BASIC FINANCE

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 Table of Contents
1 INTRODUCTION TO ACCOUNTING ……….............................................................................................. 5
1.1 What is Bookkeeping? ..................................................................................................................... 5
1.2 What is Accounting? ..................................................................................................................... 5
1.3 Objectives of Accounting .............................................................................................................. 5
1.4 Difference Between Bookkeeping and Accounting ................................................................................ 6
1.5 Accounting Process ........................................................................................................................ 6

2 BRANCHES OF ACCOUNTING ............................................................................................................... 8

2.1 Difference Between Financial, Cost & Management Accounting ………………………..……………....8

3 BASICS OF ACCOUNTING .................................................................................................................... 10

3.1 Accounting Basis .......................................................................................................................... 10
3.2 Classification of Accounts ...............................................................................................................11
3.3 Books of Accounts ........................................................................................................................11

4 TYPES OF BUSINESS ENTITIES ........................................................................................................... 12

4.1 Sole Proprietorship ...................................................................................................................... 12
4.2 Partnership ................................................................................................................................. 12
4.3 Limited Liability Partnership (LLP) ................................................................................................ 12
4.4 Private Limited Company ......................................................................................................................... 12
4.5 Public Limited Company ........................................................................................................................... 12
4.6 One-Person Company (OPC) ........................................................................................................... 12
4.7 Non-Profit Organizations ............................................................................................................... 12

5 BASICS OF ACCOUNTING PRINCIPLES .....................................................................................................13

5.1 Golden Rules of Accounting .......................................................................................................... 13
5.2 Rules for Modern Classification .................................................................................................... 13
5.3 Accounting Standards .................................................................................................................... 14
5.4 Fundamental Accounting Concepts and Principles ................................................................................15

6 FINANCIAL STATEMENTS .................................................................................................................. 17

6.1 Objectives and Preparation of Financial Statements ………………………………………….... 17
6.2 Balance Sheet .............................................................................................................................. 17
6.3 Income Statement ........................................................................................................................ 18
6.4 Cash Flow Statement ................................................................................................................. 18
6.5 Interlinkage Between Financial Statements ........................................................................................ 22
6.6 Impact of Transactions on Financial Statements ................................................................................. 24

7 TRIAL BALANCE AND ADJUSTMENT ................................................................................................... 25

7.1 Objective of Trial Balance ............................................................................................................. 26
7.2 Classification of Errors ................................................................................................................... 26

8 FINANCIAL RATIOS ..................................................................................................................................... 27

8.1 Liquidity Ratios ........................................................................................................................................ 27
8.2 Profitability Ratios .................................................................................................................................... 28

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 8.3 Turnover (Activity) Ratio..............................................................................................................................29
8.4 Solvency Ratios ......................................................................................................................................... 29
8.5 Market Value Ratios .................................................................................................................................. 30

9 ADVANCED FINANCIAL ANALYSIS ........................................................................................................... 32

9.1 DuPont Analysis ............................................................................................................................ 32
9.2 Common Size Statements .............................................................................................................. 33
9.3 Comparative Statements ................................................................................................................ 34

10 CASH CYCLE & CREDIT MANAGEMENT .................................................................................................. 35

10.1 Cash Conversion Cycle (CCC) ................................................................................................... 35
10.2 Credit Management .................................................................................................................... 36

11 DEPRECIATION................................................................................................................................ 38
11.1 Features and Need for Depreciation ............................................................................................. 38
11.2 Types of Depreciation .................................................................................................................. 38
11.3 Amortization and Depletion .......................................................................................................... 39

12 INVENTORY VALUATION ...................................................................................................................... 41

12.1 Inventory Valuation Methods ...................................................................................................... 41
12.2 Comparison of FIFO and LIFO ........................................................................................................ 41

13 GOODWILL ................................................................................................................................. 42
13.1 Meaning of Goodwill ................................................................................................................... 42
13.2 Methods to Calculate Goodwill ..................................................................................................... 42

14 OTHER CONCEPTS .............................................................................................................................. 43

14.1 Formula sheet…………………………………………………………………………………………….…….43
14.2 Accounting Loss ......................................................................................................................... 44
14.3 Gross Block Concept ................................................................................................................... 44
14.4 Extraordinary Loss in Depreciation ............................................................................................. 44
14.5 Extraordinary Gain in Depreciation …............................................................................................ 44
15 INTERVIEW QUESTIONS ..................................................................................................................... 45
15.1 Financial Accounting & FRA ..................................................................................................... 45
15.2 Balance Sheet Concepts ............................................................................................................... 45
15.3 Cash Flow Statement ................................................................................................................... 45
15.4 Depreciation & Accounting Treatment ........................................................................................ 45
15.5 Inventory & Working Capital ...................................................................................................... 45
15.6 Ratios & Comparative Analysis ................................................................................................... 45
15.7 Leverage & Profitability .............................................................................................................. 45
15.8 Banking & Credit Perspective ..................................................................................................... 46
15.9 Leases & Asset Treatment ........................................................................................................... 46
15.10 Financial Statements-Interlinkages ......................................................................................... 46
15.11 Core Finance Theory & Valuation .............................................................................................. 46
15.12 Markets & Instruments .............................................................................................................. 46
15.13 Annual Report & Company Analysis ......................................................................................... 46
15.14 Indian Economy & Policy .......................................................................................................... 47
15.15 Banking Crisis & Scams ............................................................................................................ 47
15.16 Corporate Law & M&A …........................................................................................................... 47

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 1 INTRODUCTION TO ACCOUNTING
transactions such as purchases, sales,
1.1 What is Bookkeeping? receipts, and payments. This ensures
accuracy, avoids reliance on memory, and
Bookkeeping involves recording, daily, the
provides reliable evidence when required.
financial transactions of the company. This
enables the companies to track all 1.3.2 Calculation of Profit and Loss
information on their books to make key
operating, investing, and financing Accounting enables the business to
decisions. determine its profit or loss for a specific
period by comparing revenues with
1.2 What is Accounting? expenses. This helps owners assess
business performance and efficiency.
"Accounting is the art of recording,
classifying, and summarizing, in a 1.3.3 Depiction of Financial Position
significant manner and in terms of money,
Accounting shows the financial position of
transactions, and events which are, in part
a business at the end of an accounting
at least, of a financial character, and
period by listing its assets and liabilities
interpreting the results thereof."
through a balance sheet, reflecting the
In simple words, Accounting is recording financial health of the business.
financial transactions, summarizing them
and communicating the financial 1.3.4 Providing Accounting
information to the stakeholders (users) i.e. Information to Its Users
the proprietors, creditors, investors,
Accounting information is communicated
government agencies, employees etc.
through financial statements, reports,
Only if a transaction or an event has a charts, and graphs to help users make
financial implication, it will be recorded in decisions. These users are broadly
the accounting books. It is also called the classified into internal users and external
language of business. While accounting users.
and bookkeeping are often seen as similar,
Internal Users: Management uses
they have a key difference. Bookkeeping
involves recording transactions, while accounting information for planning,
accounting goes beyond that to summarize, controlling, and decision making, such as
analyse, interpret, and communicate the analyzing costs, profitability, and
results to interested parties. performance.
External Users: External users rely mainly
1.3 Objectives of Accounting on financial statements like the Profit &
1.3.1 Maintenance of Records of Loss Account and Balance Sheet. Their
Business Transactions interests include: Investors, Employees and
unions, Lenders and financial institutions,
Accounting helps maintain a systematic Suppliers and creditors, Customers,
and permanent record of all financial Government and regulators.

1.4 Difference Between Bookkeeping and Accounting

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Table 1.1: Difference Between Bookkeeping and Accounting

Basis Bookkeeping Accounting

Meaning Recording of daily transactions Analysis and interpretation of records

Nature Clerical and routine Analytical and decision-oriented

Scope Limited Broad

Focus Accuracy of records Usefulness of information

Output Books of accounts Financial statements & reports

Level Basic stage Advanced stage

Purpose Maintain records Support decision-making

Skill Required Basic accounting knowledge Professional judgment & expertise

1.5 Accounting Process

Figure 1.1: Accounting Process Flow

Identify the transaction

Record in journal

Post to ledger

Prepare trial balance

Prepare financial statement

1. Profit & Loss a/c 2. Income Statement 3. Balance Sheet

Analyse results

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1.5.1 Step 1: Identify the Transaction 1.5.4 Step 4: Prepare Trial Balance

The first step is to identify financial A trial balance is prepared to check the
transactions that affect the business, such as arithmetical accuracy of ledger accounts. It
sales, purchases, payments, or receipts. Only ensures that total debits equal total credits.
transactions that can be measured in monetary 1.5.5 Step 5: Prepare Financial
terms are recorded.
Statements
1.5.2 Step 2: Record in Journal
Using the trial balance, financial statements are
All identified transactions are recorded in the prepared:
journal in chronological order using the • Profit & Loss Account – to determine profit
double-entry system. This ensures accuracy or loss
and proper classification of debit and credit. • Balance Sheet – to show financial position
1.5.3 Step 3: Post to Ledger 1.5.6 Step 6: Analyse Results

Journal entries are transferred to the ledger, The final step is to analyze financial results to
where transactions are grouped under understand business performance, financial
individual accounts (assets, liabilities, income, health, and areas requiring improvement. This
expenses). This helps track account-wise analysis supports managerial decision-making.
balances.

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 2 BRANCHES OF ACCOUNTING

2.1 Difference Between Financial Accounting, Cost Accounting, and

Management Accounting
Table 2.1: Comparison of Financial, Cost, and Management Accounting

Management
Basis Financial Accounting Cost Accounting
Accounting

Records overall financial Determines cost of

Uses accounting data for
Meaning performance of a producing goods or
managerial decisions
business services

Profit, loss, and financial Cost control and cost Planning, decision-
Main Focus
position reduction making, and strategy

Internal users (cost

External users Internal users (top
Users managers, production
(investors, banks, govt.) management)
heads)

Both historical and

Nature Historical (past-oriented) Future-oriented
current

Profit & Loss Account, Budgets, forecasts,

Reports Prepared Cost Sheet, Cost Reports
Balance Sheet variance reports

Legal Requirement Mandatory by law Not mandatory Not mandatory

Very detailed (unit-wise, Flexible and decision-

Level of Detail Aggregate (overall view)
process-wise) specific

Time Period Usually yearly As required As required

Branches of accounting vary depending on regulatory agencies. However, public usage is

their usage. A company can either use it for beneficial to everyone who is involved in a
internal purposes or public purposes. Internal business.
usage includes reporting processes to

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 Figure 2.1: Branches of Accounting

Branches of
Accounting

Financial Accounting Management Accounting Cost Accounting

(External reporting) (Internal decisions) (Cost control & efficiency)

It involves recording and classifying It is a part of management It is a part of management

business transactions, along with accounting and aims to evaluate accounting and aims to evaluate
preparation and presentation of the cost that a company incurs for the cost that a company incurs for
financial statements. production. production.
Financial accounting analyses the Management (cost) accounting Cost accounting helps business
company’s balance sheet and helps business generate detailed generate detailed reports on costs,
prepares profit & loss statement reports on costs, which can help which help them determine
that advises on loan, investment or them determine potential financial potential financial action for the
acquisition decisions. action for the future. future.

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 3 BASICS OF ACCOUNTING

3.1 Accounting Basis when they're incurred, regardless of when the

cash changes hands.
There are two primary methods of accounting:
cash basis and accrual basis. These methods For example: A business sells goods for
differ in when a company records transactions ₹20,000, and the customer does not make the
in its books. payment immediately. In this case, no
transaction would be recorded under the cash
3.1.1 Cash Basis Accounting basis of accounting since cash has not yet been
received. However, in the case of an accrual
In cash basis accounting, transactions are basis of accounting, the transaction would be
recorded when cash is received or paid. This recorded in the books of accounts as accounts
means revenue is recognized when cash is receivable, indicating that the sale has been
received, and expenses are recorded when cash made, but the amount is still to be received
is paid out. from the customer.
3.1.2 Accrual Basis Accounting In summary, cash basis accounting records
transactions based on cash flow, while accrual
In accrual basis accounting, transactions are basis accounting records transactions when
recorded when they occur, regardless of when they occur, providing a more accurate
cash is received or paid. Revenue is recognized representation of a company's financial
when it's earned, and expenses are recorded performance

3.1.3 Cash Basis vs Accrual Basis Accounting

Table 3.1: Cash Basis vs Accrual Basis Accounting

Basis Cash Basis Accrual Basis

Record timing On cash receipt/payment On income earned/expense incurred
Income When cash is received When income is earned
Expense When cash is paid When expense is incurred
Profit focus Cash position True profit
Accuracy Low High
Matching concept Not followed Followed
Usage Small businesses Companies

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3.2Classification of Accounts
Figure 3.1: Traditional Classification of Accounts

ACCOUNTS

PERSONAL IMPERSONAL
Relate to persons i.e. These are not related
individuals, firms, to persons.
companies, debtors, Machinery, Cash,
creditors etc. Rent etc.

Natural Artificial Representative Real Nominal

Persons Companies Person or group of Tangible/intangible Expenses, losses,
Institutions etc. Institutions etc. persons assets gains, revenue etc.

Figure 3.2: Modern Classification of Accounts

ACCOUNTS

Assets Liabilities Capital/Equity Revenue Expense

3.3.2 Bank Book

3.3 Books of Accounts
A detailed record of all banking transactions,
3.3.1 Cash Book separate from cash transactions.
Records all cash receipts and payments,
including bank deposits and withdrawals. 3.3.3 Sales Book
Records all credit sales of goods and services.

3.3.4 Flow of Books of Accounts

Transaction → Journal → Ledger → Trial Balance → Financial Statements

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 4 TYPES OF BUSINESS ENTITIES

4.1 Sole Proprietorship 4.4 Private Limited Company

A private company is owned by two or more
A sole proprietorship is owned and managed by shareholders with limited liability. It requires
a single individual. The owner has unlimited high compliance, including statutory filings
liability, meaning personal assets can be used to and audits. Capital can be raised through
pay business debts. Compliance requirements private investors and shareholders, making
are minimal, but the ability to raise capital is capital availability moderate.
very limited as it depends only on the owner's
Example: Marriott Hotels India Pvt. Ltd., DHL
personal savings or borrowings. Example:
(Express) India Pvt. Ltd.
Grocery shops and General stores.
4.5 Public Limited Company
4.2 Partnership
A public company has many shareholders and
A partnership is owned by two or more persons offers the highest level of limited liability
who agree to share profits and losses. The protection. It is subject to very high compliance
liability of partners is generally unlimited and due to strict legal and regulatory requirements.
joint, making each partner responsible for Capital raising capacity is high as it can issue
business obligations. Compliance is moderate, shares and securities to the public. Example:
and capital raising is limited to partner Indian Oil Corporation Ltd.
contributions and loans. Example: ANCA &
Associates 4.6 One-Person Company (OPC)
A type of private company established by
4.3 Limited Liability single individual. The sole owner has limited
Partnership (LLP) liability, and there is a distinction between the
owner and the company. The liability of the
An LLP combines features of a partnership and member is limited to his/her shares, and he/she
a company. It has two or more partners with is not personally liable for the loss of the
limited liability, meaning partners are not company. OPCs provide a legal structure for
personally liable beyond their contribution. entrepreneurs to operate as a company while
Compliance requirements are moderate, and enjoying limited liability. Example: Bhairab
capital raising options remain limited since Builders Private Ltd. (OPC), Digitex Fabrics
LLPs cannot issue shares. Example: Malabar (OPC) Private Ltd.
Retailers LLP

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 5 BASICS OF ACCOUNTING PRINCIPLES
Table 5.2 Rules for modern classification:
5.1 Golden Rules of Accounting
Type of
Figure 5.1: Golden Rules of Accounting Debit Credit
Account
Assets
Increase (+) Decrease (–)
Account
GOLDEN
Liabilities
RULES OF Decrease (–) Increase (+)
ACCOUNTING Account
Capital
Decrease (–) Increase (+)
Account
PERSONAL NOMINAL Revenue
ACCOUNT
REAL ACCOUNT
ACCOUNT Decrease (–) Increase (+)
Debit the Receiver
Debit What Comes In
Debit All Expenses
Account
Credit the Giver
Credit What Goes Out
Credit All Incomes Expense
Increase (+) Decrease (–)
Account
5.1.1 Personal Account
Debit the receiver, Credit the giver 5.2.1 Example Application
Example: Shyam bought a cycle, so Shyam is Example: Mr. A started a business with Rs 4
the receiver and will be debited. lakhs as capital. He purchased machinery for
Rs. 2 lakhs on account while paying rent of Rs
5.1.2 Real Account 50,000 for office building. He made sales worth
Rs. 70,000 in the first month.
Debit what comes in, Credit what goes out
Example: A company purchases machinery for
cash, which is an asset; hence, machinery has Personal/Real/Nominal:
come in, so it will be debited, and money has
Figure 5.3: Personal/Real/Nominal Classification
gone out so that Cash account will be credited. Example
5.1.3 Nominal Account
Debit expenses & losses, Credit incomes &
gains
Example: The company pays salaries to
employees, and since salaries are an expense,
the salary account will be debited.

5.2 Rules for Modern Classification

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Table 5.4: Modern Classification

Type of Account Debit Credit

Assets Account Increase (+) Decrease (–)
• Cash A/c (Rs. 4 Lakh) • Cash A/c (Rs. 50,000) (Rent Paid)
• Machinery A/c (Rs. 2 Lakh)
• Cash A/c (Rs. 70,000) (Sales
received in cash)
Liabilities Account Decrease (–) Increase (+)
• Accounts Payable A/c (Rs. 2 Lakh)
(Purchase of machinery on account)
Capital Account Decrease (–) Increase (+)
• Capital A/c (from Mr. A) (Rs. 4 Lakh)
Revenue Account Decrease (–) Increase (+)
• Sales Revenue (Rs. 70,000)
Expense Account Increase (+) Decrease (–)
• Rent for office building (Rs.
50,000)

5.3 Accounting Standards

Table 5.5: Comparison of GAAP, IFRS, and Ind AS

GAAP IFRS Indian Accounting

Standards (Ind AS)
Full Form Generally Accepted Accounting International Financial Indian Accounting
Principles Reporting Standards Standards
Meaning A set of accounting rules and A globally accepted set Indian version of
guidelines followed within a of accounting standards accounting standards
specific country converged with IFRS
Nature Country-specific standards International / global National standards aligned
standards with IFRS
Issuing National accounting bodies International Accounting Institute of Chartered
Authority (e.g., FASB in the US) Standards Board (IASB) Accountants of India
(ICAI)
Geographic Primarily used in the United Used in more than 140 Used in India
Use States countries
Objective Ensure uniformity and accuracy Ensure global Bring Indian financial
within a country comparability and reporting in line with
transparency global standards
Accounting Rule-based Principle-based Principle-based (with
Approach Indian adaptations)
Flexibility Low flexibility due to strict High flexibility based on Moderate flexibility
rules substance over form
Focus Compliance with detailed rules Fair presentation of Fair presentation with
financial statements Indian regulatory context

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 5.4 Fundamental Accounting Concepts and Principles
5.4.1 Going Concern Concept forward as inventory and charged as an expense
only when the goods are sold.
The going concern concept assumes that a
business will continue its operations for the 5.4.4 Money Measurement Concept
foreseeable future and does not intend to
liquidate or significantly reduce its scale of The money measurement concept holds that
operations. This assumption is fundamental only those transactions and events that can be
because it forms the basis for asset valuation, expressed in monetary terms are recorded in
depreciation, and amortization. If a business is accounting books. This ensures objectivity,
expected to continue, assets are recorded at cost consistency, and comparability in financial
and spread over their useful life rather than records. Non-monetary factors, even if
being valued at immediate selling price. important to the business, are excluded because
they cannot be measured reliably.
Example: Machinery purchased by a company
is depreciated over several years instead of Example: The purchase of equipment for
being written down to scrap value in the first ₹10,000 is recorded, but employee morale,
year. brand value, or managerial efficiency are not
shown in the financial statements.
5.4.2 Revenue Recognition Principle
5.4.5 Cost Concept (Historical Cost
According to the revenue recognition principle, Concept)
revenue is recorded in the accounting books
when it is earned and the right to receive Under the cost concept, all assets are recorded
payment is established, irrespective of when at their original purchase price rather than their
cash is actually received. This principle ensures current market value. This principle
that income is reported in the correct emphasizes reliability and verifiability, as
accounting period and reflects the true purchase cost can be supported by documents
performance of the business. such as invoices and contracts. Even if market
values fluctuate, assets continue to be shown at
Example: If goods worth ₹5,00,000 are sold in historical cost, subject to depreciation.
December on credit and payment is received in
April of the next year, the revenue is recognized Example: Land bought for ₹10 lakh will
in December when the sale took place, not continue to be shown at ₹10 lakh in the books,
when cash is received. even if its market value increases significantly.

5.4.3 Matching Principle 5.4.6 Prudence (Conservatism) Concept

The matching principle states that expenses The prudence concept requires accountants to
should be recorded in the same accounting exercise caution while recording transactions
period as the revenues they help to generate. by anticipating probable losses but not
This principle is closely linked to accrual unrealized gains. The aim is to avoid
accounting and ensures that profits are not overstating profits or assets and to ensure that
overstated or understated. By matching financial statements do not present an overly
expenses with related revenues, financial optimistic picture.
statements present a true and fair view of
Example: Provision for doubtful debts is
performance.
created when there is uncertainty about
Example: If goods are purchased during the collection, but expected profits from future
year but remain unsold, their cost is carried sales are not recorded until they are actually
realized.

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5.4.7 Accounting Period Concept 5.4.10 Full Disclosure Principle
The accounting period concept states that the The full disclosure principle requires that all
continuous life of a business is divided into material and relevant information affecting the
equal and convenient time periods for reporting financial position of the business must be
and analysis. This allows stakeholders to assess disclosed in financial statements. This ensures
financial performance at regular intervals transparency and enables users to make
rather than waiting until the business ends. informed decisions. Disclosure may be made
Most companies prepare financial statements through notes, schedules, or additional
annually and may also report quarterly results. statements.
Example: Many Indian companies follow an Example: Information about mergers,
accounting period from April to March for contingent liabilities, or major legal disputes
preparing annual financial statements. must be disclosed to provide a complete picture
of the company's financial health.
5.4.8 Consistency Principle
5.4.11 Dual Aspect Concept
The consistency principle requires that once a
business adopts a particular accounting method The dual aspect concept states that every
or policy, it should continue using it business transaction has two aspects and affects
consistently from one accounting period to at least two accounts in such a way that the
another. Consistency ensures comparability of accounting equation remains balanced. This
financial statements over time and helps users concept forms the foundation of the double-
analyze trends accurately. A change in method entry system of accounting. For every debit
is allowed only if it improves reliability and entry, there is a corresponding credit entry of
must be properly disclosed. equal amount.
Example: If a company uses the straight-line Example: When a business borrows ₹50,000
method of depreciation, it should not switch to from a bank, cash increases by ₹50,000 and
another method arbitrarily. liabilities also increase by ₹50,000.
5.4.9 Business Entity (Separate Legal 5.4.12 Materiality Principle
Entity) Concept
The materiality principle states that only
According to the business entity concept, the information that is significant enough to
business is treated as a separate entity distinct influence the decisions of users should be
from its owners. All transactions are recorded disclosed in financial statements. What is
from the viewpoint of the business and not the considered material depends on the size and
owner. This principle ensures clarity and nature of the business. This principle helps
prevents mixing of personal and business avoid unnecessary details that do not affect
transactions. decision-making.

Example: When an owner introduces capital Example: A small repair expense may be
into the business, it is recorded as a liability of immaterial for a large corporation but material
the business towards the owner, not as business for a small enterprise, while the closure of a
income. production unit would always be considered
material.

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 6 FINANCIAL STATEMENTS

A financial statement is a written record that (1) Balance Sheet, (2) Income Statement,
shows the financial performance and financial (3) Cash Flow Statement.
position of a business over a specific period of
time. In simple words, it tells how much a 6.2 Balance Sheet
company earns, owns, owes, and spends. These
statements are prepared from accounting A balance sheet is a financial statement that
records and help owners, managers, investors, reports a company's assets, liabilities, and
banks, and the government understand the shareholders' equity at a specific point in time
financial health of a business. and provides a basis for computing rates of
return and evaluating its capital structure. It is
6.1 Objectives and Preparation a financial statement that provides a snapshot
of what a company owns and owes, as well as
of Financial Statements the amount invested by shareholders. The
6.1.1 Primary Objectives balance sheet has two parts, assets, and
liabilities (including shareholder's equity).
1. To provide a true and fair view of the Accounts of capital and liabilities are shown on
financial performance of the business the left hand side, known as Liabilities. Assets
during a particular period. and other debit balances are shown on the right
2. To present a true and fair view of the hand side, known as Assets. As the name
financial position of the business at a balance sheet suggests, at any given point,
specific point in time. these two should balance each other.
To achieve these objectives, a firm
generally prepares the following financial
statements:
Table 6.1: Balance Sheet difference

Assets Liabilities Shareholders’ Equity

Liabilities are the
Assets are the application of
sources of funds that It equals the assets that the
funds that the company owns
create an obligation on company owns minus the amount
and controls for future
the company that it owes the company owes.
benefits.
to somebody.
Includes cash, inventory, Includes loans, accounts It represents the net worth of the
equipment, etc. payable, mortgages, etc. company.
Assets in the future can be Liabilities are In other words, the total capital in
used to generate cash flows. obligations that need to a company that is directly linked
be paid off in the future. to its owners.

Accounting Equation

Assets = Liabilities + Owners’ Equity (Capital)

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6.3 Income Statement
The Trading and Profit & Loss Account is prepared to find out the profit earned or loss incurred by a
business during a specific accounting period. It presents a summary of the business's revenues and
expenses and calculates the final result known as net profit or net loss. Profit arises when revenues
exceed expenses, whereas a loss occurs when expenses are higher than revenues. This account reflects
the overall financial performance of the business for the accounting period.
The Trading and Profit & Loss Account is prepared by transferring revenue and expense balances from
the trial balance to it. Like other accounts, it has Debit and Credit sides. All expense items and losses
with debit balances are recorded on the debit side, while income items with credit balances are recorded
on the credit side of the Trading and Profit & Loss Account.
R𝑒𝑣𝑒𝑛𝑢𝑒 - 𝐸𝑥𝑝𝑒𝑛𝑠𝑒 = 𝑁𝑒𝑡 𝐼𝑛𝑐𝑜𝑚𝑒

The income statement is also known as a "profit & loss statement", or a "P&L". Revenue is also known
as “top line”. Net income is also known as "earnings" and "profit," in addition to being called "the
bottom line".
(₹ in crores)
Year ended
Particulars Notes
March 31, 2023
Revenue from operations
Revenue 65,298.84
Other operating revenue 458.49
I. Total revenue from operations 31(b) 65,757.33
II. Other income 32(b) 820.94
III. Total income (I + II) 66,578.27
IV. Expenses
Cost of materials consumed 42,226.81
Purchases of products for sale 6,561.32
Changes in inventories 484.69
Employee benefits expense 33 4,021.63
Finance costs 34 2,047.51
Foreign exchange loss (net) 279.76
Depreciation and amortisation expense 1,766.86
Product development / engineering expenses 899.06
Other expenses 35 8,719.74
Amount transferred to capital and other account 36 (1,066.73)
Total expenses (IV) 65,040.65
V. Profit before exceptional items and tax 1,537.62
VI. Exceptional items 37 282.82
VII. Profit before tax 1,254.80
VIII. Tax expense / (credit) 28
Current tax 81.60
Deferred tax (1,554.93)
Total tax credit (net) (1,473.33)
IX. Profit for the year (VII-VIII) 2,728.13
X. Other comprehensive income /loss
(i) Items that will not be reclassified to profit or loss

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 Remuneration losses on defined benefit obligations (net) (61.43)
Equity instruments at fair value through other
(134.12)
comprehensive income(net)
(ii) income tax (expenses)/credit relating to items that will
34.96
not be classified to profit or loss
(i) items that will be reclassified to profit or loss-
(99.69)
gains/losses) in cash flow hedges
(ii) income tax expenses/ credit relating to items that will
9.93
be reclassified to profit or loss
Total other comprehensive income/ loss for the year
(250.35)
(net of tax)
Total comprehensive income for the year 2,477.78
Earnings per equity share (EPS) 39
Ordinary shares (face value of (₹) 2 each)
Basic EPS 7.11
Diluted EPS 7.11
‘A’ ordinary shares (face value of (₹) 2 each)
Basic EPS 7.21
Diluted EPS 7.21

Top Line: Represents gross sales or revenues.

6.4 Cash Flow Statement
Bottom Line: Represents net income, which is The cash flow statement shows the inflows and
the result after all expenses, including taxes and outflows of cash and cash equivalents in a
interest, have been deducted from the top line. company, indicating how well it manages its
cash position, in terms of liquidity and
COGS: Costs directly associated with the solvency.
production of the goods or services the
company sells. 6.4.1 Objectives of Cash Flow Statement

Operating, Gross, and Net Profit: Gross • Shows the inflow and outflow of cash and
Profit: Revenue minus COGS. cash equivalents of a company during a specific
period.
Operating Profit: Gross profit minus all
• Provides information about cash flows from
operating expenses, excluding interest and
operating, investing, and financing activities.
taxes.
• Helps users understand how cash is generated
Net Profit: The remaining profit after all and used by the business.
expenses, including taxes and interest, have
been deducted. • Assists in assessing the ability of the
enterprise to generate cash and cash
Depreciation: An accounting method of equivalents.
allocating the cost of a tangible asset over its
useful life, representing how much of an asset's • Indicates the cash requirements of the
value has been used up over a period. enterprise for meeting obligations and
investments.

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6.4.2 Direct vs. Indirect Method in Cash Flow

Basis Direct Method Indirect Method

Lists all major operating cash receipts and Begins with net income and adjusts
Meaning payments for the period, directly showing net it to arrive at cash flow from
cash from operating activities. operating activities.
Adjusts net income for non-cash
Measures only the cash received and the cash
Focus transactions and changes in
payments made during the period.
working capital.
Cash flow is calculated by
Cash inflows and outflows are calculated and
Approach modifying net income through
then combined to arrive at net cash flow.
additions and subtractions.
Treatment of Explicitly adjusts for non-cash
Does not focus on non-cash transactions directly.
non-cash items transactions.
Working capital Calculated using the net increase or decrease in Changes in working capital are
changes asset and liability balances. adjusted against net income.
Figures are presented in a straightforward and Presentation is indirect and requires
Presentation
easily understandable manner. adjustments to net income.
Basis of Uses beginning and ending balances of various Uses net income as the starting
calculation asset and liability accounts. point and adjusts for differences.

6.4.3 Three Areas of Cash Flow 2. Investing Activities: Cash used in or

Statement generated from buying and selling assets. Cash
flow from investing activities includes the
1. Operating Activities: Cash generated from acquisition and disposal of non-current assets
or used in the core business operations. and other investments not included in cash
Operating activities are the principal revenue- equivalents.
producing activities of the entity. Cash flow
3. Financing Activities: Cash exchanged with
from operations typically includes the cash lenders and shareholders. Cash flow from
flows associated with sales, purchases, and financing activities results from changes in a
other expenses. We start with the net income company's capital structure. Financing cash
from the Income Statement. We add back flows include cash flows associated with
Depreciation & Amortization expenses because borrowing and repaying bank loans or bonds
they are non-cash expenses. Any changes in and issuing and buying back shares. The
current assets (other than cash) and current payment of a dividend is also treated as a
liabilities (other than debt) affect the cash financing cash flow. For instance, the issuance
balance in operating activities, and are added or of debt is a cash inflow, because a company
subtracted accordingly. finds investors willing to act as lenders.
However, when these debt investors are paid
back, then the repayment is a cash outflow.

Table 6.6: Cash Flow Activities Breakdown

(₹ in crores)
Particulars Year ended March Year ended
31, 2024 March 31, 2023
Cash flows from operating activities:
Profit for the year 7,902.08 2,728.13
Adjustments for:

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 Depreciation and amortisation expense 2,016.84 1,766.86
Allowance for trade receivables, loans and 114.28 105.12
other receivables
Discounting of warranty and other provisions (90.84) (128.53)
Inventory write down (net) 98.73 32.21
Profit on sale of investments in subsidiary (3,747.91) -
Non cash exceptional items 939.50 281.46
Accrual for share-based payments 28.19 20.46
Lease charges (Amortisation considered as 58.32 -
employee cost)
Profit on sale of assets (net) (32.04) (88.47)
Profit on sale of investments at FVTPL (net) (81.21) (71.82)
Marked-to-market gain on investments (3.53) (6.81)
measured at FVTPL
Gain on fair value of below market interest (11.31) -
loans
Tax credit (net) (51.26) (1,473.33)
Finance costs 1,705.74 2,047.51
Interest income (201.24) (245.42)
Dividend income (655.33) (187.52)
Unrealised foreign exchange loss (net) 533.78 230.40
620.71 2282.12
Cash flows from operating activities before 8,522.79 5,010.25
changes in working capital
Trade receivables (553.14) (306.46)
Loans and other financial assets 123.78 126.28
Other current and non-current assets 212.54 (98.21)
Inventories (541.21) 658.37
Trade payables 315.79 (957.24)
Other current and non-current liabilities 598.51 620.22
Other financial liabilities (52.19) (88.17)
Provisions 281.22 (21.46)
Cash generated from operations 8,908.09 4,943.58
Income tax paid (net) (246.38) (168.15)
Net cash from operating activities 8,661.71 4,775.43
Cash flows from investing activities:
Payments for property, plant and equipments (1,005.42) (761.29)
Payments for other intangible assets (985.85) (936.07)
Proceeds from sale of property, plant and 39.48 122.70
equipments
Investments in Mutual Fund sold (net) 1,267.34 2,078.75
Investments in Government securities (42.45) -
Redemption of investments in Government 9.69 -
securities
Investments in subsidiary companies (678.06) (191.18)
Investments in an associate company (150.00) -
Sale of investment in a subsidiary company 3,812.31 -
Redemption of investment in a subsidiary 13.54 -
company
Loan given to subsidiary companies (16.00) (45.00)
Return of investment by subsidiary company - 131.83
Increase in short term inter corporate deposit (95.12) (15.00)
Deposits/restricted deposits with banks (1,789.93) (276.64)

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 Realisation of deposits/restricted deposits 273.28 141.78
with banks
Interest received 180.05 185.27
Dividend received 655.33 187.52
Net cash generated from investing activities 1,488.19 922.67
Cash flows used in financing activities:
Proceeds from issue of shares and share 81.87 19.60
application pending allotment (net of issue
expenses)
Proceeds from long-term borrowings 25.71 8.99
Repayment of long-term borrowings (5,948.57) (4,808.33)
Payment of option settlement of long term (82.78) (106.51)
borrowings
Proceeds from short-term borrowings - 52.35
Repayment of short-term borrowings - (937.10)
Net change in other short-term borrowings 756.92 825.77
(with maturity up to three months)
Repayment of lease liabilities (including (154.94) (68.33)
interest)
Dividend paid (769.04) -
Interest paid (including discounting charges (1,839.62) (2,007.76)
paid 405.03 crores (march 31,2023 425.37
crores)
Net cash used in financing activities (7,930.45) (7,021.32)
Net increase/(decrease) in cash and cash 2,219.45 (1,323.22)
equivalents
Cash and cash equivalents at April 1 1,121.43 2,450.23
(opening balance)
Effect of foreign exchange on cash and cash 4.01 (5.58)
equivalents
Cash and cash equivalents at March 31 3,344.89 1,121.43
(closing balance)
Non-cash transactions:
Liability towards property, plant and 300.28 317.14
equipment and other intangible assets
purchased on credit/deferred credit

6.5 Interlinkage Between Although it belongs to shareholders, the

company keeps it for future growth and
Financial Statements strategic needs.
The Balance Sheet, Income Statement, and
Depreciation and amortization are recorded as
Cash Flow Statement are closely connected and
expenses in the Income Statement to reflect the
together present a complete picture of a
usage of tangible and intangible assets during
business’s financial activities.
the period. At the same time, the value of these
assets is reduced in the Balance Sheet by the
The profit earned during the year, as shown in
same amount.
the Income Statement, is partly retained in the
business after dividends are paid. This retained
Under the accrual concept, revenues are
portion is added to Reserves and Surplus under
recorded when sales occur, not when cash is
shareholders’ equity in the Balance Sheet.

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received. Therefore, total sales appear in the Statement of Retained Earnings. During the
Income Statement, while the unpaid portion is year, net income from the Income Statement is
shown as Trade Receivables in the Balance added to retained earnings. After dividends are
Sheet. paid, the remaining balance is transferred to the
closing Balance Sheet.
Similarly, expenses are recorded in the Income
Statement when goods or services are The opening cash balance from the Balance
consumed. If payment has not yet been made, Sheet is the starting point of the Cash Flow
the unpaid amount appears as Trade Payables Statement. Net income forms the base for
in the Balance Sheet. calculating cash flow from operating activities,
and changes in Balance Sheet items help
The business begins the year with an opening determine actual cash movements. Finally, the
Balance Sheet, which includes cash and ending cash balance in the Cash Flow
retained earnings. The opening retained Statement matches the closing cash balance in
earnings become the starting point for the the Balance Sheet.

Table 6.7 Linkage between three statements

Key Item Links To →

Income Balance Sheet
Net Income
Statement (Retained Earnings)
Income Cash Flow (CFO
Net Income
Statement Starting Point)
Income Depreciation/Amortiz Cash Flow (CFO
Statement ation Add-Back)
Income
Interest Expense Balance Sheet (Debt)
Statement
Cash Flow (Beg/End
Balance Sheet Cash & Equivalents
Balance)
Working Capital
Balance Sheet Changes (AR, Cash Flow (CFO)
Inventory, AP)
Balance Sheet PP&E/Fixed Assets Cash Flow (CFI)
Balance Sheet Debt Cash Flow (CFF)
Income Statement
Balance Sheet Retained Earnings
(NI - Div)
Cash Flow
Net Change in Cash Balance Sheet (Cash)
Statement
Cash Flow All Sections Balance Sheet
Statement (CFO/CFI/CFF) Accounts

6.5.1 Example of Interlinkage deducted from the total revenue to arrive at net
In the financial statements above, the total profit in the profit and loss statement. The
depreciation and amortization expenses depreciation and amortization expenses are
amounting to Rs. 2,016.84 crores were deducted from the property, plant and
equipment (Rs. 979.62 crore), right to use asset

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(Rs. 63.20 crore), other intangible assets (Rs. increases both the income statement (as it
974.02 crore) in the balance sheet. The same increases net income) and the balance sheet (as
amount of Rs. 2016.84 crore, being a non-cash it increases cash or receivables). Expenses
expense is added back to the net profit in the decrease net income on the income statement
cash flow statement to arrive at Cash flow from and reduce assets or increase liabilities on the
operating activities. In this manner, the three balance sheet.
statements are always in tandem.

6.6 Impact of Transactions on

Financial Statements
Every business transaction impacts the
financial statements. For example, revenue

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 7 TRIAL BALANCE AND ADJUSTMENT
A trial balance is a statement that shows the in the preparation of final accounts. By using
debit and credit balances of all ledger accounts the trial balance, the accountant can prepare
to verify the arithmetical accuracy of ledger financial statements easily without referring to
postings. It is an important step in the individual ledger accounts. Usually, a trial
accounting process as it presents the final balance is prepared using account balances.
balances of all accounts at one place and helps

Table 7.1: Trial Balance format

Debit Credit
Account Title L.F.
Balance ₹ Balance ₹
Capital ✔
Land and Buildings ✔
Plant and Machinery ✔
Equipment ✔
Furniture and
✔
Fixtures
Cash in Hand ✔
Cash at Bank ✔
Debtors ✔
Bills Receivable ✔
Stock of Raw
✔
Materials
Stock of Finished
✔
Goods
Purchases ✔
Carriage Inwards ✔
Carriage Outwards ✔
Sales ✔
Sales Return ✔
Purchases Return ✔
Interest Paid ✔
Commission/Discount
✔
Received
Salaries ✔
Long Term Loan ✔
Bills Payable ✔
Creditors ✔
Advances from
✔
Customers
Drawings ✔
Total xxx xxx

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7.1 Objective of Trial Balance 7.1.2 To Help in Locating Errors
Trial balance helps identify discrepancies and
7.1.1 To Ascertain the Arithmetical errors in the accounting records.
Accuracy of Ledger Accounts
The primary objective is to verify that total 7.1.3 To Help in the Preparation of the
debits equal total credits. Financial Statements

It serves as the basis for preparing the Income Credit sales recorded in the sales book but not
Statement and Balance Sheet. posted to the customer's account.

7.2 Classification of Errors 7.2.3 Errors of Principle

Accounting errors are broadly classified into the

Errors of principle occur when accounting
following four types:
principles are violated, mainly due to wrong
7.2.1 Errors of Commission classification between capital and revenue items.
These errors affect the correctness of financial
Errors of commission arise due to clerical mistakes statements but do not affect the trial balance.
such as wrong posting of amounts, incorrect
totalling or balancing of accounts, wrong casting of Example: Amount spent on building improvements
subsidiary books, or recording an incorrect amount treated as a repair expense instead of capital
in the books of original entry. expenditure. This leads to incorrect profit and asset
Example: If ₹25,000 paid to a supplier is correctly values.
recorded in the cash book but only ₹2,500 is posted
to the supplier’s ledger account, it is an error of 7.2.4 Compensating Errors
commission. Such errors generally affect the trial
balance. Compensating errors occur when two or more
errors cancel each other’s effect, resulting in no net
7.2.2 Errors of Omission
impact on the debit and credit totals. Hence, the trial
balance still agrees.
Errors of omission occur when a transaction is not
Example: If purchases are overstated by ₹10,000
recorded either fully or partially in the books.
and sales returns are understated by ₹10,000, the
Complete omission: When a transaction is not two errors offset each other and the trial balance
recorded at all. Example: Credit sales of ₹10,000 remains unaffected.
not entered in the sales book.
Partial omission: When the transaction is recorded
but not posted to one of the accounts. Example:

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 8 FINANCIAL RATIOS
Financial ratios are key indicators used to • Liquidity ratios
analyze a company's financial health,
performance, efficiency, and profitability. • Profitability ratios
They provide insights into various aspects of a • Turnover ratios
business, from its ability to meet short term
obligations to its overall profitability and • Solvency ratios
growth potential.
• Market value ratios
Financial ratios are grouped into the following
categories:
Figure 8.1: Financial ratios are grouped into

confidence in meeting short-term obligations.

8.1 Liquidity Ratios Generally, a 2:1 ratio is considered an ideal
benchmark.
Liquidity ratios indicate a company's ability to
meet its short-term obligations by converting Current Ratio = Current Assets / Current
assets into cash or by generating cash from its Liabilities
operations. A higher liquidity position reflects
better financial stability in the short run. 8.1.2 Quick Ratio (Acid-Test Ratio)
The important liquidity ratios are explained The quick ratio evaluates a company's ability to
below: pay short-term liabilities using quick assets,
making it a stricter measure of liquidity than the
8.1.1 Current Ratio current ratio. It includes only those assets that
can be quickly converted into cash. Inventories
The current ratio measures a firm's capacity to
are excluded due to lower liquidity, and prepaid
settle its short-term liabilities using current
expenses are excluded as they do not result in
assets. A higher current ratio indicates a
cash inflow. Normally, it is advocated to be
stronger liquidity position and greater

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safe to have a ratio of 1:1 as unnecessarily low costs, reflecting the efficiency of production
ratio will be very risky and a high ratio suggests and pricing.
unnecessarily deployment of resources in
otherwise less profitable short-term Gross Margin Ratio = Gross Profit / Net
investments. Sales × 100

Quick Ratio = (Current Assets – Inventories 8.2.2 Operating Margin Ratio

– Prepaid Expenses) / Current Liabilities
The operating margin ratio measures the
8.1.3 Cash Ratio relationship between operating income and net
sales, showing how efficiently a company
The cash ratio measures a company's ability to manages its core business operations.
meet its short-term liabilities using only cash Operating income is often referred to as
and cash equivalents. It is the most Earnings Before Interest and Taxes (EBIT). A
conservative liquidity measure, highlighting higher operating margin suggests better
that cash is ultimately required to settle operational stability and cost control.
immediate obligations.
Operating Margin Ratio = Operating
Cash Ratio = (Cash and Cash Equivalents + Income / Net Sales × 100
Marketable Securities) / Current Liabilities
8.2.3 Return on Assets (ROA)
8.1.4 Operating Cash Flow Ratio
The return on assets ratio evaluates how
It assesses how well current liabilities are effectively a company uses its total assets to
covered by cash flow from operating activities. generate profits. It shows how efficiently the
It indicates the ability to pay off short-term debt investment in assets is converted into net
from core business operations. income, indicating asset utilization efficiency.
Operating Cash Flow Ratio = Operating Return on Assets Ratio = Net Income / Total
Cash Flow / Current Liabilities Assets
Or
8.2 Profitability Ratios
Return on Assets Ratio = PBIT (1 - Tax
Profitability ratios assess a company's ability Rate) / Average Total Assets
to generate profits in relation to its revenue,
assets, operating costs, and shareholders' 8.2.4 Return on Equity (ROE)
equity. These ratios help in
The return on equity ratio measures how
efficiently a company uses shareholders' equity
to generate profits. It indicates the amount of
evaluating the earning capacity and overall
profit earned for every unit of equity invested
financial performance of a business.
by the owners.
Some commonly used profitability ratios are
Return on Equity Ratio = Net Income /
explained below:
Shareholders' Equity
8.2.1 Gross Margin Ratio
8.2.5 Net Profit Margin
The gross margin ratio compares a company's
Reveals the percentage of revenue that remains
gross profit with its net sales to determine how
as net income after all expenses.
much profit remains after covering the cost of
goods sold. It indicates the percentage of sales Net Profit Margin = Net Income / Revenue ×
revenue left after paying all direct production 100

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8.2.6 Return on Capital Employed Days Accounts Receivable = 365 /
(ROCE) Receivables Turnover Ratio

Assesses the efficiency and profitability of a 8.3.3 Accounts Payable Turnover Ratio
company's capital investments. A higher
The accounts payable turnover ratio indicates
ROCE suggests better utilization of capital.
how efficiently a company pays its suppliers. A
ROCE = PBIT (1 - Tax Rate) / Average lower ratio suggests that the firm takes more
Capital Employed time to settle its payables, thereby retaining
cash for a longer period.
Or
Payables Turnover Ratio = Net Credit
ROCE = Profit After Tax (PAT) + After Tax Purchases / Average Accounts Payable
Interest / Average (Capital + Long term
debt) Days Accounts Payable = 365 / Payables
Turnover Ratio
8.3 Turnover (Activity) Ratios 8.3.4 Asset Turnover Ratio
Turnover ratios, also known as activity ratios, The asset turnover ratio measures a company's
measure how efficiently a firm utilizes its ability to generate sales from its assets. It shows
resources and assets in day-to-day operations. how efficiently assets are used to produce
These ratios indicate the speed with which revenue. A higher ratio reflects better
assets are converted into sales or cash and help utilization of assets.
assess operational efficiency.
Asset Turnover Ratio = Net Sales / Average
The important turnover/activity ratios are Total Assets
explained below:
8.3.5 Cash Conversion Cycle (CCC)
8.3.1 Inventory Turnover Ratio
The cash conversion cycle measures the time
The inventory turnover ratio shows how many taken by a company to convert its investment in
times a company's inventory is sold and inventory and other resources into cash. It
replaced during a given period. A higher ratio shows how long cash remains tied up in
indicates efficient inventory management and operations before it is recovered from
strong sales performance. customers. A shorter cycle indicates better
Inventory Turnover Ratio = Cost of Goods liquidity management.
Sold / Average Inventory Cash Conversion Cycle = Days Sales in
Days Sales in Inventory = 365 / Inventory Inventory + Days Accounts Receivable −
Turnover Ratio Days Accounts Payable

8.3.2 Accounts Receivable Turnover 8.4 Solvency Ratios

Ratio
Solvency ratios measure a company's long-
This ratio measures how effectively a business term financial stability and its ability to meet
collects cash from its customers. A higher ratio long-term debt obligations. These ratios focus
implies faster collection of receivables. Net on the firm's capital structure, degree of
credit sales are considered since only credit leverage, and its capacity to service debt from
sales create receivables. earnings. A strong solvency position indicates
that the company is financially sound and
Receivables Turnover Ratio = Net Credit capable of sustaining operations in the long run.
Sales / Average Accounts Receivable

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The key solvency ratios are explained below: 8.4.5 Debt Service Coverage Ratio
(DSCR)
8.4.1 Debt Ratio
The debt service coverage ratio measures a
This ratio measures the proportion of a
company's ability to repay total debt
company's assets that are financed through
obligations, including principal repayments,
debt. It includes both current and long-term
interest payments, and lease payments. A
liabilities. A higher ratio indicates greater
higher DSCR indicates better debt repayment
financial risk due to higher reliance on
capacity and lower default risk.
borrowed funds.
Debt Service Coverage Ratio = Operating
Debt Ratio = Total Liabilities / Total Assets
Income / Total Debt Service
8.4.2 Debt to Equity Ratio
8.4.6 Fixed Charge Coverage Ratio
The debt-to-equity ratio compares a company's
It measures a company's ability to meet its fixed
total liabilities with shareholders' equity. It
financial obligations, such as interest, lease
indicates the extent to which the business is
rentals, and preference dividends, from its
financed by creditors versus owners. A higher
operating earnings. It indicates the margin of
ratio implies higher leverage and increased
safety available to cover these fixed charges; a
financial risk.
higher ratio reflects a
Debt to Equity Ratio = Total Liabilities /
stronger capacity to meet fixed commitments
Shareholders' Equity
and lower financial risk.
8.4.3 Capital Gearing Ratio Fixed Charge Coverage Ratio = (EBIT +
It shows the proportion of fixed-interest Fixed Charges) / Fixed Charges
bearing funds (such as debentures, long-term
loans, and preference share capital) used in a 8.5 Market Value Ratios
company's capital structure compared to
shareholders' funds. It helps assess the level of Market value ratios are used to assess a
financial risk in the business, as a higher ratio company's share price in relation to its financial
indicates greater reliance on debt and higher performance and shareholders' returns. These
fixed interest obligations, while a lower ratio ratios help investors evaluate whether a stock is
reflects a stronger equity base and lower risk. fairly valued in the market.

Capital Gearing Ratio = Fixed Interest Commonly used market value ratios are
Bearing Funds / Shareholders' Funds explained below:

8.4.4 Interest Coverage Ratio 8.5.1 Book Value per Share Ratio

The interest coverage ratio shows how The book value per share ratio calculates the
comfortably a company can pay interest on its value of equity available to common
outstanding debt using its operating earnings. A shareholders on a per-share basis. It represents
higher ratio reflects a stronger ability to meet the minimum value of a company's equity if the
interest obligations. If the ratio is less than 1, it business were liquidated and reflects the firm's
means earnings before interest and tax (EBIT) book value per share.
are insufficient to cover interest expenses, Book Value per Share = (Shareholders'
forcing the firm to seek alternative sources of Equity − Preferred Equity) / Total Common
funds. Shares Outstanding
Interest Coverage Ratio = EBIT / Interest
Expenses

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8.5.2 Dividend Yield Ratio portion of a company's net income that belongs
to each shareholder if profits were distributed.
The dividend yield ratio measures the cash
return received by shareholders in the form of Earnings per Share = (Net Income −
dividends relative to the market price of the Preferred Dividends) / Total Shares
share. It indicates how much income an Outstanding
investor earns from dividends on their
investment. 8.5.4 Price–Earnings (P/E) Ratio

Dividend Yield = Dividend per Share / The price–earnings ratio compares the market
Market Price per Share price of a share with its earnings per share. It
reflects how much investors are willing to pay
8.5.3 Earnings per Share (EPS) for one unit of earnings based on current
performance and future expectations.
Earnings per share measures the profit earned
for each outstanding equity share. It shows the Price–Earnings Ratio = Market Price per
Share / Earnings per Share

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 9 ADVANCED FINANCIAL ANALYSIS
Dupont Analysis ROE. While you can calculate ROE given the
The return on common equity is often more components of either the original or extended
thoroughly analyzed using the DuPont DuPont equations, this isn't necessary if you
Decomposition. The DuPont analysis is an have the financial statements. If you have net
approach that can be used to analyze return on income and equity, you can calculate ROE. The
equity (ROE). It uses basic algebra to break DuPont method is a way to decompose ROE, to
down ROE into a function of different ratios, so better see what is driving the changes in ROE.
an analyst can see the impact of leverage, profit 9.1.1 Extended DuPont Analysis
margins, and turnover on shareholder returns.
The extended (5-way) DuPont equation takes
There are two variants of the DuPont system:
the net profit margin and breaks it down
the original three-part approach and the
further:
extended five-part system.
ROE = (Net Income / EBT) × (EBT / EBIT)
For the original approach, start with ROE
× (EBIT / Revenue) × (Revenue / Average
defined as:
Total Assets) × (Average Total Assets /
Return on Equity (ROE) = Net Income / Average Equity)
Average Equity
The first term in the three-part DuPont
Average or year-end values for equity can be equation, net profit margin, has been
used. Multiplying ROE by (average total assets decomposed into three terms:
/ average total assets) and rearranging terms
• (EBT / EBIT) is called the interest burden
produces the following:
• (EBIT / Revenue) is called the EBIT margin
ROE = (Net Income / Average Total Assets)
• (EBT / EBIT) is called the interest burden
× (Average Total Assets / Average Equity)
• (EBIT / Revenue) is called the EBIT margin
The first term becomes net profit margin, the
We then have the following:
second term is now total asset turnover, and the
third term is a financial leverage ratio that will ROE = (Tax Burden) × (Interest Burden) ×
increase as the use of debt financing increases. (EBIT Margin) × (Total Asset Turnover) ×
The leverage ratio is sometimes called the (Financial Leverage)
equity multiplier.
An increase in interest expense as a proportion
of EBIT will decrease the interest burden ratio.
Increases in either the tax burden or the interest
ROE = Net Profit Margin × Total Asset
burden (i.e., decreases in the ratios) will tend to
Turnover × Financial Leverage
decrease ROE. Note that in general, high profit
This is the original DuPont equation. It is margins, leverage, and asset turnover will lead
arguably the most important equation in ratio to high levels of ROE. However, this version of
analysis because it breaks down a very the formula shows that more leverage does not
important ratio (ROE) into three key always lead to higher ROE. As leverage rises,
components. If ROE is relatively low, it must so does the interest burden. Hence, the positive
be that at least one of the following is true: the effects of leverage can be offset by the higher
company has a poor profit margin, the company interest payments that accompany more debt.
has poor asset turnover, or the firm has too little High taxes will always lead to lower levels of
leverage. Often, candidates get confused and ROE.
think the DuPont method is a way to calculate

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DuPont analysis breaks out the different drivers for that period. The analysis helps to
of return on equity (ROE), allowing company understand the impact of each item in the
managers and investors to focus on them financial statements and its contribution to the
individually to identify strengths and resulting figure. Common size financial
weaknesses. There are three major financial statements make it easier to determine what
metrics that drive ROE: profitability or drives a company's profits and to compare the
operational efficiency, asset use efficiency, and company to similar businesses.
financial leverage.
This type of financial statement allows for easy
analysis between companies, or between
9.2 Common Size Statements periods, for the same company. However, if the
Common size analysis is a tool that financial companies use different accounting methods,
managers use to analyze financial statements. It any comparison may not be accurate. Below is
evaluates financial statements by expressing an example using data from the Balance Sheet
each line item as a percentage of a base amount above.

Table 9.1: Common Size Statement

PARTICULARS AMOUNT (Rs.) PERCENTAGE

I. ASSETS
1. NON-CURRENT ASSETS
a) Property, Plant and Equipment 11,563.76 17.50%
b) Capital work-in-progress 645.03 0.98%
c) Right of use assets 426.50 0.65%
d) Other Intangible Assets 2,353.79 3.56%
e) Intangible Assets under development 588.92 0.89%
f) Financial Assets 32,247.80 48.80%
g) Deferred Tax Assets (net) 1,558.65 2.36%
h) Non-current Tax Assets (net) 1,008.32 1.53%
i) Other non-current assets 483.30 0.73%
Total Non-current Assets 50,876.07 76.99%
2. CURRENT ASSETS
a) Inventories 3,470.38 5.25%
b) Financial Assets 10,589.31 16.02%
c) Current Tax Assets (net) 12.00 0.02%
d) Other Current Assets 1,099.37 1.66%
Total Current Assets 15,171.06 22.96%
3. Assets classified as held-for-sale 36.61 0.06%
TOTAL ASSETS 66,083.74 100.00%

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 Analysts, investors, and business managers use
9.3 Comparative Statements a company's income statement, balance sheet,
and cash flow statement for comparative
A comparative statement is a document used to
purposes. They want to see how much is spent
compare a particular financial statement with
chasing revenues from one period to the next
prior period statements. Previous financials are
and how items on the balance sheet and the
presented alongside the latest figures in side-
movements of cash vary over tim
by-side columns, enabling investors to identify
trends, track a company's progress and compare
it with industry rivals.

Table 9.2: Comparative Statement

PARTICULARS YEAR ENDED YEAR ENDED PERCENTAGE

MARCH 31, MARCH 31, 2023 CHANGE
2024
Revenue from Operations
a) Revenue 72,745.92 65,298.84 11%
b) Other Operating Revenue 557.16 458.49 22%
Total Revenue from Operations 73,303.08 65,757.33 11%
Other Income 1,149.88 820.94 40%
Total Income 74,452.92 66,578.27 12%
Expenses
a) Cost of material consumed 45,025.05 42,226.81 7%
b) Purchases of products for sale 7,764.19 6,561.32 18%
c) Changes in inventories of (600.44) 484.69 (224%)
finished goods, work-in-progress
and products of sale
d) Employee benefit Expenses 4,308.15 4,021.63 7%
e) Finance Costs 1,705.74 2,047.51 (17%)
f) Foreign exchange loss (net) 254.98 279.76 (9%)
g) Depreciation and amortisation 2,016.84 1,766.84 14%
expense
h) Product development/ 1,104.79 899.06 23%
engineering expenses
i) Other expenses 8,960.98 7,819.74 15%
j) Amount transferred to capital (1,129.73) (1,066.73) 6%
and other account
Total Expenses 69,410.55 65,040.65 7%
Profit before exceptional items 5,042.41 1,537.62 228%
and tax
Exceptional Items (2,808.41) 282.82 (1093%)
Profit before Tax 7,850.82 1,254.80 526%
Total Tax Credit (net) (51.26) (1,473.33) (97%)
Profit for the year 7,902.08 2,728.13 190%

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 10 CASH CYCLE & CREDI MANAGEMENT

The Cash Conversion Cycle (CCC) measures lower DSO indicates faster collection and
the time taken by a business to convert its strong credit control, improving the company's
investment in inventory and other resources liquidity. A higher DSO reflects delayed
into cash from sales. It is an important indicator collections and weak credit management.
of a company's operational efficiency and
working capital management. By tracking CCC Third Stage: Payables Stage (Days Payable
over time, a company can assess whether its Outstanding – DPO)
efficiency is improving or deteriorating. This stage shows how long a business takes to
10.1.1 Stages of the Cash Conversion pay its suppliers. A higher DPO means the
company retains cash for a longer period,
Cycle which can be used for operations or
The cash conversion cycle moves through three investments. However, excessive delay may
logical stages, each measured in days. harm supplier relationships.
Together, these stages explain how cash flows Formula:
through the business from inventory purchase
to final cash collection. Cash Conversion Cycle (CCC) = DIO + DSO
– DPO
First Stage: Inventory Stage (Days
Inventory Outstanding – DIO) Formula for Cash Operating Cycle (COC):
This stage measures how long a business takes Cash Operating Cycle = Inventory Days +
to convert inventory into sales. It shows the Receivable Days – Payable Days
efficiency of inventory management. A lower
DIO indicates faster inventory turnover and
efficient sales performance, while a higher DIO
suggests slow-moving stock and blocked funds.
Second Stage: Receivables Stage (Days Sales
Outstanding – DSO)
This stage measures the time taken to collect
cash from customers after sales are made. A

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35
10.1.2 Why Cash Cycle Matters • Lower profitability: Bad debts and financing
costs reduce overall profits.
• Shows how quickly a business converts • Loss of goodwill: Delays and defaults can
investment into cash harm the company's credibility in the market.
• Indicates operational efficiency and liquidity • Lower profitability: Bad debts and financing
position costs reduce overall profits.
• Loss of goodwill: Delays and defaults can
• Improves cash flow and profitability
harm the company's credibility in the market.
• Supports better inventory and credit decisions
• Improves cash flow and profitability 10.2.2 Process of Providing Credit to
• Supports better inventory and credit decisions Customers

10.1.3 What Increase / Decrease Means Providing credit to customers is a structured

process aimed at increasing sales while
minimizing the risk of non-payment. Each step
helps the firm assess risk, control receivables,
Increase Decrease and ensure timely cash inflows.
Component
Means Means
1. Credit Application by Customer: The
Inventory is customer applies for credit by sharing
moving Inventory is details such as business background,
DIO (Days
slowly; more sold faster; financial information, bank references,
Inventory
cash is better sales and previous credit history. This helps
Outstanding)
blocked in efficiency
the firm understand the customer's
stock
profile.
Faster cash 2. Credit Decision: Based on the
Customers
DSO (Days collection;
take longer evaluation, management decides
Sales strong
Outstanding)
to pay; weak
receivables
whether to grant credit or reject the
credit control request to avoid potential bad debts.
management
3. Fixing Credit Terms: If credit is
Payments to approved, the firm decides the credit
Suppliers are
DPO (Days suppliers are limit, credit period, and any cash
paid faster;
Payable delayed; cash discounts. Clear terms help avoid future
quicker cash
Outstanding) retained
outflow disputes.
longer
4. Grant of Credit and Sale: Goods or
services are supplied to the customer on
10.2 Credit Management the agreed credit terms, and the
transaction is recorded as accounts
10.2.1 Risks of Poor Credit Management
receivable.
• Cash flow problems: Slow collection of 5. Monitoring Receivables: The firm
receivables leads to shortage of cash for daily regularly tracks outstanding amounts
operations. using ageing schedules to identify
overdue accounts and potential risks.
• Increase in bad debts: Weak credit control 6. Collection of Dues: Payments are
increases the risk of non-recovery from collected as per agreed terms. Follow-
customers. ups, reminders, or stricter actions are
• Blocking of working capital: Excess funds get taken in case of delays to reduce bad
locked in receivables, reducing business debts.
flexibility.

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10.2.3 How Management Can Improve 10.2.4 Link Between Cash Cycle and
the Cash Cycle Credit Management
• Reduce excess inventory Credit management plays a crucial role in
controlling the cash cycle. Liberal credit
• Speed up customer collections policies increase receivables and lengthen
• Strengthen credit policy DSO, while efficient credit evaluation and
timely collection shorten the cash cycle.
• Negotiate longer supplier credit Effective credit management improves
• Automate invoicing and payments liquidity and reduces the need for external
financing.
• Negotiate longer supplier credit
• Automate invoicing and payments

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 11 DEPRECIATION

Depreciation refers to the permanent, gradual 11.1.2 Need for Depreciation

reduction in the book value of a fixed asset due
to its usage, passage of time, or wear and tear. 1. Matching of Costs and Revenue:
It is calculated based on the cost of the asset Fixed assets are used to generate
consumed in business operations, not on its revenue over many years. As these
market value. assets are consumed through use, their
cost should be charged as an expense in
Examples of depreciable assets are machines, the periods in which revenue is earned.
plants, furniture, buildings, computers, trucks, Depreciation ensures proper matching
vans, equipment, etc. Moreover, depreciation is of costs with revenue, in line with
the allocation of 'depreciable amount', which is Generally Accepted Accounting
the "historical cost", or other amount Principles (GAAP).
substituted for historical cost less estimated 2. True and Fair Financial Position: If
salvage value. depreciation is not charged, fixed assets
Depreciation = Cost of Asset - Estimated Net will be shown at inflated values in the
Residual Value / Estimated Useful Life of the balance sheet. Providing depreciation
Asset ensures that assets are reported at
realistic values and the financial
Rate of Depreciation = Annual Depreciation statements present a true and fair view
Amount / Acquisition Cost × 100 of the business.
3. Compliance with Law: Various laws
11.1.1 Features of Depreciation and regulations require certain business
3. Reduction in book value of fixed entities, especially companies, to
assets: Depreciation represents a charge depreciation on fixed assets.
decrease in the book value of fixed Hence, depreciation is necessary to
assets over time. comply with statutory and legal
4. A continuous process: Depreciation is requirements.
charged every year throughout the
useful life of the asset.
5. An expired cost deducted before tax: 11.2 Types of Depreciation
Depreciation is treated as an expense
and is deducted from profits to 11.2.1 Straight Line Method (SLM)
determine taxable income. Example: If Depreciation is charged equally every year over
profit before depreciation is ₹50,000 the useful life of an asset. This method assumes
and depreciation is ₹10,000, profit that the asset is used uniformly throughout its
before tax will be ₹40,000. life, so the same amount of cost is allocated to
6. A non-cash expense: Depreciation each accounting period. It is simple, easy to
does not involve any cash outflow. It apply, and widely used for assets that provide
represents the systematic write-off of consistent benefits.
the cost of an asset already paid for.
7. A non-cash expense: Depreciation Example: A machine is purchased for
does not involve any cash outflow. It ₹2,50,000 with a residual value of ₹50,000 and
represents the systematic write-off of a useful life of 10 years. Annual depreciation =
the cost of an asset already paid for. (2,50,000 − 50,000) ÷ 10 = ₹20,000 per year,
charged every year.

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11.2.2 Written Down Value Method of an asset's life and lower depreciation in later
(WDV) years. This method assumes that an asset
provides more benefits when it is new and
Depreciation is charged on the book value of gradually becomes less productive over time.
the asset at the beginning of each year. Since
the book value reduces annually, the Depreciation = Remaining Life / Sum of
depreciation amount also decreases year after Years Digits × (Cost – Scrap Value)
year. This method is suitable for assets that lose Sum of years' digits = 5 + 4 + 3 + 2 + 1 = 15
efficiency with age or become obsolete Depreciable amount = 1,50,000 − 30,000 =
quickly. ₹1,20,000
Example: A machine costing ₹2,00,000 is Sum of years' digits = 5 + 4 + 3 + 2 + 1 = 15
depreciated at 10% per year. In Year 1, Depreciable amount = 1,50,000 − 30,000 =
depreciation is ₹20,000 (10% of 2,00,000), ₹1,20,000
leaving a book value of ₹1,80,000. In Year 2,
depreciation is ₹18,000 (10% of 1,80,000), and Year 2 depreciation = (4/15) × 1,20,000 =
so on, with depreciation reducing each year. ₹32,000
Year 3 depreciation = (3/15) × 1,20,000 =
11.2.3 Sum of the Years' Digits Method ₹24,000
(SYD)
Year 2 depreciation = (4/15) × 1,20,000 =
The Sum of the Years' Digits Method is an ₹32,000
accelerated depreciation method in which Year 3 depreciation = (3/15) × 1,20,000 =
higher depreciation is charged in the early years ₹24,000
11.2.4 Difference Between Straight Line and Written Down Value Methods
Table 11.1: Difference Between Straight Line and Written Down Value Methods

Basis Straight Line Method Written Down Value Method

Depreciation base Original cost Book value

Annual charge Fixed every year Reduces every year
Effect on P&L (with Uneven over time Almost uniform
repairs)
Income tax acceptance Generally not accepted Accepted
Suitability Assets with low repairs & Assets with high repairs & fast
obsolescence obsolescence

Amortization applies to intangible assets Depletion applies to natural resources like

such as patents, copyrights, trademarks, and coal, oil, gas, minerals, and forests. It
goodwill (where applicable). It spreads the allocates the cost of extracting natural
cost of an intangible asset over its estimated resources based on the quantity used or
useful life, reflecting the gradual extracted during a period. Depletion
consumption of its economic benefits. The recognizes the physical reduction of the
amortization amount is charged as an resource and is recorded as an expense,
expense in the Income Statement and while the asset value on the Balance Sheet
reduces the carrying value of the intangible decreases accordingly.
asset in the Balance Sheet.

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 12 INVENTORY VALUATION
12.1 Inventory Valuation Methods
12.1.1 FIFO (First In, First Out) 12.1.3 Weighted Average Cost Method

FIFO assumes that the goods purchased first Under this method, the average cost per unit is
are sold first. The cost of the oldest inventory is calculated by dividing total cost by total
charged to the cost of goods sold, while the quantity available. All issues and closing stock
latest purchases remain in closing stock. This are valued at this average price. This method
method closely matches the actual flow of smooths price fluctuations.
goods in many businesses.
Example: A company has 10 units at ₹100 and
Example: A shop buys 10 units at ₹100 and 10 units at ₹120. Total cost = ₹2,200. Average
later 10 units at ₹120. If it sells 10 units, the cost per unit = ₹110. If 10 units are sold, cost
cost of sales will be ₹1,000 (10 × 100), and the of sales = ₹1,100, and remaining stock is also
closing stock will be valued at ₹120 per unit. valued at ₹110 per unit.

12.1.2 LIFO (Last In, First Out) 12.1.4 Average Profit Method (Stock
Valuation)
LIFO assumes that the latest goods purchased
are sold first. The cost of recent purchases is The Average Profit Method is used when the
charged to the cost of goods sold, while older cost of goods is not known, such as in fire loss
inventory remains in stock. This method shows claims. Stock is valued using the average gross
lower profit during rising prices. profit rate of past years.
Example: A firm buys 10 units at ₹100 and Example: If average gross profit is 25% on
later 10 units at ₹120. If it sells 10 units, the sales and sales are ₹4,00,000, then cost of
cost of sales will be ₹1,200 (10 × 120), and the goods sold = 75% of sales = ₹3,00,000. This
closing stock will be valued at ₹100 per unit. rate is used to estimate closing stock.

12.2 Comparison of FIFO and LIFO

Particulars FIFO (First In, First Out) LIFO (Last In, First Out)
Material Assumes that materials purchased first Assumes that the most recently purchased
flow are issued or sold first, which generally materials are issued or sold first, which is
matches the physical flow in most less common in actual practice
businesses
Effect during Older, cheaper inventory is issued first, Recent, costlier inventory is issued first,
inflation resulting in lower cost of goods sold, resulting in higher cost of goods sold, lower
higher profits, and higher tax liability profits, and lower tax liability
Financial Permitted under both GAAP and IFRS Not permitted under IFRS; allowed under US
reporting GAAP, but must be used consistently across
the entity
Record Fewer inventory layers as older stock is More inventory layers may remain for long
keeping regularly consumed, making record periods, making record keeping complex
keeping simpler
Profit Cost of goods sold is more stable as it Cost of goods sold may fluctuate sharply if
fluctuations reflects recent prices old inventory layers are issued

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 13 GOODWILL

Goodwill is an intangible asset that represents multiplied by its respective weight, and the
the value of a business's reputation, brand total is divided by the sum of weights to obtain
name, customer loyalty, skilled employees, and the weighted average profit. The goodwill is
good management. It arises when a business then calculated by multiplying this weighted
earns higher profits than normal or when one average profit by the agreed number of years'
business is purchased for a price more than the purchase.
fair value of its net assets. Goodwill cannot be
seen or touched, but it helps the business Formula: Goodwill = Weighted Average
generate future profits. Profit × Number of Years' Purchase

Example: A company purchases another 13.2.3 Super Profit Method

business for ₹10,00,000. The fair value of its
Under the super profit method, goodwill is
assets is ₹8,00,000 and liabilities are ₹1,00,000.
valued on the basis of excess profits earned
Goodwill = Purchase price − Net assets over normal profits. Normal profit is calculated
Goodwill = 10,00,000 − 7,00,000 = ₹3,00,000 by applying the normal rate of return to the
capital employed. The difference between
Goodwill = Purchase price − Net assets future maintainable profit and normal profit is
Goodwill = 10,00,000 − 7,00,000 = ₹3,00,000 known as super profit. Goodwill is calculated
by multiplying super profit by the agreed
This extra ₹3,00,000 is paid for the business's
number of years' purchase.
reputation and earning capacity.
Steps involved to calculate Goodwill:
13.2 Methods to Calculate
• Compute capital employed
Goodwill
• Calculate normal profit
13.2.1 Average Profit Method
• Find super profit
Under this method, goodwill is valued on the • Multiply super profit by years' purchase
basis of the average profits earned in the past
few years. While calculating the average profit,
abnormal profits or abnormal losses are
excluded to arrive at a fair estimate of future • Find super profit
earnings. The average profit is then multiplied • Multiply super profit by years' purchase
by an agreed number of years' purchase, usually Formula: Goodwill = Super Profit ×
ranging between three to five years, depending Number of Years' Purchase
on the nature of business and industry
conditions. 13.2.4 Annuity Method
Formula: Goodwill = Average Profit × The annuity method is a refined form of the
Number of Years' Purchase super profit method that considers the time
value of money. Under this method, expected
13.2.2 Weighted Average Profit Method super profits are discounted to their present
This method is an improved version of the value using an appropriate annuity factor.
average profit method, where higher When super profits are expected to be equal
importance is given to recent profits by every year, an annuity factor is applied to
assigning weights. Each year's profit is calculate goodwill.

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Formula: Goodwill = Super Profit × Annuity 13.2.6 Capitalization of Super Profits
Factor Method
13.2.5 Capitalization of Future Under this method, goodwill is valued by
Maintainable Profits Method capitalizing super profits at the normal rate of
return. It directly reflects the extra earning
In this method, the value of the business is capacity of the business. The goodwill is
determined by capitalizing future maintainable calculated by dividing super profit by the
profits at the normal rate of return. Goodwill is normal rate of return and converting it into
calculated as the excess of the capitalized value capital value.
of profits over the capital employed in the
business. Formula: Goodwill = (Super Profit ÷
Normal Rate of Return) × 100
Formula: Goodwill = Capitalized Value of
Profits − Capital Employed

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 14 OTHER CONCEPTS

Formula Sheet

14.1 Liquidity Ratios

Current Ratio = Current Assets / Current Liabilities.
Quick Ratio = (Current Assets – Inventories – Prepaid Expenses) / Current Liabilities.
Cash Ratio = (Cash and Cash Equivalents + Marketable Securities) / Current Liabilities.
Operating Cash Flow Ratio = Operating Cash Flow / Current Liabilities.

14.2 Profitability Ratios

Gross Margin Ratio = Gross Profit / Net Sales × 100.
Operating Margin Ratio = Operating Income / Net Sales × 100.
Return on Assets (ROA) = Net Income / Total Assets Or PBIT (1 - Tax Rate) / Average Total
Assets.
Return on Equity (ROE) = Net Income / Shareholders' Equity.
Net Profit Margin = Net Income / Revenue × 100.
Return on Capital Employed (ROCE) = PBIT (1 - Tax Rate) / Average Capital Employed
Or
Profit After Tax (PAT) + After Tax Interest / Average (Capital + Long term debt).
14.3 Turnover Ratios
Inventory Turnover Ratio = Cost of Goods Sold / Average Inventory; Days Sales in Inventory =
365 / Inventory Turnover Ratio.
Accounts Receivable Turnover Ratio = Net Credit Sales / Average Accounts Receivable; Days
Accounts Receivable = 365 / Receivables Turnover Ratio.
Accounts Payable Turnover Ratio = Net Credit Purchases / Average Accounts Payable; Days
Accounts Payable = 365 / Payables Turnover Ratio.
Asset Turnover Ratio = Net Sales / Average Total Assets.
Cash Conversion Cycle (CCC) = Days Sales in Inventory + Days Accounts Receivable − Days
Accounts Payable.

14.4 Solvency Ratios

Debt Ratio = Total Liabilities / Total Assets.

Debt to Equity Ratio = Total Liabilities / Shareholders' Equity.
Capital Gearing Ratio = Fixed Interest Bearing Funds / Shareholders' Funds.
Interest Coverage Ratio = EBIT / Interest Expenses.
Debt Service Coverage Ratio (DSCR) = Operating Income / Total Debt Service.
Fixed Charge Coverage Ratio = (EBIT + Fixed Charges) / Fixed Charges.
14.5 Market Value Ratios

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Book Value per Share = (Shareholders' Equity − Preferred Equity) / Total Common Shares
Outstanding.
Dividend Yield = Dividend per Share / Market Price per Share.
Earnings per Share (EPS) = (Net Income − Preferred Dividends) / Total Shares Outstanding.
Price–Earnings (P/E) Ratio = Market Price per Share / Earnings per Share

14.6 Accounting Loss Example: If a company owns a building that is

partially destroyed by a natural disaster such as
Occurs when expenses exceed revenues in each an earthquake, the cost to repair the damage or
period, indicating that the business has not the reduction in the building's useful life would
generated enough income to cover its costs result in an extraordinary loss. This loss would
require an adjustment to the asset's depreciation
Example: A company incurs $200,000 in costs schedule, accelerating depreciation expense or
but only generates $150,000 in revenue, recognizing an immediate loss to reflect the
resulting in a $50,000 accounting loss. asset's decreased value.

14.7 Gross Block Concept 14.9 Extraordinary Gain in

Represents the total amount invested in fixed Depreciation
assets before depreciation, showing the
historical cost of acquiring these assets. Conversely, an extraordinary gain in the
context of depreciation would involve
Example: If a company has purchased situations where an asset's value or useful life
machinery for $100,000 and buildings for unexpectedly increases due to rare events.
$400,000, the gross block value is $500,000 While less common, these situations can lead to
before accounting for depreciation. adjusting depreciation expenses downwards.

14.8 Extraordinary Loss in Example: Suppose a company's specialized

machinery was expected to become obsolete
Depreciation due to technological advancements, and its
depreciation was accelerated accordingly. If a
An extraordinary loss in depreciation occurs sudden market demand for the product made
when an asset suddenly loses value beyond its with this machinery extends its useful life, the
standard depreciation due to unforeseen events. company might adjust its depreciation schedule
These are not regular market or operational to reflect the lower annual depreciation
factors but significant incidents that drastically expense, resulting in an extraordinary gain.
reduce the asset's useful life or value.

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 15 INTERVIEW QUESTIONS

15.1 Financial Accounting & Financial Statement Analysis (FRA)

1. Profit is constant but tax is increasing. What could be the reasons?
2. Broadly, what is measured by the P/L and Balance Sheet?
3. What is the relation between balance sheet and P&L?
4. Relation between cash flow and P&L.
5. How do you construct a P&L account? Why is a P&L constructed in this way?
6. If I give you only the top few lines of the P&L statement, up to the operating profit, what can
you infer about how the company is doing? (with no other info available)
7. 2 Companies in garments business. One has better gross margin, other has better net profit.
What could be the reasons?

15.2 Balance Sheet Concepts

1. How is Balance Sheet Depreciation different from Depreciation in the P&L? Is Depreciation
part of the Cash Flow Statement?
2. How should a Bank provide for a loss?
3. What is the impact of goodwill on balance sheet?
4. One important number from balance sheet, profit and loss and CFS each
15.3 Cash Flow Statement
1. How do you analyse cash flow statement of a company?
2. One company expenses, other company capitalises. What will be the effect on CFO and
FCFF?
15.4 Depreciation & Accounting Treatment
1. What is depreciation? Why do you depreciate assets? Why do we depreciate fixed assets and
not current assets? Where does depreciation appear in financial statements?
15.5 Inventory & Working Capital
1. How to value inventory in Indian GAAP?
2. What is working capital management? What is cash conversion cycle of a company?

15.6 Ratios, Performance & Comparative Analysis

1. What are solvency ratios. How can a bank use solvency ratios to decide whether to grant loan
to a borrower?
2. Which ratios are used to analyse which industries? If 2 companies are given, one is levered
and other is unlevered then which will have high ROE?
3. ROA is same for two companies, what could be the reasons behind difference ROE?
4. ROA ROE ROI; Which one is better?

15.7 Leverage, Cost Structure & Profitability

1. What is operating leverage? What will be operating leverage for a high growth economy?

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 2. What is a DuPont Analysis? How can it be used to analyse financial performance of a
company

15.8 Banking, Credit & Lending Perspective

1. How will you evaluate a borrower from a lender's perspective?
2. What is Contingent Liability?
3. When does a bank go bankrupt?
4. How should you evaluate a company before giving it a loan?
5. An online medical company wants a loan - discuss whether you would give them a loan or
not
6. What are the factors you would look at when analysing a bank's financial statement?

15.9 Leases & Asset Treatment

1. What is the difference between financial lease and operating lease?

15.10 Financial Statements – Interlinkages

1. How will loan, depreciation, asset purchase affect the financial statements?

15.11 Core Finance Theory & Valuation

1. Why Finance?
2. What is the difference between Finance and Accounting?
3. What are the different branches of Finance?
4. What is the difference between NPV & IRR? Which is better & why?
5. What is: (i) WACC, (ii) Beta, (iii) CAPM Model
6. What is the Discounted cash flow model? Can you explain the same briefly?
7. How would you value a bond?
8. How can we measure risk?
9. Explain what a yield curve is. What do you mean by an inverted yield curve?
10. Can you explain a few multiples used in relative valuation?
11. What is LBO? How is it different from an MBO? Give hypothetical examples for each
12. What is LBO? How is it different from an MBO? Give hypothetical examples for each

15.12 Markets, Instruments & Corporate Actions

1. What is an oversubscription?
2. What is PE Ratio? How is it useful?
3. What is the purpose of Cash Flow Statements?
4. What is a money market? How is it different from the stock market?
5. What is a money market? How is it different from the stock market?

15.13 Annual Report & Company Analysis

1. What key financial ratios do you consider in comparing two companies?
2. What are key metrics you consider in comparing two stocks of a given industry? Why do you
use those metrics?

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 3. What are key metrics you consider in comparing two stocks of a given industry? Why do you
use those metrics?

15.14 Indian Economy, Policy & Current Affairs

1. What is the budgeted fiscal deficit (in percentage terms) for the year 2022-23? How is the
same being funded?
2. What is currently happening with the Indian economy?
3. Do you think the current slowdown is cyclical or structural? Justify.
4. Why do you think the stock market has been rising even though the economy is slowing
down?
5. Do you agree with the RBI's monetary policy stance?
6. If you were the finance minister, what measures would you have taken for post-covid
recovery?
7. If you were the finance minister, what measures would you have taken for post-covid
recovery?

15.15 Banking Crisis, Scams & Systemic Risk

1. Can you explain the modus-operandi of any recent scam in India?
2. Explain the sub-prime crisis of 2008. What was the trigger?
3. Explain the sub-prime crisis of 2008. What was the trigger?

15.16 Corporate Law, Structures & M&A

1. Recent M&A deals in India. What were the reasons behind that transaction?
2. What is the break-even point?
3. Why does the marginal cost curve rise?

15.17 Accounting Adjustments & Tax

1. What are deferred tax assets and deferred tax liabilities? Give examples
2. What is depreciation? How will depreciation affect the bargaining power of a seller? Explain
how depreciation drives bargaining power in the real estate sector.
3. What is funding winter? Why has there been a reduction in capital availability for start-ups?
4. Name some unicorns (start-ups) in India. What do you think is their USP?
5. What is decentralised finance? What are its applications and future potential?

15.18 Workforce & Global Trends

1. What is the great resignation?

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