Accounts & Finance
Complete Notes

Relationship Between Accounting & Finance

Accounting Equation

ASSETS = LIABILITIES + EQUITY

Financial Statements Overview

• Income Statement: Profit/Loss over period
• Balance Sheet: Financial position at date
• Cash Flow Statement: Cash movements
• Statement of Changes in Equity: Owner's stake changes

Purpose of Financial Information

• Decision-making by managers
• Accountability to stakeholders
• Tax compliance
• Obtaining credit from banks
• Attracting investments

Accounting Process

Transaction → Journal Entry → Ledger Posting
                                    ↓
                            Trial Balance
                                    ↓
                           Adjusted Trial Balance
                                    ↓
                          Financial Statements

Income Statement

         Income Statement - Year ended 31-Dec-2023
        ______________________________________________
Sales Revenue                              500,000
Less: Cost of Goods Sold                  (250,000)
Gross Profit                               250,000

Operating Expenses:
  Salaries                   80,000
  Rent                       24,000
  Marketing                  20,000
  Utilities                  16,000
  Depreciation              10,000   (150,000)

Operating Profit                          100,000
Less: Interest Expense                     (5,000)
Profit Before Tax                          95,000
Less: Income Tax (30%)                    (28,500)
Net Profit                                 66,500

Balance Sheet

         Balance Sheet - 31-December-2023
        ___________________________________
ASSETS
Current Assets:
  Cash              100,000
  Receivables        80,000
  Inventory          60,000    240,000

Fixed Assets:
  Equipment         300,000
  Less: Deprec.     (30,000)   270,000
Total Assets                   510,000

LIABILITIES & EQUITY
Current Liabilities:
  Payables           60,000
  Short-term Loan   40,000    100,000

Long-term Liabilities:
  Loan              150,000

Equity:
  Capital           180,000
  Retained Earnings  80,000    260,000
Total Liab. + Equity           510,000

Cash Flow Statement

Shows inflows and outflows of cash from three activities:

• Operating: Core business activities
• Investing: Buying/selling assets
• Financing: Raising capital, repaying debt

Ratio Analysis Framework

Profitability Ratios

• Gross Profit Margin: (Sales - COGS) / Sales
• Operating Margin: Operating Income / Sales
• Net Profit Margin: Net Income / Sales
• ROA: Net Income / Total Assets
• ROE: Net Income / Shareholder Equity

Liquidity Ratios

• Current Ratio: > 1.5 is good
• Quick Ratio: (Current Assets - Inventory) / Current Liabilities
• Cash Ratio: (Cash + Receivables) / Current Liabilities

Leverage Ratios

• Debt-to-Equity: Total Debt / Equity
• Debt Ratio: Total Debt / Total Assets
• Interest Coverage: EBIT / Interest Expense

Cash Flow vs Profit

Cash Flow Statement

         Cash Flow Statement - 2023
        ________________________________
Operating Activities:
  Net Income                 100,000
  Add: Depreciation           10,000
  Changes in Working Capital  (5,000)
  Cash from Operations       105,000

Investing Activities:
  Equipment Purchase        (50,000)
  Sale of Assets             20,000
  Cash used in Investing    (30,000)

Financing Activities:
  Loan proceeds              30,000
  Dividend paid             (20,000)
  Cash from Financing        10,000

Net Change in Cash:
  Beginning Cash             50,000
  Change                     85,000
  Ending Cash              135,000

Working Capital Management

• Accounts Receivable: Collect quickly from customers
• Inventory: Optimize stock levels
• Accounts Payable: Manage payment timing
• Goal: Positive operating cash flow

Cash Flow Problems

• Rapid growth (inventory, receivables increase)
• Long payment cycles
• High fixed costs
• Seasonal variations

Budget Definition

Budget is quantified plan for future period showing expected revenues, expenses, and cash flows.

Types of Budgets

Budget Process

Step 1: Set strategic objectives
Step 2: Sales forecast
Step 3: Production and expense budgets
Step 4: Cash flow forecast
Step 5: Pro forma financial statements
Step 6: Approve and communicate
Step 7: Monitor and control
Step 8: Analyze variances and adjust

Forecasting Methods

• Historical Analysis: Past trends continue
• Market Research: Customer surveys, competitor analysis
• Regression Analysis: Statistical relationships
• Expert Opinion: Manager/industry judgment

Variance Analysis

Compare actual results with budget. Identify reasons for differences.

Sources of Finance

Cost of Capital

Minimum return required by investors to invest in company.

WACC = (E/V × Re) + (D/V × Rd × (1-Tc))

E = Market value of equity
D = Market value of debt
V = Total value
Re = Cost of equity
Rd = Cost of debt
Tc = Tax rate

Capital Allocation Decisions

• Strategic Investments: New products, markets
• Maintenance: Keep existing operations
• Acquisitions: Buy other companies
• Dividends: Return to shareholders

Time Value of Money

• Present Value: What future money is worth today
• Future Value: What money will be worth in future
• Discount Rate: Interest rate used

Investment Evaluation Methods

NPV Calculation

Example: Equipment investment
Initial Investment: Rs. 100,000
Annual cash flow: Rs. 30,000 for 5 years
Discount rate: 10%

Year 1: 30,000 / 1.1 = 27,273
Year 2: 30,000 / 1.1² = 24,793
Year 3: 30,000 / 1.1³ = 22,539
Year 4: 30,000 / 1.1⁴ = 20,490
Year 5: 30,000 / 1.1⁵ = 18,627

Total PV: 113,722
Less: Investment: 100,000
NPV: 13,722 (Accept project)

Risk Considerations

• Sensitivity Analysis: How changes affect NPV
• Scenario Analysis: Best, worst, likely cases
• Probability Weighting: Expected value approach

Working Capital Components

Working Capital = Current Assets - Current Liabilities

Cash Management

• Maintain minimum cash balance
• Invest excess cash
• Plan for seasonal variations
• Optimize cash flow timing

Accounts Receivable Management

Inventory Management

• Just-in-time: Minimize inventory levels
• EOQ: Economic order quantity optimization
• Inventory Turnover: How quickly inventory sells

Accounts Payable Management

• Negotiate favorable terms with suppliers
• Take advantage of early payment discounts
• Manage payment timing strategically

Types of Financial Risks

Hedging Strategies

• Forward Contracts: Lock in future prices
• Futures: Standardized contracts
• Options: Right but not obligation
• Swaps: Exchange cash flows

Debt Management

• Maintain manageable debt levels
• Diversify debt maturity
• Monitor interest coverage ratio
• Maintain credit rating

Insurance & Contingency

• Business interruption insurance
• Key person insurance
• Liability coverage
• Emergency reserves (cash buffer)

Financial Reporting Standards

• IFRS: International Financial Reporting Standards
• IAS: International Accounting Standards
• Local: Pakistan Standards for Accounting & Auditing (PSQC/PSA)

Audit and Assurance

• Internal Audit: Management tool
• External Audit: Independent verification
• Auditor's Opinion: Unqualified or qualified

Internal Controls

Corporate Governance

• Board of Directors oversight
• Executive compensation alignment
• Whistleblower protection
• Transparent disclosure
• Stakeholder accountability

Tax Compliance

• Accurate record keeping
• Timely tax payments
• Tax planning (legal)
• Documentation of deductions