What does mean Financial Control?Finance Control has now become an essential part of any company’s finances.It refers to the systems implemented in place to trace the directed resources of an organization with timely monitoring and measurement. So, what is the topic we are going to discuss; Financial Control – Meaning, Definition, Objectives, Importance, and Steps. Hence, it is very important to understand the meaning of financial control, its objectives and benefits, and the steps that must be taken if it is to implement correctly.
The Concept of Financial Control explains – their Meaning, Definition, Objectives, Importance, and finally Steps.
Exercising financial control is one of the important functions of a finance manager. Also, It aims at planning, evaluation, and coordination of financial activities to achieve the objective of the firm.
Meaning and Definition of Financial Control:
Control of financial activities carried out in an organization to achieve the desired objectives. They also provide a set of rules and regulations about the financial management systems followed in an organization.
All organizations have financial controls to ensure effective financial management. Also, Most organizations have financial controls to ensure that everyone is aware of procedures to follow and to ensure that there is a better understanding of each one’s responsibility.
The concept of Financial Control: It is concerned with the policies and procedures framed by an organization for managing, documenting, evaluating and reporting financial transactions of an organization. In other words, they indicate those tools and techniques adopted by a concern to control its various financial matters.
Objectives of Financial Control:
The main objectives of financial control discuss below:
1] Economic Use of Resources:
As well as, They aim to evaluate and coordinate financial activities. This helps prevent leakage of funds and thus desired returns on investments can realize.
2] Preparation of Budget:
They help the management prepare the budget for a particular department. Also, Budgets provide a basis to compare actual performance with standard performance.
3] Maintenance of Adequate Capital:
It shows the way to maintain adequate capital, i.e. proper implementation of financial control verifies the adequacy of capital, and hence the evils of over-capitalization or under-capitalization can avoid.
4] Maximization of Profit:
As well as they compel the management to procure funds from cheaper sources and to apply the said funds efficiently to lead to profit maximization.
5] Survival of Business:
A good financial control system ensures proper utilization of resources, which creates a sound and strong base for an organization’s existence.
6] Reduction in Cost of Capital:
They aim at raising capital from cheaper sources by maintaining a proper debt-equity mix. So, the overall cost of capital remains at its lowest.
7] Fair Dividend Payment:
Their system aims to distribute a fair and adequate dividend to the investors thereby creating satisfaction among the shareholders.
8] Strengthening Liquidity:
One of the important objectives of financial control is to maintain the liquidity of the firm by exercising proper control over different components of the working capital.
9] Checking that everything is running on the Right Lines:
Sometimes, it just checks that everything is running well and that the levels set and objectives proposed at the financial level regarding sales, earnings, surpluses, etc., are being met without any significant alterations.
The company thus becomes more secure and confident, its operating standards and decision-making processes being stronger.
10] Detecting Errors or Areas for Improvement:
An irregularity in the company finances may jeopardize the achievement of an organization’s general goals, causing it to lose ground to its competitors and in some cases compromising its very survival.
Therefore, it is important to detect irregularities quickly. Various areas and circuits may also identify which while not afflicted by serious flaws or anomalies could improve for the general good of the company.
11] Increase in Goodwill:
A sound financial control system increases the productivity and efficiency of a firm. This helps in increasing the prosperity of the firm in the short run and its goodwill in the long run.
12] Increasing Confidence of Suppliers of Funds:
The proper, they prepare the ground to create a sound financial base of a firm and thereby increases the confidence of investors and suppliers.
Financial Control: Meaning, Definition, Objectives, Importance, and Steps. Image credit from #Pixabay.
Importance of Financial Control:
Finance is important for any organization and financial management is the science that deals with managing of finance; however the objectives of financial management cannot achieve without the proper controlling of finance.
The importance of financial control discuss below:
1] Financial Discipline:
They ensure adequate financial discipline in an organization by efficient use of resources and by keeping adequate supervision on the inflow and outflow of resources.
2] Coordination of Activities:
As well as they seek to achieve the objectives of an organization by coordinating the activities of different departments of an organization.
3] Ensuring Fair Return:
Proper financial control increases the earnings of the company, which ultimately increases the earnings per share.
4] Reduction in Wastages:
Adequate financial control ensures optimal utilization of resources leaving no room for wastages.
5] Creditworthiness:
As well as they help maintain a proper balance between the debt collection period and the creditors’ payment period; thereby ensuring proper liquidity exists in a firm that increases the creditworthiness of the firm.
The Steps of Financial Control:
According to Henry Fayol,
“In an undertaking, control consists in verifying whether everything occurs in conformity with the plan adopted, the instructions issued and principles established”.
Thus, as per the definition of Fayol’s, the steps of financial control are:
1] Setting the Standard:
The first step in financial control is to set up the standard for every financial transaction of the concern. Standards should be set in respect of cost, revenue, and capital. Also, Standard costs should determine in respect of goods and services produced by the concern taking into account every aspect of costs.
Revenue standard should fix taking into account the selling price of a similar product of the competitor, sales target of the year, etc. While determining capital structure, the various aspects like production level, returns on investment, cost of capital, etc., should take into account so that over-capitalization or under-capitalization can avoid.
However, while setting up the standard, the basic objective of a firm, i.e. wealth-maximization, should take into account.
2] Measurement of Actual Performance:
As well as the next step in financial control is to measure the actual performance. For keeping records of actual performance financial statements should systematically prepare periodically.
3] Comparing Actual Performance with Standard:
In the third step, actual performances compare with the pre-determined standard performance. The comparison should finish regularly.
4] Finding Out Reasons for Deviations:
If there are any deviations in the actual performance with the standard performance, the amount of variation or deviations should also ascertain along with the causes of the deviations. This should report to the appropriate authority for necessary action.
5] Taking Remedial Measures:
The last and final step in financial control is to take appropriate steps so that the gaps between actual performance and standard performance can bridge in the future, i.e. so that there is no deviation between actual and standard performance in the future.Read and share, Their Meaning, Definition, Objectives, Importance, and Steps in Hindi.
Goodwill – Meaning, Definition, Classification, Features, Types, and Accounting Concept (In Hindi). In other words, goodwill shows that a business has value beyond its actual physical assets and liabilities. Discover the meaning and significance of goodwill in business. Learn how it adds value beyond physical, identifiable assets and liabilities. Goodwill is a company’s value that exceeds its assets minus its liabilities. This value can create from the excellence of management, customer loyalty, brand recognition, favorable location, or even the quality of employees. The number of goods is the purchase price the business minus the fair market value of the tangible assets, the intangible assets that can identify, and the liabilities obtained in the purchase.
Here are explains; What is Goodwill? First Meaning, Definition, Classification, Features, Types, and finally their Accounting Concept.
The amount in the Goodwill account will adjust to a smaller amount if there is an impairment in the value of the acquired company as of a balance sheet date or accounting treatment. Goodwill in the world of business refers to the established reputation of a company as a quantifiable asset and calculate as part of its total value when it takes over or sale. It is the vague and somewhat subjective excess value of a commercial enterprise or asset over its net worth. It is a vital component for increasing a company’s customer base and retaining existing clients.
Meaning of Goodwill:
Meaning; that may describe as the aggregate of those intangible attributes of a business that contributes to its superior earning capacity over a normal return on investment. It may arise from such attributes as favorable locations, the ability, and skill of its employees and management, quality of its products and services, customer satisfaction, etc.
Definition of Goodwill:
Definition; it is an asset that has countless definitions. Accountants, Economists, Engineers, and the Courts have to define Goodwill in several ways from their respective angles. As such, they have suggested different methods for their nature and valuation. No doubt it is an intangible real asset and not a fictitious one. “It is perhaps the most intangible of intangibles.” It is a valuable asset if the concern is profitable; on the other hand, it is valueless if the concern is a losing one. Therefore, it can state that Goodwills the value of the representative firm, judged in respect of its earning capacity.
Some definitions of goodwill are:
UK Accounting Standard on Accounting for Goodwill,
“Goodwill is the difference between the value of a business as a whole and the aggregate of the fair values of its separable net assets.”
Lord Eldon by,
“Goodwill is nothing more than the profitability that the old customers will resort to the old place.”
Dr. Canning by,
“Goodwill is the present value of a firm’s anticipated excess earnings.”
Prof. Dicksee by,
“When a man pays for goodwill he pays for something which places him in the position of being able to earn more money than he would be able to do by his own unaided efforts.”
Here, the word excess indicates some special hints as to its valuation which, perhaps, is equal to earnings attributable to the rate of return on tangible and intangible assets over the normal rate of return earns by the representative firms in the same industry. In short, the excess reveals the difference between the actual profits earns minus the normal rate of return on the capital employed.
Classification of Goodwill:
The following classification by P. D. Leake as:
Dog-Goodwills: Dogs are attaching to the persons and, hence, such customers lead to personal they which is not transferable,
Cat-Goodwills: Since cats prefer the person of the old home, similarly, such customers give rise to locality goodwills.
Rat-Goodwills: The other variety of customers has an attachment neither to the person nor to the place, which, in other words, is known as fugitive goodwills.
Other Classifications:
The following classifications below are:
1] Purchased/Acquired Goodwill:
Purchased goodwills arise when a firm purchases another firm and when payment makes more than net assets acquired for that purpose; such excess payment know as Purchase Goodwills. The same has also been corroborating by AS 10 (Accounting for Fixed-Assets).
2] Treatment of Purchased Goodwills as per AS 10 (Accounting for Fixed-Assets):
In general records in the books only when some consideration in money or money’s worth has been paying for it. Whenever a business is acquired for a price (payable either in cash or in shares) that is more than the value of the net assets of the business taken over the excess is termed Goodwill. It arises from business’s reputation, connections, trade name or reputation of an enterprise, or other intangible benefits enjoyed by an enterprise. As a matter of financial prudence, goodwill written off over a period. However, many enterprises do not write off goodwill and retain it as an asset.
3] Treatment of Purchased Goodwills as per AS 14 (Accounting for Amalgamation):
They arising on amalgamation represent a payment made in anticipation of future income and it is appropriate to treat it as an asset to amortize to income on a systematic basis over its useful life. Due to the nature of goodwill, it is frequently difficult to estimate its useful life with reasonable certainty. Such estimation is, however, made on a prudent basis. Accordingly, it is considered appropriate to amortize goodwill over a period not exceeding 5 years unless a somewhat longer period can justify.
4] Inherent/Latent Goodwill:
It is practically the reputation of a firm that has been acquiring by the business over some time. It is not purchased for cash consideration. That is why; it is not recording in the books of accounts like Purchase Goodwills. This types of goodwill depends on several factors, viz, supplying goods and services at a reasonable price to the society, etc. Accountants are not concerning about it.
5] Inherent/Internally Generated Tangible Assets — As per AS 26:
Internally generated goodwill should not recognize as an asset. In some cases, expenditure is incurring to generate future economic benefits, but it does not result in the creation of an intangible asset that meets the recognition criteria in this statement.
Such expenditure is often describing as contributing to internally generated them. Internally generated and factors affecting goodwill not recognizing as an asset because it is not an identifiable resource control by the enterprise that can measure reliably at cost.
The difference between the market value of an enterprise and the carrying amount of its identifiable net assets at any point in time may be due to a range of factors that affect the value of the enterprise. However, such a difference cannot consider representing the cost of intangible assets controlled by the enterprise.
The Features of Goodwill:
The following features below are:
It is an intangible asset, it is non-visible, but it is not a fictitious asset.
It cannot separate from the business and therefore cannot sell like other identifiable and separable assets, without disposing of the business as a whole.
The value of goodwill has no relation to the amount invested or the cost incurred to build it.
Valuation of goodwill is subjective and is highly dependent on the judgment of the valuer.
It is subject to fluctuations. The value of goodwill is an intangible may fluctuate widely according to internal and external factors of the business.
Types of Goodwill:
It is generally of two types:
Purchased, and.
Non-Purchased or Inherent.
1] Purchased Goodwill:
Purchased goodwills arise when a business concern is purchased and the purchase consideration paid exceeds the fair value of the separable net assets acquired. The purchased goodwills show on the assets side of the Balance sheet. Para 36 of AS-10 “Accounting for fixed assets” states that only purchased goodwill should recognize in the books of accounts.
2] Non-Purchased Goodwill/Inherent Goodwill:
Inherent goodwills the value of the business over the fair value of its separable net assets. It is referred to as internally generated them and it arises over some time due to the good reputation of a business. The value of goodwill may be positive or negative. Positive goodwill arises when the value of the business as a whole is more than the fair value of its net assets. It is negative when the value of the business is less than the value of its net assets.
Goodwills for Accounting:
Accounting for goodwill, the various ways in which they can account for are as follows:
Carry it as an asset and write it off over years through the profit and loss account.
Write it off against profits or accumulated reserves immediately.
Retain it as an asset with no write-off unless a permanent diminution in value becomes evident.
Show it as a deduction from shareholders funds which may authorize carry forward indefinitely.
In this connection, it is important to state that they should recognize and recorded in business only when some consideration in money or money’s worth has been paying for it.
How Goodwill entry in the Accounting Book?
It is always paying for the future. A record of Goodwill in accounting makes only when it has a value. When a business is purchasing and an additional amount is paid more than the number of assets, then the additional amount calls goodwill. It treats as an asset and the payment made for it is a capital expenditure. It treats as an intangible asset and thus depreciation is not charging. The value of goodwill decreases and increases but the fluctuations are not recording in the books.
The presence of goodwill in the books is not necessarily a sign of prosperity. A prospective purchaser would agree to make any payment for the goodwill only when he is convinced that the profit likely to accrue to him from the acquired business would be more than the normal return expects in a business of a similar nature. This means that any such payment refers to the future differential earnings and is a premium to the vendor for relinquishing his right thereto in favor of the vendee.
The goodwill of a business is the intangible value to it, independent of its visible assets because the business is a well-established one having a good reputation. But at the same time, it is obvious that goodwill is inseparable from the business to which it adds value. The value of the goodwill of the business will, therefore, be the value that a reasonable and prudent buyer would give for the business as a going concern minus the value of the tangible assets.
Departmental Accounting and Departmental Accounts both are the same. The main point explains; Meaning, Concept, Objectives, Methods, Advantages, with Principles. Modern life is very mechanical, especially in big cities. The citizens of such cities expect all the goods and services just under a single roof. Such individual accounts will help to evaluate and control the different departments. So, what is the topic we are going to discuss; Departmental Accounting: Meaning, Objectives, Methods, and Advantages…Read in Hindi.
Here explains What is Departmental Accounting? Meaning, Concept, Objectives, Methods, Advantages, with Principles.
What does mean Departmental Accounting? Departmental Accounting refers to maintaining accounts for one or more branches or departments of the company. Revenues and expenses of the department record and report separately. The departmental accounts are then consolidated into accounts of the head office to prepare financial statements of the company.
The departmental stores are the example of large-scale retail selling just under a single roof. Different departments involve in different goods to sell out. To calculate the net result of the whole organization, full-fledged trading, and profit, and loss account are to prepare. But to evaluate individual department, it will be creditworthy to prepare individual trading and profit and loss account.
For example, a textile mill which is having head office and factory. Separate accounts maintain for production facilities and then the final results are sent to the head office which then incorporates by the head office in their accounts. Maintenance of separate accounts for each branch of a bank or financial institution also falls under the category of departmental accounting. The bank then prepares its financial statement after consolidating accounts of all branches.
A departmental accounting system is an accounting information system that records the activities and financial information about the department. Departmental Accounting is a vital one for large prosperous business organizations. It controls wastage & misusing, compensates the employee in terms of profit and commission, compares performance and progress of year to year or department to department or similar type of firm to firm.
Meaning of Departmental Accounting:
Where a big business with diverse trading activities conduct under the same roof the same usually divide into several departments and each department deals with a particular kind of goods or service. For example, a textile merchant may trade in cotton, woolen and jute fabrics. The overall performance for this type of business depends, however, on departmental efficiency.
As a result, it is desirable to maintain accounts in such a manner that the result of each department can be known—together with the result as a whole. The system of accounting follows for this; the purpose knows as Departmental Accounts. This system of accounting helps the proprietors to:
Compare the results among the different departments together with the previous results thereof,
Formulate policy to extend or to develop the enterprise in the proper line; and
Reward the departmental managers based on departmental results.
The Concept of Departmental Accounting:
Departmentalization enables big firms to determine the areas needing special attention to the achievement of overall objectives. The units or departments needing more funds and more attention than others and the one(s) contributing more toward goal attainment could identify with good departmentalization. The purpose is basically to find out the performance and capability of the units or departments to make adjustments for the achievement of the firm’s objectives.
Each unit, department or subsidiary gives the free use of some of the assets of the firm and some responsibilities which can be profit-making, revenue generation or cost control. As expenses incur by the firm on behalf of all its departments, indirect expenses are to apportion to the departments, if each department is to present a financial statement or if the statement is to prepare by the company on a departmental basis.
Departmental accounting is about the preparation of final accounts taking into consideration divisional performance before the overall performance. With that system of accounting, companies that departmentalize can easily conclude as they are very well’ performing units, averagely or moderately performing units. Departmental accounting aims at separating the several activities of a business to compare results and to assist the proprietors/owners in formulating policies.
Objectives of Departmental Accounting:
The main objectives of departmental accounting are:
To check out an interdepartmental performance.
To evaluate the performance of the department with the previous period result.
The gross profit of each department can ascertain.
Methods and Techniques of Departmental Accounting:
Departmental accounts prepare in such a manner that all desired information is available and departmental profit can correctly make.
Here are two methods advocate viz:
Where the individual set of books maintains, and.
Where all departmental accounts maintain columnar- wise collectively.
They explain below;
Where Individual Set of Books Maintain:
Under this method, the accounts of each department independently maintain. The departmental results of all the departments collect and take into consideration to find out the net result of the organization.
Where All Departmental Accounts Maintain Columnar-Wise Collectively:
A Departmental Trading and Profit and Loss Account open for each department in a columnar form together with a separate column for ‘Total’ to ascertain the individual result of the different departments and also as a whole. But the Balance Sheet prepares in a combining form.
And to incorporate the purchase and sale of goods, the subsidiary books and also the nominal accounts into the ledger must rule out with extra columns for each department in arriving at the desired departmental figures to prepare departmental final accounts. If there is a larger volume of cash purchases and cash sales, the Cash Book also must maintain separate columns for cash purchases and cash sales of various departments.
Appropriateness of some of the apportionment methods – key points:
It can be a very subjective process.
The best way to apportion costs base on the greatest benefit- i.e. the department who gets the greatest benefit from the cost must take the greatest amount of the cost.
This makes the apportionment process very time consuming and expensive.
The more appropriate basis may be for depreciation to base on the book value of assets in each department.
Insurance of the assets based on the book value of the assets.
Advantages of Departmental Accounting:
The most significant advantages of departmental accounts are:
Individual results of each department can know which helps to compare the performances among all the departments, i.e., the trading results can compare.
Departmental accounts help to understand or locate the success, failure, rates of profit, etc.
It helps the management to make a proper plan of action, policies to increase profit after analyzing the results of the operation of various departments.
Departmental accounting helps us to understand which department should expand further or which one should close down as per the results of the operation.
It also helps to encourage a healthy competitive spirit among the various departments which, ultimately, helps to increase the profits of the firm as a whole.
For additions or alterations of various departments, departmental accounts help a lot as it supplies the necessary information.
As detailed information about the firm is available from departmental accounting the users of accounting information, particularly, the auditors and investors widely benefit.
Since departmental accounting presents separate departmental results, the Performance, of a successful department encourages the management, employees and increases the motivation of the staff as a whole.
The percentage of gross profit on sales and stock turnover ratio of each department helps to make a comparative study among all departments.
Departmental Accounting: Meaning, Objectives, Methods, and Advantages. Image credit from #Pixabay.
Principles of Departmental Accounting:
Preparation of final accounts of a departmentalized business requires the following:
That the gross profit or loss and the net profit or loss of each department determine separately before taking. The totals to the appropriate account or the balance sheet of the business, and.
That there should be some basis of apportioning gains and expenses to the departments or units of the business. And, that should be done as fair and equitable as possible.
Sometimes control accounts have to resort to determine the creditors’ or debtors’ value to the business. In any case, as the departmental values show. The total figures, for the business as a whole, are, to sum up.
Accounting is the systematic recordation of the financial transactions of a business. Accounting principles are built on a foundation of a few basic concepts. The meaning of accounting can be erroneously expanded to include internal and external auditing. Internal auditing involves the testing of systems to see if they operate as intended, and so falls outside of the traditional definition of accounting. External auditing involves the examination of accounting records to see if the auditor can attest to the fairness of the information presented in the financial statements; again, this task falls outside of the traditional definition of accounting. So, what is the question we going to study; How to explain the important Concept of Accounting?
Here are explained the Concept of Accounting; Important with Basic.
These concepts are so basic that most preparers of financial statements do not consciously think of them. As stated earlier, they are regarded as self-evident. Some accounting researchers and theorists argue that certain of the present accounting concepts are wrong and should be changed. Nevertheless, in order to understand accounting as it now exists, one must understand the underlying concepts currently used. Basic accounting concepts discussed herein may not be identical to those listed by other authors or groups. However, these are the concepts that are widely accepted and used in practice by preparers of financial statements and by auditors while verifying such statements.
The important accounting concepts are as follows:
The Concept of Accrual:
According to the Financial Accounting Standards Board (US):
“Accrual accounting attempts to record the financial effects on an enterprise of transactions and other events and circumstances that have cash consequences for the enterprise in the periods in which those transactions, events, and circumstances occur rather than only in the periods in which cash is received or paid by the enterprise. Accrual accounting is concerned with the process by which cash expended on resources and activities is returned as more (or perhaps less) cash to the enterprise, not just with the beginning and end of that process. It recognizes that the buying, producing, selling and other operations of an enterprise during a period, as well as other events that affect enterprise performance often do not coincide with the cash receipts and payments of the periods.”
Realization concept and matching concept are central to accrual accounting. Accrual accounting measures income for a period as the difference between the revenues recognized in that period and the expenses that are matched with those revenues. Under accrual accounting, the period’s revenues generally are not the same as the period’s cash receipts from customers, and the period’s expenses generally are not the same as the period’s cash disbursements.
Cash-Basis Accounting:
Under cash-basis accounting, sales are not recorded until the period in which they are received in cash. Similarly, costs are deducted from sales in the period in which they are paid for cash disbursements. Thus, neither the realization nor matching concept applies in cash-basis accounting. In practice, “pure” cash-basis accounting is rare. This is because a pure cash-basis approach would require treating the acquisition of inventories as a reduction in profit when the acquisition costs are paid rather than when the inventories are sold.
Similarly, costs of acquiring items of plant and equipment would be treated as profit reductions when paid in cash rather than in the later periods when these long-lived items are used. Clearly, such a pure cash-basis approach would result in balance sheets and income statements that would be of limited usefulness. Thus, what is commonly called cash-basis accounting is actually a mixture of a cash basis for some items (especially sales and period costs) and accrual basis for other items (especially product costs and long-lived assets).
This mixture is also sometimes called modified cash-basis accounting to distinguish it from a pure cash-basis method. Cash-basis accounting is seen most often in small firms that provide services and therefore do not have significant amounts of inventories. Examples include restaurants, beauty parlors, and barber shops, and income tax preparation firms. Since most of these establishments do not extend credit to their customers, cash-basis profit may not differ dramatically from accrual-basis income. Nevertheless, cash-basis accounting is not permitted by GAAP for any type of business entity.
The Concept of Conservatism:
This principle is often described as “anticipate no profit, and provide for all possible losses.” This characterization might be viewed as the reactive version of the mini-max managerial philosophy, i.e., minimize the chance of maximum losses. The concept of accounting conservatism suggests that when and where uncertainty and risk exposure so warrant, accounting takes a wary and watchful stance until the appearance of evidence to the contrary. Accounting conservatism does not mean intentionally understating income and assets; it applies only to situations in which there are reasonable doubts.
For example, inventories are valued at the lower ends of the cost or market value. In its application to the income statement, conservatism encourages the recognition of all losses that have occurred or are likely to occur but does not acknowledge gains until actually realized. The early amortization of intangible assets and the restrictions against recording appreciation of assets have also, at least to some extent, been motivated by conservatism. Failure to recognize revenue until a sale has taken place is still another manifestation of conservatism.
The Concept of Matching:
The matching concept in financial accounting is the process of matching (relating) accomplishments or revenues (as measured by the selling prices of goods and services delivered) with efforts or expenses (as measured by the cost of goods and services used) to a particular period for which the income is being determined. This concept emphasizes which items of cost are expenses in a given accounting period. That is, costs are reported as expenses in the accounting period in which the revenue associated with those costs is reported.
For example, when the sales value of some goods is reported as revenue in a year, the cost of those goods would be reported as expenses in the same year. Matching concepts need to be fulfilled only after realization concept has been completed by the accountant: first revenues are measured in accordance with the realization concept and then costs are associated with these revenues. Costs are matched with revenues, not the other way around. The matching process, therefore, requires cost allocation which is significant in historical cost accounting.
Past (historical) costs are examined and are subjected to a procedure whereby elements of cost regarded as having expired service potential are allocated or matched against relevant revenues. The remaining elements of costs which are regarded as continuing to have future service potential are carried forward in the historical balance sheet and are termed as assets. Thus, the balance sheet is nothing more than a report of unallocated past costs waiting for the expiry of their estimated future service potential before being matched with suitable revenues.
The Concept of Realization or Recognition:
The realization or recognition concept indicates the amount of revenue that should be recognized from a given sale. Realization rules help the accountant in determining that a revenue or expense has occurred so that it can be measured, recorded, and reported in financial reports. Realization refers to inflows of cash or claims to cash (e.g., accounts, receivable) arising from the sale of goods or services.
Thus, if a customer buys Rs. 500 worth of items at a grocery store, paying cash, the store realizes Rs. 500 from the sale. If a clothing store sells a suit for Rs. 3,000, the purchaser agreeing to pay within 30 days, the store realizes Rs. 3,000 (in receivables) from the sale, provided that the purchaser has a good credit record so that payment is reasonably certain (conservatism concept). The realization concept states that the amount recognized as revenue is the amount that is reasonably certain to be realized—that is, that customers are reasonably certain to pay.
Of course, there is room for differences in judgment as to how certain “reasonably certain” are. However, the concept does clearly allow for the amount of revenue recognized to be less than the selling price of the goods and services sold. The obvious situation is the sale of merchandise at a discount—at an amount less than its normal selling price. In such cases, revenue is recorded at the lower amount, not the normal price.
The Concept of Consistency:
This concept requires that once an organization has decided on one method, it should use the same method for all subsequent transactions and events of the same nature unless it has sound reasons to change methods. If accounting methods are frequently changed, comparison of financial statements for one period with those of another period would be difficult. The consistent use of accounting methods and procedures over time will check the distortion of profit and loss account and the balance sheet and the possible manipulation of these statements. Consistency is necessary to help external users in comparing financial statements of a given firm over time and in making sound economic decisions.
The Concept of Materiality:
In law, there is a doctrine called de minimis noncurative lex, which means that the court will not consider trivial matters. Similarly, the accountant does not attempt to record events so insignificant that the work of recording them is not justified by the usefulness of the results. Materiality concept implies that the transactions and events that have immaterial or insignificant effects should not be recorded and reported in the financial statements. It is argued that the recording of insignificant events cannot be justified in terms of its subsequent poor utility to users.
For example, conceptually, a brand-new pad of paper is an asset of the entity. Every time someone writes on a page of the pad, part of this asset is used up, and retained earnings decrease correspondingly. Theoretically, it would be possible to ascertain the number of parts used pads that are owned by the entity at the end of the accounting period and to show this amount as an asset. But the cost of such an effort would obviously be unwarranted, and no accountant would attempt to do this.
Accountants take the simpler, even though less exact, course of action and treat the asset as being used up (expensed) either at the time the pads were purchased or at the time they were issued from supplies inventory to the user. Unfortunately, there is no agreement on the meaning of materiality and the exact line separating material events from immaterial events.
The decision depends on judgment and common sense. It is for the preparer of accounts to interpret what is and what is not material. Probably the materiality of an event or transaction can be decided in terms of its impact on the financial position, results of operations, changes in the financial position of an organization and on evaluation or decisions made by users.
The Concept of Full Disclosure:
The full disclosure concept requires that a business enterprise should provide all relevant information to external users for the purpose of sound economic decisions. This concept implies that no information of substance or of interest to the average investors will be omitted or concealed from an entity’s financial statements.
The Concept of Entity:
The entity concept assumes that the financial statements and other accounting information are for the specific business enterprise which is distinct from its owners. Consequently, the analysis of business transactions involving costs and revenue is expressed in terms of the changes in the firm’s financial conditions. Similarly, the assets and liabilities devoted to business activities are entity assets and liabilities.
The transactions of the enterprise are to be reported rather than the transaction of the enterprise’s owners. This concept, therefore, enables the accountant to distinguish between personal and business transactions. The concept applies to the sole proprietorship, partnership, companies, and small and large enterprise. It may also apply to a segment of a firm, such as division, or several firms, such as when inter-related firms are consolidated.
The Concept of Going-Concern:
A business entity is viewed as continuing in operation in the absence of evidence to the contrary. Because of the relative permanence of enterprises, financial accounting is formulated assuming that the business will continue to operate for an indefinitely long period in the future. The going-concern concept justifies the valuation of assets on a non-liquidation basis and it calls for the use of historical cost for many valuations.
Also, the fixed assets and intangibles are amortized over their useful life rather than over a shorter period in expectation of early liquidation. The going-concern concept leads to the proposition that individual financial statements are part of a continuous, inter-related series of statements. This further implies that data communicated are tentative and that current statements should disclose adjustments to past year statements revealed by more recent developments.
The Concept of Money Measurement:
A unit of exchange and measurement is necessary to account for the transactions of business enterprises in a uniform manner. The common denominator chosen in accounting is the monetary unit. Money is the common denominator in terms of which the exchangeability of goods and services, including labor, natural resources, and capital, are measured. Money measurement concept holds that accounting is a measurement and communication process of the activities of the firm that are measurable in monetary terms. Obviously, financial statements should indicate the money used. Money measurement concept implies two limitations of accounting.
First, accounting is limited to the production of information expressed in terms of a monetary unit: it does not record and communicate other relevant but non-monetary information. Secondly, the monetary measurement concept concerns the limitations of the monetary unit itself as a unit of measure. The primary characteristics of the monetary unit—purchasing power, or the number of goods or services that money can acquire—is of concern. Traditionally, financial accounting has dealt with this problem by stating that this concept assumes either that the purchasing power of the monetary unit is stable over time or that the changes in prices are not significant. While still accepted for current financial reporting, the stable monetary unit concept is the object of continuous and persistent criticism.
The Concept of Accounting Period:
Financial accounting provides information about the economic activities of an enterprise for specified time periods that are shorter than the life of the enterprise. Normally, the time periods are of equal length to facilitate comparison. The time period is identified in the financial statements.
The time periods are usually of twelve months. Sometimes quarterly or half-yearly statements are also issued. These are considered interim and different from annual statements. For managerial use, statements covering shorter periods such as a month or a week may also be prepared.
The Concept of Cost:
The cost concept requires that assets be recorded at the exchange price, i.e., acquisition cost or historical cost. Historical cost is recognized as the appropriate valuation basis for recognition of the acquisition of all goods and services, expenses, costs, and equities. For accounting purposes, business transactions are normally measured in terms of the actual prices or costs at the time the transaction occurs, i.e., financial accounting measurements are primarily based on exchange prices at which economic resources and obligations are exchanged.
Thus, the amounts at which assets are listed in the accounts of a firm do not indicate what the assets could be sold for. The historical cost concept implies that since the business is not going to sell its asset as such there is little point in revaluing assets to reflect current values. In addition, for practical reasons, the accountant prefers the reporting of actual costs to market values which are difficult to verify.
How to explain the important Concept of Accounting? Image credit from #Pixabay.
The Concept of Dual-Aspect:
This concept lies at the heart of the whole accounting process. The accountant records events affecting the wealth of a particular entity. The question is—which aspect of this wealth is important? Since an accounting entity is an artificial creation, it is essential to know to whom its resources belong to or what purpose they serve. It is also important to know what kind of resources it controls, e.g., cash, buildings or land.
Accounts recording systems have therefore developed so as to show two main things: (a) the source of wealth, and (b) the form it takes. Suppose Mr. X decides to establish a business and transfers Rs. 1, 00,000 from his private bank account to a separate business account.
He might record this event as follows:
Clearly, the source of wealth must be numerically equal to the form of wealth. Since they are simply different aspects of the same thing, i.e., in the form of an equation: S (sources) must equal F (forms). Moreover, any transaction or event affecting the wealth of entity must have two aspects recorded in order to maintain the equality of both sides of the accounting equation.
If the business has acquired an asset, it must have resulted in one of the following:
Some other asset has been given up.
The obligation to pay for it has arisen.
There has been a profit, leading to an increase in the amount that the business owes to the proprietor.
The proprietor has contributed money for the acquisition of the asset.
This does not mean that a transaction will affect both the source and form of wealth.
There are four categories of events affecting the accounting equation:
Both, sources and forms of wealth, increase by the same amount.
Both, sources and forms of wealth, decrease by the same amount.
Some forms of wealth increase while others decrease without any change in the source of wealth.
Some sources of wealth increase while others decrease without any change in the form in which wealth is held.
The example given above illustrates category (a) since the commencing transaction for the entity results in the source of wealth, and form of wealth, cash, both increasing from zero to Rs. 1,00,000. By contrast, X might decide to withdraw Rs. 20,000 cash from the business.
The financial position of the business entity would result in:
It is essential to appreciate why both sides of the equation decrease. By taking out cash, X automatically reduces his supply of private finance to the business by the same amount. Suppose now that Mr. X buys stocks of goods for Rs. 30,000 with the available cash. His supply of capital does not change, but the composition of the business assets does.
The two aspects of this transaction are not in the same direction but compensatory, an increase in stocks of setting a decrease in cash. Similarly, sources of wealth also may be affected by a transaction. Thus, if X gives his son Y, an Rs. 20,000 share in the business by transferring part of his own interest, the effect is as follows: If, however, X gives Y; Rs. 20,000 in cash privately and Y then puts it into the business, both sides of the equation would be affected. Y’s capital of Rs. 20,000 being balanced by an extra Rs. 20,000 in cash, X’s capital remaining at Rs. 80,000.
What does mean Economic Laws? The Generalization or Law is the establishment of a general truth based on particular observations or experiments. Which trace a causal relationship between two or more phenomena. But economic laws are statements of general tendencies or uniformities in the relationships between two or more economic phenomena. So, what is the question we going to study?
The Concept of Economic Laws: first study their Meaning, Definition, Features, Nature, and finally Limitations.
Meaning and definition of Economic Laws: Economic laws are nothing more than careful conclusions and inferences drawn with the help of reasoning or by the aid of observation of human and physical nature. In everyday life, we see that man is always busy satisfying his unlimited wants with limited means. In doing so, it acts upon certain principles.
Marshall defined economic laws in these words,
“Economic laws, or statements of economic tendencies, are those social laws, which relate to those branches of conduct in which the strength of the motives chiefly concerned can be measured by money price.”
On the other hand, according to Robbins,
“Economic laws are statements of uniformities about human behavior concerning the disposal of scarce means with alternative uses for the achievement of ends that are unlimited.”
These two definitions are common in that they consider economic laws as statements of tendencies or uniformities relating to human behavior.
Features of Economic Law:
The following six points highlight the features of economic laws.
Are not Commands:
Economic laws are not orders of the state (government) and do not command. They formulate based on people’s behavior in the real world.
Are not Exact:
Since economic laws deal with the actions of human beings having free will. They are not as exact as the laws of the natural sciences. They are statements that are true only in general. For example, the statement that men will buy goods at the cheapest available market is true generally but not universally. A man intentionally pays a higher price to help a relative or a friend. But such cases form a small fraction of the total transactions of human beings.
Economists tacitly ignore these exceptional cases and frame them. Their laws on the expectation that men’s actions will, in the great majority of cases, follow a uniform pattern. This makes economic laws generally true, but less exact than physical laws. “Economic laws are probability laws, not exact relationships.” “Abnormal as well as normal patterns of probabilities occur in economics”, as Samuelson has commented.
Statements of Cause and Effect:
Economic laws, like scientific laws, are statements of cause and effect. They attempt to state the effects that will follow from particular causes. Unfortunately, in economic affairs, many factors operate simultaneously. And it is impossible to isolate each factor to find out its effects separately. The qualifying clause “other things remaining the same” (ceteris paribus), uses to get over this difficulty. But in economic life, other things generally do not remain the same. Hence, economic laws are never exact enough to enable accurate predictions or prophecies existing made.
Hypothetical:
Economic laws are hypothetical Economic laws are also hypothetical, i.e. They are conclusions drawn from certain assumptions or hypotheses. But in this, economic laws do not differ from other scientific laws. The laws of science also start from certain hypotheses and deduce certain consequences.
Predictions are Difficult:
As regards making predictions the following example may note. The simple and exact laws of gravitation enable astronomers to make accurate forecasts. But in the case of tides, the level of water depends on so many factors (e.g., the strength of the attracting force, geographical features of the country, etc.) that it is impossible to forecast the level accurately. Marshall, therefore, says, “The laws of economics are to compare with the laws of tides rather than with the simple and exact laws of gravitation”.
There are the Same Physical Laws:
Some laws dealt with in books of economics deal with inanimate nature, e.g., the Law of Diminishing Returns. These laws borrow from other sciences.
Nature of Economic Laws:
The following Nature of Economic Laws below are;
The nature of economic laws is that they are less exact as compared to the laws of natural sciences like Physics, Chemistry, Astronomy, etc. An economist cannot predict with surety what will happen in the future in the economic domain. He can only say what is likely to happen shortly. The reasons why economic laws are not as exact as that of natural sciences are as follows:
First
Natural sciences deal with the lifeless matter. While economics, we are concerned with the man who endows with the freedom of or may act in whatever manner he likes. Nobody can predict with certainty his future actions. This element of uncertainty in human behavior results in making the laws of economics less exact than the laws of natural sciences.
Secondly
In economics, it is very difficult to collect factual data on which economic laws are to be based. Even if the data stands collected it may change at any moment due to sudden changes in the tastes of the people or their attitudes.
Thirdly
Many unknown factors affect the expected course of action and thus can easily falsify economic predictions. Dr. Marshall has devoted one chapter in his famous book “Principles of Economies” to discussing the nature of economic laws. He writes, that laws of economics are to compare with the laws of tides rather than with the simple and exact law of gravitation.
The reason for comparing the laws of economics with the laws of tides by Marshall is that the laws of tides are also not exact. The rise of tides cannot be accurately predicted. It can only say that the tide expects to rise at a certain time. It may or may not rise. Strong wind may change its direction to the opposite side. Instead of rising may fall. So is the case with the laws of economics.
Scientific or Natural or Physical Laws:
Economic laws are like scientific laws which trace out a causal relationship between two or more phenomena. As in natural sciences, a definite result expects to follow from a particular cause in economics. The law of gravitation states that things coming from above must fall to the ground at a specific rate, other things being equal. But when there is a storm, the gravitational force will reduce and the law will not work properly.
As pointed out by Marshall, “The law of gravitation is, therefore, a statement of tendencies”. Similarly, economic laws are statements of tendencies. For instance, the law of demand states that other things remain the same, a fall in price leads to an extension in demand and vice versa. Again, some economic laws are positive like scientific laws. Such as the Law of Diminishing Returns which deals with inanimate nature.
Since economic laws are like scientific laws, they are universally valid. According to Robbins, “Economic laws describe inevitable implications. If the data they postulate are given, then the consequences they predict necessarily follow. In this sense, they are on the same footing as other scientific laws.”
Non-Precise like the Laws of Natural Sciences:
Despite these similarities, economic laws are not as precise and positive as the laws of natural sciences. This is because economic laws do not operate with as much certainty as scientific laws. For instance, the law of gravitation must operate whatever the conditions may be. Any object coming from above must fall to the ground. But demand will not increase with the fall in price. If there is a depression in the economy because consumers lack purchasing power.
Therefore, according to Marshall, “There are no economic tendencies. Which act as steadily and can measure as exactly as gravitation can, and consequently. There are no laws of economics. Which can compare for precision with the law of gravitation”. Their control of experimentation in the natural sciences and the natural scientist can test scientific laws very rapidly by altering natural conditions such as temperature and pressure in their experiments in the laboratory.
But in economics
Controlled experiments are not possible because an economic situation is never repeated exactly at another time. Moreover, the economist has to deal with the man who acts by his tastes, habits, idiosyncrasies, etc. The entire universe or that part of it in which he carries out his research is the economist’s laboratory. As a result, predictions concerning human behavior are liable to error.
For instance, a price rise may not lead to a contraction in demand rather it may expand it. If people fear the shortage of goods in anticipation of war. Even if demand contracts as a result of the price rise. It is not possible to predict accurately how much the demand will contract. Thus economic laws “do not necessarily apply in every individual case. They may not be reliable in the ever-changing environment of the real economy. And they are in no sense, of course, inviolable.”
Non-predictable like the Law of Tide:
But accurate predictions are not possible in economics alone. Even sciences like biology and meteorology cannot predict or forecast events correctly. The law of tide explains why the tide is strong at the full moon and weak at the moon’s first quarter. On this basis, it is possible to predict the exact hour when the tide will rise. But this may not happen. It may rise earlier or later than the predicted time due to some unforeseen circumstances.
Marshall, therefore, compared the laws of economics with the laws of tides “rather than with the simple and exact law of gravitation. For the actions of men are so various and uncertain that the best statements of tendencies, which we can make in a science of human conduct, must need be inexact and faulty.”
Behaviorist:
Most economic laws are behaviorist, such as the law of diminishing marginal utility, the law of Equimarginal utility, the law of demand, etc., which depend upon human behavior. But the behaviorist laws of economics are not as exact as the laws of natural sciences because they are based on human tendencies which are not uniform. This is because all men are not rational beings.
Moreover, they have to act under the existing social and legal institutions of the society in which they live. As rightly pointed out by Prof. Schumpeter: “Economic laws are much less stable than are the ‘laws’ of any physical science…and they work out differently in different institutional conditions”
Indicative:
Unlike scientific laws, economic laws are not assertive. Rather, they are indicative. For instance, the Law of Demand simply indicates that other things being equal, quantity demanded varies inversely with price. But it does not assert that demand must fall when price increases.
Hypothetical:
Prof. Seligman characterized economic laws as “essentially hypothetical” because they assume ‘other things being equal and draw conclusions from certain hypotheses. In this sense, all scientific laws are also hypothetical as they too assume the ceteris paribus clause. For instance, other things being equal, a combination of hydrogen and oxygen in the proportion of 2:1 will form water. If, however, this proportion is varied or/and the required temperature and pressure are not maintained, water will not be formed.
Still, there is a difference between hypothetical elements present in economic laws and against scientific laws. It is more pronounced in the former because economics deals with human behavior and natural sciences with the matter. But as compared with the laws of other social sciences, the laws of economics are less hypothetical but more exact, precise, and accurate.
This is because economies possess the measuring rod of money which is not available to other social sciences like ethics, sociology, etc. which makes economics more pragmatic and exact. Despite this, economic laws are less certain than the laws of social sciences because the value of money does not always remain constant. Rather, it changes from time to time.
Truisms or Axioms:
Certain generalizations in economics may state as a truism. They are like axioms and do not have any empirical content, such as ‘saving is a function of income,’ ‘human wants are numerous’, etc. Such statements are universally valid and need no proof. So they are superior to scientific laws. But all economic laws are not like axioms and hence not universally valid.
Historico-Relative:
On the other hand, economists of the Historical School regarded economic laws as abstractions that are historical-relative, that is economic laws have only a limited application to a given time, place, and environment.
They have limited validity to certain historical conditions and have no relevance to the analysis of social phenomena outside that. But Robbins does not agree with this view because according to him, economic laws are not historical-relative. They are simply relative to the existence of certain conditions which assume to give. If the assumptions are consistent with one another and if the process of reasoning is logical, economic laws would be universally valid.
But these are big “ifs”. We, therefore, agree with Prof. Peterson that economic laws “are not detailed and photographically faithful reproductions of a portrait of the real world, but are rather simplified portraits whose purpose is to make the real world intelligible.”
Economic Laws: Meaning, Definition, Features, Nature, and Limitations. Image credit from #Pixabay.
Limitation of Economic Laws:
One major drawback of economic laws is they lack generality. For example, the laws developed to explain the nature and functioning of capitalist economies do not have any relevance to socialist countries. For example, Alfred Marshall developed the laws of demand and supply which apply in a free market in the absence of government intervention. Such laws do not apply in erstwhile countries like the former Soviet Union where the price (market) system yielded place to the planning system.
In a planned economy, the market mechanism replaces by government allocation or rationing. So, the question of applying the laws of demand and supply does not arise. Thus, economic laws lack generality and are not universally applicable. Furthermore, some laws of economics which have been developed in the context of advanced industrial countries may not find application in developing countries like India.
As V. K. R. V. Rao has pointed out, the multiplier principle, as enunciated by Keynes in the context of the advanced countries of the world, does not work in developing countries like India. This is attributable to the structure of such economies. Similarly, the Quantity Theory of Money has been developed in the context of industrially advanced countries. It seeks to establish an exact, proportional relationship between money and prices.
But, it cannot explain’ the present price situation in India.
Here, inflation is not a purely monetary phenomenon as predicted by the Quantity Theory. These two examples make one thing clear at least — the laws and theories of economics developed in the context of advanced countries cannot be applied in developing countries like India. There is a feeling among some groups of economists that, people in developing countries like India behave and respond differently from those in advanced countries.
For example, greater self-consumption of farmers in India explains why the supply response of agricultural commodities is not always favorable in the event of a rise in the price of agricultural products. It is often observed that, if the price of a particular commodity rises, farmers produce less of it to maintain the same level of income. Thus,’ they not only produce less at a higher price but generate less marketable surplus when the price rises. Thus, the marketable surplus of, say, wheat varies inversely with its price.
But, in developed countries, it is observed that, as usual, the supply curve of agricultural output slopes upward from left to right, and the marketable surplus increases when the price rises. All these examples make it abundantly clear that most of the laws and principles of economics which have been developed in the context of advanced countries cannot be applied in developing countries like India.
What is Free Trade? Free trade area is a trade policy that does not restrict imports or exports; it is the idea of the free market as applied to international trade. In government, free trade is predominately advocated by political parties that hold right-wing or liberal economic positions, while economically left-wing political parties generally support protectionism, the opposite of free trade. So, what is the discussing topic; Free Trade Area, Short Explain, Advantages and Disadvantages in Free Trade.
The Concept of Study; first Free Trade Area, after Short Explain of Free Trade, then discuss Advantages and Disadvantages in Free Trade.
Free trade: The system in which goods, capital, and labor flow freely between nations, without barriers that could hinder the trade process. Many nations have free trade agreements, like NAFTA (North America Free Trade Agreement, between Canada, the United States, and Mexico) and several international organizations promote free trade between their members. A number of barriers to trade are struck down in a free trade agreement. Taxes, tariffs, and import quotas are all eliminated, as are subsidies, tax breaks, and other forms of support to domestic producers. In the words of Adam Smith:
“After all why the protection in needed just to save the gold from going into the other country. I do not give much importance to it. It is a kind of commodity which is less important than other commodities because goods can serve many other purposes besides purchasing money but money can serve many other purposes besides purchasing goods. If protection is levied, it will divert industries from more advantageous trade to less advantageous trade”.
Free Trade Area (FTA):
Free trade area is a designated group of countries that have agreed to eliminate tariffs, quotas and preferences on most (if not all) goods and services traded between them. It can be considered the second stage of economic integration. Countries choose this kind of economic integration form if their economic structures are complementary. If they are competitive, they will choose the customs union.
A group of countries, such as the North American Free Trade Area (Canada, Mexico and the United States), pledged to remove barriers to mutual trade, though not to movements of labor or capital. Each member continues to determine its own commercial relations with non-members so that a free trade area is distinguished from a customs union by the need to prevent the most liberal of its members from providing an open door for imports. This is done by agreeing rules of origin, which set the terms on which goods manufactured outside the area may move from one state to another within it.
The illustration of a Free Trade Area:
Unlike a customs union, members of a free trade area do not have the same policies with respect to non-members, meaning different quotas and customs. To avoid evasion (through re-exportation) the countries use the system of certification of origin most commonly called rules of origin, where there is a requirement for the minimum extent of local material inputs and local transformations adding value to the goods. Goods that don’t cover these minimum requirements are not entitled to the special treatment envisioned in the free trade area provisions.
Cumulation is the relationship between different FTAs regarding the rules of origin sometimes different FTAs supplement each other, in other cases, there is no cross-cumulation between the FTAs. A free trade area is a result of a free trade agreement (a form of trade pact) between two or more countries. Free trade areas and agreements (FTAs) are cascadable to some degree if some countries sign agreement to form free trade area and choose to negotiate together (either as a trade block or as a form of individual members of their FTA) another free trade agreement with some external country (or countries) then the new FTA will consist of the old FTA plus the new country (or countries).
Within an industrialized country, there are usually few if any significant barriers to the easy exchange of goods and services between parts of that country. For example, there are usually no trade tariffs or import quotas; there are usually no delays as goods pass from one part of the country to another (other than those that distance imposes); there are usually no differences of taxation and regulation. Between countries, on the other hand, many of these barriers to the easy exchange of goods often do occur. It is commonplace for there to be import duties of one kind or another (as goods enter a country) and the levels of sales tax and regulation often vary by country.
The aim of a free trade area is to so reduce barriers to easy exchange that trade can grow as a result of specialization, the division of labor and most importantly via (the theory and practice of) comparative advantage. The theory of comparative advantage argues that in an unrestricted marketplace (in equilibrium) each source of production will tend to specialize in that activity where it has comparative (rather than absolute) advantage.
The theory argues that the net result will be an increase in income and ultimately wealth and well-being for everyone in the free trade area. However, the theory refers only to aggregate wealth and says nothing about the distribution of wealth. In fact, there may be significant losers, in particular among the recently protected industries with a comparative disadvantage. The proponent of free trade can, however, retort that the gains of the gainers exceed the losses of the losers.
Short Explain of Free Trade:
The commercial policy is concerned with whether a country should adopt the policy of free trade or of protection. If the policy of protection of domestic industries is adopted, the question which is faced whether protection should be granted, through imposing tariffs on imports or through the fixation of quota or through licensing of imports. The commercial policy has been the subject of heated discussion since the time of Adam Smith who advocated for free trade and recommended that tariffs should be removed to avail of the advantages of free trade.
Even today, economists are divided over this question of commercial policy. Various arguments have been given for and against free trade. If the policy of protection of domestic industries is adopted, the question is whether for this purpose tariffs should be imposed on imports or quantitative restrictions through quota and licensing be applied. The readers should be knowing that a Bharatiya Janata Party in India has been demanding a policy of ‘Swadeshi’ which in essence means that domestic industries should be protected against low-priced imports of goods from abroad, that is, free trade should not be allowed.
Besides Adam Smith, the other famous classical economist David Ricardo in his famous work “On the Principles of Political Economy and Taxation” also defended free trade to promote efficiency and productivity in the economy. Adam Smith and the other earlier economists thought that it pays a country to specialize in the production of those goods it can produce more cheaply than any other country and import those goods it can obtain at less cost or price than it would cost to produce them at home. This means they should specialize according to absolute cost advantage.
However, Ricardo put forward the ‘Theory of Comparative Cost’ where he demonstrated that to obtain benefits from the trade it is not necessary that countries should produce these goods for which their absolute cost of production is the lowest. He proved that it could pay a country to import a good even though it could produce that good at a lower cost if its cost is relatively lower in the production of some other good.
Ricardo’s theory of trade rests on the idea of relative efficiency or comparative cost. Despite the classical arguments for free trade to promote efficiency and well-being of the people, various countries have been following the protectionist policies which militate against free trade. By imposing heavy tariff duties on imports of goods or fixing quotas of imports they have prevented free trade to take place between countries. Several arguments have been given in favor of protection. In what follows we spell out this free trade vs. protection controversy.
Advantages of Free Trade:
The advocates of free trade put forward the following advantages of free trade:
International Specialization: Free trade causes international specialisation as it enables the different countries to produce those goods in which they have a comparative advantage. International trade enables countries to obtain the advantages of specialization. First, a great variety of products may be obtained. If there were no international trade, many countries would have to go without some products. Thus, Iceland would have no coal, Nepal no oil, Spain no gold and Britain no tea. Second, specialization leads to an increase in total production.
Increase in World Production and World Consumption: International trade permits industry to take full advantages of the economies of scale (large-scale production). If certain goods were produced only for the home market, it would not be possible to achieve the full advantage of large-scale production. So, free trade increases the world production and the world consumption of internationally traded goods as every trading country produces only the selected goods at lower costs.
Safeguard against the Advent of Monopolies: Thirdly, if there were no international competition, the home market would be so narrow that it would be comparatively easy for the combinations of firms in many industries, e.g., motor cars, paper, and electrical goods, to exercise some control over it. Free trade is often an efficient way of breaking up domestic monopolies.
Links with Other Countries: International trade and commercial relations often lead to an interchange of knowledge, ideas and culture between nations. This often produces a better understanding of those countries and leads to amity and theory reduces the possibility of commercial rivalry and war.
Higher Earnings of the Factors of Production: Furthermore, free trade increases the earnings of all the factors as they are engaged in the production of those goods in which the country has a comparative advantage. It would increase the productivity of each factor.
Benefits to Consumers: On account of free trade the consumers of the different countries get the best quality foreign goods, often of a wider range of choice, at low prices.
Higher Efficiency and Optimum Utilisation of Resources: Free trade stimulates home producers, who face foreign competition, to put forth their best effort and thus increase managerial efficiency. Again, as under free trade, each country produces those goods in which it has the best advantages, the resources (both human and material) of each country are utilized in the best possible manner.
Evil Effects of Protection: Free trade is also advocated because it can remove the evil effects of protection, such as high prices, the growth of monopolies, etc. It is also immune from such abuses as ‘corruption and bribery’ and the creation of vested interests which often arise under a protectionist system.
If the policy of free trade is adopted by all the countries of the world, it promotes a mutually profitable international division of labor which leads to specialization in the production of those commodities in which they have the greatest relative advantage. The diversification of human and material resources of the country into remunerative channels results in increasing the real national product of all the countries. The standard of living of people all over the world goes up.
Free trade is undoubtedly the best from the point of view of the consumers because they can get a wider range of goods and commodities at lower prices. When protection is levied, the choice is reduced and the prices of commodities go up.
Disadvantages of Free Trade:
But, free trade is opposed on several grounds. The following Disadvantages of Free Trade below are:
Excessive Dependence: As a country depends too much on foreign countries, an outbreak of war may upset its economy. During the 1991 Gulf War America refused to sell its products to its enemies.
Obstacles to the Development of Home Industries: If foreign goods are imported freely, the domestic industries of the developing countries would not be able to develop rapidly due to the superior strength of foreign industries.
Empire-Builder: Under free trade, the foreign traders particularly the dominant ones may try to become empire-builders in the future. In the past, free trade gave rise to colonialism and imperialism.
Import of Expensive Harmful Goods: A country may also import expensive and harmful foreign goods.
Rivalry and Friction: Finally, free trade sometimes creates rivalry and frictions among the trading nations. In other words, commercial rivalries resulting from trade often lead to war. This is an important point.
One of the most captivating arguments put forth against free trade is that it leads to over-dependence upon other countries. In the time of war or any other emergency, the over-specialized countries may not be able to supply the required goods to the non-specialized ones.
It is pointed out that under the system of free trade, the economically backward country remains always at a disadvantage with the economically advanced country. So in order to build up industries, the backward nations must erect tariff walls the USA. and Germany in the late 19th century abandoned free trade because they were late in entering the industrial field. They developed the industries behind tariff barriers. So is also the case with India.
Free Trade Area, Short Explain, Advantages and Disadvantages in Free Trade. Image credit from #Pixabay.
What does the Organization Mean? For entrepreneurial productive activities, organizes various factors of production such as land, labor, capital, machinery, etc. for channeling. Eventually, the product reaches consumers through different agencies. Business activities are divided into different functions, these tasks are assigned to different individuals. So, what are we going to discuss; The different types of Organization and their Meaning with Merits and Demerits.
If there are different types of Organizations in different departments, their Merits and Demerits will also be there, and together with their meanings.
There should be the achievement of common business goals with various personal endeavors. An organizational organization has a structural framework of the duties and responsibilities required for personnel in carrying out various tasks with the approach of achieving business goals. The management attempts to combine various business activities to meet pre-determined goals. Definition:“The organization is the process of identifying and formulating the process of establishing relationships with the purpose of executing, defining and delegating and fulfilling objectives, to work the most effective way of working people.” In Alan’s words, an organization is a tool to achieve organizational goals. The work of each person is defined and the authority and responsibility are decided to fulfill it.
Different types of Organizations:
Project organization
Functional organization
Matrix organization
Line organization, and
Line and staff organization
Project Organization:
Meaning of the project organization: Project organization consists of several horizontal organizational units to complete long-term projects. Each project is extremely important for the organization. Therefore, a team of experts has been formed from different areas for each project. The size of the project team varies from project to project. The activities of the project team are coordinated by the project manager, who has the right to seek advice and assistance of experts within and outside the organization.
The main concept of the project organization is to gather a team of experts to work on and complete a specific project. Project employee is different and independent of functional departments. The project organization is employed in professional areas such as aerospace, construction, aircraft manufacturing and management consulting etc.
Qualifications and Merits of the project organization:
It focuses on the demand for a complex project.
It completes the completion of the organization without disturbing the normal routine of any organization.
It provides a logical point of view for any challenge in completing a major project with a definite start, end, and clearly defined result.
Project organization Demerits or faults:
Organizational uncertainty is because a project manager has to deal with professionals from different fields.
There can be inter-departmental conflicts with organizational uncertainties.
There is a great fear among the personnel that the completion of the project can lead to job loss. This sense of insecurity can cause great anxiety about career progression.
Functional Organization:
Functional organization means: In this type of organization, the number of experts each organization has near a particular task or group of related organizations. Every expert has control over the function under his charge, it does not matter where this ceremony is done in the organization. He controls all those working in that functional area.
For example, a Human Resources Department will recruit, train and develop the necessary people for all other departments of the organization. Each employee receives orders and is responsible for many experts. The functional organization can also be used at a higher level at the lower level of management. At the higher level, it involves the group of all functions to be included in the main functional departments and keeping each department under an expert executive. Each functional issues the order in the whole organization in relation to the tasks in the main question.
Qualifications and merits of functional organization:
There is a full specialization of work and each worker gets expert guidance from many experts.
Work is done more effectively because each manager is responsible for one task rather than the abundance of tasks.
The growth and expansion of the enterprise are not limited to the capabilities of some line managers.
The fault or Demerits of functional organization:
It violates the principle of unity of the command because a person receives orders from many experts. It leads to conflict and poor discipline.
Responsibility is divided. It is not possible to decide the responsibilities of specific individuals.
There is a delay in decision-making. Decision problems cannot be taken quickly to include many experts because all functional managers need consultation.
Matrix Organization:
Meaning of Matrix Organization: The matrix organization or grid organization has a hybrid structure with the combination of the functional department of two complementary structures with the net project structure. Functional structure matrix is the permanent feature of the organization and retains the authorization for the overall operation of the functional units.
The matrix organization has been developed to meet the needs of a large and complex organization, for which it is necessary to make the structure more flexible and technically oriented rather than structural structures. Temporary project teams are consistent with successful completion of special projects. The right of the project manager flows horizontally while the functional manager’s right flows vertically.
Properties or Merits of Matrix Organization:
It helps individually focus on focus, talent, and resources on a single project which provides better planning and control.
It provides an environment in which professionals can test their abilities and make the most contribution.
This project gives motivation to the employees because they can focus directly on the completion of a particular project.
Matrix organization Demerits or faults:
It violates the principle of unity of order. Each employee has two senior executives- one functional superior and other projects are better.
The scalar theory is also violated because there is no fixed hierarchy.
Organizational relations here are more complex. In addition to formal relationships, informants also arise which cause problems of coordination.
Line Organization:
Meaning of Line Organization: This is the basic framework for the entire organization. It represents a direct vertical relationship through which the authority flows. This is the simplest and oldest form of internal organization. This organization is also known as the Scalar organization. Authorization flows from top to lower level. Every person is in charge of all the persons under him and he himself is responsible for his superiority.
All persons responsible for the execution of the authority flows through vertical and top persons. On the other hand, liability flows upwards. Everyone is responsible for their work and is responsible for their senior. Since authority and responsibility flows in a straightforward straight line, it is called line organization. This form of organization is followed in military establishments.
Line organization qualifications and merits:
It is easy to set up and easy to understand by employees. There is no complexity in this organization because every person is responsible for only one superior.
Line organization helps in fixing the rights and responsibilities of each person in the organization. The authority is given in the context of the assignment of the work.
Since only one person is in charge of division or division, the decisions are early. The unity of command theory is followed.
Line organization’s demand and Demerits:
There is a lack of coordination between different departments.
The final authority to take all the decisions is with the officers. The flow of information is downwards.
Business is dependent on some key individuals and the sudden disappearance of such persons from the scene can lead to instability.
Line and Staff Organization:
Meaning of Line and Staff Organization: Because of the underlying lack of line organization and functional organization, they are rarely used in pure forms. Line organization is very focused and the functional organization is very much spread. New Organization Structure Line and Staff Organization have been developed to eliminate the shortage of both types of organizations.
Properties or Merits of Line and Staff Organization:
Have a schematic specialization. And, there is a well-defined authority and responsibility. The line of command is maintained.
Ideal and executive functioning is the division.
Employees with their expert knowledge provide opportunities for line officers to adopt a rational multi-dimensional approach to a problem.
This type of organization nurtures growth because each person grows in their own characteristics. It also helps coordinate through co-operation and leadership.
Drawbacks or Demerits of Line and Staff Organization:
On occasions, lines and employees may vary. It can be from the conflict of interest and inhibit harmony relations.
Incompetent line officers have a misinterpretation of expert advice.
Employees feel less without conditions of authority.
Employees become ineffective in the absence of authority.
The different types of Organization and their Meaning with Merits and Demerits. Image credit fro #Pixabay.
Concepts of Organization:
There are two concepts of organization:
Static Concept:
Under the static concept, the term ‘organisation’ is used as a structure, an entity or a network of specified relationship. In this sense, an organization is a group of people bound together in a formal relationship to achieve common objectives. It lays emphasis on position and not on individuals.
Dynamic Concept:
Under the dynamic concept, the term ‘organisation’ is used as a process of an on-going activity. In this sense, an organization is a process of organizing work, people and the systems. It is concerned with the process of determining activities which may be necessary for achieving an objective and arranging them in suitable groups so as to be assigned to individuals. It considers the organization as an open adoptive system and not as a closed system. Dynamic concept lays emphasis on individuals and considers the organization as a continuous process.
Learn about the different sales forecasting methods, their importance, advantages, and limitations. Optimize your sales strategy with expert insights. Sales Forecasting; Every manufacturer makes an estimation of the sales likely to take place in the near future. It gives focus to the activities of a business enterprise. In the absence of sales forecast, a business has to work at random. Forecasting is one of the important aspects of administration. The comer-stone of successful marketing planning is the measurement and forecasting to market demand. The sales forecast is the estimate of the number of sales to be expected for an item/product or products for a future period of time. So, what we discussing is – Types, Importance, Advantages, and Limitations of Sales Forecasting.
The Concept of Forecasting explains Sales Forecasting by Types, Importance, Advantages, and Limitations.
In this article is discussing, Sales Forecasting: Types of Sales Forecasting, Importance of Sales Forecasting, Advantages of Sales Forecasting, and Limitations of Sales Forecasting. So, let’s discuss; Meaning of Sales Forecasting: Any forecast can be termed as an indicator of what is likely to happen in a specified future time frame in a particular field. Therefore, the sales forecast indicates as to how much of a particular product is likely to be sold in a specified future period in a specified market at the specified price. Accurate sales forecasting is essential for a business house to enable it to produce the required quantity at the right time.
Types of Sales Forecasting:
The following Types of Sales Forecasting below are:
Economic: This type of forecast is important to understand the general economic trend through a careful study of Five Year Plans, Gross national products. National income, Government expenditure, Unemployment, Consumer spending habits etc. This is in order to have an accurate forecast. Big companies, in India, adopt this method.
Industry: The future market demand is calculated through industrial forecast or market forecast. The expected sales forecasts of all the industries, in the same line of business are combined. Market demand may be affected by controllable-price, distribution, promotion, etc., and uncontrollable-demographic, economic, political, technological development, cultural activities etc. The executive must take into account all these conditions while forecasting.
Company: The third step goes to the firm concerned to look into the market share, for which forecast is to be made. By considering both controllable and uncontrollable, based on chosen marketing plans within the firm, with that of other industries, steps are taken in formulating forecasts.
There are three classes (Periods) of sales forecasts:
Short-run Forecast:
It is also known as operating forecast, covering a maximum of one year or it may be half-yearly, quarterly, monthly and even weekly. This type of forecasting can be advantageously utilized for estimating stock requirements, providing working capital, establishing sales quotas, fast-moving factors. It facilitates the management to improve and coordinate the policies and practice of Marketing-production, inventory, purchasing, financing etc. The short-run forecast is preferred to all types and brings more benefits than other types.
Purpose of Short-Term Forecasting:
Production Policy: By knowing the future demand the decision regarding production policy can be taken so that there is no problem of overproduction and short supply of input materials.
Material Requirement Planning: By knowing the future demand, the availability of the right quantity and quality of materials could be ensured.
Purchase Procedure: The purchase programme could be decided depending on the material requirements.
Inventory Control: Proper control of inventory could be ensured so that inventory carrying cost is minimum or optimum.
Equipment Requirement: The decision regarding procurement of new equipment in view of the capacity and capability of the existing equipment can be taken.
Man-Power Requirement: The decision regarding recruitment of extra labor on the full time or part time could be taken.
Finance: The arrangement of funds for the purchase of raw materials, machines, and parts could be made.
Medium-run Forecast:
This type of forecast may cover from more than one year to two or four years. This helps the management to estimate probable profit and control over budgets, expenditure, production etc. The factors-price trend, tax policies, institutional credit etc., are specially considered for a good forecast.
Long-run Forecast:
This type of forecast may cover one year to five years, depending on the nature of the firm. Seasonal changes are not considered. The forecaster takes into account the population changes, competition changes, economic depression or boom, inventions etc. Also, This type is good for adding new products and dropping old ones. The forecasting that covers a considerable period of time, such as 5, 10, 20 years is called long-term forecasting.
The period no doubt depends upon the nature of business or type of the product the firm is engaged in manufacturing. In many industries like steel plants petroleum refinery or paper mills where the total investment for the equipment/infrastructure is quite high, long-term forecasting is needed.
Purposes of Long-Term Forecasting:
To plan for the new unit of production, or expansion of the existing unit or diversification of lines of production or shut down of the existing units depending upon the level of demand.
Also, To plan the long-term financial requirement for various needs.
To make proper arrangement for training the personnel so that manpower requirement of desired expertise can be met in future.
Importance of Sales Forecasting:
The following Importance of Sales Forecasting below are:
Supply and demand for the products can easily be adjusted, by overcoming temporary demand, in the light of the anticipated estimate; and regular supply is facilitated.
A good inventory control is advantageously benefited by avoiding the weakness of understocking and overstocking.
Allocation and reallocation of sales territories are facilitated.
It is a forward planner as all other requirements of raw materials, labor, plant layout, financial needs, warehousing, transport facility etc., depend in accordance with the sales volume expected in advance.
Sales opportunities are searched out on the basis of forecast; mid thus discovery of selling success is made.
It is a gear, by which all other activities are controlled as a basis of forecasting.
Advertisement programmes are beneficially adjusted with full advantage to the firm.
It is an indicator to the department of finance as to how much and when finance is needed; it helps to overcome difficult situations.
It is a measuring rod by which the efficiency of the sales personnel or the sales department, as a whole, can be measured.
Sales personnel and sales quotas are also regularized-increasing or decreasing-by knowing the sales volume, in advance.
Additional:
It regularizes productions through the vision of sales forecast and avoids overtime at high premium rates. It also reduces idle time in manufacturing.
As is the sales forecast, so is the progress of the firm. The master plan or budget of a firm is based on forecasts. “The act of forecasting is of great benefit to all who take part in the process and is the best means of ensuring adaptability to changing circumstances. The collaboration of all concerned leads to a unified front, an understanding of the reasons for decisions, and a broadened outlook.”
Sales forecast enables all the departments of the business to work together in proper coordination and cooperation.
Sales forecast helps in product mix decisions as well. It enables the business to decide whether to add a new product to its product line or to drop an unsuccessful one.
The sales forecast is a commitment on the part of the sales department and it must be achieved during the given period, and.
It helps in guiding marketing, production and other business activities for achieving these targets.
Advantages of Sales Forecasting:
Sales are the lifeblood of every company. The advantages of forecasting your company’s sales lie mainly in giving you a firm idea of what to expect in the coming months. A standard sales forecast looks at conditions present in your business during previous months and then applies assumptions regarding customer acquisition, the economy, and your product and service offerings. Forecasting sales identifies weaknesses and strengths before you set your budget and marketing plans for the next year, allowing you to optimize your purchasing and expansion plans.
The following Advantages of Sales Forecasting are four types:
1. Cash Flow:
Forecasting helps manage cash flow by predicting future sales and ensuring that the company can meet its financial obligations. This foresight can prevent potential shortfalls and ensure that there are sufficient funds for operations, investments, and emergencies.
2. Purchasing:
Sales forecasting aids in planning purchasing activities. By anticipating future demand, companies can make timely and cost-efficient procurement decisions, avoiding both overstocking and stockouts.
3. Planning:
It assists in strategic planning by providing a basis for making informed decisions. This includes production planning, workforce planning, and setting realistic sales targets and marketing strategies.
4. Tracking:
Sales forecasting offers a framework for tracking progress and performance. This allows management to monitor actual sales against forecasts, identify variances, and adjust strategies accordingly to stay on track with company goals.
By leveraging these advantages, businesses can enhance their operational efficiency, financial stability, and overall market competitiveness.
Limitations of Sales Forecasting:
In certain cases forecast may become inaccurate. The failure may be due to the following factors:
Fashion:
Changes are throughout. Present style may change any time. It is difficult to say as to when a new fashion will be adopted by the consumers and how long it will be accepted by the buyers. If our product is similar to fashion and is popular, we are able to have the best result; and if our products are not in accordance with the fashion, then sales will be affected.
Lack of Sales History:
A sales history or past records are essential for a sound forecast plan. If the past data are not available, then the forecast is made on guess-work, without a base. Mainly a new product has no sales history and forecast made on guess may be a failure.
Psychological Factors:
Consumer’s attitude may change at any time. The forecaster may not be able to predict exactly the behavior of consumers. Certain market environments are quick in action. Even rumors can affect market variables. For instance, when we use a particular brand of soap, it may generate itching feeling on a few people and if the news spread among the public, sales will be seriously affected.
Other Reasons:
It is possible that the growth may not remain uniform. It may decline or be stationary. The economic condition of a country may not be favorable to the business activities-policies of the government, the imposition of controls etc. It may affect the sales.
Basic Limitations of Sales Forecasting;
The tastes and preferences of the buyers do not remain constant. A sudden change in the preference of the buyers may render the forecasts meaningless.
The economic conditions prevailing in every country also do not remain stable. The purchasing power of money, desire to save and invest etc., are some of the important economic factors having a bearing on sales forecast.
The political conditions in a State also influence sales forecast. The policies of the Government regarding business change often. A sudden hike in excise duty or sales tax by the Government may affect sales.
The entry of competitors may also affect sales. A firm enjoying monopoly status may lose such a position if the buyers find the competitors’ products more superior.
Progress in science and technology may render the present technology obsolete. As a result, products which are right now enjoying a good market may lose the market and the demand for products made using the latest technology will increase. This is particularly true in the case of the market for electronic goods, computer hardware, software and so on.
The methods of sales forecasting discussed above have respective advantages and limitations or merits and demerits. No single method may be suitable. Therefore, a combination method is suitable and may give a good result. The forecaster must be cautious while drawing decisions on sales forecast. Periodical review and revision of sales forecast may be done, in the light of performance. A method which is quick, less costly and more accurate may be adopted.
Explore business forecasting with insights on its meaning, definition, types, and the need of forecasting for strategic planning and informed decision-making. What is Business Forecasting? It is an estimate or prediction of future developments in business such as sales, expenditures, and profits. Given the wide swings in economic activity and the drastic effects these fluctuations can have on profit margins. It is not surprising that business forecasting has emerged as one of the most important aspects of corporate planning.
The Concept of Management explains Business Forecasting in the points of Meaning, Definition, Types, and Need.
In this article discussingBusiness Forecasting: First Meaning of Business Forecasting, then the second Definition of Business Forecasting, the third Types of Business Forecasting, and finally Need of Business Forecasting. Forecasting has become an invaluable tool for business people to anticipate economic trends and prepare themselves either to benefit from or to counteract them.
If, for instance, business people envision an economic downturn, they can cut back on their inventories, production quotas, and hiring. If, on the contrary, an economic boom seems probable, those same business people can take the necessary measures to attain the maximum benefit from it. Good business forecasts can help business owners and managers adapt to a changing economy.
Meaning of Business Forecasting:
Business forecasting is an act of predicting the future economic conditions on the basis of past and present information. It refers to the technique of taking a perspective view of things likely to shape the turn of things in the foreseeable future. As the future is always uncertain, there is a need for an organized system of forecasting in business.
Thus, scientific business forecasting involves:
Analysis of the past economic conditions, and.
Analysis of the present economic conditions; so as to predict the future course of events accurately.
In this regard, business forecasting refers to the analysis of the past and present economic conditions with the object of drawing inferences about the future business conditions.
Definition of Business Forecasting:
In the words of Allen,
“Forecasting is a systematic attempt to probe the future by inference from known facts. The purpose is to provide management with information on which it can base planning decisions.
Leo Barnes observes,
“Business Forecasting is the calculation of reasonable probabilities about the future, based on the analysis of all the latest relevant information by tested and logically sound statistical econometric techniques, as interpreted, modified and applied in terms of an executive’s personal judgment and social knowledge of his own business and his own industry or trade.”
In the words of C.E. Sulton,
“Business Forecasting is the calculation of probable events, to provide against the future. It, therefore, involves a ‘look ahead’ in business and an idea of predetermination of events and their financial implications as in the case of budgeting.”
According to John G. Glover,
“Business Forecasting is the research procedure to discover those economic, social and financial influences governing business activity, so as to predict or estimate current and future trends or forces which may have a bearing on company policies or future financial, production and marketing operations.”
The essence of all the above definitions is that business forecasting is a technique to analyze the economic. Social and financial forces affecting the business with an object of predicting future events on the basis of past and present information.
No business is completely independent and hence general business forecast is undertaken. It helps to read the future conditions for business and to predict the probable changes in business conditions that are likely to occur in the near future. Every business is affected by the conditions of the c community in which it is located.
We should not be under the impression that only business conditions influence the general business. Political conditions, fiscal policy, controls, population, and national income etc. have a direct bearing on the business. So, it is necessary for the manager to take into consideration all these factors. While forecasting the prospects of his enterprise.
Sales Forecast:
This type of forecasting decides the fate of the organization as the sales determine the success of the company. Therefore, sales forecasting should be undertaken with due care and precaution. So as to see that whatever planning department has decided is carried out to promote the sales. It is from this point of view only that sales forecasting has been deemed to be as a guiding factor in planning an important aspect of the organizational setup.
In this connection O’ Donnell points out that,
“It is the sales forecast that must set the stage for internal planning, business expenses, capital outlays. Policies of all kinds are made the purpose ordinarily of maximizing profits obtainable from expected sales, whether this forecast is for a period of months or for a period of years; it is the key to future business plans.”
Capital Forecast:
Every business enterprise will have to think of its financial plans. It should be determined so as to meet the needs of the company. With this object in view, forecasting of capital requirements has become a necessity and is taken as a primary step in the organization.
In every business concern, the capital is required not only to meet fixed and working capital. But also for depreciation, replacement, development, reorganization etc. Thus accurate forecasting helps the organization to employ its capital to the fullest extent and can get the optimum returns on its investment.
The Need for Business Forecasting:
Some of the important needs of business forecasting are listed below:
Production Planning:
The rate of producing the products must be matched with the demand which may be fluctuating over the time period in the future. Since its time consuming to change the rate of output of the production processes, so production manager needs medium range demand forecasts to enable them to arrange for the production capacities to meet the monthly demands which are varying.
Financial Planning:
Sales forecasts are driving force in budgeting. Sales forecasts provide the timing of cash inflows and also provide a basis for budging the requirements of cash outflows for purchasing materials, payments to employees and to meet other expenses of power and utilize etc. Hence forecasting helps finance manager to prepare budgets taking into consideration the cash inflow and cash outflows.
Economic Planning:
Forecasting helps in the study of macroeconomic variables like population, total income, employment, savings, investment, general price-level, public revenue, public expenditure, the balance of trade, the balance of payments and a host of other macro aspects at national or regional levels.
The forecasts of these variables are generally for a long period of time ranging between one year to ten or twenty years ahead. Much would depend on the perspective of planning, longer the perspective longer would be period of forecasting. Such forecasts are often called as projections. These are helpful not only for planning and public policy making. But they also include likely economic environment and aid formulation of business policies as well.
Workforce Scheduling:
The forecast of monthly demand may further be broken down to weekly demands and the workforce may have to be adjusted to meet these weekly demands. Hence, forecasts are needed to enable managers to get tuned with the workforce changes to meet the weekly production demands.
Decisions Making:
The goal of the forecaster is to provide information for decision making. The purpose is to reduce the range of uncertainty about the future. Businessmen make forecasts for the purpose of making profits. In business, the forecast has to be done at every stage.
A businessman may dislike statistics or statistical theories of forecasting, but he can not do without making forecasts. Business plans of production, sales, and investment require predictions regarding demand for the product, the price at which the product can be soled and the availability of inputs. The forecast for demand is the most crucial.
Operating budgets of various departments of a company have to be based upon the expected sales. Efficient production schedules, minimization of operating cost and investment in fixed assets is when accurate forecasts recording sales and availability of inputs are available.
Controlling Business Cycles:
It is commonly believed that business cycles are always very harmful in their effects. Abrupt rise and fall in the price level injurious not only to businessmen. But to all types of persons, industries, trade, agriculture. All suffer from the painful effects of depression.
Trade cycle increase the risk of business; create unemployment; induce speculation and discourage capital formation. Their effects are not confined to one country only. Business forecasting reduces the risk associated with business cycles.
Prior knowledge of a phase of a trade cycle with its intensity and expected period of happening may help businessmen, industrialist, and economists to plan accordingly to reduce the harmful effects of trade cycle’s statistics is thus needed for the purpose of controlling the business-cycles.
What is the Meaning of Ratio Analysis? Ratio analysis refers to the analysis and interpretation of the figures appearing in the financial statements (i.e., Profit and Loss Account, Balance Sheet and Fund Flow statement, etc.). So, What we discussing is – Importance, Objectives, Advantages of Ratio Analysis. It is a process of comparison of one figure against another. It enables users like shareholders, investors, creditors, government, and analysts, etc. to get a better understanding of financial statements.
The Concept of Accounting explains Ratio Analysis in the points of Importance, Objectives, Advantages.
Definition of Ratio Analysis: Define the term ratio analysis 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 conditions, can determine.” Ratio analysis is a very powerful analytical tool useful for measuring the performance of an organization.
Accounting ratios may just use as a symptom like blood pressure, pulse rate, body temperature, etc. The physician analyses this information to know the causes of illness. Similarly, the financial analyst should also analyze the accounting ratios to diagnose the financial health of an enterprise. In this article discussing Ratio Analysis: First Importance of Ratio Analysis, then second Objectives of Ratio Analysis, and finally Advantages of Ratio Analysis.
Importance of Ratio Analysis:
The following 10 best points of Importance of Ratio Analysis below are:
Measure General Efficiency:
Ratios enable the mass of accounting data to summarize and simplify. They act as an index of the efficiency of the enterprise. As such they serve as an instrument of management control.
Measure Financial Solvency:
Ratios are useful tools in the hands of management and other concerned to evaluate the firm’s performance over some time by comparing the present ratio with the past ones. They point out the firm’s liquidity position to meet its short-term obligations and long-term solvency.
Forecasting and Planning:
Ratio analysis is an invaluable aid to management in the discharge of its basic function such as planning, forecasting, control, etc. The ratios that are derived after analyzing and scrutinizing the past result, helps the management to prepare budgets to formulate policies and to prepare the plan of action, etc.
Facilitate Decision-Making:
It throws light on the degree of efficiency of the management and utilization of the assets and that is why it is called a surveyor of efficiency. They help management in decision-making.
Corrective Action:
Ratio analysis provides the inter-firm comparison. They highlight the factors associated with successful and unsuccessful firms. If the comparison shows an unfavorable variance, corrective actions can initiate. Thus, it helps the management to take corrective action.
Intra Firm Comparison:
Intra firm comparisons are facilitating. It is an instrument for the diagnosis of the financial health of an enterprise. It facilitates the management to know whether the firm’s financial position is improving or deteriorating by setting a trend with the help of ratios.
Act as a Good Communication:
Ratios are an effective means of communication and play a vital role in informing the position of and progress made by the business concern to the owners and other interested parties. The communications by the use of simplifying and summarize ratios are more easy and understandable.
Evaluation of Efficiency:
Ratio analysis is an effective instrument that, when properly used, is useful to assess important characteristics of business—liquidity, solvency, profitability, etc. A study of these aspects may enable conclusions to draw relating to the capabilities of the business.
Effective Tool:
Ratio analysis helps in making effective control of the business- measuring performance, control of cost, etc. Effective control is the keynote of better management. The ratio ensures secrecy.
Detection of Unfavourable Factors:
Analysis of financial statements enables the analyst to find out the soundness or otherwise of the business. If the analysis reveals financial unsoundness, the factors responsible for such unsoundness can separate and corrective action was taken without loss of time.
The Objectives of Ratio Analysis:
The main objectives of ratio analysis are to show a firm’s relative strengths and weaknesses. Other objectives of ratio analysis include comparisons for a useful interpretation of financial statements, finding solutions to unfavorable financial statements and to help take corrective measures when, in comparison to other similar firms, financial conditions and performance of the firm are unfavorable.
Ratio analysis also determines the financial condition and financial performance of a firm. Using ratio analysis allows an analyst to determine the ability of the firm to meet its obligations, the overall operating efficiency, and performance of the firm and the efficiency with which the firm is utilizing its assets in generating sales.
Ratio analysis is a tool used to conduct a quantitative analysis of information in a company’s financial statements. Ratios are calculated by individuals from current year numbers and are these numbers are then used to judge the performance of the company by comparing them to previous years, other companies, the industry or even the economy.
Extra Knowledge:
Ratio analysis can help give a quick indication of how a company is doing in certain key areas and the ratios can categorize as short-term solvency ratios, debt management ratios, asset management ratios, profitability ratios, and market value ratios. Ratio analysis should only use as the first step in financial analysis.
As it is a tool that is based on accounting information, it can limit by any distortions that arise in financial statements due to historical cost accounting and inflation. It can also be difficult to draw comparisons using ratio analysis due to differences in the analysis made by other firms.
Using ratio analysis can identify areas that may need to be investigating further. Some of the advantages of ratio analysis include that it helps in credit analysis, it can help in financial performance analysis and that it simplifies a financial statement.
The basic important advantages of Ratio Analysis are also great.
Ratio analysis is an important tool for analyzing the company’s financial performance. The following are the important advantages of the accounting ratios.
Analyzing Financial Statements:
Ratio analysis is an important technique of financial statement analysis. Accounting ratios are useful for understanding the financial position of the company. Different users such as investors, management. bankers and creditors use the ratio to analyze the financial situation of the company for their decision making purpose.
Judging Efficiency:
Accounting ratios are important for judging the company’s efficiency in terms of its operations and management. They help judge how well the company has been able to utilize its assets and earn profits.
Locating Weakness:
Accounting ratios can also use in locating the weakness of the company’s operations even though its overall performance may be quite good. Management can then pay attention to the weakness and take remedial measures to overcome them.
Formulating Plans:
Although accounting ratios are using to analyze the company’s past financial performance, they can also use to establish future trends of its financial performance. As a result, they help formulate the company’s plans.
Comparing Performance:
A company needs to know how well it is performing over the years and as compared to the other firms of a similar nature. Besides, it is also important to know how well its different divisions are performing among themselves in different years. Ratio analysis facilitates such comparison.
Main Advantages of Ratio Analysis:
Ratio analysis is widely used as a powerful tool for financial statement analysis. It establishes the numerical or quantitative relationship between two figures of a financial statement to ascertain the strengths and weaknesses of a firm as well as its current financial position and historical performance. It helps various interested parties to evaluate a certain aspect of a firm’s performance.
The following 10 best points are the principal advantages of ratio analysis:
Forecasting and Planning:
The trend in costs, sales, profits, and other facts can know by computing ratios of relevant accounting figures for the last few years. This trend analysis with the help of ratios may be useful for forecasting and planning future business activities.
Budgeting:
The budget is an estimate of future activities based on experience. Accounting ratios help to estimate budgeted figures. For example, the sales budget may prepare with the help of an analysis of past sales.
Measurement of Operating Efficiency:
The analysis indicates the degree of efficiency in the management and utilization of its assets. Different activity ratios indicate operational efficiency. The solvency of a firm depends upon the sales revenues generated by utilizing its assets.
Communication:
Ratios are effective means of communication and play a vital role in informing the position of and progress made by the business concern to the owners or other parties.
Control of Performance and Cost:
Ratios may also use for control of performances of the different divisions or departments of an undertaking as well as control of costs.
Inter-firm Comparison:
A comparison of the performance of two or more firms reveals efficient and inefficient firms, thereby enabling inefficient firms to adopt suitable measures for improving their efficiency. The best way of inter-firm comparison is to compare the relevant ratios of the organization with the average ratios of the industry.
The indication of Liquidity Position:
They help to assess the liquidity position i.e., the short-term debt-paying ability of a firm. Liquidity ratios indicate the ability of the firm to pay and help in credit analysis by banks, creditors and other suppliers of short-term loans.
The indication of Long-term Solvency Position:
They also use to assess the long-term debt-paying capacity of a firm. The long-term solvency position of a borrower is a prime concern to the long-term creditors, security analysts and the present and potential owners of a business. It measures by the leverage/capital structure and profitability ratios which indicate the earning power and operating efficiency. Ratio analysis shows the strength and weaknesses of a firm in this respect.
The indication of Overall Profitability:
The management is always a concern with the overall profitability of the firm. They want to know whether the firm can meet. It is short-term as well as long-term obligations to its creditors, to ensure a reasonable return to its owners. And, secures optimum utilization of the assets of the firm. This is possible if all the ratios are considered together.
The signal of Corporate Sickness:
A company is sick when it fails to generate a profit continuously and suffers a severe liquidity crisis. Proper ratio analysis can give the signal of corporate sickness in advance. So, timely measures can take to prevent the occurrence of such sickness.
Aid to Decision-making:
They help to make decisions like whether to supply goods on credit to a firm. Whether bank loans will make available etc.
Simplification of Financial Statements:
They make it easy to grasp the relationship between various items and helps in understanding the financial statements.
Importance, Objectives, Advantages of Ratio Analysis. Image credit from #Pixabay.
