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Distinguish between job and batch costing ( 2 Marks) Job Costing: It is a method of costing which is used when the

work is undertaken as per the customers special requirement. When an inquiry is received from the customer, costs expected be incurred on the job are estimated and on the basis of this estimate, a price is quoted to the customer. Actual cost of materials, labour and overheads are accumulated and on the completion of job, these actual costs are compared with the quoted price and thus the profit or loss on it is determined. Job costing is applicable in printing press, hardware, ship-building, heavy machinery, foundry, general engineering works, machine tools, interior decoration, repairs and other similar work. Batch Costing: It is a variant of job costing. Under batch costing, a lot of similar units which comprises the batch may be used as a unit for ascertaining cost. In the case of batch costing separate cost sheets are maintained for each batch of products by assigning a batch number. Cost per unit in a batch is ascertained by dividing the total cost of a batch by the number of units produced in that batch. Such a method of costing is used in the case of pharmaceutical or drug industries, readymade garment industries, industries, manufacturing electronic parts of T.V. radio sets etc.

What is the managerial application of target costing? (2Marks) Target Costing and Its Application Target costing should be viewed as an integral part of a strategic profit management system. The initial consideration in target costing is the determination of an estimate of the selling price for a new product which will enable a firm to capture its required share of the market. Then it is necessary to reduce this figure to reflect the firms desired level of profit, having regard to the rate of return required on new capital investment and working capital requirements. The deduction of required profit from the proposed selling price will produce a target price that must be met in order to ensure that the desired rate of return is obtained. Thus the main theme that underpins target costing can be seen to be 'what should a product cost in order to achieve the desired level of return. Target costing will necessitate comparison of current estimated cost levels against the target level which must be achieved if the desired levels of profitability, and hence return on investment, are to be achieved. Thus where a gap exists between the current estimated cost levels and the target cost, it is essential that this gap be closed.

What do you mean by abnormal loss ? (2 Marks) Abnormal process loss The loss realized over the normal loss is called an abnormal loss. Abnormal loss arises because of abnormal working conditions, bad working condition, carelessness, rough handling, lack of proper knowledge, low quality raw material, machine breakdown, accident etc. Therefore an abnormal loss is an unanticipated loss. Abnormal loss is a controllable loss and thus can be avoided if corrective measures are taken. Therefore, abnormal loss is also called an avoidable loss. The value of an abnormal loss is assessed on the basis of the production cost with which the profit and loss account is charged. Define Margin of safety ? (2 Marks) An excess of a company's actual sales revenue over the breakeven sales revenue, expressed usually as a percentage. The greater this margin, the less sensitive the company to any abrupt fall in revenue. Formula: Actual Sales Break even Sales

Give examples for opportunity cost (2Marks/ 5 Marks) opportunity cost The next best benefit foregone. The opportunity lost. Often measured as the contribution margin given up by not doing an activity. For example, if a sole proprietor is foregoing a salary and benefits of Rs 50,000 at another job, the sole proprietor has an opportunity cost of Rs 50,000. Accountants do not record opportunity costs in the general ledger or report them on the income statement, but they are costs that should be considered in making decisions. What is the relevance of material variance in decision making ? (2 Marks) Variance analysis is usually associated with explaining the difference (or variance) between actual costs and the standard costs allowed for the good output. For example, the difference in materials costs can be divided into a materials price variance and a materials usage variance. Variance analysis helps management to understand the present costs and then to control future costs.

Why do company prepare fund flow statement ? (2 Marks) Generally a fund is interpreted as working capital. Thus, funds flow is change in working capital. Hence, the changes in working capital is called as flow, the flow may be inflow or outflow. The term working capital has two concepts, gross working capital and net working capital. Gross working capital is the total of all current assets, whereas net working capital is the excess of current assets over current liabilities. Fund flow statement is prepared and interpreted on the basis of net working capital concept. Funds flow statement measures and presents in an analytical manner the summarized version of the numerous flows of funds for a specified period. Euro (Short note 5 Marks) The euro is the second largest reserve currency as well as the second most traded currency in the world after the United States dollar As of February 2012, with more than 890 billion in circulation, the euro has the highest combined value of banknotes and coins in circulation in the world, having surpassed the US dollar. Based on International Monetary Fund estimates of 2008 GDP and purchasing power parity among the various currencies, the eurozone is the second largest economy in the world. The name euro was officially adopted on 16 December 1995. The euro was introduced to world financial markets as an accounting currency on 1 January 1999, replacing the former European Currency Unit (ECU) at a ratio of 1:1. Euro coins and bank notes entered circulation on 1 January 2002. June 30, 2002 was the last day for changing old currency to Euro at any bank for the original twelve member states.[10]Since late 2009 the euro has been immersed in the European sovereign-debt crisis which has led to the creation of the European Financial Stability Facility as well as other reforms aimed at stabilizing the currency.

Short note on Break-even point (5Marks) Breakeven Analysis is the process of categorizing costs of production between variable and fixed components and deriving the level of output at which the sum of these costs, referred to as total costs per unit become equal to sales revenue. The analysis helps to determine the 'Breakeven Point' from this point of equality of sales revenue with total costs. At the breakeven point, the production activity neither generates a profit nor a loss. Breakeven analysis is used in production management and Management Accounting. State the methods of handling spoilage and scrap (2 Marks) Spoilage It is the term used for materials which are badly damaged in the manufacturing operations, and they cannot be rectified economically and hence taken out of process to be disposed of in some manner without further processing. Spoilage may either be normal or abnormal. Normal Spoilage (i.e. which is inherent in the operation) cost are included in costs either charging the loss due to spoilage to the production order or by charging it to production overhead so that it is spread over all the products. Any value released form spoilage is credited to the production order or production overhead account as the case may be. The cost of abnormal spoilage (i.e. arising out of causes not inherent in manufacturing process) is charged to the costing Profit and loss account

Scrap It has been defined as the incidental residue from certain types of manufacture, usually of a small amount and low value, recoverable without further processing. Scrap may be treated in the cost accounts in the following ways:Where, the value of scrap is negligible, it may be excluded from the costs. In other words, the cost of scrap is borne by the good units and income scrap is treated as other income The sales value of scrap net of selling and distribution cost, is deducted from overhead to reduce the overhead rate. A variation of this method is to deduct the net realizable value form material cost. This method is followed when scraps cannot be aggregated job or process wise. When the scrap is identifiable with a particular job or process and its value is significant, the scrap account should be charge with full cost. The credit is given to the job or process concerned. The profit or loss in the scrap account, on realization, will be transferred to the Costing Profit and Loss Account.

Short note on depreciation (5 Marks) Depreciation Buildings, machinery, equipment, furniture, fixtures, computers, outdoor lighting, parking lots, cars, and trucks are examples of assets that will last for more than one year, but will not last indefinitely. During each accounting period (year, quarter, month, etc.) a portion of the cost of these assets is being used up. The portion being used up is reported as Depreciation Expense on the income statement. In effect depreciation is the transfer of a portion of the asset's cost from the balance sheet to the income statement during each year of the asset's life. Depreciation is a non-cash expense that reduces the value of an asset over time. Assets depreciate for two reasons: Wear and tear. For example, an auto will decrease in value because of the mileage, wear on tires, and other factors related to the use of the vehicle. Obsolescence. Assets also decrease in value as they are replaced by newer models. Last year's car model is less valuable because there is a newer model in the marketplace

Cash Flow Statement (Short note 5 Marks) Complementing the balance sheet and income statement, the cash flow statement (CFS), a mandatory part of a company's financial reports since 1987, records the amounts of cash and cash equivalents entering and leaving a company. The CFS allows investors to understand how a company's operations are running, where its money is coming from, and how it is being spent. Here you will learn how the CFS is structured and how to use it as part of your analysis of a company A company can use a cash flow statement to predict future cash flow, which helps with matters in budgeting. For investors, the cash flow reflects a company's financial health: basically, the more cash available for business operations, the better. However, this is not a hard and fast rule. Sometimes a negative cash flow results from a company's growth strategy in the form of expanding its operations. By adjusting earnings, revenues, assets and liabilities, the investor can get a very clear picture of what some people consider the most important aspect of a company: how much cash it generates and, particularly, how much of that cash stems from core operations.

What do you mean by contingent liabilities? (2Marks) Contingent liabilities are liabilities that may or may not be incurred by an entity depending on the outcome of a future event such as a court case. These liabilities are recorded in a company's accounts and shown in the balance sheet when both probable and reasonably estimable. A footnote to the balance sheet describes the nature and extent of the contingent liabilities. The likelihood of loss is described as probable, reasonably possible, or remote. The ability to estimate a loss is described as known, reasonably estimable, or not reasonably estimable. What is the implication of outstanding expenses on profit and loss account ? (2Marks) outstanding expenses are those expenses which are payable but not paid , so it is our duty to record it at the closing of financial year . According to the accounting principals any expenses paid or payable is the expenses of business , so when we prepare profit and loss account of business , it must be added in paid expense. The International Accounting Standards Board (IASB) is the independent, accounting standard-setting body of the IFRS Foundation. The IASB was founded on April 1, 2001 as the successor to the International Accounting Standards Committee (IASC). It is responsible for developing International Financial Reporting Standards (the new name for International Accounting Standards issued after 2001), and promoting the use and application of these standards.

What are the significance of the following in the process of measuring Performance and financial position ? (2 Marks) Voucher 1. A piece of substantiating evidence; a proof.(Invoice/Bill) 2. A written record of expenditure, disbursement, or completed transaction.(Voucher of Concern) 3. A written authorization or certificate, especially one exchangeable for cash or representing a credit against future expenditures.(Advance payment) Definition of 'Journal' In accounting, a first recording of financial transactions as they occur in time, so that they can then be used for future reconciling and transfer to other official accounting records such as the general ledger. A journal will state the date of the transaction, which account(s) were affected and the amounts, usually in a doubleentry bookkeeping method. A ledger is the principal book or computer file for recording and totaling monetary transactions by account, with debits and credits in separate columns and a beginning balance and ending balance for each account. The ledger is a permanent summary of all amounts entered in supporting journals which list individual transactions by date. Every transaction flows from a journal to one or more ledgers. A company's financial statements are generated from summary totals in the ledgers.



Ledgers include: Sales ledger, records accounts receivable. This ledger consists of the financial transactions made by customers to the company. Purchase ledger records money spent for purchasing by the company. General ledger representing the 5 main account types: assets, liabilities, income, expenses, and equity. What is depreciation ? Outline its significance in determining profitability. The Need for depreciation arises for the following reasons: Ascertainment of True Profit or Loss: Depreciation is a loss. So Unless it is considered like all other expenses and losses, true profit or loss cannot be ascertained. In other words, depreciation must be considered in order to find out true profit or loss of a business.

Ascertainment of True Cost of Production:

Goods are produced with the help of plant and machinery which incurs depreciation in the process of production. This depreciation must be considered as a part of the cost of production of goods. Otherwise, the cost f production would be shown less than the true cost. Sales price is fixed normally on the basis of cost of production. So, if the cost of production is shown less by ignoring depreciation, the sale price will also be fixed at low level resulting in a loss to the business.

True Valuation of Assets: Value of assets gradually decreases on account of depreciation, if depreciation is not taken into account, the value of asset will be shown in the books at a figure higher than its true value and hence the true financial position of the business will not be disclosed through balance sheet. Replacement of Assets: After sometime an asset will be completely exhausted on account of use. A new asset must then be purchased requiring a large sum of money. If the whole amount of profit is withdrawal from business each year without considering the loss on account of depreciation, necessary sum may not be available for buying the new asset. In such a case the required money is to be collected by introducing fresh capital or by obtaining loan or by selling some other assets. This is contrary to sound commerce policy. Keeping Capital Intact: Capital invested in buying an asset, gradually diminishes on account of depreciation. If loss on account of depreciation is not considered in determining profit or loss at the year end, profit will be shown more. If the excess profit is withdrawal, the working capital will gradually reduce, the business will become weak and its profit earning capacity will also fall.

State the basic purpose of auditors report A financial audit, or more accurately, an audit of financial statements, is the verification of the financial statements of a legal entity, with a view to express an audit opinion. The audit opinion is intended to provide reasonable assurance that the financial statements are presented fairly, in all material respects, and/or give a true and fair view in accordance with the financial reporting framework. The purpose of an audit is to enhance the degree of confidence of intended users in the financial statements. Financial audits are typically performed by firms of practicing accountants who are experts in financial reporting. The financial audit is one of many assurance functions provided by accounting firms. Many organizations separately employ or hire internal auditors, who do not attest to financial reports but focus mainly on the internal controls of the organization. External auditors may choose to place limited reliance on the work of internal auditors Definition of 'Profit-Volume (PV) Chart (5 Marks) A graphic that shows the relationship between a company's earnings (or losses) and its sales. The chart tells how different levels of sales affect a company's profits. Companies can use profit-volume charts to establish sales goals, to analyze whether a potential project is likely to be profitable and to see the maximum potential profit or loss of a given project, as well as where the breakeven point lies. Companies use PV charts in cost-volume-profit analysis along with breakeven charts and contribution charts.

What is responsibility accounting (2 Marks) Responsibility accounting is an underlying concept of accounting performance measurement systems. The basic idea is that large diversified organizations are difficult, if not impossible to manage as a single segment, thus they must be decentralized or separated into manageable parts. These parts, or segments are referred to as responsibility centers that include: 1) revenue centers, 2) cost centers, 3) profit centers and 4) investment centers. This approach allows responsibility to be assigned to the segment managers that have the greatest amount of influence over the key elements to be managed. These elements include revenue for a revenue center (a segment that mainly generates revenue with relatively little costs), costs for a cost center (a segment that generates costs, but no revenue), a measure of profitability for a profit center (a segment that generates both revenue and costs) and return on investment (ROI) for an investment center (a segment such as a division of a company where the manager controls the acquisition and utilization of assets, as well as revenue and costs). Product Costing (5 Marks) Product Costing helps a company know the costs incurred by its products in order to successfully manage its product portfolio. The product cost accounting business process calculates cost of goods manufactured (COGM) or cost of goods sold (COGS)broken down by each step of the production process.

Job Costing: It is a method of costing which is used when the work is undertaken as per the customers special requirement. When an inquiry is received from the customer, costs expected be incurred on the job are estimated and on the basis of this estimate, a price is quoted to the customer. Actual cost of materials, labour and overheads are accumulated and on the completion of job, these actual costs are compared with the quoted price and thus the profit or loss on it is determined. Job costing is applicable in printing press, hardware, ship-building, heavy machinery, foundry, general engineering works, machine tools, interior decoration, repairs and other similar work.

State the assumptions in break even-analysis.(2 Marks) The Break-even Analysis depends on three key assumptions: Average per-unit sales price (per-unit revenue): This is the price that you receive per unit of sales. Take into account sales discounts and special offers. Get this number from your Sales Forecast. For non-unit based businesses, make the per-unit revenue Re 1 and enter your costs as a percent of a Rupee. The most common questions about this input relate to averaging many different products into a single estimate. The analysis requires a single number, and if you build your Sales Forecast first, then you will have this number. You are not alone in this, the vast majority of businesses sell more than one item, and have to average for their Break-even Analysis. Average per-unit cost: This is the incremental cost, or variable cost, of each unit of sales. If you buy goods for resale, this is what you paid, on average, for the goods you sell. If you sell a service, this is what it costs you, per rupee of revenue or unit of service delivered, to deliver that service. If you are using a Units-Based Sales Forecast table (for manufacturing and mixed business types), you can project unit costs from the Sales Forecast table. If you are using the basic Sales Forecast table for retail, service and distribution businesses, use a percentage estimate, e.g., a retail store running a 50% margin would have a per-unit cost of .5, and per-unit revenue of 1.

Monthly fixed costs: Technically, a break-even analysis defines fixed costs as costs that would continue. Instead, using regular running fixed costs, including payroll and normal expenses (total monthly Operating Expenses). This will give a better insight on financial realities. If averaging and estimating is difficult, use your Profit and Loss table to calculate a working fixed cost estimateit will be a rough estimate, but it will provide a useful input for a conservative Break-even Analysis.

Distinguish between: cost, expense and loss. Classify the following items as cost, expense and loss: 1) Cost of goods sold ; 2) Cash discount allowed to debtors ; 3) Bad debts Cost An amount that has to be paid or given up in order to get something. In business, cost is usually a monetary valuation of (1) effort, (2) material, (3) resources, (4) time and utilities consumed, (5) risks incurred, and (6) opportunity forgone in production and delivery of a good or service. All expenses are costs, but not all costs (such as those incurred in acquisition of an income-generating asset) are expenses. Expense Money spent or cost incurred in an organization's efforts to generate revenue, representing the cost of doing business. Expenses may be in the form of actual cash payments (such as wages and salaries), a computed expired portion (depreciation) of an asset, or an amount taken out of earnings (such as bad debts). Expenses are summarized and charged in the income statement as deductions from the income before assessing income tax. Whereas all expenses are costs, not all costs (such as those incurred in acquisition of income generating assets) are expenses.

1. Cost of goods sold---- Cost 2. Cash discount allowed to debtors ---3. Bad debts - Loss


What do you mean by corporate failure prediction ? (2 Marks) Corporate failure refers to companies ceasing operations following its inability to make profit or bring in enough revenue to cover its expenses. This can occur as a result of poor management skills, inability to compete or insufficient marketing. There are three classic symptoms of corporate failure prediction. 1. Low profitability 2. High gearing and 3. Low liquidity Each of the above three symptoms indicate trends in the companys accounts, these symptoms are interrelated. The classic path to corporate failure starts with the company experiencing low profitability. This may be indicated by trends in the ratios For 1. Profit margin 2. Return on capital expenditure 3. Return on net assets

A downward trend in profitability will raise the issue of whether and for how long the company can tolerate a return on capital that is below its cost of capital. If profitability problems become preoccupying, the failing of the company may seek additional funds and working capital by increasing its borrowings, whether in the form of short term or long-term debt. This increases the companys gearing, since the higher the proportion of borrowed funds, the higher the gearing within the capital structure. The increased debt burden may then aggravate the situation, particularly if the causes of the decreasing profitability have not been resolved What is cost accounting ? And what are its important objectives ? The cost accounting is an important practice adopted in any big manufacturing firms especially whose turnover is 10 million in Indian rupee or more. Any manufacturing company wisely assesses the cost of production of its product, in each step up to getting final product and also calculates the fixed cost incurred, namely depreciation of machinery used to produce the product, Rent or tax of the land or factory yard etc. Finally the financial performance of the company is determined by comparing the total cost of production with the revenue earned. Some standard procedures are adopted to record the various costs those incurred to produce a final product, finally the ratio between the revenue earned to the total cost of the product is determined, this all procedures included in cost account.

These are the following important objectives of cost accounting: Ascertainment of Cost: The primary objectives of the cost accounting is to ascertain cost of each product, process, job, operation or service rendered. Ascertainment of Profitability: Cost accounting determines the profitability of each product, process, job, operation or service rendered. The statement of profit or losses and Balance Sheet also submitted to the management periodically. Classification of Cost: Cost accounting classifies cost in to different elements such as materials, laborer and expenses. It has further been divided as direct cost and indirect cost for cost control and recording. Control of Cost: Cost accounting aims at controlling cost by setting standards and compared with the actual, the deviation or variation between two is identified and necessary steps are taken to control them. Fixation or Selling Prices: Cost accounting guides management in regard to fixation of selling prices of the products. It is also helpful for preparing tender and quotations.

What are the various methods of measurement of elements of financial statements ? Measurement of the Elements of Financial Statements According to the Framework of IAS, the term 'measurement' has been defined in the following words: "Measurement is the process of determining the monetary amounts at which the elements of the financial statements are to be recognized and carried in the balance sheet and income statement." There are a number of measurement basis that are employed in different degrees and in varying combinations in financial statements. They are listed below: 1.Historical cost: Historical cost is the most common measurement basis adopted by enterprises in preparing their financial statements. This is usually combined with other measurement basis, such as current cost basis, realizable basis, etc., which are discussed later in this section. Under historical cost measurement basis, assets are originally recorded at their costs or purchasing price or the fair value of the consideration given to acquire them at the time of their acquisition. Liabilities are recorded at the amount of proceeds received in exchange for the obligation. 2.Current cost: Under current cost basis, assets are carried at the amount of cash that would have to be paid if the same or an equivalent asset was acquired currently. Liabilities are carried at the undiscounted amount of cash that would be required to settle the obligations currently.

3. Realizable value: Assets are carried at the amount of cash that could currently be obtained by selling the asset in an orderly disposal. Liabilities are carried at their settlement values; that is, the undiscounted amount of cash expected to be paid or satisfy the liabilities in the normal course of business. 4. Present value: Assets are carried at the present discounted value of the future net cash inflows that the item is expected to generate in the normal course of business. Liabilities are carried at the presented discounted value of the future net cash outflows that are expected to be required to settle the liabilities in the normal course of business. Work in Progress (WIP) (5 Marks) Construction Work in Progress is a long-term asset account in which the costs of constructing long-term assets are recorded. The account Construction Work in Progress will have a debit balance and will be reported on the balance sheet as part of a companys Property, Plant and Equipment. The costs of a constructed asset are accumulated in the account Construction Work in Progress until the asset is placed into service. When the asset is completed and placed into service, the account Construction Work in Progress will be credited for the accumulated costs of the asset and will be debited to the appropriate Property, Plant and Equipment account. Depreciation begins after the asset has been placed into service

What do you mean by CVP analysis ? (2 Marks) Cost-volume-profit (CVP) analysis expands the use of information provided by breakeven analysis. A critical part of CVP analysis is the point where total revenues equal total costs (both fixed and variable costs). At this breakeven point (BEP), a company will experience no income or loss. This BEP can be an initial examination that precedes more detailed CVP analyses. Cost-volume-profit analysis employs the same basic assumptions as in breakeven analysis. The assumptions underlying CVP analysis are: 1.The behavior of both costs and revenues in linear throughout the relevant range of activity. (This assumption precludes the concept of volume discounts on either purchased materials or sales.) 2. Costs can be classified accurately as either fixed or variable. 3. Changes in activity are the only factors that affect costs. 4. All units produced are sold (there is no ending finished goods inventory). U.S. GAAP(5 Marks) Again, it has to be remembered that GAAP are not a rigid set of rules. These are flexible guidelines only. Over the years, these groups of conventions and standards have evolved in the specific need of standard common platform for the preparation and presentation of financial statements In United States, the American Institute of Certified Public Accountants (AICPA), The Financial Accounting Standards Board (FASB) and the Securities and Exchange Commission(SEC)offer guidance and assistance about standard acceptable practices of accounting

Amortization (5 Marks) 1. Preferred term for the apportionment (charging or writing off) of the cost of an intangible asset as an operational cost over the asset's estimated useful life. It is identical to depreciation, the preferred term for tangible assets. The purpose of both terms is to (1) reflect reduction in the book value of the asset due to usage and/or obsolescence, (2) spread a large expenditure proportionately over a fixed period, and thereby (3) reduce the taxable income (not the actual or cash income) of a firm. In effect, it is a process by which invested capital of a firm is recovered by gradual sale of the firm's asset(s) to its customers over the years. Depletion (5 Marks) A reduction of the value of an asset on a balance sheet that comes about as a result of the physical reduction of the asset's features. For example, there is only so much oil in an oil field. Depletion reduces the value of the oil field in a way related to the amount of oil drilled up over a given period of time. Depletion is used most often with natural resources.

How do you carry out analysis of final accounts from investors point of view ? (10 Marks) Financial statements shed light on the financial health of an organization. That is, they help shareholders and investors gain an understanding of what the creature as a whole looks like. Is it a cash cow? Or is it a dog? And while everybody understands why investors need these statements, there is considerably less information about how they use them to reach their investment decisions. In other words, what financial statements telling investors about a company? Equity investors are looking at financial statements to understand your company's ability to grow. Equity investors try to understand the amount of capital which the company will require as it grows. If the company will require substantially more equity capital than the investor is able or prepared to provide, then perhaps it's not such a good investment. These differing investors will approach your financial statements. Let's take a close look at the precise analysis each one undertakes. HOW EQUITY INVESTORS ANALYZE FINANCIAL STATEMENTS Equity Investor Balance Sheet Analysis Equity investors at general outlook on the balance sheet, they will invest regardless of the asset characteristics, if there's the opportunity to generate a large increase in value."

Next, "If the inventory account is high relative to the revenues, or has been creeping up over time, that's a big question, the company is simply mismanaged. On the accounts receivable, investor will take a high interest in the revenue recognition companys policy. When during the sales cycle it actually books its revenues. Growing companies, sometimes push sales out the door. For investors this is bad because it makes profits look high, when in truth the cash flow might be very poor because customers are not paying as quickly as the company is counting their sales. In general investors looking at the sales to ensure that a high percentage of what are booked as sales are indeed done deals. Many equity investors will look very closely at the accounts payable section of the balance sheet before making an investment. Why? They want to see how much of their equity investment is going to get eaten by creditors. Sometimes a Rs 500,000 investment will get whittle down to Rs 250,000 after the creditors stake their claim Most equity investors are looking for term loans. Most equity investors would prefer longer, rather than shorter term loans. Why? Shorter term loans require much more cash than long term loans, because the payment is divided by more periods. Also some term loans are interest only with a big balloon payment. The equity investor wants that balloon payment coming due as far into the future as possible.

Finally, investors will look at the equity section of the balance sheet. As practical, they want the lowest debt to equity ratio possible. It's not that he has any aversion to bank debt, or financial leverage. He just wants to make sure that the company founders are his equity partners, and motivated to create an increase in value. After all, if the only real money in the business comes from lenders, then it's easier for the owners to walk away when the going gets tough. Income Statement Analysis For the Equity Investor Next, investors will dig into the statements of income (Profit & Loss Account), and cash flow. Of these, the cash flow statement will provide more information. In the world of equity investing, especially with growth companies, the concept of profit gets slippery. "If a company is increasing its sales dramatically, and operates in a slow paying industry, there could be cash flow negative the whole year. More often than not, companies go out of business not because they lack profitability, but because they run out of cash." If that's the case, what good are profits? The point precisely, and the reason that, equity investors, have a decided preference for the cash flow statement. Still there are a few items he looks for on the income statement. First, like a banker, they are going to look at gross, operating and net margins to see if they are in line with industry averages. And they are going to look at the trends in contributions to revenues, if the company has more than one product or line. "Ideally, they would like to see the revenues moving toward the higher margin products over time."

Also, they will be looking at whether or not the revenues are recurring, meaning is there a lot of repeat business, or does the company have to find new customers all the time? "Obviously, it's much less expensive to generate revenues from existing customers than it is to go out and find new ones," "If the revenue structure is a recurring one, the company can substantially increase its earnings over a period of time." Next, they look at the general and administrative expenses. Though high general and administrative expenses are not viewed favorably. Next, they will be looking for some R&D expenses on the income statement. This only applies to technology companies, where innovation is the key to future profits. For most service or manufacturing companies, a commitment to R&D does not matter to equity investors. In addition to the value of expenses, most equity investors will also look at the trend relative to revenues. "They're looking for operating leverage," he says. "Ideally, the company is engaged in a business where general and administrative expenses, as a percentage of sales, decrease as sales increase." That's a significant benefit, since under those conditions, the company becomes more profitable, hence more valuable, the larger it gets.

Cash flow Analysis for the Equity Investor That would be a first cut at the income statement. For a closer look, like most equity investors are going to analyze the cash flow statement. "Overall, they want to see how capital intensive the business is," by which he is referring to financial capital as well as plant and equipment. There's nothing wrong with capital intensity per se. It's just that if the business needs a lot of money to grow, the equity investor must know this up front. Seasonality, for instance leads to capital intensity because a company must bulk up on inventory, and endures carrying costs. He's also checking out the rate at which accounts receivable turnover. Remember accounts receivable eat cash. And the longer a receivable is outstanding, the more cash it eats. For growth companies, lengthy collection periods, in conjunction with an overall increases in the volume of receivable means that the company is really getting squeezed. In fact, it's possible for a growth company to be highly profitable, but cash flow negative every month. Though receivables financing from banks would seem to solve capital intensity issues, it's not always available. For instance companies that are very young often cannot get receivables financing. Also, companies which have new or untested products also have a tough time landing receivables financing. And services receivables always cause problems because there is no exchange of a physical product, and therefore nothing the seller can take back if the buyer fails to pay.

At the end of the day, it's the often equity investor who has to step up to the plate, and provide the extra layer of capital, so that the operation can catch its breath. But the question in investors mind says Just how much capital is this going to take?" The answer to this question requires more than just an analysis of what's happening with various balance sheet accounts, and how they affect cash. There are also things like the principal portion of loan payments, and capitalized lease obligations (i.e., where you own the equipment when the lease is over) that never show up on an income statement, but nonetheless are vital, and often requires voluminous outlays for any company that is ramping up for the future. Ergo, the preference for the cash flow statement over the income statement for most equity investors.