Tag: University of Mumbai BMS Notes

The management of a company cannot wait for the year to end to analyze their financial performance and their profits. This must be done year-round. These profitability ratios help the management determine an entity’s ability to use its assets and create earnings. The most useful comparisons for these ratios is to the performance of the previous years.

Profitability ratios are both revenue statement ratios and balance sheet ratios. They compare the revenue of a firm to different types of expense accounts within the Profit and Loss Statement. And then some profitability ratios also compare revenue to aspects of the balance sheet such as assets and equity.

There are a variety of profitability ratios calculated with the help of the Income Statement and the Balance Sheet.

Gross Profit Ratio

This ratio simply compares the gross profit of a company to its net sales. Both of these figures are obtained from the Income Statement. The ratio is also known as Margin ratio or the Rate of Gross Profit. The ratio is represented as a percentage of sales.

This ratio basically signifies the basic profitability of the firm. This is why it is one of the most important profitability ratios. It shows the margin in the selling price before the company will incur losses from operations. The formula is

Gross Profit Ratio = (Gross Profits / Net Revenue from Operations) × 100

Net Revenue from Operations = Net Sales = Sales – Sale Returns

Gross Profit = Sales – Cost of Sales

Operating Ratio

The second one of the profitability ratios is the operating ratio. This ratio measures the equation between the cost of operating activities and the net sales, or revenue from operations. This ratio expresses the cost of goods sold as a percentage of the net sales.

Operating ratio also takes into account operating expenses such as administration and office expenses, selling and distribution costs, salaries paid, depreciation expenses etc. Also, it ignores the non-operating incomes such as interests, commisions, dividends etc.

Operating Ratio = (COGS + Operating Expenses / Net Revenue from Operations) × 100

This ratio can actually help ascertain the efficiency of the organization along with its profitability. There is no standard ratio, but a trend analysis must be done on year on year basis to check the progress of the firm.

Net Profit Ratio

Unlike the operating ratio, the net profit ratio includes the total revenue of the firm. It takes into account both the operating income as well as the non-operating income. Then it compares net profit to these incomes. This ratio too is represented as a percentage. The formula for Net Profit ratio is,

Net Profit Ratio = (Net Profit / Net Revenue) × 100

Net Profit = Net Profit after Tax (NPAT)

This ratio helps measure the overall profitability of the firm. It indicates the portion of the net revenue that is available to the proprietors. It also reflects on the efficiency of the business and is a very important ratio for investors and financiers.

Return on Capital Employed

This ratio is one of the important ones of the profitability ratios. It measures the overall efficiency of the utilization of the firm’s funds. The ratio explores the relationship between the total income/profit earned by a firm and the total capital employed by the firm, or the total investment made.  The formula is as follows,

Return on Capital Employed = (PBIT / Capital Employed) × 100

PBIT = Profit Before Income and Tax

This ratio measures the efficiency with which the capital is being utilized and it indicates the productivity of the capital employed. It is a good tool to measure the overall profitability of the firm as well.

Earnings Per Share

This ratio represents the profit or the earnings of a company in the context of one share. It represents the earnings of a firm whether or not dividends were actually declared on such shares. The formula for this ratio is

Earnings Per Share (EPS) = (Profit available to Equity Shareholders / Number of equity Shareholders) × 100

Profit available to Equity Shareholders = NPAT – Preference Dividend

This is an important ratio for the shareholders, it helps them decide whether to hold onto the shares or sell them. It also is a good indicator of the dividends to be declared and/or bonus issues.

Solvency Ratios also known as leverage ratios determine an entity’s ability to service its debt. So, these ratios calculate if the company can meet its long-term debt. It is important since the investors would like to know about the solvency of the firm to meet their interest payments and to ensure that their investments are safe. Hence solvency ratios compare the levels of debt with equity, fixed assets, earnings of the company etc.

One thing to make note of is the difference between solvency ratios and liquidity ratios. These two are often confused for the other. Liquidity ratios compare current assets with current liabilities, i.e. short-term debt. Whereas solvency ratios analyze the ability to pay long-term debt.

1) Debt to Equity Ratio

The debt to equity ratio measures the relationship between long-term debt of a firm and its total equity. Since both these figures are obtained from the balance sheet itself, this is a balance sheet ratio. Let us look at the formula:

Debt to Equity Ratio = Long-Term Debt / Shareholders Funds

Long Term Debt = Debentures + Long Term Loans

Shareholders Funds = Equity Share Capital + Preference Share Capital + Reserves – Fictitious Assets

The debt-equity ratio holds a lot of significance. Firstly, it is a great way for the company to measure its leverage or indebtedness. A low ratio means the firm is more financially secure, but it also means that the equity is diluted.

In contrast, a high ratio indicates a risky business where there are more creditors of the firm than there are investors. In fact, a high debt to equity ratio may deter more investors from investing in the firm, and even deter creditors from lending money.

While there is no industry standard as such it is best to keep this ratio as low as possible. The maximum a company should maintain is the ratio of 2:1, i.e. twice the amount of debt to equity.

2) Debt Ratio

Next, we learn about debt ratio. This ratio measures the long-term debt of a firm in comparison to its total capital employed. Alternatively, instead of capital employed, we can use net fixed assets. So the debt ratio will measure the liabilities (long-term) of a firm as a percent of its long-term assets. The formula is as follows:

Debt Ratio = Long-Term Debt / Capital Employed OR Long-Term Debt / Net Assets

Capital Employed = Long Term Debt + Shareholders Funds

Net Assets = Non-Fictitious Assets – Current Liabilities

This is one of the more important solvency ratios. It indicates the financial leverage of the firm. A low ratio points to a more financially stable business, better for the creditors. A higher ratio points to doubts about the firms long-term financial stability.  But a higher ratio helps the management with trading on equity, i.e. earn more income for the shareholders. Again there is no industry standard for this ratio.

3) Proprietary Ratio 

The third of the solvency ratios is the proprietary ratio or equity ratio. It expresses the relationship between the proprietor’s funds, i.e. the funds of all the shareholders and the capital employed or the net assets. Like the debt ratio shows us the comparison between debt and capital, this ratio shows the comparison between owner’s funds and total capital or net assets. The ratio is as follows:

Proprietary Ratio = Shareholders Funds / Capital Employed OR Shareholders Funds / Net Assets

A high ratio is a good indication of the financial health of the firm. It means that a larger portion of the total capital comes from equity. Or that a larger portion of net assets is financed by equity rather than debt. One point to note, that when both ratios are calculated with the same denominator, the sum of debt ratio and the proprietary ratio will be 1.

4) Interest Coverage Ratio

All debt has a cost, which we normally term as an interest. Debentures, loans, deposits etc all have an interest cost. This ratio will measure the security of this interest payable on long-term debt. It is the ratio between the profits of a firm available and the interest payable on debt instruments. The formula is:

Interest Coverage Ratio = Net Profit before Interest and Tax / Interest on Long-Term Debt

Common size statements are also known as ‘Vertical analysis’. Financial statements, when read with absolute figures, can be misleading. Therefore, a vertical analysis of financial information is done by considering the percentage form. The balance sheet items are compared:

• To the total assets in terms of percentage by taking the total assets as 100.
• To the total liabilities in terms of percentage by taking the total liabilities as 100.

Therefore the whole Balance Sheet is converted into percentage form. And such converted Balance Sheet is known as Common-Size Balance Sheet. Similarly profit & loss items are compared:

• To the total incomes in terms of percentage by taking the total incomes as 100.
• To the total expenses in terms of percentage by taking the total expenses as 100.

Therefore the whole Profit & loss account is converted into percentage form. And such converted profit & loss account is known as Common-Size Profit & Loss account. As the numbers are brought to a common base, the percentage can be easily compared with the results of corresponding percentages of the previous year or of some other firms.

Advantages of Common-Size Statement:

(a) Easy to Understand:

Common-size Statement helps the users of financial statement to make clear about the ratio or percentage of each individual item to total assets/liabilities of a firm. For example, if an analyst wants to know the working capital position he may ascertain the percentage of each individual component of current assets against total assets of a firm and also the percentage share of each individual component of current liabilities.

(b) Helpful for Time Series Analysis:

A Common-Size Statement helps an analyst to find out a trend relating to percentage share of each asset in total assets and percentage share of each liability in total liabilities.

(c) Comparison at a Glance:

An analyst can compare the financial performances at a glance since percentage of increase or decrease of each individual component of cost, assets, liabilities etc. are available and he can easily ascertain his required ratio.

(d) Helpful in analysing Structural Composition:

A Common-Size Statement helps the analyst to ascertain the structural relations of various components of cost/expenses/assets/liabilities etc. to the required total of assets/liabilities and capital.

Limitations of Common-Size Statement:

(a) Standard Ratio:

Common-Size Statement does not help to take decisions since there is no standard ratio/percentage regarding the change of percentage in the various component of assets, liabilities, sales etc.

(b) Change in Price-level:

Common-Size statement does riot recognise the change in price level i.e. inflationary effect. So, it supplies misleading information’s since it is based on historical cost.

(c) Following Consistency:

If consistency in the accounting principle, concepts, conventions is not maintained then Common Size Statement becomes useless.

(d) Seasonal Fluctuation:

Common-Size Statement fails to convey proper records during seasonal fluctuations in various components of sales, assets liabilities etc. e.g. sales and closing stock significantly vary. Thus, the statement fails to supply the real information to the users of financial statements.

(e) Window Dressing:

Effect of window dressing in financial statements cannot be ignored and Common-Size Statements fail to supply the real positions of sales, assets, liabilities etc. due to the evil effects of window dressing appearing in the financial statements.

(f) Qualitative Element:

Common-Size Statement fails to recognise the qualitative elements, e.g. quality of works, customer relations etc. while measuring the performance of a firm although the same should not be ignored.

(g) Liquidity and Solvency Position:

Liquidity and solvency position cannot be measured by Common-Size Statement. It considers the percentage of increase or decrease in various components of sales, assets, liabilities etc. In other words it does not help to ascertain the Current Ratio, Liquid Ratio, Debt Equity Capital Ratio, Capital Gearing Ratio etc. which are applied in testing liquidity and solvency position of a firm.

The common-size statements, balance sheet and income statement are shown in analytical percentages. The figures are shown as percentages of total assets, total liabilities and total sales. The total assets are taken as 100 and different assets are expressed as a percentage of the total. Similarly, various liabilities are taken as a part of total liabilities.

These statements are also known as component percentage or 100 per cent statements because every individual item is stated as a percentage of the total 100. The short-comings in comparative statements and trend percentages where changes in items could not be compared with the totals have been covered up. The analyst is able to assess the figures in relation to total values.

The common-size statements may be prepared in the following way:

(1) The totals of assets or liabilities are taken as 100.

(2) The individual assets are expressed as a percentage of total assets, i.e., 100 and different liabilities are calculated in relation to total liabilities. For example, if total assets are Rs 5 lakhs and inventory value is Rs 50,000, then it will be 10% of total assets (50,000×100/5,00,000)

Types of Common-Size Statements:

(i) Common-Size Balance Sheet:

A statement in which balance sheet items are expressed as the ratio of each asset to total assets and the ratio of each liability is expressed as a ratio of total liabilities is called common-size balance sheet.

For example, following assets are shown in a common-size balance sheet:

The total figure of assets Rs 2,00,000, is taken as 100 and all other assets are expressed as a percentage of total assets. The relation of each asset to total assets is expressed in the statement. The relation of each liability to total liabilities is similarly expressed.

The common-size balance sheet can be used to compare companies of differing size. The comparison of figures in different periods is not useful because total figures may be affected by a number of factors. It is not possible to establish standard norms for various assets. The trends of figures from year to year may not be studied and even they may not give proper results.

(ii) Common Size Income Statement:

The items in income statement can be shown as percentages of sales to show the relation of each item to sales. A significant relationship can be established between items of income statement and volume of sales. The increase in sales will certainly increase selling expenses and not administrative or financial expenses.

In case the volume of sales increases to a considerable extent, administrative and financial expenses may go up. In case the sales are declining, the selling expenses should be reduced at once. So, a relationship is established between sales and other items in income statement and this relationship is helpful in evaluating operational activities of the enterprise.

Importance of Common Size Analysis

One of the benefits of using common size analysis is that it allows investors to identify drastic changes in a company’s financial statement. This mainly applies when the financials are compared over a period of two or three years. Any significant movements in the financials across several years can help investors decide whether to invest in the company. For example, large drops in the company’s profits in two or more consecutive years may indicate that the company is going through financial distress. Similarly, considerable increases in the value of assets may mean that the company is implementing an expansion or acquisition strategy, making the company attractive to investors.

Common size analysis is also an excellent tool to compare companies of different sizes but in the same industry. Looking at their financial data can reveal their strategy and their largest expenses that give them a competitive edge over other comparable companies. For example, some companies may sacrifice margins to gain a large market share, which increases revenues at the expense of profit margins. Such a strategy allows the company to grow faster than comparable companies because they are more preferred by investors.

Management Accounting is a branch of accounting focused on providing financial and non-financial information to help managers make informed decisions, plan and control business operations, and optimize performance. It involves the preparation and analysis of financial data, cost identification and control, budgeting, forecasting, and performance evaluation, tailored to the needs of internal management. Unlike financial accounting, which aims at providing information to external stakeholders, management accounting is oriented towards the internal analysis for strategic and operational decision-making. It supports the management in policy formulation, enhances efficiency through cost reduction and profit maximization strategies, and aids in risk management. Through its diverse tools and techniques, management accounting facilitates strategic planning, resource allocation, and operational control, contributing to the overall growth and sustainability of an organization.

Objectives of Management Accounting

• Aiding Decision Making:

To provide relevant financial and non-financial information that assists managers in making informed decisions about various aspects of the business, such as pricing, budget allocation, and resource utilization.

• Facilitating Planning and Budgeting:

To assist in setting short-term and long-term goals, developing strategic plans, and preparing budgets that align with the organization’s objectives.

• Enhancing Operational Control:

To help in monitoring day-to-day operations, ensuring activities are aligned with plans and budgets, and identifying areas where improvements are needed.

• Improving Efficiency and Reducing Costs:

To analyze operational processes and cost structures, identifying opportunities for cost reduction and efficiency enhancement.

• Supporting Strategic Management:

To provide insights and analyses that support strategic decision-making, including market analysis, competitive analysis, and internal capability assessment.

• Risk Management:

To identify, assess, and manage risks, ensuring that the organization is aware of potential challenges and is prepared to address them.

Functions of Management Accounting

• Cost Accounting:

Analyzing the cost of acquiring or producing goods and services to provide a basis for cost control and pricing decisions.

• Budgeting:

Preparing detailed budgets that forecast revenues, expenses, and cash flows, helping managers plan for future operations.

• Financial Analysis and Interpretation:

Evaluating financial statements and other data to assess the organization’s financial performance and position.

• Performance Measurement:

Using key performance indicators (KPIs) and other metrics to evaluate the efficiency and effectiveness of operations and the achievement of business objectives.

• Variance Analysis:

Comparing actual results to budgeted or planned figures to identify deviations, understand their causes, and take corrective actions.

• Capital Budgeting:

Evaluating investment opportunities and making decisions about long-term capital projects based on their potential to generate value.

• Internal Reporting:

Preparing internal reports that provide managers with timely and relevant information about financial and operational performance.

• Strategic Analysis:

Conducting analyses that help in formulating, evaluating, and implementing strategic plans.

Also known as ‘horizontal analysis, are financial statements showing financial position & profitability at different periods of time. These statements give an idea of the enterprise financial position of two or more periods. Comparison of financial statements is possible only when same accounting principles are used in preparing these statements.

Comparative Balance Sheet

The progress of the company can be seen by observing the different assets and liabilities of the firm on different dates to make the comparison of balances from one date to another. To understand the comparative balance sheet, it must have two columns for the data of original balance sheets. A third column is used to show increases/decrease in figures. The fourth column gives percentages of increases or decreases.

By comparing the balance sheets of different dates, one can observe the following aspects

• Current financial position and Liquidity position
• Long-term financial position
• Profitability of the concern

Comparative Income Statement

Traditionally known as trading and profit and loss A/c. Net sales, cost of goods sold, selling expenses, office expenses etc are important components of an income statement. To compare the profitability, particulars of profit & loss are compared with the corresponding figures of previous years individually. To analyze the profitability of the business, the changes in money value and percentage is determined.

By comparing the profits of different dates, one can observe the following aspects:

• The increase/decrease in gross profit.
• The study of operational profits.
• The increase or decrease in net profit
• Study of the overall profitability of the business.

Advantages of Comparative Financial Statement:

(a) Comparison:

The comparative statements show the figures of various firms or number of years side by side i.e. both for inter-firm comparison and intra-firm comparison.

(b) Horizontal Analysis:

The variables are arranged horizontally for the purpose of analysis and interpretations of data taken from financial statements for assessing profitability, overall efficiency and financial position of a firm.

(c) Trend Analysis:

The comparative financial statement helps to ascertain the ‘trend’ relating to sales, cost of goods sold, operating expenses etc. so that a proper comparison can easily be made which helps the analyst to understand the overall performance of a firm.

(d) Trend and Directions:

The comparative financial statement provides necessary information for comparison of trends in related items e.g. the analyst can compare the trend of sales with the trend of accounts receivable which gives very useful information. A 20% increase in accounts receivable and an increase of sales by only 10% warrants investigation into the reasons for this difference in the rate of increase.

(e) Evaluation of:

The comparative financial statement helps the analyst to compare Performance the performance of one firm with that of other similar firm in the industry and also compare the performance of the competitors in the line. This comparison helps to find out the weakness or strength of a firm and to take adequate steps.

(f) Measuring Financial:

Comparative financial statements help to measure important Distress financial ratios which are used for predicting financial distress and predicting corporate failure with the help of Multivariate Model.

Disadvantages of Comparative Financial Statement:

(a) Inter-firm Comparison:

Inter firm comparison will only be effective if both the firms follow the same accounting principles, method of valuations of stocks, assets etc. i.e. all the accounting concepts and conventions, which in real world situation, are not identically followed by both the firms e.g. Firm A follows the FIFO method of valuing stock whereas Firm B follows LIFO method for the same.

(b) Inflationary Effect:

Comparative financial statements do not recognise the change in prices level and, as such, it will be of no use.

(c) Ascertaining Correct Trend:

It is very difficult to ascertain the correct trend if there is a structural changes in a firm which are frequently happened.

(d) Supply Misleading Information:

Sometimes a comparative financial statement provides meaningless information, e.g. if a negative amount comes in base year, and a positive amount in the next year, it is not possible to find out the change in percentage.

(e) Uniformity in Principle:

There must be a consistency while following accounting principles, concepts and convention. But in practice, this is not done and as such, multi-year analysis becomes useless.

Types

Comparative Income Statement:

We know that an Income Statement presents the results of the operation i.e. net profit or net loss. A Comparative Income Statement shows the absolute figures of incomes and expenses of two or more years and also the absolute change of those figures, together with the percentage change of those figures which, in other words, help the analyst to understand the change both in terms of absolute figures, as well as in terms of percentage.

The analyst can draw a meaningful conclusion after analysing and scrutinizing the figures presented in absolute and percentage form, i.e. to record the change between the two figures at a glance. For example, as the figures are presented or shown side by side, the analyst can easily determine whether a particular item is increased or decreased, e.g. percentage of gross profit on sales.

Comparative Expenses Statement:

When we want to prepare a comparative income statement we consider also the amount of various expenses. Without considering the amount of expenses income can never be ascertained. We will explain here the various components of expenses both in absolute figure as well as in percentage figure.

Comparative Expenses statement helps to ascertain the changes of various component of expenses which will help the management to take decision in future. For expense, if it is found that percentage of direct expenses are comparatively high in succeeding years or previous year, the reason for such increase must be ascertained.

So comparative expenses statement will highlight the changes in various components of expenses which provide very useful information to the management and accordingly the management can look into the matter and will take necessary steps.

Comparative Balance Sheet:

A single Balance Sheet exhibits the final position at a particular date i.e. the position of assets and liabilities. Comparison from a single Balance Sheet is not possible, the same can be compared with the Balance Sheets of the previous years.

In other words, if we take two or more Balance Sheets and compare them with their respective figures of assets and liabilities, a meaningful conclusion can be drawn after analysing and scrutinizing their changed figures and the reason for such changes which is very helpful on the part of the management to take financial decisions and future courses of action.

A single Balance Sheet presents only the current information of the firm. That is why a meaningful or significant conclusion about the financial status can be drawn only when we take the Balance Sheets for at least 3 years to 5 years after ascertaining the changes of both assets and liabilities position in terms of absolute figures as well as in terms of percentage.

Analysis of Comparative Balance Sheet:

A comparative Balance Sheet can be analysed with the help of the following:

(a) Ascertaining short-term Solvency position/Liquidity position/Working Capital Position:

A comparative Balance Sheet presents the position of current assets and current liabilities of the two consecutive years for the purpose of ascertaining the Gross Working Capital (i.e. the sum total of current assets), Net Working Capital (i.e. Current Assets – Current liabilities) i.e. it helps to know the short-term liquidity position.

If it is found that the net working capital employed with the firm is found to be less in comparison with the previous year, causes of such reduction must be found out, or, if it is found that the period of realisation of accounts receivables is more in comparison with the previous year, rea­sons for the same must be enquired for. Thus, a comparative Balance Sheet highlights us to know the working capital positions (both gross and net) and the liquidity positions as well.

(b) Ascertaing Long-Term Solvency position:

A comparative Balance Sheet helps to ascertain the long-term solvency position of a firm with the comparative study of Debt-Equity Ratio, Capital Gearing Ratio and various other ratios. In other words, the analyst must consider the changes made in long-term liabilities, fixed assets or change in proprietor’s fund.

Thus, these three items have a special bearing on the long-term solvency position of a firm. For example if the amount of long-term liabilities increase there will be a higher capital Gearing ratio/Debt Equity Ratio which is not desirable from the standpoint of long-term solvency position of a firm.

It is interesting to note that if the amount of long-term liabilities increase with a corresponding increase in fixed assets that will not be a problem but problem will arise only when a part of long-term liabilities is used by way of working capital.

(c) Increase in Net Worth:

An analyst must see that the net worth must be increased which indicates the rate of growth. If net worth/proprietors’ fund increases due to increase in net profit, in indicates a healthy sign and vice-versa is the opposite case.

(d) Analysis/Interpretation/Comment:

An analyst with the help of analysis of comparative Balance Sheets must interpret or comment on the financial positions as a whole i.e., not in an isolated manner. He must analyse the liquidity and solvency position, profitability position, Capital structure position, as well as on management efficiency position.

If he only analyses the liquidity position alone the real picture of the financial position cannot be known. Thus, in order to arrive at a proper conclusion he must examine the various financial ratios that are frequently used in this regard.

Cost Accounting:

1. Deal with: Cost accounting deals with ascertainment, allocation, appointment and accounting aspect of costs.
2. Base: Cost accounting provides a base for management accounting.
3. Role: Cost accounting is helpful in collecting costing data for the management.
4. Status: The status of cost accountant comes after the management accountant.
5. Outlook: Cost accountant has a narrow approach. He has to refer to economic and statistical data for analysing cost effects.
6. Tools & Techniques: Cost accounting has standard costing, variable costing, break even analysis etc. as the basic tools and techniques.
7. Scope: Cost accounting does not include financial accounting, tax planning and tax accounting.
8. Period of planning: Cost accounting is concerned with short term planning.
9. Assistance: Cost accounting merely assists the management in its functions.
10. Approach: Cost accounting is historical in its approach.
11. Installation: It can be installed without management accounting.

Management Accounting:

1. Deal with: Management accounting deals with effect and impact of cost on the business.
2. Base: Management accounting is derived from both cost accounting and financial accounting.
3. Role: Management accounting has a greater degree of relevance and objectivity as the management accountant has a clear idea of the types of cost and items requiring analysis problems of business.
4. Status: Management accountant is senior in position to cost accountant.
5. Outlook: Management accountant reports the effect of cost on the business along with cost analysis.
6. Tools & Techniques: Along-with tools and techniques of cost accounting, the management accountant has funds and cash flow statement, ratio analysis etc. as his accounting tools and techniques.
7. Scope: Management accounting includes financial accounting, cost accounting, tax planning and tax accounting.
8. Period of planning: Management accounting Is concerned with short range and long range planning and uses techniques like sensitivity analysis, probability structure etc. its special field is evaluation of capital investment project.
9. Assistance: Management accounting assists and evaluates the management performance.
10. Approach: Management accounting is futuristic in its approach.
11. Installation: Management accounting needs financial and cost accounting as its base for its installation.

Management Accountant is a professional responsible for analyzing, interpreting, and presenting financial information to support managerial decision-making within an organization. They focus on internal financial processes, including budgeting, forecasting, and cost analysis, to enhance operational efficiency and strategic planning. Unlike traditional accountants who prepare financial statements for external use, management accountants produce reports and financial models for internal stakeholders, aiming to improve financial performance and inform strategic decisions. Their role extends to advising on risk management, performance measurement, and resource allocation, ensuring the organization’s financial health and alignment with its objectives. Management accountants act as a bridge between the financial and operational aspects of a business, providing insights that contribute to achieving sustainable growth and competitive advantage.

Role of Management Accountant

The role of a management accountant is pivotal in guiding the strategic and operational decisions of an organization. They serve as vital contributors to the management team by providing financial data and analysis that help in making informed business decisions. Here’s an overview of the key roles and responsibilities of a management accountant:

• Strategic Planning:

Assisting in formulating business strategies by providing financial insights and analysis that highlight opportunities and risks.

• Budgeting and Forecasting:

Preparing detailed budgets that project revenues, costs, and cash flows, and forecasting future financial conditions and performance to ensure resources are allocated efficiently.

• Cost Management:

Analyzing and controlling costs to enhance profitability. This includes determining the cost of operations, products, and services, and identifying opportunities for cost reduction and operational improvements.

• Financial Reporting and Analysis:

Creating periodic financial reports that detail the organization’s financial status and performance for internal use. They also analyze financial data to identify trends, variances from budget, and areas of improvement.

• Decision Support:

Providing support to management in making key business decisions, such as pricing strategies, investment appraisals, and product profitability analysis, through relevant financial and non-financial information.

• Performance Measurement:

Developing and monitoring performance metrics and indicators that assess organizational, departmental, and individual performance against targets and objectives.

• Risk Management:

Identifying financial and operational risks and advising on risk mitigation strategies to protect the organization’s assets and ensure its sustainability.

• Internal Controls:

Designing and evaluating internal control systems to safeguard company assets, ensuring the reliability of financial reporting, and promoting compliance with laws and regulations.

• Advisory Role:

Acting as a financial advisor to senior management, providing insights and recommendations on how to improve financial performance, minimize risks, and capitalize on new opportunities.

• Compliance and Governance:

Ensuring that financial practices and records comply with regulatory requirements and ethical standards, contributing to transparent and responsible governance.

• Communication:

Bridging financial and non-financial departments by translating complex financial information into actionable insights for various stakeholders across the organization.

Functions of Management Accountant:

• Financial Planning and Analysis (FP&A):

Management accountants play a key role in financial planning and analysis, which includes budgeting, forecasting future financial performance, and analyzing financial data to support strategic decisions.

• Cost Accounting:

They determine and manage the cost of production or services, including direct costs (like materials and labor) and indirect costs (overheads). This function is crucial for pricing, controlling expenses, and maximizing profitability.

• Budgeting:

Creating detailed budgets that forecast revenues, expenses, capital expenditures, and cash flow, enabling the organization to plan for the future, allocate resources efficiently, and monitor financial performance against expectations.

• Variance Analysis:

Comparing actual financial performance to planned or budgeted performance, identifying variances, and analyzing the reasons behind these discrepancies to inform management decisions and corrective actions.

• Internal Financial Reporting:

Preparing and presenting periodic financial reports for internal stakeholders, providing insights into financial performance, productivity, cost management, and resource utilization.

• Decision Support:

Offering analytical support for decision-making by providing relevant financial and non-financial information on various issues, such as investment appraisal, project feasibility, and resource allocation.

• Performance Management:

Developing and managing performance measurement systems, including key performance indicators (KPIs), to evaluate and improve the efficiency and effectiveness of various business operations.

• Strategic Management Support:

Assisting in the formulation and implementation of strategic plans by providing financial insights and analyses that highlight market trends, competitive landscape, and internal capabilities.

• Risk Management:

Identifying and assessing financial risks, such as currency fluctuations, credit risks, and market volatility, and advising on risk mitigation strategies.

• Advisory Role:

Acting as advisors to management, offering recommendations on financial matters, operational improvements, and strategic initiatives based on comprehensive analyses.

• Compliance and Governance:

Ensuring that accounting practices adhere to legal and regulatory requirements, and contributing to the establishment of governance practices that uphold corporate ethics and social responsibility.

• Capital Structure and Investment Management:

Advising on the optimal capital structure for the organization and managing investments to ensure they align with the organization’s strategic goals and financial health.

Trend analysis is a technique employed by technical analyst in the financial industry to predict the future movements of a given asset. They employ historical data to determine the direction of the trend. The goal of this procedure is to identify attractive investment opportunities that are currently showing an upward trend; and of course, to identify downtrends too, so investors can get out before losing money.

Perhaps one of the disadvantages of trend analysis is that past behavior is not always consistent in the future, in other words, whatever the price of a given security did in the past is not necessary an indication of what it will do in the future because there are a lot of other significant elements that come into play when it comes to determining the value a financial security.

Trend analysis involves the collection of information from multiple time periods and plotting the information on a horizontal line for further review. The intent of this analysis is to spot actionable patterns in the presented information. In business, trend analysis is typically used in two ways, which are as follows:

• Revenue and cost analysis: Revenue and cost information from a company’s income statement can be arranged on a trend line for multiple reporting periods and examined for trends and inconsistencies. For example, a sudden spike in expense in one period followed by a sharp decline in the next period can indicate that an expense was booked twice in the first month. Thus, trend analysis is quite useful for examining preliminary financial statements for inaccuracies, to see if adjustments should be made before the statements are released for general use.
• Investment analysis. An investor can create a trend line of historical share prices and use this information to predict future changes in the price of a stock. The trend line can be associated with other information for which a cause-and-effect relationship may exist, to see if the causal relationship can be used as a predictor of future stock prices. Trend analysis can also be used for the entire stock market, to detect signs of an impending change from a bull to a bear market, or the reverse. The logic behind this analysis is that moving with a trend is more likely to generate profits for an investor.

When used internally (the revenue and cost analysis function), trend analysis is one of the most useful management tools available. The following are examples of this type of usage:

• Examine revenue patterns to see if sales are declining for certain products, customers, or sales regions.
• Examine expense report claims for evidence of fraudulent claims.
• Examine expense line items to see if there are any unusual expenditures in a reporting period that require additional investigation.
• Extend revenue and expense line items into the future for budgeting purposes, to estimate future results.

When trend analysis is being used to predict the future, keep in mind that the factors formerly impacting a data point may no longer be doing so to the same extent. This means that an extrapolation of a historical time series will not necessarily yield a valid prediction of the future. Thus, a considerable amount of additional research should accompany trend analysis when using it to make predictions.

Advantages of Trend Analysis:

(a) Possibility of making Inter-firm Comparison:

Trend analysis helps the analyst to make a proper comparison between the two or more firms over a period of time. It can also be compared with industry average. That is, it helps to understand the strength or weakness of a particular firm in comparison with other related firm in the industry.

(b) Usefulness:

Trend analysis (in terms of percentage) is found to be more effective in comparison with the absolutes figures/data on the basis of which the management can take the decisions.

(c) Useful for Comparative Analysis:

Trend analyses is very useful for comparative analysis of date in order to measure the financial performances of firm over a period of time and which helps the management to take decisions for the future i.e. it helps to predict the future.

(d) Measuring Liquidity and Solvency:

Trend analysis helps the analyst/and the management to understand the short-term liquidity position as well as the long-term solvency position of a firm over the years with the help of related financial Trend ratios.

(e) Measuring Profitability Position:

Trend analysis also helps to measure the profitability positions of an enterprise or a firm over the years with the help of some related financial trend ratios (e.g. Operating Ratio, Net Profit Ratio, Gross Profit Ratio etc.).

Disadvantages of Trend Analysis:

(a) Selection of Base Year:

It is not so easy to select the base year. Usually, a normal year is taken as the base year. But it is very difficult to select such a base year for the propose of ascertaining the trend. Otherwise, comparison or trend analyses will be of no value.

(b) Consistency:

It is also very difficult to follow a consistent accounting principle and policy particularly when the trends of business accounting are constantly changing.

(c) Useless in Inflationary Situations:

Analysis of trend percentage is useless at the time of price-level change (i.e. in inflation). Trends of data which are taken for comparison will present a misleading result.

Types of trend

Uptrend

It is the trend when financial markets and assets move in upward directions, resulting in an increase in the price. It is usually the time of boom in the economy, where overall sentiments are favorable.

Downtrend

In the downtrend or the bear market, the economy, financial markets, and assets prices move in the downward direction. It is the time when companies shrink operations and overall investor sentiment is not favorable.

Sideways / Horizontal Trend

In this, the assets prices or the broader economy-level are not moving in any direction, rather are moving sideways. This means, moving up for some time and then down on the same level.  It is a risky movement as investors are unsure of what will happen to their investment.

The co-operative societies Act,1912, a central act, contain fundamental law regarding the formation and working of co-operative societies in India and is applicable in many states with or without amendments.

Co-operative society is a business organization with a special mode of doing business , by pulling together all the means of production co-operatively, eliminating the middlemen and exploitation from outside force.

Any ten persons who are competent to enter into contract may make an application to the Registrar of Co-operative Societies as per section 6 of the Co-operative Societies Act, 1912. By-laws may be framed by each society and should be registered with Co-operative Societies. Effectiveness of change in by-laws of societies is applicable only when changes are approved by Registrar of Societies. There are two types of society’s, limited liabilities and un-limited liabilities societies. Any member is not liable to pay more than the nominal value of share held by them and no member can own more than 20% of shares of societies.

Government is encouraging co-operative societies to help society. Co-operative societies are operative in various sections like consumer, industrial, service, marketing, etc.

Under accounting system of Co-operative societies, the terms receipt and payment are used for two-fold aspect of double entry system.

Members are elected at the annual general meeting of the society. Day-to-day work of cooperative society is managed by the managing committee.

Audit of Co-operative Society

Let us now discuss the provisions for Audit as Per Section 17 of the Co-operative Society Act, 1912 −

The Registrar shall audit or cause to be audited by some person authorized by him by general or special order in writing on his behalf, the accounts of every registered society once at least every year.

The Audit under sub-section (1) shall include an examination of overdue debts, if any, and a valuation of the assets and liabilities of the society.

The Registrar, the Collector or any person authorized by general or special order in writing on his behalf by the Registrar, shall at all-time have access to all the books, accounts, papers and securities of a society, and every officer of the society shall furnish such information concerning the transactions and working of the society as the person making such inspection may require.

Audit as per Section 17 of the Co-operative Societies Act , 1912.

• The registrar shall audit or cause to be audited by some person authorized by him, the accounts of every registered society at least once a year.
• The audit under shall include an examination of overdue debts , if any, and a valuation of assts and liabilities of the society.
• The registrar, the collector or any person authorized shall at all the times have access to all the books , accounts, papers and securities of a society, and every officer of the society shall furnish such information in regard to the transactions and working of the society as the person making such inspection may require.

REGISTRAR means a person appointed to perform the duties of registrar of co-operative societies under this act.

The following points are required to be kept in mind in connection with the audit of co-operative society:

• Qualification of auditor: Apart from the chartered Accountant within the meaning of the Chartered Accountancy Act, 1949, some of the state co-operative Acts have permitted persons holding a government diploma in co-operative accounts or in co-operation and accountancy and also a person who has served as an auditor in the co-operative department of government to act as an auditor.
• Appointment of the auditor: An auditor of co-operative society is appointed by the registrar of co-operative societies and the auditor so appointed conducts the audit in behalf of registrar and also submits his audit report to him as well as to the society.
• Books, Accounts and other records of co: operative societies-under section 43(h) of the Act . a state government can frame rules prescribing the books and accounts to be kept by a co-operative society.

Special features of co-operative Audit

The general process of auditing involved in audit work such as checking of posting , ascertainment of arithmetical accuracy ,vouching , verification of assets and liabilities and final scrutiny of balance sheet are well known by everyone. But in case of co-operative society audit certain special features are there to be borne in mind while doing audit of it. These features are as follows:

• Examination of overdue debts: Auditor shall report these overdue debts as for period from 6 months to 5 years and more than 5 years. Furthermore, analysis is done by the auditor in viewpoint of recovery of these debts and these are classified as good debt or bad debts. Now auditor is also liable to checkout whether provision regarding bad debts is provided or not and if provided then that is appropriate or not for current situation of bad debts of the society.
• Overdue interest: Overdue interest should be excluded from interest outstanding and accrued due while calculating profit. In practice an overdue interest reserve is created and the credit of overdue interest credited to interest account is reduced.
• Certification of bad debts: As per the law, bad debts can be written off only when they are being certified by the auditor as bad where the law requires it and if not then managing committee of society must authorize the write-off.
• Valuation of assets and liabilities: They will have to ascertain the existence, ownership and valuation of assets. Fixed assets should be valued at cost less adequate provision for depreciation. The incidental expenses incurred in acquisition and the installation expenses of assets should be properly capitalized. The current assets be valued at cost or market price , whichever is lower. Regarding liabilities, the auditor should see that all the known liabilities are brought into the account, the contingent liabilities are stated by way of a note.
• Adherence to co-operative principles: The auditor will have to ascertain that how far the objective for which the co-operative organization is set up , have been achieved in the course of its working. The assessment is not necessary in terms of profits, but in terms of extension of benefits to its members who have formed it. While auditing the expense, the auditor should see that they are economically incurred and no wastage of funds. The principle of propriety audit should be followed for this purpose.
• Observations of the provisions of the act and rules: The financial implications of the infringements which are pointed out by the co-operative societies Act and rules and bye-laws, should be assessed by the auditor and they should be reported properly.
• Verification of member’s register and examination of their pass books: Examination of the entries in member’s pass books regarding the loan given and its repayment and confirmation of loan balances in person is very much important in co-operative societies to assure that the entries in books of accounts are free from manipulation.
• Special report to registrar: During the course of audit if the auditor notices that there is some serious irregularity then he has report this irregularity to the registrar by drawing his specific attention to the point. The registrar on receipt of such special report may take necessary action against the society.
• Audit classification of the society: After the judgement of an overall society, the auditor has to award a class to the society. This specific class is awarded by the auditor as accordance to the criteria given by the registrar. It is to be noted that if management is not satisfied by the class given by the auditor then they may appeal to the registrar.
• Discussion of draft audit report with managing committee: On conclusion of the audit , they should ask to the secretary of the society to convene managing committee meeting to discuss the audit draft report. The audit report should never be finalized without the discussion with the managing committee.

Form of Audit Report

The form of audit report to be submitted by the auditor, as prescribed in various states , contains a number of matters which the auditor has to state or comment upon. In addition to the report the auditor has to attach schedules to the report regarding the following Information:

• All transactions which appears to be contrary to the provisions of the Act , the rules and bye-laws of the society.
• All sums which ought to have been, but have not been brought into account by the society.
• Any material, or property belonging to society which appears to the auditor to be bad or doubtful of recovery.
• Any material, or property belonging to society which appears to the auditor to be bad or doubtful of recovery.
• Any material irregularity or impropriety in expenditure or in the realization or monies due to society.
• Any other matters specified by the registrar in this behalf.

The Insurance auditors shall examine policy and liability procedures, risk valuation, tax documents, and various other financial records of insurance. It is to ensure that proper insurance rates and premiums are implemented and regulators laws are being followed by insurance companies. Claims and commissions are also the core areas to verify during the course of insurance audits. In addition to these responsibilities, insurance auditors might be expected to maintain quality control between insurance companies and policyholders.

An Indian insurance company is formed and registered under the Companies Act, 2013 and the aggregate holdings of equity shares by a foreign company, either by itself or through its subsidiary companies or its nominees, do not exceed twenty-six per cent of the paid-up equity capital of such Indian insurance company. The sole objects of the Indian Insurance Company shall be to carry on life insurance business or general insurance business or re-insurance business. The said definition is according to section 2 of Insurance Act 1938.

The Insurance Audit & Role of Insurance Auditors

As per Section 12 of the Insurance Act, 1938, the financial statements of every insurer are required to be audited annually by an auditor. According to IRDA Act, 1999, every insurer, in respect of insurance business transacted by him and in respect of his shareholders ‘funds, should prepare, a Balance Sheet, a Profit and Loss Account, a separate Account of Receipts and Payments and a Revenue Account in accordance with the regulations made by the IRDA at the end of each financial year.

The central and branch auditors of an insurance company are appointed at the annual general meeting of the company and the approval of the C & AG required before the appointment is made. With the latest amendment to the Insurance Act, 1938 and the Companies Act, 2013, Authority (IRDAI) has issued the revised guidelines that Insurers shall comply with the provisions relating to appointment of Auditors as contained in the Companies Act, 2013. Additionally, insurers shall also comply with the provisions contained in such guidelines. Further the recommendation of the Audit Committee, the Board shall appoint the statutory auditors, subject to the shareholders’ approval at the general meeting of an Indian insurance company. The branch auditors is appointed to conduct the audit of the divisions have the same rights and obligations under the statute as those of the, statutory auditors to whom they are expected to submit their report. However the branch auditors at division level certified the Trial balance of the division duly incorporated the financial statements of the branches under divisions.

An insurer cannot remove its statutory auditor without the prior approval of the Authority. An audit firm cannot accept the audits of more than three insurers (Life/Nonlife/Health /Reinsurer) at a time. The appointment can be cancelled if found that the appointment of auditors by insurers is not in line with the guidelines.

Four Important Audit Points in Insurance Company Profit & Loss Account

1. Verification of Premium

The premium collections are credited to a separate bank account and no withdrawals are normally permitted from that account for meeting the general expenditure. As per the policy of the insurance company, the collections are transferred to the Regional Office or Head Office. No Risk shall be assumed by the insurer without receipt of premium according to section 64VB of the Insurance Act, 1938. Verification of premium is of utmost importance to an auditor because Insurance premium is collected upon issuing policies. It is the consideration for bearing the risk by the insurance company. The auditor should apply the following procedures: –

• Before commencing verification of premium income, the auditor should look into the internal controls and compliance which are laid down for collection and recording of the premiums.
• Cover notes should be serially numbered
• The auditor should check whether Premium Registers have been maintained chronologically, giving full particulars including GST charged as per acceptance advice on a day -to-day basis.
• The auditor should verify whether the figures of premium mentioned in the register tally with those in General Ledger.
• The auditor should verify whether instalments falling due on or before the balance sheet date, whether received or not, have been accounted for as premium income as for the year under audit.

2. Verification of Claims

The auditor should obtain from the divisions/branches, the information for each class of business. The auditor should determine the total number of documents to be checked giving due importance to claim provisions of higher value. The claims under policies comprise the claims paid for losses incurred, and those estimated or anticipated claims pending settlements under the policies. Settlement cost of claims includes surveyor fee, legal expenses, etc. The Claim Account is debited with all the payments including repair charges, fire fighting expenses, police report fees, survey fees, amount decreed by the Courts, travel expenses, photograph charges, etc. The auditor should-

• Check whether provision has been made for all unsettled claims.
• Check whether provision has been made for only such claims for which the company is legally liable.
• Check whether provision made is normally not in excess of the amount insured.
• Check in case of co-insurance arrangements, the company has made provisions only in respect of its own share of anticipated liability.
• Check claimed paid should be duly sanctioned by the authority concerned

3. Verification of Commission

The remuneration of an agent is paid by way of commission which is calculated by applying a percentage to the premium collected by him. Commission is payable to the agents for the business procured and is debited to Commission on Direct Business Account. An insurance business is solicited by insurance agents. The auditor should verify-

• Voucher disbursement entries with reference to the disbursement vouchers with copies of commission bills and commission statements.
• Check whether the vouchers are authorized by the officers- in –charge as per rules and income tax is deducted at source, as applicable.
• Test check correctness of amounts of commission allowed.
• To check whether commission outgo for the period under audit been duly accounted or not.

4. Verification of Operating Expenses

All the administrative expenses in an insurance company are broadly classified under 13 heads as mentioned in Schedule IV. The auditor should check-

• Expenses in excess of Rs.5 Lakhs or 1% of net premium, whichever is higher, should be shown separately.
  
• Expenses not directly relating to insurance business should be shown separately for example, expenses relating to investment department, bank charges etc.