Competitive Exams: Management Accounting (Part 1 of 3)

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Cash Flow Statement

When we compare two or more years total cash flow may be in three type of activities

  1. In operating activities from one financial year to another financial year we can get cash from selling of goods, receiving the money or any other operating activities or we can outflow of cash in B/p, creditors or any buying of goods. So different can be said as net flow of operating activities.

  2. Investing activities You know very well that with two years any company can buy or sell any assets buying of fixed assets is outflow and selling any asset is inflow of cash difference of both is net cash flow from investing activities.

  3. Financial activities Financial activities are related to buying and selling of shares and debentures. Selling of shares and debenture is inflow of cash and opposite if company buys shares of other company, this is called outflow of shares.

Cash Flow Statement

After calculating all net inflow and this is called flow of cash and statement making for this is called cash flow statement.

Benefit is it only for cash management who wants to make different planning. An account manager easily calculate what is the real cash flow position. Company's overall flow of cash is favorable or not. Some time cash book shows good current cash balance but a good account manager should investigate the overall flow of cash before buying high funded assets. This decision should be taken after complete analyzing of cash flow statement. Cash flow statement shows more outflow than inflow this is unbalanced situation. So be careful.


Question: Define inflation accounting or price level accounting? what are the main method of price level accounting? What are its main advantages and disadvantages?

Answer: Definition of inflation

Inflation accounting is recording, classifying and summarizing of all transaction on current or market cost and update recording amount according to time and changes. In price level accounting, the value of money is changed, our balance sheet's figure unit also changed.

Method of price level or Inflation accounting

Current purchasing power accounting

According to current purchasing power method, we calculate current cost with following method

I Take current price index and Calculate.

Current value of asset = Value of asset (Actual basis) X Current index/previous price index

For example Record value of Rs. 40000 machine on inflation accounting basis if 2005 index 100 and 2006 price index = 200 = 40000 × 200/180 = 80000 B/S Machine 80000

current cost accounting

In the current cost accounting following point must take in mind:

  1. value of fixed asset Will be take on current cost Not historical cost basis

  2. stock will be taken on market cost basis

  3. Transfer of difference between historical cost and current cost of asset to revaluation reserve account

  4. Calculate current operating profit

  5. Replacement cost accounting method

Improvemnet on Existing Method

This method is just improvement of current purchasing price method. In replacement cost accounting, we calculate current value basis of respective asset price index

Suppose book value of machinery is 300000and price index of machinery is 2005 is 100 and 2006 is 300 then book value of furniture Rs. 200000 price index of furniture 2005 = 200 and 2006 = 400

Current value of machinery = 300000 × 300/100

Current value of furniture = 200000 × 400/200

  1. Current value accounting method

  2. In current value accounting method, we take all asset of business in balance sheet on their current value

Definition of current ratio

This ratio is a relationship of current asset and current liabilities. It states the business current position to pay the current liabilities in time as when due.

There are two components of this ratio

current assets

  1. cash in hand

  2. cash at bank

  3. marketable securities

  4. sundry debtors

  5. bills receivable

  6. stock in trade

  7. prepaid exp

Current liabilities

  1. sundry creditors

  2. bill payable

  3. outstanding bill

  4. bank overdraft

Current Ratio

current ratio = current assets/current liabilities.

Importance of Calculating Average Collection period and Average Payment period

Average collection period and and Average payment period is basic test of the business's good or bad activity or operation. This is the main part of financial analysis to calculate these type of ratio. Even a small business man want to time in which he gets his debt from his debtors in whole year. He also wants to know at what period he pays his creditors.

These two ratios are the good symbol for calculating the efficiency and capacity of any type of organisation

These two ratios are the good symbol for making good planning for increase or decrease working capital efficiently. Because working capital is more effected from sundry debtors and sundry creditors.

Calculating the two ratios

  1. Average Collection Period = 12 months or 365 days/Debtors Turnover ratio. Because it is based on debtors turnover ratio. So we should also know debtor turnover ratio = Net Credit Sale/Average Debtors amount. Average debtors amount is equal to sum of opening and closing debtors and after divide 2, we can calculate the average debtors amount.

  2. Average Payment Period = 12 months or 365 days/Creditors Turnover ratio. Because it is based on Creditors turnover ratio. So we should also know Creditors turnover ratio = Net credit Purchase/Average Creditors amount, Average Creditors amount is equal to sum of opening and closing Creditors and after divide 2, we can calculate the average Creditors amount.

What are Profitability Ratios

Profitability ratios are so important, because of these ratios, we can take several decision for improving our business concern. These ratios tells us the basic relationship between profit and net sale. What amount of return we have receive on the basis of our sale. Is it good or not. If this is not good then what should we do in the improve actions of company.

There following main profitability ratios which is calculated in any company type of business.

  1. Gross profitability ratio = Gross profit/Net Sale X 100

  2. Operating Ratio = Operating Cost/Net Sale X 100

  3. Operating Profit ratio = Operating Profit/Net Sale X 100

  4. Net Profit ratio = Net profit/Net Sale X 100

  5. Rate on Investment = Net profit before interest and tax/Capital Employed X 100

  6. Earning Per Share (EPS) = Net profit after interest, tax and pref. Dividend/Numbers of equity shares X 100

  7. Dividend Per Share (DPS) Price Earning Ratio = Dividend on equity shares/Numbers of equity shares X 100