Accounting and Finance Management

M.S Ramaiah School of Advanced Studies - Bangalore

PEMP- GP-POM

Session 7

Accounting and Finance Management

Vinay Basavaraj

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PEMP- GP-POM

Session Objectives

At the end of this session, students will be able to:– Elaborate the accounting rules and concepts– Explain the nuances of financial statements– Perform ratio analysis– Explain the uses of management accounting– Elaborate different business structures

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PEMP- GP-POM

Session Objectives

At the end of this session, students will be able to:– Calculate cash flows– Perform capital budgeting– Explain the dividend discount model and using the model,

calculate intrinsic value of common stock

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Contents

• Accounting rules and concepts• Financial statements• Ratio analysis• Managerial Accounting• Business Structures• Cash Flow• Capital Budgeting• Dividend discount model

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Accounting rules and concepts

• Accountancy, or accounting, is the production of financial records about an organization

• Many tedious accounting practices have been simplified with the help of computer software

• Today, accounting is called "the language of business"

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• Key concepts– Accounting period – Accrual – Bookkeeping – Cash flow forecasting – Cost of goods sold

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• In India, Indian Accounting Standards (AS), are a set of accounting standards notified by the Ministry of Corporate Affairs which are converged with International Financial Reporting Standards (IFRS)

• These accounting standards are formulated by Accounting Standards Board of Institute of Chartered Accountants of India (ICAI)

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Financial statements

• A financial statement (or financial report) is a formal record of the financial activities of a business, person, or other entity

• Relevant financial information is presented in a structured manner and in a form easy to understand

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• Statement of financial position: also referred to as a balance sheet, reports on a company's assets, liabilities, and ownership equity at a given point in time

• A profit and loss statement provides information on the operation of the enterprise. These include sales and the various expenses incurred during the processing state

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• Statement of comprehensive income: reports on a company's income, expenses, and profits over a period of time

• Statement of cash flows: reports on a company's cash flow activities, particularly its operating, investing and financing activities

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• Key concepts– Double-entry system – Mark-to-market accounting – FIFO and LIFO – GAAP / IFRS – Management Accounting Principles– Matching principle – Revenue recognition

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Ratio analysis

• What is Financial statement analysis?– Financial statement analysis (or financial analysis)

the process of understanding the risk and profitability of a firm (business, sub-business or project)

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Ratio analysis

• What is Financial statement analysis?– The analyst uses reported financial information

and different accounting tools and techniques

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Ratio analysis

• Constituents of financial statement analysis

Reformulating reported financial statements

Analysis and adjustments of measurement errors

Financial ratio analysis

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Managerial Accounting

• Management accounting or managerial accounting is concerned with the provisions and use of accounting information to managers within organizations

• It provides them with the basis to make informed business decisions that will allow them to be better equipped in their management and control functions

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• In contrast to financial accountancy, management accounting is:– primarily forward-looking– designed and intended for use by managers within

the organization– computed by reference to the needs of managers

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• Tools of management accounting– Activity-based costing (ABC)– Grenzplankostenrechnung (GPK)– Lean accounting– Resource consumption accounting (RCA)– Transfer pricing– Throughput accounting

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Business Structures

• Of all the decisions one makes when starting a business, probably the most important one relating to taxes is the type of legal structure of the company

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Business Structures

• The most common forms of business are– Sole Proprietorship– Partnership– Corporation

• A more recent development to these forms of business is the limited liability company (LLC) and the limited liability partnership (LLP)

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Cash Flow

• Cash flow is the movement of money into or out of a business, project, or financial product

• Measurement of cash flow can be used for calculating other parameters that give information on a company's value and situation

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Cash Flow

• Statement of cash flow– The (total) net cash flow of a company over a

period (typically a quarter, half year, or a full year) is equal to the change in cash balance over this period

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Cash Flow

• Statement of cash flow– The total net cash flow is the sum of cash flows

that are classified in three areas:• Operational cash flows• Investment cash flows• Financing cash flows

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Capital Budgeting

• Capital budgeting (or investment appraisal) is the planning process used to determine whether an organization's long term investments such as new machinery, replacement machinery, new plants, new products, and research development projects are worth the funding

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Capital Budgeting

• It is the process of allocating resources for major capital, or investment, expenditures

• One of the primary goals of capital budgeting investments is to increase the value of the firm to the shareholders

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Capital Budgeting• Many formal methods are used in capital

budgeting, including the techniques such as:– Accounting rate of return– Payback period– Net present value– Profitability index– Internal rate of return– Modified internal rate of return– Equivalent annuity– Real options valuation

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Capital Budgeting

• Among the methods of Capital Budgeting mentioned, the most common are:

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Net present value (NPV)

Internal rate of return

(IRR)


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Capital Budgeting

• However, in case of conflict between NPV and IRR, the former prevails

• Conflict arises when the two methods choose different investment projects

• The NPV method is a more technically-sound method of capital budgeting

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Capital Budgeting

• Funding Sources– Capital budgeting investments and projects must

be funded through excess cash provided through the raising of debt capital, equity capital, or the use of retained earnings

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Capital Budgeting

• Need For Capital Budgeting– As large sum of money is involved which

influences the profitability of the firm making capital budgeting an important task

– Long term investment once made can not be reversed without significance loss of invested capital

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Capital Budgeting

• Need For Capital Budgeting– Investment decision are the base on which the

profit will be earned and probably measured through the return on the capital

– The implication of long term investment decisions are more extensive than those of short run decisions because of time factor involved

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Dividend discount model

• The dividend discount model (DDM) is a method of valuing a company based on the theory that a stock is worth the discounted sum of all of its future dividend payments

• Also known as the Gordon model

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• Derivation of equation

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• Problems with the model– The presumption of a steady and perpetual growth

rate less than the cost of capital may not be reasonable

– If the stock does not currently pay a dividend, like many growth stocks, more general versions of the discounted dividend model must be used to value the stock

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• Problems with the model– The stock price resulting from the Gordon model is

hyper-sensitive to the growth rate chosen

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Summary

• Accounting rules and concepts– Accountancy, or accounting, is the production of

financial records about an organization– Key concepts include accounting period,

Bookkeeping, Accrual etc.• Financial statements

– A financial statement (or financial report) is a formal record of the financial activities of a business, person, or other entity

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PEMP- GP-POM

Summary

• Ratio analysis– Financial statement analysis (or financial analysis)

the process of understanding the risk and profitability of a firm (business, sub-business or project)

• Managerial Accounting– Managerial accounting is concerned with the

provisions and use of accounting information to managers within organizations

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PEMP- GP-POM

Summary

• Business Structures– Of all the decisions one makes when starting a

business, probably the most important one relating to taxes is the type of legal structure of the company

• Cash Flow– Cash flow is the movement of money into or out of

a business, project, or financial product

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PEMP- GP-POM

Summary

• Capital Budgeting– Capital budgeting (or investment appraisal) is the

planning process used to determine whether an organization's long term investments such as new machinery, replacement machinery, new plants, new products, and research development projects are worth the funding

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PEMP- GP-POM

Summary

• Capital Budgeting– Among the methods of Capital Budgeting

mentioned, the most common are NPV and IRR (the former prevails in case of any conflict)

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PEMP- GP-POM

Summary

• Dividend discount model– The dividend discount model (DDM) is a method

of valuing a company based on the theory that a stock is worth the discounted sum of all of its future dividend payments

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Accounting and Finance Management

Documents

Transcript of Accounting and Finance Management