with 3.

32 CGPA
Tulsiramji Gaikwad-Patil College of Engineering and Technology
Wardha Road, Nagpur-441 108
NAAC Accredited A+
Approved by AICTE, New Delhi, Govt. of Maharashtra & Affiliated to RTM Nagpur
University, Nagpur

Department of Mechanical Engineering

Name of Subject: - Industrial Management Subject Code:- BEME801T

Unit - IV Semester: - VIII

Syllabus: -
Financial management: Sources of finance, financing organizations, types of capital, elements of
costs & allocation of indirect expenses, cost control, break even analysis, budgets & budgetary
control, equipment replacement policy, make or buy analysis, balance sheet, ratio analysis, profit &
loss statement.

Course Outcome (CO):-

Examine the financial management for different sources of generating the finance.

Learning Outcomes (LOs):-

1. Describe the concept sources of finance and types of capital

2. Illustrate the objective costs & allocation of indirect expenses, cost control

3. Explain make or buy analysis, balance sheet, ratio analysis and profit & loss
statement.

4. Elaborate the budgets & budgetary control, equipment replacement policy, make
or buy analysis
1. What is financial management? Discuss the objectives and importance of
financial management.

Ans: In the words of John J. Hampton, the term finance can be defined as the
management of the flows of money through an organization, whether it will be a
corporation, school, bank or government agency.

Definition of Finance According to F.W.Paish, Finance may be defined as the

position of money at the time it is wanted.

According to Howard and Upton, “finance may be defined as that administrative area or
set of administrative functions in an organization which relates with the
arrangement of each and credit so that the organization may have the means to
carry out the objectives as satisfactorily as possible.

In the words of Bonneville and Dewey, Financing consists in the raising,

providing, managing of all the money, capital or funds of any kind to be used in
connection with the business.

Objectives of Financial Management

1. To ensure regular and adequate supply of funds to the concern.
2. To ensure adequate returns to the shareholders (Stocks and share) this will
depend upon the earning capacity, market price of the share, expectations
of the shareholders.
3. To ensure optimum funds utilization. Once the funds are procured, they
should be utilized in maximum possible way at least cost.
4. To ensure safety on investment, i.e., funds should be invested in safe
ventures so that adequate rate of return can be achieved.
5. To plan a sound capital structure: There should be sound and fair
composition of capital so that a balance is maintained between debt and
equity capital (investment in business).
6. Wealth Maximization: The one of the most important objective of
financial managers is to maximize the value of shares of their
shareholders.
7. Profit Maximization

Function of financial management can be divided into two categories:

a) Executive Finance Functions:

The finance manager takes important financial decisions by his experience,

expertise, capability and qualifications. The decision taken will have long term
financial implications in the present as well as future of the firm. Some of the
important executive functions of financial management are as follows:

1. Investment Decision/Capital Budgeting Decision (amount invested in

business):

This involves the decision of allocation of capital or commitment of fund to long

term asset which would yield benefits in the future. One of its main tasks is
measuring the prospective profitability of new investment. The investment
decision determines the total amount of assets held by the firm, the composition
of these assets, and the business risk complexion of the firm as perceived by the
supplier of capital. The essence of investment decision is that return from the
investment would exceed the firms required rate of return on capital.
Asset: value-benefit-future/ company own and control / not in intention of sales
Expense: value-benefit-already taken
2. Financing Decision:

This is the second important function to be performed by financial manager.

He/She must decide when, where and how to acquire funds to meet the firm’s
investment needs. The firm must maintain an optimal mix of equity and debt
capital, also known as capital structure. The firm’s capital structure is said to be
optimum when market value of shares is maximized.

Equity = Assets – Liabilities (bank loan)

 Time –> Asset (increases) –> Equity (increases)

 Time –> Liabilities (increases: more bank loan) –> Equity (decreases)
3. Dividend Decision (Part of profit given to shareholders):

The financial manager should make a sound dividend policy that determines
whether the firm should distribute dividend or not. If the firm should distribute
dividend, then how much should be distributed. Since, the optimal dividend
policy maximizes the value of the firm, it is one of the important aspects of
decision making.

4. Liquidity Decision:

Liquidity is defined as the ability of a firm to make its short term obligations. The
management of current assets affects the liquidity of the firm. Hence, current
assets should be managed efficiently for safeguarding the firm against the danger
of illiquidity and insolvency.

There is always conflict between profitability and liquidity while managing

current assets. If a firm does invest sufficient funds in current assets, it may
become illiquid whereas it would lose profitability as idle current assets would
not earn anything. Therefore, the finance manager should estimate the firm’s needs
for current assets and make sure that funds would be made available when needed.

5. Financial Forecasting:

Financial Forecasting includes the estimation of financial requirement and

development of finance structure. The finance manager should ensure adequate
availability of cash for the smooth operation of the firm. Therefore, forecasting
should also be made regarding the technical changes, situation of capital market,
funds necessary for investment, returns from proposed investment projects, and
the demand for the firm’s product.

6. Analysis and appraisal of financial performance:

The financial manager should perform various financial analysis in order to

appraise the finance performance of the business such as ratio analysis, funds
flow analysis, break-even analysis, trend analysis, etc.

7. Advising to the top level Management:

Another important function of finance manager is to advise the top level

management about the financial position of the firm. He should provide advice on
some crucial financial problems by giving the comparative study of different
financial alternatives.

8. Procurement of fund:

The finance manager should try to find out the sources of fund and procure them.
He should decide how much fund should be raised from different sources through
detailed financial planning.

9. Allocation of fund to all parts of Organization:

It includes the proper allocation of funds to the different departments in

accordance with their need.

10. Pricing:

Pricing is a crucial part of decision making. If the goods and services were priced
lower priced, then the firm would find difficulty in covering its operating cost.
The firm would lose competitive strength if priced excessively. Hence, the
finance manager should evaluate the impact of pricing policy on profitability.
This helps to determine the price of the firm’s product in a reasonable way.

11. Control:

The finance manager should have the centralized control over the firm’s activities.
For this, he should interact with other executives. This ensures the efficient
operation of the firm.

b) Routine Functions:

This includes those functions which are performed by lower-level employee.

These functions help management to take important decisions. These functions
include:
 Supervision of cash flows and protection of cash balance.
 Protection and safety of financial documents
  Recording, keeping and reporting.
 Preservation of accounting document.
 Preparing financial statements.
 Management of credit.
 Disbursement (pay loan) and collection of credit.
 Making incentive schemes such as insurance and pension.
 Management of payroll (salary list), tax-related matters, inventory, fixed
assets, computer operators, etc.
1. Explain the function of financial management
Ans: The finance functions are divided into long term and short term
functions/decisions Long term Finance Function Decisions.
(a) Investment decisions (I):
 These decisions relate to the selection of assets in which funds will be invested
by a firm.
 Funds procured from different sources have to be invested in various kinds of
assets. Long term funds are used in a project for various fixed assets and also for
current assets.
 The investment of funds in a project has to be made after careful assessment of
the various projects through capital budgeting.
 A part of long term funds is also to be kept for financing the working capital
requirements. Asset management policies are to be laid down regarding various
items of current assets.
 The inventory policy would be determined by the production manager and the
finance manager keeping in view the requirement of production and the future
price estimates of raw materials and the availability of funds.
(b) Financing decisions (F):
 These decisions relate to acquiring the optimum finance to meet financial
objectives and seeing that fixed and working capital effectively managed.
 The financial manager needs to possess a good knowledge of the sources of
available funds and their respective costs and needs to ensure that the company
has a sound capital structure, i.e. a proper balance between equity capital and
debt.
 Such managers also need to have a very clear understanding as to the difference
between profit and cash flow, bearing in mind that profit is of little avail unless
the organization is adequately supported by cash to pay for assets and sustain
the working capital cycle.
 Financing decisions also call for a good knowledge of evaluation of risk, e.g.
excessive debt carried high risk for an organization’s equity because of the
priority rights of the lenders.
 A major area for risk-related decisions is in overseas trading, where an
organization is vulnerable to currency fluctuations, and the manager must be
well aware of the various protective procedures such as hedging (it is a strategy
 designed to minimize, reduce or cancel out the risk in another investment)
available to him. For example, someone who has a shop, takes care of the risk of
the goods being destroyed by fire by hedging it via a fire insurance contract.
(c) Dividend decisions(D):
 These decisions relate to the determination as to how much and how frequently
cash can be paid out of the profits of an organization as income for its
owners/shareholders.
 The owner of any profit making organization looks for reward for his
investment in two ways, the growth of the capital invested and the cash paid out
as income; for a sole trader this income would be termed as drawings and for a
limited liability company the term is dividends.
 The dividend decision thus has two elements – the amount to be paid out and the
amount to be retained to support the growth of the organization, the latter being
also a financing decision; the level and regular growth of dividends represent a
significant factor in determining a profit-making company’s market value, i.e.
the value placed on its shares by the stock market.
 All three types of decisions are interrelated, the first two pertaining to any kind
of organization while the third relates only to profit-making organizations, thus
it can be seen that financial management is of vital importance at every level of
business activity, from a sole trader to the largest multinational corporation.

Short- term Finance Decisions/Function.

Working capital Management (WCM): Generally short term decision are
reduced to management of current asset and current liability (i.e., working
capital Management)

2. Explain the executive function of financial management

Ans: Modern financial management has come a long way from the traditional
corporate finance. As the economy is opening up and global resources are being
tapped, the opportunities available to finance managers virtually have no limits. A
new era has ushered during the recent years for chief financial officers in different
organization to finance executive is known in different name, however their role
and functions are similar. His role assumes significance in the present day context
of liberalization, deregulation and globalization

To sum it up, the finance executive of an organization plays an important role in

the company’s goals, policies, and financial success. His responsibilities include:
(a) Financial analysis and planning: Determining the proper amount of funds to
employ in the firm, i.e. designating the size of the firm and its rate of growth.
(b) Investment decisions: The efficient allocation of funds to specific assets.
(c) Financing and capital structure decisions: Raising funds on favorable terms
as possible i.e. determining the composition of liabilities.
(d) Management of financial resources (such as working capital).
(e) Risk management: Protecting assets.
The figure below shows how the finance function in a large organization may be
organized.

Role of Finance executive in today’s World vis-a-vis in the past

Today, the role of chief financial officer, or CFO, is no longer confined to
accounting, financial reporting and risk management. It’s about being a strategic
business partner of the chief executive officer, or CEO. Some of the key
differences that highlight the changing role of a CFO are as follows:-
 3. What do you mean by financial statements?
Ans: Financial statements are a collection of summary-level reports about an
organization's financial results, financial position, and cash flows. They include the
income statement, balance sheet, and statement of cash flows.

Advantages of Financial Statements

Financial Statements are useful for the following reasons:

 To determine the ability of a business to generate cash, and the sources and
uses of that cash.
 To determine whether a business has the capability to pay back its debts.
 To track financial results on a trend line to spot any looming profitability
issues.
 To derive financial ratios from the statements that can indicate the
condition of the business.
 To investigate the details of certain business transactions, as outlined in the
disclosures that accompany the statements.
 To use as the basis for an annual report, which is distributed to a company’s
investors and the investment community.
Importance of Financial Statement
The significance of financial statements prevails in their service to persuade the
diverse interests of distinct classes of parties such as creditors, public,
management, etc.,

Importance to Management: Increase in size and intricacies of aspects

influencing the business functions requires scientific and strategic access in the
management of contemporary trading concerns. The management team needs up to
date, precise and methodical financial data for the intentions. Financial statements
assist the management in comprehending the progress, prospects, and position of
the business counterpart in the industry.
Importance to the Shareholders: Management is detached from control in the
case of companies. Shareholders cannot take part in the day-to-day business
pursuits. However, the outcome of these pursuits should be disclosed to
shareholders during the annual general body meeting in the form of financial
statements.

Uses of Financial Statements

Following are some of the uses of financial statements:
1. Determine the financial position of the business: The most important use of the
financial statements is to provide information about the financial position of the
business on a given date. This piece of information is used by various stakeholders
in order to take important decisions regarding the business.
2. To obtain credit: Financial statements present the picture of the business to the
potential lenders and this information can be used by them to provide additional
credit for business expansion or restrict the credit so as to start recovery.
3. Helps investors in decision making: Financial statements contain all the essential
information required by the potential investors for determining how much they
want to invest in the business. It is also helpful in decision making regarding the
 price per share that the investors want to invest. A sound financial statement is the
key to obtaining investments.
4. Helps in policy making: The financial statements help the government in deciding
the taxation and regulations policies based on the way the company is running its
operations. The government bodies can tax a business based on the level of their
income and assets.
5. Useful for stock traders: Financials statements help stock traders with the
knowledge of the situation the company is in and therefore adjusting their quotes
accordingly.

4. What is costing? What are the elements of costing? Method of Costing?

Ans: Costing is defined as the method and process of ascertaining the costs. Its
main objectives are Ascertainment of costs. It is basically cost per unit which is
one of the main functions of cost accounting. In case of every economic activity in
order to measure and expressed in identifiable units for costing purpose, certain
units are explained as:
(i) Unit of product
(ii) Unit of time
(iii) Unit of weight
(iv) Unit of measurement
(v) Operating unit of service

So, cost unit is the unit of product, service or time in terms of which cost is
ascertained or
expressed. But the selection of cost unit must be proper and appropriate. It is seen
that an
ideal cost unit should be
(a) Suitable for cost ascertainment
(b) Easier to associate expenses
(c) In accordance to the nature and practice of business.

Example of Costing
When it comes to recording the costs, it’s done according to the purpose and the
reason for the cost. For instance, when there is a record of the cost of purchase
inventory it is booked under the account of cost of goods sold when a sale of the
goods are made. When you record costs that are necessary for the organization,
which includes rent, salary, and more, it is recorded as a selling expense and it is
added in the multi-step income statement.
 Elements of Cost Accounting
In Accounting, a cost is composed of three elements –
 Material
 Labor
 Expenses
The above three elements can either be direct and indirect cost.

Thus, to understand the elements of cost we need to learn them vividly.

 Direct Materials:
As there will be only one product and the process of manufacture is simple, the
raw material if any is directly charged to the production of the period in total cost.

 Labor:
The labor costs are collected periodically on a regular basis through pay rolls
which are prepared separately for each work department.

 Chargeable Expenses:
Expenses other than material and labor are chargeable expenses like excise duty,
royalty, expenses on designs, patterns and models.

Overhead – Another Element of Cost

Overhead consists of all the indirect costs. Overhead is also known as the on-cost,
supplementary cost, burden cost etc.
Overhead consists of three elements:
1. Indirect materials
2. Indirect labor
3. Indirect expenses
 Indirect materials – These materials cannot be conveniently identified with the
individual cost units. They are generally of minor importance. Examples of indirect
materials are - coal, lubricating oil, sand paper, soap, etc.
 Indirect labor –This cannot be identified with a particular cost unit. Indirect labor
is not engaged in the production process directly but only this is indirectly and this
assists in the production operations. Examples of indirect labor are peon,
supervisor, clerk, watchman etc.
 Indirect expenses – All kinds of indirect costs, other than the indirect materials
and indirect labor costs, are termed as indirect expenses. This cost cannot be
directly identified with a particular job, process or identified with work order and
is common to cost units and cost centers. Examples of Indirect expenses - rent and
rates, insurance, depreciation, power and lighting, cartage, advertising.

Cost Center in Cost Accounting

A cost center is a department or function within an organization which does not
directly add to the profit but still incurs costs the organization money to operate
effectively. Cost centers merely contribute to a company's profitability indirectly.
Managers of cost centers, like human resources and accounting departments. They
are responsible for keeping their cost line low budget.

Thus, to sum up:

 A cost center is a function within an organization which does not directly add to
the profit but still costs money to operate, like working in the accounting, HR, or
IT departments.
 The main use of a cost center is to track the actual expenses for comparison to the
budget.
 A cost center indirectly contributes to a company’s profit professing in operational
excellence, customer service, with enhanced product value.
 The manager is only responsible for keeping the costs in line with the budget and
who does not bear any responsibility regarding the revenue or in investment
decisions.
 Whatever operations that take place in cost’s center, they don’t get displayed in the
company’s profit. However, services, such as customer service enhance the overall
value of the company

Different Methods of Costing

 Unit costing: This method is also known as "single output costing."

This method of costing is used for products that can be expressed in
identical quantitative units. Unit costing is suitable for products that
are manufactured by continuous manufacturing activity: for example,
mining, cement manufacturing, dairy operations, or flour mills. Costs
are ascertained for convenient units of output.

 Job costing: Under this method, costs are ascertained for each work
order separately as each job has its own specifications and scope. Job
costing is used, for example, in painting, car repair, decoration, and
building repair.
 Contract costing: Contract costing is performed for big jobs
involving heavy expenditure, long periods of time, and often
different work sites. Each contract is treated as a separate unit for
costing. This is also known as terminal costing. Projects requiring
contract costing include construction of bridges, roads, and
buildings.

 Batch costing: This method of costing is used where units produced

in a batch are uniform in nature and design. For the purpose of
costing, each batch is treated as an individual job or separate unit.
Industries like bakeries and pharmaceuticals usually use the batch
costing method.

 Operating costing or service costing: Operating or service costing

is used to ascertain the cost of particular service-oriented units, such
as nursing homes, busses, or railways. Each particular service is
treated as a separate unit in operating costing. In the case of a
nursing home, a unit is treated as the cost of a bed per day, while, for
busses, operating cost for a kilometre is treated as a unit.

 Process costing: This kind of costing is used for products that go

through different processes. For example, the manufacturing of
clothes involves several processes. The first process is spinning. The
output of that spinning process, yarn, is a finished product which can
either be sold on the market to weavers, or used as a raw material for
a weaving process in the same manufacturing unit. To find out the
cost of the yarn, one needs to determine the cost of the spinning
process. In the second step, the output of the weaving process, cloth,
can also be sold as a finished product in the market. In this case, the
cost of cloth needs to be evaluated. The third process is converting
the cloth to a finished product, for example a shirt or pair of trousers.
Each process that can result in either a finished good or a raw
material for the next process must be evaluated separately. In such
multi-process industries, process costing is used to ascertain the cost
at each stage of production.

 Multiple costing or composite costing: When the output is

comprised of many assembled parts or components, as with
television, motor cars, or electronics gadgets, costs have to be
ascertained for each component, as well as with the finished product.
Such costing may involve different methods of costing for different
components. Therefore, this type of costing is known as composite
costing or multiple costing.
  Uniform costing: This is not a separate method of costing, but rather
a system in which a number of firms in the same industry use the
same method of costing, using agreed-on principles and standard
accounting practices. This helps in setting the price of the product
and in inter-firm comparisons. (Apple: Standards and quality)

5. Explain
A. Profit & loss statement.

A profit and loss statement (P&L), or income statement or statement of operations,

is a financial report that provides a summary of a company’s revenues, expenses,
and profits/losses over a given period of time. The P&L statement shows a
company’s ability to generate sales, manage expenses, and create profits. It is
prepared based on accounting principles that include revenue recognition,
matching, and accruals, which makes it different from the cash flow statement.

Types of Profit and Loss (P&L) Statements

Cash method
The cash method, which is also called the cash accounting method, is only used
when cash goes in and out of the business. This is a very simple method that only
accounts for cash received or paid. A business records transactions as revenue
whenever cash is received and as liabilities whenever cash is used to pay any bills
or liabilities. This method is commonly used by smaller companies as well as
people who want to manage their personal finances.3
Accrual method
The accrual accounting method records revenue as it is earned. This means that a
company using the accrual method accounts for money that it expects to receive in
the future. For instance, a company that delivers a product or service to its
customer records the revenue on its P&L statement, even though it hasn’t yet
received payment. Similarly, liabilities are accounted for even when the company
hasn’t yet paid for any expenses.
B. Balance sheet & its contents.
Ans: The financial statements generally include two statements: balance
sheet and statement of profit and loss which are required for external
reporting and also for internal needs of the management like planning,
decision-making and control. Apart from these, there is also a need to know
about movements of funds and changes in the financial position of the
company.
For this purpose, a cash flow statement is prepard. Every company
registered under The Companies Act 2013 shall prepare its balance sheet,
statement of profit and loss and notes to account thereto in accordance with
the manner prescribed in the revised Schedule III to the Companies Act,
2013 to harmonise the disclosure requirement with the accounting
standards and to converge with new reforms.
 Important Features of Balance Sheet

1. It applies to all Indian companies preparing financial statement as per Schedule

III to the Comapnies Act, 2013.
2. It does not apply to (i) Insurance or Banking Company, (ii) Company for which a
form of balance sheet or income statement is specified under any other Act.
3. Accounting standards shall prevail over Schedule III of the Companies Act, 2013.
4. Disclosure on the face of the financial statements or in the notes are essential and
mandatory.
5.Terms in the revised Schedule III will carry the meaning as defined by the
applicable accounting standards.
6. Balance to be maintained between excessive details that may not assist users of
financial statements and not providing important information.
7. Current and non-current bifurcation of assets and liabilities is applicable.

6. What is ratio analysis? Explain its types.

Ans: Ratio analysis is a quantitative method of gaining insight into a company's
liquidity, operational efficiency, and profitability by studying its financial
statements such as the balance sheet and income statement. Ratio analysis is a
cornerstone of fundamental equity analysis.

 Ratio analysis compares line-item data from a company's financial statements to

reveal insights regarding profitability, liquidity, operational efficiency, and
solvency.
 Ratio analysis can mark how a company is performing over time, while comparing
a company to another within the same industry or sector.
 Ratio analysis may also be required by external parties that set benchmarks often
tied to risk.
 While ratios offer useful insight into a company, they should be paired with other
metrics, to obtain a broader picture of a company's financial health.
 Examples of ratio analysis include current ratio, gross profit margin ratio,
inventory turnover ratio.

Types of Ratio Analysis

The various kinds of financial ratios available may be broadly grouped into the following
six silos, based on the sets of data they provide:

1. Liquidity Ratios
Liquidity ratios measure a company's ability to pay off its short-term debts as they
become due, using the company's current or quick assets. Liquidity ratios include the
current ratio, quick ratio, and working capital ratio.
2. Solvency Ratios
Also called financial leverage ratios, solvency ratios compare a company's debt levels
with its assets, equity, and earnings, to evaluate the likelihood of a company staying
afloat over the long haul, by paying off its long-term debt as well as the interest on its
debt. Examples of solvency ratios include: debt-equity ratios, debt-assets ratios, and
interest coverage ratios.

3. Profitability Ratios
These ratios convey how well a company can generate profits from its operations. Profit
margin, return on assets, return on equity, return on capital employed, and gross margin
ratios are all examples of profitability ratios.

4. Efficiency Ratios
Also called activity ratios, efficiency ratios evaluate how efficiently a company uses its
assets and liabilities to generate sales and maximize profits. Key efficiency ratios include:
turnover ratio, inventory turnover, and days' sales in inventory.

5. Coverage Ratios
Coverage ratios measure a company's ability to make the interest payments and other
obligations associated with its debts. Examples include the times interest earned ratio and
the debt-service coverage ratio.

6. Market Prospect Ratios

These are the most commonly used ratios in fundamental analysis. They include dividend
yield, P/E ratio, earnings per share (EPS), and dividend payout ratio. Investors use these
metrics to predict earnings and future performance.

For example, if the average P/E ratio of all companies in the S&P 500 index is 20, and the
majority of companies have P/Es between 15 and 25, a stock with a P/E ratio of seven
would be considered undervalued. In contrast, one with a P/E ratio of 50 would be
considered overvalued. The former may trend upwards in the future, while the latter may
trend downwards until each aligns with its intrinsic value.

7. What are the various types of capital. Explain any two in brief.
Ans: Finance may be obtained by borrowing from an Insurance
company, Investment company, Industrial development corporation, etc.

Capital required for a business can be classified under two main

categories
(i) Fixed Capital, and ii) Working Capital.

 Every business needs funds for two purposes-for its establishment and to
carry out its day-to-day operations.
 Long-term funds are required to create production facilities through
purchase of fixed assets such as plant and machinery, land, building,
furniture, etc.
 Investments in these assets represent that part of firm’s capital which is
blocked on a permanent or fixed basis and is called fixed capital.
  Funds are also needed for short-term purposes for the purchase of raw
materials, payment of wages and other day-to-day expenses, etc. These funds are
known as working capital.

 In simple words, working capital refers to that part of the firm’s capital which
is required for financing short term or current assets such as cash, marketable
securities, debtors and inventories. (Retailer: Producer delay and consumer delay)

 Funds, thus, invested in current assets keep revolving fast and are being
constantly converted into cash and these cash flows out again in exchange for
other current assets. Hence, it is also known as revolving or circulating capital or
short-term capital.

 In the words of Shubin, “Working capital is the amount of funds necessary to

cover the cost of operating the enterprise.”

 According to Genestenberg, “Circulating capital means current assets of a

company that are changed in the ordinary course of business from one form to
another, as for example, from cash to inventories, inventories to receivables,
receivables into cash.”

TYPES OF WORKING CAPITAL

There are two concepts of working capital:

(i) Gross concept, and
(ii) Net concept.

(i) Gross Concept of Working Capital:

 The gross working capital refers to the total fund invested in (total) current
assets.
 Current assets are those assets which are easily converted into cash within a
time period of one year.
 It includes cash in hand and at bank, short term securities, debtors, bills
receivable, prepaid expenses, accrued expenses and inventories like raw materials,
work-in- progress, stores and spare parts, finished goods.
 The gross concept of working capital refers to the firm’s investment in above
current assets.
 Amount of current assets that a business firm has to maintain for its day to
day operations

 Example: Stocks of retail shops = current assets (that can be converted into
cash within one operating cycle or max. One year = working capital of retail shop
 Current assets: cash, bank balance, stock and inventories (raw material, stock
in process, finished goods)
 Retail shops: Computers for accounting of shop are not current assets
(ii) Net Concept of Working Capital:

 The term net working capital refers to the excess of current assets over
current liabilities.
 In other words, the amount of current assets that would remain in a firm
after all its
current liabilities are paid.
 Current liabilities are those claims of outsiders to the business enterprise
which are payable within a period of one year, and include bills payable,
outstanding expenses, short-term loans, advances and deposits, bank
overdraft, proposed dividend, provision for taxation etc.

Net Working Capital = Current Assets—Current liabilities

 Current Assets: Cash in hand and bank balance, Bills Receivable,

Inventories (raw material, work-in progress, stores, spares, finished
goods), surplus funds and others
 Current liabilities: Bills payable, dividend payable, Bank overdraft and
others

S Gross Working Capital Net Working Capital

r
.
N
o
.
1 Total amount available for financing To meet its operating expenses and
the current assets current liabilities

2 Total sum of current assets Current asset - current liabilities

3 If gross concept of working capital is If net concept of working capital is used,

used, there will always be positive there may be positive, negative or zero
working capital as it represents only (nil) working capital.
current assets.
 1. Types on the basis of concept

a) Gross working capital: the total amount of current asset maintained by business firm
b) Net working capital: amount of contribution or margin the business enterprise has to provide to finance
the gross working capital (bank or contribution by business promoter)

Net working capital = current asset (GWC) - current liabilities

2. Types on the basis of Time

a) Permanent working capital: example for product Display

b) Variable and Temporary working capital: product for sales product not for showcase

8. What is the difference between balance sheet and profit & loss statement? Explain in brief.
Ans: A company’s P&L statement shows its income, expenditures, and profitability over a period of
time. The balance sheet, on the other hand, provides a snapshot of its assets and liabilities on a certain
date. The balance sheet is typically presented as of the last day of the company’s fiscal year. Investors
use the balance sheet to understand the financial strength of the company, comparing the amount and
quality of its assets against its liabilities.

BASIS FOR
COMPARISO BALANCE SHEET PROFIT AND LOSS ACCOUNT
N

Meaning A statement that shows company's Account that shows the company's
assets, liabilities and equity at a revenue and expenses over a period
specific date. of time.
What is it? Statement Account

Represents Financial position of the Profit earned or loss suffered by

business on a particular date. business for the accounting period
Preparation Prepared on the last day of financial Prepared for the financial
year. year.
Information Assets, liabilities, and capital of Income, expenses, gains and losses.
Disclosed shareholders.
Accounts Accounts shown in the Balance Accounts transferred to Profit and
Sheet do not lose their identity, Loss account are closed and cease to
rather their balance is carry forward exist.
to next year as opening balance.
Sequence It is prepared after the preparation of It is prepared before the
Profit & Loss Account. preparation of Balance Sheet.
9. What is budgetary control? How does it affect "Make or buy" decision or analysis of an
organization?
Ans: A system of management control in which actual income and spending are compared with
planned income and spending, so that you can see if plans are being followed and if those plans need to
be changed in order to make a profit.
It performs the following important functions:

1.Budgets present the objectives, plans and programmes of the enterprise and express them in
financial and/or quantitative terms in the organisation.
2.Budgets serve as job descriptions. They define the tasks, which have to be performed at
various levels in the organisation.
3.Budgetary control involves continuous comparison of actual results with the planned ones and
taking corrective actions in the organisation.
Benefits of Budgetary Control:

1. Budgeting is an all inclusive management tool. It integrates and ties together various
organisational activities in the organization right from planning to controlling.
2. Budgets provide standards against which actual performance can be measured. This helps in
taking corrective action, which is an important part of controlling.
3. Budgets are an important tool to coordination in the organisation. In preparation of various
budgets, knowledge, skill and experience of many executives are combined and business plans are
reduced into concrete numerical terms in the organisation. This leads to proper coordination of the
efforts of various departments of the enterprise in the organisation.
4. Budgeting in the organisation helps in reducing unproductive operations by minimizing waste
of resources. Budgets are prepared after considerable thought and are directed towards certain aims
and objectives.
5. Budgeting in the organisation makes financial planning and control easy. The ultimate effect of
budgeting is the thorough examination and scrutinizing the financial aspect of the business
enterprise. This helps in optimum use of financial resources of the enterprise.
6. Budgetary control in the organisation facilities ‘control by exception’. It helps in focusing the
time and effort of the managers upon areas, which are most important for the survival of the
organisation.
7. Budgeting in the organisation is an important device for fixing the responsibility of various
positions. The persons occupying various positions can be made to understand their responsibilities
with the help of budgets.

In using these techniques consider:

 company's pricing policy
 general economic and political conditions
 changes in the population
 competition
 consumers' income and tastes
 advertising and other sales promotion techniques
 after sales service
 credit terms offered.
 a) Production budget: expressed in quantitative terms only and is geared to the sales
budget. The production manager's duties include:
· analysis of plant utilisation
· work-in-progress budgets.
If requirements exceed capacity he may:
· subcontract
· plan for overtime
· introduce shift work
· hire or buy additional machinery
· The materials purchases budget's both quantitative and financial.
b) Raw materials and purchasing budget:
· The materials usage budget is in quantities.
· The materials purchases budget is both quantitative and financial.
c) Labour budget: is both quantitative and financial. This is influenced by:
· production requirements
· man-hours available
· grades of labour required
· wage rates (union agreements)
· the need for incentives.
d) Cash budget: a cash plan for a defined period of time. It summarises monthly receipts
and payments. Hence, it highlights monthly surpluses and deficits of actual cash. Its main uses are:
· to maintain control over a firm's cash requirements, e.g. stock and debtors
· to enable a firm to take precautionary measures and arrange in advance for investment and loan
facilities whenever cash surpluses or deficits arises
· to show the feasibility of management's plans in cash terms
· to illustrate the financial impact of changes in management policy, e.g. change of credit terms
offered to customers.
 10. What are the duties of a finance manager?
Ans: A financial manager is a person who is responsible for taking care of all the essential
financial functions of an organization. Nowadays, Finance Managers spend less time producing
financial reports and prefer to invest more time in conducting data analysis, planning and
strategizing, or advising senior managers or top executives.
Responsibilities of Finance Manager:
 Raising of funds: to meet the needs of the business, it is essential to have cash and liquidity so,
that a firm can raise funds by way of equity or debt. A financial manager is responsible for
maintaining the right balance between equity and debt.
 Allocation of funds: After the funds are raised, the next important thing is to allocate the funds.
The best possible manner of allocating the funds:
 Size of the organizations and their growth capability
 Status of assets about long term or short term
 The mode by which the funds are raised
These types of financial decisions can, directly and indirectly, influence other activities.
 Profit Planning: It is one of the primary functions of any business organizations. Profit earning
is essential for the survival and livelihood of any organization. Profits emerge due to various
factors such as pricing, industry competition, state of the economy, mechanism of demand and
supply, cost and output.
 Understanding capital markets: Shares of a company are traded on the stock exchange for a
continuous sale and purchase. It is understood that the capital market is an essential factor for a
financial manager. Hence, it is the responsibility of a concern person to understand and
calculate the risk involved in this trading of shares debts.
Role of a Financial Manager
The role of a financial manager is rapidly increasing due to advance technology which has
significantly reduced the amount of time that was occupied to produce financial reports.
 They analyze market trends to find opportunities for expansion or for acquiring
companies.
 They have to do some tasks that are specific to their organization or industry
 They manage company credit
 Make some dividend pay-out decisions
 Keep in touch with the stock market if the company is listed
 Appreciate the financial performance concerning return investments
 They maximize the wealth for company shareholders
 To handle financial negotiations with banks and financial institutions
Types of Financial Managers:
 Controllers: They direct the preparation of financial reports that summarize and forecast
the organization's financial reports such as income statements, balance sheets, etc.
 Treasures and finance officers: These officers direct their organization's budgets to meet
its financial goals to oversee the investment of funds.
 Credit managers- They manage the organization's credit business.
 Cash managers: They monitor the flow of the cash that comes in and goes out of the
company to meet the investment needs of an organization.
 Risk managers: They control financial risk by using strategies to limit the probability of a
financial loss.
Above, are mentioned some roles and responsibilities of a financial manager who work closely
with top executives and departments to develop the data they need.
 11. Discuss the role of budget in controlling the activities in organizations.
Ans: In other words, the budgetary control device in the organisation encompasses practically
the whole range of management activities right from planning and policy formulation to the
final function of control over various activities of the manufacturing enterprise.

Budgetary control has the following specific objectives:

1. Planning:
Budgets are the plans to be pursued during the designed period of time to attain certain
objectives in the organisation. Budgetary control will force the management at all levels to plan various
activities well in advance in the organisation.
Budgets are generally drawn on the basis of forecasts made about market forces, supply
conditions and consumer’s preferences in the organisation. This help in making and revising business
policies in the organisation.

2. Control:
Budgetary control is an important instrument of managerial control in any enterprise.
Budgetary control helps in comparing the performance of various individuals and departments with the
predetermined standards laid down in various budgets.
Budgetary control reports the significant variations from the budgets to the top management in
the organisation. Since separate budgets are prepared for each department becomes easier to determine
the weak points and the sources of waste of time, money and resources.

3. Coordination:
Budgetary control involves the participation of a master budget, which helps in bringing
effective coordination among different departments of a business enterprise in the organisation. It force
the executive to make plans as a group in the organisation. Delays involved in the red tapism (Rigid
Rules and regulations) and discussing matters with one another sets procedural wrangles aside.

4. Increase in Efficiency:
Budgetary controls lay down the standards of production, sales, costs and overheads taking into
consideration various internal and external factors. This compels and stimulates every
department to attain maximum efficiency over the use of men, machine, material, methods and
money.

5. Financial Planning:
Budgets are generally expressed in financial terms in the organisation. They provide the
estimates of expenditures and revenues in the organisation. This helps the management to
make plans about the flow of cash in such a way that it would never run short of working
capital in the organization. Cash budget is also useful to convince the financial institution that
their loans will be paid back in time.
12. Define "Budget and budgetary control", state advantages and disadvantages of budget.
Ans:
Essential of Effective Budgetary Control:

Following are requirements of a good system of budgetary control in the organization

1. Quick Reporting:
A good system of budgetary control in the organisation requires the establishment of such
procedures, which will provide reports on the performance of various operations. The reports
should reach the persons concerned with the implementation of budgets without any delay so
that quick actions may be taken wherever necessary in the organization.
2. Detailed Organization Structure:
There should be a detailed organization structure with precisely designed authorities,
responsibilities and lines of communication so that everybody in the organisation understands
the significance of objectives in detail.
3. Frequent Comparison:
There should be frequent comparison between budget estimates and operating
results in the organisation. Alford and Beatty are of opinion that careful analysis of
both operating results and budget estimates is the essence of budgetary control in
the organisation.

4. Definite Plan:
There should be comprehensive planning in the enterprise. All the operations in the
organisation should be planned in clear terms. The administration of the budgets
should also be properly planned in the organisation. It must be pre-determined who
is to be held responsible for the implementation of budget in the organisation.

5. Responsibility Matched by the Authority:

Those assigned with the responsibility to implement the budgets should also be
given the necessary authority to achieve the budgeted targets in the organisation.
Lack of sufficient authority will make the implementation of budgets ineffective in
the organisation.

6. Participation:
The purpose of budgetary control is to achieve coordination of various functions of
the business in the organisation. Therefore, it is essential that participation up to
the lowest level in the enterprise be ensured to make the people committed to the
budgets. Everybody in the organisation should understand his role in achieving the
budgeted targets.

7. Support of the Management:

The top management in the organisation supports a good system of budgetary
control. Top management in the organisation should take the preparation of
budgets and their implementation seriously in order to achieve the objectives of the
enterprise.

8. Flexibility:
Budgets should not be rigid, but flexible enough to allow altering or remodelling in
the light of any change in circumstances in the organization. They must be flexible
to achieve the desired objectives in the organisation. A good system of budgetary
control allows sufficient flexibility to the persons concerned with the
implementation of budgets in the organisation.
 Disadvantages:

Following precautions could be taken while preparing and using budgets for
the purpose of managerial planning and control:

1. Estimates are not too high to be attained in the organisation.

2. Budgets are not prepared and installed hurriedly in the organization.
3. Administration and supervision of the operations are not insufficient in
the organisation.
4. Organisational structure is not defective in the organisation.
5. Accounting and cost systems are not inadequate in the organisation.
6. Statistics of past operations are not inadequate and unreliable in the organisation.
7. Results are not expected in too short period in the organisation.