Finance for Non-Finance People

Sandeep Goel is a Professor of Accounting and Finance and Corporate Governance at the Management Development Institute (MDI) Gurgaon, India. He holds three decades of rich industry and academic experience, and is an accomplished Forensic Accounting, Fraud Risk Management and Corporate Governance professional.

List of figures xv

List of tables xvii

About the Author xix

Preface xxi

Acknowledgements xxvi

Abbreviations xxviii

PART I

Introduction 1

1 Business organisations 3

Meaning of a business organisation 3

Types of business organisations 3

I. Private sector enterprise 4

II. Public sector enterprise 4

III. Joint sector enterprise 4

Types of private sector enterprises 5

1. Sole proprietorship 5

2. Joint Hindu family business 5

3. Partnership 5

4. Cooperative organisation 5

5. Joint stock company 5

6. One person company 7

Types of public sector enterprises 8

Departmental undertakings 8

Statutory corporations 9

Government companies 9

PART II

Financial accounting and analysis 11

2 Fundamentals of accounting 13

Meaning of accounting 13

Branches of accounting 14

1. Financial accounting 14

2. Cost accounting 14

3. Management accounting 15

Objectives of accounting 15

Limitations of accounting 15

Accounting elements 16

Double-entry system of accounting 18

Basis of accounting 21

3 Accounting process 24

Accounting cycle 24

1. Recording in the ‘Journal’ 26

2. Classification into the ‘Ledger’ 28

3. Summarising in ‘Trial Balance’ 31

4 Accounting principles 33

Basic accounting principles 34

A. Accounting concepts 34

1. Business entity principle 34

2. Money measurement principle 35

3. Accounting period principle 35

4. Cost principle 36

5. Going concern principle 36

6. Matching principle 37

7. Revenue recognition principle 37

8. Dual aspect principle 37

B. Accounting conventions 38

1. Materiality 38

2. Full disclosure 38

3. Consistency 39

4. Conservatism 39

5 Financial statements 41

Financial statements 41

Statement of profit and loss 42

1. Revenue from operations (Turnover/sales) 43

2. Other income 43

3. Operating expenses 44

4. Finance costs/Non-operating expenses 45

5. Other expenses 45

6. Profit before tax/earnings before tax (PBT/EBT) 45

7. Income tax 45

8. Profit after tax (PAT) 45

Balance sheet 48

I Assets side of balance sheet 49

II Liabilities side of balance sheet 52

Depreciation accounting 55

Depreciation methods 56

1. Straight Line Method (SLM) 56

2. Written-Down-Value Method (WDV) 56

3. Other Depreciation Methods 57

Statement of cash flows 58

A. Steps to calculate CFO: 60

B. Steps to calculate CFI and CFF: 60

C. Final Step to prepare CFS: 60

Other disclosures in annual report 62

Components of a company’s annual report 62

6 Financial analysis 65

Financial analysis: The concept and process 66

1. Common-size analysis 66

2. Trend analysis 69

3. Ratio analysis 71

Ranking and weight based on the DuPont scores 77

Financial analysis of Maruti Suzuki and Tata Motors 78

Indian automobile sector 78

I Profitability analysis of Maruti Suzuki and Tata Motors 82

Operating efficiency analysis of Maruti Suzuki and Tata

Motors 88

Liquidity analysis of Maruti Suzuki and Tata Motors 91

Solvency analysis of Maruti Suzuki and Tata Motors 94

Market analysis of Maruti Suzuki and Tata Motors 96

Corporate cases 98

I Indian telecom sector 99

II Indian banking sector 102

Global landscape 105

A. Apple Inc. (USA) 106

B. Unilever (UK) 107

PART III

Cost accounting and management 109

7 Cost concepts and classification 111

Cost accounting 111

Significance of cost accounting 112

Cost! 112

Elements of cost 113

Cost unit 114

Cost centres 115

Process of costing 115

Cost classification 116

1. On the basis of traceability 116

2. On the basis of association 116

3. On the basis of nature 117

4. On the basis of controllability 117

5. On the basis of decision-making 118

Components of total cost 118

1. Prime cost 118

2. Factory cost 118

3. Office cost 118

4. Total cost/cost of sales 119

Cost sheet 119

Methods of costing 120

1. Job costing 120

2. Process costing 121

Techniques of costing 121

1. Budgetary control 121

2. Standard costing 122

3. Marginal costing 122

4. Absorption costing 122

8 Budgetary control 124

Budgeting 124

Budget 124

Budgetary control 125

Process of budgetary control 125

Types of budgets 126

A. On the basis of time 126

B. On the basis of functions 127

C. On the basis of flexibility 128

Essentials of good budgeting 130

Caselets of different budgets 131

1. Manufacturing overhead budget 131

2. Sales overhead budget 131

3. Cash budget 132

9 Marginal costing and managerial decision-making 135

Marginal cost 135

Marginal costing 136

Cost-Volume-Profit analysis (CVP analysis) 137

Tools of CVP analysis 137

(a) Contribution 137

(b) Contribution margin/P/V ratio 138

(c) Break-even point 138

(d) Margin of safety 140

Managerial decision-making 141

1. Pricing decisions 141

2. Key factor 143

3. Profit planning 144

4. Make or buy 145

5. Continue or discontinue? 147

6. Selection of the best method of production 148

PART IV

Financial management 151

10 Nature of financial management 153

What is financial management? 153

Elements 153

Objectives of financial management 154

Functions of financial management 154

Financial management scenario in India 155

Financial management problems 156

11 Capital budgeting: Concept and application 158

Meaning of capital budgeting 158

Capital budgeting process 159

Capital budgeting projects 160

Indian realty sector 161

12 Time value of money 165

What is time value of money? 165

Methods of valuation 166

A. Compounding – ‘future value’ (FV) 166

B. Discounting – ‘present value’ (PV) 169

13 Estimation of cash flows for capital expenditures 173

Cash flows estimation 173

1. Relevant cash flows 174

2. Incremental cash flows 175

14 Capital budgeting appraisal methods 181

I Non-discounted cash flow techniques 182

1. PBP 182

2. ARR 183

II DCF techniques 184

1. Discounted PBP 184

2. NPV 185

3. PI/Benefit-cost ratio (B/C ratio) 187

4. IRR 188

Case: Indian Cloth Mills Ltd. 190

15 Cost of capital 196

What is cost of capital? 196

Classification of costs 197

Computation of cost of capital 197

I Computation of specific costs 197

Beta coefficient and its application 200

Categories of beta 201

II Assigning weights to specific costs 202

III Multiplication of specific costs with weights to get total cost 203

16 Capital structure planning 205

Capital structure defined 206

Types of business finance 206

1. Long-term finance 206

2. Medium-term finance 206

3. Short-term finance 207

Instruments of finance 207

1. Shares 208

2. Retained earnings 208

3. Debentures 208

4. Institutional finance 208

5. Public deposits 208

6. Bank finance 208

Factors affecting capital structure 209

1. Profitability 209

2. Liquidity 209

3. Cost of raising capital 209

4. Stability of enterprise 209

5. Control 209

6. Flexibility of financial structure 209

7. Capital market conditions 210

8. Legal requirements 210

Concept of leverage 210

Leverage ratio 210

Factors determining financial leverage 211

Capital structure analysis of UltraTech Cement and Shree Cement 212

Indian cement industry 213

17 Working capital management 217

Meaning of working capital 217

Concept of working capital 219

1. Gross working capital 219

2. Net working capital 220

Constituents of working capital 220

A. Current assets 220

B. Current liabilities 221

Estimation of working capital 221

Types of working capital 223

1. Permanent working capital 223

2. Temporary working capital 223

Determinants of working capital 224

1. Nature and size of business 224

2. Manufacturing cycle 224

3. Production policy 224

4. Firm’s credit policy 224

5. Sales growth 224

6. Business cycle 224

Types of working capital policy 225

1. Aggressive working capital policy 225

2. Conservative working capital policy 225

3. Matching working capital policy 226

Working capital management: The concept 227

Significance of working capital management 228

Working capital analysis of Nestle India and Dabur

India 228

Indian FMCG sector 229

18 Dividend policy 232

Dividend policy: Overview 232

Forms of dividends 233

Procedure for cash dividend payment 234

1. Recommendation by board of directors 234

2. Approval by the shareholders 234

3. Dividend – ‘interim dividend’ 235

4. Dividend to be deposited in a separate bank account 235

Determinants of dividend policy 235

A. External factors 235

B. Internal factors 236

Dividend policies: Types 237

I Constant dividend per share (DPS) policy 237

II Constant dividend payout policy 238

III Long-run residual dividend policy 238

IV Hybrid dividend policy 239

Dividend policy of HUL and Dabur India 239

Indian FMCG sector 239

PART V

Financial markets 245

19 Financial System: Constituents and instruments 247

Financial markets: Overview 247

1 Based on the nature of securities 248

2 Based on the timing of issue 248

Financial Regulatory institutions 248

1. Reserve Bank of India (RBI) 249

2. Securities and Exchange Board of India (SEBI) 249

A. Markets based on types of securities 250

I. Money market 250

II. Capital market 252

B. Markets based on issue of securities 255

I. Primary market 255

II. Secondary market 256

C. Other markets 256

Derivatives market 257

20 Mutual funds 260

What are mutual funds? 260

Growth of mutual funds 261

Types of mutual funds 261

1. Based on structure 262

2. Based on investment objective 263

3. Based on special schemes 263

Importance of mutual funds 264

PART VI

Tax planning 267

21 Income tax 269

Indian tax structure: Overview 269

Revenue authority 270

Direct vs. indirect tax: Distinction 270

Basic terminologies under Income Tax Act, 1961 271

Income tax classification 274

A. Salaries [Sec. 15] 274

B. Income from house property [Sec. 22] 275

C. Profits and gains of business or profession [Sec. 28] 275

D. Capital gains [Sec. 45] 276

E. Income from other sources [Sec. 56] 276

Computation of tax liability 278

1. Individual Tax 279

2. Cooperative society tax 281

3. Partnership firm tax 282

4. Local authority tax 282

5. Corporate tax 282

Appendix I: Future/Compound value factor of a lump sum (FVIF/CVIF) of Re 1, FVIF(i, n) 288

Appendix II: Future/Compound value factor of an annuity (FVIFA/CVIFA) of Re 1, FVIFA(i, n) 290

Appendix III: Present value factor of a lump sum (PVIF) of Re 1, PVIF(i, n) 292

Appendix IV: Present value factor of an annuity (PVIFA) of Re 1, PVIFA(i, n) 294

Glossary 296

Index 310