Welcome to Management Source

Member Login

Lost your password?

Not a member yet? Sign Up!

Archive for the ‘Management Accounting’ category

Problems with the P/E (28) Views

Jul 3rd
by admin |
in Financial Management, Management Accounting
( 0 )

So far we’ve learned that, in the right circumstances, the P/E ratio can help us determine whether a company is over- or under-valued. But P/E analysis is only valid in certain circumstances and it has its pitfalls. Some factors that can undermine the usefulness of the P/E ratio include: Accounting Earnings is an accounting figure that includes non-cash items. Furthermore, the guidelines for determining earnings are governed by accounting rules (GAAP) that change over time and are different in each country. To complicate matters, EPS can be twisted, prodded and squeezed into various numbers depending on how you do the books. The result is that we often don’t know whether we are comparing the same figures, or apples to oranges. Inflation In times of high inflation, inventory and depreciation costs tend to be understated because the replacement costs of goods and equipment rises with the general level of prices. Thus, P/E ratios tend to be lower during times of high inflation because the market sees earnings as artificially distorted upwards. As with all ratios, it’s more valuable to look at the P/E over time in order to determine the trend. Inflation makes this difficult, as past information is less useful today.

Many Interpretations A low P/E ratio does not necessarily mean that a company is undervalued. Rather, it could mean that the market believes the company is headed for trouble in the near future. Stocks that go down usually do so for a reason. It may be that a company has warned that earnings will come in lower than expected. This wouldn’t be reflected in a trailing P/E ratio until earnings are actually released, during which time the company might look undervalued.

Don’t Buy/Short Just Because of the P/E What goes up … well, sometimes it stays up for an awfully long time. A common mistake among beginning investors is the short selling of stocks because they have a high P/E ratio. If you aren’t familiar with short selling, it’s an investing technique by which an investor can make money when a shorted security falls in value. First of all, we believe that novice investors shouldn’t be shorting. Secondly, you can get into a lot of trouble by valuing stocks using only simple indicators such as the P/E ratio. Although a high P/E ratio could mean that a stock is overvalued, there is no guarantee that it will come back down anytime soon. On the flipside, even if a stock is undervalued, it could take years for the market to value it in the proper way. Security analysis requires a great deal more than understanding a few ratios. While the P/E is one part of the puzzle, it’s definitely not a crystal ball.

Conclusion

What have we learned about the P/E ratio? Although the P/E often doesn’t tell us much, it can be useful to compare the P/E of one company to another in the same industry, to the market in general, or to the company’s own historical P/E ratios.

Some points to remember:

  • The P/E ratio is the current stock price of a company divided by its earnings per share (EPS).
  • Variations exist using trailing EPS, forward EPS, or an average of the two.
  • Historically, the average P/E ratio in the market has been around 15-25.
  • Theoretically, a stock’s P/E tells us how much investors are willing to pay per dollar of earnings.
  • A better interpretation of the P/E ratio is to see it as a reflection of the market’s optimism concerning a firm’s growth prospects.
  • The P/E ratio is a much better indicator of a stock’s value than the market price alone.
  • In general, it’s difficult to say whether a particular P/E is high or low without taking into account growth rates and the industry.
  • Changes in accounting rules as well as differing EPS calculations can make analysis difficult.
  • P/E ratios are generally lower during times of high inflation.
  • There are many explanations as to why a company has a low P/E.
  • Don’t base any buy or sell decision on the multiple alone.
Tags: , , , , , , , , , , , , , , ,

Management accounting vs. financial accounting (43) Views

Jun 24th
by admin |
in Accounting Management, Management Accounting
( 0 )

Financial accounting and management accounting are two interrelated facets of the accounting system. They are not independent of each other but they are interdependent. Financial accounting provides the basic data which are analysed and interpreted suitably and in the required manner by management accounting. Although there exists close relationships between financial accounting and management accounting, distinction is always drawn between financial accounting and management accounting since they differ in their emphasis and approaches.

Tags: , , , , , , , , , , , , , , , , , , , , , , , , , , , , ,

Functions of management accounting (57) Views

Jun 24th
by admin |
in Accounting Management, Management Accounting
( 0 )
  1. Modification of data: The management accounting system modifies the data furnished by financial accounting to serve the managerial needs in such a way that the process of classification and combination which enables to retain similarities without eliminating dissimilarities.
  2. Validating the data: To make reliable decisions valid data should be made available to managers. The effectiveness of managerial function depends too much upon the accuracy and adequacy of the data. It is the function of management accounting to present before the management the required data with some sort of reasonable accuracy and it need not be with perfect accuracy.
  3. Analysis and interpretation of data: Though management accounting is concerned with recording of business transactions, the analysis and interpretation of such data, in analyzing and interpreting the data lies the essence of management accounting. To discharge this function management accounting uses a number of tools like Marginal costing, budgeting, standard costing etc.
  4. Communicating the data: The collected and interpreted data must be communicated to those who are interested in it or to whom it has some meaning. Otherwise these data may not yield any meaningful result and the whole process of collecting, validating and interpreting would amount to be a futile exercise. The communication of the data should be done within a reasonable time. Data delayed is decision delayed and a delayed decision may delay the prosperity of its concern. To accomplish this function of management accounting several reports and statements are being used.

Functions of a management accountant:

Although it is understood that all the functions of management accounting are to be performed by the management accountant, the following may be said to be the important role of the management accountant in the management of a company.

  1. Collection of data: The management accountant has to collect data about the problems faced by the management through primary and secondary sources.
  2. Analysis of data: After the collection of data, the management accountant has to analyse it for the purpose of interpretation using various tools and techniques.
  3. Presentation of data: The management accountant is required to present the data to the management in columns and rows to facilitate proper understanding.
  4. Planning: The management accountant assists the management in long range planning as well as in formulation of policies of the organisation.
  5. Controlling: The management accountant follows different techniques like standard costing, budgetary control etc to ensure adequate control for implementation of plans and achievement of objectives.
  6. Reporting: Reporting being a very important function of a management accountant, he has to prepare different types of reports periodically and communicated to the concerned departments to meet the requirements at different levels of management for necessary action.
  7. Coordinating: The management accountant has to co-ordinate the various activities of the organization for the preparation of master budget and other such activities.
  8. Decision making: The management accountant has to assist the management in taking realistic decisions through analysis and interpretation of data that suggests a particular course of action with the help of various tools of management accounting.

Tags: , , , , , , , , , , , , ,

Nature and Scope of Management Accounting (154) Views

Jun 24th
by admin |
in Accounting Management, Management Accounting
( 0 )

Nature of management accounting:

Managerial personnel are entrusted with authority and responsibility of operating business activities. Management accounting provides information to the personnel are entrusted with authority and responsibility of operating business activities. Management accounting provides information to the managerial personnel at three levels of management viz., top, middle and lower levels of management. It provides the management with the tools for an analysis of its administrative action that can lay suitable emphasis on the possible alternatives in terms of costs, prices and profits. The decisions made by management are based on quantitative information and common sense, foresight, knowledge and experience. Management accounting includes financial accounting information and raw material from several other disciplines such as costing, statistics, mathematics, political science, sociology, psychology, management economics, law etc. With all these data he can ensure optimum utilization of all the resources including employees by maintaining sound morale of the employees, maximization of output and minimization of inputs, analyze the managerial questions in terms of costs, revenues, profits and growth. It is thus a highly personalized service with the help of which management can explore and exploit business opportunities and take sound and correct decisions. It is not a precise science as it uses its own conventions rather than standardized principles. Therefore the inferences drawn from the facts provided, depends on the skill, judgment and common sense of different management accountants. Thus it is said that management accounting serves as a management information system which enables the effective management of an enterprise.

Scope of management accounting:

Management accounting is a wide and diverse subject. As stated earlier it includes various branches of knowledge such as psychology, sociology, economics, laws, political science, mathematics, statistics, finanacial accounting, cost accounting etc.  It is thus very difficult to define its scope, as it is a dynamic and ever growing discipline of knowledge. The important techniques and systems used by management accounting are briefly stated below.

  1. Historical cost accounting: Maintenance of books of cost accounting enables to know the actual costs incurred by the firm.
  2. Standard costing: The standard costs laid down by experts are compared with the natural costs in order to know the deviations
  3. Marginal costing: The costs are divided into fixed and variable costs which help is making vital decisions.
  4. Decision accounting: Decisions are made after studying the impact of decisions in terms of costs, resource, profits, growth etc.
  5. Budgetary control: It is a system of controlling the cost with the help of budgets.
  6. Control accounting: It includes the techniques such as standard costing, budgetary control, control reports, internal check, internal audit and reports.
  7. Revaluation accounting: It is based on current costs to ensure that the investment is intact and profits from investment are kept in mind.
  8. Financial planning & policies: It consists of raising the long term and short term finance and invest it on optimum basis and enhance the profitability of the firm.
  9. Capital expenditure: The large amounts of future capital expenditure and future profits are analysed to take important decisions.
  10. Break even analysis: This is an important technique which is used to analyse the behavior of costs viz., fixed and marginal costs, indicating the level of activity at which the total costs would equal the total revenue and also the margin of safety.
  11. Inter-period comparison: It is a technique of comparing the present performance with the past performance.
  12. Techniques of forecasting: Some techniques like decision tree, probability and sensitivity analysis are used by management accountants for forecasting which forms a base for planning.
  13. Operations research: It consists of statistical and mathematical techniques that are increasingly used in decision making process.
  14. Statistics: The statistical techniques used by management accountant are correlation, regression, probability, time series, standard deviation, linear programming, control charts etc.
  15. Other techniques: Other techniques employed are: Financial reporting, data processing, project management and appraisal, management audit, efficiency audit, cost audit, performance budgeting, tax planning, social accounting & audit, human resource accounting, responsibility accounting and divisional performance.
Tags: , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , ,

MANAGEMENT ACCOUNTING-Introduction (36) Views

Jun 24th
by admin |
in Accounting Management, Management Accounting
( 0 )

Introduction:

Accounting may be broadly classified into two categories – accounting which is meant to serve all parties external to the operating responsibility of the firms and the accounting which is designed to serve internal parties who take care of the operational needs of the firm. The first category which is conventionally referred to as financial accounting, looks to the interest of those who have primarily a financial stake in the organization’s affairs – creditors, investors, employees etc. On the other hand the second category of accounting is primarily concerned with providing information relating to the conduct of the various aspects of a business like cost or profit associated with some portions of business operations to the internal parties viz., management. This category of accounting is called as Management accounting.

In order to perform the primary task of decision making managers of business enterprises need information about the past, present and future in the functional areas of management such as personnel, finance, marketing and production. Right decision making has to be based on quantitative and qualitative information. The management thus constantly needs accounting information to base its decisions upon. Thus management accounting provides the information needed by management personnel.

Definition:

The Institute of Chartered Accountants of England has defined management accounting as: “Any form of accounting which enables a business to be conducted more efficiently can be regarded as Management Accounting”.

As per American Accounting Association, “Management Accounting includes the methods and concepts necessary for effective planning, for choosing among alternative business actions and for control through the evaluation and interpretation of performances.

As per Institute of Chartered Accountants of India, “Such of its techniques and procedures by which accounting mainly seeks to aid the management collectively have come to be known as management accounting”.

The Chartered Institute of Management Accounts (UK) defines management accounting as under:

“Management accounting is an integral part of management concerned with identifying, presenting and interpreting information used for:

  1. Formulating strategy
  2. Planning and controlling activities
  3. Decision making
  4. Optimizing the use of resources
  5. Disclosures to shareholders and others external to the entity
  6. Disclosure to employees
  7. Safeguarding assets.”
Tags: , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , ,

Tools used for Financial Analysis (61) Views

May 11th
by admin |
in Financial Management, Management Accounting
( 0 )

The various tools used for financial analysis are:

Fund flow Statement

Ratio Analysis

Common Size Statements

Comparative Financial Statements

Trend Analysis

Cash Budget

Working Capital

Leverages


Fund Flow Statement

Fund flow statement also referred to as statement of “source and application of funds” provides insight into the movement of funds and helps to understand the changes in the structure of assets, liabilities and equity capital. The information required for the preparation of funds flow statement is drawn from the basic financial statements such as the Balance Sheet and Profit and loss account. “Funds Flow Statement” can be prepared on total resource basis, working capital basis and cash basis. The most commonly accepted form of fund flow is the one prepared on working capital basis.

Ratio Analysis

Ratio analysis is the method or process by which the relationship of items or groups of items in the financial statements are computed, determined and presented. Ratio analysis is an attempt to derive quantitative measures or guides concerning the financial health and profitability of the business enterprise. Ratio analysis can be used both in trend and static analysis. There are several ratios at the disposal of the analyst but the group of ratios he would prefer depends on the purpose and the objectives of the analysis.

Accounting ratios are effective tools of analysis. They are indicators of managerial and overall operational efficiency. Ratios, when properly used are capable of providing useful information. Ratio analysis is defined as the systematic use of ratios to interpret the financial statements so that the strengths and weaknesses of a firm as well as its historical performance and current financial condition can be determined the term ratio refers to the numerical or quantitative relationship between items/ variables. This relationship can be expressed as:

  1. Fraction
  2. Percentages
  3. Proportion of numbers

These alternative methods of expressing items which are related to each other are, for purposes of financial analysis, referred to as ratio analysis. It should be noted that computing the ratio does not add any information in the figures of profit or sales. What the ratios do is that they reveal the relationship in a more meaningful way so as to enable us to draw conclusions from them. Read more…

Tags: , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , ,

Limitations of Ratio Analysis (44) Views

May 10th
by admin |
in Ratio Analysis
( 0 )

An investor should caution that ratio analysis has its own limitations. Ratios should be used with extreme care and judgment as they suffer from certain serious drawbacks. Some of them are listed below:

Rations can sometimes be misleading if an analyst does not know the reliability and soundness of the figures from which they are computed and the financial position of the business at other times of the year. A business enterprise for example may have an acceptable current ratio of 3:1 but a larger part of accounts receivables comprising a great portion of the current assets may be uncollectible and of no value. When these are deducted the ratio might be 2:1

It is difficult to decide on the proper basis for comparison. Ratios of companies have meaning only when they are compared with some standards. Normally, it is suggested that ratios should be compared with industry averages. In India, for example, no systematic and comprehensive industry ratios are complied.

The comparison is rendered difficult because of differences in situations of 2 companies are never the same. Similarly the factors influencing the performance of a company in one year may change in another year. Thus, the comparison of the ratios of two companies becomes difficult and meaningless when they are operation in different situations.

Changes in the price level make the interpretations of the ratios Invalid. The interpretation and comparison of ratios are also rendered invalid by the changing value of money. The accounting figures presented in the financial statements are expressed in monetary unit which is assumed to remain constant. In fact, prices change over years and as a result. Assets acquired at different dates will be expressed at different values in the balance sheet. This makes comparison meaningless.

For e.g. two firms may be similar in every respect except the age of the plant and machinery. If one firm purchased its plant and machinery at a time when prices were very low and the other purchased when prices were high, the equal rates of return on investment of the two firms cannot be interpreted to mean that the firms are equally profitable. The return of the first firm is overstated because its plant and machinery have a low book value.

The differences in the definitions of items, accounting, policies in the balance sheet and the income statement make the interpretation of ratios difficult. In practice difference exists as to the meanings and accounting policies with reference to stock valuation, depreciation, operation profit, current assets etc. Should intangible assets be excluded to calculate the rate of return on investment? If intangible assets have to be included, how will they be valued? Similarly, profit means different things to different people.

Ratios are not reliable in some cases as they many be influenced by window / dressing in the balance sheet.

The ratios calculated at a point of time are less informative and defective as they suffer from short-term changes. The trend analysis is static to an extent. The balance sheet prepared at different points of time is static in nature. ­They do not reveal the changes which have taken place between dates of two balance sheets. The statements of changes in financial position reveal this information, bur these statements are not available to outside analysts.

The ratios are generally calculated from past financial statements and thus are no indicator of future. The basis to calculate ratios are historical financial statements. The financial analyst is more interested in what happens in future.

While the ratios indicate what happened in the past Art outside analyst has to rely on the past ratios which may not necessarily reflect the firm’s financial position and performance in future.

Tags: , , ,

Advantages of Ratio Analysis (31) Views

May 10th
by admin |
in Ratio Analysis
( 0 )

Ratio analysis is the method or process by which the relationship of items or groups of items in the financial statements are computed, determined and presented. Ratio analysis is an attempt to derive quantitative measures or guides concerning the financial health and profitability of the business enterprise. Ratio analysis can be used both in trend and static analysis. There are several ratios at the disposal of the analyst but the group of ratios he would prefer depends on the purpose and the objectives of the analysis.

Accounting ratios are effective tools of analysis. They are indicators of managerial and overall operational efficiency. Ratios, when properly used are capable of providing useful information. Ratio analysis is defined as the systematic use of ratios to interpret the financial statements so that the strengths and weaknesses of a firm as well as its historical performance and current financial condition can be determined the term ratio refers to the numerical or quantitative relationship between items/ variables. This relationship can be expressed as:

1)   Fraction

2)   Percentages

3)   Proportion of numbers

These alternative methods of expressing items which are related to each other are, for purposes of financial analysis, referred to as ratio analysis. It should be noted that computing the ratio does not add any information in the figures of profit or sales. What the ratios do is that they reveal the relationship in a more meaningful way so as to enable us to draw conclusions from them.

Advantages of Ratio Analysis

  • Ratios simplify and summarize numerous accounting data in a systematic manner so that the simplified data can be used effectively for analytical studies.
  • Ratios avoid distortions that may result the study of absolute data or figures.
  • Ratios analyze the financial health, operating efficiency and future prospects by inter-relating the various financial data found in the financial statement.
  • Ratios are invaluable guides to management. They assist the management to discharge their functions of planning, forecasting, etc. efficiently.
  • Ratios study the past and relate the findings to the present. Thus useful inferences are drawn which are used to project the future.
  • Ratios are increasingly used in trend analysis.
  • Ratios being measures of efficiency can be used to control efficiency and profitability of a business entity.
  • Ratio analysis makes inter-firm comparisons possible. i.e. evaluation of interdepartmental performances.
  • Ratios are yard stick increasingly used by bankers  and financial institutions in evaluating the credit standing of their borrowers and customers.

Tags: , , , , , , , , , , , , , ,

Ratio Analysis- Its Use (47) Views

May 8th
by admin |
in Ratio Analysis
( 0 )

Ratio analysis is a widely used tool of financial analysis. It is defined as the systematic use of ratio to interpret the financial statements so that the strength and weaknesses of a firm as well as its historical performance and current financial condition can be determined. The term ratio refers to the numerical or quantitative relationship between two variables.

It’s a tool which enables the banker or lender to arrive at the following factors :

Liquidity position

The liquidity position is the difference between the sum of liquid assets and incoming cash flows on one side and outgoing cash flows resulting from commitments on the other side, measured over a defined period, being the measure of the liquidity risk.  Related position codes are: 1. Liquidity position -spot. 2. Liquidity position – forward. The related report is the Liquidity Risk Analysis report. Two position codes are defined, one for the spot time bracket and one for the forward time brackets. See also Position, position administration tables, standard position codes, combined position code, risk management, foreign exchange risk, forex, open currency position, mismatch, interest risk, liquidity risk, forward revaluation, interest revaluation, break even.

Profitability

Profitability ratios offer several different measures of the success of the firm at generating profits.

The gross profit margin is a measure of the gross profit earned on sales. The gross profit margin considers the firm’s cost of goods sold, but does not include other costs. It is defined as follows:

Gross Profit Margin  =  Sales – Cost of Goods Sold / Sales

Return on assets is a measure of how effectively the firm’s assets are being used to generate profits. It is defined as:

Return on Assets = Net Income / Total Assets

Return on equity is the bottom line measure for the shareholders, measuring the profits earned for each dollar invested in the firm’s stock. Return on equity is defined as follows:

Return on Equity = Net Income / Shareholder Equity

Solvency

Solvency is the ability of a business to have enough assets to cover its liabilities. Solvency is often confused with liquidity,     but it is not the same thing. Solvency is often measured as a ratio, the “current ratio,” which is the total current assets divided by the total current liabilities. In order to be solvent and cover liabilities, a business should have a current ratio of 2/1, meaning that it has twice as many current assets as current liabilities. This ratio recognizes the fact that selling assets to obtain cash may result in losses, so more assets are needed.

Financial Stability

The firm’s ability to remain in business in the long run, without having to sustain significant losses in the conduct of its business. Assessing a company’s stability requires the use of both the income statement and the balance sheet, as well as other financial and non-financial indicators.

Tags: , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , ,
Page 1 of 3123

Links

Articles

Projects