SESHADRI RAO GUDLAVALLERU ENGINEERING COLLEGE

Academics Strengthening & Advancement (AS&A)

Department of Business and Management Studies

R – 23
II B.Tech. I Semester
Learning Material
On

MANAGERIAL ECONOMICS AND FINANCIAL ANALYSIS

(Common to CE, ECE, and AI&DS)

Prepared by: Department of Business and Management Studies

 SYLLABUS
MANAGERIAL ECONOMICS AND FINANCIAL ANALYSIS
(Common to CE, ECE, and AI&DS)

II Year – I Semester
Lecture : 2 Internal Marks : 30
Credits : 2 External Marks : 70
Course Objectives:
• To expose the importance of managerial economics and its role in achieving business objective
• To present fundamental skills on accounting and to explain the process of preparing financial statements.
Course Outcomes:
• Classify the concepts of Managerial Economics, financial accounting and management
• Interpret the Concept of Product cost and revenues for effective Business decision
• Describe the fundamentals of Economics viz., Demand, Production, cost, revenue and markets
• Analyze how to invest their capital and maximize returns using capital Budgeting techniques
• Develop the accounting statements and evaluate the financial performance of business entity

UNIT - I Managerial Economics

Introduction — Nature, meaning, significance, functions, and advantages. Demand-Concept, Function, Law of
Demand - Demand Elasticity- Types — Measurement. Demand Forecasting- Factors governing Forecasting,
Methods. Managerial Economics and Financial Accounting and Management.

UNIT - II Product and Cost Analysis

Introduction – Segmentation - Product Life cycle-Channels of Distribution- Cost & Break-Even Analysis - Cost
concepts and Cost behavior - Break-Even Analysis (BEA) - Determination of Break-Even Point (Simple Problems).

UNIT - III Business Organizations and Markets

Introduction — Forms of Business Organizations- Sole Proprietary - Partnership - Joint Stock Companies - Public
Sector Enterprises. Types of Markets - Perfect and Imperfect Competition - Features of Perfect Competition
Monopoly- Monopolistic Competition— Oligopoly-Price-Output Determination - Pricing Methods and Strategies

UNIT - IV Capital Budgeting

Introduction — Nature, meaning, significance. Types of Working Capital, Components, Sources of Short-term and
Long-term Capital, Estimating Working capital requirements. Capital Budgeting— Features, Proposals, Methods
and Evaluation. Projects — Pay Back
Method, Accounting Rate of Return (ARR) Net Present Value (NPV) Internal Rate Return (IRR) Method (sample
problems)

UNIT - V Financial Accounting and Analysis

Introduction — Concepts and Conventions- Double-Entry Bookkeeping, Journal, Ledger, Trial Balance- Final
Accounts (Trading Account, Profit and Loss Account and Balance Sheet with simple adjustments). Introduction to
Financial Analysis - Analysis and Interpretation of Liquidity Ratios, Activity Ratios, and Capital structure Ratios
and Profitability.
Textbooks:
1.Varshney&Maheswari: Managerial Economics, Sultan Chand, 2013.
2Aryasri: Business Economics and Financial Analysis, 4/e, MGH, 2019.
Reference Books:
1.Ahuja Hl Managerial economics Schand,3/e,2013
2.S.A. Siddiqui and A.S. Siddiqui: Managerial Economics and Financial Analysis, New Age International, 2013.
3.Joseph G. Nellis and David Parker: Principles of Business Economics, Pearson, 2/e, New Delhi.
4.Domnick Salvatore: Managerial Economics in a Global Economy, Cengage, 2013.

Online Learning Resources:

https://www.slideshare.net/123ps/managerial-economics-ppt
https://www.slideshare.net/rossanz/production-and-cost-45827016
https://www.slideshare.net/darky1a/business-organizations-19917607
https://www.slideshare.net/ba1arajbl/market-and-classification-of-market
https://www.slideshare.net/ruchi101/capital-budgeting-ppt-59565396
https://www.slideshare.net/ashu1983/financial-accounting

UNIT – I

Managerial Economics

Objective:
• To expose the importance of managerial economics and its role in achieving business
objectives

Modules
1. Introduction — Nature, meaning, significance, functions, and advantages.
2. Demand-Concept, Function,
3.Law of Demand. Demand Elasticity- Types — Measurement.
4.Demand Forecasting- Factors governing Forecasting, Methods.
5. Managerial Economics and Financial Accounting and Management.

1.Introduction
Managerial Economics as a subject gained popularity in USA after the publication of the
book “Managerial Economics” by Joel Dean in 1951.
Managerial Economics refers to the firm’s decision making process. It could be also interpreted
as “Economics of Management” or “Economics of Management”. Managerial Economics is also
called as “Industrial Economics” or “Business Economics”.
As Joel Dean observes managerial economics shows how economic analysis can be used in
formulating polices.

1.1Meaning & Definition:

In the words of E. F. Brigham and J. L. Pappas Managerial Economics is “the applications of
economics theory and methodology to business administration practice”.
Managerial Economics bridges the gap between traditional economics theory and real
business practices in two days. First it provides a number of tools and techniques to enable the
manager to become more competent to take decisions in real and practical situations. Secondly it
serves as an integrating course to show the interaction between various areas in which the firm
operates.
M. H. Spencer and Louis Siegelman explain the “Managerial Economics is the integration of
economic theory with business practice for the purpose of facilitating decision making and
forward planning by management”.

1.2Nature of Managerial Economics

Managerial economics is, perhaps, the youngest of all the social sciences. Since it
originates from Economics, it has the basis features of economics, such as assuming that other
things remaining the same (or the Latin equivalent ceteris paribus). This assumption is made to
simplify the complexity of the managerial phenomenon under study in a dynamic business
environment so many things are changing simultaneously. This set a limitation that we cannot
really hold other things remaining the same. In such a case, the observations made out of such a
study will have a limited purpose or value. Managerial economics also has inherited this problem
from economics.
The other features of managerial economics are explained as below:

(a) Close to microeconomics: Managerial economics is concerned with finding the solutions for
different managerial problems of a particular firm. Thus, it is more close to
microeconomics.
(b) Operates against the backdrop of macroeconomics: The macroeconomics conditions of the
economy are also seen as limiting factors for the firm to operate. In other words, the
managerial economist has to be aware of the limits set by the macroeconomics conditions
such as government industrial policy, inflation and so on.
(c) Normative statements: A normative statement usually includes or implies the words ‘ought’
or ‘should’. They reflect people’s moral attitudes and are expressions of what a team of
people ought to do. For instance, it deals with statements such as ‘Government of India
should open up the economy. Such statement are based on value judgments and express
views of what is ‘good’ or ‘bad’, ‘right’ or ‘ wrong’.
(d) Prescriptive actions: Prescriptive action is goal oriented. Given a problem and the
objectives of the firm, it suggests the course of action from the available alternatives for
optimal solution. If does not merely mention the concept, it also explains whether the
concept can be applied in a given context on not.
(e) Applied in nature: ‘Models’ are built to reflect the real life complex business situations and
these models are of immense help to managers for decision-making. The different areas
where models are extensively used include inventory control, optimization, project
management etc. In managerial economics, we also employ case study methods to
conceptualize the problem, identify that alternative and determine the best course of action.
(f) Offers scope to evaluate each alternative: Managerial economics provides an opportunity
to evaluate each alternative in terms of its costs and revenue. The managerial economist can
decide which is the better alternative to maximize the profits for the firm.
(g) Interdisciplinary: The contents, tools and techniques of managerial economics are drawn
from different subjects such as economics, management, mathematics, statistics,
accountancy, psychology, organizational behavior, sociology and etc.
(h) Assumptions and limitations: Every concept and theory of managerial economics is based
on certain assumption and as such their validity is not universal. Where there is change in
assumptions, the theory may not hold good at all.
1.3 Significance of Managerial Economics:

Managerial economics is significant for several reasons, as it applies economic theory and
methodology to business management. Here are some key points highlighting its importance:

Decision-Making: Managerial economics provides a systematic framework for analyzing

business decisions. It helps managers make informed choices regarding resource allocation,
production, pricing, and investment by applying economic principles and quantitative methods.

Optimizing Resources: It assists in the efficient utilization of resources such as labor, capital,
and materials. By understanding cost structures and market dynamics, managers can minimize
costs and maximize outputs, leading to improved profitability.

Demand Analysis and Forecasting: Managerial economics involves analyzing consumer

behavior and market demand. This understanding helps businesses predict future demand for
their products or services, allowing for better planning and inventory management.

Pricing Strategies: It aids in developing effective pricing strategies by analyzing factors like
cost, competition, and consumer willingness to pay. This ensures that businesses can set prices
that maximize profits while remaining competitive.

Risk Management: Managerial economics provides tools for assessing and managing business
risks. Techniques such as cost-benefit analysis, decision trees, and sensitivity analysis help
managers evaluate potential outcomes and make risk-informed decisions.

Strategic Planning: It contributes to long-term strategic planning by analyzing market trends,

competitive dynamics, and economic conditions. This helps businesses anticipate changes in the
market and adapt their strategies accordingly.

Policy Formulation: Businesses operate within the broader economic environment influenced by
government policies. Managerial economics helps managers understand the impact of fiscal and
monetary policies, regulations, and trade policies on their operations.

Enhancing Competitiveness: By applying economic analysis, businesses can gain a competitive

edge. This includes understanding market structures, competitive strategies, and positioning to
better compete in the marketplace.

1.4 Functions of Managerial Economics:

Managerial economics serves several vital functions that help managers in decision-making and
strategic planning. Here are the primary functions of managerial economics:
Demand Analysis and Forecasting:
Understanding Market Demand: Analyze consumer behavior to understand the demand for
products and services.
Forecasting Demand: Predict future demand using statistical tools and models, helping in
planning and inventory management.
Cost and Production Analysis:
Cost Analysis: Examine and control production costs to improve profitability. This includes
fixed, variable, and marginal costs.
Production Analysis: Optimize production processes and determine the most efficient production
methods and scale of operation.
Pricing Decisions:
Setting Prices: Develop pricing strategies based on cost, demand, and competition analysis to
maximize profits.
Price Elasticity: Understand how changes in price affect the quantity demanded and adjust
pricing strategies accordingly.
Profit Management:
Profit Maximization: Identify the profit-maximizing output level and price.
Cost-Volume-Profit Analysis: Analyze the relationship between costs, revenue, and profit to
make informed business decisions.
Risk and Uncertainty Analysis:
Risk Assessment: Evaluate business risks and uncertainties using tools like sensitivity analysis,
decision trees, and scenario planning.
Risk Management: Develop strategies to mitigate and manage risks, ensuring business stability
and growth.
Capital Budgeting:
Investment Decisions: Evaluate potential investment projects using methods like Net Present
Value (NPV), Internal Rate of Return (IRR), and Payback Period.
Resource Allocation: Allocate capital efficiently to maximize returns on investment.
Market Structure Analysis:
Competitive Analysis: Analyze the structure of the market (e.g., perfect competition, monopoly,
oligopoly) to develop competitive strategies.
Market Positioning: Determine the firm's position in the market and strategize to enhance its
market share and competitiveness.
Strategic Planning:
Long-term Planning: Develop long-term business strategies based on economic forecasts and
market trends.
Business Policy Formulation: Formulate policies that align with the company's strategic goals
and market conditions.
Resource Allocation:
Efficient Use of Resources: Ensure optimal allocation and utilization of resources such as labor,
capital, and materials.
Cost-Benefit Analysis: Evaluate the benefits and costs of different business initiatives and
projects.
Performance Measurement:
Economic Indicators: Use economic indicators and financial metrics to measure and evaluate
business performance.
Benchmarking: Compare the firm's performance against industry standards and competitors to
identify areas for improvement.

1.5 Advantages of Managerial Economics:

Managerial economics offers several advantages that can significantly benefit businesses and
organizations. Here are some of the key advantages:

Improved Decision-Making:
Informed Choices: By applying economic theories and analytical tools, managers can make more
informed and rational decisions.
Quantitative Analysis: Use of quantitative methods helps in making data-driven decisions,
reducing uncertainty and subjectivity.

Optimal Resource Allocation:

Efficiency: Helps in the efficient allocation of resources such as labor, capital, and materials,
ensuring they are used in the most productive manner.
Cost Reduction: Identifies cost-saving opportunities and optimizes production processes to
minimize waste and reduce costs.

Strategic Planning and Forecasting:

Future Planning: Provides tools for demand forecasting and trend analysis, enabling businesses
to plan for the future effectively.
Market Analysis: Helps in understanding market dynamics, consumer behavior, and competitive
landscape, aiding in long-term strategic planning.

Profit Maximization:
Revenue Management: Assists in developing pricing strategies that maximize revenues and
profits.
Cost-Volume-Profit Analysis: Helps in understanding the relationship between cost, revenue,
and profit to make profitable business decisions.

Enhanced Risk Management:

Risk Assessment: Identifies and evaluates potential risks and uncertainties in business
operations.
Mitigation Strategies: Develops strategies to manage and mitigate risks, ensuring business
continuity and stability.

Better Pricing Strategies:

Price Setting: Uses economic principles to set optimal prices for products and services.
Competitive Pricing: Helps in understanding the impact of pricing on demand and competition,
allowing for strategic pricing decisions.

Improved Performance Measurement:

Performance Metrics: Provides tools to measure and evaluate business performance using
economic indicators and financial metrics.
Benchmarking: Facilitates comparison with industry standards and competitors, identifying areas
for improvement.

Enhanced Competitiveness:
Competitive Strategies: Helps in developing strategies to gain a competitive edge in the market.
Market Positioning: Assists in positioning the business effectively within the market to attract
and retain customers.
Effective Capital Budgeting:
Investment Appraisal: Provides methods to evaluate and prioritize investment projects.
Resource Allocation: Ensures capital is allocated to projects with the highest potential returns,
optimizing investment decisions.

Policy Formulation and Implementation:

Business Policies: Aids in formulating business policies that align with economic conditions and
organizational goals.
Regulatory Compliance: Helps in understanding and complying with government regulations and
policies that impact business operations.

Economic Environment Analysis:

Macroeconomic Insights: Offers insights into the broader economic environment, including
inflation, interest rates, and economic cycles.
Policy Impact: Analyzes the impact of fiscal and monetary policies on business operations.

2. DEMAND ANALYSIS
2.1 Introduction & Meaning:
Demand in common parlance means the desire for an object. But in economics demand is
something more than this. According to Stonier and Hague, “Demand in economics means
demand backed up by enough money to pay for the goods demanded”. This means that the
demand becomes effective only it if is backed by the purchasing power in addition to this there
must be willingness to buy a commodity.

2.2Factors Affecting Demand:

There are factors on which the demand for a commodity depends. These factors are economic,
social as well as political factors. The effect of all the factors on the amount demanded for the
commodity is called Demand Function.
These factors are as follows:
1. Price of the Product (P )
2. Income of the Consumer (I )
3. Tastes and Preferences of the Consumers (T )
4. Prices of related goods which may be substitutes /Complementory( P R)

5. Expectations about the prices in future (EP )

6. Expectations about the Incomes in future (EI )
7. Size of Population ( SP)
8. Distribution of Consumers over different regions: ( D C)
9. Advertising Efforts ( A)
10. Any other factor capable of affecting the demand (O )
2.3 Demand Function:
A demand function is a mathematical representation that describes the relationship between the
quantity of a good or service demanded and its determinants, such as price, income levels, prices
of related goods, and other factors. It essentially shows how the quantity demanded changes in
response to changes in these determinants.

The general form of a demand function can be expressed as:

Qd= f (P,I,T,PR,EP,SP,DC,A,O)

3.1 Law of Demand:

Law of demand shows the relation between price and quantity demanded of a commodity in the
market. In the words of Marshall, “the amount demand increases with a fall in price and
diminishes with a rise in price”.

A rise in the price of a commodity is followed by a reduction in demand and a fall in price is
followed by an increase in demand, if a condition of demand remains constant.
The law of demand may be explained with the help of the following demand schedule.

Demand Schedule.

Price of Apple (In. Rs.) Quantity Demanded

10 1

8 2

6 3

4 4

2 5

When the price falls from Rs. 10 to 8 quantity demand increases from 1 to 2. In the same way as
price falls, quantity demand increases on the basis of the demand schedule we can draw the
demand curve.
The demand curve DD shows the inverse relation between price and quantity demand of apple. It
is downward sloping.

Assumptions:
Law is demand is based on certain assumptions:
 1. This is no change in consumers taste and preferences.
2. Income should remain constant.
3. Prices of other goods should not change.
4. There should be no substitute for the commodity
5. The commodity should not confer at any distinction
6. The demand for the commodity should be continuous
7. People should not expect any change in the price of the commodity

Exceptional demand curve:

Sometimes the demand curve slopes upwards from left to right. In this case the demand curve
has a positive slope.

Price

When price increases from OP to Op1

quantity demanded also increases from to OQ1 and vice versa. The reasons for exceptional
demand curve are as follows.

1. Giffen paradox
2. Veblen or Demonstration effect
3. Ignorance
4. Speculative effect
5. Fear of shortage
6. Necessaries

3.2 Elasticity of demand

Elasticity of demand explains the relationship between a change in price and consequent change
in amount demanded. “Marshall” introduced the concept of elasticity of demand. Elasticity of
demand shows the extent of change in quantity demanded to a change in price.
Elastic demand: A small change in price may lead to a great change in quantity demanded. In
this case, demand is elastic.

In-elastic demand: If a big change in price is followed by a small change in demanded then the
demand in “inelastic”.

Types of Elasticity of Demand:

There are three types of elasticity of demand:
1. Price elasticity of demand
2. Income elasticity of demand
3. Cross elasticity of demand
4. Advertising Elasticity of Demand

1. Price elasticity of demand:

Marshall was the first economist to define price elasticity of demand. Price elasticity of demand
measures changes in quantity demand to a change in Price. It is the ratio of percentage change in
quantity demanded to a percentage change in price.

Proportionate change in the quantity demand of commodity

Price elasticity = ------------------------------------------------------------------
Proportionate change in the price of commodity
There are five cases of price elasticity of demand

A. Perfectly elastic demand:

When small change in price leads to an infinitely large change is quantity demand, it is called
perfectly or infinitely elastic demand. In this case E=∞

The demand curve DD1 is horizontal straight

line. It shows the at “OP” price any amount is
demand and if price increases, the consumer
will not purchase the commodity.

B.
Perfectl
y
Inelasti
c Demand
In this case, even a large change in price fails to bring
about a change in quantity demanded.
C. Relatively elastic demand:
Demand changes more than proportionately to a change
in price. i.e. a small change in price loads to a very big
change in the quantity demanded. In this case
E > 1. This demand curve will be flatter.

D. Relatively in-elastic demand.

Quantity demanded changes less than proportional
to a change in price. A large change in price leads to
small change in amount demanded. Here E < 1.
Demanded carve will be steeper.

E. Unit elasticity of demand:

The change in demand is exactly equal to the
change in price. When both are equal E=1 and elasticity if said to be unitary.

When price falls from ‘OP’ to ‘OP1’

quantity demanded increases from ‘OP’
to ‘OP1’, quantity demanded increases
from ‘OQ’ to ‘OQ1’. Thus a change in
price has resulted in an equal change in
quantity demanded so price elasticity of
demand is equal to unity.

2. Income elasticity of demand:

Income elasticity of demand shows the
change in quantity demanded as a result
of a change in income. Income elasticity
of demand may be slated in the form of a formula.

Proportionate change in the quantity demand of commodity

Income Elasticity = ------------------------------------------------------------------

 Proportionate change in the income of the people

Income elasticity of demand can be classified in to five types.

A. Zero income elasticity:

Quantity demanded remains the same, even though money income increases. Symbolically, it
can be expressed as Ey=0. It can be depicted in the following way:

As income increases from OY to OY1, quantity demanded never changes.

B. Negative Income elasticity:

When income increases, quantity demanded falls. In this case, income elasticity of demand is
negative. i.e., Ey < 0.

When income increases

from OY to OY1, demand falls from OQ to OQ1.

c. Unit income elasticity:

When an increase in income brings about a proportionate increase in quantity demanded, and
then income elasticity of demand is equal to one. Ey = 1

When income increases from OY to OY1, Quantity demanded also increases from OQ to OQ1.

d. Income elasticity greater than unity:

In this case, an increase in come brings about a more than proportionate increase in quantity
demanded. Symbolically it can be written as Ey > 1.

E. Income elasticity leas than unity:

When income increases quantity demanded also increases but less than proportionately. In this
case E < 1.
3. Cross elasticity of Demand:
A change in the price of one commodity leads to a change in the quantity demanded of another
commodity. This is called a cross elasticity of demand. The formula for cross elasticity of
demand is:

Proportionate change in the quantity demand of commodity “X”

Cross elasticity = -----------------------------------------------------------------------
Proportionate change in the price of commodity “Y”

a. In case of substitutes, cross elasticity of demand is positive. Eg: Coffee and Tea
When the price of coffee increases, Quantity demanded of tea increases. Both are substitutes.

b. In case of compliments, cross elasticity is negative. If increase in the price of one commodity
leads to a decrease in the quantity demanded of another and vice versa.
c. In case of unrelated commodities, cross elasticity of demanded is zero. A change in the price
of one commodity will not affect the quantity demanded of another.

4. Advertising Elasticity of Demand

Advertising Elasticity of Demand (AED) is a measure of how sensitive the quantity demanded of
a good or service is to changes in advertising expenditure. Essentially, it helps businesses
understand how changes in their advertising efforts might influence sales.

Formula
The formula for Advertising Elasticity of Demand is:

% Change in Quantity Demanded

Advertising elasticity = -----------------------------------------------------------------------

% Change in Advertising Expenditure

3.3 Factors influencing the elasticity of demand
1. Nature of commodity
2. Availability of substitutes
3. Variety of uses
4. Postponement of demand

5. Amount of money spent

6. Time
7. Range of Prices

4.1 Demand Forecasting

 Demand Forecasting is the process of predicting future customer demand for a product or
service. It involves analyzing historical data, market trends, and other relevant factors to estimate
the quantity of a product that consumers will purchase in the future. Accurate demand
forecasting helps businesses make informed decisions about production, inventory management,
pricing strategies, and resource allocation.

4.2Factors Governing Demand Forecasting

Historical Sales Data:
Past sales figures are a primary input for forecasting future demand.
Seasonality, trends, and cyclical patterns observed in historical data help in making accurate
predictions.
Market Trends:
General market trends, including changes in consumer preferences, technological advancements,
and economic conditions, impact demand.
Keeping track of these trends is crucial for accurate forecasting.
Economic Indicators:
Macroeconomic factors such as GDP growth, unemployment rates, inflation, and interest rates
influence consumer purchasing power and demand.
These indicators provide context for demand predictions.
Competitive Environment:
The actions of competitors, such as new product launches, pricing changes, and marketing
strategies, can affect demand for a product.
Understanding the competitive landscape is important for forecasting.
Promotional Activities:
Marketing campaigns, discounts, and other promotional efforts can temporarily boost demand.
Forecasting must account for these short-term fluctuations.
Consumer Behavior:
Changes in consumer preferences, lifestyle, and demographics impact demand.
Analyzing consumer behavior helps in understanding future demand patterns.
Regulatory Environment:
Government policies, regulations, and trade restrictions can impact demand for certain products.
Understanding the regulatory environment helps in anticipating changes in demand.
Technological Changes:

Technological innovations can create new demand or render existing products obsolete.
Staying updated with technological advancements is essential for accurate forecasting.
Weather and Seasonal Factors:
Seasonal variations and weather conditions can significantly influence demand for certain
products.
Products like clothing, food items, and travel services often experience seasonal demand
patterns.
Geopolitical Factors:
Political stability, international relations, and global events can impact demand, especially in
global markets.
Geopolitical analysis helps in understanding potential demand shifts.

4.3 Methods of Demand Forecasting:

I.Survey method.
1) Survey of buyer’s intention.
A] Census method
B] Sample method.
2) Sales force opinion method.

II.Statistical methods
1) Trend projection method.
A] Trend line observation.
B] Least square method.
C] Time series analysis.
D] Moving average method.
E] Exponential smoothing.
2) Barometric techniques.
3) Simultaneous equations method.
4) Correlation & regression method.

III. Other methods

1) Expert opinion method
2) Test marketing.
3) Controlled experiments.
4) Judgmental approach.

I. Survey methods:-

Survey of buyer’s intention:-

To anticipate what buyers are likely to do under a given set of circumstances, a most
useful source of information would be the buyers themselves. It is better to draw a list of all
potential buyers, approach each buyer to ask how much does her plans to buy of the given
product at a given point of time under particular conditions.
This is the most effective method because the buyer is the ultimate decision maker and
we are collecting the information directly from him.
The survey of the buyers can be conducted either by covering the whole population or by
selecting a sample group of buyers.

Advantages of the survey methods:-

1. Where the product is new in the market for which no data exists previously.
2. When the buyers are few and they are accessible.
3. When the cost of reaching them is not significant.
4. When consumers stick to their intentions.
5. When they are willing to disclose what they are willing to do.
Disadvantages:-
1. Survey may be expensive.
2. Sample size and timing of survey.
3. Methods of sampling.
4. In consisted buying behavior.
Sales Force Opinions:-
Another source of getting reliable information about possible level of sales or demand for a
given product or services is the group of people who sell the same. Thus we can control the
limitation of cost and delays in contacting the costumers. The sales people are those who are in
constant touch with the main and large buyers of particular market. The sales force is capable of
assessing the likely reaction of the costumers in their territories quickly; giving the company’s
marketing strategy. It is less costly and can be conducted through telephones, fax, video
conferences and many more.
Here also there is a danger that salesmen may sometimes become biased with their views.
 The sales people are paid based on their results.
 Targets are set for the salesmen.
 The salary of the salesmen depends upon the targets.
 Incentives are paid to the salesmen who achieved the targets.
 Salespersons having more knowledge about the information of sources.
 Salesmen are cooperative.
II. Statistical Methods:-
For forecasting the demand for goods and services in the long-run, statistical and mathematical
methods are used considering the past data.
(a)Trend projection methods:-
This is based on past sales patterns. The necessary information is already available in company
files with different time periods.

There are five main techniques:

1. Trend line by observation.
2. Least square method.
3. Time series analysis.
4. Moving average method.
5. Exponential smoothing.

(1)Trend line by observation:-

It is easy and quick as it involves plotting the actual sales data on a chart and then
estimating just by observation when the trend line lies.

(2) Least square method:-

In this statistical method is used. The trend line is the basis to extrapolate the line for
future demand for the given product or service on graph. Here it is assumed that there is a
proportional exchange in sales over a period of time. In such a case the trend line equation is in
linear form.

The estimated linear trend equation of sales is written as:

S = x + y (T)
x & y have been calculated from past data.
S = sales;
T = year no. for which the forecast is made.

To find x & y values,

ΣΣ S = N x + yΣΣ T
ΣΣΣ ST = x Σ T + yΣ (T * T )
S = sales;
T = year number
N = no. of years.

Example 1:

Year 1996 1998 2000 2002 2004

Sales (lakhs) 75 84 92 98 88

Estimate the sales for the years 2004 & 2006.

Sol:
Σ S = N x + yΣ T
Σ ST = x Σ T + yΣ (T * T )

Year Year no. (T) Sales (s) ST T*T

1992 1 75 75 1

1994 3 84 252 9

1996 5 92 460 25

1998 7 98 686 49

2000 9 88 792 81

ΣT = 25 ΣS=437 ΣST=2265 Σ(t*t)=165

Substituting the values in the formula,

437 = 5x + 25 y
2265 = 25x + 165 y

By solving these equations

x=77.4 & y=2;
Years 2004 & 2006 take on the year numbers 11 and 13 respectively.
By substituting the values in the trend equations x + y (T)
S 2002 = 77.4 + 2 (11)= 99.4 lakh units
S 20o4 = 77.4 + 2 (13)= 103.4 lakh units.
Thus the forecast sales for year 2004 & 2006 are 99.4 and 103.4 lakh units.

3) Time Series Analysis:-

Where the surveys or market tests are costly and time consuming, statistical and
mathematical analysis of past sales data offers another method to prepare the forecasts that is
time series analysis.
The product should have actively been traded in the market for quite sometime in the
past.
Considerable data on the performance of the product or service over significantly large
period should be available for better results under this method.
 Time series emerge from a data when arranged chronologically, given significantly large
data.

The following 4 major components analyzed from time series while forecasting the demand.

Trend (T):
It also called as long term trend, is the result f basic developments in the population,
capital formation & technology. These developments relate to over a period of long time say 5 t0
10 years, not definitely over night. The trend is considered statistically significant when it has
reasonable degree of consistency. A significant trend is central and decisive factor considered
while preparing a long range forecast.

Cycle Trend (C):

It is wave like movement of sales inflation, during the period of inflation prices go up and
down.

Seasonal Trend (S):

More goods are sold in festivals seasons, weather factors, holidays.

Eratic Trend (E):

Results from the sporadic occurrence of strikes, riots etc.

4) MOVING AVERAGE METHOD:

This method considers that the average of past events determine the future events.
This method provides consistent results when the past events are consistent and
unaffected by wide changes.
The average keeps on moving depending upon the no. of years selected. Selection of no.
of years is the decisive factor in this method. Moving averages get updated as new information
flow in.
This method is easy to compute. One major advantage with this method is that the old
data can be dispensed with once the averages are calculated. These averages, not original data,
are further used as the forecast for next period. It gives equal weightage to data both in the recent
past and the earlier one.

Example: - Compute 3-day moving average from the following daily sales data.

Date and month Daily sales (lakhs) 3-day moving average

Jan 1 40
Jan 2 44
Jan 3 48
Jan 4 45 44
Jan 5 53 45.7

Sol:-
To calculate 3-days moving avg…
S4 = (40 + 44 + 48)/ 3 == 44
S5 = (44 + 48 + 45)/3 == 45.7

5) EXPONENTIAL SMOOTHING:
This is a more popular technique used for short-run forecasts. This method is an
improvement over moving averages method.

All time periods ( ranging from the immediate part to distant part ) here are given varying
weights , that is the value of the given variable in the recent times are given higher weights and
the values of the given variable in the distant past are given relatively lower weights for further
processing.
The formula used for exponential smoothing,
S t + 1 == c S T + (1 -- C) S MT
S t + 1 == exponentially smoothed average for New Year.
S t == actual data in the most recent part.
S Mt == most recent smoothed forecast.
C = smoothing constant.
If the smoothing constant ` c ` is higher, higher weight is given to the most recent
information. The value of `c` varies between `0` and inclusive and the exact values of `c` is
determined by the magnitude of random variation. If the magnitude of random variations is large,
lower values of c are assigned and vice versa. However, it is considered that a value between 0.1
& 0.2 is more appropriate in most of cases.

BAROMETRIC TECHNIQUES:
Where forecasting based on time series analyses or extrapolation may not yield
significant results, barometric techniques can be made use of . Under the barometric technique,
one set of data is use to predict another set.
To forecast demand for a particular product or service, use some other relevant indicator which is
known as a barometer of future demand.
To assess the demand for services in India and abroad. We can see the percentage of
population in each occupation. In the US 78%of the labour force is employed in services 15% of
them in manufacturing. In India, according to 1991 census, 21%of work force is engaged in
services, 13%in manufacturing, and 67% in agriculture. The world over, an increase in
prosperity has been accomplished by an increase in demand for services.

Simultaneous Equation Method

In this method al variables are simultaneously considered, with the conviction that every
variable influences the other variable in an economic environment. Hence the set of eqns equal
the no. of dependent variable which is also called endogenous variables.
This method is more practical in the sense that it requires to estimate the future values of
only predetermined variables. it is difficult to compute where the no. of eqns is larger.

CORRELATION AND REGRESSION METHODS:

Correlation and regression methods are statistical techniques. Correlation describes the
degree of association between 2 variables such as sales and advertisement expenditure, when the
2 variables tend to change together then they are said to be correlated. The extent to which they
are correlated can be measured by correlation coefficient.
 In regression analysis an equation is estimated which best fits in the sets of observations
of dependent variables and independent variables. The main advantage of this method is that it
provides the values of independent variables from with in the model itself. Thus it frees the
forecaster from the difficulty of estimating them exogenously.

III. OTHER METHODS

EXPERT OPINION:
Well informed persons are called experts. Experts constitute yet another source of
information. These persons are generally the generally the outside experts and they do not have
any vested interests in the results of a particular survey.
Main advantages are:
1. Results of this method would be more reliable as the expert is unbiased, has no direct
commercial involvement in its primary activities.
2. Independent demand forecast can be made relatively quick and cheap.
3. This method constitutes a valid strategy particularly in the case of new products.
The main disadvantage is that an expert can’t be held accountable if his estimates are found
incorrect.

TEST MARKETING:
It is likely that opinions give in by buyers, sales man or other experts may be at times,
misleading. This is the reason why most of the manufacturers favour to test there product or
service in a limited matter as test-run before they launch their products nation wide.
Advantages:
1. Acceptability of the product can be judged in a limited market.
2. Before its too late, the corrections can be made to product design if necessary, thus
major catestrophy, in terms of failure, can be avoided.
3. The customer psychology is more focused in this method and the product and services
are aligned or redesigned accordingly to gain more customer acceptance.
Disadvantages:
1. It reveals the quality of product to the competitors before it is launched in his wider
market. The competitors may bring about a similar product or often misuse the results
of the test marketing against the given company.
2. It is not always easy to select a representative audience or market.
3. It may also be difficult to extrapolate the feedback received from such a test market,
particularly where the chosen market is not fully representative.

CONTROLLED EXPERIMENTS:
Controlled experiments refer to such exercises where some of the major determinants of
demand are manipulated to suit to the customers with different tastes and preferences, income
groups and such others. This method can not provide better results, unless these markets are
homogenous in terms of, tastes and preferences of customers, their income and soon.
This method is in infancy state and not much tried because of following reasons:
It is costly and time consuming. It involves elaborate process of studying different
markets and different permutations and combinations that push the product aggressively. If it
fails in one market, it may affect other markets also.

JUDGEMENT APPROACH:
When none of the above methods are directly related to the given product or service, the
management has no other alternative than using its own judgment. Even when the above
methods are used, the forecasting process is supplemented with the factor of judgment for the
following reasons:

1. Historical data for significantly long period is not available.

2. Turning points in terms of policies or procedures or casual factors cannot be precisely
demanded.
3. Sales fluctuations are wide and significant.

5.1 Managerial Economics and Financial Accounting and Management

Managerial Economics and Financial Accounting and Management are two key areas within the
broader field of business management. They provide essential tools and frameworks for
decision-making, planning, and control within an organization. Here's an overview of each:
Managerial Economics
Managerial Economics is the application of economic theory and methodology to business
administration practice. It bridges the gap between economic theory and managerial practice by
providing a framework for analyzing business decisions.
Financial Accounting and Management
Financial Accounting and Management involves the preparation, analysis, and interpretation of
financial statements, as well as the management of an organization’s financial resources.
Integration of Managerial Economics and Financial Accounting
Decision Making: Managerial economics provides the analytical framework for making
economic decisions, while financial accounting provides the data and metrics needed for those
decisions.
Planning and Budgeting: Financial management involves planning and budgeting based on
economic forecasts and financial data.
Performance Evaluation: Economic analysis helps in setting performance benchmarks, and
financial accounting provides the tools to measure and evaluate performance against those
benchmarks.
Both areas are crucial for effective business management, providing the tools and frameworks
necessary for making informed and strategic decisions.

Assignment-Cum-Tutorial Questions

PART A
Objective Questions

Module 1: Introduction — Nature, meaning, significance, functions, and advantages

1. What is the primary focus of Managerial Economics? ( )
A) Optimization of resources
B) Profit maximization
C) Market competition
D) Economic theory
2.Which of the following is NOT a function of managerial economics? ( )
A) Decision-making
B) Demand forecasting
C) Production planning

D) Political analysis
3. What is the significance of understanding the nature of managerial economics? ( )
A) To determine tax policies
B) To optimize business decisions
C) To increase political influence
D) To study historical economic trends
4. Which advantage is associated with the application of managerial economics? ( )
A) Increased legal compliance
B) Enhanced production efficiency
C) Improved employee morale
D) Better understanding of cultural trends
5. Managerial Economics integrates concepts from which fields? ( )

A) Psychology and Sociology

B) Physics and Chemistry
C) Economics and Management
D) Medicine and Biology

Module 2: Demand - Concept, Function

1. Which term best describes the relationship between price and quantity demanded? ( )

A) Direct relationship
B) Inverse relationship
C) Linear relationship
D) Exponential relationship
2. What does the demand function represent? ( )
A) The cost of production

B) The relationship between supply and demand

C) The relationship between price and quantity demanded
D) The market equilibrium
3. Which factor does NOT typically affect demand? ( )
A) Consumer preferences

B) Production costs
C) Income levels
D) Price of substitutes
4. What is the concept of demand primarily concerned with? ( )
A) Supply chain logistics
B) Consumer purchasing power
C) Market regulations
D) Government policies
5. An increase in consumer income typically shifts the demand curve in which direction? ( )
A) Leftward
B) Rightward
C) Downward

D) Upward

Module 3: Law of Demand. Demand Elasticity - Types — Measurement

1. The Law of Demand states that, ceteris paribus, an increase in price leads to: ( )
A) An increase in quantity demanded
B) A decrease in quantity demanded
C) No change in quantity demanded

D) A decrease in demand
2. What is Price Elasticity of Demand? ( )
A) The responsiveness of demand to changes in supply
B) The responsiveness of demand to changes in price
C) The responsiveness of supply to changes in demand
D) The responsiveness of price to changes in demand
3. Which type of demand elasticity indicates a proportional change in quantity demanded to a
change in price? ( )

A) Perfectly elastic
B) Perfectly inelastic
C) Unit elastic
D) Inelastic
4. What does it mean if a product has an elasticity of demand greater than 1? ( )
A) The product is inelastic

B) The product is elastic

C) The product has unit elasticity
D) The product has no elasticity
5. Which method is commonly used to measure elasticity of demand? ( )
A) Marginal Cost Method
B) Total Revenue Method

C) Supply Chain Method

D) Equilibrium Method

Module 4: Demand Forecasting - Factors governing Forecasting, Methods

1. Which of the following is a qualitative method of demand forecasting? ( )
A) Time series analysis
B) Expert opinion method
C) Regression analysis
D) Econometric models
2. Which factor does NOT influence demand forecasting? ( )
A) Economic conditions
B) Consumer tastes and preferences
C) Market competition

D) Geological factors
3. What is the main objective of demand forecasting? ( )
A) To set product prices
B) To predict future demand for products or services
C) To understand past sales trends
D) To analyze competitors
4. Which method uses historical data to predict future demand? ( )

A) Delphi method
B) Market experiment method
C) Time series analysis
D) Survey method
5. What is a key advantage of using quantitative methods in demand forecasting? ( )
A) Incorporation of expert judgment
B) Use of statistical and mathematical models
C) Adaptability to changing market conditions
D) Ability to gather consumer opinions

Module 5: Managerial Economics and Financial Accounting and Management

1. Which of the following is a primary objective of financial management? ( )
A) Minimizing production costs

B) Maximizing shareholder wealth

C) Increasing employee satisfaction
D) Expanding market share
2. What is a fundamental principle of managerial economics? ( )
A) Cost minimization
B) Profit maximization

C) Market regulation
D) Resource conservation
3. Which financial statement provides information about a company’s profitability over a
specific period? ( )

A) Balance sheet
B) Cash flow statement
C) Income statement
D) Statement of changes in equity
4. Which accounting method records revenues and expenses when they are incurred, regardless
of when cash is exchanged? ( )
A) Cash basis accounting
B) Accrual basis accounting
C) Managerial accounting
D) Financial accounting
5. What is the role of financial accounting within an organization? ( )

A) Internal decision-making
B) External reporting to stakeholders
C) Cost control
D) Marketing strategy development

Part-B
2 Marks: Short Answer Questions

Module 1: Introduction — Nature, meaning, significance, functions, and advantages

1. Define Managerial Economics.
2. What are the main functions of managerial economics?
3. Explain the significance of managerial economics in decision-making.
4. List two advantages of applying managerial economics in business.

Module 2: Demand - Concept, Function

1. What is the basic concept of demand?
2. Describe the relationship between price and quantity demanded as per the law of demand.
3. What role does consumer purchasing power play in demand?

Module 3: Law of Demand. Demand Elasticity - Types — Measurement

1. State the Law of Demand.

2. What is price elasticity of demand?

3. Differentiate between elastic and inelastic demand.
4. How is unitary elasticity of demand defined?
 5. Name two methods for measuring demand elasticity.

Module 4: Demand Forecasting - Factors governing Forecasting, Methods

1. Define demand forecasting.
2. List two qualitative methods of demand forecasting.

3. Name three factors that influence demand forecasting.

4. Explain the Time Series Analysis method of demand forecasting.

Module 5: Managerial Economics and Financial Accounting and Management

1. What is the main objective of financial management?

2. How does managerial economics assist in decision-making?

3. What is the role of financial accounting within an organization?

PART C
Descriptive Questions
Module 1: Introduction — Nature, Meaning, Significance, Functions, and Advantages
1. Explain the nature and scope of managerial economics and its relevance to business
decision-making.
2. Discuss the various functions of managerial economics in guiding managerial decisions.
3. Analyze the significance of managerial economics in optimizing resource allocation and
achieving business objectives.
4. Evaluate the advantages of integrating economic theories with management practices in
managerial economics.

Module 2: Demand - Concept, Function

1. Define the concept of demand and explain its key determinants.
2. Illustrate the relationship between price and quantity demanded with the help of a
demand curve.
3. Analyze how changes in consumer income levels affect demand for normal and inferior
goods.

Module 3: Law of Demand. Demand Elasticity - Types — Measurement

1. Explain the Law of Demand and its underlying assumptions.
2. Discuss the different types of demand elasticity and their significance in managerial
decision-making.
 3. Describe the methods used to measure price elasticity of demand and their respective
advantages and disadvantages.

Module 4: Demand Forecasting - Factors Governing Forecasting, Methods

1. Define demand forecasting and explain its importance in strategic planning and decision-
making.
2. Discuss the various methods of demand forecasting and its advantages and disadvantages

3. Analyze the factors that influence demand forecasting and how they can affect the
accuracy of forecasts.

Module 5: Managerial Economics and Financial Accounting and Management

1. Explain the objectives and functions of financial management in a business organization.

2. Discuss the role of managerial economics in optimizing financial and operational

decisions.
3. Describe the key financial statements used in financial accounting and their significance
for stakeholders.
SESHADRI RAO GUDLAVALLERU ENGINEERING COLLEGE

Academics Strengthening & Advancement (AS&A)

Department of Business and Management Studies

R – 23
II B.Tech. I Semester
Learning Material

On

MANAGERIAL ECONOMICS AND FINANCIAL ANALYSIS

(Common to all B.Tech Branches)

Prepared by: Department of Business and Management Studies

 SYLLABUS
MANAGERIAL ECONOMICS AND FINANCIAL ANALYSIS
(Common to CSE, EEE and IOT)
II Year – II Semester
Lecture : 2 Internal Marks : 30
Credits : 2 External Marks : 70
Course Objectives:
• To expose the importance of managerial economics and its role in achieving business objective
• To present fundamental skills on accounting and to explain the process of preparing financial statements.
Course Outcomes:
• Classify the concepts of Managerial Economics, financial accounting and management
• Interpret the Concept of Product cost and revenues for effective Business decision
• Describe the fundamentals of Economics viz., Demand, Production, cost, revenue and markets
• Analyze how to invest their capital and maximize returns using capital Budgeting techniques
• Develop the accounting statements and evaluate the financial performance of business entity

UNIT - I Managerial Economics

Introduction — Nature, meaning, significance, functions, and advantages. Demand-Concept, Function, Law of
Demand - Demand Elasticity- Types — Measurement. Demand Forecasting- Factors governing Forecasting,
Methods. Managerial Economics and Financial Accounting and Management.
UNIT - II Product and Cost Analysis
Introduction – Segmentation - Product Life cycle-Channels of Distribution- Cost & Break-Even Analysis - Cost
concepts and Cost behavior - Break-Even Analysis (BEA) - Determination of Break-Even Point (Simple Problems).
UNIT - III Business Organizations and Markets
Introduction — Forms of Business Organizations- Sole Proprietary - Partnership - Joint Stock Companies - Public
Sector Enterprises. Types of Markets - Perfect and Imperfect Competition - Features of Perfect Competition
Monopoly- Monopolistic Competition— Oligopoly-Price-Output Determination - Pricing Methods and Strategies
UNIT - IV Capital Budgeting
Introduction — Nature, meaning, significance. Types of Working Capital, Components, Sources of Short-term and
Long-term Capital, Estimating Working capital requirements. Capital Budgeting— Features, Proposals, Methods
and Evaluation. Projects — Pay Back
Method, Accounting Rate of Return (ARR) Net Present Value (NPV) Internal Rate Return (IRR) Method (sample
problems)
UNIT - V Financial Accounting and Analysis
Introduction — Concepts and Conventions- Double-Entry Bookkeeping, Journal, Ledger, Trial Balance- Final
Accounts (Trading Account, Profit and Loss Account and Balance Sheet with simple adjustments). Introduction to
Financial Analysis - Analysis and Interpretation of Liquidity Ratios, Activity Ratios, and Capital structure Ratios
and Profitability.
Textbooks:
1.Varshney&Maheswari: Managerial Economics, Sultan Chand, 2013.
2Aryasri: Business Economics and Financial Analysis, 4/e, MGH, 2019.
Reference Books:
1.Ahuja Hl Managerial economics Schand,3/e,2013
2.S.A. Siddiqui and A.S. Siddiqui: Managerial Economics and Financial Analysis, New Age International, 2013.
3.Joseph G. Nellis and David Parker: Principles of Business Economics, Pearson, 2/e, New Delhi.
4.Domnick Salvatore: Managerial Economics in a Global Economy, Cengage, 2013.

Online Learning Resources:

https://www.slideshare.net/123ps/managerial-economics-ppt
https://www.slideshare.net/rossanz/production-and-cost-45827016
https://www.slideshare.net/darky1a/business-organizations-19917607
https://www.slideshare.net/ba1arajbl/market-and-classification-of-market
https://www.slideshare.net/ruchi101/capital-budgeting-ppt-59565396
https://www.slideshare.net/ashu1983/financial-accounting
 UNIT – II
Product and Cost Analysis
Objective:
 Interpret the Concept of Product cost and revenues for effective Business decision

Modules
Introduction – Segmentation - Product Life cycle-Channels of Distribution- Cost & Break-Even Analysis - Cost
concepts and Cost behavior - Break-Even Analysis (BEA) - Determination of Break-Even Point (Simple Problems).

1. Introduction — Segmentation.
2. Product Life Cycle
3. Channels of Distribution
4. Cost Analysis and Cost Concepts
5. Break-Even Analysis (BEA) - Determination of Break-Even Point
1.1 Introduction

In the product era, the goal was to build a better mouse trap and it was assumed that buyers will
flock the seller who does it. However, a better mousetrap is no guarantee of success and
marketing history is full of miserable failures despite better mousetrap designs. Inventing the
greatest new product is not enough. That product must also solve a perceived marketplace need.
Otherwise, even the best-engineered and highest quality product will fail.

A product is anything that can be offered to a market to satisfy a need or want. People
satisfy their needs and wants with products. Though the word suggests a physical object, the
concept of product is not limited to physical objects. Marketers often use the expressions goods
and services to distinguish between physical products and intangible ones. These goods and
services can represent cars, groceries, computers, places, persons and even ideas. Customers
decide which entertainers to watch on television, which places to visit for a holiday, which ideas
to adopt for their problems and so on. Thus the term ‘product’ covers physical goods, services
and a variety of other vehicles that can satisfy customers’ needs and wants. If at times the term
‘product’ does not seem to be appropriate, other terms such as market offering, satisfier are used.

It emphasizes the importance of product quality, features, and innovation. It assumes that
consumers will prefer products that offer superior quality or unique features.

1.2Market Segmentation:

Market segmentation being customer-oriented is resemblance with the marketing

concept philosophy. In market segmentation, a company first identifies the needs of
consumers within a segment and then decides if it is practical to develop a product and
marketing mix to satisfy those needs. By practicing market segmentation and a company
may obtain the following advantages and benefits.
 By tailoring marketing programs to each market segment, a company can do a
better marketing job and can make more efficient use of its marketing resources.

A small company with limited resources may be in a better position to compete more
effectively in one or two small market segments, whereas the same company would be
overwhelmed by the competition from bigger companies if it aimed for a major segment.

A company with effective market segmentation strategy can create a more fine tuned
product or service offering and price it appropriately for the target segment.

The company can more easily select the most appropriate distribution network and
communication strategy, and it will be able to understand its competitors in a better way,
which is serving the same segment.

By developing strong position in a specialized market segments, a medium sized

company can grow rapidly.

Even very large companies with the vast resources at their disposal are abandoning
mass marketing strategies and embracing market segmentation as more effective strategy
to reach various market segments in broad product market. For example, Hindustan Lever
Ltd (HLL), one of the most admired companies, has developed a number of detergent
brands to cater to the needs of various segments in detergent market. This has been done
by HLL after it faced stiff competition in the 1970s from a sinall and lesser known Nirma
Chemicals Ltd, in the form of Nirma brand. As a result of Nirma's onslaught HLL came
up with an economical brand named Wheel to cater to the needs of middle class and
economy conscious detergent buyers.

Because of these factors and the benefits from the market segmentation most of the
companies both in consumer and industrial markets are practicing this strategy. Because
of obvious benefits, today not only market segmentation is practiced by the companies
manufacturing goods and services but it has also been adopted by retailers. Many
marketing experts are of the view that the days of mass marketing have gone and even if
some companies are following mass marketing its days are numbered. Therefore, today
companies use market segmentation to stay focused rather than scattering their marketing
resources

Bases of Segmentation:

Some of the major bases for market segmentation are as follows:

 Geographic Segmentation

 Demographic Segmentation
  Psychographic Segmentation

 Behaviorist Segmentation

A large number of variables are used to segment a consumer market. The most
common bases for segmenting markets are as follows: Traditional: Geographic,
Demographic. Modern: Psychographic, Behaviouristic

1: Geographic Segmentation: Geographic location is one of the simplest methods of

segmenting the market. People living in one region of the country have purchasing and
consuming habit which differs from those living in other regions. For example, life style
products sell very well in metro cities, e.g., Mumbai, Delhi, Kolkata and Chennai but do
not sell in small towns. Banking needs of people in rural areas differ from those of urban
areas. Even within a city, a bank branch located in the northern part of the city may
attract more clients than a branch located in eastern part of the city.

2: Demographic Segmentation: Demographic variables such as age, occupation,

education, sex and income are commonly used for segmenting markets. (a) Age:
Teenagers, adults, retired. (b) Sex: Male and female. (c) Occupation: Agriculture,
industry, trade, students, service sector, house-holds, institutions.

(i) Industrial sector: Large, small, tiny.

(ii) Trade: Wholesale, retail, exporters.

(iii) Services: Professionals and non-professionals.

(iv) Institutions: Educational, religions, clubs.

(v) Agriculture and cottage industries.

(d) Income Level: Above Rs. 1 lakh per annum, Rs. 50,000 to Rs. 1 lakh, Rs. 25,000 to
Rs. 50,000 per annum, i.e., higher, middle and lower.

(e) Family Life-cycle: Young single, young married no children, young married youngest
child under six, young married youngest child over six, older married with children, older
married no children under eighteen, older single, etc.

3: Psychographic Segmentation: Under this method consumers are classified into market
segments on the basis of their psychological make-up, i.e., personality, attitude and
lifestyle. According to attitude towards life, people may be classified as traditionalists,
achievers, etc. Rogers has identified five groups of consumer personalities according to
the way they adopt new products:
(а) Innovators: These are cosmopolitan people who are eager to try new ideas. They are
highly venturesome and willing to assume the risk of an occasional bad experience with a
new product.

(b) Early Adopters: These are influential people with whom the average person checks
out an innovation.

(c) Early Majority: This group tends to deliberate before adopting a new product. Its
members are important in legitimizing an innovation but they are seldom leaders.

(d) Late Majority: This group is cautious and adopts new ideas after an innovation has
received public confidence.

(e) Laggards: These are past-oriented people. They are suspicious of change and
innovations. By the time they adopt a product, it may already have been replaced by a
new one. Understanding of psychographic of consumers enables marketers to better
select potential markets and match the product image with the type of consumer using it.
For example, women making heavy use of bank credit cards are said to lead an active
lifestyle and are concerned with their appearance. They tend to be liberated and are
willing to try new things. Psychographic classification may, however, be an
oversimplification of consumer personalities and purchase behaviour. So many factors
influence consumers that an early adopter of one product might well be a laggard for
some other product and vice versa.

4: Behavioristic Segmentation: In this method consumers are classified into market

segments not the basis of their knowledge, attitude and use of actual products or product
attributes. Any of the following variables might be used for this purpose:

(а) Purchase Occasion: Buyers may be differentiated on the basis of when they use a
product or service. For example, air travelers might fly for business or vacation.
Therefore, one airline might promote itself as a business flyer while another might target
the tourists.

(b) Benefits Sought: The major benefit sought in a product is used as the basis of classify
consumers. High quality, low price, good taste, speed, sex appeal are examples of
benefits. For example, some air travellers prefer economy class (low price), while others
seek executive class (status and comfort).

(c) User Status: Potential buyers may be classified as regular users, occasional users and
non-users. Marketers can develop new products or new uses of old products by targeting
one or another of these groups.
 Dividing the overall market into distinctive segments based on identified criteria to better
understand the diverse needs and characteristics of different groups. Segmentation helps in
developing targeted marketing strategies.

2.1Product Life Cycle (PLC):

A new product passes through set of stages known as product life cycle. Product life cycle
applies to both brand and category of products. Its time period vary from product to product.
Modern product life cycles are becoming shorter and shorter as products in mature stages are
being renewed by market segmentation and product differentiation. Companies always attempt to
maximize the profit and revenues over the entire life cycle of a product. In order to achieving the
desired level of profit, the introduction of the new product at the proper time is crucial. If new
product is appealing to consumer and no stiff competition is out there, company can charge high
prices and earn high profits.

Stages of Product Life Cycle Product life cycle comprises four stages: 1. Introduction stage 2.
Growth stage 3. Maturity stage 4. Decline stage

 Introduction:

The stage where the product is launched into the market. Sales start slowly as customers
become aware of the product.

At this stage the product is new to the market and few potential customers are aware with
the existence of product. The price is generally high. The sales of the product is low or may be
restricted to early adopters. Profits are often low or losses are being made, this is because of the
high advertising cost and repayment of developmental cost. At the introductory stage :-

The product is unknown,

The price is generally high,

The placement is selective, and

The promotion is informative and personalized.

At introduction stage, the company core focus is on establishing a market and arising demand for
the product. So, the impact on marketing mix is as follows:

Product: Branding, Quality level and intellectual property and protections are obtained to
stimulate consumers for the entire product category. Product is under more consideration, as first
impression is the last impression.

Price: High(skim) pricing is used for making high profits with intention to cover initial cost in a
short period and low pricing is used to penetrate and gain the market share. company choice of
pricing strategy depends on their goals.

Place: Distribution at this stage is usually selective and scattered.

Promotion: At introductory stage, promotion is done with intention to build brand awareness.
Samples/trials are provided that is fruitful in attracting early adopters and potential customers.
Promotional programs are more essential in this phase. It is as much important as to produce the
product because it positions the product.

 Growth:

A phase of rapid sales growth, increasing market acceptance, and expanding customer adoption
as awareness spreads.

At this stage the product is becoming more widely known and acceptable in the market.
Marketing is done to strengthen brand and develop an image for the product. Prices may start to
fall as competitors enters the market. With the increase in sales, profit may start to be earned, but
advertising cost remains high. At the growth stage:-

The product is more widely known and consumed,

The sales volume increases,

The price begin to decline with the entry of new players,

The placement becomes more widely spread, and

The promotion is focused on brand development and product image formation.

During this stage, firms focus on brand preference and gaining market share. It is market
acceptance stage. But due to competition, company invest more in advertisement to convince
customers so profits may decline near the end of growth stage. Affect on 4 P’s of marketing is as
under:

Product: Along with maintaining the existing quality, new features and improvements in
product quality may be done. All this is done to compete and maintain the market share.

Price: Price is maintained or may increase as company gets high demand at low competition or it
may be reduced to grasp more customers.

Distribution: Distribution becomes more significant with the increase demand and acceptability
of product. More channels are added for intensive distribution in order to meet increasing
demand. On the other hand resellers start getting interested in the product, so trade discounts are
also minimal.

Promotion: At growth stage, promotion is increased. When acceptability of product increases,

more efforts are made for brand preference and loyalty.

 Maturity:

Sales peak during this phase, but competition intensifies as market saturation is reached.
Companies focus on differentiating and retaining market share.

At this stage the product is competing with alternatives. Sales and profits are at their peak.
Product range may be extended, by adding both with and depth. With the increases in
competition the price reaches to its lowest point. Advertising is done to reinforce the product
image in the consumer's minds to increase repeat purchases. At maturity stage:-

The product is competing with alternatives,

The sales are at their peak,

The prices reach to its lowest point,

The placement is intense, and

The promotion is focused on repeat purchasing.

At this stage, there are more competitors with the same products. So, companies defend the
market share and extending product life cycle, rather than making the profits, By offering sales
promotions to encourage retailer to give more shelf space to the product than that of competitors.
At this stage usually loyal customers make purchases.
Marketing mix decisions include:

Product: At maturity stage, companies add features and modify the product in order to compete
in market and differentiate the product from competition. At this stage, it is best way to get
dominance over competitors and increase market share.

Price: Because of intense competition, at maturity stage, price is reduced in order to compete. It
attracts the price conscious segment and retain the customers.

Distribution: New channels are added to face intense competition and incentives are offered to
retailers to get shelf preference over competitors.

Promotion: Promotion is done in order to create product differentiation and loyalty. Incentives
are also offered to attract more customers.

 Decline:

At this stage sales start to fall fast as a result product range is reduced. The product faces
reduced competition as many players have left the market and it is expected that no new
competitor will enter the market. Advertising cost is also reduced. Concentration is on
remaining market niches as some price stability is expected there. Each product sold could be
profitable as developmental costs have been paid at earlier stage. With the reduction in sales
volume overall profit will also reduce. At decline stage:-

The product faces reduced competition,

The sales volume reduces,

The price is likely to fall,

The placement is selective, and

The promotion is focused on reminding.

At this stage market becomes saturated so sales declines. It may also be due technical
obsolescence or customer taste has been changed. At decline stage company has three options:

1. Maintain the product, Reduce cost and finding new uses of product

2. Harvest the product by reducing marketing cost and continue offering the product to loyal
niche until zero profit.

3. Discontinue the product when there’s no profit or a successor is available. Selling out to
competitors who want to keep the product. At declining stage, marketing mix decisions depends
on company’s strategy.
For example, if company wants to harvest, the product will remain same and price will be
reduced. In case of liquidation, supply will be reduced dramatically.

3.1Channels of Distribution:

Channels of distribution, also known as marketing channels or distribution channels, refer to the
pathways through which goods and services travel from the producer to the final consumer.
These channels can vary significantly depending on the type of product, target market, and
overall business strategy. They play a crucial role in the marketing mix and have a significant
impact on a company's ability to reach its customers efficiently and effectively. Here’s an
overview:

3.2 Types of Distribution Channels

1. Direct Channels
o Direct Selling: This involves a company selling its products directly to the
consumer without any intermediaries. Examples include online stores, company-
owned retail outlets, and direct mail.
o E-commerce: Companies sell directly to consumers through their websites or
online marketplaces like Amazon or eBay.
o Direct Mail/Telemarketing: Companies use mail or telephone to reach
customers directly.
2. Indirect Channels
o Retailers: Products are sold through retail outlets, which buy goods from
wholesalers or manufacturers and sell them to the final consumer.
o Wholesalers: These intermediaries buy large quantities of goods from
manufacturers and sell them in smaller quantities to retailers or other businesses.
o Distributors: Similar to wholesalers, but often provide additional services such
as product promotion, storage, and transport.
o Agents/Brokers: These intermediaries do not take ownership of the products but
facilitate transactions between buyers and sellers.

3.3 Channel Levels

1. Zero-Level Channel (Direct Channel): No intermediary levels; the manufacturer sells

directly to the consumer.
2. One-Level Channel: One intermediary, typically a retailer.
3. Two-Level Channel: Two intermediaries, typically a wholesaler and a retailer.
4. Three-Level Channel: Three intermediaries, typically including an agent in addition to
the wholesaler and retailer.

3.4 Factors Influencing the Choice of Distribution Channel

1. Product Characteristics: Perishable goods require faster channels. Complex and high-
value items often need direct selling.
 2. Market Considerations: Target market size, geographic distribution, and customer
buying habits affect channel choice.
3. Company Objectives and Resources: Companies with strong brand recognition and
large sales volumes might bypass intermediaries.
4. Competitor Channels: The distribution strategies of competitors can influence channel
selection.
5. Cost and Efficiency: Companies aim to choose channels that minimize costs and
maximize efficiency.

3.4 Functions of Distribution Channels

1. Transactional Functions: Involve buying, selling, and risk-taking.

2. Logistical Functions: Include assorting, storing, sorting, and transporting.
3. Facilitating Functions: Financing, grading, marketing information, and research.

Benefits of Effective Distribution Channels

1. Market Coverage: Efficient channels allow companies to reach a broader market.

2. Customer Convenience: Channels that offer various buying options increase customer
satisfaction.
3. Sales Growth: Properly managed channels can enhance sales and revenue.
4. Cost Efficiency: Well-structured channels can reduce overall distribution costs.

Challenges in Distribution Channels

1. Channel Conflicts: Conflicts may arise between different channel members, affecting
relationships and efficiency.
2. Complexity Management: Managing multiple channels can be complex and requires
significant coordination.
3. Adapting to Change: Channels must adapt to changes in market conditions, consumer
behavior, and technological advancements.

Trends in Distribution Channels

1. Omnichannel Distribution: Integrating multiple channels to provide a seamless

customer experience.
2. Digital Transformation: Increasing use of digital platforms for direct selling and
customer engagement.
3. Sustainability: Focus on sustainable and eco-friendly distribution practices.
4. Customer-Centric Models: Channels designed to enhance the overall customer
experience.

4.1 COST ANALYSIS

Profit is the ultimate aim of any business and the long-run prosperity of a firm depends upon its
ability to earn sustained profits. Profits are the difference between selling price and cost of
production. In general the selling price is not within the control of a firm but many costs are
under its control. The firm should therefore aim at controlling and minimizing cost. Since every
business decision involves cost consideration, it is necessary to understand the meaning of
various concepts for clear business thinking and application of right kind of costs.

4.2 COST CONCEPTS:

A managerial economist must have a clear understanding of the different cost concepts for clear
business thinking and proper application. The several alternative bases of classifying cost and the
relevance of each for different kinds of problems are to be studied. The various relevant concepts
of cost are:

1. Opportunity costs and outlay costs

2. Explicit and implicit costs
3. Historical and Replacement costs
4. Short – run and long – run costs
5. Out-of pocket and books costs
6. Fixed and variable costs
7. Past and Future costs
8. Avoidable and unavoidable costs.
9. Controllable and uncontrollable costs
10. Incremental and sunk costs
11. Total, average and marginal costs
Accounting costs are the costs recorded for the purpose of preparing the balance sheet and
profit and ton statements to meet the legal, financial and tax purpose of the company. The
accounting concept is a historical concept and records what has happened in the post.

Economics concept considers future costs and future revenues, which help future planning, and
choice, while the accountant describes what has happened, the economics aims at projecting
what will happen.

5.1 BREAKEVEN ANALYSIS

The study of cost-volume-profit relationship is often referred as BEA. The term BEA is
interpreted in two senses. In its narrow sense, it is concerned with finding out BEP; BEP is the
point at which total revenue is equal to total cost. It is the point of no profit, no loss. In its broad
determine the probable profit at any level of production.

Assumptions:
1. All costs are classified into two – fixed and variable.
2. Fixed costs remain constant at all levels of output.
3. Variable costs vary proportionally with the volume of output.
4. Selling price per unit remains constant in spite of competition or change in the volume of
production.
5. There will be no change in operating efficiency.
6. There will be no change in the general price level.
7. Volume of production is the only factor affecting the cost.
8. Volume of sales and volume of production are equal. Hence there is no unsold stock.
 9. There is only one product or in the case of multiple products. Sales mix remains constant.
Merits:
1. Information provided by the Break Even Chart can be understood more easily then those
contained in the profit and Loss Account and the cost statement.
2. Break Even Chart discloses the relationship between cost, volume and profit. It reveals
how changes in profit. So, it helps management in decision-making.
3. It is very useful for forecasting costs and profits long term planning and growth
4. The chart discloses profits at various levels of production.
5. It serves as a useful tool for cost control.
6. It can also be used to study the comparative plant efficiencies of the industry.
7. Analytical Break-even chart present the different elements, in the costs – direct material,
direct labour, fixed and variable overheads.
Demerits:
1. Break-even chart presents only cost volume profits. It ignores other considerations such
as capital amount, marketing aspects and effect of government policy etc., which are
necessary in decision making.
2. It is assumed that sales, total cost and fixed cost can be represented as straight lines. In
actual practice, this may not be so.
3. It assumes that profit is a function of output. This is not always true. The firm may
increase the profit without increasing its output.
4. A major drawback of BEC is its inability to handle production and sale of multiple
products.
5. It is difficult to handle selling costs such as advertisement and sale promotion in BEC.
6. It ignores economics of scale in production.
7. Fixed costs do not remain constant in the long run.
8. Semi-variable costs are completely ignored.
9. It assumes production is equal to sale. It is not always true because generally there may
be opening stock.
10. When production increases variable cost per unit may not remain constant but may
reduce on account of bulk buying etc.
11. The assumption of static nature of business and economic activities is a well-known
defect of BEC.
5.2 Important terms in BEP
1. Fixed cost
2. Variable Cost
3. Contribution
4. Margin of safety
5. Angle of incidence
6. Profit Volume Ratio
7. Break – Even- Point
 Assignment-Cum-Tutorial Questions

PART A

Objective Questions

Module 1. Introduction — Segmentation

1.What is market segmentation? ( )

a) Dividing a market into distinct groups with different needs, characteristics, or behaviors.

b) Combining multiple markets into one homogeneous market.

c) Eliminating unprofitable segments from a market.

d) Identifying a single target market for a product.

2.Which of the following is not a common basis for market segmentation? ( )

a) Geographic

b) Demographic

c) Psychographic

d) Economic

3.Psychographic segmentation divides the market based on: ( )

a) Age, gender, income

b) Lifestyle, personality, values

c) Region, climate

d) Usage rate, loyalty status

4.The process of targeting involves: ( )

a) Developing a detailed understanding of market segments.

b) Evaluating and selecting the most attractive market segments.

c) Identifying broad market differences.

d) None of the above.

5.Which of the following segmentation strategies is used when a company targets a single
segment? ( )

a) Undifferentiated marketing

b) Differentiated marketing

c) Concentrated marketing

d) Micromarketing

Module 2. Product Life Cycle

1.Which stage of the product life cycle is characterized by rapid market acceptance and
increasing profits? ( )

a) Introduction

b) Growth

c) Maturity

d) Decline

2.During which stage of the product life cycle do competitors begin to enter the market? ( )

a) Introduction

b) Growth

c) Maturity

d) Decline

3.In which stage of the product life cycle are sales and profits at their peak? ( )

a) Introduction

b) Growth

c) Maturity

d) Decline

4.Which of the following is not a typical marketing objective during the decline stage of the
product life cycle? ( )

a) Reduce costs
b) Harvest or divest the product

c) Increase promotional efforts

d) Phase out weak items

5.What is a common strategy during the introduction stage of the product life cycle? ( )

a) Market skimming pricing

b) Market penetration pricing

c) Cost leadership pricing

d) Competitive pricing

Module 3. Channels of Distribution

1. Which of the following is a direct channel of distribution? ( )

a) Manufacturer → Wholesaler → Retailer → Consumer

b) Manufacturer → Retailer → Consumer

c) Manufacturer → Consumer

d) Manufacturer → Agent → Wholesaler → Retailer → Consumer

2. What is the main advantage of using intermediaries in distribution channels? ( )

a) Direct contact with customers

b) Greater control over sales

c) Reduced distribution costs

d) Increased market reach and efficiency

3. Which of the following is an example of a multi-channel distribution system? ( )

a) Selling products only through physical stores

b) Selling products through a single online store

c) Selling products through both physical stores and online platforms

d) Selling products through door-to-door sales only

4. In which type of distribution strategy does a manufacturer distribute its product through a
limited number of intermediaries? ( )

a) Intensive distribution

b) Selective distribution

c) Exclusive distribution

d) Direct distribution

5. A vertical marketing system (VMS) consists of: ( )

a) Independent producers, wholesalers, and retailers

b) Integrated and coordinated producers, wholesalers, and retailers

c) Producers only

d) Retailers only

Module 4. Cost Analysis and Cost Concepts

1.Fixed costs are those that: ( )

a) Change with the level of production

b) Remain constant regardless of the level of production

c) Vary with the level of sales

d) Decrease as production increases

2.Variable costs are: ( )

a) Costs that do not change with the level of production

b) Costs that change directly with the level of production

c) Costs that remain fixed over a period of time

d) Costs that increase as sales decrease

3.The contribution margin is calculated as: ( )

a) Sales revenue minus fixed costs

b) Sales revenue minus variable costs

c) Total costs minus fixed costs

d) Variable costs minus fixed costs

4.Which of the following costs is considered a direct cost? ( )

a) Salary of the company CEO

b) Depreciation on factory equipment

c) Raw materials used in production

d) Rent of the corporate office

5. An example of a semi-variable cost is: ( )

a) Rent

b) Electricity

c) Raw materials

d) Direct labor

Module 5. Break-Even Analysis (BEA) - Determination of Break-Even Point

1.The break-even point is the level of sales at which: ( )

a) Total revenue equals total costs

b) Total revenue exceeds total costs

c) Total costs exceed total revenue

d) Profit is maximized

2. Which of the following equations represents the break-even point in units? ( )

a) Fixed Costs / (Selling Price per Unit - Variable Cost per Unit)

b) (Fixed Costs + Variable Costs) / Selling Price per Unit

c) Selling Price per Unit / (Fixed Costs - Variable Costs)

d) Fixed Costs / Selling Price per Unit

3. If fixed costs increase, the break-even point will: ( )

a) Decrease
b) Increase

c) Remain unchanged

d) Fluctuate unpredictably

4. To lower the break-even point, a company should: ( )

a) Increase fixed costs

b) Decrease selling price per unit

c) Increase variable costs

d) Decrease fixed costs

5. Which of the following is not a component of break-even analysis? ( )

a) Fixed costs

b) Variable costs

c) Contribution margin

d) Market share

Part-B

2 Marks: Short Answer Questions

1. Introduction — Segmentation

1. What is market segmentation?

2. Name three common bases for market segmentation.

3. What does psychographic segmentation focus on?

2. Product Life Cycle

1. What are the four stages of the product life cycle?

2. At what stage are sales and profits typically at their peak?

3. What strategy is often used during the introduction stage of a product?

4. What happens to marketing efforts during the decline stage?

3. Channels of Distribution
 1. What is a direct channel of distribution?

2. Why are intermediaries used in distribution channels?

3. What is a multi-channel distribution system?

4. What is selective distribution?

4. Cost Analysis and Cost Concepts

1. What are fixed costs?

2. What are variable costs?

3. Give an example of a direct cost.

4. What is a semi-variable cost?

5. Break-Even Analysis (BEA) - Determination of Break-Even Point

1. What is the break-even point?

2. How is the break-even point in units calculated?

3. Name one component of break-even analysis.

PART C

Descriptive Questions

Module 1. Introduction — Segmentation

1. Explain the concept of market segmentation and discuss its importance in modern
marketing strategies. Provide examples to illustrate your points.

2. Discuss the different bases for market segmentation.

Module 2. Product Life Cycle

1. Describe the product life cycle and its stages. How can understanding the product life
cycle help businesses in making strategic decisions?

2. Compare and contrast the marketing strategies appropriate for each stage of the product
life cycle. Provide examples of products at different stages and their marketing
approaches.
 3. Examine the impact of technological advancements on the product life cycle. How can
technology accelerate or alter the traditional life cycle of a product?

Module 3. Channels of Distribution

1. Explain the role of distribution channels in the overall marketing strategy of a company.
How do distribution channels impact customer satisfaction and business performance?

2. Discuss the different types of distribution channels and the factors that influence a
company’s choice of a specific channel. Provide examples from various industries.

3. Evaluate the benefits and challenges of multi-channel distribution systems. How can
companies effectively manage multiple channels to optimize their reach and efficiency?

Module 4. Cost Analysis and Cost Concepts

1. Discuss the importance of cost analysis in managerial decision-making. How can

understanding cost behavior improve business strategies and operations?

2. Explain the difference between fixed and variable costs. How do these cost concepts
impact pricing and production decisions?

3. Discuss about various cost concepts with suitable examples.

Module 5. Break-Even Analysis (BEA) - Determination of Break-Even Point

1. Explain the concept of break-even analysis and its significance in business planning.

2. Discuss the process of determining the break-even point (BEP ) with graphical
representation.

3. The information about Raj & Co are given below:

PV ratio : 20%
Fixed Cost : Rs. 36,000/-
Selling Price per Unit: Rs. 150/-
Calculate (i) BEP in rupees (ii) BEP in Units.
4. Mrs. Venu and co. is producing Water purifiers.The cost incurred in the production are as
below
a) Fixed cost Rs.1, 20,000/-.
b) Variable cost per unit is Rs.400/-
When the organization is selling each unit Rs.800/-find the Break-even point in volume and
sales.
SESHADRI RAO GUDLAVALLERU ENGINEERING COLLEGE

Academics Strengthening & Advancement (AS&A)

Department of Business and Management Studies

R – 23
II B.Tech. I Semester
Learning Material
On

MANAGERIAL ECONOMICS AND FINANCIAL ANALYSIS

(Common to CE, ECE, and AI&DS)

Prepared by: Department of Business and Management Studies

 SYLLABUS
MANAGERIAL ECONOMICS AND FINANCIAL ANALYSIS
(Common to CE, ECE, and AI&DS)

II Year – I Semester
Lecture : 2 Internal Marks : 30
Credits : 2 External Marks : 70
Course Objectives:
• To expose the importance of managerial economics and its role in achieving business objectives.
• To present fundamental skills on accounting and to explain the process of preparing financial statements.
Course Outcomes:
• Classify the concepts of Managerial Economics, financial accounting and management.
• Interpret the Concept of Product cost and revenues for effective Business decision.
• Establish suitable business organisation and analyse markets to understand their impact on pricing and output
decision.
• Analyse how to invest their capital and maximize returns using capital budgeting techniques.
• Develop the accounting statements and evaluate the financial performance of business entity.
UNIT – I: Managerial Economics
Introduction – Nature, meaning, significance, functions, and advantages. Demand-Concept, Function, Law of Demand -
Demand Elasticity- Types – Measurement. Demand Forecasting- Factors governing Forecasting, Methods.
UNIT – II: Product and Cost Analysis
Introduction – Segmentation – Product Life Cycle – Channels of Distribution – Cost & Break-Even Analysis – Cost
concepts and Cost behaviour – Break-Even Analysis (BEA) - Determination of Break-Even Point (Simple Problems).
UNIT – III: Business Organizations and Markets
Introduction – Forms of Business Organizations- Sole Proprietary - Partnership - Joint Stock Companies - Public Sector
Enterprises. Types of Markets - Perfect and Imperfect Competition - Features of Perfect Competition Monopoly,
Monopolistic Competition, Oligopoly, Price-Output Determination – Pricing Methods and Strategies.
UNIT – IV: Capital Budgeting
Introduction – Nature, meaning, significance. Types of Working Capital, Components, Sources of Short-term and
Long-term Capital, Estimating Working capital requirements. Capital Budgeting– Features, Proposals, Methods and
Evaluation. Projects – Pay Back Method, Accounting Rate of Return (ARR), Net Present Value (NPV), Internal Rate
Return (IRR) Method (sample problems)
UNIT – V: Financial Accounting and Analysis
Introduction – Concepts and Conventions- Double-Entry Bookkeeping, Journal, Ledger, Trial Balance- Final Accounts
(Trading Account, Profit and Loss Account and Balance Sheet with simple adjustments). Introduction to Financial
Analysis - Analysis and Interpretation of Liquidity Ratios, Activity Ratios, and Capital structure Ratios and
Profitability.
Textbooks:
1. Varshney, R. L., & Maheswari, K. L. Managerial Economics,22nd Rev. ed., Sultan Chand, 2014.
2. Aryasri, A. R., Business Economics and Financial Analysis, 4th ed., McGraw Hill, 2019.
3. Kotler, P. Marketing Management, 15th ed., Pearson, 2016.
Reference Books:
1. Ahuja, H. L., Managerial Economics, 3rd ed.. S. Chand, 2013.
2. Siddiqui, S. A., & Siddiqui, A. S., Managerial Economics and Financial Analysis. New Age International,
2013.
3. Nellis, J. G., & Parker, D. (n.d.). Principles of Business Economics (2nd ed.). Pearson.
Online Learning Resources:
https://www.slideshare.net/123ps/managerial-economics-ppt
https://www.slideshare.net/rossanz/production-and-cost-45827016
https://www.slideshare.net/darky1a/business-organisations-19917607
https://www.slideshare.net/ba1arajbl/market-and-classification-of-market
https://www.slideshare.net/ruchi101/capital-budgeting-ppt-59565396
https://www.slideshare.net/ashu1983/financial-accounting
 UNIT – III
Business Organizations and Markets
Objective:
 Understand the various forms of business organizations and analyze the characteristics and
pricing strategies of different market structures.
Modules
1. Introduction to Business - Forms of Business Organizations - Sole Proprietary - Partnership -
Joint Stock Companies - Public Sector Enterprises.
2. Introduction to Market - Types of Markets - Perfect and Imperfect Competition - Features of
Perfect Competition – Monopoly - Monopolistic Competition – Oligopoly - Price-Output
Determination
3. Pricing Methods and Strategies

1. Introduction
Business refers to the organized efforts and activities of individuals or entities to produce and sell
goods or services for profit. It is a fundamental aspect of economic systems, serving as the engine
of economic growth by providing products and services that meet the needs of consumers. A
business can take various forms, ranging from small, sole proprietorships to large corporations.

The primary goal of most businesses is to generate profit, but they also play a key role in creating
jobs, fostering innovation, and contributing to the overall development of society. Businesses
operate in various environments, including competitive markets and different types of economies,
and they must adhere to legal and regulatory standards to ensure fairness and sustainability.

Businesses can be categorized by ownership structure, industry type, and the nature of their
operations. Common forms of business organizations include sole proprietorships, partnerships,
corporations, and public sector enterprises. Each form has distinct characteristics, legal
implications, and operational processes.

Imagine you want to do business. Which are you interested in? For example, you want to get into
InfoTech industry. What can you do in this industry? Which one do you choose? The following are
the alternatives you have on hand:

 You can buy and sell

 You can set up a small/medium/large industry to manufacture

 You can set up a workshop to repair

 You can develop software

 You can design hardware

  You can be a consultant/trouble-shooter

If you choose any one or more of the above, you have chosen the line of activity. The next step for
you is to decide whether.

 You want to be only owner (It means you what to be sole trader) or

 You want to take some more professionals as co-owners along with you (If means you what
to from partnership with others as partners) or

 You want to be a global player by mobilizing large resources across the country/world

 You want to bring all like-minded people to share the benefits of the common enterprise
(You want to promote a joint stock company) or

 You want to involve government in the IT business (here you want to suggest government
to promote a public enterprise!)

To decide this, it is necessary to know how to evaluate each of these alternatives.

1.1 Meaning and Definition:

A business can be described as an organization or enterprising entity that engages in professional,

commercial or industrial activities. There can be different types of businesses depending on various
factors. Some are for-profit, while some are non-profit. Similarly, their ownership also makes them
different from each other. For instance, there are sole proprietorships, partnerships, Joint Stock
Company, and more. Business is also the efforts and activities of a person who is producing goods
or offering services with the intent to sell them for profit

"Business may be defined as human activity directed towards producing or acquiring wealth
through buying and selling of goods." - L.H. Haney

"Business refers to a form of activity pursued primarily with the object of earning profits for the
benefit of those on whose behalf the activity is conducted." – Dicksee

"Business is a social institution with profit-making as an incentive but with service to the
community as the primary function." - Keith Davis
1.2. Factors affecting the choice of form of business organization

The following are the factors affecting the choice of a business organization:
1. Easy to start and easy to close: The form of business organization should be such that it
should be easy to close. There should not be hassles or long procedures in the process of
setting up business or closing the same.
2. Division of labour: There should be possibility to divide the work among the available
owners.
3. Large amount of resources: Large volume of business requires large volume of resources.
Some forms of business organization do not permit to raise larger resources. Select the one
which permits to mobilize the large resources.
4. Liability: The liability of the owners should be limited to the extent of money invested in
business. It is better if their personal properties are not brought into business to make up the
losses of the business.
5. Secrecy: The form of business organization you select should be such that it should permit
to take care of the business secrets. We know that century old business units are still
surviving only because they could successfully guard their business secrets.
6. Transfer of ownership: There should be simple procedures to transfer the ownership to the
next legal heir.
7. Ownership, Management and control: If ownership, management and control are in the
hands of one or a small group of persons, communication will be effective and coordination
will be easier. Where ownership, management and control are widely distributed, it calls for
a high degree of professional’s skills to monitor the performance of the business.
8. Continuity: The business should continue forever and ever irrespective of the uncertainties
in future.
9. Quick decision-making: Select such a form of business organization, which permits you to
take decisions quickly and promptly. Delay in decisions may invalidate the relevance of the
decisions.
10. Personal contact with customer: Most of the times, customers give us clues to improve
business. So choose such a form, which keeps you close to the customers.
11. Flexibility: In times of rough weather, there should be enough flexibility to shift from one
business to the other. The lesser the funds committed in a particular business, the better it is.
12. Taxation: More profit means more tax. Choose such a form, which permits to pay low tax.

1.3. Forms of Business Organization:

A business organization refers to the structure or framework within which a business operates to
achieve its goals. The form of business organization determines how ownership, control, and profit-
sharing are handled. It also affects the legal responsibilities, risks, and tax obligations of the
business.
There are several forms of business organizations, each with distinct characteristics, advantages,
and disadvantages. These forms range from simple structures like sole proprietorships to more
complex arrangements such as corporations. The most common forms include:

a) Sole Proprietorship.

b) Partnership

c) Joint Stock Company

d) Public Sector Enterprises.

1.4. Sole Proprietorship or Sole Trader:

The sole trader is the simplest, oldest and natural form of business organization. It is also called
sole proprietorship. ‘Sole’ means one. ‘Sole trader’ implies that there is only one trader who is the
owner of the business.
It is a one-man form of organization wherein the trader assumes all the risk of ownership carrying
out the business with his own capital, skill and intelligence. He is the boss for himself. He has total
operational freedom. He is the owner, Manager and controller. He has total freedom and flexibility.
Full control lies with him. He can take his own decisions. He can choose or drop a particular
product or business based on its merits. He need not discuss this with anybody. He is responsible
for himself. This form of organization is popular all over the world. Restaurants, Supermarkets, pan
shops, medical shops, hosiery shops etc.

Features

 It is easy to start a business under this form and also easy to close.
 He introduces his own capital. Sometimes, he may borrow, if necessary
 He enjoys all the profits and in case of loss, he lone suffers.
 He has unlimited liability which implies that his liability extends to his personal properties
in case of loss.
 He has a high degree of flexibility to shift from one business to the other.
 Business secretes can be guarded well
 There is no continuity. The business comes to a close with the death, illness or insanity of
the sole trader. Unless, the legal heirs show interest to continue the business, the business
cannot be restored.
 He has total operational freedom. He is the owner, manager and controller.
 He can be directly in touch with the customers.
 He can take decisions very fast and implement them promptly.
 Rates of tax, for example, income tax and so on are comparatively very low.
Advantages

The following are the advantages of the sole trader from of business organization:
1. Easy to start and easy to close: Formation of a sole trader from of organization is
relatively easy even closing the business is easy.
2. Personal contact with customers directly: Based on the tastes and preferences of the
customers the stocks can be maintained.
3. Prompt decision-making: To improve the quality of services to the customers, he can take
any decision and implement the same promptly. He is the boss and he is responsible for his
business Decisions relating to growth or expansion can be made promptly.
4. High degree of flexibility: Based on the profitability, the trader can decide to continue or
change the business, if need be.
5. Secrecy: Business secrets can well be maintained because there is only one trader.
6. Low rate of taxation: The rate of income tax for sole traders is relatively very low.
7. Direct motivation: If there are profits, all the profits belong to the trader himself. In other
words. If he works more hard, he will get more profits. This is the direct motivating factor.
At the same time, if he does not take active interest, he may stand to lose badly also.
8. Total Control: The ownership, management and control are in the hands of the sole trader
and hence it is easy to maintain the hold on business.
9. Minimum interference from government: Except in matters relating to public interest,
government does not interfere in the business matters of the sole trader. The sole trader is
free to fix price for his products/services if he enjoys monopoly market.
10. Transferability: The legal heirs of the sole trader may take the possession of the business.

Disadvantages

The following are the disadvantages of sole trader form:

1. Unlimited liability: The liability of the sole trader is unlimited. It means that the sole trader
has to bring his personal property to clear off the loans of his business. From the legal point
of view, he is not different from his business.
2. Limited amounts of capital: The resources a sole trader can mobilize cannot be very large
and hence this naturally sets a limit for the scale of operations.
3. No division of labour: All the work related to different functions such as marketing,
production, finance, labour and so on has to be taken care of by the sole trader himself.
There is nobody else to take his burden. Family members and relatives cannot show as
much interest as the trader takes.
4. Uncertainty: There is no continuity in the duration of the business. On the death, insanity
of insolvency the business may be come to an end.
5. Inadequate for growth and expansion: This from is suitable for only small size, one-man-
show type of organizations. This may not really work out for growing and expanding
organizations.
6. Lack of specialization: The services of specialists such as accountants, market researchers,
consultants and so on, are not within the reach of most of the sole traders.
 7. More competition: Because it is easy to set up a small business, there is a high degree of
competition among the small businessmen and a few who are good in taking care of
customer requirements along can service.
8. Low bargaining power: The sole trader is the in the receiving end in terms of loans or
supply of raw materials. He may have to compromise many times regarding the terms and
conditions of purchase of materials or borrowing loans from the finance houses or banks.

1.5. PARTNERSHIP
Partnership is an improved from of sole trader in certain respects. Where there are like-minded
persons with resources, they can come together to do the business and share the profits/losses of the
business in an agreed ratio. Persons who have entered into such an agreement are individually
called ‘partners’ and collectively called ‘firm’. The relationship among partners is called a
partnership.
Indian Partnership Act, 1932 defines partnership as the relationship between two or more persons
who agree to share the profits of the business carried on by all or any one of them acting for all.

Features

1. Relationship: Partnership is a relationship among persons. It is relationship resulting out of

an agreement.
2. Two or more persons: There should be two or more number of persons.
3. There should be a business: Business should be conducted.
4. Agreement: Persons should agree to share the profits/losses of the business
5. Carried on by all or any one of them acting for all: The business can be carried on by all
or any one of the persons acting for all. This means that the business can be carried on by
one person who is the agent for all other persons. Every partner is both an agent and a
principal. Agent for other partners and principal for himself. All the partners are agents and
the ‘partnership’ is their principal.
The following are the other features:
(a) Unlimited liability: The liability of the partners is unlimited. The partnership and partners,
in the eye of law, and not different but one and the same. Hence, the partners have to bring
their personal assets to clear the losses of the firm, if any.
(b) Number of partners: According to the Indian Partnership Act, the minimum number of
partners should be two and the maximum number if restricted, as given below:
 10 partners is case of banking business
 20 in case of non-banking business
(c) Division of labour: Because there are more than two persons, the work can be divided
among the partners based on their aptitude.
(d) Personal contact with customers: The partners can continuously be in touch with the
customers to monitor their requirements.
(e) Flexibility: All the partners are likeminded persons and hence they can take any decision
relating to business.
Partnership Deed:

The written agreement among the partners is called ‘the partnership deed’. It contains the terms and
conditions governing the working of partnership. The following are contents of the partnership
deed.
1. Names and addresses of the firm and partners
2. Nature of the business proposed
3. Duration
4. Amount of capital of the partnership and the ratio for contribution by each of the partners.
5. Their profit sharing ration (this is used for sharing losses also)
6. Rate of interest charged on capital contributed, loans taken from the partnership and the
amounts drawn, if any, by the partners from their respective capital balances.
7. The amount of salary or commission payable to any partner
8. Procedure to value good will of the firm at the time of admission of a new partner,
retirement of death of a partner
9. Allocation of responsibilities of the partners in the firm
10. Procedure for dissolution of the firm
11. Name of the arbitrator to whom the disputes, if any, can be referred to for settlement.
12. Special rights, obligations and liabilities of partners(s), if any.

Kind of Partners
The following are the different kinds of partners:
1. Active Partner: Active partner takes active part in the affairs of the partnership. He is also
called working partner.
2. Sleeping Partner: Sleeping partner contributes to capital but does not take part in the
affairs of the partnership.
3. Nominal Partner: Nominal partner is partner just for namesake. He neither contributes to
capital nor takes part in the affairs of business. Normally, the nominal partners are those
who have good business connections, and are well places in the society.
4. Partner by Estoppels: Estoppels means behavior or conduct. Partner by estoppels gives an
impression to outsiders that he is the partner in the firm. In fact be neither contributes to
capital, nor takes any role in the affairs of the partnership.
5. Partner by holding out: If partners declare a particular person (having social status) as
partner and this person does not contradict even after he comes to know such declaration, he
is called a partner by holding out and he is liable for the claims of third parties. However,
the third parties should prove they entered into contract with the firm in the belief that he is
the partner of the firm. Such a person is called partner by holding out.
6. Minor Partner: Minor has a special status in the partnership. A minor can be admitted for
the benefits of the firm. A minor is entitled to his share of profits of the firm. The liability of
a minor partner is limited to the extent of his contribution of the capital of the firm.
Right of partners

Every partner has right

(a) To take part in the management of business
(b) To express his opinion
(c) Of access to and inspect and copy and book of accounts of the firm
(d) To share equally the profits of the firm in the absence of any specific agreement to the
contrary
(e) To receive interest on capital at an agreed rate of interest from the profits of the firm
(f) To receive interest on loans, if any, extended to the firm.
(g) To be indemnified for any loss incurred by him in the conduct of the business
(h) To receive any money spent by him in the ordinary and proper conduct of the business of
the firm.

Advantages
The following are the advantages of the partnership from:
1. Easy to form: Once there is a group of like-minded persons and good business proposal, it
is easy to start and register a partnership.
2. Availability of larger amount of capital: More amount of capital can be raised from more
number of partners.
3. Division of labour: The different partners come with varied backgrounds and skills. This
facilities division of labour.
4. Flexibility: The partners are free to change their decisions, add or drop a particular product
or start a new business or close the present one and so on.
5. Personal contact with customers: There is scope to keep close monitoring with customers
requirements by keeping one of the partners in charge of sales and marketing. Necessary
changes can be initiated based on the merits of the proposals from the customers.
6. Quick decisions and prompt action: If there is consensus among partners, it is enough to
implement any decision and initiate prompt action. Sometimes, it may more time for the
partners on strategic issues to reach consensus.
7. The positive impact of unlimited liability: Every partner is always alert about his
impending danger of unlimited liability. Hence he tries to do his best to bring profits for the
partnership firm by making good use of all his contacts.
Disadvantages:
The following are the disadvantages of partnership:
1. Formation of partnership is difficult: Only like-minded persons can start a partnership. It
is sarcastically said,’ it is easy to find a life partner, but not a business partner’.
2. Liability: The partners have joint and several liabilities beside unlimited liability. Joint and
several liability puts additional burden on the partners, which means that even the personal
properties of the partner or partners can be attached. Even when all but one partner become
insolvent, the solvent partner has to bear the entire burden of business loss.
3. Lack of harmony or cohesiveness: It is likely that partners may not, most often work as a
group with cohesiveness. This result in mutual conflicts, an attitude of suspicion and crisis
 of confidence. Lack of harmony results in delay in decisions and paralyses the entire
operations.
4. Limited growth: The resources when compared to sole trader, a partnership may raise little
more. But when compare to the other forms such as a company, resources raised in this
form of organization are limited.
5. Instability: The partnership form is known for its instability. The firm may be dissolved on
death, insolvency or insanity of any of the partners.
6. Lack of Public confidence: Public and even the financial institutions look at the
unregistered firm with a suspicious eye. Though registration of the firm under the Indian
Partnership Act is a solution of such problem, this cannot revive public confidence into this
form of organization overnight. The partnership can create confidence in other only with
their performance.

1.6. Joint Stock Company:

The joint stock company emerges from the limitations of partnership such as joint and several
liability, unlimited liability, limited resources and uncertain duration and so on. Normally, to take
part in a business, it may need large money and we cannot foretell the fate of business. It is not
literally possible to get into business with little money. Against this background, it is interesting to
study the functioning of a joint stock company. The main principle of the joint stock company from
is to provide opportunity to take part in business with a low investment as possible say Rs.1000.
Joint Stock Company has been a boon for investors with moderate funds to invest.
The word ‘ company’ has a Latin origin, com means ‘ come together’, pany means ‘ bread’, joint
stock company means, people come together to earn their livelihood by investing in the stock of
company jointly.

Company Defined

Lord Justice Lindley explained the concept of the joint stock company form of organization as ‘an
association of many persons who contribute money or money’s worth to a common stock and
employ it for a common purpose.

Features

This definition brings out the following features of the company:

1. Artificial person: The Company has no form or shape. It is an artificial person created by
law. It is intangible, invisible and existing only, in the eyes of law.
2. Separate legal existence: it has an independence existence, it separate from its members. It
can acquire the assets. It can borrow for the company. It can sue other if they are in default
in payment of dues, breach of contract with it, if any. Similarly, outsiders for any claim can
sue it. A shareholder is not liable for the acts of the company. Similarly, the shareholders
cannot bind the company by their acts.
3. Voluntary association of persons: The Company is an association of voluntary association
of persons who want to carry on business for profit. To carry on business, they need capital.
So they invest in the share capital of the company.
 4. Limited Liability: The shareholders have limited liability i.e., liability limited to the face
value of the shares held by him. In other words, the liability of a shareholder is restricted to
the extent of his contribution to the share capital of the company. The shareholder need not
pay anything, even in times of loss for the company, other than his contribution to the share
capital.
5. Capital is divided into shares: The total capital is divided into a certain number of units.
Each unit is called a share. The price of each share is priced so low that every investor
would like to invest in the company. The companies promoted by promoters of good
standing (i.e., known for their reputation in terms of reliability character and dynamism) are
likely to attract huge resources.
6. Transferability of shares: In the company form of organization, the shares can be
transferred from one person to the other. A shareholder of a public company can cell sell his
holding of shares at his will. However, the shares of a private company cannot be
transferred. A private company restricts the transferability of the shares.
7. Common Seal: As the company is an artificial person created by law has no physical form,
it cannot sign its name on a paper; so, it has a common seal on which its name is engraved.
The common seal should affix every document or contract; otherwise the company is not
bound by such a document or contract.
8. Perpetual succession: ‘Members may comes and members may go, but the company
continues forever and ever’ A. company has uninterrupted existence because of the right
given to the shareholders to transfer the shares.
9. Ownership and Management separated: The shareholders are spread over the length and
breadth of the country, and sometimes, they are from different parts of the world. To
facilitate administration, the shareholders elect some among themselves or the promoters of
the company as directors to a Board, which looks after the management of the business. The
Board recruits the managers and employees at different levels in the management. Thus the
management is separated from the owners.
10. Winding up: Winding up refers to the putting an end to the company. Because law creates
it, only law can put an end to it in special circumstances such as representation from
creditors of financial institutions, or shareholders against the company that their interests are
not safeguarded. The company is not affected by the death or insolvency of any of its
members.
11. The name of the company ends with ‘limited’: it is necessary that the name of the
company ends with limited (Ltd.) to give an indication to the outsiders that they are dealing
with the company with limited liability and they should be careful about the liability aspect
of their transactions with the company.

Formation of Joint Stock Company

There are two stages in the formation of a joint stock company. They are:
 (a) To obtain Certificates of Incorporation
(b) To obtain certificate of commencement of Business
Certificate of Incorporation: The certificate of Incorporation is just like a ‘date of birth’
certificate. It certifies that a company with such and such a name is born on a particular day.

Certificate of commencement of Business: A private company need not obtain the certificate of
commencement of business. It can start its commercial operations immediately after obtaining the
certificate of Incorporation.
The persons who conceive the idea of starting a company and who organize the necessary initial
resources are called promoters. The vision of the promoters forms the backbone for the company in
the future to reckon with.
The promoters have to file the following documents, along with necessary fee, with a registrar of
joint stock companies to obtain certificate of incorporation:
(a) Memorandum of Association: The Memorandum of Association is also called the charter
of the company. It outlines the relations of the company with the outsiders. If furnishes all
its details in six clause such as (ii) Name clause (II) situation clause (iii) objects clause (iv)
Capital clause and (vi) subscription clause duly executed by its subscribers.
(b) Articles of association: Articles of Association furnishes the byelaws or internal rules
government the internal conduct of the company.
(c) The list of names and address of the proposed directors and their willingness, in writing to
act as such, in case of registration of a public company.
(d) A statutory declaration that all the legal requirements have been fulfilled. The declaration
has to be duly signed by any one of the following: Company secretary in whole practice,
the proposed director, legal solicitor, chartered accountant in whole time practice or
advocate of High court.
The registrar of joint stock companies peruses and verifies whether all these documents are in order
or not. If he is satisfied with the information furnished, he will register the documents and then
issue a certificate of incorporation, if it is private company, it can start its business operation
immediately after obtaining certificate of incorporation.

Advantages:
The following are the advantages of a joint Stock Company
1. Mobilization of larger resources: A joint stock company provides opportunity for the
investors to invest, even small sums, in the capital of large companies. The facilities rising
of larger resources.
2. Separate legal entity: The Company has separate legal entity. It is registered under Indian
Companies Act, 1956.
3. Limited liability: The shareholder has limited liability in respect of the shares held by him.
In no case, does his liability exceed more than the face value of the shares allotted to him.
4. Transferability of shares: The shares can be transferred to others. However, the private
company shares cannot be transferred.
5. Liquidity of investments: By providing the transferability of shares, shares can be
converted into cash.
6. Inculcates the habit of savings and investments: Because the share face value is very low,
this promotes the habit of saving among the common man and mobilizes the same towards
investments in the company.
7. Democracy in management: the shareholders elect the directors in a democratic way in the
general body meetings. The shareholders are free to make any proposals, question the
practice of the management, suggest the possible remedial measures, as they perceive, The
directors respond to the issue raised by the shareholders and have to justify their actions.
8. Economics of large scale production: Since the production is in the scale with large funds
at
9. Continued existence: The Company has perpetual succession. It has no natural end. It
continues forever and ever unless law put an end to it.
10. Institutional confidence: Financial Institutions prefer to deal with companies in view of
their professionalism and financial strengths.
11. Professional management: With the larger funds at its disposal, the Board of Directors
recruits competent and professional managers to handle the affairs of the company in a
professional manner.
12. Growth and Expansion: With large resources and professional management, the company
can earn good returns on its operations, build good amount of reserves and further consider
the proposals for growth and expansion.

Disadvantages

1. Formation of company is a long drawn procedure: Promoting a joint stock company

involves a long drawn procedure. It is expensive and involves large number of legal
formalities.
2. High degree of government interference: The government brings out a number of rules
and regulations governing the internal conduct of the operations of a company such as
meetings, voting, audit and so on, and any violation of these rules results into statutory
lapses, punishable under the companies act.
3. Inordinate delays in decision-making: As the size of the organization grows, the number
of levels in organization also increases in the name of specialization. The more the number
of levels, the more is the delay in decision-making. Sometimes, so-called professionals do
not respond to the urgencies as required. It promotes delay in administration, which is
referred to ‘red tape and bureaucracy’.
 4. Lack or initiative: In most of the cases, the employees of the company at different levels
show slack in their personal initiative with the result, the opportunities once missed do not
recur and the company loses the revenue.
5. Lack of responsibility and commitment: In some cases, the managers at different levels
are afraid to take risk and more worried about their jobs rather than the huge funds invested
in the capital of the company lose the revenue.
6. Lack of responsibility and commitment: In some cases, the managers at different levels
are afraid to take risk and more worried about their jobs rather than the huge funds invested
in the capital of the company. Where managers do not show up willingness to take
responsibility, they cannot be considered as committed. They will not be able to handle the
business risks.

1.7. Public enterprises

Public enterprises occupy an important position in the Indian economy. Today, public enterprises
provide the substance and heart of the economy. Its investment of over Rs.10,000 crore is in heavy
and basic industry, and infrastructure like power, transport and communications. The concept of
public enterprise in Indian dates back to the era of pre-independence.

Genesis of Public Enterprises

In consequence to declaration of its goal as socialistic pattern of society in 1954, the Government of
India realized that it is through progressive extension of public enterprises only, the following aims
of our five years plans can be fulfilled.

 Higher production

 Greater employment

 Economic equality, and

 Dispersal of economic power

The government found it necessary to revise its industrial policy in 1956 to give it a socialistic bent.
Forms of public enterprises

Public enterprises can be classified into three forms:

(a) Departmental undertaking

(b) Public corporation

(c) Government company

These are explained below

a) Departmental Undertaking

This is the earliest from of public enterprise. Under this form, the affairs of the public enterprise are
carried out under the overall control of one of the departments of the government. The government
department appoints a managing director (normally a civil servant) for the departmental
undertaking. He will be given the executive authority to take necessary decisions. The departmental
undertaking does not have a budget of its own. As and when it wants, it draws money from the
government exchequer and when it has surplus money, it deposits it in the government exchequer.
However, it is subject to budget, accounting and audit controls.

Examples for departmental undertakings are Railways, Department of Posts, All India Radio,
Doordarshan, Defence undertakings like DRDL, DLRL, ordinance factories, and such.

Features:

1. Under the control of a government department: The departmental undertaking is not an

independent organization. It has no separate existence. It is designed to work under close
control of a government department. It is subject to direct ministerial control.

2. More financial freedom: The departmental undertaking can draw funds from government
account as per the needs and deposit back when convenient.

3. Like any other government department: The departmental undertaking is almost similar
to any other government department

4. Budget, accounting and audit controls: The departmental undertaking has to follow
guidelines (as applicable to the other government departments) underlying the budget
preparation, maintenance of accounts, and getting the accounts audited internally and by
external auditors.

5. More a government organization, less a business organization . The set up of a

departmental undertaking is more rigid, less flexible, slow in responding to market needs.
Advantages

1. Effective control: Control is likely to be effective because it is directly under the Ministry.

2. Responsible Executives: Normally the administration is entrusted to a senior civil servant.

The administration will be organized and effective.

3. Less scope for mystification of funds: Departmental undertaking does not draw any money
more than is needed, that too subject to ministerial sanction and other controls. So chances
for mis-utilisation are low.

4. Adds to Government revenue: The revenue of the government is on the rise when the
revenue of the departmental undertaking is deposited in the government account.

Disadvantages

1. Decisions delayed: Control is centralized. This results in lower degree of flexibility.

Officials in the lower levels cannot take initiative. Decisions cannot be fast and actions
cannot be prompt.

2. No incentive to maximize earnings: The departmental undertaking does not retain any
surplus with it. So there is no inventive for maximizing the efficiency or earnings.

3. Slow response to market conditions: Since there is no competition, there is no profit

motive; there is no incentive to move swiftly to market needs.

4. Redtapism and bureaucracy: The departmental undertakings are in the control of a civil
servant and under the immediate supervision of a government department. Administration
gets delayed substantially.

5. Incidence of more taxes: At times, in case of losses, these are made up by the government
funds only. To make up these, there may be a need for fresh taxes, which is undesirable.

Any business organization to be more successful needs to be more dynamic, flexible, and
responsive to market conditions, fast in decision marking and prompt in actions. None of these
qualities figure in the features of a departmental undertaking. It is true that departmental
undertaking operates as a extension to the government. With the result, the government may miss
certain business opportunities. So as not to miss business opportunities, the government has thought
of another form of public enterprise, that is, Public corporation.
 b) Public corporation

Having released that the routing government administration would not be able to cope up with the
demand of its business enterprises, the Government of India, in 1948, decided to organize some of
its enterprises as statutory corporations. In pursuance of this, Industrial Finance Corporation,
Employees’ State Insurance Corporation was set up in 1948.

Public corporation is a ‘right mix of public ownership, public accountability and business
management for public ends’. The public corporation provides machinery, which is flexible, while
at the same time retaining public control.

Definition

A public corporation is defined as a ‘body corporate create by an Act of Parliament or Legislature

and notified by the name in the official gazette of the central or state government. It is a corporate
entity having perpetual succession, and common seal with power to acquire, hold, dispose off
property, sue and be sued by its name”.

Examples of a public corporation are Life Insurance Corporation of India, Unit Trust of India,
Industrial Finance Corporation of India, Damodar Valley Corporation and others.

Features

1. A body corporate: It has a separate legal existence. It is a separate company by itself. If can
raise resources, buy and sell properties, by name sue and be sued.

2. More freedom and day-to-day affairs: It is relatively free from any type of political
interference. It enjoys administrative autonomy.

3. Freedom regarding personnel: The employees of public corporation are not government
civil servants. The corporation has absolute freedom to formulate its own personnel policies
and procedures, and these are applicable to all the employees including directors.

4. Perpetual succession: A statute in parliament or state legislature creates it. It continues

forever and till a statue is passed to wind it up.

5. Financial autonomy: Through the public corporation is fully owned government

organization, and the initial finance are provided by the Government, it enjoys total
financial autonomy, Its income and expenditure are not shown in the annual budget of the
government, it enjoys total financial autonomy. Its income and expenditure are not shown in
the annual budget of the government. However, for its freedom it is restricted regarding
capital expenditure beyond the laid down limits, and raising the capital through capital
market.
 6. Commercial audit: Except in the case of banks and other financial institutions where
chartered accountants are auditors, in all corporations, the audit is entrusted to the
comptroller and auditor general of India.

7. Run on commercial principles: As far as the discharge of functions, the corporation shall
act as far as possible on sound business principles.

Advantages

1. Independence, initiative and flexibility: The corporation has an autonomous set up. So it
is independent, take necessary initiative to realize its goals, and it can be flexible in its
decisions as required.

2. Scope for Redtapism and bureaucracy minimized: The Corporation has its own policies
and procedures. If necessary they can be simplified to eliminate redtapism and bureaucracy,
if any.

3. Public interest protected: The corporation can protect the public interest by making its
policies more public friendly, Public interests are protected because every policy of the
corporation is subject to ministerial directives and board parliamentary control.

4. Employee friendly work environment: Corporation can design its own work culture and
train its employees accordingly. It can provide better amenities and better terms of service to
the employees and thereby secure greater productivity.

5. Competitive prices: the corporation is a government organization and hence can afford
with minimum margins of profit, It can offer its products and services at competitive prices.

6. Economics of scale: By increasing the size of its operations, it can achieve economics of
large-scale production.

7. Public accountability: It is accountable to the Parliament or legislature; it has to submit its

annual report on its working results.

Disadvantages

1. Continued political interference: the autonomy is on paper only and in reality, the
continued.

2. Misuse of Power: In some cases, the greater autonomy leads to misuse of power. It takes
time to unearth the impact of such misuse on the resources of the corporation. Cases of
misuse of power defeat the very purpose of the public corporation.
 3. Burden for the government: Where the public corporation ignores the commercial
principles and suffers losses, it is burdensome for the government to provide subsidies to
make up the losses.

c) Government Company

Section 617 of the Indian Companies Act defines a government company as “any company in
which not less than 51 percent of the paid up share capital” is held by the Central Government or by
any State Government or Governments or partly by Central Government and partly by one or more
of the state Governments and includes and company which is subsidiary of government company as
thus defined”.

A government company is the right combination of operating flexibility of privately organized

companies with the advantages of state regulation and control in public interest.

Government companies differ in the degree of control and their motive also.

Some government companies are promoted as

 industrial undertakings (such as Hindustan Machine Tools, Indian Telephone Industries, and
so on)

 Promotional agencies (such as National Industrial Development Corporation, National

Small Industries Corporation, and so on) to prepare feasibility reports for promoters who
want to set up public or private companies.

 Agency to promote trade or commerce. For example, state trading corporation, Export
Credit Guarantee Corporation and so such like.

 A company to take over the existing sick companies under private management (E.g.
Hindustan Shipyard)

 A company established as a totally state enterprise to safeguard national interests such as

Hindustan Aeronautics Ltd. And so on.

 Mixed ownership company in collaboration with a private consult to obtain technical know
how and guidance for the management of its enterprises, e.g. Hindustan Cables)
Features

The following are the features of a government company:

1. Like any other registered company: It is incorporated as a registered company under the
Indian companies Act. 1956. Like any other company, the government company has
separate legal existence. Common seal, perpetual succession, limited liability, and so on.
The provisions of the Indian Companies Act apply for all matters relating to formation,
administration and winding up. However, the government has a right to exempt the
application of any provisions of the government companies.

2. Shareholding: The majority of the share are held by the Government, Central or State,
partly by the Central and State Government(s), in the name of the President of India, It is
also common that the collaborators and allotted some shares for providing the transfer of
technology.

3. Directors are nominated: As the government is the owner of the entire or majority of the
share capital of the company, it has freedom to nominate the directors to the Board.
Government may consider the requirements of the company in terms of necessary
specialization and appoints the directors accordingly.

4. Administrative autonomy and financial freedom: A government company functions

independently with full discretion and in the normal administration of affairs of the
undertaking.

5. Subject to ministerial control: Concerned minister may act as the immediate boss. It is
because it is the government that nominates the directors, the minister issue directions for a
company and he can call for information related to the progress and affairs of the company
any time.

Advantages

1. Formation is easy: There is no need for an Act in legislature or parliament to promote a

government company. A Government company can be promoted as per the provisions of the
companies Act. Which is relatively easier?

2. Separate legal entity: It retains the advantages of public corporation such as autonomy,
legal entity.

3. Ability to compete: It is free from the rigid rules and regulations. It can smoothly function
with all the necessary initiative and drive necessary to complete with any other private
organization. It retains its independence in respect of large financial resources, recruitment
of personnel, management of its affairs, and so on.
 4. Flexibility: A Government company is more flexible than a departmental undertaking or
public corporation. Necessary changes can be initiated, which the framework of the
company law. Government can, if necessary, change the provisions of the Companies Act.
If found restricting the freedom of the government company. The form of Government
Company is so flexible that it can be used for taking over sick units promoting strategic
industries in the context of national security and interest.

5. Quick decision and prompt actions: In view of the autonomy, the government company
take decision quickly and ensure that the actions and initiated promptly.

6. Private participation facilitated: Government company is the only from providing scope
for private participation in the ownership. The facilities to take the best, necessary to
conduct the affairs of business, from the private sector and also from the public sector.

Disadvantages

1. Continued political and government interference: Government seldom leaves the

government company to function on its own. Government is the major shareholder and it
dictates its decisions to the Board. The Board of Directors gets these approved in the general
body. There were a number of cases where the operational polices were influenced by the
whims and fancies of the civil servants and the ministers.

2. Higher degree of government control: The degree of government control is so high that
the government company is reduced to mere adjuncts to the ministry and is, in majority of
the cases, not treated better than the subordinate organization or offices of the government.

3. Evades constitutional responsibility: A government company is creating by executive

action of the government without the specific approval of the parliament or Legislature.

4. Poor sense of attachment or commitment: The members of the Board of Management of

government companies and from the ministerial departments in their ex-officio capacity.
The lack the sense of attachment and do not reflect any degree of commitment to lead the
company in a competitive environment.

5. Divided loyalties: The employees are mostly drawn from the regular government
departments for a defined period. After this period, they go back to their government
departments and hence their divided loyalty dilutes their interest towards their job in the
government company.

6. Flexibility on paper: The powers of the directors are to be approved by the concerned
Ministry, particularly the power relating to borrowing, increase in the capital, appointment
of top officials, entering into contracts for large orders and restrictions on capital
expenditure. The government companies are rarely allowed to exercise their flexibility and
independence.
2. MARKET

Market is a place where buyer and seller meet, goods and services are offered for the sale and
transfer of ownership occurs. A market may be also defined as the demand made by a certain group
of potential buyers for a good or service. The former one is a narrow concept and later one, a
broader concept. Economists describe a market as a collection of buyers and sellers who transact
over a particular product or product class (the housing market, the clothing market, the grain market
etc.). For business purpose we define a market as people or organizations with wants (needs) to
satisfy, money to spend, and the willingness to spend it. Broadly, market represents the structure
and nature of buyers and sellers for a commodity/service and the process by which the price of the
commodity or service is established. Hence the understanding on the market structure and the
nature of competition are a pre-requisite in price determination.

2.1 Different Market Structures

Market structure describes the competitive environment in the market for any good or service. A
market consists of all firms and individuals who are willing and able to buy or sell a particular
product. This includes firms and individuals currently engaged in buying and selling a particular
product, as well as potential entrants.

The determination of price is affected by the competitive structure of the market. This is because
the firm operates in a market and not in isolation. In making decisions concerning economic
variables it is affected, as are all institutions in society by its environment.

I) Perfect Competition

Perfect competition refers to a market structure where competition among the sellers and buyers
prevails in its most perfect form. In a perfectly competitive market, a single market price prevails
for the commodity, which is determined by the forces of total demand and total supply in the
market.
Characteristics of Perfect Competition: The following features characterize a perfectly
competitive market:

1. A large number of buyers and sellers: The number of buyers and sellers is large and the
share of each one of them in the market is so small that none has any influence on the
market price.

2. Homogeneous product: The product of each seller is totally undifferentiated from those of
the others.

3. Free entry and exit: Any buyer and seller is free to enter or leave the market of the
commodity.

4. Perfect knowledge: All buyers and sellers have perfect knowledge about the market for the
commodity.

5. Indifference: No buyer has a preference to buy from a particular seller and no seller to sell
to a particular buyer.

6. Non-existence of transport costs: Perfectly competitive market also assumes the non-
existence of transport costs.

7. Perfect mobility of factors of production: Factors of production must be in a position to

move freely into or out of industry and from one firm to the other.

8. The firm as price taker: The single firm takes its price from the industry, and is,
consequently, referred to as a price taker. The industry is composed of all firms in the
industry and the market price is where market demand is equal to market supply. Each
single firm must charge this price and cannot diverge from it.

Under such a market no single buyer or seller plays a significant role in price determination. One
the other hand all of them jointly determine the price. The price is determined in the industry,
which is composed of all the buyers and seller for the commodity. The demand curve facing the
industry is the sum of all consumers’ demands at various prices. The industry supply curve is the
sum of all sellers’ supplies at various prices.

II) Imperfect Competition

Imperfect competition refers to any market structure where the conditions of perfect competition
are not fully met. In perfect competition, many firms sell identical products, and no single firm can
influence the market price. Imperfect competition, by contrast, occurs when individual firms have
some control over prices and product offerings due to factors such as product differentiation,
limited competition, or barriers to entry.
a) Monopoly

The word monopoly is made up of two syllables, Mono and poly. Mono means single while poly
implies selling. Thus monopoly is a form of market organization in which there is only one seller of
the commodity. There are no close substitutes for the commodity sold by the seller. Pure monopoly
is a market situation in which a single firm sells a product for which there is no good substitute.

Features of monopoly: The following are the features of monopoly.

1. Single person or a firm: A single person or a firm controls the total supply of the
commodity. There will be no competition for monopoly firm. The monopolist firm is the
only firm in the whole industry.

2. No close substitute: The goods sold by the monopolist shall not have closely competition
substitutes. Even if price of monopoly product increase people will not go in far substitute.
For example: If the price of electric bulb increase slightly, consumer will not go in for
kerosene lamp.

3. Large number of Buyers: Under monopoly, there may be a large number of buyers in the
market who compete among themselves.

4. Price Maker: Since the monopolist controls the whole supply of a commodity, he is a
price-maker, and then he can alter the price.

5. Supply and Price: The monopolist can fix either the supply or the price. He cannot fix
both. If he charges a very high price, he can sell a small amount. If he wants to sell more, he
has to charge a low price. He cannot sell as much as he wishes for any price he pleases.

6. Downward Sloping Demand Curve: The demand curve (average revenue curve) of
monopolist slopes downward from left to right. It means that he can sell more only by
lowering price.

b) Monopolistic competition

Perfect competition and pure monopoly are rate phenomena in the real world. Instead, almost every
market seems to exhibit characteristics of both perfect competition and monopoly. Hence in the real
world it is the state of imperfect competition lying between these two extreme limits that work.
Edward. H. Chamberlain developed the theory of monopolistic competition, which presents a more
realistic picture of the actual market structure and the nature of competition.

Characteristics of Monopolistic Competition:

The important characteristics of monopolistic competition are:

1. Existence of Many firms: Industry consists of a large number of sellers, each one of whom
does not feel dependent upon others. Every firm acts independently without bothering about
the reactions of its rivals. The size is so large that an individual firm has only a relatively
small part in the total market, so that each firm has very limited control over the price of the
product. As the number is relatively large it is difficult for these firms to determine its price-
output policies without considering the possible reactions of the rival forms. A
monopolistically competitive firm follows an independent price policy.

2. Product Differentiation: Product differentiation means that products are different in some
ways, but not altogether so. The products are not identical but the same time they will not be
entirely different from each other. IT really means that there are various monopolist firms
competing with each other. An example of monopolistic competition and product
differentiation is the toothpaste produced by various firms.

3. Large Number of Buyers: There are large number buyers in the market. But the buyers have
their own brand preferences. So the sellers are able to exercise a certain degree of monopoly
over them. Each seller has to plan various incentive schemes to retain the customers who
patronize his products.

4. Free Entry and Exist of Firms: As in the perfect competition, in the monopolistic
competition too, there is freedom of entry and exit. That is, there is no barrier as found under
monopoly.

5. Selling costs: Since the products are close substitute much effort is needed to retain the
existing consumers and to create new demand. So each firm has to spend a lot on selling cost,
which includes cost on advertising and other sale promotion activities.

6. Imperfect Knowledge: Imperfect knowledge about the product leads to monopolistic

competition. If the buyers are fully aware of the quality of the product they cannot be
influenced much by advertisement or other sales promotion techniques. But in the business
world we can see that thought the quality of certain products is the same, effective
advertisement and sales promotion techniques make certain brands monopolistic. For
examples, effective dealer service backed by advertisement-helped popularization of some
brands through the quality of almost all the cement available in the market remains the same.

7. The Group: Under perfect competition the term industry refers to all collection of firms
producing a homogenous product. But under monopolistic competition the products of
various firms are not identical through they are close substitutes. Prof. Chamberlin called the
collection of firms producing close substitute products as a group.

c) Oligopoly
The term oligopoly is derived from two Greek words, oligos meaning a few, and pollen meaning to
sell. Oligopoly is the form of imperfect competition where there are a few firms in the market,
producing either a homogeneous product or producing products, which are close but not perfect
substitute of each other.
Characteristics of Oligopoly
The main features of oligopoly are:
1. Few Firms: There are only a few firms in the industry. Each firm contributes a sizeable
share of the total market. Any decision taken by one firm influence the actions of other
firms in the industry. The various firms in the industry compete with each other.
2. Interdependence: As there are only very few firms, any steps taken by one firm to increase
sales, by reducing price or by changing product design or by increasing advertisement
expenditure will naturally affect the sales of other firms in the industry. An immediate
retaliatory action can be anticipated from the other firms in the industry every time when
one firm takes such a decision. He has to take this into account when he takes decisions. So
the decisions of all the firms in the industry are interdependent.
3. Indeterminate Demand Curve: The interdependence of the firms makes their demand
curve indeterminate. When one firm reduces price other firms also will make a cut in their
prices. So he firm cannot be certain about the demand for its product. Thus the demand
curve facing an oligopolistic firm loses its definiteness and thus is indeterminate as it
constantly changes due to the reactions of the rival firms.
4. Advertising and selling costs: Advertising plays a greater role in the oligopoly market
when compared to other market systems. According to Prof. William J. Banumol “it is only
oligopoly that advertising comes fully into its own”. A huge expenditure on advertising and
sales promotion techniques is needed both to retain the present market share and to increase
it. So Banumol concludes “under oligopoly, advertising can become a life-and-death matter
where a firm which fails to keep up with the advertising budget of its competitors may find
its customers drifting off to rival products.”
5. Price Rigidity: In the oligopoly market price remain rigid. If one firm reduced price it is
with the intention of attracting the customers of other firms in the industry. In order to retain
their consumers they will also reduce price. Thus the pricing decision of one firm results in
a loss to all the firms in the industry. If one firm increases price. Other firms will remain
 silent there by allowing that firm to lost its customers. Hence, no firm will be ready to
change the prevailing price. It causes price rigidity in the oligopoly market.
d) Other Market Structures
Duopoly
Duopoly refers to a market situation in which there are only two sellers. As there are only
two sellers any decision taken by one seller will have reaction from the other. Eg. Coca-Cola and
Pepsi. Usually these two sellers may agree to co-operate each other and share the market equally
between them, So that they can avoid harmful competition.
The duopoly price, in the long run, may be a monopoly price or competitive price, or it may
settle at any level between the monopoly price and competitive price. In the short period, duopoly
price may even fall below the level competitive price with the both the firms earning less than even
the normal price.
Monopsony
Mrs. Joan Robinson was the first writer to use the term monopsony to refer to market, which
there is a single buyer. Monoposony is a single buyer or a purchasing agency, which buys the show,
or nearly whole of a commodity or service produced. It may be created when all consumers of a
commodity are organized together and/or when only one consumer requires that commodity which
no one else requires.
Bilateral Monopoly
A bilateral monopoly is a market situation in which a single seller (Monopoly) faces a single buyer
(Monoposony). It is a market of monopoly-monoposy.
Oligopsony
Oligopsony is a market situation in which there will be a few buyers and many sellers. As the
sellers are more and buyers are few, the price of product will be comparatively low but not as low
as under monopoly.

2.2 Price- Output determination in case of Perfect Competition

a) Short Run

The price and output of the firm are determined, under perfect competition, based on the industry
price and its own costs. The industry price has greater say in this process because the firm’s own
sales are very small and insignificant. The process of price output determination in case of perfect
competition is illustrated in below figure.

The firm's demand curve is horizontal at the price determined in the industry (MR-AR Price). This
demand curve is also known as average revenue curve. This is because if all the units are sold at the
same price, on an average, the revenue to the firm equals its price.

When the average revenue is constant (neither falling nor rising). It will coincide with the marginal
revenue curve. Thus, CC is the demand curve representing the price, average revenue curve, and
also de marginal revenue curve (Price ARMR). Average cost (AC) and marginal cost (MC) are the
firm’s average and marginal cost curves

In below Fig., the firm satisfies both conditions: (a) MR =MC: and (b) MC curve must cut the MR
curve from below. The firm attains equilibrium at point D MR = MC The MC curve passes through
the minimum point of AC curve.

Fig. Equilibrium Output Determination of a Firm Under Perfect Competition in the Short
run

The firm gets higher profits as long as the price (in this case MR or AR) it receives for each unit
exccel the average cost (AC) of production.

OC = QD which is the price.

OF = QE which is the average cost.

OO = FE which is the equilibrium output

Average profit Price minus Average cost

Here, DE is the average profit and the area CDEF is the total profit which constitutes the
supernormal or 'abnormal profits.

Based on its cost function and market condition, the firm may make profits, losses, or just break
ever in the short-run.
Long-run

Having been attracted by supernormal profits, more and more firms enter the industry With the
result, there will be a scramble for scarce inputs among the competing firms pushing the input
prices. Hence, the average cost increases. The entry of more and more firms will expand the supply
pulling down the market price. As a result, the super normal profits hitherto enjoyed by the firms
get eroded. The entry of the firms into the industry continues till the supernormal profits are
completely eroded. In the long-run, the firms will be in a position to enjoy only normal profits but
not supernormal profits. Normal profits are the profits that are just sufficient for the firms to stay in
the business. It is to be noted that normal profits are included in the average cost curve. All those
firms that are not able to earn at least normal profits will leave the industry.

Figure shows the long-run equilibrium position of the firm under perfect competition. Two
conditions are to be fulfilled in the long-ran: (a) MR = MC, (b) AR=AC, and AC must be tangential
to AR at its lowest point. QE is the price and also the long-run average cost (LAC). Long-run
marginal cost (LMC) curve passes through the minimum point of the long-run average cost curve
(LAC) at E, while passing through the marginal revenue curve. E is the equilibrium point and the
firm produces OQ units of output. It be noted that normal profits are not visible to the naked eye
since normal profits are included in the average cost. Long-run average cost includes the
opportunity cost of staying in business.

Fig. Price-output Determination in Case of Long-run Under Perfect Competition

If the market price is below long-run average cost of the firm, the firm will have to quit the indust
since in the long run, the firms have to recover average costs.

3. PRICING METHODS

Pricing objectives or goals give direction to the whole pricing process. Determining what your
objectives are is the first step in pricing. When deciding on pricing objectives you must consider: 1)
the overall financial, marketing, and strategic objectives of the company; 2) the objectives of your
product or brand; 3) consumer price elasticity and price points; and 4) the resources you have
available.

1. Cost-oriented methods of pricing:

a) Cost plus pricing:

Cost plus pricing involves adding a certain percentage to cost in order to fix the price. For instance,
if the cost of a product is Rs. 200 per unit and the marketer expects 10 per cent profit on costs, then
the selling price will be Rs. 220. The difference between the selling price and the cost is the profit.
This method is simpler as marketers can easily determine the costs and add a certain percentage to
arrive at the selling price.

b) Mark-up pricing:

Mark-up pricing is a variation of cost pricing. In this case, mark-ups are calculated as a percentage
of the selling price and not as a percentage of the cost price. Firms that use cost- oriented methods
use mark-up pricing.

2. Competitor-based pricing

If there is strong competition in a market, customers are faced with a wide choice of who to buy
from. They may buy from the cheapest provider or perhaps from the one which offers the best
customer service. But customers will certainly be mindful of what is a reasonable or normal price in
the market.

Most firms in a competitive market do not have sufficient power to be able to set prices above their
competitors. They tend to use "going-rate" pricing – i.e. setting a price that is in line with the
prices charged by direct competitors. In effect such businesses are "price-takers" – they must
accept the going market price as determined by the forces of demand and supply.

An advantage of using competitive pricing is that selling prices should be line with rivals, so price
should not be a competitive disadvantage.

The main problem is that the business needs some other way to attract customers. It has to use non-
price methods to compete – e.g. providing distinct customer service or better availability.

3. Demand – oriented pricing:

a. Perceived value pricing:

The valuation of good or service according to how much consumers are willing to pay for it, rather
than upon its production and delivery costs. Using a perceived value pricing technique might be
somewhat arbitrary, but it can greatly assist in the effective marketing of a product since it sets
product pricing in line with its perceived value by potential buyers.

b. Price Discrimination

Price discrimination is the practice of charging a different price for the same good or service. The
term differential pricing is also used to describe the practice of charging different prices to different
buyers for the same quality and quantity of a product, but it can also refer to a combination of price
differentiation and product differentiation.

4. Strategy Based Pricing:

a) Creaming or skimming

In most skimming, goods are sold at higher prices so that fewer sales are needed to break even.
Selling a product at a high price, sacrificing high sales to gain a high profit is therefore "skimming"
the market. Skimming is usually employed to reimburse the cost of investment of the original
research into the product: commonly used in electronic markets when a new range, such as DVD
players, are firstly dispatched into the market at a high price. This strategy is often used to target
"early adopters" of a product or service. Early adopters generally have a relatively lower price-
sensitivity - this can be attributed to: their need for the product outweighing their need to
economize; a greater understanding of the product's value; or simply having a higher disposable
income. it will maximize profits for the better of the company

b) Penetration Pricing:
A penetration pricing strategy is designed to capture market share by entering the market with a low
price relative to the competition to attract buyers. The idea is that the business will be able to raise
awareness and get people to try the product. Even though penetration pricing may initially create a
loss for the company, the hope is that it will help to generate word-of-mouth and create awareness
amid a crowded market category.

c) Two parts Pricing:

Pricing strategy comprising a fixed (lump-sum) charge that does not vary with usage or
consumption and an additional charge that does vary with usage or consumption. Providers of
services including banking and finance, telecommunications and transport commonly apply two-
part pricing. One reason to set a two-part price is to cover some customer-specific fixed cost, such
as the cost of connection in telecommunications or the cost of line rental.

d) Bundling pricing:

The act of placing several products or services together in a single package and selling for a lower
price than would be charged if the items were sold separately. The package usually includes one big
ticket product and at least one complementary good. Bundled pricing is a marketing method used
by retailers to sell products in high supply. Common examples include option packages on new
cars, value meals at restaurants and cable TV channel plans. Pursuing a bundle pricing strategy
allows you to increase your profit by giving customers a discount.

e) Transfer pricing

Transfer pricing is the setting of the price for goods and services sold between controlled (or
related) legal entities within an enterprise. For example, if a subsidiary company sells goods to a
parent company, the cost of those goods is the transfer price. Legal entities considered under the
control of a single corporation include branches and companies that are wholly or majority owned
ultimately by the parent corporation. Certain jurisdictions consider entities to be under common
control if they share family members on their boards of directors. It can be used as a profit
allocation method to attribute a multinational corporation's net profit (or loss) before tax to
countries where it does business. Transfer pricing results in the setting of prices among divisions
within an enterprise.

f) Cross subsidization

Cross subsidization is the practice of charging higher prices to one group of consumers in order to
subsidize lower prices for another group. State trading enterprises with monopoly control over
marketing agricultural exports are sometimes alleged to cross subsidize, but lack of transparency in
their operations makes it difficult, if not impossible, to determine if that is the case. A strategy
where support for a product comes from the profits generated by another product. This is usually
done to attract customers to a newly introduced product by giving them a lower price. The low
price is sustained by the earnings of another product sold by the same company.

g) Psychological pricing

It is a type of pricing which can be translated into a small incentive that can make a huge impact
psychologically on customers. Customers are more willing to buy the necessary products at $499
than products costing $99. The difference in price is actually completely irrelevant. However, it
make a great difference in the mind of the customers. This strategy can frequently be seen in the
supermarkets and small shops.

PART A

Objective Questions

Module 1 - Introduction to Business - Forms of Business Organizations - Sole Proprietary -

Partnership - Joint Stock Companies - Public Sector Enterprises.

1. Which one of the following is not a factor affecting the choice of a business organization?
( )
(a) Liability (b)Agreement
(c) Quick Decision making (d) Flexibility
2. An agreement to share profit implies: ( )
(a) To share only profits (c) To share only negative profits
(b) To share both profits and losses (d) Neither to share profits nor losses
3. “People may come and people may leave, but I go on forever” is applicable to ______
Business organization. ( )

(a) Sole proprietorship (b) Partnership

(c) Company (d) Joint Hindu Family
4. In the absence of agreement the partners are entitled to share the profits ( )
(a) Proportionate to capital brought in (c) equally
(b) Proportionate to their drawings (d) based on their admission.
5. Certificate of commencement of business should be obtained by ___Company to start its
functions. ( )
(a) Private (b) Statutory
 (c) Public (d) Chartered
6. ____ is not required to private company to start its functions. ( )
(a) Certificate of incorporation (b) Registration
(c) Certificate of commencement of business (d) None

7. ___ partner can enjoy profits but no liability for losses. ( )

(a) Active (b) Sleeping (c) Minor (d) Nominal
8. In public sector unit’s ownership is in the hands of _____. ( )
(a) Private persons (b) Public
(c) Government (d) None
9. If either state government or central government or both have got notless than 51% of share
in the organization. Then that is called____. ( )
(a) Private organization (b) Partnership organization
(c) Government organization (d) Joint sector organization
10. Which of the following statement does not hold well? ( )
A partner’s act binds the firm provided:
(a) He acts within the scope of his authority.

(b) Carries business in the firm’s name.

(c) Does something for the purpose of the business of the firm.
(d) Carries in his name personally.
11. F is a sole proprietor; D is admitted as a partner where D does not bring any capital then, ( )
(a) D and F are Partners (c) D is to be treated as an employee
(b) D is not partner as no capital is brought in (d) F is the Principal

12. Which of the following statement is incorrect about a nominal partner? ( )

(a) He does not invest in the firm nor does he share in profit.
(b) He does not take part in management of the firm.
(c) He is liable along with other partners for all the debts of the firm.
(d) He is not liable along with other partners for all the debts of the firm.
13. Which of the following is a characteristic of a Sole Proprietorship? ( )
 (a) Unlimited liability (b) Limited liability

© Separate legal entity (d)Transferable share

14 Which of the following is a feature of Public Sector Enterprises? ( )

(a) Ownership by private individuals
(b)Profit is the sole objective
(c) Government ownership and control
(d)No legal existence separate from its owners

15. In a Limited Liability Partnership (LLP), the liability of partners is: ( )

(a) Unlimited

(b) Limited to their investment

(c) Based on mutual agreement

(d) Dependent on the total revenue

16. Which form of business organization is easiest to set up and manage? ( )

(a) A. Sole Proprietorship

(b) B. Partnership

(c) C. Joint Stock Company

(d) D. Public Sector Enterprise

17. Which of the following is NOT a characteristic of a partnership? ( )

(a) Mutual agency
(b) Limited liability
(c) Sharing of profits and losses
(d) At least two owners
18. Which of the following forms of organization can raise capital by issuing shares to the public?
( )
(a) Sole Proprietorship

(b) Partnership

(c) Joint Stock Company

(d) Public Sector Enterprise

19. Which of the following is a major disadvantage of Public Sector Enterprises? ( )

(a) Government support
(b) Accountability to the public
 (c) Bureaucratic inefficiency
(d) Ability to pursue social objectives

Module 2 - Introduction to Market - Types of Markets - Perfect and Imperfect Competition -

Features of Perfect Competition – Monopoly - Monopolistic Competition – Oligopoly - Price-
Output Determination
1. Based on which of the following, the market can be divided into perfect markets and
imperfect markets? ( )
(a) Degree of concentration (c) Degree of differentiation
(b)Degree of condition (d) Degree of competition
2. The price of a product is determined by the of that product. ( )
(a) Demand and supply (c) Place and time
(b) Production and sales (d) Cost and income
3. Monopoly is not desirable as ( )
(a) Efficient allocation of resources is not possible.
(b) Lessens the gap of rich and poor.
(c) Extends the slope for research and development.
(d) It leads to exploitation of consumers.
4. Which of the following is the best example of a perfectly competitive market? ( )
(a) diamonds (c) soft drinks
(b) Athletic shoes (d) farming.
5. Railways is an example of ( )
(a) Oligopoly. (c) Monopolistic
(b) Monopoly (d) Perfect
6. To achieve more market power, firms can: ( )
(a) Differentiate their products from the products of their rivals.
(b) Reduce their costs of production.
(c) Raise their profit margin on prices.
(d) Advertise that they charge low prices
7. The difference between a market and an industry is that ( )
(a) Industries consist of firms producing the same good while markets consist of industries
producing substitute goods.
 (b) Industries consist of markets producing the same good while markets consist of firms
producing substitute goods.
(c) Industries are collections of markets while markets are collections of firms.
(d) Firms make up a market while markets make up an industry.
Module 3 - Pricing Methods and Strategies.
1. Which of the following is a common pricing strategy used for new products? ( )
(a) Skimming pricing
(b) Penetration pricing
(c) Bundle pricing
(d) Psychological pricing
2. Penetration pricing is most effective when: ( )
(a) The product is perceived as premium
(b) The market is highly sensitive to price
(c) The competition is very low
(d) The product is highly differentiate
3. What does cost-plus pricing involve? ( )
(a) Setting the price below the cost to gain market share
(b) Adding a fixed percentage or amount to the cost of producing a product
(c) Basing the price on competitors' prices
(d) Pricing products based on customer demand
4. Which pricing strategy focuses on setting a low initial price to quickly attract customers and
gain market share? ( )
(a) Price skimming
(b) Value-based pricing
(c) Penetration pricing
(d) Premium pricing

5. In psychological pricing, which of the following is commonly used? ( )

(a) Bundle pricing
 (b) Pricing just below a round number (e.g., $9.99 instead of $10)
(c) Setting prices based on production cost
(d) Charging higher prices during peak demand
6. Which pricing strategy sets a high price for a product with the goal of signaling high quality or
exclusivity? ( )
(a) Cost-plus pricing
(b) Skimming pricing
(c) Penetration pricing
(d) Premium pricing
7. Price discrimination involves: ( )
(a) Charging different prices to different customer groups for the same product
(b) Setting one uniform price for all customers
(c) Charging less than the cost of production
(d) Using cost-based pricing methods exclusively
8. Which pricing strategy involves combining several products or services and offering them at a
reduced price? ( )
(a) Skimming pricing
(b) Bundle pricing
(c) Premium pricing
(d) Loss leader pricing
 Part-B

2 Marks: Short Answer Questions

Module 1 - Introduction to Business - Forms of Business Organizations - Sole Proprietary -

Partnership - Joint Stock Companies - Public Sector Enterprises.

1. Write short notes on (a) Sole trader b) Partner.

2. What is a partnership deed? Discuss the main contents partnership deed.
3. Write short note on (a) Memorandum of Association (b) articles of association.
4. What is meant by unlimited liability in a Sole Proprietorship?
5. Define a Joint Stock Company.
6. What is meant by limited liability in a Partnership?
7. Define a Public Sector Enterprise.

Module 2 - Introduction to Market - Types of Markets - Perfect and Imperfect Competition -

Features of Perfect Competition – Monopoly - Monopolistic Competition – Oligopoly - Price-
Output Determination

1. Define Market.
2. Explain the concept of Monopoly.
3. What is Market Structure?
4. What are some common features of oligopoly markets?

Module 3 - Pricing Methods and Strategies.

1. Define cost-plus pricing.

2. What is price skimming?
3. Give an example of psychological pricing.
4. What is price discrimination?
5. What is penetration pricing?
6. What is a loss leader pricing strategy?
 PART C

Descriptive Questions

Module 1 - Introduction to Business - Forms of Business Organizations - Sole Proprietary -

Partnership - Joint Stock Companies - Public Sector Enterprises.

1. Discuss the factors affecting the choice of form of business organization.

2. Define a joint stock company & explain its basic features, advantages & disadvantages.
3. Describe the key characteristics of a Sole Proprietorship. What are its advantages and
disadvantages?
4. Define partnership form of business. Explain its salient features.
5. What is partnership deed and explain the different types of partners.
6. Explain the concept of a Joint Stock Company. How does it differ from other forms of
business organizations such as Sole Proprietorship and Partnership?
7. What are the different types of Public Sector Enterprises? Provide examples of each.
8. Discuss the legal formalities involved in the formation of a Joint Stock Company.

Module 2 - Introduction to Market - Types of Markets - Perfect and Imperfect Competition -

Features of Perfect Competition – Monopoly - Monopolistic Competition – Oligopoly - Price-
Output Determination
1. What is a market? Explain about types of Markets?
2. Discuss the differences between Monopoly and Perfect competition.
3. Explain the characteristics of Monopoly and Monopolistic markets.
4. Discuss Features of Market structures.
5. Define a perfectly competitive market. What are its main features, and how does it
differ from other market structures like monopoly and oligopoly?
6. Explain the price-output determination process in perfect competition.
7. Describe the characteristics of monopolistic competition. How does product
differentiation play a key role in this market structure?
8. What are the primary differences between perfect competition and monopolistic
competition?

Module 3 - Pricing Methods and Strategies.

1. Discuss cost based and strategy based pricing methods.
2. List out different methods of pricing and explain them with suitable examples.
3. Under what conditions price skimming and price penetration strategy is advisable-
Elaborate.
SESHADRI RAO GUDLAVALLERU ENGINEERING COLLEGE

Academics Strengthening & Advancement (AS&A)

Department of Business and Management Studies

R – 23
II B.Tech. I Semester
Learning Material
On

MANAGERIAL ECONOMICS AND FINANCIAL ANALYSIS

(Common to all B.Tech Branches CSE, EEE and IOT)

UNIT IV

“Capital Budgeting”

Prepared by : Ms.K.Susmitha ,
Assistant Professor,

MBA Dept.
SRGEC, Gudlavalleru
 SYLLABUS
MANAGERIAL ECONOMICS AND FINANCIAL ANALYSIS
(Common to CSE, EEE and IOT)
II Year – II Semester
Lecture : Internal Marks : 30
Credits : 2 External Marks : 70
Course Objectives:
• To expose the importance of managerial economics and its role in achieving business objectives.
• To present fundamental skills on accounting and to explain the process of preparing financial
statements.
Course Outcomes:
• Classify the concepts of Managerial Economics, financial accounting and management.
• Interpret the Concept of Product cost and revenues for effective Business decision.
• Establish suitable business organisation and analyse markets to understand their impact on pricing
and output decision.
• Analyse how to invest their capital and maximize returns using capital budgeting techniques.
• Develop the accounting statements and evaluate the financial performance of business entity.
UNIT – I: Managerial Economics
Introduction – Nature, meaning, significance, functions, and advantages. Demand-Concept, Function, Law of
Demand - Demand Elasticity- Types – Measurement. Demand Forecasting- Factors governing Forecasting,
Methods.
UNIT – II: Product and Cost Analysis
Introduction – Segmentation – Product Life Cycle – Channels of Distribution – Cost & Break-Even Analysis – Cost
concepts and Cost behaviour – Break-Even Analysis (BEA) - Determination of Break-Even Point (Simple
Problems).
UNIT – III: Business Organizations and Markets
Introduction – Forms of Business Organizations- Sole Proprietary - Partnership - Joint Stock Companies - Public
Sector Enterprises. Types of Markets - Perfect and Imperfect Competition - Features of Perfect Competition
Monopoly, Monopolistic Competition, Oligopoly, Price-Output Determination – Pricing Methods and Strategies.
UNIT – IV: Capital Budgeting
Introduction – Nature, meaning, significance. Types of Working Capital, Components, Sources of Short-term and
Long-term Capital, Estimating Working capital requirements. Capital Budgeting– Features, Proposals, Methods and
Evaluation. Projects – Pay Back Method, Accounting Rate of Return (ARR), Net Present Value (NPV), Internal
Rate Return (IRR) Method (sample problems)
UNIT – V: Financial Accounting and Analysis
Introduction – Concepts and Conventions- Double-Entry Bookkeeping, Journal, Ledger, Trial Balance- Final
Accounts (Trading Account, Profit and Loss Account and Balance Sheet with simple adjustments). Introduction to
Financial Analysis - Analysis and Interpretation of Liquidity Ratios, Activity Ratios, and Capital structure Ratios
and Profitability.
Textbooks:
1. Varshney, R. L., & Maheswari, K. L. Managerial Economics,22nd Rev. ed., Sultan Chand, 2014.
2. Aryasri, A. R., Business Economics and Financial Analysis, 4th ed., McGraw Hill, 2019.
3. Kotler, P. Marketing Management, 15th ed., Pearson, 2016.
Reference Books:
1. Ahuja, H. L., Managerial Economics, 3rd ed.. S. Chand, 2013.
2. Siddiqui, S. A., & Siddiqui, A. S., Managerial Economics and Financial Analysis. New Age International,
2013.
3. Nellis, J. G., & Parker, D. (n.d.). Principles of Business Economics (2nd ed.). Pearson.
Online Learning Resources:
https://www.slideshare.net/123ps/managerial-economics-ppt
https://www.slideshare.net/rossanz/production-and-cost-45827016
https://www.slideshare.net/darky1a/business-organisations-19917607
https://www.slideshare.net/ba1arajbl/market-and-classification-of-market
https://www.slideshare.net/ruchi101/capital-budgeting-ppt-59565396
https://www.slideshare.net/ashu1983/financial-accounting
 UNIT – IV
Capital Budgeting
Outcome:
Analyse how to invest their capital and maximize returns using capital budgeting techniques.
Modules
1. Introduction – Nature, meaning, significance. Types of Working Capital, Components
2. Sources of Short-term and Long-term Capital, Estimating Working capital requirements.
3. Capital Budgeting– Features, Proposals, Methods and Evaluation. Projects – Pay Back
Method, Accounting Rate of Return (ARR), Net Present Value (NPV), Internal Rate Return
(IRR) Method (sample problems)
1.Introduction
1.1.Introduction:
Capital is defined as wealth, which is created over a period of time through abstinence to spend.
There are different forms of capital: property, cash or titles to wealth. It is the aggregate of funds
used in the short-run and long- run. An economist views capital as the value of total assets
available with the business. An accountant sees the capital as the difference between assets and
Liabilities.
1.2.Types of working Capital:
There are two concepts of working capital:
1. Gross working capital
2. Net working capital
Gross working capital: In the broader sense, the term working capital refers to the gross
working capital. The notion of the gross working capital refers to the capital invested in total
current assets of the enterprise. Current assets are those assets, which in the ordinary course of
business, can be converted into cash within a short period, normally one accounting year.
Examples of current assets: 1. Cash in hand and bank balance 2. Bills receivables or Accounts
Receivables 3. Sundry Debtors (less provision for bad debts) 4. Short-term loans and advances.
5. Inventories of stocks, such as: (a) Raw materials (b) Work – in process (c) Stores and spares
(d) Finished goods 6. Temporary Investments of surplus funds. 7. Prepaid Expenses 8. Accrued
Incomes etc.
Net working capital: In a narrow sense, the term working capital refers to the net working
capital. Networking capital represents the excess of current assets over current liabilities. Current
liabilities are those liabilities, which are intend to be paid in the ordinary course of business
within a short period, normally one accounting year out of the current assets or the income of the
business. Net working capital may be positive or negative. When the current assets exceed the
current liabilities net working capital is positive and the negative net working capital results
when the liabilities are more than the current assets.
Examples of current liabilities: 1. Bills payable 2. Sundry Creditors or Accounts Payable. 3.
Accrued or Outstanding Expanses. 4. Short term loans, advances and deposits. 5. Dividends
payable 6. Bank overdraft 7. Provision for taxation etc.
1.3. Components of working capital:
Working capital is the difference between current assets and current Liabilities. Current Assets
consist of Cash, Stock of Raw Materials, Stock of finished goods, Debtors, Prepaid Expenses,
Bills Receivables. Current liabilities include Creditors and Bills payables.
2.1. Estimating the working capital requirements:
There are a large number of factors such as the nature and size of business, the character of their
operations, the length of production cycle, the rate of stock turnover and the state of economic
situation etc. that decode requirement of working capital. These factors have different
importance and influence on firm differently. In general following factors generally influence the
working capital requirements.
1. Nature or character of business: The working capital requirements of a firm basically
depend upon the nature of its business. Public utility undertakings like electricity, water supply
and railways need very limited working capital as their sales are on cash and are engaged in
provision of services only. On the other hand, trading firms require more investment in
inventories, receivables and cash and such they need large amount of working capital. The
manufacturing undertakings also require sizable working capital.
2. Size of business or scale of operations: The working capital requirements of a concern are
directly influenced by the size of its business, which may be measured in terms of scale of
operations. Greater the size of a business unit, generally, larger will be the requirements of
working capital. However, in some cases, even a smaller concern may need more working
capital due to high overhead charges, inefficient use of available resources and other economic
disadvantages of small size.
3. Production policy: If the demand for a given product is subject to wide fluctuations due to
seasonal variations, the requirements of working capital, in such cases, depend upon the
production policy.
The production could be kept either steady by accumulating inventories during stack periods
with a view to meet high demand during the peck season or the production could be curtailed
during the slack season and increased during the peak season. If the policy is to keep the
production steady by accumulating inventories it will require higher working capital.
4. Manufacturing process/Length of production cycle: In manufacturing business, the
requirements of working capital will be in direct proportion to the length of manufacturing
process. Longer the process period of manufacture, larger is the amount of working capital
required, as the raw materials and other supplies have to be carried for a longer period.
5. Seasonal variations: If the raw material availability is seasonal, they have to be bought in
bulk during the season to ensure an uninterrupted material for the production. A huge amount is,
thus, blocked in the form of material, inventories during such season, which give rise to more
working capital requirements. Generally, during the busy season, a firm requires larger working
capital then in the slack season.
6. Working capital cycle: In a manufacturing concern, the working capital cycle starts with the
purchase of raw material and ends with the realization of cash from the sale of finished products.
This cycle involves purchase of raw materials and stores, its conversion into stocks of finished
goods through work–in progress with progressive increment of labour and service costs,
conversion of finished stock into sales, debtors and receivables and ultimately realization of
cash. This cycle continues again from cash to purchase of raw materials and so on. In general the
longer the operating cycle, the larger the requirement of working capital.
7. Credit policy: The credit policy of a concern in its dealings with debtors and creditors
influences considerably the requirements of working capital. A concern that purchases its
requirements on credit requires lesser amount of working capital compared to the firm, which
buys on cash. On the other hand, a concern allowing credit to its customers shall need larger
amount of working capital compared to a firmselling only on cash.
8. Business cycles: Business cycle refers to alternate expansion and contraction in general
business activity. In a period of boom, i.e., when the business is prosperous, there is a need for
larger amount of working capital due to increase in sales. On the contrary, in the times of
depression, i.e., when there is a down swing of the cycle, the business contracts, sales decline,
difficulties are faced in collection from debtors and firms may have to hold large amount of
working capital.
9. Rate of growth of business: The working capital requirements of a concern increase with the
growth and expansion of its business activities. The retained profits may provide for a part of
working capital but the fast growing concerns need larger amount of working capital than the
amount of undistributed profits.
2.2. Sources of Short-term and Long-term Capital
Based upon the time, the financial resources may be classified into
(1) sources of long term
(2) sources of short – term finance.
Some of these sources also serve the purpose of medium – term finance.
I. The source of long – term finance are: 1. Issue of shares 2. Issue debentures 3. Loan from
financial institutions 4. Retained profits and 5. Public deposits
II. Sources of Short-term Finance are: 1. Trade credit 2. Bank loans and advances and 3.
Short-term loans from finance companies.
Sources of Long Term Finance
1. Issue of Shares: The amount of capital decided to be raised from members of the public is
divided into units of equal value. These units are known as share and the aggregate values of
shares are known as share capital of the company. Those who subscribe to the share capital
become members of the company and are called shareholders. They are the owners of the
company. Hence shares are also described as ownership securities.
2. Issue of Preference Shares: Preference share have three distinct characteristics. Preference
shareholders have the right to claim dividend at a fixed rate, which is decided according to the
terms of issue of shares. Moreover, the preference dividend is to be paid first out of the net
profit. The balance, it any, can be distributed among other shareholders that is, equity
shareholders. However, payment of dividend is not legally compulsory. Only when dividend is
declared, preference shareholders have a prior claim over equity shareholders.
3. Loans from financial Institutions: Government with the main object of promoting industrial
development has set up a number of financial institutions. These institutions play an important
role as sources of company finance. Besides they also assist companies to raise funds from other
sources. These institutions provide medium and long-term finance to industrial enterprises at a
reason able rate of interest.
Thus companies may obtain direct loan from the financial institutions for expansion or
modernization of existing manufacturing units or for starting a new unit. Often, the financial
institutions subscribe to the industrial debenture issue of companies some of the institutions
(ICICI) and (IDBI) also subscribe to the share issued by companies. All such institutions also
underwrite the public issue of shares and debentures by companies. Underwriting is an
agreement to take over the securities to the extent there is no public response to the issue. They
may guarantee loans, which may be raised by companies from other sources. Loans in foreign
currency may also be granted for the import of machinery and equipment wherever necessary
from these institutions, which stand guarantee for re-payments. Apart from the national level
institutions mentioned above, there are a number of similar institutions set up in different states
of India. The state-level financial institutions are known as State Financial Corporation, State
Industrial Development Corporations, State Industrial Investment Corporation and the like. The
objectives of these institutions are similar to those of the national-level institutions. But they are
mainly concerned with the development of medium and small-scale industrial units. Thus,
smaller companies depend on state level institutions as a source of medium and long-termfinance
for the expansion and modernization of their enterprise
4. Retained Profits: Successful companies do not distribute the whole of their profits as
dividend to shareholders but reinvest a part of the profits. The amount of profit reinvested in
the business of a company is known as retained profit. It is shown as reserve in the accounts.
The surplus profits retained and reinvested may be regarded as an internal source of finance.
Hence, this method of financing is known as self-financing. It is also called sloughing back of
profits. Since profits belong to the shareholders, the amount of retained profit is treated as
ownership fund. It serves the purpose of medium and long-term finance. The total amount of
ownership capital of a company can be determined by adding the share capital and
accumulated reserves.
5. Public Deposits: An important source of medium – term finance which companies make
use of is public deposits. This requires advertisement to be issued inviting the general public
of deposits. This requires advertisement to be issued inviting the general public to deposit
their savings with the company. The period of deposit may extend up to three yeas. The rate
of interest offered is generally higher than the interest on bank deposits. Against the deposit,
the company mentioning the amount, rate of interest, time of repayment and such other
information issues a receipt. Since the public deposits are unsecured loans, profitable
companies enjoying public confidence only can be able to attract public deposits. Even for
such companies there are rules prescribed by government limited its use.
Sources of Short Term Finance
The major sources of short-term finance are discussed below:
1. Trade credit: Trade credit is a common source of short-term finance available to all
companies. It refers to the amount payable to the suppliers of raw materials, goods etc. after
an agreed period, which is generally less than a year. It is customary for all business firms to
allow credit facility to their customers in trade business. Thus, it is an automatic source of
finance. With the increase in production and corresponding purchases, the amount due to the
creditors also increases. Thereby part of the funds required for increased production is
financed by the creditors. The more important advantages of trade credit as a source of short-
term finance are the following: It is readily available according to the prevailing customs.
There are no special efforts to be made to avail of it. Trade credit is a flexible source of
finance. It can be easily adjusted to the changing needs for purchases. Where there is an open
account for any creditor failure to pay the amounts on time due to temporary difficulties does
not involve any serious consequence Creditors often adjust the time of payment in view of
continued dealings. It is an economical source of finance. However, the liability on account of
trade credit cannot be neglected. Payment has to be made regularly.
If the company is required to accept a bill of exchange or to issue a promissory note against
the credit, payment must be made on the maturity of the bill or note. It is a legal commitment
and must be honored; otherwise legal action will follow to recover the dues.
2. Bank loans and advances: Money advanced or granted as loan by commercial banks is
known as bank credit. Companies generally secure bank credit to meet their current operating
expenses. The most common forms are cash credit and overdraft facilities. Under the cash
credit arrangement the maximum limit of credit is fixed in advance on the security of goods
and materials in stock or against the personal security of directors. The total amount drawn is
not to exceed the limit fixed. Interest is charged on the amount actually drawn and
outstanding. During the period of credit, the company can draw, repay and again draw
amounts within the maximum limit. In the case of overdraft, the company is allowed to
overdraw its current account up to the sanctioned limit. This facility is also allowed either
against personal security or the security of assets. Interest is charged on the amount actually
overdrawn, not on the sanctioned limit. The advantage of bank credit as a source of short-term
finance is that the amount can be adjusted according to the changing needs of finance. The
rate of interest on bank credit is fairly high. But the burden is no excessive because it is used
for short periods and is compensated by profitable use of the funds.
Commercial banks also advance money by discounting bills of exchange. A company having
sold goods on credit may draw bills of exchange on the customers for their acceptance. A bill
is an order in writing requiring the customer to pay the specified amount after a certain period
(say 60 days or 90 days). After acceptance of the bill, the company can drawn the amount as
an advance from many commercial banks on payment of a discount. The amount of discount,
which is equal to the interest for the period of the bill, and the balance, is available to the
company. Bill discounting is thus another source of short-term finance available from the
commercial banks.
3. Short term loans from finance companies: Short-term funds may be available from
finance companies on the security of assets. Some finance companies also provide funds
according to the value of bills receivable or amount due from the customers of the borrowing
company, which they take over.
3. Capital Budgeting
3.1. Introduction:
According to Richard and Green law- “Capital budgeting is acquiring inputs with long-term
return”.
According to the definition of G.C. Philippatos, “capital budgeting is concerned with the allocation
of the firms source financial resources among the available opportunities. The consideration of
investment opportunities involves the comparison of the expected future streams of earnings from a
project with the immediate and subsequent streams of earning from a project, with the immediate
and subsequent streams of expenditure”.
Need and Importance of Capital Budgeting
1. Huge investments: Capital budgeting requires huge investments of funds, but the available
funds are limited, therefore the firm before investing projects, plan are control its capital
expenditure.
2. Long-term: Capital expenditure is long-term in nature or permanent in nature. Therefore
financial risks involved in the investment decision are more. If higher risks are involved, it
needs careful planning of capital budgeting.
3. Irreversible: The capital investment decisions are irreversible, are not changed back. Once the
decision is taken for purchasing a permanent asset, it is very difficult to dispose of those assets.
without involving huge losses.
4. Long-term effect: Capital budgeting not only reduces the cost but also increases the revenue
in long-term and will bring significant changes in the profit of the company by avoiding over
or more investment or under investment. Over investments leads to be unable to utilize assets
or over utilization of fixed assets. Therefore before making the investment, it is required
carefully planning and analysis of the project thoroughly.
 3.2.Methods of Capital Budgeting:
The capital budgeting appraisal methods are techniques of evaluation of investment proposal
will help the company to decide upon the desirability of an investment proposal depending
upon their; relative income generating capacity and rank them in order of their desirability.
These methods provide the company a set of norms on the basis of which either it has to
accept or reject the investment proposal. The most widely accepted techniques used in
estimating the cost-returns of investment projects can be grouped under two categories.
1. Traditional methods
2. Discounted Cash flow methods
1. Traditional methods: These methods are based on the principles to determine the
desirability of an investment project on the basis of its useful life and expected returns. These
methods depend upon the accounting information available from the books of accounts of the
company. These will not take into account the concept of ‘time value of money’, which is a
significant factor to determine the desirability of a project in terms of present value.
A. Pay-back period method: It is the most popular and widely recognized traditional method
of evaluating the investment proposals. It can be defined, as ‘the number of years required to
recover the original cash out lay invested in a project’. According to Weston & Brigham,
“The pay back period is the number of years it takes the firm to recover its original investment
by net returns before depreciation, but after taxes”. According to James. C. Vanhorne, “The
payback period is the number of years required to recover initial cash investment. The pay
back period is also called payout or payoff period. This period is calculated by dividing the
cost of the project by the annual earnings after tax but before depreciation under this method
the projects are ranked on the basis of the length of the payback period. A project with the
shortest payback period will be given the highest rank and taken as the best investment. The
shorter the payback period, the less risky the investment is the formula for payback period is
Cash outlay (or) original cost of project
Pay-back period = -------------------------------------------
Annual cash inflow
Merits:
1. It is one of the earliest methods of evaluating the investment projects.
2. It is simple to understand and to compute.
3. It does not involve any cost for computation of the payback period
4. It is one of the widely used methods in small scale industry sector
5. It can be computed on the basis of accounting information available from the books.
Demerits:
1. This method fails to take into account the cash flows received by the company after the
payback period.
2. It doesn’t take into account the interest factor involved in an investment outlay.
3. It doesn’t take into account the interest factor involved in an investment outlay.
4. It is not consistent with the objective of maximizing the market value of the company’s share.
5. It fails to consider the pattern of cash inflows i. e., the magnitude and timing of cash inflows.
B. Accounting (or) Average rate of return method (ARR):
It is an accounting method, which uses the accounting information repeated by the financial
statements to measure the probability of an investment proposal. It can be determined by
dividing the average income after taxes by the average investment i.e., the average book value
after depreciation. According to ‘Soloman’, accounting rate of return on an investment can be
calculated as the ratio of accounting net income to the initial investment, i.e.,
Average net income after taxes
ARR= ------------------------------------- X 100
Average Investment
Total Income after Taxes
Average net income after taxes = -----------------------------
No. Of Years
Total Investment
Average investment= ----------------------
2
On the basis of this method, the company can select all those projects whose ARR is higher than
the minimum rate established by the company. It can reject the projects with an ARR lower than
the expected rate of return. This method can also help the management to rank the proposal on
the basis of ARR. A highest rank will be given to a project with highest ARR, where as a lowest
rank to a project with lowest ARR.
Merits:
1. It is very simple to understand and calculate.
2. It can be readily computed with the help of the available accounting data.
3. It uses the entire stream of earning to calculate the ARR.
Demerits:
1. It is not based on cash flows generated by a project.
2. This method does not consider the objective of wealth maximization
3. IT ignores the length of the projects useful life. 4. It does not take into account the fact that the
profits can be re-invested.
II: Discounted cash flow methods:
The traditional method does not take into consideration the time value of money. They give
equal weight age to the present and future flow of incomes. The DCF methods are based on the
concept that a rupee earned today is more worth than a rupee earned tomorrow. These methods
take into consideration the profitability and also time value of money.
A. Net present value method (NPV)
The NPV takes into consideration the time value of money. The cash flows of different
years and valued differently and made comparable in terms of present values for this the
net cash inflows of various period are discounted using required rate of return which is
predetermined. According to Ezra Solomon, “It is a present value of future returns,
discounted at the required rate of return minus the present value of the cost of the
investment.” NPV is the difference between the present value of cash inflows of a project
and the initial cost of the project. According the NPV technique, only one project will be
selected whose NPV is positive or above zero. If a project(s) NPV is less than ‘Zero’. It
gives negative NPV hence. It must be rejected. If there are more than one project with
positive NPV’s the project is selected whose NPV is the highest. The formula for NPV is
NPV= Present value of cash inflows – investment.
Merits:
1. It recognizes the time value of money.
2. It is based on the entire cash flows generated during the useful life of the asset.
3. It is consistent with the objective of maximization of wealth of the owners.
4. The ranking of projects is independent of the discount rate used for determining the present
value.
Demerits:
1. It is different to understand and use.
2. The NPV is calculated by using the cost of capital as a discount rate. But the concept of cost
of capital. If self is difficult to understood and determine.
3. It does not give solutions when the comparable projects are involved in different amounts of
investment.
4. It does not give correct answer to a question whether alternative projects or limited funds are
available with unequal lines.
B. Internal Rate of Return Method (IRR)
The IRR for an investment proposal is that discount rate which equates the present value of cash
inflows with the present value of cash out flows of an investment. The IRR is also known as
cutoff or handle rate. It is usually the concern’s cost of capital. According to Weston and
Brigham “The internal rate is the interest rate that equates the present value of the expected
future receipts to the cost of the investment outlay. When compared the IRR with the required
rate of return (RRR), if the IRR is more than RRR then the project is accepted else rejected. In
case of more than one project with IRR more than RRR, the one, which gives the highest IRR, is
selected.
The IRR is not a predetermine rate, rather it is to be trial and error method. It implies that one has
to start with a discounting rate to calculate the present value of cash inflows. If the obtained
present value is higher than the initial cost of the project one has to try with a higher rate. Like
wise if the present value of expected cash inflows obtained is lower than the present value of
cash flow. Lower rate is to be taken up. The process is continued till the net present value
becomes Zero. As this discount rate is determined internally, this method is called internal rate of
return method.
P1 – Q
IRR = L+ --------- X D
P1 –P2
L- Lower discount rate P1 - Present value of cash inflows at lower rate. P2 - Present
value of cash inflows at higher rate. Q- Actual investment D- Difference in Discount rates.
Merits:
1. It consider the time value of money
2. It takes into account the cash flows over the entire useful life of the asset.
3. It has a psychological appear to the user because when the highest rate of return projects are
selected, it satisfies the investors in terms of the rate of return an capital
4. It always suggests accepting to projects with maximum rate of return.
5. It is inconformity with the firm’s objective of maximum owner’s welfare.
Demerits:
1. It is very difficult to understand and use.
2. It involves a very complicated computational work.
3. It may not give unique answer in all situations.
C. Probability Index Method (PI) The method is also called benefit cost ration. This method is
obtained cloth a slight modification of the NPV method. In case of NPV the present value of
cash out flows are profitability index (PI), the present value of cash inflows are divide by the
present value of cash out flows, while NPV is a absolute measure, the PI is a relative measure. If
the PI is more than one (>1), the proposal is accepted else rejected. If there are more than one
investment proposal with the more than one PI the one with the highest PI will be selected. This
method is more useful in case of projects with different cash outlays cash outlays and hence is
superior to the NPV method. The formula for PI is
Present Value of Future Cash Inflow
Probability index = ----------------------------------------
Investment
Merits:
1. It requires less computational work then IRR method
2. It helps to accept / reject investment proposal on the basis of value of the index.
3. It is useful to rank the proposals on the basis of the highest/lowest value of the index.
4. It is useful to tank the proposals on the basis of the highest/lowest value of the index.
5. It takes into consideration the entire stream of cash flows generated during the useful life of
the asset.
Demerits:
1. It is somewhat difficult to understand
2. Some people may feel no limitation for index number due to several limitation involved in
their competitions
3. It is very difficult to understand the analytical part of the decision on the basis of probability
index
Assignment-Cum-Tutorial Questions

PART A
Objective Questions
Module 1: Introduction – Nature, meaning, significance. Types of Working Capital,
Components
1. Which type of working capital represents the minimum amount required to
maintain operations?
A) Temporary Working Capital
B) Permanent Working Capital
C) Gross Working Capital
D) Net Working Capital
2. Negative working capital indicates that:
A) Current assets exceed current liabilities
B) Current liabilities exceed current assets
 C) The company is highly liquid
D) The company is generating high profits
3. What is gross working capital?
A) Total current liabilities
B) Total current assets
C) Current assets minus current liabilities
D) Long-term assets
4. Accounts receivable is classified as:
A) Current Liability
B) Current Asset C) Fixed Asset
D) Long-term Liability
5. Prepaid expenses are considered:
A) Current Liabilities
B) Fixed Assets
C) Current Assets
D) Long-term Investments
6. Which of the following factors can affect working capital needs?
A) Economic conditions
B) Business growth
C) Seasonal sales variations
D) All of the above

Module 2: Sources of Short-term and Long-term Capital, Estimating Working capital

requirements.
1. Which of the following is a source of short-term capital?
A) Equity shares
B) Trade credit
C) Debentures
D) Retained earnings
2. Which of the following is typically considered a long-term source of capital?
A) Bank overdraft
B) Commercial paper
C) Term loans
D) Accounts payable
3. Which of the following is NOT a component of working capital?
A) Cash
B) Inventory
C) Long-term investments
D) Accounts receivable
4. The formula for calculating working capital is:
A) Current Assets - Current Liabilities
B) Total Assets - Total Liabilities
C) Fixed Assets + Current Liabilities
D) Cash + Accounts Payable
5. When estimating working capital requirements, which of the following factors is considered?
A) Seasonal sales fluctuations
B) Market trends
 C) Production cycles
D) All of the above
Module 3: Capital Budgeting– Features, Proposals, Methods and Evaluation. Projects – Pay
Back Method, Accounting Rate of Return (ARR), Net Present Value (NPV), Internal Rate
Return (IRR) Method (sample problems)
1. The Payback Method calculates:
A) The time required to recover the initial investment
B) The total profit generated by the project
C) The annual return on investment
D) The present value of future cash flows
2. Which method considers the time value of money?
A) Payback Method
B) Accounting Rate of Return
C) Net Present Value
D) Simple Payback Period
3. What does ARR stand for?
A) Average Return Ratio
B) Accounting Rate of Return
C) Actual Rate of Return
D) Average Revenue Rate
4. The formula for Net Present Value (NPV) is:
A) Cash inflows - Cash outflows
B) Sum of present values of cash flows - Initial investment
C) Total profits - Total costs
D) Cash inflows / Cash outflows
5. The Internal Rate of Return (IRR) is:
A) The discount rate that makes NPV equal to zero
B) The rate of return on equity
C) The average rate of return over the project's life
D) The required rate of return on capital

Part-B
2 Marks: Short Answer Questions
Module 1: Introduction – Nature, meaning, significance. Types of Working Capital,
Components
1. List the main components of current assets and explain why they are important for
working capital.
2. What is gross working capital, and how is it calculated?
3. Define working capital and explain its significance.
4. What are the components of working capital?
Module 2: Sources of Short-term and Long-term Capital, Estimating Working capital
requirements.
1. List three factors that can influence a company's working capital requirements.
2. Define short-term capital and provide two examples.
3. What is the formula for calculating working capital, and what does it indicate?
Module 3: Capital Budgeting– Features, Proposals, Methods and Evaluation. Projects – Pay
Back Method, Accounting Rate of Return (ARR), Net Present Value (NPV), Internal Rate
Return (IRR) Method (sample problems)
What are the main features of capital budgeting?
1. List three common methods used in capital budgeting evaluation.
2. Explain the concept of Net Present Value (NPV) and its importance in project evaluation.
3. Describe the Payback Method and its primary advantage.
4. What is the Accounting Rate of Return (ARR), and how is it calculated?
5. What does the Internal Rate of Return (IRR) represent in capital budgeting?
6. A company invests $50,000 in a project that generates cash inflows of $15,000 per year.
How long will it take to recover the initial investment?
PART C
Descriptive Questions
Module 1: Introduction – Nature, meaning, significance. Types of Working Capital,
Components
1. Explain the distinction between permanent and temporary working capital. How do
businesses manage these two types in their operations?
2. What is working capital, and why is it important for a business? Explain how it differs
from other forms of capital.
3. Identify and describe the main components of current assets that contribute to working
capital.
Module 2: Sources of Short-term and Long-term Capital, Estimating Working capital
requirements.
1. What are the primary sources of long-term capital?
2. What are the main sources of short-term capital available to businesses? Describe each
source, including trade credit, bank loans, and lines of credit.
3. What are the key components that need to be considered when estimating working capital
requirements? Discuss how current assets and current liabilities impact this estimation.
Module 3: Capital Budgeting– Features, Proposals, Methods and Evaluation. Projects – Pay
Back Method, Accounting Rate of Return (ARR), Net Present Value (NPV), and Internal Rate
Return (IRR) Method (sample problems)
1. Explain the methods of capital budgeting.
2. Describe the key capital budgeting techniques, such as Net Present Value (NPV), Internal
Rate of Return (IRR), Payback Period, and Profitability Index. What are the main
features and calculations associated with each?
3. A project requires an initial investment of $150,000 and is expected to generate the
following cash inflows over 5 years: $30,000, $40,000, $50,000, $60,000, and $70,000. If
the discount rate is 10%, what is the NPV?
4. A project requires an initial investment of $200,000 and will incur cash outflows of
$50,000 in Year 1, followed by cash inflows of $80,000 in Year 2, $90,000 in Year 3,
and $100,000 in Year 4. If the discount rate is 10%, what is the NPV?
5. A company has the opportunity to invest in a new project for $500,000. The project is
expected to generate cash inflows of $150,000 for the first three years and $200,000 for
the next two years. If the required rate of return is 12%, should the project be accepted
based on NPV?
6. Initial investment for a project is 20 lakhs. The project life is 6 years and the cash inflow
for 6 years is as given below.
Year Cash inflow

1 3,50,000
2 4,00,000
3 5,00,000
4 5,50,000
5 6,00,000
6 5,00,000

The cost of capital is 13%. Compute NPV, IRR and PBP.

7. The Alpha Co Ltd ., is considering the purchase of a new machine. Two alternative
machines (A and B) have been suggested, each having an initial cost of Rs. 4,00,000.
Earnings after taxation are expected to be as follows:

Years Cash Inflows

Machine A Machine B
1 40,000 1,20,000
2 1,20,000 1,60,000
3 1,60,000 2,00,000
4 2,40,000 1,20,000
5 1,60,000 80,000
The company has a target of return on capital of 10% and on this basis, you are required to
compare the profitability of the machines on Profitability Index and state which alternative you
consider as financially preferable.
SESHADRI RAO GUDLAVALLERU ENGINEERING COLLEGE

Academics Strengthening & Advancement

(AS&A)

Department of Business and Management

Studies

R – 23
II B.Tech. I Semester
Learning Material
On

MANAGERIAL ECONOMICS AND FINANCIAL ANALYSIS

UNIT – V
“Financial Accounting and Analysis”

Prepared by: Dr. Hemanth Kumar T

Assistant Professor,
MBA Dept.
SRGEC, Gudlavalleru
 SYLLABUS
MANAGERIAL ECONOMICS AND FINANCIAL ANALYSIS
(Common to CSE, EEE and IOT)
II Year – II Semester
Lecture: Internal Marks: 30
Credits: 2 External Marks: 70
Course Objectives:
• To expose the importance of managerial economics and its role in achieving business objectives
• To present fundamental skills on accounting and to explain the process of preparing financial statements.
Course Outcomes:
• Classify the concepts of Managerial Economics, financial accounting and management
• Interpret the Concept of Product cost and revenues for effective Business decision
• Describe the fundamentals of Economics viz., Demand, Production, cost, revenue and markets
• Analyze how to invest their capital and maximize returns using capital Budgeting techniques
• Develop the accounting statements and evaluate the financial performance of the business entity
UNIT - I Managerial Economics
Introduction — Nature, meaning, significance, functions, and advantages. Demand-Concept, Function, Law of
Demand - Demand Elasticity- Types — Measurement. Demand Forecasting- Factors governing Forecasting,
Methods. Managerial Economics and Financial Accounting and Management.

UNIT - II Product and Cost Analysis

Introduction – Segmentation - Product Life Cycle-Channels of Distribution- Cost & Break-Even Analysis - Cost
concepts and Cost behavior - Break-Even Analysis (BEA) - Determination of Break-Even Point (Simple Problems).

UNIT - III Business Organizations and Markets

Introduction — Forms of Business Organizations- Sole Proprietary - Partnership - Joint Stock Companies - Public
Sector Enterprises. Types of Markets - Perfect and Imperfect Competition - Features of Perfect Competition
Monopoly- Monopolistic Competition— Oligopoly-Price-Output Determination - Pricing Methods and Strategies

UNIT - IV Capital Budgeting

Introduction — Nature, meaning, significance. Types of Working Capital, Components, Sources of Short-term and
Long-term Capital, Estimating Working capital requirements. Capital Budgeting— Features, Proposals, Methods
and Evaluation. Projects — Pay Back
Method, Accounting Rate of Return (ARR) Net Present Value (NPV) Internal Rate Return (IRR) Method (sample
problems)

UNIT - V Financial Accounting and Analysis

Introduction — Concepts and Conventions- Double-Entry Bookkeeping, Journal, Ledger, Trial Balance- Final
Accounts (Trading Account, Profit and Loss Account and Balance Sheet with simple adjustments). Introduction to
Financial Analysis - Analysis and Interpretation of Liquidity Ratios, Activity Ratios, and Capital structure Ratios
and Profitability.
Textbooks:
1.Varshney&Maheswari: Managerial Economics, Sultan Chand, 2013.
2Aryasri: Business Economics and Financial Analysis, 4/e, MGH, 2019.
Reference Books:
1.Ahuja Hl Managerial economics Schand,3/e,2013
2.S.A. Siddiqui and A.S. Siddiqui: Managerial Economics and Financial Analysis, New Age International, 2013.
3.Joseph G. Nellis and David Parker: Principles of Business Economics, Pearson, 2/e, New Delhi.
4.Domnick Salvatore: Managerial Economics in a Global Economy, Cengage, 2013.

Online Learning Resources:

https://www.slideshare.net/123ps/managerial-economics-ppt
https://www.slideshare.net/rossanz/production-and-cost-45827016
https://www.slideshare.net/darky1a/business-organizations-19917607
https://www.slideshare.net/ba1arajbl/market-and-classification-of-market
https://www.slideshare.net/ruchi101/capital-budgeting-ppt-59565396
https://www.slideshare.net/ashu1983/financial-accounting
 UNIT – V: Financial Accounting and Analysis

INTRODUCTION: The main object of any Business is to make profit. Every trader generally
starts business for the purpose of making a profit. While establishing Business, he brings his own
capital, borrows money from relatives, friends, outsiders or financial institutions, then purchases
machinery, plant, furniture, raw materials and other assets. He starts buying and selling of goods,
paying for salaries, rent and other expenses, depositing and withdrawing cash from Bank. Like
this he undertakes innumerable transactions in Business.
The number of Business transactions in an organization depends up on the
size of the organization. In small organizations the transactions generally will be in the thousands
and in big organizations they may be in lakhs. As such it is humanly impossible to remember all
these transactions. Further it may not be possible to find out the result of the Business without
recording and analyzing these transactions.
Accounting came in practice as an aid to human memory by maintaining
a systematic record of Business transactions.

BOOKKEEPING AND ACCOUNTING:

According to G. A. Lee the Accounting system has two stages. The first
stage is Bookkeeping, and the second stage is accounting.

[A]. BOOKKEEPING:
Bookkeeping involves the chronological recording of financial transactions in a set of books in
a systematic manner
“Bookkeeping is the system of recording Business transactions for the purpose of providing
reliable information to the owners and managers about the state and prospect of the
Business concepts”.
Thus, Bookkeeping is an art of recording business transactions in the books of original entry and
the ledges.

[B]. ACCOUNTING: Accounting begins where the Bookkeeping ends

1. SMITH AND ASHBUNNE: Accounting means “measuring and reporting the results of
economic activities”.
2. R.N ANTHONY: Accounting is a system of “collecting, summarizing, Analyzing and
reporting in monster terms, the information about the Business”.
3. ICPA: Recording, classifying and summarizing is a significant manner and in terms of money
transactions and events, which are in part at least, of a financial character and interpreting the
results there.

Thus accounting is an art of recording, classifying, summarizing and interpreting business

transactions of financial nature. Hence accounting is the “Language of Business”.
ADVANTAGE OF ACCOUNTING

The following are the advantages of accounting…………

1. PROVIDES FOR SYSTEMATIC RECORDS: Since all the financial transactions are
recorded in the books, one need not rely on memory. Any information required is readily
available from these records.

2. FACILITATES THE PRPARATION OF FINANCIAL STATEMENTS: Profit and Loss

account and balance sheet can be easily prepared with the help of the information in the
records. This enables the trader to know the net result of Business operations (i.e.
profit/loss) during the accounting period and the financial position of the business at the
end of the accounting period.

3. PROVIDES CONTROL OVER ASSETS: Bookkeeping provides information regarding

cash in hand, cash at hand, stack of goods, accounts receivable from various parties and
the amounts invested in various other assets. As the trader knows the values of the assets
he will have control over them.

4. PROVIES THE REQUIRED INFORMATION: Interested parties such as owners, lenders,

creditors etc, get necessary information at frequent intervals.

5. COMPARITIVE STUDY: One can compare the present performance of the organization
with that of its past. This enables the managers to draw useful conclusions and make
proper decisions.

6. LESS SCOPE FOR FRAUD OR THEFT: It is difficult to conceal fraud or theft etc.
because of the balancing of the books of accounts periodically. As the work is divided
among many people, there will be check and counter check.

7. TAX MALTERS: Properly maintained Bookkeeping records will help in the settlement
of all tax matters with the tax authorities.

8. ASCERTAINING VALUE OF BUSINESS: The accounting records will help in

ascertaining the correct value of the Business. This helps in the event of the sale or
purchase of a business.

9. DOCUMENTARY EVIDENCE: Accounting records can also be used as evidence in the

court of substantial claims of the Business. Thus, records are based on documentary
proof. Authentic vouchers support every entry. As such, courts accept these records as
evidence.
 10.HELPFUL TO MANAGEMENT: Accounting is useful to the management in various
ways. It enables the management to assess the achievement of its performance. The
weaknesses of the business can be identified, and corrective measures can be applied to
remove them with the help of accounting.

LIMITATIONS OF ACCOUNTING

The following are the limitations of accounting………….

1.DOES NOT RECORD ALL EVENTS: Only the transactions of a financial character will be
recorded under bookkeeping. So, it does not reveal a complete picture about the quality of
human resources, locational advantages, business contacts etc.

2.DOES NOT REFLECT CURRENT VLAUES: The data available under bookkeeping is
historical in nature. So, they do not reflect current values. For instance, we record the values
of stock at cost price or market price, whichever is less. In case of building, machinery etc.,
we adapt historical case as the basis. In fact, the current values of Buildings, plant and
machinery may be much more than what is recorded in the balance sheet.

3. ESTIMATES BASED ON PERSONAL JUDGEMENT: The estimates used for determining

the values of various items may not be correct. For example, debtors are estimated in terms
of collectibles, inventories are based on marketability and fixed assets are based on useful
working life. These estimates are based on personal judgment and hence sometimes may not
be correct.

4. INADEQUATE INFORMATION ON COSTS AND PROFITS: Bookkeeping only

provides information about the overall profitability of the business. No information is
given about the cost and profitability of different activities of products or divisions.

BASIC ACCOUNTING CONCEPTS

Accounting is a system evolved to achieve a set of objectives. To achieve the goals, we need a
set of rules or guidelines. These guidelines are termed here as “BASIC ACCOUNTING
ONCEPTS”. The term concept means an idea or thought. Basic accounting concepts are the
fundamental ideas or basic assumptions underlying the theory and profit of FINANCIAL
ACCOUNTING. These concepts help in bringing about uniformity in the practice of accounting.
In accountancy the following concepts are quite popular.
1. BUSINESS ENTITY CONEPT: In this concept “Business is treated as separate from the
proprietor”. All the
Transactions recorded in the book of Business and not in the books of proprietor. The proprietor
is also treated as a creditor for the Business.
2. GOING CONCERN CONCEPT: This concept relates to the long life of Business. The
assumption is that business will continue to exist for unlimited periods unless it is dissolved due
to some reasons or the other.

3. MONEY MEASUREMENT CONCEPT: In this concept “Only those transactions are recorded
in accounting which can be expressed in terms of money, those transactions which cannot be
expressed in terms of money are not recorded in the books of accounting”.

4. COST CONCEPT: Accounting to this concept, can asset be recorded at its cost in the books
of account. i.e., the price which is paid at the time of acquiring it. In balance sheet, these assets
appear not at cost price every year, but depreciation is deducted, and they appear at the amount,
which is cost, less classification.

5. ACCOUNTING PERIOD CONCEPT: every Businessman wants to know the result of his
investment and efforts after a certain period. Usually a one-year period is regarded as an ideal
for this purpose. This period is called Accounting Period. It depends on the nature of the business
and object of the proprietor of business.

6. DUAL ASCEPT CONCEPT: According to this concept “Every business transaction has two
aspects”, one is the receiving benefit aspect another one is giving benefit aspect. The receiving
benefit aspect is termed as
“DEBIT”, whereas the giving benefit aspect is termed as “CREDIT”. Therefore, for every debit,
there will be corresponding credit.

7. MATCHING COST CONCEPT: According to this concept “The expenses incurred during an
accounting period, e.g., if revenue is recognized on all goods sold during a period, cost of those
good sole should also
Be charged to that period.

8. REALISATION CONCEPT: According to this concept revenue is recognized when a sale is

made. Sale is
Considered to be made at the point when the property in goods possessed to the buyer and he
becomes legally liable to pay.

ACCOUNTING CONVENTIONS
Accounting is based on some customs or usages. Naturally accountants here to adopt that usage
or custom.
They are termed as convert conventions in accounting. The following are some of the important
accounting conventions.

1.FULL DISCLOSURE: According to this convention accounting reports should disclose fully
and fairly the information. They purport to represent. They should be prepared honestly and
sufficiently to disclose information which is of material interest to proprietors, present and
potential creditors and investors. The companies ACT, 1956 makes it compulsory to provide all
the information in the prescribed form.

2.MATERIALITY: Under this convention the trader records important factors about the
commercial activities. In the form of financial statements if any unimportant information is to
be given for the sake of clarity it will be given as footnotes.

3.CONSISTENCY: It means that the accounting method adopted should not be changed from
year to year. It means that there should be consistent in the methods or principles followed. Or
else the results of a year
Cannot be conveniently compared with that of another.

4. CONSERVATISM: This convention warns the trader not to take unrealized income into
account. That is why the practice of valuing stocks at cost or market price, whichever is lower,
is in vague. This is the policy of “playing safe”; it takes into consideration all prospective losses
but leaves all prospective profits.

KEY WORDS IN BOOK-KEEPING

1. TRANSACTIONS: Any sale or purchase of goods of services is called the transaction.

Transactions are two types of transactions.
[a]. cash transaction: cash transaction is one where cash receipt or payment is involved in
the exchange.
[b]. Credit transaction: Credit transaction will not have cash, either received or paid, for
something given or received respectively.
2.GOODS: Fill those things which a firm purchase for sale are called goods.
3.PURCHASES: Purchases means purchase of goods, unless they are stated otherwise, they also
represent the Goods purchased.
4.SALES: Sales means sale of goods, unless it is stated otherwise it also represents these goods
sold.
5.EXPENSES: Payments for the purchase of goods as services are known as expenses.
6.REVENUE: Revenue is the amount realized or receivable from the sale of goods or services.
7.ASSETS: The valuable things owned by the business are known as assets. These are the
properties owned by the business.
8.LIABILITIES: Liabilities are the obligations or debts payable by the enterprise in future in
terms of money or goods.
9. DEBTORS: Debtors means a person who owes money to the trader.
10.CREDITORS: A creditor is a person to whom something is owned by the business.
11.DRAWINGS: cash or goods withdrawn by the proprietor from the Business for his personal
or Household is termed to as “drawing”.
12.RESERVE: An amount set aside out of profits or other surplus and designed to meet
contingencies.
13.ACCOUNT: A summarized statement of transactions relating to a particular person, thing,
expense or income.
14.DISCOUNT: There are two types of discounts...
a. cash discount: An allowable made to encourage frame payment or before the
expiration of the period allowed for credit.
b. Trade discount: A deduction from the gross or catalogue price allowed to traders who
buy them for sale.

CLASSIFICATION OF BUSINESS TRANSACTIONS

All business transactions are classified into three categories:

1.Those relating to people
2.Those relating to property (Assets)
3.Those relating to income & expenses
Thus, three classes of accounts are maintained for recording all business transactions.
They are:
1.Personal accounts
2.Real accounts
3.Nominal accounts

1.Personal Accounts: Accounts which are transactions with persons are called “Personal
Accounts”.
A separate account is kept on the name of each person recording the benefits received from or
given to the person during dealings with him.
E.g.: Krishna’s A/C, Gopal’s A/C, SBI A/C, Nagarjuna Finanace Ltd.A/C, ObulReddy & Sons
A/C, HMT Ltd. A/C, Capital A/C, Drawings A/C etc.
2.Real Accounts: The accounts relating to properties or assets are known as “Real Accounts”.
Every business needs assets such as machinery, furniture etc., for running its activities. A
separate account is maintained for each asset owned by the business.
E.g.: cash A/C, furniture A/C, building A/C, machinery A/C etc.
3.Nominal Accounts: Accounts relating to expenses, losses, incomes and gains are known as
“Nominal Accounts”. A separate account is maintained for each item of expenses, losses, income
or gain.
E.g.: Salaries A/C, stationery A/C, wages A/C, postage A/C, commission A/C, interest A/C,
purchases A/C, rent A/C, discount A/C, commission received A/C, interest received A/C, rent
received A/C, discount received A/C.

Before recording a transaction, it is necessary to find out which of the accounts is to be debited
and which is to be credited. The following three different rules have been laid down for the three
classes of accounts….
1.Personal Accounts: The account of the person receiving benefit (receiver) is to be debited and
the account of the person giving the benefit (given) is to be credited.

Rule: “Debit----The Receiver

Credit---The Giver”

2.Real Accounts: When an asset is coming into the business, the account of that asset is to be
debited. When an asset is going out of the business, the account of that asset is to be credited.

Rule: “Debit----What comes in

Credit---What goes out”

3. Nominal Accounts: When an expense is incurred or loss encountered, the account representing
the expense or loss is to be debited. When any income is earned or gain made, the account
representing the income of gain is to be credited.

Rule: “Debit----All expenses and losses

Credit---All incomes and gains”

JOURNAL

The first step in accounting therefore is the record of all the transactions in the books of original
entry viz., Journal and then posting into ledges.

JOURNAL: The word Journal is derived from the Latin word ‘journ’ which means a day.
Therefore, journal means a ‘day Book’ in day-to-day business transactions are recorded in
chronological order.

Journal is treated as the book of original entry or first entry or prime entry. All the business
transactions are recorded in this book before they are posted in the ledges. The journal is a
complete and chronological (in order of dates) record of business transactions. It is recorded in
a systematic manner. The process of recording a transaction in the journal is called
“JOURNALISING”. The entries made in the book are called “Journal Entries”.
 The proforma of Journal is given below.

Date Date Particulars L.F. no Debit Credit

RS. RS.
1998 Jan 1 Purchases account to cash 10,000/- 10,000/-
account (being goods
purchased for cash)

LEDGER

All the transactions in a journal are recorded in chronological order. After a certain period, if we
want to know whether a particular account is showing a debit or credit balance it becomes very
difficult. So, the ledger is designed to accommodate the various accounts maintained by the
trader. It contains the final or permanent record of all the transactions in duly classified form. “A
ledger is a book which contains various accounts.” The process of transferring entries from
journal to ledger is called “POSTING”.

Posting is the process of entering in the ledger the entries given in the journal. Posting into ledger
is done periodically, maybe weekly or fortnightly as per the convenience of the business. The
following are the guidelines for posting transactions in the ledger.

1. After the completion of Journal entries only posting is to be made in the ledger.
2. For each item in the Journal a separate account is to be opened. Further, for each new
item a new account is to be opened.
3. Depending upon the number of transactions, space for each account is to be determined
in the ledger.
4. For each account there must be a name. This should be written in the top of the table.
At the end of the name, the word “Account” is to be added.
5. The debit side of the Journal entry is to be posted on the debit side of the account, by
starting with “TO”.
6. The credit side of the Journal entry is to be posted on the debit side of the account, by
starting with “BY”.

Proforma for ledger: LEDGER BOOK

Particulars account

Date Particulars Lfno Amount Date Particulars Lfno amount

 sales account

Date Particulars Lfno Amount Date Particulars Lfno amount

cash account

Date Particulars Lfno Amount Date Particulars Lfno amount

TRAIL BALANCE

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

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

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

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

Thus, a trail balance is a list of balances of the ledger accounts and cash book of a business
concern at any given date.
PROFORMA FOR TRAIL BALANCE:
Trail balance for MR…………………………………… as on …………
NO NAME OF ACCOUNT DEBIT CREDIT
(PARTICULARS) AMOUNT(RS.) AMOUNT(RS.)

Trail Balance

Specimen of trial balance

1 Capital Credit Loan

2 Opening stock Debit Asset
3 Purchases Debit Expense
4 Sales Credit Gain
5 Returns inwards Debit Loss
6 Returns outwards Debit Gain
7 Wages Debit Expense
8 Freight Debit Expense
9 Transport expenses Debit Expense
10 Royalities on production Debit Expense
11 Gas, fuel Debit Expense
12 Discount received Credit Revenue
13 Discount allowed Debit Loss
14 Bas debts Debit Loss
15 Dab debts reserve Credit Gain
16 Commission received Credit Revenue
17 Repairs Debit Expense
18 Rent Debit Expense
19 Salaries Debit Expense
20 Loan Taken Credit Loan
21 Interest received Credit Revenue
22 Interest paid Debit Expense
23 Insurance Debit Expense
24 Carriage outwards Debit Expense
25 Advertisements Debit Expense
26 Petty expenses Debit Expense
27 Trade expenses Debit Expense
28 Petty receipts Credit Revenue
29 Income tax Debit Drawings
30 Office expenses Debit Expense
31 Customs duty Debit Expense
32 Sales tax Debit Expense
33 Provision for discount on debtors Debit Liability
34 Provision for discount on creditors Debit Asset
35 Debtors Debit Asset
36 Creditors Credit Liability
37 Goodwill Debit Asset
38 Plant, machinery Debit Asset
39 Land, buildings Debit Asset
40 Furniture, fittings Debit Asset
41 Investments Debit Asset
42 Cash in hand Debit Asset
43 Cash at bank Debit Asset
44 Reserve fund Credit Liability
45 Loan advances Debit Asset
46 Horse, carts Debit Asset
47 Excise duty Debit Expense
48 General reserve Credit Liability
49 Provision for depreciation Credit Liability
50 Bills receivable Debit Asset
51 Bills payable Credit Liability
52 Depreciation Debit Loss
53 Bank overdraft Credit Liability
54 Outstanding salaries Credit Liability
55 Prepaid insurance Debit Asset
56 Bad debt reserve Credit Revenue
57 Patents & Trademarks Debit Asset
58 Motor vehicle Debit Asset
59 Outstanding rent Credit Revenue
FINAL ACCOUNTS

In every business, the businessman is interested in knowing whether the business has
resulted in profit or loss and what the financial position of the business is at a given time. In
brief, he wants to know (i)The profitability of the business and (ii) The soundness of the business.
The trader can ascertain this by preparing the final accounts. The final accounts are
prepared from the trial balance. Hence the trial balance is said to be the link between the ledger
accounts and the final accounts. The final accounts of a firm can be divided into two stages. The
first stage is preparing the trading and profit and loss account, and the second stage is preparing
the balance sheet.

TRADING ACCOUNT
The first step in the preparation of the final account is the preparation of the trading
account. The main purpose of preparing the trading account is to ascertain gross profit or gross
loss because of buying and selling the goods.
Trading account of MR……………………. for the year ended ……………………

Particulars Amount Particulars Amount

To opening stock Xxxx By sales xxxx

To purchases xxxx Less: returns xxx Xxxx
Less: returns xx Xxxx By closing stock Xxxx

To carriage inwards Xxxx

To wages Xxxx
To freight Xxxx
To customs duty, octroi Xxxx

To gas, fuel, coal,

Water Xxxx

To factory expenses
To other man. Expenses Xxxx
To productive expenses Xxxx
To gross profit c/d
Xxxx Xxxx

Xxxx

Xxxx
Finally, a ledger may be defined as a summary statement of all the transactions relating to a
person, asset, expense or income which have taken place during a given period of time. The up-
to-date state of any account can be easily known by referring to the ledger.

PROFIT AND LOSS ACCOUNT

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

PROFIT AND LOSS A/C OF MR……………………. FOR THE YEAR

ENDED…………
PARTICULARS AMOUNT PARTICULARS AMOUNT
TO office salaries Xxxxxx By gross profit b/d Xxxxx
TO rent,rates,taxes Xxxxx Interest received Xxxxx
TO Printing and stationery Xxxxx Discount received Xxxx
TO Legal charges Commission received Xxxxx
Audit fee Xxxx Income from investments
TO Insurance Xxxx Dividend on shares
TO General expenses Xxxx Miscellaneous Xxxx
TO Advertisements Xxxxx investments Xxxx
TO Bad debts Xxxx Rent received
TO Carriage outwards Xxxx xxxx
TO Repairs Xxxx
TO Depreciation Xxxxx
TO interest paid Xxxxx
TO Interest on capital Xxxxx
TO Interest on loans Xxxx
TO Discount allowed Xxxxx
TO Commission Xxxxx
TO Net profit------- Xxxxx
(transferred to capital a/c)
xxxxxx Xxxxxx

BALANCE SHEET

The second point of final accounts is the preparation of balance sheet. It is prepared often in the
trading and profit and loss accounts have been compiled and closed. A balance sheet may be
considered as a statement of the financial position of the concern at a given date.
DEFINITION: A balance sheet is an item-wise list of assets, liabilities and proprietorship of a
business at a certain state.

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

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

BALANCE SHEET OF ………………………… AS ON

…………………………………….
Liabilities and capital Amount Assets Amount

Creditors Xxxx Cash in hand Xxxx

Bills payable Xxxx Cash at bank Xxxx
Bank overdraft Xxxx Bills receivable Xxxx
Loans Xxxx Debtors Xxxx
Mortgage Xxxx Closing stock Xxxx
Reserve fund Xxxx Investments Xxxx
Capital xxxxxx Furniture and fittings Xxxx
Add: Plats&machinery
Net Profit xxxx Land & buildings Xxxx
------- Patents, TM, copyrights Xxxx
xxxxxxx Goodwill Xxxx
-------- Prepaid expenses
Outstanding incomes Xxxx
Less: Xxxx
Drawings xxxx Xxxx Xxxx
--------- XXXX XXXX

Advantages: The following are the advantages of final balance .

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

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

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

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

(ii)If closing stock is given as adjustment:

1. First, it should be posted at the credit side of “Trading Account”.
2. Next, shown at the asset side of the “Balance Sheet”.

2.OUTSTANDING EXPENSES: -
(i)If outstanding expenses are given in Trail Balance: It should be only on the liability side of
Balance Sheet.
(ii)If outstanding expenses given as adjustment:
1. First, it should be added to the expenses concerned on the
debit side of the profit and loss account or Trading Account.
2. Next, it should be added at the liabilities side of the
Balance Sheet.

3.PREAPID EXPENSES: -
(i)If prepaid expenses are given in Trial Balance: It should be shown only on the assets side of
the Balance Sheet.
(ii)If prepaid expense given as adjustment:
1. First, it should be deducted from the expenses concerned at the debit side of the profit
and loss account or Trading Account.
2. Next, it should be shown at the assets side of the Balance Sheet.
4.INCOME EARNED BUT NOT RECEIVED [OR] OUTSTANDING INCOME [OR] ACCURED
INCOME: -
(i)If incomes given in Trial Balance: It should be shown only on the assets side of the Balance
Sheet.
(ii)If incomes outstanding given as adjustment:
1. First, it should be added to the income concerned at the credit side of profit and loss
account.
2. Next, it should be shown at the assets side of the Balance sheet.

5. INCOME RECEIVED IN ADVANCE: UNEARNED INCOME: -

(i)If unearned incomes given in Trail Balance: It should be shown only on the liabilities side of
the Balance Sheet.
(ii)If unearned income given as adjustment:
1. First, it should be deducted from the income concerned in the credit side of the profit and
loss account.
2. Secondly, it should be shown in the liabilities side of the
Balance Sheet.

6.DEPRECIATION: -
(i)If Depreciation given in Trail Balance: It should be shown only on the debit side of the profit
and loss account.
(ii)If Depreciation given as adjustment
1. First, it should be shown on the debit side of the profit and loss account.
2. Secondly, it should be deducted from the assets concerned in the Balance sheet assets
side.

7.INTEREST ON LOAN [OR] CAPITAL: -

(i)If interest on loan (or) capital given in Trail balance: It should be shown only on debit side of
the profit and loss account.
(ii)If interest on loan (or)capital given as adjustment:
1. First, it should be shown on the debit side of the profit and loss account.
2. Secondly, it should add to the loan or capital in the liabilities side of the Balance Sheet.

8.BAD DEBTS: -
(i)If bad debts given in Trail balance: It should be shown on the debit side of the profit and loss
account.
(ii)If bad debts given as adjustment:
1. First, it should be shown on the debit side of the profit and loss account.
2. Secondly, it should be deducted from debtors in the assets side of the Balance Sheet.
9.INTEREST ON DRAWINGS: -
(i)If interest on drawings given in Trail balance: It should be shown on the credit side of the
profit and loss account.
(ii)If interest on drawings given as adjustments:
1. First, it should be shown on the credit side of the profit and loss account.
2. Secondly, it should be deducted from capital on liabilities
side of the Balance Sheet.

10.INTEREST ON INVESTMENTS: -
(i)If interest in the investments given in Trail balance: It should be shown on the credit side of
the profit and loss account.
(ii)If interest in investments given as adjustments:
1. First, it should be shown on the credit side of the profit and loss account.
2. Secondly, it should be added to the investments on assets side of the Balance Sheet.

Note: Problems to be solved on final accounts

 FINANCIAL ANALYSIS THROUGH RATIOS

Ratio Analysis

Absolute figures are valuable but they standing alone convey no meaning unless compared with
another. Accounting ratios show inter-relationships which exist among various accounting data.
When relationships among various accounting data supplied by financial statements are worked
out, they are known as accounting ratios.

Accounting ratios can be expressed in various ways such as:

1. A pure ratio says the ratio of current assets to current liabilities is 2:1 or
2. a rate say current assets are two times of current liabilities or
3. The percentage says current assets are 200% of current liabilities.

Each method of expression has a distinct advantage over the other, the analyst will select that
mode which will best suit his convenience and purpose.

Uses or Advantages or Importance of Ratio Analysis

Ratio Analysis stands for the process of determining and presenting the relationship of items and
groups of items in the financial statements. It is an important technique of financial analysis. It
is a way by which financial stability and health of a concern can be judged. The following are
the main uses of Ratio analysis:

(a) Useful in financial position analysis: Accounting reveals the financial position of the
concern. This helps banks, insurance companies and other financial institutions in
lending and making investment decisions.
(ii) Useful in simplifying accounting figures: Accounting ratios simplify, summaries and
systematic the accounting figures to make them more understandable and in lucid form.

(iii) Useful in assessing the operational efficiency: Accounting ratios helps to have an idea
of the working of a concern. The efficiency of the firm becomes evident when analysis is
based on accounting ratio. This helps the management to assess financial requirements and
the capabilities of various business units.

(iv) Useful in forecasting purposes: If accounting ratios are calculated for number of years,
then a trend is established. This trend helps in setting up future forecasting.

(v) Useful in locating the weak spots of the business: Accounting ratios are of great assistance
in locating the weak spots in the business even though the overall performance may be
efficient.
 (vi) Useful in comparison of performance: Managers are usually interested to know which
department’s performance is good and for that he compare one department with the another
department of the same firm. Ratios also help him to make any change in the organization
structure.

Limitations of Ratio Analysis: These limitations should be kept in mind while making use
of ratio analyses for interpreting the financial statements. The following are the main
limitations of ratio analysis.

1. False results if based on incorrect accounting data: Accounting ratios can be correct only
if the data (on which they are based) are correct. Sometimes, the information given in the
financial statements is affected by window dressing, i.e. showing position better than
what is.
2. No idea of probable happenings in future: Ratios are an attempt to make an analysis of
past financial statements; so, they are historical documents. Now-a-days keeping in view
the complexities of the business, it is important to have an idea of the probable
happenings in the future.
3. Variation in accounting methods: The two firms’ results are comparable with the help of
accounting ratios only if they follow some accounting methods or bases. Comparison
will become difficult if the two concerns follow the different methods of providing
depreciation or valuing stock.
4. Price level change: Change in price levels make comparisons for various years difficult.
5. Only one method of analysis: Ratio analysis is only a beginning and gives just a fraction
of information needed for decision-making so to have a comprehensive analysis of
financial statements, ratios should be used along with other methods of analysis.
6. No common standards: It is very difficult to by a common standard for comparison
because circumstances differ from concern to concern, and the nature of each industry is
different.
7. Different meanings assigned to some terms: Different firms, to calculate ratio may assign
different meanings. This may affect the calculation of ratio in different firms and such
ratio when used for comparison may lead to wrong conclusions.
8. Ignores qualitative factors: Accounting ratios are tools of quantitative analysis only. But
sometimes qualitative factors may surmount the quantitative aspects. The calculations
derived from the ratio analysis under such circumstances may get distorted.
9. No use if ratios are worked out for insignificant and unrelated figure: Accounting ratios
should be calculated based on cause-and-effect relationship. One should be clear as to
what cause is and what effect it is before calculating a ratio between two figures.

Ratio Analysis: Ratio is an expression of one number in relation to another. It is one of the
methods of analyzing financial statements. Ratio analysis facilities the presentation of the
information of the financial statements in simplified and summarized form. Ratio is a measuring
of two numerical positions. It expresses the relation between two numeric figures. It can be found
by dividing one figure by other ratios are expressed in three ways.
 1. Jines method
2. Ratio Method
3. Percentage Method

Classification of ratios: All the ratios broadly classified into four types due to the interest of
different parties for different purposes. They are:

1. Profitability ratios
2. Turnover ratios
3. Financial ratios
4. Leverage ratios

1. Profitability ratios: These ratios are calculated to understand the profit position of the
business. These ratios measure the profit earning capacity of an enterprise. These ratios
can be related to its saving or capital to a certain margin on sales or profitability of capital
employed. These ratios are of interest to management. Who is responsible for success
and growth of enterprise? Owners as well as financiers are interested in profitability
ratios as these reflect the ability of enterprises to generate return on capital employed
important profitability ratios are:

Profitability ratios in relation to sales: Profitability ratios are almost important of concern.
These ratios are calculated in focus the end results of the business activities which are
the sole eritesiour of overall efficiency of organization.

gross profit
1. Gross profit ratio: x 100
Nest sales
Note: Higher the ratio the better it is

Net profit after interest & Tax

2. Net profit ratio: X 100
Net sales
Note: Higher the ratio the better it is

3. Operating ratio (Operating expenses ratio)

Cost of goods sold  operating exenses

X 100
Net sales
Note: The Lower the Ratio the Better It is

Operating profit
4. Operating profit ratio: X 100 = 100 operating ratio
Net sales
Note: Higher the ratio the better it is cost of goods sold= opening stock + purchase + wages
+ other direct expenses- closing stock (or) sales – gross profit.
 Operating expenses:

= administration expenses + setting, distribution expenses operating profit= gross profit

– operating expense.

concern expense
Expenses ratio = X 100
Net sales
Note: Lower the ratio the better it is

Profitability ratios in relation to investments:

Net profit after tax & latest depreciati on

1. Return on investments: X 100
share holders funds
Shareholders’ funds = equity share capital + preference share capital + receives & surpluses
+undistributed profits.

Note: Higher the ratio the better it is

Net Profit after tax & interest - preference divident

2. Return on equity capital: X 100
equity share capital
Note: Higher the ratio the better it is

Net profit after tax - preferecne divident

3. Earnings per share=
No. of equity shares
operating profit
4. Return on capital employed = x 100
capital employed
N. P. after tax and interest
5. Return on total assets =
Total Assets
Here, capital employed = equity share capital + preference share capital + reserves &
surpluses + undistributed profits + debentures+ public deposit + securities + long term loan
+ other long term liability – factious assets (preliminary expressed & profit & loss account
debt balance)

II. Turn over ratios or activity ratios:

These ratios measure how efficiently the enterprise employees the resources of assets at its
command. They indicate the performance of the business. The performance of an enterprise is
judged by its save. It means ratios are also laced efficiency ratios.

These ratios are used to know the turnover position of various things in the ___________. The
turnover ratios are measured to help the management in taking the decisions regarding the levels
maintained in the assets, and raw materials and in the funds. These ratios are measured in ratio
method.
 cost of goods sold
1. Stock turnover ratio =
average stock
Here,
opening stock  closing stock
Average stock=
2
Note: Higher the ratio, the better it is

sales
2. Working capital turnover ratio =
working capital
Note: Higher the ratio the better it is working capital = current assets – essential liabilities.

sales
3. Fixed assets turnover ratio =
fixed assets
Note: Higher the ratio the better it is.

sales
3 (i) Total assets turnover ratio is:
total assets
Note: Higher the ratio the better it is.

Sales
4. Capital turnover ratio=
Capital employed
Note: Higher the ratio the better it is

credits sales or sales

5. Debtors’ turnover ratio=
average debtors
5(i)= Debtors collection period= 365 (or) 12
Turnove ratio

Here,
opening debitors  closing bebtors
Average debtors =
2
Debtors = debtors + bills receivable

Note: Higher the ratio the better it is.

credit purchasers or purchases

6. Creditors’ turnover ratio =
average credetors

365 (or) 12
6 (i) creditors collection period=
Creditor t urnover ratio
Here,
opening  closing credetors
Average creditor=
2
Creditors = creditors + bills payable.

Note: lower the ratio the better it is.

3. Financial ratios or liquidity ratios:

Liquidity refers to the ability of organization to meet its current obligation. These ratios are used
to measure the financial status of an organization. These ratios help the management to make
decisions about the maintained level of current assets & current libraries of the business. The
main purpose of calculating these ratios is to know the short terms solvency of the concern.
These ratios are useful to various parties having interest in the enterprise over a short period –
such parties include banks. Lenders, suppliers, employees and others.

The liquidity ratios assess the capacity of the company to repay its short-term liabilities. These
ratios are calculated in ratio method.

current assets
Current ratio =
current liabilitie s
Note: The ideal ratio is 2:1
i. e., current assets should be twice. The current liabilities.

quick assets
Quick ratio or liquid ratio or acid test ratio:
current liabilitie s
Quick assets = cash in hand + cash at bank + short term investments + debtors + bills receivables
short term investments are also known as marketable securities.
Here the ideal ratio is 1:1 is, quick assets should be equal to the current liabilities.

absolute liquid assets

Absolute liquid ratio= 𝑐𝑢𝑟𝑟𝑒𝑛𝑡 𝑙𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠

Here,
Absolute liquid assets=cash in hand + cash at bank + short term investments + marketable
securities.

Here, the ideal ratio is 0,0:1 or 1:2 it, absolute liquid assets must be half of current liabilities.

Leverage ratio of solvency ratios: Solvency refers to the ability of a business to honor long item
obligations like interest and installments associated with long term debts. Solvency ratios
indicate long term stability of an enterprise. These ratios are used to understand the yield rate if
the organization.
Lenders like financial institutions, debenture, holders, banks are interested in ascertaining the
solvency of the enterprise. The important solvency ratios are:

outsiders funds Debt

1. Debt – equity ratio= =
share holders funds Equity
Here,
Outsiders’ funds = Debentures, public deposits, securities, long term bank loans + other long-
term liabilities.

Shareholders’ funds = equity share capital + preference share capital + reserves & surpluses +
undistributed projects.

The ideal ratio is 2:1

share holder funds

2. Preprimary ratio or equity ratio=
total assets
The ideal ratio is 1:3 or 0.33:1

3. Capital – greasing ratio:

(equity share capital  reserves & surplusses  undistribu ted projects)

=
Here, (Outsiders funds  preference share capital )

The higher gearing ratio is not good for a new company or the company in which future earnings
are uncertain.

outsiders funds
11. Debt to total fund ratio=
capital employed
Capital employed= outsiders funds + shareholders’ funds = debt + equity.
The ideal ratio is 0.6.7 :1 or 2:3.
 Assignment cum Tutorial Questions
Module 1: Concepts and Conventions
1. Which of the following is an example of an accounting convention?
a) Historical cost
b) Going concern
c) Prudence
d) Consistency
2. Which accounting concept assumes that a business will continue operating for the
foreseeable future?
a) Matching
b) Accrual
c) Going concern
d) Dual aspect
3. What is the concept of ‘conservatism’ in accounting also known as?
a) Consistency concept
b) Prudence concept
c) Accrual concept
d) Materiality concept
4. Which accounting convention requires that transactions are recorded at their
original cost?
a) Realization
b) Historical cost
c) Full disclosure
d) Materiality
5. The matching concept relates to which of the following?
a) Recording revenue when cash is received
b) Matching expenses with revenues
c) Recording expenses as they are incurred
d) Valuing assets at historical cost
Module 2: Double-Entry Bookkeeping, Journal, Ledger, Trial Balance
1. Which principle is the foundation of the double-entry bookkeeping system?
a) Single-entry
b) Dual aspect
c) Matching principle
d) Materiality
2. In the double-entry system, every transaction affects how many accounts?
a) 1
b) 2
c) 3
d) 4
3. Which of the following is recorded first in the accounting cycle?
a) Ledger
b) Trial Balance
 c) Journal
d) Final Accounts
4. A trial balance is prepared to check the accuracy of:
a) The balance sheet
b) Journal entries
c) Posting to the ledger
d) Double-entry bookkeeping
5. What is the purpose of preparing a ledger?
a) To record individual transactions
b) To summarize journal entries
c) To verify trial balance
d) To prepare financial statements
Module 3: Final Accounts (Trading Account, Profit and Loss Account, Balance Sheet)
1. Which of the following appears in the Trading Account?
a) Net profit
b) Gross profit
c) Operating expenses
d) non-operating income
2. Which of these accounts is used to calculate the net profit of a business?
a) Trading Account
b) Profit and Loss Account
c) Balance Sheet
d) Ledger
3. Which of the following adjustments is made while preparing final accounts?
a) Bad debts
b) Accruals and prepayments
c) Depreciation
d) All of the above
4. Which financial statement shows the financial position of a business at a specific
point in time?
a) Trading Account
b) Profit and Loss Account
c) Balance Sheet
d) Cash Flow Statement
5. The Balance Sheet is prepared to:
a) Calculate gross profit
b) Show the financial position of the business
c) Calculate the cash flow
d) Record daily transactions
Module 4: Financial Analysis - Liquidity Ratios
1. Which of the following is a liquidity ratio?
a) Current ratio
b) Debt-to-equity ratio
 c) Inventory turnover ratio
d) Return on equity
2. The formula for the current ratio is:
a) Current assets / Total liabilities
b) Current assets / Current liabilities
c) Total liabilities / Current assets
d) Current liabilities / Total liabilities
3. Which of the following is considered a good current ratio?
a) 1:1
b) 2:1
c) 3:1
d) 0.5:1
4. Which ratio helps assess a company's ability to pay short-term obligations without
relying on inventory?
a) Quick ratio
b) Current ratio
c) Debt ratio
d) Return on capital employed
5. A low quick ratio may indicate:
a) Strong liquidity
b) Potential cash flow problems
c) Excessive inventory
d) Strong profitability
Module 5: Financial Analysis - Activity, Capital Structure, and Profitability Ratios
1. Which of the following is an activity ratio?
a) Inventory turnover ratio
b) Return on assets
c) Quick ratio
d) Gross profit margin
2. The debt-to-equity ratio is a measure of:
a) Profitability
b) Liquidity
c) Capital structure
d) Activity
3. Which of the following is a profitability ratio?
a) Gross profit margin
b) Inventory turnover ratio
c) Debt ratio
d) Current ratio
4. Return on equity (ROE) measures:
a) Efficiency of asset usage
b) Profitability in relation to equity
 c) Company's ability to pay off short-term liabilities
d) Leverage
5. A high inventory turnover ratio typically indicates:
a) Slow-moving inventory
b) Efficient inventory management
c) Poor sales performance
d) High liquidity

Part-B
2 Marks: Short Answer Questions
Module 1: Concepts and Conventions
1. Define the going concern concept.
2. What is the historical cost concept in accounting?
3. Briefly explain the prudence concept.
4. What is meant by the matching concept in accounting?
5. Differentiate between consistency and materiality concepts.
Module 2: Double-Entry Bookkeeping, Journal, Ledger, Trial Balance
1. What is double-entry bookkeeping?
2. Explain the purpose of preparing a trial balance.
3. What is a journal, and why is it important in accounting?
4. How does a ledger differ from a journal?
5. What is the purpose of balancing a ledger account?
Module 3: Final Accounts (Trading Account, Profit and Loss Account, Balance Sheet)
1. What is the purpose of a trading account?
2. Briefly explain the profit and loss account.
3. What are final accounts?
4. List two key components of a balance sheet.
5. What is the significance of adjustments in final accounts?
Module 4: Financial Analysis - Liquidity Ratios
1. What is a liquidity ratio?
2. Define the current ratio.
3. What does the quick ratio indicate?
4. Explain the significance of liquidity ratios in financial analysis.
5. How is the current ratio calculated?
Module 5: Financial Analysis - Activity, Capital Structure, and Profitability Ratios
1. Define the inventory turnover ratio.
2. What is the debt-to-equity ratio used for?
3. Explain the gross profit margin.
4. What does return on equity (ROE) measure?
5. How do activity ratios help in financial analysis?
 PART C
Long Answer Questions
Module 1: Concepts and Conventions
1. Explain the various accounting concepts and conventions with examples.
2. Discuss the importance of the matching concept and the going concern concept in
financial accounting. Provide relevant examples.
Module 2: Double-Entry Bookkeeping, Journal, Ledger, Trial Balance
1. Journalize the following transactions in the books of Rama Krishna [CO5,BL:3]
1. Commence business with cash rs.10,000
2. paid into bank rs.8,000
3.Bought goods for cash rs.500
4. Bought furniture by cheque rs.500.
5. withdrawn from bank rs.900
6. He sold goods to Gopal Rs.500
7.Bought goods from Ram for rs.510
8. Paid trade expenses rs.200
9.Received cash from Gopal and allowed discount rs.10- 490
10.paid wages rs.70
11.paid Ram in full settelment rs.500
12.paid rent rs.150
13.Interest on capital rs.500

2. Journalize the following transactions & post them to ledger. [CO5, BL:3]
1. Ram invites Rs.10, 000 in cash
2. He bought goods worth rs.2, 000 from Shyam
3. He bought a machine for rs.5, 000 from Lakshman on account.
4. He paid to Lakshman Rs. 2,000.
5. He sold goods for cash Rs. 3,000.
6. He sold goods to A on account Rs.4, 000.
7. He paid to Shyam Rs.1, 000.
8. He received amount from A Rs.2, 000.
 3. The following are the transactions in the month of January, 2009 of Mr. Prasad & Co:
[CO5,BL:4]
Jan 1 Purchase goods worth Rs. 5,000 for cash
less 20% trade discount and 5% cash discount.
Jan 4 Purchase of goods from Bharat Rs. 5,000
Jan 12 Sold goods to Rohan on credit Rs. 600
Jan 18 Sold goods to Ram for cash Rs. 1000.
Jan 20 Paid salary to Ratan Rs. 2000
Jan 26 Interest received from Madhu Rs. 200
Jan 31 Sold goods for cash Rs. 500.
Jan 31 Withdrew goods from business for personal use Rs. 200

4. Journalize the following transactions in the books of Ravi and post them into ledgers:
[CO5,BL:4]
Particulars Amount
2008 March 1 Started business with cash 4,50,000
March 1 Purchase of goods from ram 3, 20,000
March10 Paid rent for the month 2,000
March11 Purchase of Machine 1, 00,000
March12 Paid salaries 12,000
March15 Paid to ram 1, 00,000
March20 Sold goods to Shyam 20,000
March25 Received from Shyam 30,000
March31 Received cash from cash sales 2, 50,000
March31 Wages paid 5,000

Module 3: Final Accounts (Trading Account, Profit and Loss Account, Balance Sheet)
5. Prepare Trading, Profit and loss account and Balance sheet for the year ending 31/3/2003
after taking into consideration the following information. [CO5,BL:4]

Rs. Rs.
Furniture 15000 Insurance 6000
Capital A/C 54000 Rent 22000
Cash in hand 3000 Sundry debtors 60000
Opening stock 50000 Sales 600000
Fixed deposits 134600 Advertisement 10000
Drawings 5000 Postages and telephone 3400
Provision for bad debts 3000 Bad debts 2000
Cash at Bank 10000 Printing and stationary 9000
Purchases 300000 General charges 13000
Salaries 19000 Sundry creditors 40000
Carriage inwards 41000 Deposit from customers 6000
Adjustments:
a) Closing stock as on 31st March was Rs. 10000.
b) Salary of Rs. 2000 is yet to be paid to an employee
6. Trail Balance of Bharat is given below. Prepare the Trading Account and Profit and Loss
Account for the year ending 31st December, 2005 and Balance Sheet as on that date
[CO5,BL:4]

Particulars Debit Rs. Credit Rs.

Drawings and Capital 10,550 1,19,400
Plant & Machinery 38,300
Sundry Debtors and Creditors 62,000 59,360
Wages 43,750
Purchases and Sales 2,56,590
Opening Stock 95,300
Salaries 12,880
Insurance 930
Cash at Bank 18,970
Interest on Loan 14,370
Discount allowed 4,870
Furniture 12,590
Loan Payable 79,630
Land & Buildings 43,990
6,15,090 6,15,090
Closing Stock was Values at Rs. 90,000
7. Prepare trail balance from the following information [CO5,BL:4]

Particulars Amount
Capital 1,00,000
Plant & Machinery 1,60,000
Sales 3,54,000
Purchases 1,20,000
Returns outwards 1,500
Returns inwards 2,000
Opening stock 60,000
Discount allowed 700
Discount Received 1,600
Bank Charges 150
Sundry Debtors 90,000
Sundry Creditors 50,000
Salaries 13,600
Manufacturing Wages 20,000
Carriage inwards 1,500
Carriage outwards 2,400
Provision for bad debts 1,050
Rent, rates and taxes 20,000
Advertisements 4,000
Cash 1,800
Bank 12,000
Closing stock 70,000
 8. The following are the particulars of Ledger Account balances taken from the books of
Bhaskar for the year ending 31st March 2005. You are required to prepare Trading
Account and Profit and Loss Account and Balance Sheet as on that date [BL:4]
Particulars Debit Rs. Credit Rs.
Capital 1,00,000
Bills receivables and Bills Payable 4,00,000 7,00,000
Sundry Debtors and Creditors 75,000 50,000
Cash 15,000
Bank 25,000
Business Premises 2,50,000
Loan Payable 25,000
Opening stock 40,000
Purchase & Returns 60,000 8,000
Sales & Returns 37,000 2,75,000
Wages 35,000
Salaries 65,000
Rent, Taxes and rates 15,000
Depreciation 5,000
Furniture 78,000
Advertisement 58,000
11,58,000 11,58,000
Adjustments:
1. Closing Stock was Values at Rs. 80,000
2. Write off Bad Debts of Rs. 5,000 out of sundry debtors.
3. Prepaid Insurance amounted Rs. 1,000
Module 4: Financial Analysis - Liquidity Ratios
1. Calculate and interpret liquidity ratios (Current and Quick Ratios) from the following
information:
Particulars ₹
Current Assets 1,50,000
Inventory 50,000
Current Liabilities 75,000
Compute the current ratio and quick ratio.
Comment on the company's liquidity position based on these ratios.
 2. Explain the role of liquidity ratios in financial analysis. Discuss how they help in
assessing the short-term solvency of a business.
Module 5: Financial Analysis - Activity, Capital Structure, and Profitability Ratios
1. Using the following data, calculate and interpret the inventory turnover ratio, gross
profit margin, and return on equity (ROE):
Particulars ₹
Cost of Goods Sold (COGS) 3,00,000
Average Inventory 50,000
Sales 5,00,000
Gross Profit 2,00,000
Net Income 1,00,000
Equity 2,50,000
Inventory Turnover Ratio = COGS / Average Inventory
Gross Profit Margin = (Gross Profit / Sales) × 100
ROE = (Net Income / Equity) × 100
Comment on the efficiency, profitability, and return to shareholders based on your
calculations.
2. Discuss the importance of profitability and capital structure ratios in assessing the
financial health of a company.