Need for Business Forecasting to Business examples the Theories. Business Forecasting is an estimate or prediction of future developments in business such as sales, expenditures, and profits. 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 a business. 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. So, what we the question is: Different Theories explain why a need for Business Forecasting to Business?
The Concept of Financial Management ExamplesBusiness Forecasting for Business, in points of Theories and Need.
In this article, we will discuss Business Forecasting for Business; First Theories of Business Forecasting, that we look again at the need for Business Forecasting. So, let’s discuss: The essence of all the previous article on business forecasting is to explain meaning and definition is that business forecasting is a technique to analyze the economic, social, and financial forces affecting the business with the object of predicting future events based on past and present information. Need to study:Importance, Advantages, Limitations of Business Forecasting to Business.
Examples the different theories of Business Forecasting:
The following different theories ExamplesBusiness Forecasting needed are:
Historical:
This theory is based on the assumption that history repeats itself. It simply implies that whatever happened in the past under a set of circumstances is likely to happen in the future under the same set of conditions. Thus, a forecaster has to analyze the past data to select such a period whose conditions are similar to the period of forecasting. Further, while predicting for the future, some adjustments may make for the special circumstances which prevail at the time of making the forecasts.
Action and Reaction:
This theory is based on Newton’s ‘Third Law of Motion’, i.e., for every action; there is an equal and opposite reaction. When we apply this law to business, it implies that if there is depression in a particular field of business; there is bound to be a boom in it sooner or later. It reminds us of the business, cycle which has four phases, i.e., prosperity, decline, depression, and prosperity.
This theory regards a certain level of business activity as normal and the forecaster has to estimate the normal level carefully. According to this theory, if the price of the commodity goes beyond the normal level; it must come down also below the normal level because of the increased production and supply of that commodity.
Economic Rhythm:
This theory propounds that the economic phenomena behave rhythmically and cycles of nearly the same intensity and duration tend to recur. According to this theory, the available historical data have to analyze into their components, i.e. trend, seasonal, cyclical, and irregular variations. The secular trend obtains from the historical data project several years into the future on a graph or with the help of mathematical trend equations.
If the phenomena are cyclical in behavior, the trend should adjust for cyclical movements. When the forecast for a year is to be split into months or quarters then the forecaster should adjust the projected figures for seasonal variations also with the help of seasonal indices. It becomes difficult to predict irregular variations and hence, the rhythm method should use along with other methods to avoid inaccuracy in forecasts. However, it must remember that business cycles may not be strictly periodic and the very assumptions of this theory may not be true as history may not repeat.
Sequence Method/Time-Lag Method:
This theory is based on the behavior of different businesses which show similar movements occurring successively but not simultaneously. As such, this method takes into account time lag based on the theory of lead-lag relationship which holds good in most cases. The series that usually change earlier serve as the forecast for other related series. However, the accuracy of forecasts under this method depends upon the accuracy with which time lag estimate.
Cross-Cut Analysis:
In this method of business forecasting, the combined effect of various factors is not studied; but the effect of each factor, that has a bearing on the forecast, is studied independently. This theory is similar to the Analysis of Time Series under the statistical methods.
Modernity:
This approach makes use of mathematical equations for drawing economic models. These models depict the inter-relationships amongst the various factors affecting the economy or business. The expected values for dependent variables then ascertain by putting the values of known variables in the model. This approach is highly mechanical and this can rarely employe in business conditions. Very helpful:Elements, Techniques, and Steps of Business Forecasting.
The Need for Business Forecasting:
Some of Examplesthe important needs of business forecasting list below:
These are Six need:
Production Planning.
Financial Planning.
Economic Planning.
Workforce Scheduling.
Decisions Making, and.
Controlling Business Cycles.
Now, Explain each one:
Production Planning:
The rate of producing the products must match 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, the 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 a 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 managers 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 often call projections. These are helpful not only for planning and public policymaking; but, they also include likely economic environment and aid formulation of business policies as well.
Workforce Scheduling:
The forecast of monthly demand may further break down to weekly demands and the workforce may have to adjust to meet these weekly demands. Hence, forecasts need to enable managers to get in tune 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 to make 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 the 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. The 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 are 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. The Trade cycle increases the risk of business; creates unemployment; induces speculation and discourages 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, industrialists, and economists to plan accordingly to reduce the harmful effects of trade cycle statistics is thus needed to control the business cycles.
Different Theories explain why a need for Business Forecasting to Business? Image credit from #Pixabay.
Types and utility of Accounting; This article in we discuss first the utility of accounting after that we will finally discuss the types of accounting. So, What is the utility of Accounting? There are three types and utility of accounting: financial, management, and also cost accounting. The preceding section only brought the importance of information to the fore. Effective decisions require accurate, reliable, and timely information. The quantity and quality requirement of information differs with the importance of that decision which should take based on that information.
Here are explains; The utility and types of Accounting, discussion each one.
Individuals can use accounting information to manage and manage their bank accounts, to evaluate job eligibility in the organization, to invest money, rent a house, and manage their routine matters. Business managers have to set goals, evaluate progress, and start corrective action in case of adverse deviations from planned courses of action.
Many such decisions require accounting information – purchasing equipment, maintenance of inventory, borrowing, and lending, etc. Investors and creditors are willing to evaluate the profitability and solvency of a company before giving benefits to the company. Therefore, they are interested in obtaining financial information about the company in which they are considering an investment.
Financial statements;
Financial statements are the main source of information for them, which are published in a company’s annual report and various financial dailies and journals. Government and regulatory agencies have the responsibility to direct a country’s Socio-economic system in such a way that it promotes the common good. For example, the Securities and Exchange Board of India (SEBI) makes it mandatory to disclose some financial information to the public investment for a company.
The government’s task of managing the industrial economy becomes simpler if accounting information such as profit, cost, tax, etc. is presented uniformly without any manipulation or “window-dressing”. Central and state governments make various taxes Therefore, taxation officials must know the company’s income to calculate the amount of the company tax.
The information generated by accounting helps them in such calculations and also helps in finding any attempt to tax evasion. Employees and trade unions use accounting information to resolve various issues related to wages, bonuses, profit sharing, etc. Consumers and the general public are also interest in knowing the amount of income earned by various business houses.
Accounting information helps in determining whether a company is overcharging or exploiting customers, whether companies are showing better business performance or not, whether the country is emerging from the economic recession, etc. The aspects are closely related to accounting information and our quality of life.
What are the types of Accounting?
The financial literature classifies accounting into two broad categories, viz, Financial Accounting, and Management Accounting. Financial accounting is primarily concerned with the preparation of financial statements whereas management accounting covers areas such as interpretation of financial statements, cost accounting, etc.
Types of Accounting – List
Both these utility and types of accounting are examining in below;
As mentioned earlier, financial accounting deals with the preparation of financial statements for the basic purpose of providing information to various interested groups like creditors, banks, shareholders, financial institutions, government, consumers, etc. Financial statements, i.e. the income statement and the balance sheet indicate. How the activities of the business have been conducting during a given period of time.
Financial accounting is charge with the primary responsibility for external reporting. The users of the information generated by financial accounting, like bankers, financial institutions, regulatory authorities, government, investors, etc. want the accounting information to be consistent to facilitate comparison.
Therefore, financial accounting is based on certain concepts and conventions. Which include a separate business entity, going concern concept, money measurement concept, cost concept, dual aspect concept, accounting period concept, matching concept, realization concept, and conventions of conservatism, disclosure, consistency, etc. All such concepts and conventions would deal with detail in subsequent lessons.
Importance of financial accounting;
The significance of financial accounting lies in the fact that it aids the management in directing and controlling the activities of the firm and to frame relevant managerial policies related to areas like production, sales, financing, etc.
However, it suffers from certain drawbacks which are discussing below;
The information provided by financial accounting is consolidating in nature. It does not indicate a break-up for different departments, processes, products, and jobs. As such, it becomes difficult to evaluate the performance of different sub-units of the organization.
Financial accounting does not help in knowing the cost behavior as it does not distinguish between fixed and variable costs.
The information providing by financial accounting is historical in nature and as such the predictability of such information is limited.
The management of a company has to solve certain ticklish questions like the expansion of business, making or buying a component, adding or deleting a product line, deciding on alternative methods of production, etc. The financial accounting information is of little help in answering these questions.
The limitations of financial accounting;
However, should not lead one to believe that it is of no use. It is the basic foundation on which other branches and tools of accounting analysis are based. It is the source of information, which can further analyze and interpreted according to the tailor-made requirements of decision-makers.
Management accounting is ‘tailor-made’ accounting. It facilitates management by providing accounting information in such a way. So, that it is conducive for policy-making and running the day-to-day operations of the business. Its basic purpose is to communicate the facts according to the specific needs of decision-makers by presenting. The information in a systematic and meaningful manner.
Management accounting, therefore, specifically helps in planning and control. It helps in setting standards and in case of variances between planning and actual performances. It helps in deciding the corrective action. An important characteristic of management accounting is that it is forward-looking. Its basic focus is one future activity to perform and not what has already happened in the past.
Since management accounting caters to the specific decision needs, it does not rest upon any well-defined and set principles. The reports generated by a management accountant can be of any duration– short or long, depending on the purpose. Further, the reports can prepare for the organization as a whole as well as its segments.
One important variant of management accounting is the cost analysis. Cost accounting makes elaborate cost records regarding various products, operations, and functions. It is the process of determining and accumulating the cost of a particular product or activity. Any product, function, job, or process for which costs are determining and accumulate, are calls cost centers. The basic purpose of cost accounting is to provide a detailed break- up of the cost of different departments, processes, jobs, products, sales territories, etc. So, that effective cost control can exercise.
Cost accounting also helps in making revenue decisions such as those related to pricing, product-mix, profit-volume decisions, expansion of business, replacement decisions, etc. The objectives of cost accounting, therefore, can summarize in the form of three important statements, viz, to determine costs. To facilitate planning and control of business activities and to supply information for short- and long-term decisions. Cost accounting has certain distinct advantages over financial accounting. Some of them have been discussing succeedingly.
Cost accounting system;
The cost accounting system provides data about profitable and non-profitable products and activities, thus prompting corrective measures. It is easier to segregate and analyze individual cost items and to minimize losses and wastages arising from the manufacturing process. Production methods can vary to minimize costs and increase profits. Cost accounting helps in making realistic pricing decisions in times of low demand, competitive conditions, technology changes, etc.
Various alternative courses of action can properly evaluate with the help of data generate by cost accounting. It would not be an exaggeration if it is saying that a cost accounting system ensures maximum utilization of physical and human resources. It checks frauds and manipulations and directs the employer and employees towards achieving the organizational goal.
What are the utility and types of Accounting? Discussion
The behavioral implication of Control; The control system should make as fair and as meaningful as possible and must be clearly communicating to all employees. It will be easier for the employees to accept control if they have to participate in the formulation of the control system and process of implementation. Though control should aim at satisfying the needs of the members of the organization, they often take it otherwise. This may be either because of the adverse real impact of control on them or because of Misperception of the impact of control.
What is the behavioral implication of Control? Perfect Explanation.
Managers must recognize several behavioral implications in the process of control and its implementation. Although an effective control system should aid in employee motivation, it can also have negative effects on employee morale and performance. Thus, while designing the control system, it must keep in mind that almost everybody in the organization not only resents the idea of being controlling but also objects to being evaluated. It means the results of the control may not same as anticipated by those who are exercising control.
The behavioral implication of Control – List
What are the Essentials of Effective Control System? The major behavioral problems of control can analyze by taking the nature of control, perception of those who are controlling, and action taken by them.
Nature or Control:
Control often puts pressure for engaging in desirable behavior by those who are subject to control. The basic question is: will they not behave in a desirable way if there is no control? Though opinions may differ on this question, often it is recognized that people engage in that behavior, which provides them satisfaction whether control or no control.
It means if the organizational processes are in tune with the needs of the organizational participants, they can perform well in the absence of control and not in the presence of control. Behavioral scientists have concluded that people try to self-actualize but the basic problem, which comes in the way, is providing by the organization itself. They are inherently self-motivating.
For example, McGregor believes that more people behave according to the assumptions of Theory Y as compared to Theory X. In such a case, if their behavior is controlled, it may be counter-productive for the organization. The results may be against organizational interests. Thus, the basic nature of control itself against the very basic nature of the people.
However, this is not true in all cases. Many people may still behave according to the assumptions of Theory X and they need rigid control, In fact, the best control system may be one which focuses attention on the individual needs also, as discussed earlier, otherwise, it will provide more behavioral problems and may be detrimental to the organization itself.
People or Perception:
Another behavioral implication of control is the perception of people who are controlling. Though perception may be that control is against the nature of people, it is further aggravated by the fact that people perceive it to be for benefit of the organization but against them. Thus perception may be right or otherwise, that control if brings a better result, is sharing by the organization alone whereas it may, be brought by the organizational members.
The control in most of the cases is using as a pressure tactic for increasing performance. This is true also because people may produce more if they are aware that their performance is being evaluated. However, increase performance is also determining by several other factors, most important or them being how it is sharing between the organization and its members.
Thus, if they have a positive perception of this aspect also, they will engage in higher performance. In an alternative case, they will take certain actions to thwart the control action. There is another implication of people’s perception of control. The manager may develop some plan for control, but there are many un-planning controls also necessitated by the organizational requirements. Thus un-plan control is also the part of the organizational control.
It is this un-plan control that has more serious repercussion and is more counter-productive. The participants may feel that it is due to improper planning on the part of management. Thus they are controlled not because of their own shortcomings but for the shortcomings of others. Naturally, this may be more serious for those who are controlling.
Actions by Participants:
Participants in most of the cases resist control attempt. In the first case, people may try to overcome the pressure from control through fanning group. People can stand only to a certain amount of pressure. After this point is pass, it becomes intolerable to them and they will try to find out the alternatives.
One of the alternatives is the formation of the group if people cannot reduce the pressure individually. The group helps them to absorb much of the pressure and thus relieves the individual personality. It gets rid of the tension generated by the control and people feel more secure by belonging to a group, which can counteract the pressure.
They will try to escape from the purview of control and may take several actions:
Control may try to bring behavior which is satisfying to them but not necessarily satisfying to the organization.
They may engage in a behavior which may appear to be in conformity with organizational requirements but actually, it is not, and.
If these are not possible they may try to engage in behavior as required by the organization.
Now the question is:
Does the group disappear if the control pressure is off?
The answer is generally in negative because, by the time, control pressure is oft, people have socialized and identify with a particular group and the group has become attractive to them in more than one respect. Thus, they are likely to continue to be the members of the group even after the control pressure is off. Another alternative of overcoming the pressure of control is that an individual solves it at his own level.
This happens more so if control pressure affects only a few individuals. In such cases, the individuals may engage in a behavior, which on the surface seems to satisfy organizational needs but actually, it is not so. In such cases, they will try to camouflage the information meant for control like providing wrong information or coming in time at the work-place but not quite engaging in meaningful behavior or looking busy but without doing anything. This situation is also quite counterproductive.
If the individuals are not able to go for any of these alternatives. They will fall in line with organizational control attempt. This situation may, however, not take as an ideal because it may be counter-productive in the logs run; People may develop alienation to the work and to the organization which may have an adverse effect on their efficiency. Organization in such cases may lose, not only the efficiency of their members but them also.
What is the behavioral implication of Control? Perfect Explanation #Pixabay.
Behavioral Implications in the Process of Control:
Some of the behavioral implications of control are as follows:
Controls may influence the generation of invalid and inaccurate information. For example, if the top management habitually reduces budget requests when reviewing them (a control activity), then the lower management, when proposing a new budget or a new project may overstate the cost of resources needed. Similarly, managers may set objectives lower than what is attainable so that higher output will look better at performance appraisal time.
Controls can resent by employees if they have no control over the situation. For example, if a professor’s performance is appraising over the number of publication of books and research articles. But he is not affording the freedom of time to do so because of heavy teaching loads and excessive committee work. Then it can result in frustration which may be detrimental to the entire control system. Similarly, the manager will become highly frustrated. If his performance evaluation is based upon profits achieved by his department. But he does not have the authority and control to make operational changes such as hiring and firing of workers.
The control system must synchronize to create a balance among all affecting and inter-connected variables. The standards should complement each other and not contradict each other. For example, a control system which emphasizes increased sales as well as a reduction in advertising expenditure at the same time. May seem contradictory to the marketing manager and thus may be frustrating for him.
What does Preference Shares mean?Preference Shares, as its name suggests, gets precedence over equity shares on the matters like distribution of dividend at a fixed rate and repayment of capital in the event of liquidation of the company. Preference shares are one of the important sources of hybrid financing. As the name suggests, these have certain preferences as compared to other types of shares. These shares are given two preferences. There is a preference for payment of dividend. Whenever the company has distributable profits, the dividend is first paid on preference share capital.
Know and Understand the Preference Shares.
The content of study from Preferred Shares: Explanation of Preference Shares, Features of Preference Shares, Good and Bad of Preferred Shares (Advantages and Disadvantages of Preference Shares).
The preference shareholders are also the part owners of the company like equity shareholders, but in general, they do not have voting rights. However, they get right to vote on the matters which directly affect their rights like the resolution of winding up of the company, or in the case of the reduction of capital.
Other shareholders are paid a dividend only out of the remaining profits if any. The second preference for shares is repayment of capital at the time of liquidation of the company. After payment of outside creditors, preference share capital is returned. Equity shareholders will be paid only when preference share capital is paid in full.
Explanation of Preference Shares.
They are those shares which carry certain special or priority rights. Firstly, the dividend at a fixed rate is payable on these shares before any dividend is paid on equity shares. Secondly, at the time of winding up of the company, capital is repaid to preference shareholders prior to the return of equity capital. Preferred Shares do not carry voting rights. However, holders of preferred shares may claim voting rights if the dividends are not paid for two years or more on cumulative preference shares and three years or more on non-cumulative preferred shares.
Meaning of Preference Shares.
The share which entitles the holder to a fixed dividend, whose payment takes priority over that of ordinary share dividends. Preferred Shares are one of the important sources of hybrid financing. It is hybrid security because it has some features of equity shares as well as some features of debentures. The holders of preference shares enjoy the preferential rights with regard to receiving of dividend and getting back of capital in case the company winds-up.
Definition of Preference Shares.
They are a long-term source of finance for a company. They are neither completely similar to equity nor equivalent to debt. The law treats them as shares but they have elements of both equity shares and debt. For this reason, they are also called “Hybrid financing instruments”. These are also known as preferred stock, preferred shares, or only preferred’s in a different part of the world.
Features of Preference Shares.
They have the characteristics of both equity shares and debentures. Like equity shares, dividend on preferred shares is payable only when there are profits and at the discretion of the Board of Directors.
Preferred Shares are similar to debentures in the sense that the rate of dividend is fixed and preference shareholders do not generally enjoy voting rights. Therefore, they are a hybrid form of financing.
The features of preference shares are listed below:
Dividends.
They have dividend provisions which are cumulative or non- cumulative. Most shares have the cumulative provisions, which mean that any dividend not paid by the company accumulates. Normally, the firm must pay these unpaid dividends prior to the payment of dividends on the common stock. These unpaid dividends are known as dividends in arrears or arrearages. Non-cumulative dividends do not accumulate if they are not paid when due.
An investor contemplating the purchase of preferred shares with a non-cumulative dividend provision needs to be especially diligent in the investigation of the company because of the investor’s potentially weak position vis-a-vis those preference shares with a cumulative dividend provision. In the case of cumulative preferred shares, even if the arrears of the preference dividend are cleared in full, the investor would be the loser as he is to get less in net worth.
Participating.
Most they are non-participating, meaning that the preference shareholder receives only his stated dividend and no more. The theory is that the preference shareholder has surrendered claim to the residual earnings of his company in return for the right to receive his dividend before dividends are paid to common shareholders.
The participating preference shareholder receives stipulated dividend and shares additional earnings with the common shareholders. But this share is usually non-cumulative which confirms the view that preference share does have both protective and profit participating provisions.
Voting Rights.
They do not normally confer voting rights. The basis for not allowing the preference shareholder to vote is that the preference shareholder is in a relatively secure position and, therefore, should have no right to vote except in the special circumstances.
The cumulative preferred shares can vote if their dividend is in arrears for 2 years. The voting right of each preference shareholder is to be in the proportion which the paid-up share capital on his shares bears to the total equity share capital of the company.
Par Value.
Most they have a par value. When it does, the dividend rights and call price are usually stated in terms of the par value. However, those rights would be specified even if there were no par value. It seems, therefore, as with equity shares, the preference share that has a par value has no real advantage over preference share that has no par value.
Redeemable or Callable.
Typically, they have no maturity date. In this respect, it is similar to equity shares. Redeemable or callable preferred shares may be retired by the issuing company upon the payment of a definite price stated in the investment. Although the “call price” provides for the payment of a premium, the provision is more advantageous to the corporation than to the investor.
When money rates decline, the corporation is likely to call in its preferred shares and refinance it at a lower dividend rate. When money rates rise, the value of the preference shares declines so as to produce higher yield, the call price acts as an upper peg or plateau through which the price will break only in a very strong market.
Non-callable preferred shares and bonds are issued in periods of High-interest rates. The issue is barred from redeeming them later in the event of generally falling yields or for a certain period so the investor has important protection against declining income.
Preference Shares: Explanation, Features, Good and Bad, #Pixabay.
Advantages of Preference Shares:
The following advantages of preference shares are:
The obligation for Dividends:
No Obligation for Dividends; A company is not bound to pay the dividend on preference shares if its profits in a particular year are insufficient. It can postpone the dividend in case of cumulative preferred shares also. No fixed burden is created on its finances.
Interference:
No Interference; Generally, they do not carry voting rights. Therefore, a company can raise capital without dilution of control. Equity shareholders retain exclusive control over the company.
Trading on Equity:
The rate of dividend on they are fixed. Therefore, with the rise in its earnings, the company can provide the benefits of trading on equity to the equity shareholders.
Flexibility:
A company can issue redeemable preference shares for a fixed period. The capital can be repaid when it is no longer required in business. There is no danger of over-capitalization and the capital structure remains elastic.
Variety:
Different types of preference shares can be issued depending on the needs of investors. Participating preferred shares or convertible they may be issued to attract bold and enterprising investors.
They can be made more popular by giving special rights and privileges such as voting rights, right of conversion into equity shares, right of shares in profits and redemption at a premium.
Disadvantages of Preference Shares:
They suffer from the following disadvantages:
Obligation:
Fixed Obligation; The dividend on preferred shares has to be paid at a fixed rate and before any dividend is paid on equity shares. The burden is greater in the case of cumulative preference shares on which accumulated arrears of dividend have to be paid.
Appeal:
Limited Appeal; Bold investors do not like preferred shares. Cautious and conservative investors prefer debentures and government securities. In order to attract sufficient investors, a company may have to offer a higher rate of dividend on preference shares.
Return Earning:
Low Return in this shares; When the earnings of the company are high, fixed dividend on they becomes unattractive. Preference shareholders generally do not have the right to participate in the prosperity of the company.
Voting Rights:
No Voting Rights; They generally do not carry voting rights. As a result, preference shareholders are helpless and have no say in the management and control of the company.
Fear of Redemption:
The holders of redeemable preference shares might have contributed finance when the company was badly in need of funds. But the company may refund their money whenever the money market is favorable. Despite the fact that they stood by the company in its hour of need, they are shown the door unceremoniously.
What does Business Risk mean?Business risks related to the response of the firm’s earnings before interest and taxes, or operating profits, to changes in sales. When the cost of capital is used to evaluate investment alternatives, it is assumed that acceptance of the proposed projects will not affect the firm’s business risk.
Know and understand the Explanation of Business Risk.
The business risk may be defined in terms of the possibility of occurrence of un-favorable events; which maximize chances of losses and minimize chances for gain, in business. The term business risk refers to the possibility of inadequate profits or even losses due to uncertainties e.g., changes in tastes, preferences of consumers, strikes, increased competition, change in government policy, obsolescence etc.
Every business organization contains various risk elements while doing the business. Business risks imply uncertainty in profits or danger of loss and the events that could pose a risk due to some unforeseen events in the future, which causes the business to fail. The types of projects accepted by a firm can greatly affect its business risk.
If a firm accepts a project that is considerably more risky than average, suppliers of funds to the firm are quite likely to raise the cost of funds. This is because of the decreased probability of the fund suppliers receiving the expected returns on their money. A long-term lender will charge higher interest on loans if the probability of receiving periodic interest from the firm and ultimately regaining the principal is decreased.
Common stockholders will require the firm to increase earnings as compensation for increases in the uncertainty of receiving dividend payments or ably appreciation in the value of their stock. In analyzing the cost of capital it is assumed that the business risk of the firm remains unchanged (i.e., that the projects accepted do not affect the variability of the firm’s sales revenues).
This assumption eliminates the need to consider changes in the cost of specific sources of financing resulting from changes in business risk. The definition of the cost of capital developed in this chapter is valid only for projects that do not change the firm’s business risk.
Meaning of Business Risk:
Business risk is that portion of the unsystematic risk caused by the prevailing environment of the business. In other words, business risk is a function of operating conditions being faced by a firm. These risks influence the operating income of a firm and consequently the dividends.
Every company has its own objectives and goals and aims at a particular gross profit and operating income. It expects itself to pay to its shareholders a certain rate of dividend and plow back some profits.
For example, an owner of a business may face different risks like in production, risks due to irregular supply of raw materials, machinery breakdown, labor unrest, etc. In marketing, risks may arise due to different market price fluctuations, changing trends and fashions, error in sales forecasting, etc. In addition, there may be the loss of assets of the firm due to fire, flood, earthquakes, riots or war and political unrest which may cause unwanted interruptions in the business operations. Thus business-risks may take place in different forms depending upon the nature and size of the business.
Definition of Business Risk:
Definition: By the term “Business risk” we mean the uncertainty with respect to the firm’s operations. It is a type of systematic risk wherein there is volatility associated with the future income or earnings arising from events, circumstances, conditions, action, or inactions that hinders the attainment of goals and objectives and carry out the strategies.
Business risk refers to the anticipation that the firm may earn lower than expected profits or even suffer losses, because of the uncertainties inherent in the business such as competition, change in customer tastes and preferences, input cost, change in government policies, and so forth. It may impede the business ability to provide returns on the investment.
Following are cited some popular definition of the term business risk:
According to B.O.Wheeler,
“Risk is the chance of loss. It is the possibility of some un-favorable occurrence.”
According to C.O. Hardy,
“Risk may be defined as uncertainty in regard to cost, loss, or damage.”
Characteristics of Business Risk:
Characteristics of business-risks could be highlighted with reference to its following features:
The Time.
In ancient times, business-risks were less and limited. In the present-day-times-characterized by intense competition, advanced technology and globalization of the economy; business-risks are quite severe. Further, in times to come, business-risks are likely to increase in intensity.
The Size of Business Enterprise.
Small businesses are less exposed to business-risks; because they enjoy the flexibility of operations and can easily adapt themselves to changing circumstances. On the other hand, the bigger is the size of business; the lesser is the flexibility possessed by it. Hence bigger businesses are more exposed to business risks.
Nature of Business Risks.
In case of business enterprises engaged in the manufacture/purchase of necessary items e.g. salt, sugar, oil, cloth etc. there is the lesser risk because demand for most of the necessary item is inelastic or less elastic. On the other hand, business enterprises engaged in the manufacture/purchase of luxury items are more exposed to business-risks; because demand for luxury items is highly elastic.
Terms of Sales.
In the case of business enterprises conducting sales only on a cash basis, business-risks are nil; so far as the possibility of bad debts is concerned. On the other hand, business enterprises conducting large scale credit sales are severely exposed to the risk of bad debts.
The Degree of Competition.
In those lines of business activities, where there is intense competition; business enterprises are exposed to severe risks caused by the actions and reactions of competitors. As such, business enterprises characterized by monopolistic situations face little risk on account of competition. Actually, in a perfectly monopolistic situation, the business enterprise has no risk caused by competition.
The Competence of Management.
The more competent the management of business enterprises is; the lesser is the possibility of losses to be caused as a result of business risks, and vice-versa.
The Age of the Business Enterprise.
From this viewpoint, old business enterprises are less exposed to business-risks, because of the experience of successfully handling business-risks, in the past. New business concerns are more exposed to business-risks, because of the lack of experience.
Opportunities for Gains are Hidden in Business Risks.
If the management of the business enterprise is able to successfully handle and manage business-risks; these provide many opportunities for gains to the business enterprise.
Sources of Business Risk:
Business risk can be divided into two broad Sources, namely;
Internal business risk, and.
External business risk.
Now explain;
Internal Business risks.
Internal business risk is associated with the internal environment of the firm. The internal business-risks are such that the firm has to conduct its business within its limiting environment. The internal business-risks will vary from firm to firm depending upon the constraints in the internal environment. Thus, each firm has its own set of internal risks and the firm’s success depends upon the ability to coping with these risks.
The important internal risks include:
Fluctuations in sales.
Research and development.
Personnel Management.
Fixed Cost, and.
Production of a single product.
The risks that emerge as a result of the events occurring within the organization is termed as an internal risk. These risks can be predicted as the possibility of their incidence, and so, they are controllable in nature. They arise due to factors like strikes & lockouts by a trade union, accidents in the factory, negligence of workers, failure of the machine, technological obsolescence, damages to the goods, fire outbreak, etc.
External Business risks.
External business-risks are associated with circumstances beyond a firm’s control. Each firm has to deal with specific external factors that may be unique and peculiar to its industry.
However, important external factors influencing all businesses are:
Business cycle.
Demographic factors.
Government policies, and.
Social and regulatory factors.
The risk arising as a result of the events external to the firm and so the firm’s management has no control over it. So, these cannot be forecasted easily. It may arise due to price fluctuations, changes in customer taste, earthquake, floods, changes in government regulations, riots, etc.
Business Risk: Explanation, Characteristics, and Sources, #Pixabay.
Types of Business Risks:
Some risks are common to all human being alike everywhere e.g. risks due to fire, theft, flood, earthquakes, cyclones, drought, war, civil riots etc. As such these are not the risks peculiar only to business. Moreover, some risks are insurable with insurance companies.
Hence, as such, in the present- day-times offering many types and varieties of insurances; these risks could not be termed as risks in the real sense of the term. Accordingly, business-risks are those which are peculiar only to business and are also not- insurable.
Following is a brief account of the above types of business-risks:
Natural Types.
Risks which arise due to the actions of Nature (and hence uncontrollable) are called natural risks. For example, the risk of rainfall not occurring on time or excessive rainfall causing flood is a serious risk for farmers. Again, there may be the risk of hail storm destroying crops in the field.
Political Types.
Risks due to political causes may arise, in the forms of:
Price regulations, restricting profit margins for businessmen.
High rates of taxes, taking away a major part of business profits.
Un-favorable economic policies, discouraging some lines of business activities, and.
Strict legislation imposed on business enterprises etc.
Social Types.
Risks due to social causes are those which may arise from consumer behavior or due to changes taking place in the social scene.
Examples of social risks may be:
Changes in fashions.
Change in the tastes or preference of consumers.
Changes in the income of consumers, and.
Changing social values leading to a new pattern of social life etc.
Economic Types.
Some of the economic types leading to business-risks may be:
The rising cost of raw materials due to inflation or crop failure.
The economic recession in industry, leading to poor demand.
Increase in the rate of interest, making borrowings costlier, and.
Pessimistic capital market conditions, discouraging people to invest in companies etc.
Managerial Types.
Risks due to managerial types may be (a few examples only):
Wrong estimation of demand by management.
Poor labor-management relations, and.
The inefficient operational life of the business enterprise due to incompetent or untrained managerial staff.
Competitive Types.
Competitive Types may cause business-risks e.g. in the form of the following:
Entry of an unduly large number of persons in the same line of business activity, and.
Entry of multinational companies threatening the very survival of domestic companies.
Technological Types.
In the present-day times, technology is changing at a very fast pace; so much so that business experts call this phase of changes as a “technological revolution”. The appearance of new technology renders the old technology as obsolete (i.e. out of use); causing severe financial losses to firms operating with old technology. They are virtually compelled to install new technology to ensure their survival amidst intensely competitive conditions.
Miscellaneous Types.
Some miscellaneous types of business-risks may be:
Insolvency of a customer.
Worker’s strike.
Sudden power failure.
The premature death of an expert employee or manager, and.
What does the Statement of Cash Flows mean? In accounting, a statement of cash flows, also known as the cash flow statement, is a financial statement that shows how changes in balance sheet accounts and income affect cash and cash equivalents, and breaks the analysis down to operating, investing, and financing activities. Explanation of Statement of Cash Flows with Objectives. The statement of cash flows is one of three very important financial reports. That managers and investors look at when analyzing a company’s past or present financial status.
Know and Understand the Concept of the Statement of Cash Flows.
The balance sheet and the income statement are the other two reports. All of these reports are very important in running a successful business. But the statement of cash flows is the most important. It is like the blood of a company since it would not survive successfully without it. Cash on hand can be much more important. Than income, profits, assets, and liabilities put together, especially in the early stages of any company.
Introduction:
The statement of cash flows tells us how much cash we have on hand after all costs are met. It shows how much cash we started with and how much we pay out. There are two parts to the statement of cash flows which are the top and bottom halves. The top half deals with the inflow and outflow of the company’s cash.
The bottom half of the statement reports where the funds end up. Just like the balance sheet, the top and bottom halves of a cash flow statement match. Knowing just how important it is to have cash on hand to pay the bills we want to make sure and review cash flow statement regularly.
Cash flow is a little more honest than an income statement because the cash flow statement shows money coming in only when we deposit it and money going out only when we physically write out a check. Because the statement of cash flows reflects the actual receipt of cash, no matter where it comes from, the entries are a bit different from the revenue shown in a company’s income statement.
These funds are usually made up of gross receipts on sales, dividend and interest income, and invested capital. Gross receipts on sales represent the total money that we take in on sales during the period. Gross receipts are based on our gross revenue, of course, but they also take into account when you receive payment. Dividend and interest income is the income that we receive from savings accounts and other securities.
Meaning:
The statement of cash flows is one of the financial statements issued by business and describes the cash flows into and out of the organization. Its particular focus is on the types of activities that create and use cash, which are operations, investments, and financing. Though the statement of cash flows is generally considered less critical than the income statement and balance sheet, it can use to discern trends in business performance that are not readily apparent in the rest of the financial statements.
This is one of those amounts that are also reporting on the income statement and should be the same as long as we receive the money during the period covered by the cash flow statement. Invested capital is part of the owner’s equity in the balance sheet. Although it does not represent revenue from our business operations and would not be part of the income statement, it can be a source of cash for our company.
Extra Knowledge:
The statement of cash flows keeps track of the costs and expenses that incur for anything and everything. Some of the expenses appear in the income statement and some don’t because they don’t directly relate to our costs of doing business. These funds consist of the cost of goods produced, sales, administration, interest expense, taxes, etc. The cost of goods produced is exactly that, the cost incurred to produce our product or service during the period. Sales expenses are the same expenses that appear in an income statement except that paying off bills or postponing payments may change the amounts. On to the bottom half of the statement of cash flows which shows where the money is ending up.
When the company’s cash reserves raise the money flows into one or more of asset accounts. The bottom half of the cash flow statement keeps track of what is happening to those accounts. This part of the statement consists of changes in liquid assets and net change in cash position. With cash flowing in and out of the company, liquid assets are going to change during the period covered by the cash flow statement. The items listed in this portion of the cash flow statement are the same ones that appear in the balance sheet. Raising the level of our liquid asset accounts has the effect of strengthening the cash position.
Explanation of Statement of Cash Flows with Objectives, #Pixabay.
Cash flow analysis:
To properly construct a cash flow analysis, we have to look at three very important activities which are operating, investing and financing.
Operating activities are the cash components that are generating from the sales of the companies goods or products affecting the core business operation. These include the purchase of raw materials, production costs, advertising cost and even the delivery to customers.
Investing activities are straight forward items that report adjustments in the balances of fixed asset accounts like equipment, buildings, land, and vehicles. Investing activities include making and collecting loans and acquiring and disposing of investments and property, plant and equipment.
Financing activities are cash adjustments to fixed liabilities and owners’ equity. Cash increases when the company takes up a loan or raised capital when dividends are paid out, cash decreases accordingly. Financing activities involve liabilities and owner’s equity items. They include obtaining resources from owners and providing them with a return on their investments and borrowing money from creditors to repay the amounts borrowed.
#Objectives of the statement of cash flows:
There are a few main objectives of the statement of cash flows one of which is to help assess the timing, amounts and the uncertainty of future cash flows. This is one of the quarterly financial reports that publicly traded companies are required to release to the public. Because public companies tend to use accrual accounting. The income statements they release each quarter may not necessarily reflect changes in their cash positions.
The statement of cash flows is very important to businesses. Because it helps investors see where the company can benefit from better cash management. There are many profitable companies today that still fail at adequately managing their cash flow. So it is important to be able to see where the weaknesses are to correct them.
Conclusion of Objectives:
In conclusion, the objectives are to explain why the statement of cash flows is very important for companies and people. That want to invest in a certain company. It shows how well a company manages its cash in-comings and outgoings as well as showing how profitable a company might be or become.
It is a very clear document to understand so that we don’t fall victim to making a profit while still going broke. It’s also helpful for the companies finance department. So that they can see where the company stands to get more potential investors. It’s a great resource to look at to recap a company’s financial standing that most people can understand.
What does Financial Statements mean?
A firm communicates to the users through financial statements and reports. The financial statements contain summarized information of the firm’s financial affairs, organized systematically. Preparation of the financial statements is the responsibility of top management. They should prepare very carefully and contain as much information as possible.
Two basis financial statements prepared for external reporting to owners, investors, and creditors are:
Balance sheet:
The balance sheet contains information about the resources and obligations of a business entity and about. Its owner’s interests in the business at a particular point of time. In accounting’s terminology, balance sheet communicates. Information about assets, liabilities and owner’s equity for a business firm as on a specific date. It provides a snapshot of the financial position of the firm at the close of the firm’s accounting period.
Profit and loss account:
The profit and loss account presents the summary of revenues, expenses and net income (or net loss) of a firm for some time. Net income is the amount by which the revenues earned during a period exceed the expenses incurred during that period.
More information requires planning and controlling and therefore the financial accounting information is presenting in different statements and reports in such a way as to serve the internal needs of management. Financial statements are preparing from the accounting records maintaining by the firm.
The various objectives of financial statements are:
To provide reliable financial information about economic resources and obligations of a business enterprise.
To provide reliable information about changes in the resources of an enterprise that result from the profit-directed activities.
Also, financial information that assists in estimating the earning potential of the enterprise.
To provide other needed information about changes in economic resources and obligations.
To disclose, to the extent possible, other information related to the financial statement that is relevant to statement users.
What does Cash Flow Statement mean? A cash flow statement counters the ambiguity regarding a company’s solvency that various accrual accounting measures create. We are studying Cash Flow Statement: Explanation, Classification, and Objectives; In financial accounting, a cash flow statement, also known as statement of cash flows, is a financial statement that shows how changes in balance sheet accounts and income affect cash and cash equivalents, and breaks the analysis down to operating, investing, and financing activities.
Here explains the Concept of Cash Flow Statement with their Explanation, Classification, Objectives, and Limitations.
The following concept is; Explanation of Cash Flow Statement, Classification of Cash Flow Statement, Objectives of Cash Flow Statement, and Limitations of the Cash Flow Statement.Meaning: A Cash Flow Statement is a statement which is prepared by acquiring Cash from different sources and the application of the same for different payments throughout the year. It is prepared from analysis of cash transactions, or it converts the financial transactions prepared under accrual basis to cash basis.
The information about the number of resources provided by operating activities or net income after the adjustment of certain other charges can also obtain from it. The changes in Cash both at the beginning and at the end can also know with the help of this statement and that is why it is called Cash Flow Statement.
#Explanation of Cash Flow Statement:
A cash flow statement is an important indicator of financial health because a company can show profits while not having enough cash to sustain operations. It is a financial report that shows to the user the source of a company’s cash and how it was spent over a specific period. A cash flow statement counters the ambiguity regarding a company’s solvency that various accrual accounting measures create.
It also categorizes the sources and uses of cash to provide the reader with an understanding of the amount of cash a company generates and uses in its operations. As opposed to the amount of cash provided by sources outside the company. Such as borrowed funds or funds from stockholders. They also tell the reader how much money was spent on items that do not appear on the income statement. Such as loan repayments, long-term asset purchases, and payment of cash dividends.
The cash flow statement was previously known as the flow of funds statement. The cash flow statement reflects a firm’s liquidity. The balance sheet is a snapshot of a firm’s financial resources and obligations at a single point in time, and the income statement summarizes a firm’s financial transactions over an interval of time. These two financial statements reflect the accrual basis accounting used by firms to match revenues with the expenses associated with generating those revenues.
Extra Knowledge:
They include only inflows and outflows of cash and cash equivalents; it excludes transactions that do not directly affect cash receipts and payments. These non-cash transactions include depreciation or write-offs on bad debts or credit losses to name a few. It is a cash basis report on three types of financial activities: operating activities, investing activities, and financing activities. Non-cash activities are usually reported in footnotes.
It is intended to provide information on a firm’s liquidity and solvency and its ability to change cash flows in future circumstances provide additional information for evaluating changes in assets, liabilities, and equity improve the comparability of different firms’ operating performance by eliminating the effects of different accounting methods indicate the amount, timing and probability of future cash flows. The cash flow statement has been adopting as a standard financial statement because it eliminates allocations, which might derive from different accounting methods, such as various time-frames for depreciating fixed assets.
#Classification of Cash Flow Statement:
The cash flow statement should report cash flows during the period classification by operating, investing and financing activities.
Thus, cash flows are classifying into three main categories:
Operating activities.
Investing activities.
Financing activities.
Now, explain;
Operating Activities:
Operating activities are the principal revenue-producing activities of the enterprise and other activities that are not investing or financing activities. The amount of cash flows arising from operating activities is a key indicator of the extent to which the operations of the enterprise have generated sufficient cash flows to maintain the operating capability of the enterprise, pay dividends, repay loans, and make new investments without recourse to external sources of financing.
Information about the specific components of historical operating cash flows is useful, in conjunction with other information, in forecasting future operating cash flows. Cash flows from operating activities are primarily derived from the principal revenue-producing activities of the enterprise. Therefore, they generally result from the transactions and other events that enter into the determination of net profit or loss.
Explanations:
Examples of cash flows from operating activities are:
A cash receipts and cash payments of an insurance enterprise for premiums and claims, annuities and other policy benefits.
Cash receipts from the sale of goods and the rendering of services.
Cash receipts from royalties, fees, commissions, and other revenue.
The cash payments to suppliers of goods and services.
Cash payments to and on behalf of employees.
Refunds or cash payments of income taxes unless they can specifically identify with financing and investing activities, and.
Cash receipts and payments relating to futures contracts, forward contracts, option contracts, and swap contracts when the contracts are heling for dealing or trading purposes.
Some transactions, such as the sale of an item of plant, may give rise to a gain or loss which includes in the determination of net profit or loss. However, the cash flows relating to such transactions are cash flows from investing activities.
Investing Activities:
Investing activities are the acquisition and disposal of long-term assets and other investments not included in cash equivalents. The separate disclosure of cash flows arising from investing activities is important because the cash flows represent the extent to which expenditures have been making for resources intended to generate future income and cash flows.
Explanations:
Examples of cash flows arising from investing activities are:
The cash payments to acquire fixed assets. These payments include those relating to capitalized research & development costs and self-constructed fixed assets.
Cash receipts from the disposal of shares, warrants, or debt instruments of other enterprises and interests in the joint venture.
Cash advances and loans made to third parties, other than advances and loans made by a financial enterprise.
The cash receipts from disposal of fixed assets.
Cash receipts from the repayment of advances and loans made to third parties, other than advances and loans of a financial enterprise.
Cash payments to acquire shares, warrants, or debt instruments of other enterprises and interests in joint ventures. Other than payments for those instruments considering to be cash equivalents and those held for dealing or trading purposes.
The cash payments for futures contracts, forward contracts, option contracts, and swap contracts except when the contracts are heling for dealing or trading purposes, or the payments are classifying as financing activities, and.
Cash receipts from futures contracts, forward contracts, option contracts, and swap contracts except when the contracts are heling for dealing or trading purposes or the receipts are classifying as financing activities.
Financing Activities:
Financing activities are activities that result in changes in the size and composition of the owner’s capital and borrowings of the enterprise. The separate disclosure of cash flows arising from financing activities is important because .it is useful in predicting claims on future cash flows by providers of funds (both capital and borrowings) to the enterprise.
Explanations:
Examples of cash flows arising from financing activities are:
Cash proceeds from issuing shares or other similar instruments.
Cash proceeds from issuing debentures, loans, notes, bonds, and other short-or long-term borrowings, and.
The cash repayments of amounts borrowed such as redemption of debentures, bonds, preference shares.
Cash Flow Statement: Explanation, Classification, and Objectives, #Pixabay.
#Objectives of Cash Flow Statement:
The primary objectives of the cash flow statement are to supply the necessary information relating to the generation of cash to the users of the financial statement. It also highlights the future or prospective cash positions i.e. cash or cash equivalent. The inflows and outflows of cash can represent with the help of this statement.
The main objectives of the cash flow statement are:
Measurement of Cash:
Inflows of cash and outflows of cash can measure annually. Which arise from operating activities, investing activities and financing activities.
Generating inflow of Cash:
Timing and certainty of generating the inflow of cash can know. Which directly helps the management to take financing decisions in the future.
Classification of activities:
All the activities are classifying into operating activities, investing activities and financing activities. Which help a firm to analyze and interpret its various inflows and outflows of cash.
Prediction of the future:
A cash flow statement, no doubt, forecasts the future cash flows. Which help the management to take various financing decisions since synchronization of cash is possible.
Supply necessary information to the users:
A cash flow statement supplies various information relating to inflows and outflows of cash to the users of accounting information in the following ways:
Assess the ability of a firm to pay its obligations as soon as it becomes due.
Analyze and interpret the various transactions for future courses of action.
To see the cash generation ability of a firm, and.
Ascertain the cash and cash equivalent at the end of the period.
Helps the management to ascertain cash planning:
No doubt, a cash flow statement helps the management to prepare. Its cash planning for the future and thereby avoid any unnecessary trouble.
Evaluation of future cash flows:
Whether the cash flow from operating activities is quite sufficient in the future to meet the various payments e.g. payment of expense/debts/dividends/taxes.
Assessing liquidity and solvency position:
Both the inflows and outflows of cash and cash equivalent can know, and as such, liquidity and solvency position of a firm can also maintain as timing and certainty of cash generation knows i.e. It helps to assess the ability of a firm to generate cash.
#Limitations of the Cash Flow Statement:
Despite several uses, the cash flow statement suffers from the following limitations:
As the cash flow statements based on the cash basis of accounting. It ignores the basic accounting concept of accrual basis.
A cash flow statements, not a substitute for an income statement it is complementary to an income statement. Net cash flow does not mean the net income of a firm.
A cash flow statement is also not a substitute of funds flow statement which. Provides information relating to the causes that lead to an increase or decrease in working capital.
The comparative study of cash flow statements may give misleading results.
Some people feel that as working capital is a wider concept of funds. A funds flow statement provides a more complete picture than the cash flow statement, and.
Cash flow statements not suitable for judging the profitability of a firm as non-cash charges are ignored while calculating cash flows from operating activities.
What does the Fund Flow Statement mean? Funds flow statement is the statement of sources and uses of the fund. Fund Flow Statement: Explanation, Importance, and Structure.Funds flow statement shows the source from which the funds are received and the areas to which they obtained funds have been utilized. Funds flow statement indicates various mean by which funds were received during a particular period and the ways in which these funds were applied. Also learned, Venture Capital: Introduction, Definition, Characteristics, Advantages, and Disadvantages.
The Concept of Fund Flow Statement.
The topic is studying; Explanation of Fund Flow Statement, Meaning of Fund Flow Statement, Definition of Fund Flow Statement, Importance of Fund Flow Statement, and Structure of Fund Flow Statement. Funds flow statement comprises three words- fund, flow, and statement. “Fund” means the financial resources used by a concern. In the sense of working capital. The excess current asset over the current liabilities is called net working capital.
Similarly. The term “Flow” means the movement of funds and includes both inflows (receipt) and outflows (payments) of found. Funds from the operation, issue of share and debentures, additional long term debt, non-operating revenues etc. are considered as the major sources of fund. Increase in working capital, the redemption of the debenture, repayment of the long term loan, payment for non-operating expenses etc. are the amine areas of uses of the fund.
The term “Statement” represents the format or account under which the flows of fund i.e. cash inflows and outflows are recorded. Funds flow statement is known by various names such as statements of sources and uses of funds, the summary of financial operations, which got and where go statement, movement of the working capital statement, funds received and disbursement statement etc.
#Explanation of Fund Flow Statement:
The balance sheet and income statement are the traditional basis financial statements of concern. They furnish useful financial information regarding the operation of the concern; however, a serious limitation of these statements is that they fail to provide of time regarding changes in the financial position of a concern during a particular period of time. Funds flow statement, which is known as the statement of changes in financial position, overcomes these limitations of traditional financial statements.
Funds flow statement is the statement of sources and uses of the fund. Funds flow statement shows the source from which the funds are received and the areas to which they obtained funds have been utilized. Funds flow statement indicates various mean by which funds were received during a particular period and the ways in which these funds were applied.
Meaning of Fund Flow Statement:
A fund flow statement is a statement in summary form that indicates changes in terms of financial position between two different balance sheet dates showing clearly the different sources from which funds are obtained and uses to which funds are put. The profit and loss account and balance sheet statements are the common important accounting statements of a business organization.
The profit and loss account provides financial information relating to only a limited range of financial transactions entered into during an accounting period and its impact on the profits to be reported. The balance sheet contains information relating to capital or debt raised or assets purchased. But both the above two statements do not contain a sufficiently wide range of information to make an assessment of the organization by the end user of the information.
In view of the recognized importance of capital inflows and outflows, which often involve large amounts of money should be reported to the stakeholders, the funds flow statement is devised. In funds flow analysis, the details of financial resources availed and the ways in which such resources are used during a particular accounting period, are given in a statement form called “Funds flow statement”.
The sources of funds also include the funds generated from operations internally. The funds flow statement can explain the reasons for the liquidity problems of the firm even though it is earning profits. It helps the efficient working capital management and indicates the ability of the firm in servicing its long-term debt obligations. The changes in working capital position can also be tracked by observing the surplus/deficit of funds during a particular accounting period.
Definition of Fund Flow Statement:
Funds Flow Statement is a method by which we study changes in the financial position of a business enterprise between the beginning and ending financial statements dates. It is a statement showing sources and uses of funds for a period of time.
Some definitions of financial experts are given for the clear conception of fund flow statement:
Foulke defines these statements as:
“A statement of sources and application of funds is a technical device designed to analyze the changes in the financial condition of a business enterprise between two dates.”
According to R. N. Anthony:
“The fund’s flow statement describes the sources from which additional funds were derived and the use to which these sources were put.”
I.C.W.A. in Glossary of Management Accounting terms defines Funds Flow Statement as,
“A Statement prospective or retrospective, setting out the sources and applications of the funds of an enterprise. The purpose of the statement is to indicate clearly the requirement of funds and how they are proposed to be raised and the efficient utilization and application of the same.”
Roy A. Fouke defines a fund flow statement as,
“A statement of sources and application of funds is a technical device designed to analyze the changes in the financial condition of a business enterprise between two dates.”
Thus, the fund flow statement reveals the volume of financial transactions and explains the flow of funds taking place within a business during a particular period of time and its effect on the net working capital. It is not a substitute for either the Profit and Loss Account or the Balance Sheet, but it is a useful supplement to them. It describes the sources from which funds are obtained and the uses of these funds, in a condensed form.
#Importance of Fund Flow Statement:
A funds flow statement is an essential tool for financial analysis and is of primary importance to financial management. Nowadays, it is being widely used by the financial analysts, credit granting institutions and financial managers.
The basic purpose of a funds flow statement is to reveal the changes in the working capital on the two balance sheet dates. It also describes the sources from which additional working capital has been financed and the uses to which working capital has been applied.
The importance of fund flow statement may be summarised:
Analyses Financial Statements:
Balance Sheet and Profit and Loss Account do not reveal the changes in the financial position of an enterprise. Fund flow analysis shows the changes in the financial position between two balance sheet dates. It provides details of inflow and outflow of funds i.e., sources and application of funds during a particular period.
Hence it is a significant tool in the hands of the management for analyzing the past, and for planning the future. They can infer the reasons for imbalances in the uses of funds in the past and take corrective measures for the future.
Answers Various Financial Questions:
Fund flow statement helps us to answers various financial questions such as:
How many funds flowed into the business?
How much of these funds were provided by the operations?
What are the other sources of funds?
How were these funds used?
Why was there less/more amount of net working capital at the end of the period than at the beginning?
Why were the dividends not larger?
How was the purchase of fixed assets financed?
Where has the net profit is gone?
How were the loans repaid?
Rational Dividend Policy:
Sometimes it may happen that a firm, instead of having sufficient profit, cannot pay dividend due to inadequate working capital. In such circumstances, fund flow statement shows the working capital position of a firm and helps the management to take policy decisions on dividend etc.
Proper Allocation of Resources:
Financial resources are always limited. So it is the duty of the management to make its proper use. A projected fund flow statement enables the management to take the proper decision regarding allocation of limited financial resources among different projects on a priority basis.
Guide to Future Course of Action:
The future needs of the fund for various purposes can be known well in advance from the projected fund flow statement. Accordingly, timely action may be taken to explore various avenues of the fund. A projected funds flow statement also acts as a guide for the future to the management.
The management can come to know the various problems it is going to face in near future for want of funds. The firm’s future needs of funds can be projected well in advance and also the timing of these needs. The firm can arrange to finance these needs more effectively and avoid future problems.
Proper Managing of Working Capital:
It helps the management to know whether working capital has been effectively used to the maximum extent in business operations or not. It depicts the surplus or deficit in working capital than required. This helps the management to use the surplus working capital profitably or to locate the resources of additional working capital in case of scarcity. A funds flow statement helps in explaining how efficiently the management has used its working capital and also suggests ways to improve the working capital position of the firm.
Guide to Investors:
It helps the investors to know whether the funds have been used properly by the company. The lenders can make an idea regarding the creditworthiness of the company and decide whether to lend money to the company or not.
Evaluation of Performance:
Fund flow statement helps the management in judging the financial and operating performance of the company.
Fund Flow Statement: Explanation, Importance, and Structure, #Pixabay.
#Structure of Fund Flow Statement:
The structure of fund flow statement like other accounting statements is based on the equality of financial assets and liabilities.
To bring the form of fund flow statement on a scientific line, the fund flow statement is divided into two parts:
Schedule of working capital changes, and.
Statement of sources and uses of the fund.
Now explain;
Schedule of Working Capital Changes:
This schedule is also called “Comparative Change in Working Capital Statement” of “Statement of Working Capital Changes” or “Working Capital Variation Statement” or “Net Current Assets Account” or “Working Capital Account”. The increase in working capital is treated as use of fund and decrease in working capital is termed as sources of fund.
This statement or schedule is prepared in such a way or form as to indicate the amount of working capital at the end of two years as well as increase or decrease in the individual items of current assets and current liabilities.
The following rules should be taken into account while ascertaining the increase or decrease in individual items of current assets and current liabilities and its impact on working capital:
Increase in the items of Current Assets will increase the Working Capital.
The decrease in the items of Current Assets will decrease the Working Capital.
Increase in the items of Current Liabilities will decrease the Working Capital.
The decrease in the items of Current Liabilities will increase the Working Capital.
Statement of Sources and Uses of Fund:
This is the second but most important part of Fund Flow Statement. It is prepared on the basis of the changes in Fixed Assets. The preparation of Statement of Sources and Uses of Fund involves the ascertainment of increase/decrease in the various items of fixed assets, long term liabilities and share capital in the light of additional information given below.
To give an idea of the different items of sources and uses, the probable items of sources and uses of the fund are tabulated below.
Sources of Fund:
The following sources below are;
An issue of fresh shares (derived from an increase in share capital).
The Issue of Debentures (derived from the increase in debentures).
Raising of new loans (derived from the increase in long term loans).
Sale of fixed assets for cash or for other current assets (derived from the decrease in fixed assets and additional information).
Non-trading income.
Profit from operations (before deducting non-cash items of expenses and losses and before adding non-cash, non-trading income), and.
The decrease in working capital (derived from the schedule of working capital changes).
Uses of Fund:
The following uses below are;
Redemption of Preference Shares in cash (derived from the decrease in share capital).
Redemption of debentures in cash (derived from the decrease in debentures).
Repayment of loans (derived from the decrease in long-term loans).
Purchase of fixed assets for consideration other than shares, debentures or long term debt (derived from the increase in fixed assets and additional information).
Loss from operations.
Payment of dividend in cash, and.
Increase in working capital (derived from the schedule of working capital changes).
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.
