required to be measured on adaily basis in terms of IFRS excluding the stable measuring unit assumption and the costmodel in the valuation of property, plant, equipment and investment property afterrecognition under the Capital Maintenance in Units of Constant Purchasing Power paradigm.When they are not valued on a daily basis, then they as well as historic variable real valuenon-monetary items are required to be updated daily in terms of a daily rate as indicatedabove. Current period impairment losses in variable real value non-monetary items arerequired to be treated in terms of IFRS. They are constant real value non-monetary itemsonce they are accounted. All accounted losses and profits are constant real value non-monetary items.

Under the Capital Maintenance in Units of Constant Purchasing Power paradigm dailymeasurement is required of all items in terms of

a) a Daily Consumer Price Index or monetized daily indexed unit of account, e.g. theUnidad de Fomento in Chile, during low inflation, high inflation and deflation and

b) in terms of a relatively stable foreign currency parallel rate (normally the US Dollardaily parallel rate) or a Brazilian-style Unidade Real de Valor daily index duringhyperinflation. Hyperinflation is defined in IAS 29 as cumulative inflation being equalto or approaching 100 per cent over three years, i.e. 26 per cent annual inflation forthree years in a row.


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Qualitative characteristics of financial statements:

Qualitative characteristics of financial statements include:

Relevance (Materiality) Faithful representation

Enhancing qualitative characteristics include: Comparability Verifiability Timeliness Understandability

Elements of financial statements (IAS 1 article 10):

The financial position of an enterprise is primarily provided in the Statement of FinancialPosition. The elements include:

a) Asset: An asset is a resource controlled by the enterprise as a result of past events

from which future economic benefits are expected to flow to the enterprise.b) Liability: A liability is a present obligation of the enterprise arising from the past

events, the settlement of which is expected to result in an outflow from theenterprise' resources, i.e., assets.

c) Equity: Equity is the residual interest in the assets of the enterprise after deductingall the liabilities under the Historical Cost Accounting model. Equity is also known asowner's equity. Under the units of constant purchasing power model equity is theconstant real value of shareholders equity.

The financial performance of an enterprise is primarily provided in the Statement of Comprehensive Income (income statement or profit and loss account). The elements of an

income statement or the elements that measure the financial performance are as follows:a) Revenues: increases in economic benefit during an accounting period in the form of

inflows or enhancements of assets, or decrease of liabilities that result in increases inequity. However, it does not include the contributions made by the equityparticipants, i.e., proprietor, partners and shareholders.

b) Expenses: decreases in economic benefits during an accounting period in the form of outflows, or depletions of assets or incurrences of liabilities that result in decreasesin equity.

Revenues and expenses are measured in nominal monetary units under the Historical CostAccounting model and in units of constant purchasing power (inflation-adjusted) under the

Units of Constant Purchasing Power model.

a) Statement of Changes in Equityb) Statement of Cash Flowsc) Notes to the Financial Statements


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Recognition of elements of financial statements:

An item is recognized in the financial statements when:

it is probable future economic benefit will flow to or from an entity. the resource can be reliably measured otherwise the stable measuring unit

assumption is applied under the Historical Cost Accounting model: i.e. it is assumedthat the monetary unit of account (the functional currency) is perfectly stable (zeroinflation or deflation); it is simply assumed that there is no inflation or deflation ever,and items are stated at their original nominal Historical Cost from any prior date: 1month, 1 year, 10 or 100 or 200 or more years before; i.e. the stable measuring unitassumption is applied to items such as issued share capital, retained earnings,capital reserves, all other items in shareholders equity, all items in the Statement of Comprehensive Income (except salaries, wages, rentals, etc., which are inflation-adjusted annually), etc.

Under the Units of Constant Purchasing Power model, all constant real value non-monetary items are inflation-adjusted during low inflation and deflation; i.e. all itemsin the Statement of Comprehensive Income, all items in shareholders equity,Accounts Receivables, Accounts Payables, all non-monetary payables, all non-monetary receivables, provisions, etc.

Measurement of the elements of financial statements:

Par. 99. Measurement is the process of determining the monetary amounts at which theelements of the financial statements are to be recognized and carried in the balance sheetand income statement. This involves the selection of the particular basis of measurement.

Par. 100. A number of different measurement bases are employed to different degrees and

in varying combinations in financial statements. They include the following:a) Historical cost. Assets are recorded at the amount of cash or cash equivalents paid or

the fair value of the consideration given to acquire them at the time of theiracquisition. Liabilities are recorded at the amount of proceeds received in exchangefor the obligation, or in some circumstances (for example, income taxes), at theamounts of cash or cash equivalents expected to be paid to satisfy the liability in thenormal course of business.

b) Current cost. Assets are carried at the amount of cash or cash equivalents that wouldhave to be paid if the same or an equivalent asset was acquired currently. Liabilitiesare carried at the undiscounted amount of cash or cash equivalents that would berequired to settle the obligation currently.

c) Realisable (settlement) value. Assets are carried at the amount of cash or cashequivalents that could currently be obtained by selling the asset in an orderlydisposal. Assets are carried at the present discounted value of the future net cashinflows that the item is expected to generate in the normal course of business.Liabilities are carried at the present discounted value of the future net cash outflowsthat are expected to be required to settle the liabilities in the normal course of business.


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Par. 101. The measurement basis most commonly adopted by entities in preparing theirfinancial statements is historical cost. This is usually combined with other measurementbases. For example, inventories are usually carried at the lower of cost and net realisablevalue, marketable securities may be carried at market value and pension liabilities arecarried at their present value. Furthermore, some entities use the current cost basis as a

response to the inability of the historical cost accounting model to deal with the effects of changing prices of non-monetary assets.

Concepts of capital and capital maintenance

A major difference between US GAAP and IFRS is the fact that three fundamentally differentconcepts of capital and capital maintenance are authorized in IFRS while US GAAP onlyauthorize two capital and capital maintenance concepts during low inflation and deflation:

a) physical capital maintenance andb) financial capital maintenance in nominal monetary units (traditional Historical Cost

Accounting) as stated in Par 45 to 48 in the FASB Conceptual Satement N 5. US

GAAP does not recognize the third concept of capital and capital maintenance duringlow inflation and deflation, namely, financial capital maintenance in units of constantpurchasing power as authorized in IFRS in the Framework, Par 104 (a) in 1989.

Concepts of capital:

Par. 102. A financial concept of capital is adopted by most entities in preparing theirfinancial statements. Under a financial concept of capital, such as invested money orinvested purchasing power, capital is synonymous with the net assets or equity of theentity. Under a physical concept of capital, such as operating capability, capital is regardedas the productive capacity of the entity based on, for example, units of output per day.

Par. 103. The selection of the appropriate concept of capital by an entity should be based onthe needs of the users of its financial statements. Thus, a financial concept of capital shouldbe adopted if the users of financial statements are primarily concerned with themaintenance of nominal invested capital or the purchasing power of invested capital. If,however, the main concern of users is with the operating capability of the entity, a physicalconcept of capital should be used. The concept chosen indicates the goal to be attained indetermining profit, even though there may be some measurement difficulties in making theconcept operational.

Concepts of capital maintenance and the determination of profit

Par. 104. The concepts of capital in paragraph 102 give rise to the following two concepts of capital maintenance:

a) Financial capital maintenance. Under this concept a profit is earned only if thefinancial (or money) amount of the net assets at the end of the period exceeds thefinancial (or money) amount of net assets at the beginning of the period, afterexcluding any distributions to, and contributions from, owners during the period.Financial capital maintenance can be measured in either nominal monetary units orunits of constant purchasing power.


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b) Physical capital maintenance. Under this concept a profit is earned only if thephysical productive capacity (or operating capability) of the entity (or the resourcesor funds needed to achieve that capacity) at the end of the period exceeds thephysical productive capacity at the beginning of the period, after excluding anydistributions to, and contributions from, owners during the period.

The concepts of capital in paragraph 102 give rise to the following three concepts of capitalduring low inflation and deflation:

a) Physical capital. See paragraph 102&103b) Nominal financial capital. See paragraph 104.c) Constant purchasing power financial capital. See paragraph 104.

The concepts of capital in paragraph 102 give rise to the following three concepts of capitalmaintenance during low inflation and deflation:

1. Physical capital maintenance: optional during low inflation and deflation. Current

Cost Accounting model prescribed by IFRS. See Par 106.2. Financial capital maintenance in nominal monetary units (Historical cost accounting):authorized by IFRS but not prescribed optional during low inflation and deflation.See Par 104 (a) Historical cost accounting. Financial capital maintenance in nominalmonetary units per se during inflation and deflation is a fallacy: it is impossible tomaintain the real value of financial capital constant with measurement in nominalmonetary units per se during inflation and deflation.

3. Financial capital maintenance in units of constant purchasing power (Constant ItemPurchasing Power Accounting): authorized by IFRS but not prescribed optionalduring low inflation and deflation. See Par 104(a). IAS 29 is prescribed duringhyperinflation: i.e. the restatement of Historical Cost or Current Cost period-end

financial statements in terms of the period-end monthly published Consumer PriceIndex. Only financial capital maintenance in units of constant purchasing power(CIPPA) per se can automatically maintain the real value of financial capital constantat all levels of inflation and deflation in all entities that at least break even in realvalue ceteris paribus for an indefinite period of time. This would happen whetherthese entities own revaluable fixed assets or not and without the requirement of more capital or additional retained profits to simply maintain the existing constantreal value of existing shareholders equity constant. Financial capital maintenance inunits of constant purchasing power requires the calculation and accounting of netmonetary losses and gains from holding monetary items during low inflation anddeflation. The calculation and accounting of net monetary losses and gains during

low inflation and deflation have thus been authorized in IFRS since 1989.Par. 105. The concept of capital maintenance is concerned with how an entity defines thecapital that it seeks to maintain. It provides the linkage between the concepts of capital andthe concepts of profit because it provides the point of reference by which profit ismeasured; it is a prerequisite for distinguishing between an entity's return on capital and itsreturn of capital; only inflows of assets in excess of amounts needed to maintain capitalmay be regarded as profit and therefore as a return on capital. Hence, profit is the residual


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amount that remains after expenses (including capital maintenance adjustments, whereappropriate) have been deducted from income. If expenses exceed income the residualamount is a loss.

Par. 106. The physical capital maintenance concept requires the adoption of the current costbasis of measurement. The financial capital maintenance concept, however, does notrequire the use of a particular basis of measurement. Selection of the basis under thisconcept is dependent on the type of financial capital that the entity is seeking to maintain.

Par. 107. The principal difference between the two concepts of capital maintenance is thetreatment of the effects of changes in the prices of assets and liabilities of the entity. Ingeneral terms, an entity has maintained its capital if it has as much capital at the end of theperiod as it had at the beginning of the period. Any amount over and above that required tomaintain the capital at the beginning of the period is profit.

Par. 108. Under the concept of financial capital maintenance where capital is defined interms of nominal monetary units, profit represents the increase in nominal money capital

over the period. Thus, increases in the prices of assets held over the period, conventionallyreferred to as holding gains, are, conceptually, profits. They may not be recognised as such,however, until the assets are disposed of in an exchange transaction. When the concept of financial capital maintenance is defined in terms of constant purchasing power units, profitrepresents the increase in invested purchasing power over the period. Thus, only that partof the increase in the prices of assets that exceeds the increase in the general level of pricesis regarded as profit. The rest of the increase is treated as a capital maintenanceadjustment and, hence, as part of equity.

Par. 109. Under the concept of physical capital maintenance when capital is defined in termsof the physical productive capacity, profit represents the increase in that capital over the

period. All price changes affecting the assets and liabilities of the entity are viewed aschanges in the measurement of the physical productive capacity of the entity; hence, theyare treated as capital maintenance adjustments that are part of equity and not as profit.

Par. 110. The selection of the measurement bases and concept of capital maintenance willdetermine the accounting model used in the preparation of the financial statements.Different accounting models exhibit different degrees of relevance and reliability and, as inother areas, management must seek a balance between relevance and reliability. ThisFramework is applicable to a range of accounting models and provides guidance onpreparing and presenting the financial statements constructed under the chosen model. Atthe present time, it is not the intention of the Board of IASC to prescribe a particular modelother than in exceptional circumstances, such as for those entities reporting in the currencyof a hyperinflationary economy. This intention will, however, be reviewed in the light of world developments.


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Accounting Terms:

Reconciliation is the adjusting of the difference between two items (e.g., balances, amounts,statements, or accounts) so that the figures are in agreement. Often the reasons for thedifferences must be explained. One example would be reconciling a checking account(bringing the checking ledger and bank balance statement into agreement).

Reasons for Reconciliation:

Cheques deposited into bank but not recorded in the bank book. Cheques issued but not presented in bank. Bank charges directly debited from bank account not mentioned in bank book. ECS, not mentioned in bank book. Interested credited into bank account not mentioned in bank book. Cheques deposited not cleared.

Difference between A/P and A/R:

Accounts Payable:

This current liability account will show the amount a company owes for items orservices purchased on credit and for which there was not a promissory note.

Accounts Receivable:

A current asset resulting from selling goods or services on credit (on account)

What is corporate restructuring?

Corporate restructuring is necessary when a company needs to improve its efficiency and

profitability and it requires expert corporate management. A corporate restructuringstrategy involves the dismantling and rebuilding of areas within an organization that needspecial attention from the management and CEO.

The process of corporate restructuring often occurs after buy-outs, corporate acquisitions,takeovers or bankruptcy. It can involve a significant movement of an organizationsliabilities or assets.

Stock split:

A stock split or stock divide increases or decreases the number of shares in a publiccompany. The price is adjusted such that the before and after market capitalization of the

company remains the same and dilution does not occur. Options and warrants are included.On a stock exchange, a reverse stock split or reverse split is the opposite of a stocksplit, i.e. a stock merge - a reduction in the number of shares and an accompanyingincrease in the share price. [1] The ratio is also reversed: 1-for-2, 1-for-3 and so on.


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Spin-Offs:

A spin-off is a new organization or entity formed by a split from a larger one, such as atelevision series based on a pre-existing one, or a new company formed from a universityresearch group or business incubator. In literature, especially in milieu-based popularfictional book series like mysteries, westerns, fantasy or science fiction, the term sub-series is generally used instead of spin-off , but with essentially the same meaning.

Spin-offs as a descriptive term can also include a dissenting faction of a membershiporganization, a sect of a cult, or a denomination of a church. In business, a spin-off isessentially the opposite of a merger. In computing, a spin-off from a software project isoften called a fork.

A spin-off product is a product deriving elements of design, branding or function from anexisting product, but which is itself a new distinct product.

Corporate spin-off: The common definition of spin out is a division of a company ororganization that becomes an independent business.

Government spin-off: Civilian goods which are the result of mili tary or governmentalresearch are also known as spinoffs.

Media spin-off: Media spin-off is the process of deriving new radio, video game, filmseries, book series or television programs from existing ones.

Research spin-off: A research spin-off is a new company based on the findings of amember or by members of a research group at a university.

Net Asset Value (NAV) is the per share price of a mutual fund. For a no-load fund, NAV isthe price received by both buyers and sellers. For front loaded mutual funds, NAV isequivalent of the bid price (what shareholders can get for selling a share), while the offeringprice is the price buyers must pay per share (and includes front load). The NAV is usuallycalculated at the end of each trading day by taking the closing prices of all securities ownedplus cash and equivalents and subtracting all liabilities then dividing by the number of shares outstanding, which for open-end funds, fluctuates depending on daily number of redemptions and purchases. Many new funds are issued at a NAV of $10. After adistribution, the NAV falls by the amount equal to the distribution.

What It Is: Most commonly used in reference to mutual or closed-end funds, net asset value (NAV)measures the value of a fund's assets, minus its liabilities. NAV is typically calculated on aper-share basis.

How It Works/Example: A fund's NAV fluctuates along with the value of its underlying investments. The formula forNAV is:

NAV = (Market Value of All Securities Held by Fund + Cash and Equivalent Holdings - FundLiabilities) / Total Fund Shares Outstanding


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Let's assume at the close of trading yesterday that a particular mutual fund held$10,500,000 worth of securities, $2,000,000 of cash, and $500,000 of liabilities. If the fundhad 1,000,000 shares outstanding, then yesterday's NAV would be:

NAV = ($10,500,000 + $2,000,000 - $500,000) / 1,000,000 = $12.00

A fund's NAV will change daily as the value of a fund's securities, cash held, liabilities, andthe number of shares outstanding fluctuate.

Q. What is the difference between stocks and shares?

Ans: Stock is a general term used to describe the shares of any company and "shares"refers to a specific stock of a particular company. So, if investors say they own stocks,they are generally referring to their overall ownership in one or more companies. If investors say they own shares - the question then becomes - shares in what company?

Stocks : A type of security that signifies ownership in a corporation and represents aclaim on part of the corporation's assets and earnings.

Shares : A unit of ownership interest in a corporation or financial asset. While owningshares in a business does not mean that the shareholder has direct control over thebusiness's day-to-day operations, being a shareholder does entitle the possessor to anequal distribution in any profits, if any are declared in the form of dividends. The two maintypes of shares are common shares and preferred shares.

Capital Markets : The capital market (securities markets) is the market for securities, where companies and the government can raise long-term funds. The capital marketincludes the stock market and the bond market. It is a place where investors come togetherto buy and sell shares.

Primary Markets: The primary market is that part of the capital markets that deals withthe issuance of new securities. Companies, governments or public sector institutions canobtain funding through the sale of a new stock or bond issue. This is typically done througha syndicate of securities dealers. The process of selling new issues to investors is calledunderwriting. In the case of a new stock issue, this sale is called an initial public offering(IPO). Dealers earn a commission that is built into the price of the security offering, thoughit can be found in the prospectus.

Secondary Market: The secondary market is the financial market for trading of securities that have already been issued in an initial private or public offering.

Dividend: The periodic, usually quarterly, payment made by a corporation to itsshareholders, generally expressed as dividend per share. Dividends represent earningsthat are not reinvested by the corporation. Some stocks pay no dividends and others, suchas utility companies pay substantial ones that represent a large portion of the total returna shareholder will get from his investment. Dividends are a type of distribution and areusually taxable in year received.
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Equity is, normally, ownership or percentage of ownership in a company.

Equity Share is a) a share or class of shares whether or not the share carries votingrights, b) any warrants, options or rights entitling their holders to purchase or acquire theshares referred to under (a), or c. other prescribed securities.

What Does Reverse Stock Split Mean?

A reduction in the number of a corporation's shares outstanding that increases the parvalue of its stock or its earnings per share. The market value of the total number of shares(market capitalization) remains the same.

Preference Shares usually, non-voting capital stock that pays dividends at a specifiedrate and has preference over common stock in the payment of dividends and theliquidation of assets.

Debenture A bond issued by a corporation which is secured by the general credit or promise to pay of

the issuer. It is not backed by collateral such as tangible assets.Example: A certificate or voucher acknowledging a debt. An unsecured bond issued by a civil or governmental corporation or agency and

backed only by the credit standing of the issuer.

Derivatives:

Financial instruments, such as futures and options, which derive their value fromunderlying securities including bonds, bills, currencies, and equities. Equity derivatives arefinancial derivative products whose value is dependent on the value of an underlying shareor group of shares.

Underlying Security:

The security that must be delivered when another security is exercised. For example, if acall option is exercised, then the underlying stock is delivered to the call owner. Warrants,rights, options, and convertible securities all have underlying securities. For futures options,futures are the underlying security.

Futures:

Investment contracts which specify the quantity and price of a commodity to be purchasedor sold at a later date. On contract date, the buyer must take physical possession or makedelivery of the commodity, which can only be avoided by closing out the contract(s) beforethat date. Futures can be used for speculation or hedging.

Option:

A contract that gives the owner the right, i f exercised, to buy or sell a security or basket of securities (index) at a specific price within a specific time limit. Usually, they are traded assecurities themselves, with buyers and sellers trying to profit from price changes. They aregenerally available for 1 to 9 months, with some longer term options (called LEAPS) also


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available for selected securities. Stock option contracts are generally for the right to buy orsell 100 shares of the underlying stock (100 is the multiplier). Trading in options should onlybe undertaken by sophisticated investors.

Call Option:

A call option gives the owner the right, but not the obligation, to buy the underlying stock ata given price (the strike price) by a given time (the expiration date). The owner of the call isspeculating that the underlying stock will go up in value, hence, increasing the value of theoption. The purpose can be to speculate with the option (hope it goes up and sell for aprofit), to invest in the underlying stock at a locked in price if the stock price goes highenough, or to generate income. Each option contract equals 100 shares of stock. Forexample, an AAA MAR 65 call, would give the owner the right to buy 100 shares of AAA at$65 (strike price) per share between now and the third Friday in March (expiration date).

Put Option:

A put option gives the owner the right, but not the obligation, to sell the underlying stock at

a given price (the strike price ) by a given time (the expiration date). The owner isspeculating that the option will go up in value and the underlying stock will go down invalue. The purpose can be to either speculate with the option (hope it goes up and sell for aprofit) or trade the underlying stock at a locked in price if the stock price goes downenough. For example, an AAA MAR 65 put would give the owner the right to sell 100 sharesof AAA at $65 (strike price) per share between now and the third Friday in March (expirationdate).

Hedging:

An investment strategy of lowering risk by buying securities that have offsetting riskcharacteristics. A perfect hedge eliminates risk entirely. Hedging strategies lower return

since there is a cost involved in hedging. For example, a portfolio manager could short afutures contract which will perfectly offset any decrease in the value of the portfolio. Optionsand short selling stock can also be used for hedging. Hedge funds are investment pools thatare free to use any hedging techniques they desire and they often make large bets in arelatively small number of different holdings.

Intraday Trading:

Intraday share trading refers to the buying and selling (or vise versa) of the same script inthe same trading session ( on the same day).

Portfolio Management: is where assets are combined into a portfolio that fits theinvestor's preferences (eg, level of risk) and needs (eg, regular dividends).

The aim of Portfolio Management is to achieve the maximum return from a portfolio whichhas been delegated to be managed by an individual manager or financial institution. Themanager has to balance the parameters which define a good investment ie security,liquidity and return. The goal is to obtain the highest return for the client of the managedportfolio.


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Blue Chip Companies:

A blue chip stock is the stock of a well-established company having stable earnings and noextensive liabilities. Most blue chip stocks pay regular dividends, even when business isfaring worse than usual. They are valued by investors seeking relative safety and stability,though prices per share are usually high.

Bond A long-term debt instrument on which the issuer pays interest periodically, known as Coupon. Bonds are secured by COLLATERAL in the form of immovable property. Whilegenerally, bonds have a definite MATURITY, Perpetual Bonds are securities without anymaturity. In the U.S., the term DEBENTURES refers to long-term debt instruments whichare not secured by specific collateral, so as to distinguish them from bonds.

NASDAQ: An acronym for National Association of Security Dealers Automated QuotationsSystem, which is a nationwide network of computers and other electronic equipment thatconnects dealers in the over-the-counter market across the U.S. The system provides thelatest BID and ASKING PRICES quoted for any security by different dealers. This enables an

investor to have his or her transaction done at the best price. Due to NASDAQ, the over-the-counter market in the U.S. is like a vast but convenient trading floor on which severalthousand stocks are traded.

National Stock Exchange (NSE) It is a nationwide screen-based trading network usingcomputers, satellite link and electronic media that facilitate transactions in securities byinvestors across India. The idea of this model exchange (traced to the Pherwani Committeerecommendations) was an answer to the deficiencies of the older stock exchanges asreflected in settlement delays, price rigging and a lack of transparency.

Volatility is the measure of the tendency of prices to fluctuate widely. Prices of smallcompanies tend to be more volatile than those of large corporations. Beta is a measure of volatility.

Liquidity is the ability to turn an asset into cash. A highly liquid asset is easy to sellbecause an active market exists that sets prices which are continuously adjusted for supplyand demand. An example is a listed stock or mutual fund. A less liquid asset is real estate ora collectible.

Lot is a group of identical UNITS (for securities) or nearly identical units (for collectibles) of an investment that are traded at the same time and price. Open lots are the contents of

open investments and can be long (buys) or short (short sell). Closed lots are the contentsof closed investments and can be long (sell) or short (buy to cover).

Depository A system of computerized book-entry of securities. This arrangement enables atransfer of shares through a mere book-entry rather than the physical movement of certificates. This is because the scrips are dematerialized or alternatively, immobilized under the system.


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Difference between Journal & Ledger:

Journal : The record of journal entries appearing in order by date. Some refer tothe journal as the book of original entry, since the entries are first recorded in a

journal. From the journal the entries will be posted to the designated accounts inthe general ledger. With manual systems there are likely to be a sales journal,purchases journal, cash receipts journal, cash disbursements journal, and thegeneral journal.

Ledger : A "book" containing accounts. For example, there is the general ledgerthat contains the balance sheet and income statement accounts.

Balance Sheet: A listing of all assets and liabilities for an individual or a business. The surplus of assets overliabilities is the net worth, or what is owned free of debt. The Liabilities side of the balancesheets shows the sources of income into the business and the assests side shows how theincome has been utilized.

A Custodial account is a financial account set up for a minor, but administered by aresponsible adult, known as a custodian, because the minor is under the legal age of majority. The custodian is often the minor's parent. A custodial account can be everythingfrom a bank account to a trust fund. This type of account usually come with a Coverdell ESAForm a tax advantaged contract. It deals with successor rights and other contract conditionsdepending on who issues the form.

STOCK MARKET BASICS

What is a Stock Exchange?

It is a common platform where the buyers and sellers come together to transact in stocksand shares. It may be a physical entity where brokers trade on a physical trading floor viaan "open outcry" system or a virtual environment.

What is electronic trading?Electronic trading eliminates the need for physical trading floors. Brokers can trade fromtheir offices, using fully automated screen-based processes. Their workstations areconnected to a Stock Exchange's central computer via satellite using Very Small ApertureTerminus (VSATs). The orders placed by brokers reach the Exchange's central computer andare matched electronically.How many Exchanges are there in India? The Stock Exchange, Mumbai (BSE) and the National Stock Exchange (NSE) are thecountry's two leading Exchanges. There are 20 other regional Exchanges, connected via theInter-Connected Stock Exchange (ICSE). The BSE and NSE allow nationwide trading viatheir VSAT systems.What is an Index? An Index is a comprehensive measure of market trends, intended for investors who areconcerned with general stock market price movements. An Index comprises stocks thathave large liquidity and market capitalisation. Each stock is given a weightage in the Indexequivalent to its market capitalisation. At the NSE, the capitalisation of NIFTY (fifty selected
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stocks) is taken as a base capitalisation, with the value set at 1000. Similarly, BSE SensitiveIndex or Sensex comprises 30 selected stocks. The Index value compares the day's marketcapitalisation vis-a-vis base capitalisation and indicates how prices in general have movedover a period of time.

How does one execute an order? Select a broker of your choice and enter into a broker-client agreement and fill in the clientregistration form. Place your order with your broker preferably in writing. Get a tradeconfirmation slip on the day the trade is executed and ask for the contract note at the endof the trade date.Why does one need a broker? As per SEBI (Securities and Exchange Board of India.) regulations, only registered memberscan operate in the stock market. One can trade by executing a deal only through aregistered broker of a recognised Stock Exchange or through a SEBI- registered sub-broker.What is a contract note?

A contract note describes the rate, date, time at which the trade was transacted and thebrokerage rate. A contract note issued in the prescribed format establishes a legallyenforceable relationship between the client and the member in respect of trades stated inthe contract note. These are made in duplicate and the member and the client both keep acopy each. A client should receive the contract note within 24 hours of the executed trade.

What is a no-delivery period? Whenever a company announces a book closure or record date, the Exchange sets up a no-delivery (ND) period for that security. During this period only trading is permitted in thesecurity. However, these trades are settled only after the no-delivery period is over. This isdone to ensure that investor's entitlement for the corporate benefit is clearly determid.

What is an ex-dividend date? The date on or after which a security begins trading without the dividend (cash or stock)included in the contract price.What is an ex-date? The first day of the no-delivery period is the ex-date. If there is any corporate benefits suchas rights, bonus, dividend announced for which book closure/record date is fixed, the buyerof the shares on or after the ex-date will not be eligible for he benefits.What is a Bonus Issue? While investing in shares the motive is not only capital gains but also a proportionate share

of surplus generated from the operations once all other stakeholders have been paid. Butthe distribution of this surplus to shareholders seldom happens. Instead, this is transferredto the reserves and surplus account. If the reserves and surplus amount becomes too large,the company may transfer some amount from the reserves account to the share capitalaccount by a mere book entry. This is done by increasing the number of shares outstandingand every shareholder is given bonus shares in a ratio called the bonus ratio and such anissue is called bonus issue. If the bonus ratio is 1:2, it means that for every two shares


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held, the shareholder is entitled to one extra share. So if a shareholder holds two shares,post bonus he will hold three.

What is a Buy Back?

As the name suggests, it is a process by which a company can buy back its shares fromshareholders. A company may buy back its shares in various ways: from existingshareholders on a proportionate basis; through a tender offer from open market; through abook-building process; from the Stock Exchange; or from odd lot holders.

What are the various kinds of financial ratios? There are many financial ratios. Some of the better known include:Liquidity Ratios: Liquidityratio measures the ability of a firm to meet its current obligations. Liquidity ratios byestablishing a relationship between cash and other current assets to current obligations givemeasure of liquidity.

Current ratio [CR] = Current Assets/Current liabilities.A high CR ratio (>2.5) indicates that a company can meets its short term liabilities.LeverageRatios: Leverage ratio indicates the proportion of debt and equity in financing the firm'sassets. They indicate the funds provided by owners and lenders.

Debt-equity ratio (D-E ratio) total long term debt/net worth.

A high D-E ratio indicates that the company's credit profile is bad. Activity Ratios: Activityratios are employed to evaluate the efficiency with which firms manage and run theirassets. They are also called turnover ratios.

Sales Turnover ratio = sales/total assets .A Sales Turnover ratio indicates how much business a company generates for everyadditional rupee invested.

Profitability Ratios: These ratios indicate the level of profitability of the business with relation to the inputs orcapital employed. Some better-known profit ratios include operating profit margin (OPM).Operating profit margin is a measure of the company's efficiency, either in isolation or incomparison to its peers.

What are EPS, P/E, BV and MV/BV? Earnings Per Share (EPS) represents the portion of a company's profit allocated to

each outstanding share of common stock. Net income (reported or estimated) for aperiod of time is divided by the total number of shares outstanding during thatperiod. It is one of the measures of the profitability of common shareholder's


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investments. It is given by profit after tax (PAT) divided by number of commonshares outstanding.

Price Earning Multiple (P/E): Price earning multiple is ratio between market valueper share and earnings per share.

Book Value (BV): (of a common share) The Companys Net worth (which is paid-upcapital + reserves & surplus) divided by number of shares outstanding.

Market value to book value ratio (MV/BV ratio): It is the ratio between the market price of aSecurity and Book Value of the security.

IPOs: What is an IPO? An IPO is an abbreviation for Initial Public Offer. When a company goes public for the firsttime or issues a fresh stock of shares, it offers it to the public directly. This happens in theprimary market. The primary market is where a company makes its first contact with the

public at large.

What is Book Building? Book Building is a process used for marketing a public offer of equity shares of a companyand is a common practice in most developed countries. Book Building is so- called becausethe collection of bids from investors are entered in a "book". These bids are based on anindicative price range. The issue price is fixed after the bid closing date.

How is the book built?

A company that is planning an initial public offer (IPO) appoints a category-I MerchantBanker as a bookrunner. Initially, the company issues a draft prospectus which does notmention the price, but gives other details about the company with regards to issue size,past history and future plans among other mandatory disclosures. After the draft prospectusis filed with the SEBI, a particular period isfixed as the bid period and the details of theissue are advertised.The book runnerbuilds an order book, that is, collates the bids fromvarious investors, which shows the demand for the shares of the company at various prices.For instance, a bidder may quote that he wants 50,000 shares at Rs.500 while another maybid for 25,000 shares at Rs.600. Prospective investors can revise their bids at anytimeduring the bid period, that is, the quantity of shares or the bid price or any of the bidoptions. Usually, the bid must be for a minimum of 500 equity shares and in multiples of 100 equity shares thereafter. The book runner appoints a syndicate member, a registeredintermediary who garners subscription and underwrites the issue.

On what basis is the final price decided? On closure of the book, the quantum of shares ordered and the respective prices offered areknown. The price discovery is a function of demand at various prices, and involves


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negotiations between those involved in the issue. The book runner and the companyconclude the pricing and decide the allocation to each syndicate member.

When is the payment for the shares made?

The bidder has to pay the maximum bid price at the time of bidding based on the highestbidding option of the bidder. The bidder has the option to make different bids like quoting alower price for higher number of shares or a higher price for lower number of shares. Thesyndicate member may waive the payment of bid price at the time of bidding. In suchcases, the issue price may be paid later to the syndicate member within four days of confirmation of allocation. Where a bidder has been allocated lesser number of shares thanhe or she had bid for, the excess amount paid on bidding, if any will be refunded to suchbidder.

Is the process followed in India different from abroad?

Unlike international markets, India has a large number of retail investors who activelyparticipate in IPOs. Internationally, the most active investors are the Mutual Funds andOther Institutional Investors. So the entire issue is book built. But in India, 25 per cent of the issue has to be offered to the general public. Here there are two options to thecompany. According to the first option, 25 per cent of the issue has to be sold at a fixedprice and 75 per cent is through Book Building. The other option is to split the 25 per centon offer to the public (small investors) into a fixed price portion of 10 per cent and areservation in the book built portion amounting to 15 per cent of the issue size. The rest of the book built portion is open to any investor.

What is the advantage of the Book Building process versus the normal IPO

marketing process? The Book Building process allows for price and demand discovery. Also, the costs of thepublic issue is reduced and so is the the time taken to complete the entire process.

How is Book building different from the normal IPO marketing process as

practiced in India? Unlike in Book Building, IPOs are usually marketed at a fixed price. Here the demand cannotbe anticipated by the merchant banker and only after the issue is over the response isknown. In book building, the demand for the share is known before the issue closes.Theissue may be deferred if the demand is less


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General Charges

Audit Fees

Bank Charges

Counting house Salary

Other Office Expenses

***

***

***

***

***

Cost of Production (3) ***

Add: Opening stock of Finished Goods

Less: Closing stock of Finished Goods

***

***

Cost of Goods Sold ***

Add:- Selling and Distribution OH:-

Sales man Commission

Sales man salary

Traveling Expenses

Advertisement

Delivery man expenses

Sales Tax

Bad Debts

***

***

***

***

***

***

***

Cost of Sales (5) ***

Profit (balancing figure) ***

Sales ***

Notes:-

Factory Over Heads are recovered as a percentage of direct wages Administration Over Heads, Selling and Distribution Overheads are recovered as a

percentage of works cost.


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Cash and fund flow statement:

Rules for preparing schedule of changes in working capital :-

Increase in a current asset, results in increase in working capital so AddDecrease in current asset, results in decrease in working capital so Decrease

Increase in current liability, results in decrease in working capital so DecreaseDecrease in current liability results in increase in working capital so Add

Funds from operations Format

Particulars Rs. Rs.Net profit **

*Add : Depreciation

Goodwill written off Preliminary Exp. Written off Discount on share written

off Transfer to General

ReserveProvision for TaxationProvision for DividendLoss on sale of assetLoss on revaluation of

asset

**************************

*

***

***

Less : Profit on sale of assetProfit on Revaluation of

asset

******

***

Fund flow statement ***


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Fund flow statement:

Particulars Rs.Sources of funds : -

Issue of sharesIssue of Debentures

Long term borrowingsSale of fixed assetsOperating profit

*****

*************

Total Sources ***

Application of funds : -Redumption of Redeemable preference

sharesRedumption of DebenturesPayment of other long term loansPurchase of Fixed assetsOperating LossPayment of dividends, tax etc

*********************

Total Uses ***

Net Increase / Decrease in working capital(Total sources Total

uses)***


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Cash flow statement :

Cash From Operation : -= Net profit + Decrease in Current Asset

+ Increase in Current Liability- Increase in Current Asset

- Decrease in Current Liability

Cash flow statement

Sources Rs.

Application Rs.

Opening cash and bankbalanceIssue of sharesRaising of long term loansSales of fixed assetsShort term BorrowingsCash InflowClosing Bank O/D

**************

Opening Bank O/DRedumption of Preference SharesRedumption of Long term loansPurchase of fixed assetsDecrease in Deferred paymentLiabilityCash OutflowTax paidDividend paidDecrease in Unsecured loans,DepositsClosing cash and bank balance

********************

** **

Ratio Analysis:

A) Cash Position Ratio : - Absolute Cash Ratio = Cash Reservoir

Current Liabilities

Cash Position to Total asset Ratio = Cash Reservoir * 100(Measure liquid layer of assets) Total Assets

Interval measure = Cash Reservoir(ability of cash reservoir to meet cash expenses) Average daily cash expenses

( Answer in days)

Notes : - Cash Reservoir = Cash in hand + Bank + Marketable Non trade investment at

market value. Current liabilities = Creditors + Bills Payable + Outstanding Expenses + Provision for

tax (Net of advance tax) + Proposed dividend + Other provisions. Total assets = Total in asset side Miscellaneous expenses Preliminary expenses +

Any increase in value of marketable non trading Investments. Average cash expenses =Total expenses in debit side of P & L a/c Non cash item

such as depreciation, goodwill, preliminary expenses written off, loss on sale of


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investments, fixed assets written off + advance tax (Ignore provision for tax) . Thenet amount is divided by 365 to arrive average expenses.

Remarks : - In Comparison When absolute cash ratio is lower then current liability is higher When cash position to Total Asset ratio is lower then the total asset is relatively

higher. When cash interval is lower the company maintain low cash position. It is not goodto maintain too low cash position or too high cash position.

B) Liquidity Ratio : -

1) Current ratio = Current assetCurrent Liability

2) Quick ratio or Acid Test ratio = Quick AssetQuick liability

Notes : -

Quick Asset = Current Asset Stock Quick Liability = Current liability Cash credit, Bank borrowings, OD and other Short

term Borrowings. Secured loan is a current liability and also come under cash credit Sundry debtors considered doubtful should not be taken as quick asset. Creditors for capital WIP is to be excluded from current liability. Current asset can include only marketable securities. Loans to employees in asset side are long term in nature and are not part of current

assets. Provision for gratuity is not a current liability. Gratuity fund investment is not a part of marketable securities.

Trade investments are not part of marketable securities.

Remarks : -

Higher the current ratios better the liquidity position.

C) Capital structure ratios : -

1) Debt equity ratio = Debt = External Equity(or)Leverage ratio Equity Internal Equity

= Long term debt = Share holders fundLong term fund Long term fund

2) Proprietary ratio = Proprietary fundTotal Assets

3) Total Liability to Net worth ratio = Total LiabilitiesNet worth


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4) Capital gearing ratio = Preference share capital + Debt

Equity Preference share capital

Notes : -

Share holders fund (or) Equity (or) Proprietary fund (or) Owners fund (or) Net worth= Equity share + Preference share + Reserves and surplus P & L a/c PreliminaryExpenses.

Debt (or) Long term liability (or) Long term loan fund = Secured loan (excludingcash credit) + unsecured loan + Debentures.

Total asset = Total assets as per Balance sheet Preliminary expenses. Total liability = Long term liability + Current liability (or) short term liability Long term fund = Total asset Current liability = Share holders fund + long term

loan fund.

Remarks : -

In debt equity ratio higher the debt fund used in capital structure, greater is the risk. In debt equity ratio, operates favorable when if rate of interest is lower than the

return on capital employed. In total liability to Net worth Ratio = Lower the ratio, better is solvency position of

business, Higher the ratio lower is its solvency position. If debt equity ratio is comparatively higher then the financial strength is better.

D) Profitability Ratio : -

1) Gross Profit Ratio = Gross Profit * 100Sales

2) Net Profit Ratio = Net Profit * 100Sales

3) Operating Profit ratio = Operating profit * 100Sales

4) Return to shareholders = Net profit after interest and taxShare holders fund

5) Return on Net Worth = Return on Net worth * 100Net worth

6) Return on capital employed (or) Return on investment = Return (EBIT)Capital Employed


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7) Expenses Ratios :-

a) Direct expenses Ratios : -i) Raw material consumed * 100

Sales

ii) Wages * 100Sales

iii) Production Expenses * 100Sales

c) Indirect expenses Ratios : -

i) Administrative Expenses * 100Sales

ii) Selling Expenses * 100Sales

iii) Distribution Expenses * 100Sales

iv) Finance Charge * 100Sales

Notes : -

In the above the term term is used for business engaged in sale of goods, for otherenterprises the word revenue can be used. Gross profit = Sales Cost of goods sold Operating profit = Sales Cost of sales

= Profit after operating expenses but before Interest and tax. Operating Expenses = Administration Expenses + Selling and distribution expenses,

Interest on short term loans etc. Return = Earning before Interest and Tax

= Operating profit= Net profit + Non operating expenses Non operating Income

Capital employed = Share holders fund + Long term borrowings= Fixed assets + Working capital

If opening and closing balance is given then average capital employed can besubstituted in case of capital employed which isOpening capital employed + Closing capital employed

2


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E) Debt service coverage ratios = Profit available for debt servicingLoan Installments + Interest

Notes : - Profit available for debt servicing = Net profit after tax provision + Depreciation +

Other non cash charges + Interest on debt.

Remarks : - Higher the debt servicing ratio is an indicator of better credit rating of the company. It is an indicator of the ability of a business enterprise to pay off current installments

and interest out of profits.

F) Turnover Ratios: -

i) Assets turnover = Sales___Total assets

2) Fixed assets turnover = Sales [Number of times fixed assets hasFixed assets turned into sales]

3) Working capital turnover = Sales_____Working capital

4) Inventory turnover = Cost of goods sold(for finished goods) Average inventory

5) Debtors turnover (or) Average collection period = ___Credit sales_________ (in ratio)Average accounts receivable

(or) = Average accounts receivable * 365 (in days)Credit sales

6) Creditors turnover (or) Average payment period _Credit purchases_____ (in ratio)Average accounts payable

(or) = Average accounts Payable * 365 (in days)Credit Purchases

7) Inventory Turnover (for WIP) = Cost of productionAverage Inventory (for WIP)

8) Inventory Turnover (for Raw material) = Raw material consumedAverage inventory (for raw material)

10) Inventory Holding Period = 365 .Inventory turnover ratio


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11) Capital Turnover ratio = Cost of sales

Capital employed

Note : -

Working capital = Current asset Current liability= 0.25 * Proprietary ratio Accounts Receivable = Debtors + Bills receivable Accounts payable = Creditors + Bills Payable

Remarks : -

If assets turnover ratio is more than 1, then profitability based on capital employedis profitability based on sales.

Higher inventory turnover is an indicator of efficient inventory movement. It is anindicator of inventory management policies.

Low inventory holding period lower working capital locking, but too low is not safe. Higher the debtors turnover, lower the credit period offered to customers. It is an

indicator of credit management policies. Higher the creditors turnover, lower the credit period offered by suppliers.

G) Other Ratios: -

1) Operating profit ratio = Net profit ratio + Non operating loss / Sales ratio

2) Gross profit ratio = Operating profit ratio + Indirect expenses ratio

3) Cost of goods sold / Sales ratio = 100% - Gross profit ratio

4) Earnings per share = Net profit after interest and taxNumber of equity shares

5) Price per Earning ratio = Market price per equity shareEarnings per share

6) Payout ratio = Dividend per equity share * 100Earning per equity shares

7) Dividend yield ratio = Dividend per share * 100Market price per share

8) Fixed charges coverage ratio = Net profit before interest and taxesInterest charges

9) Interest coverage ratio = Earnings before interest and taxInterest charges


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10) Fixed dividend coverage ratio = Net profit________Annual Preference dividend

11) Overall profitability ratio = Operating profit * 100

Capital employed

12) Productivity of assets employed = Net profit .Total tangible asset

13) Retained earnings ratio = Retained earnings * 100Total earnings

H) General Remarks: -

Fall in quick ratio when compared with last year or other company is due to hugestock piling up.

If current ratio and liquidity ratio increases then the liquidity position of the companyhas been increased.

If debt equity ratio increases over a period of time or is greater when comparing tworatios, then the dependence of the company in borrowed funds has increased.

Direct expenses ratio increases in comparison then the profitability decreases. If there is wages / Sales ratio increases, then this is to verified

a) Wage rateb) Output / Labour rate

Increment in wage rate may be due to increased rate or fall in labour efficiency. Again there are many reasons for fall in labour productivity namely abnormal idle

time due to machine failure, power cut etc. Reduction in Raw material consumed / sales ratio may be due to reduction in

wastage or fall in material price. Increase in production expenses ratio may also be due to price raise. Stock turnover ratio denotes how many days we are holding stock. In stock turnover ratio greater the number of days, the movement of goods will be

on the lower side. Financial ratios are Current ratio, Quick ratio, Debt equity ratio, Proprietary ratio,

Fixed asset ratio. Short term solvency ratios are current ratio, Liquidity ratio Long term solvency or testing solvency of the company ratios are Debt equity ratio,

fixed asset ratio, fixed charges coverage ratio (or) Interest coverage ratio. To compute financial position of the business ratios to be calculated are current

ratio, Debt equity ratio, Proprietary ratio, fixed asset ratio. Fictitious asset are Preliminary expenses, Discount on issue of shares and

debentures, Profit and loss account debit balance.

Complete Glossory

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