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Advantages and Limitations of Ratio Analysis

Advantages and Limitations of Ratio Analysis
What are the advantages and limitations of ratio analysis? Advantages: It is an important and useful tool to determine the efficiency with which working capital is being managed in a business organization. It is a ‘health test‘ for a business firm in that it can gauge whether the firm is financially healthy or not. It aids the management of business concern in evaluating its financial position and performance efficiency. It clearly shows the trend of changes in the market position (upward, downward or static), as it covers a number of previous accounting (financial) periods. The progress or downfall of a firm is clearly indicated by this analysis. It assists in preparing financial estimates for the future (financial forecasting). It facilitates the task of managerial control to a great extent. It helps the credit suppliers and investors in deciding upon a business firm as a potential investment outlet or desirable debtor. Ideal or Standard ratios can be established which can be used as reference points of comparison for a firm’s progress over a period of time. It communicates important information with relation to financial strength, earning capacity, debt (borrowing) capacity, liquidity position, capacity to meet fixed commitments, solvency, capital gearing, working capital management, future prospects etc. of a business concern. This analysis is also useful for bench marking purpose- to compare the working result and efficiency of performance of a business enterprise with that of other firms engaged in the same industry (inter-firm comparison). It helps the management to discharge their basic functions of planning, coordinating, controlling etc. It serves as an instrument for testing management efficiency too. It acts as a useful tool for deciding on certain policy matters. Limitations: Accounting ratios calculated based on ratio analysis will be correct only if the accounting data on which they are based are correct. It is only an analysis of past financial data. In certain cases ratio analysis might prove to be misleading with regard to profits. Continuous fluctuation in price levels ( or, purchasing power of money) seriously affect the validity or comparison of accounting ratios calculated for different accounting periods and make such comparisons very difficult. Comparisons become difficult also on account of difference in the definition of several financial (accounting) terms like gross profit, operating profit, net profit etc. There is lot of diversity in practice as regards to the measurement of ratios. Different firms use different accounting methods and the validity of comparison is severely affected by window dressing in the basic financial statements. A single ratio will not be able to convey much information. This analysis only gives part of the total information required for proper decision-making. This should not be taken as a substitute for sound judgement.  It should not be overlooked that business problems cannot be solved mechanically through ratio analysis or other types of financial analysis. Follow ManagementGuru Net’s board Accounting – Financial and Management Accounting on...
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How to Calculate Gross Profit

How to Calculate Gross Profit
Gross Profit  It is a required income statement entry that indicates total revenue minus cost of goods sold. It is the company’s profit before operating expenses, interest payment and taxes. It is also known as GROSS MARGIN. The gross profit on a product is computed as: Net Sales – Cost of Goods Sold (COGS) This concept is well understood if you are able to clearly distinguish between variable and fixed costs. VARIABLE COSTS: Materials used Direct labor Packaging Freight Plant supervisor salaries Utilities for a plant or a warehouse Depreciation expense on production equipment Machinery  FIXED COSTS: Fixed costs generally are more static in nature. They include: Office expenses such as supplies, utilities, a telephone for the office, etc. Salaries and wages of office staff, salespeople, officers and owners Payroll taxes and employee benefits Advertising, promotional and other sales expenses Insurance Auto expenses for salespeople Professional fees Rent  Variable expenses are logged as cost of goods sold. Fixed expenses are counted as operating expenses (sometimes called selling and general administrative expenses). While gross profit is a monetary entity, the margin is expressed as a percentage. It’s equally significant to track since it allows you to keep an eye on profitability trends. Gross Profit Ratio = Gross Profit / Net Sales The gross profit margin is computed as follows: When the ratio is expressed in percentage form, it is known as gross profit margin or percentage. Gross Profit / Net Sales *100 = Gross Profit Margin It is equal to the net sales minus cost of goods sold and net sales are equal to total gross sales less return inwards and discount allowed. Benefits of calculating gross profit: This ratio determines how efficiently the management utilizes labor and raw materials A company uses its gross income to fund activities such as research and development, marketing etc., which are vital for generating future sales. A prolonged decline in this margin is a cleat-cut indication of sales drop-down and ultimately earnings. Trends in this margin reflect basic pricing decisions and material costs of a company. This profit margin is an accounting measure designed to estimate the financial health of a business or industry. It may be noted that generating a profit margin alone cannot vouch for the financial health of a firm; rather the business must have sufficient cash flow in order to pay its bills and compensate employees. An entrepreneur might compare the return that would be available from a bank or another low-risk investment opportunity to that of his EXISTING profit-margin to gauge whether his startup is doing well. → Profitability...
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What Does a Career in Accounting Demands for?

What Does a Career in Accounting Demands for?
What Does a Career in Accounting Demands for? Are you vying for a career in accounting field? Everybody envy accountants for there is a misconception that they are Demi-Gods. Though a good accounts manager can act like one who can save you from a dire situation by manipulating the accounts skilfully, the demands and challenges in this field are too high to be savored. Purchase Your Copy of “Careers with a Degree in Accountancy and Finance” at Gumroad  So what does it take to become a reputed accounts man in your circle and also enjoy what you do! Self analysis is the best way to understand what you really want to be. There are certain traits characteristic to people belonging to this community. See if you are gifted with those attributes; if not, you can always train yourself to gain expertise. 1. Are you good at numbers– Mathematics, Yuck! If this is your reaction please quit reading this article as numbers play an integral role in accountancy. Figures, Figures and more Figures determine the profit and loss status of a company. If you are passionate about playing with numbers it goes without saying you are already a half accountant. The thrill of taking control and handling numbers make or break a company. Jackie Mansion jocularly puts it – “Did you ever hear of a kid playing accountant – even if they wanted to be one?” 2. Are you a good listener and can you read between the lines? A good auditor will allow the client to talk and listen to what he says. Then he tries to extract the exact kind of information he needs to make the ends meet. Empathy is an innate quality and if you are not going to be a good listener then please revise your consideration of becoming an accountant. Sometimes the client may not know what you wish to seek; it is your responsibility to frame simple questions in a language that he understands and pull out answers. 3. Can you avoid being temperamental? 90% of the time your clients are going to say “No” to whatever you suggest. Alas, it is not their fault; the corporate Bosses and CEO’s always aim big and most probably will not be aware of the consequences of their impulsive actions. They always think about clinching a deal and conveniently overlook the effects of their financial and corporate decisions on the account and subsequently on the accountant. For example cash has to be handled very carefully and every penny has to be accounted for properly.  A bank cashier will know the importance of cash handling as it is very important for them to balance the inflow and outflow at the end of the day. For corporate firms, it becomes mandatory to reduce the cash dealings and account every transaction in the form of a check or electronic transfers like RTGS or NEFT or EFT. The point is, you should have the nerve to talk to a company’s head if he is planning for a bad move and suggest what could be done for the good of the company (Income tax and Sales purposes). 4. Are you wise when it comes to choosing clients? Whether you are a part time practitioner, Full time accountant, Accounts manager or Free lancer, do your homework before accepting the offer. Ultimately you need to see your payments coming through and nobody works here for a song. Big practitioners take a big cut half yearly or annually but if you are a part time accountant, it is always better to go for monthly payments or get paid after the completion of individual project s....
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Capital Budgeting and Capital Accounting Systems

Capital Budgeting and Capital Accounting Systems
Capital Budgeting and Capital Accounting Systems  These internal accounting systems facilitate and support decision-makers in assessing potential investments with respect to cost effectiveness. The purpose of capital accounting systems support decision-makers in monitoring and planning liquidity. What is Capital Budgeting? Capital budgeting is the planning process used to determine whether an organization’s long term investments such as new machinery, replacement machinery, new plants, new products, and research development projects are worth the funding of cash through the firm’s capitalization structure. Capital budgeting systems is a framework that support management in making decisions in the context of capital investment decisions. In particular, capital budgeting systems help to determine whether or not a capital investment will earn back the original expenditure  and in addition provide a reasonable return. This type of decisions usually entails large amounts of organizational resources at risk and, at the same time, affects the future development of the organization . Capital budgeting systems usually focus on capital investment decisions that cover many years. This discriminates capital budgeting systems from income determination and planning which usually focus on the current period. Capital investment decisions usually encompass cash inflows and outflows that accrue at different points in time which are usually answered by adding accrued interest of discounting of cash-flows. Capital budgeting process consists of six steps: Project Generation Estimation Of Cash-Flows Progress Through The Organization Analysis And Selection Of Projects Authorization Of Expenditures And Post-Audit Investigations.  In the step of (1) project generation, potential investments are chosen for which in step (2) potential cash-flows are estimated. In step (3), i.e., progress through the organization,  certain projects require approval of top-management. In step (4),  analysis and selection of projects, the selected projects are assessed with respect to the fact that cash inflows and outflows usually realize at different points in time. In Step (5), authorization of expenditures, captures the final decision (usually made by top management) on whether or not to invest into the selected project. Finally, in step (6) captures a post-audit investigation, i.e., after a certain period of time actual results might be gained which potentially provide input for control purposes. Capital budgeting systems particularly support management in step (4), i.e., the analysis and selection of projects. Capital accounting systems support management in planning and controlling liquidity. Courtesy: S. Leitner, Information Quality and Management Accounting, Lecture Notes in Economics and Mathematical...
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What are Source Documents

What are Source Documents
What are the Various Source Documents in Accounting? What is meant by source document? A source document is one used to record the transactions in the books of account. These documents stand as evidence for business transactions. These include Cash Memo Invoice Receipt Debit Note Credit Note Voucher Pay in Slip Cheque etc. 1. Cash Memo: When goods are sold or purchased for cash, the firm gives or receives cash memos with details regarding cash transactions. These documents become the basis for recording these transactions in the books of accounts. 2. Invoice: Invoice is prepared when goods are sold or purchased on credit. It contains the name of the party, quantity, price per unit and the total amount payable. The original copy is sent to the buyer and the duplicate copy is kept as proof of sale and for future reference. Types of Invoice: Inland Invoice – An invoice which is used in internal trade transaction is called as an Inland Invoice. When the goods are sold within a country, the invoice relating to such a transaction is called as an Inland Invoice. Foreign Invoice – An invoice which is prepared for covering an international trade transaction is called as a Foreign Invoice. A number of copies are prepared, maybe even 10 to 12, because a number of authorities require it. Inward Invoice – Inward invoice is received by the buyer from the seller, on receipt of invoice; the buyer stamps it with date of receipt. The inward invoice number is entered in the purchase journal. Outward Invoice – Outward Invoice is a seller’s bill. An invoice which is inward to the buyer is an outward for a seller. It is called outward invoice, because it is sent to the buyer. At least one copy of the invoice is retained by the seller for necessary action and reference. Proforma Invoice – Proforma Invoice is not a real invoice. It is prepared to give a clear idea regarding the amount that would be paid by the buyer if he places an order. This is prepared at the request of the buyer. 3. Receipt: When a firm receives cash from a customer it issues a receipt as a proof of receiving cash. The original copy is handed over to the party making payment and the duplicate is kept for future reference. This document contains date, amount, name of the party and the nature of payment. 5 Kinds of Receipts Small Businesses Should Take Extra Care to Keep Meal & Entertainment Receipts Receipts from Out of Town Business Travels Vehicle Related Receipts Receipts for Gifts Home Office Receipts 4 & 5. Debit and Credit Notes: These are prepared when goods are returned to supplier or when an additional amount is recoverable from a customer. When the purchaser returns the goods to the seller the Purchaser sends a Debit Note to the seller (i.e. the purchaser debits the seller in his books. Purchasers Books) and the Seller sends a Credit Note to the purchaser (i.e. the seller credits the Purchaser in his Books. Sellers Books). Following are the JVs to be passed:- Sales Return inward A/c     Dr.     To Debtor A/c (Being goods returned by the customer) Creditor A/c          Dr.    To Goods Return A/c  (Being goods sent back to the seller) 6. Voucher: It is a written document in support of a transaction. It is a proof of a particular transaction taking place for the value stated in the voucher. This is necessary to audit the account. In book keeping, voucher is the first document to record an entry. Normally three types of vouchers are used. Receipt voucher  Payment voucher  Journal voucher RECEIPT VOUCHER Receipt voucher...
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