Basics of Accounts - Finance Compendium

FINANCE COMPENDIUM
BASICS OF ACCOUNTING
STAY INVESTED!
TEAM NIVESHAK
A Message from Niveshak
Dear PGP Batch of 2021-2023

2023-2025
Some of you might be well exposed to the domain of finance, while rest of you might seek to master it
here. But when you'll be sitting in the process of placements, it'll be a level playing field, and what would
matter is not who knows more, but who knows more than what she/he is expected of. The next few months
of your preparation will determine whether you’re willing to steer your career in the domain of finance or
not.
Finance as a field is very broad, and it is not possible to cover each aspect in this compendium. However,
we've put in our best efforts to compile the relevant information in a concise manner.
The compendium has been divided into four modules: Basics of Accounting, Corporate Finance, Capital
Markets, and Investment Banking. We’d suggest you go in similar order and cover all the modules for
your preparation.
The purpose of this compendium isn’t to provide you the answer to each and every question that might
come in your interview but give a direction to ‘your’ preparation process.
We hope you’ll put in your best efforts to extract the maximum value out of it. And, in case of any query
regarding anything related to finance, feel free to reach out to us. We'd be more than happy to solve any
query of yours, however small it might be.
Regards
Team Niveshak
Finance and Investment Club, IIM Shillong
NIVESHAK – FINANCE & INVESTMENT CLUB 1

TABLE OF CONTENTS
Important Accounting Concepts ………………………………………………………………………..03
Financial Statements …………………………………………………………………………………….06
Balance Sheet……………………………………………………………………………………08
Statement of Profit and Loss ………………………………………………………………….09
Cash Flow Statement …………………………………………………………………………..11
Ratio Analysis ……………………………………………………………………………………………15
Economics ………………………………………………………………………………………………..23

Introduction to Accounting
Book Keeping:
Book keeping involves recording, on a daily basis, the financial transactions of the company. This
enables the companies to track all information on its books to make key operating, investing, and financing
decisions.
Accounting:
According to the American Institute of Certified Public Accountants [AICPA]; "Accounting is the art of
recording, classifying and summarizing in a significant manner and terms of money, transactions and
events, which are, in part at least, of a financial character and interpreting the result thereof."
While accounting and book keeping are sometimes considered synonymous but there is a fundamental
difference between the two. While the scope of book keeping is limited to recording of transactions,
accounting is much broader in scope and, in addition to book keeping includes summarizing, analyzing,
interpreting, and communicating the results to interested parties.
Accounting Basis:
There are two major methods of accounting, namely–cash basis and accrual basis. The difference
between these is based on when the company actually records a transaction in the books.
• Cash accounting – In the case of cash accounting system, revenue is recorded during the period
when cash is actually received, and expenses are recorded when cash is actually paid. Thus, this
system focuses on recording transactions only when there is an inflow or outflow of cash.
• Accrual accounting – Contrary to cash accounting, in accrual accounting, revenue and expenses
are recorded when the transaction takes place and not when cash is actually received or paid.
For example – A business sells goods for ₹ 10,000, and the customer does not make the payment
immediately. In this case, no transaction would be recorded under the cash accounting system since cash
has not yet been received (the transaction would be recorded during the time period when the cash is
received). However, in the case of an accrual accounting system, the transaction would be recorded in the
books of accounts as accounts receivable, indicating that the sale has been made, but the amount is still
to be received from the customer.
Accounting Equation:
The accounting equation is a basic principle of accounting and a fundamental element of the balance
sheet. It sets the foundation of double-entry accounting and highlights the structure of the balance sheet.
The equation is as follows:
Assets = Liabilities + Shareholders’ / Owners’ Equity
Assets include items such as cash, accounts receivable, inventory, and equipment. Liabilities include items
such as trade payables, borrowings, and debt. Shareholder's equity includes share capital and retained
earnings.

Double Entry System:
In the double-entry system, transactions are recorded in terms of debits and credits. Since a debit in one
account offsets a credit in another, the sum of all debits must equal the sum of all credits. A debit may
increase one account while decreasing another.
The system is based on the fundamental accounting equation i.e.
Assets= Liabilities + Shareholders’ equity
For example- A business borrows ₹ 20,000 from a bank. In this case, the transaction would involve two
aspects-
a) ₹ 20,000 cash flowing into the business, which would result in an increase in the assets
b) Since ₹ 20,000 rupees have been borrowed by the bank, it is a liability for the business. Thus, the
business’ liability would also increase by 20,000 rupees.
IFRS:
The International Financial Reporting Standards (IFRS) are accounting standards that are issued by
the International Accounting Standards Board with the objective of providing a common accounting
language to increase transparency in the presentation of financial information.
IND AS:
IND AS stands for Indian Accounting standards and are converged standards for International Financial
Reporting Standards (IFRS). In simple terms, Indian accounting standards came into existence to meet
the requirements of IFRS.
• As IND AS are converged standards for IFRS, i.e., IFRS are not adopted as it is. Certain changes
have been made in IFRS, considering the economic environment of the country. These differences
are due to differences in the application of accounting principles and practices and economic
conditions prevailing in India. These differences, which are in deviation to the accounting principles
stated in IFRS, are commonly known as 'Carve- Outs.'
• A carve-out essentially means that certain requirements of an accounting standard under IFRS are
not be adopted.
• There is certain additional note or guidance given in IND AS, which is over and above what is given
in IFRS. This is termed as 'Carve-in.'
Accounting Principles:
Accounting principles are the rules that an organization follows when reporting financial information. These
uniform sets of rules or guidelines are developed to ensure uniformity and ease of understanding of the
accounting information. Thus, they form the basis upon which the complete suite of accounting standards
have been built:

o Business entity principle: According to this principle, a business is considered as a unit separate
and distinct from its owners, creditors and managers, and others. In other words, transactions are
recorded from the firm's perspective and not from its owners.
o Accrual principle: Already discussed above.
o Going concern principle: This is the concept that a business will remain in operation for a long period
in the future. This means that you would be justified in deferring the recognition of some expenses,
such as depreciation, until later periods. Otherwise, you would have to recognize all expenses at once
and not defer any of them.
o Conservatism principle: According to this principle, you should record expenses and liabilities as
soon as possible, but record revenues and assets only when you are sure that they will occur. In other
words, conservatism is the policy of playing safe.
For example,
o Provision is made for all known liabilities and losses even though the amount cannot be
determined with certainty.
o Closing Stock is valued at cost price or realizable value, whichever is less.
o As a result, the Statement of P&L will disclose lower profits in comparison to actual profits.
o Consistency principle: This concept states that the accounting principles and methods should remain
consistent from one year to another. These should not be changed from year to year in order to enable
the comparison between financial statements of two accounting periods.
E.g., If the company charges straight-line depreciation, it can’t shift to the written down value method
all of sudden.
However, it doesn’t mean that company can’t change its accounting methods according to changed
circumstances. It may do so by providing the effect of change of method and justification for the same.
o Cost principle: This is the concept that a business should only record its assets, liabilities, and equity
investments at their original purchase costs. Thus, land purchased at $10,000 remains at the same
value in the balance sheet, irrespective of the market price.
o Full disclosure principle: The information on financial statements should be complete so that nothing
is misleading. With this intention, important partners or clients will be aware of relevant information
concerning your company.
That is why, while the contingent liabilities have no monetary impact on the present status of the
business, they're still shown in the notes of accounts to give a clear picture about the company.
o Matching principle: This is the concept that, when you record revenue, you should record all related
expenses at the same time. Thus, you charge inventory to the cost of goods sold at the same time that
you record revenue from the sale of those inventory items. This is a cornerstone of the accrual basis
of accounting. The cash basis of accounting does not use the matching principle.

o Materiality principle: This is the concept that you should record a transaction in the accounting
records; if not, doing so might have altered the decision-making process of someone reading the
company's financial statements.
o Monetary unit principle: Only those transactions and events are recorded in accounting that are
capable of being expresses in terms of money. As a result, events such as strike going on, the
resignation of the manager, etc. are not recorded.
Moreover, all things are measured in terms of money only. So, if the company has 30 chairs or 700kg
of raw material, only their monetary values will be recorded.
o Reliability principle: It states that only those transactions that can be proven should be recorded. For
example, a supplier invoice is a solid evidence that an expense has been recorded. This concept is of
prime interest to auditors, who are constantly in search of evidence supporting transactions.
o Revenue recognition principle: This is the concept that you should only recognize revenue when the
business has substantially completed the earnings process. So many people have skirted around the
fringes of this concept to commit reporting fraud that a variety of standard-setting bodies have
developed a massive amount of information about what constitutes proper revenue recognition.
o Time period principle: This is the concept that a business should report the results of its operations
over a standard period of time. This may qualify as the most glaringly obvious of all accounting
principles but is intended to create a standard set of comparable periods, which is useful for trend
analysis.
Accounting Process:
Accounting process is the series of steps followed by the business entity to record the business financial
transactions that include steps for collecting, identifying, classifying, summarizing, and recording the
business transactions in the books of accounts of the company so that the financial statements of the
entity can be prepared, and the profits and the financial position of the business can be known after regular
intervals of time.
Step 1: Identify the Transactions and preparing the vouchers
Step 2: Recording of the Transactions in the Journal
Step 3: Posting in the Ledger
Step 4: Preparation of Trial Balance and Financial Statements
You would have covered this entire process in the KT sessions, and hence we'd request to brush up the
entire process once again to create a strong foundation for accounting basics.

Financial Statements:
Financial Statements are summarised statements of accounting data prepared at the end of the accounting
process i.e., after preparing Trial Balance by an enterprise. Thus, these serve as a medium of
communicating the accounting information to relevant stakeholders. These include:
o Balance Sheet
o Statement of Profit & Loss
o Cash Flow Statement
Balance Sheet:
• It shows the financial position of an enterprise on a given point of time.

• All the assets, liabilities, and equity (i.e., personal and real accounts) are finally recorded in the
balance sheet.
Statement of Profit & Loss:
• It shows the financial performance of an enterprise during a given time period.

• All the expenses and incomes (i.e., nominal accounts) are finally recorded in the P&L statement.
To give you an overview of how Balance sheet and Statement of Profit & Loss look like and the major
items in it, sample formats have been attached below. However, for better understanding, we'd suggest
you refer to the annual report of any company and read in detail about these items.

Sample Format of Balance Sheet
as on March 31, 20XX
Amt. at Amt. at
Note the end of the end of
Particulars No. Current Previous
Year Year
I. ASSETS
1. Non-Current Assets
Fixed Assets
Tangible Assets
Intangible Assets
Capital Work in Progress
Intangible Assets Under Development
Non-Current Investments
Deferred tax Assets
Long Term Loans & Advances
Other Non-Current Assets
2. Current Assets
Current Investments
Inventories
Trade Receivables
Cash and Cash equivalents
Short Term Loans & Advances
Other Current Assets
Total
I. EQUITY AND LIABILITIES

1. Shareholders' Funds
Share Capital
Reserves and Surplus
2. Non-Current Liabilities
Long Term Borrowings
Deferred Tax Liabilities
Other Long-Term Liabilities
Long Term Provision
3. Current Liabilities
Short Term Borrowings
Trade Payables
Other Current Liabilities
Short Term Provision
Total

Sample Format of Statement of Profit & Loss
as on March 31, 20XX
Amt. at Amt. at
Note the end of the end of
Particulars No. Current Previous
Year Year
I. Revenue from Operations
II. Other Income
III. Total Revenue (I+II)
IV. Expenses
Cost of Materials Consumed
Purchase of Stock in Trade
Change in Inventories of Finished Goods, WIP
and Stock in Trade
Employee Benefit Expenses
Finance Costs
Depreciation and Amortisation Expenses
Other Expenses
Total Expenses
V. Profit Before Tax (III-IV)
VI. Less: Tax
VII. Profit or Loss for the period
Explanation of certain important terms with respect to Balance Sheet and Statement of Profit & Loss:
Surplus:
It is the amount of accumulated profit that may be appropriated towards reserve or for payment as a
dividend.
Reserves:
These are the funds that are earmarked for a specific purpose, which the company intends to use in the
future.
Liability:
All debts that a company has yet to pay are referred to as Liabilities. Common liabilities include Accounts
Payable, Payroll, and Loans.
Current Liability:
These are the liabilities that are expected to be settled within 12 months.
Accounts Payable
Accounts Payable include all of the expenses that a business has incurred but has not yet paid. This
account is recorded as a liability on the Balance Sheet as it is a debt owed by the company.

Asset:
Anything the company owns that has monetary value and expects future economic benefits from the
resource.
Inventory:
Inventory is the term used to classify the assets that a company has purchased to sell to its customers
that remain unsold. As these items are sold to customers, the inventory account will lower.
Accounts / Trade Receivables:
Accounts Receivable include all of the revenue (sales) that a company has provided but has not yet
collected payment on. This account is on the Balance Sheet, recorded as an asset that will likely convert
to cash in the short term.
Cash and Cash Equivalents:
Cash comprises cash on hand and demand deposits with banks. Whereas, cash equivalents refer to short-
term, highly liquid investments that are readily convertible into cash (i.e., maturity of <3 months) and have
an insignificant risk of change in value.
Cost of Goods Sold (COGS):
Cost of Goods Sold refers to the expenses that directly relate to the creation of a product or service.
COGS = Cost of Materials Consumed + Purchase of Stock in Trade + Change in Inventories of Finished
Goods, WIP, and Stock in Trade
In fact, when we subtract COGS from Revenue, we get the Gross Profit or Gross Margin.
Employee Benefit Expenses:
These refer to the payments made to and for the benefits of employees. e.g. salaries, wages, ESOP
expenses, bonus, leave encashment, etc.
Finance Cost:
It refers to the costs incurred by the company on the borrowings and thus includes the interest paid on
loans, debentures, bonds, etc.
Depreciation:
Depreciation is the gradual and permanent decrease in the value of any asset from any cause. Generally,
an asset has to have a) substantial value and b) use for a limited number of years
in order to warrant depreciation.
Assets that are commonly depreciated include machinery, automobiles, equipment, etc.
Depreciation appears on the Income Statement as an expense and is often categorized as a “Non-Cash
Expense” since it doesn’t have a direct impact on a company’s cash position.

Here, a tricky question might be, do we charge depreciation on land?
And the answer is No. Because
The purpose behind charging depreciation is to ensure that the true value of the asset is shown in the
balance sheet, and hence, the decrease in its value due to obsolescence, constant use, etc., is deducted
as depreciation. However, in the case of land, it doesn't happen.
Moreover, the useful life of land, i.e., the number of years of its lifetime, can't be ascertained, which is
necessary to determine the depreciation amount.
Amortisation is similar to depreciation, the slight difference being that it is written off on intangible fixed
assets. E.g., goodwill, patents, etc.
Profit vs. Gain
Profit refers to the excess of revenue over total expenses. Whereas gain refers to the monetary benefit,
advantage, or profit resulting from events or transactions which are incidental to business i.e., not routine
or related to companies’ operations. E.g., gain on sale of building.
Contingent Liabilities
A contingent liability is a potential liability that may or may not occur, depending on the result of an
uncertain future event. E.g. outstanding lawsuits, tax disputes etc.
Kindly note that the contingent liabilities don’t appear in the financial statements. They’re shown only in
notes to accounts.
Notes to Accounts
These refer to the statements attached to the financial statements, which show the details regarding the
items appearing in the Statement of Profit and Loss and Balance Sheet, besides the significant accounting
policies and additional information required to be disclosed.
Cash flow statement

The cash flow statement is a detailed summary of all the cash inflows and cash outflows of a firm during
a particular period of time. The statement helps the investors in understanding how the company's
operations are running, where the money is coming from, and how the money is being spent. It comprises
of three sections-
1. Cash flow from operating activities- Cash flow from operating activities refers to the inflow and
outflow of cash from the regular ongoing business activities during a given period of time. The
operating activities include wage payments, receipts from the sale of goods and services, rent
payments, etc. This part of the cash flow statement considers the net income (calculated under the
net income) and adds back all the non-cash expenses like depreciation (since no cash outflow is
involved in such transactions).
In addition to this, any increase in the assets or decrease in the liabilities results in a decrease in
the cash flow from operations, whereas a decrease in the assets or increase in the liabilities leads
to an increase in the cash flow from operations.

2. Cash flow from investing activities- Cash flow from investing activities refers to cash inflow and
cash outflow from activities that are non-operating in nature and are outside the normal scope of
business. This involves items classified as assets under the Balance Sheet and includes the
purchase and sale of equipment and investments. For example- purchase of the building, sale of
long-term investment.
3. Cash flow from financing activities – This section involves items classified as liabilities and
equity in the Balance Sheet and includes the payment of dividends as well as issuing payment of
debt or equity. For example- Cash received from the issuance of common stock.
The sample format is mentioned below:
Sample format of Cash Flow Statement

Particulars Amount
I. Cash flow from Operating Activities
A. Net Profit before Tax and Extra Ordinary Items
Adjusting for non-cash and non-operating items
B. Add: Items to be Added
Depreciation
Goodwill, Patents & Trademarks amortized
Interest on bank overdraft
Interest on Borrowings
Loss on Sale of Fixed Assets
Increase in Provision for Doubtful Debts
C. Less: Items to be Deducted
Interest Income
Dividend Income
Rent Income
Gain on Sale of Fixed Assets
Decrease in Provision for Doubtful Debts
D. Operating Profit before Working Capital Changes (A+B-C)
E. Add: Decrease in Current Assets and Increase in Current Liabilities
Decrease in Inventories, Trade Receivables, Accrued Incomes,
Prepaid Expenses
Increase in Trade Payables, O/s Expenses, Advance Incomes
F. Less: Decrease in Current Assets and Increase in Current Liabilities
Increase in Inventories, Trade Receivables, Accrued Incomes,
Prepaid Expenses
Decrease in Trade Payables, O/s Expenses, Advance Incomes
G. Cash Generated from Operations (D+E-F)
Less: Income Tax Paid
Add/Less: Cash Flow from Extraordinary Items
Cash flow from (or Used in) Operating Activities
II. Cash flow from Investing Activities
Add: Proceeds from Sale of Fixed Assets, Investments, Intangible
Assets

Less: Payment for purchase of Fixed Assets, Investments, Intangible
Assets
Cash flow from (or Used in) Investing Activities
Cash flow from (or Used in) Investing Activities
III. Cash flow from Financing Activities
Add: Proceeds from Issue of shares, Debentures, Long Term
Borrowings
Less: Payment of Final Dividend, Interim Dividend, Interest on
Debentures & Loans, Buy Back of Shares, Redemption of Debentures
or Preference Shares
Cash flow from (or Used in) Financing Activities
IV. Net Increase/ Decrease in Cash and Cash Equivalents (I+II+III)
V. Add: Cash and Cash Equivalents in the beginning of the year
VI. Cash and Cash Equivalents at the end of the year
We’d suggest you go through a number of cash flow numerical; only then you’ll be able to gain a holistic
understanding of this concept.
Moreover, avoid cramming the treatment of items, i.e., which item is being added or subtracted. Instead,
try to understand the rationale behind them.
‘WHY’ is the loss on sale of fixed assets being added? And when you start asking the why to yourself
and start looking for the answers, you'll be able to get a good hold on accounting.
For example:
o Provisions are added as it is not a payment; hence there is no outflow of cash.

o Bad Debts: It refers to the amount customers owed to the company which is not recoverable. Hence
when these are written off as an expense in the statement of P&L, they represent the loss the
company suffers and not any outflow of cash.
Depreciation is added as it is a non-cash expense.
Certain Important Aspects:
Question: Why do we prepare a cash flow statement? Doesn't statement of Profit & Loss already
tells us about the performance of the company?
Answer: While the P&L tells us about the profitability of the company, the cash flow statement tells us
about the cash flow position of the company, which is important from the liquidity and solvency perspective.
Moreover, it is not necessary that the company which is profitable may also have cash.
E.g., If the company makes sales of $100,000 on credit, based on the accrual concept, it will be recorded
in the Statement of P&L. However, these credit sales have not generated cash for the company till now.
Hence Cash flow statement allows us to look into these finer aspects.
Similarly, a company may make a payment of prepaid insurance i.e., insurance for next year. As a result,
the cash will decrease, but the profits will remain the same as this transaction relates to the next accounting
period and hence will be recorded in the statement of P&L in that period.

Besides this, certain items can be put forward, and you'll be asked to explain their effect on the financial
statements.
Question: If the company receives rent, explain the effect of this transaction on all three financial
statements?
Answer:
Statement of Profit & Loss: Rent Received is considered as an income, and hence it will be shown in
the Statement of P&L as income.
Balance Sheet: When rent is recorded as income, it automatically leads to an increase in profits which is
shown in the Balance Sheet as Net Profits added to shareholders funds.
Cash Flow Statement: The rent received will be subtracted from Net Profit before tax and Extraordinary
Items as this income is received from an investment and not from regular operations. Thereafter, it will be
added back as a cash inflow under Investing Activity.
Similarly, explain the effect of depreciation on all three financial statements?
Answer:
Statement of Profit & Loss: Depreciation is considered as an expense, and hence it will be subtracted
from the Statement of P&L.
Balance Sheet: Here, the depreciation will be subtracted from the concerned asset, and the net value of
the asset will appear on the balance sheet.
Cash Flow Statement: Since depreciation is a non-cash expense while preparing a cash flow statement,
it will be added back to the net profits.
Similarly, try yourself the treatment of the following items:
• Gain on Sale of Fixed Assets

• Interest on Debentures Paid
• Payment for Buy-Back of Shares
• Issue of Bonus shares etc.
Now, when you have an understanding of the concepts of financial statements, you’d be able to answer
these simple questions: Why do we prepare these statements?
Well, since statements provide us the financial data about the company (resources & obligations it has),
the financial position, i.e., whether the business is profitable or not. Thus, it helps in presenting a true and
fair view of the business, which helps the various users in making decisions.
These users can be classified into two categories:
o Internal Users:
o Shareholders (Is the capital that I invested efficiently being managed?)
o Employees (If profits are high, shouldn't the employees deserve increment in salaries or
bonuses?)
o Management (Do we have the cash to make new investment or possibility of cost control
etc.)

o External Users:
o Banks (Is it safe to lend to this company?)
o Potential Investors (How safe it is to invest in this company?)
o SEBI (Oversee the company functioning)
o Govt. Authorities etc. (Calculating the national income, tax, etc.)
What are the limitations of financial statements?
o Affected by Estimates: e.g., Stock Valuation, Provision for depreciation, etc., are based on
estimates; thus, causing a scope of bias.
o Price level changes ignored: According to the cost principle, assets are shown at the historical
price. Thus, not presenting the true picture.
o Qualitative Statements are Ignored, e.g., Quality of Management, etc.
o Historical Records: These present information regarding the past, whereas users are generally
interested in the future.
o Different accounting practices: e.g., Inventory can be valued using FIFO or LIFO method. As a
result, the financial statements of one company can't be compared with another.
Having said, Accounting Standards ensure that these biases or differences are kept at a check to the
greatest extent possible.
Ratio Analysis
Ratio analysis consists of the calculation of ratios from financial statements and is a foundation of financial
analysis. A financial ratio, or accounting ratio, shows the relative magnitude of selected numerical values
taken from those financial statements.
The numbers contained in financial statements need to be put into context so that investors can better
understand different aspects of the company's operations. Ratio analysis is one method an investor can
use to gain that understanding.
Liquidity Ratios:
The terms' liquidity' and 'short -term solvency' are used synonymously.
Liquidity or short-term solvency means the ability of the business to pay its short-term liabilities. Inability
to pay off short term liabilities affects its credibility as well its credit rating.
Current Ratio:
The current ratio is one of the best-known measures of short-term solvency. It is the most common
measure of short-term liquidity.
The main question this ratio addresses is: "Does your business have enough current assets to meet the
payment schedule of its current debts with a margin of safety for possible losses in current assets?" In other
words, the current ratio measures whether a firm has enough resources to meet its current obligations.
Current Ratio = Current Assets/Current Liabilities

Quick Ratio:
The Quick Ratio is sometimes called the "acid-test" ratio and is one of the best measures of liquidity.
Quick Ratio = (Cash and cash equivalent + Marketable securities + Accounts receivable) / Current
liabilities.
Or, Quick Ratio = (Current assets - Inventory) / Current liabilities
The Quick Ratio is a much more conservative measure of short-term liquidity than the Current Ratio. It
helps answer the question: "If all sales revenues should disappear, could my business meet its current
obligations with the readily convertible quick funds on hand?"
Leverage Ratios:
The leverage ratios may be defined as those financial ratios which measure the long-term stability and
capital structure of the firm. These ratios indicate the mix of funds provided by owners and lenders and
assure the lenders of the long- term funds about:
• Periodic payment of interest during the period of the loan and

• Repayment of principal amount on maturity.
Debt Ratio:
Debt Ratio = Total Debt / Total Assets
Total debt or total outside liabilities includes short- and long-term borrowings from financial institutions,
debentures/bonds, deferred payment arrangements for buying capital equipment, bank borrowings, public
deposits, and any other interest-bearing loan.
Interpretation
This ratio is used to analyze the long-term solvency of a firm. A ratio greater than 1 would mean a greater
portion of company assets are funded by debt and could be a risky scenario.
Debt to Equity Ratio
Debt to Equity Ratio = Total Debt / Shareholders’ Equity
A high debt to equity ratio here means less protection for creditors, a low ratio, on the other hand, indicates
a wider safety cushion (i.e., creditors feel the owner's funds can help absorb possible losses of income
and capital). This ratio indicates the proportion of debt fund in relation to equity. This ratio is very often
used for making capital structure decisions such as issue of shares and/ or debentures. Lenders are also
very keen to know this ratio since it shows relative weights of debt and equity. Debt equity ratio is the
indicator of a firm's financial leverage.
Interest Coverage Ratio:

More the debt, the higher will be the interest expense. That means the company has to have higher EBIT
to cover it.
Interest Coverage Ratio = EBIT (1-tax rate) / Interest Expense
This ratio shows how the ability of the company to meet its interest payments from its operating income.
The higher the ratio, the better position a company is in, to meet its interest obligations
As a general rule of thumb, investors should not own a stock or bond that has an interest coverage ratio
under 1.5. An interest coverage ratio below 1.0 indicates the business is having difficulties generating the
cash necessary to pay its interest obligations. For a company, in a situation where its sales decline and
the there is a subsequent decrease in its net income, a high interest obligation can be a cause of concern.
An excessive decrease in the net income would result in a sudden, and equally excessive, decline in the
interest coverage ratio, which should send up red flags for any conservative investor.
Activity Ratios
Inventory Turnover Ratio:
It measures the number of times an enterprise sells and replaces its inventory i.e. no. of times inventory
was converted into sales during this period.
Inventory Turnover = Cost of Goods Sold / Average Inventory
Since it measures how fast a company sells inventory, A low turnover implies weak sales and possibly
excess inventory, also known as overstocking. It may indicate a problem with the goods being offered for
sale or be a result of too little marketing. A high ratio, on the other hand, implies either strong sales or
insufficient inventory, which may lead to a loss in business as the inventory is too low.
Days of Inventory on Hand (DIO) = 365 / Inventory Turnover Ratio
It shows the number of days it takes from buying the raw material to selling the produced goods. Thus, a
lower DIO indicates inventory efficiency of the company and is desirable.
Receivables Turnover Ratio:
It shows how quickly trade receivables are converted into cash and cash equivalents and thus efficiency
in the collection of amounts due against trade receivables.
Receivables Turnover = Net Credit Sales /Average Receivables
A high ratio is better as it shows that debts are collected more promptly, and the company has a high
proportion of quality customers that pay their debts quickly.
However, A high ratio can also suggest that a company is conservative when it comes to extending credit
to its customers. No doubt, Conservative credit policy can be beneficial since it could help the company
avoid extending credit to customers who may not be able to pay on time, however it might also indicate
that such a policy might be driving away the potential customers.

A low receivables turnover ratio might be due to an inadequate collection process, bad credit policies, or
customers that are not financially viable or creditworthy.
Debt Collection Period or Days of Sales Outstanding (DSO) = 365 / Receivables Turnover ratio
The average collection period is the amount of time it takes for a business to receive payments
owed by its clients.
The way we have receivables turnover ratio for the debtors, accounts payable ratio is used to quantify the
rate at which the company pays off its suppliers (creditors).
Payables Turnover Ratio = Net Credit Purchases /Average Payables
Days of Payables Outstanding (DPO) =Number of Days in period / Payables Turnover ratio
Fixed Asset Turnover:
The fixed asset turnover ratio is an efficiency ratio calculated by dividing a company's net sales by its net
property, plant, and equipment (property, plant, and equipment - depreciation). It measures how well a
company generates sales from its property, plant, and equipment. A higher ratio implies that management
is using its fixed assets more effectively.
Profitability Ratios:
Operating Margin: Operating profit ratio is also calculated to evaluate operating performance of business
Operating Profit = Operating Profit/Total Revenue
Where,
Operating Profit = Sales – Cost of Goods Sold (COGS) – Expenses
Operating profit ratio measures the percentage of each sale in rupees that remains after the payment of all
costs and expenses except for interest and taxes. This ratio is followed closely by analysts because it
focuses on operating results. Operating profit is often referred to as earnings before interest and taxes or
EBIT.
Net Profit Ratio/ Net Profit Margin: It measures the relationship between net profit and sales of the
business. Depending on the concept of net profit it can be calculated as:
Net Profit = Net Profit / Total Revenue
Net Profit ratio finds the proportion of revenue that finds its way into profits after meeting all expenses. A
high net profit ratio indicates positive returns from the business.
Return Ratios

Return on Assets (ROA):
Return on Assets = Net Income/Total assets
The profitability ratio is measured in terms of the relationship between net profits and assets employed to
earn that profit. This ratio measures the profitability of the firm in terms of assets employed in the firm. Based
on various concepts of net profit (return) and assets the ROA may be measured as follows:
Return on Equity (ROE):
Return on Equity measures the profitability of equity funds invested in the firm. This ratio reveals how
profitably of the owners' funds have been utilized by the firm. It also measures the percentage return
generated to equity shareholders. This ratio is computed as:
ROE = (Net Profit after taxes – Preference dividend (if any)) / Total Shareholders' Equity
Return on equity is one of the most important indicators of a firm's profitability and potential growth.
Companies that boast a high return on equity with little or no debt can grow without large capital
expenditures, allowing the owners of the business to withdraw cash and reinvest it elsewhere. Many
investors fail to realize, however, that two companies can have the same return on equity, yet one can be a
much better business. If return on total shareholders is calculated, then Net Profit after taxes (before
preference dividend) shall be divided by total shareholders' fund includes preference share capital.
Du Pont Analysis:
The DuPont identity is an expression that shows a company's return on equity (ROE) can be represented
as a product of three other ratios: the profit margin, the total asset turnover, and the equity multiplier.
DuPont identity tells us that ROE is affected by three things:
1. Operating efficiency, which is measured by net profit margin;
2. Asset use efficiency, which is measured by total asset turnover; and
3. Financial leverage, which is measured by the equity multiplier

Thus, the shareholders are dissatisfied with lower ROE, the company with the help of the DuPont Analysis
formula, can assess whether the lower ROE is due to low-profit margin, low asset turnover or poor
leverage.
Five-Step Du Pont Analysis:
Similarly, a much deeper analysis would be:
Market Ratios:
Price to Earnings Ratio (P/E ratio)
Considered as one of the important ratios, this gives information about the amount that the investors are
willing to invest in the company to earn $1.
PE Ratio = Market Price per share/Earnings per share

This is why the P/E is sometimes referred to as the price multiple because it shows how much investors
are willing to pay per dollar of earnings. If a company was currently trading at a P/E multiple of 20x, the
interpretation is that an investor is willing to pay $20 for $1 of current earnings.
In general, a high P/E suggests that investors are expecting higher earnings growth in the future compared
to companies with a lower P/E (logically, that is why the prices are high, leading to high ratio). A low P/E
can indicate either that a company may currently be undervalued or that the company is doing
exceptionally well relative to its past trends.
The inverse of the P/E ratio is the earnings yield.
Absolute P/E
The numerator of this ratio is usually the current stock price, and the denominator may be the trailing
EPS (TTM), the estimated EPS for the next 12 months (forward P/E), or a mix of the trailing EPS of the
last two quarters and the forward P/E for the next two quarters.
When distinguishing absolute P/E from relative P/E, it is important to remember that absolute P/E
represents the P/E of the current time period. For example, if the price of the stock today is $100, and the
TTM earnings are $2 per share, the P/E is 50 = ($100/$2).
Relative P/E
The relative P/E compares the current absolute P/E to a benchmark or a range of past P/Es over a relevant
time period, such as the past 10 years. The relative P/E shows what portion or percentage of the past P/Es
the current P/E has reached. The relative P/E usually compares the current P/E value to the highest value
of the range, but investors might also compare the current P/E to the bottom side of the range, measuring
how close the current P/E is to the historic low.
The relative P/E will have a value below 100% if the current P/E is lower than the past value (whether the
past high or low). If the relative P/E measure is 100% or more, this tells investors that the current P/E has
reached or surpassed the past value.
Price to Book Ratio (P/B Ratio):
P/B Ratio = Market Capitalisation / Total Book Value; or
= Market Price Per Share (MPS) / Book Value Per Share (BPS)
Where, Book Value = Total Assets – Total Liabilities
The book value refers to the amount the shareholders would receive if the company were to shut down
immediately, liquidate, and pay off all its liabilities. The amount that remains is the book value.
A low ratio (less than 1) could indicate that the stock is undervalued (i.e., a bad investment), and a higher
ratio (greater than 1) could mean the stock is overvalued (i.e., it has performed well). Many argue the
opposite, and due to the discrepancy of opinions, the use of other stock valuation methods either in
addition to or instead of the Price to Book ratio could be beneficial for a company.

A low ratio could also indicate that there is something wrong with the company. This ratio can also give
the impression that you are paying too much for what would be left if the company went bankrupt. Usually,
for banks, P/B Ratio is most widely used.
Earnings per Share (EPS):
It refers to the amount of net income that each shareholder is entitled to
EPS = (Net Income – Preferred Dividend) / Average No. of Equity Shares
A related term you'll most commonly find is diluted EPS, which gauges a company’s quality of EPS
assuming all convertible securities (such as outstanding stock options, convertible debentures, convertible
preferred shares, warrants etc.) have been exercised.
Diluted EPS = (Net Income – Preferred Dividend) / (Average No. of Equity Shares + Dilutive Shares)
A large difference between a company's basic EPS and diluted EPS can indicate high potential dilution for
the company's shares, an unappealing attribute according to most analysts and investors. For example,
company A has $9 billion outstanding shares. There is a $0.10 difference between its basic EPS and
diluted EPS. While $0.10 seems insignificant, it equates to $900 million in value not available to investors.
Dividend Pay-out Ratio:
It is the percentage of earnings paid to shareholders in dividends.
Dividend Pay-out Ratio = Total Dividends Paid / Net Income
Retention Ratio:
Similar to Dividend Payout Ratio is the Retention Ratio, which shows the percentage of earnings a
company reinvests in the business either for growth, pay off debt or add to its reserves.
Retention Ratio = (Net Income – Total Dividends Paid)/Net Income
The net income generated by a company is utilized in 2 purposes:
- To pay cash rewards to the shareholders (Dividend Payout Ratio) or

- To invest back and grow the business. (Retention Ratio)
That is why Dividend Pay-out Ratio + Retention Ratio = 100%.

Economics
In order to prepare for the economics sections, there is only one source: Business Newspaper. Try to
cover all the major issues in the economy in depth so that you’re well versed to conversate with the
interviewer about the issue and gain his eyesight through presentation of your logical understanding and
knowledge.
To kickstart your prep you can try to deep dive in the following aspects:
1. GDP- Gross domestic product is the market value of all the final goods and services newly produced
within the country during a given period of time. It is a measure of the economic activity of a country
during a given period of time.
There are three methods to measuring the GDP-
a) Product method- It measures the economic activity by adding the market values of goods and services
produced , excluding any goods and services used up in intermediate stages of production. It makes
use of the value-added concept. The value-added of any producer is the value of its output minus the
value of the inputs it purchases from other producers. The product approach computes economic
activity by summing the value added by all the producers
b) Expenditure method- This method measures the economic activity by adding the amount spent by all
the ultimate users of output.
GDP = C+I+G+NX
C = Consumption
I =Investment
G = Government expenditure
NX= Net exports
c) Income method- The income method measures the economic activity by adding all the income
received by the producers of output, including wages received by the workers and profits received by
the owners of the firms.
2. GNP- Gross national product is the market value of all the final goods and services newly produced by
the domestic factors of production during a given period of time.
3. NFP- Net factor payments from abroad is the income paid to the domestic factors of production from
the rest of the world minus the income paid to the foreign factors of production by the domestic
economy
4. Relationship between GDP and GNP
GDP= GNP-NFP
5. Real GDP vs Nominal GDP

Real GDP, also known as the constant dollar GDP, measures the physical volume of an economy’s
final production using the prices of a base year.
Nominal GDP refers to the monetary value of an economy’s final output measured at current market
prices
6. Balance of Payment- Balance of payments records all the transactions of a country with the rest of
the world, during a given period of time. The three major components of the Balance of payment
account are current account, capital account and financial account.
A) Current Account- The current account of a country records the exports and the imports of goods and
services, net income from abroad and net current transfers. The term current account deficit refers to
an excess of imports of a country over its exports.
B) Capital Account- The capital account of a country records all the capital related transactions between
the country and the rest of the world. The capital transactions may include purchase and sale of fixed
assets, loans and borrowings, etc.
C) Financial Account- The financial account of a country records transactions that arise from the
purchase or sale of financial assets. The account includes two sub accounts- domestic ownership of
foreign assets and foreign ownership of domestic assets. An increase in the domestic ownership of
foreign assets (outflow of money) decreases the financial account and vice-versa. Similarly, an
increase in the foreign ownership of domestic assets (inflow of money) increases the financial account
and vice- versa.
7. Depreciation- Depreciation of a currency refers to a decrease in the value of that currency in terms of
the foreign currency. For example, 1$ is equal to Rs 74. If the value of 1$ becomes Rs. 75 , then in
this case the Indian rupee has depreciated (equivalently the dollar has appreciated). Depreciation is
linked to a flexible exchange rate system where the exchange rate is determined by the forces of
supply and demand.
8. Devaluation – Devaluation refers to lowering the value of the currency against another currency by
the central bank. The concept is similar to depreciation. However, devaluation takes place under a
fixed exchange rate system where the currency's value is fixed against the value of one or more other
currencies.
9. Appreciation- Appreciation of a currency refers to an increase in the value of that currency in terms
of the foreign currency. For instance, 1$ is equal to Rs74. If the value of 1$ becomes Rs 73, then in
this case, the Indian rupee has appreciated (equivalently, the dollar has depreciated).Appreciation is
linked to the flexible exchange rate,
10. Revaluation- Revaluation refers to increasing the value of the currency against another currency by
the central bank. The concept is similar to appreciation; however, revaluation takes place under a fixed
exchange rate system where the currency’s value is fixed against the value of one or more other
currencies.

11. Inflation- Inflation is defined as the persistent increase in the general price level in an economy. The
index used to measure inflation is the Consumer Price index (CPI).
12. CPI- The consumer price index is based on the concept of a basket of goods. It measures changes in
the price level of the weighted average basket of goods and services purchased by the households,
compared to the base year. The basket consists of a)food and beverages, b) pan , tobacco and
intoxicants, c) clothing and footwear, d) housing e)fuel and light f)miscellaneous. The current base year
for CPI is 2011-12.
13. WPI- The wholesale price index captures the change in the price level at a wholesale level i.e. at stages
before the retail level. The base year used for computing the WPI in India is 2011-12.
14. Core Inflation – Core inflation reflects a change in the price of goods and services included in the
basket of goods except food and energy/fuel.
15. Cost-push inflation- Cost-push inflation is said to take place when the overall price level in the
economy increases due to an increase in the input prices. The reason for high cost of production can
be –
a) Increase in the prices of raw materials – This increase may be due to an increase in the global
commodity prices.
b) Increased labour costs – The wages may rise when the unemployment is low, and the bargaining
power of the workers is more than the employers, which may cause the workers to demand higher
wages. The high wages may also be due to an expectation of higher inflation in the future which may
cause the workers to demand high wages to maintain their real income.
c) Higher tax imposed by the government- An increase in the taxes may cause the suppliers to pass
the burden of taxes on the consumers, in the form of high prices.
d) A fall in the exchange rate – A fall in the exchange rate may increase the price of imported inputs
which may increase the price of the product
In short, an increase in the cost of production causes the sellers to increase the price of the product to
cover their profit margins and this consequently results in increasing the overall price level in the
economy giving rise to cost-push inflation.
16. Demand-Pull Inflation- Demand-pull inflation takes place when the aggregate demand in the
economy exceeds the aggregate supply. This excessive demand puts pressure on the prices which
cause the overall price to rise unless it reaches an equilibrium level where the aggregate demand is
equal to the aggregate supply. The demand-pull inflation may occur due to-
a) Depreciation of the currency- A depreciation of the domestic currency may make the country's
exports cheaper, thereby resulting in an increase in their demand.

b) Fiscal stimulus- An expansionary fiscal policy of the government, for instance, a decrease in the
taxes, would result in increasing the disposable income of the consumers, thereby increase the
demand for goods and services in the economy.
c) Expansionary monetary policy- An expansionary monetary policy i.e. increase in the money supply
would result in a decrease in the interest rates thereby increasing the demand for loans and thereby
causing a rise in the prices
d) Improved business confidence – This may cause firms to raise prices and increase the profit
margins
Demand-pull inflation is usually witnessed towards the end of the boom period when the output
expands beyond the country's normal capacity to supply.
17. Deflation- Deflation refers to a decrease in the general price level in an economy.
18. Disinflation – Disinflation refers to an increase in the inflation, at a decreasing rate.
19. Recession- Recession refers to a significant decline in the economic activity of a country. It is said to
occur when the GDP of a country declines for at least two consecutive quarters.
20. Depression- Depression is defined as a sustained long-term decline in the economic activity of a
country. The decline in the economic activity lasts for several years. The common rule of thumb for a
depression is a 10 per cent decline in the GDP.
21. Stagflation- Stagflation is defined as an economic situation where the economic growth is slow and is
accompanied by high unemployment and inflation levels.
22. Aggregate demand -Aggregate demand is the total amount of goods demanded in the economy. It is
the sum total of goods demanded for consumption, investment , by the government and net exports.
AD= C+I+G+NX
23. Marginal Propensity to consume- Marginal propensity to consume is the increase in consumption
per unit increase in income.
24. Money supply- It refers to the total stock of money in the economy. It is the sum of the currency in
circulation and the demand deposits. The monetary aggregates defined by the RBI are as follows –
a) Reserve Money (M0): Currency in circulation + Bankers’ deposits with the RBI + ‘Other’ deposits
with the RBI = Net RBI credit to the Government + RBI credit to the commercial sector + RBI’s claims
on banks + RBI’s net foreign assets + Government’s currency liabilities to the public – RBI’s net non-
monetary liabilities.
b) M1: Currency with the public + Deposit money of the public (Demand deposits with the banking
system + ‘Other’ deposits with the RBI).
c) M2: M1 + Savings deposits with Post office savings banks.

d) M3: M1+ Time deposits with the banking system = Net bank credit to the Government + Bank credit
to the commercial sector + Net foreign exchange assets of the banking sector + Government’s currency
liabilities to the public – Net non-monetary liabilities of the banking sector (Other than Time Deposits).
e) M4: M3 + All deposits with post office savings banks (excluding National Savings Certificates)
25. Quantity theory of money- The quantity theory of money gives the relationship between the money
supply and inflation. It states that an increase in the quantity of money in the economy would result in
an increase in the price level/inflation.
26. Money market equilibrium- The money market equilibrium occurs at the interest rate where the
quantity of money demanded is equal to the quantity of money supplied. If there is an increase in the
money supplied over the demand, the interest rate falls, which reduces the cost of borrowing and
causes people to accommodate the money injected into the economy. If the money supply decreases,
the interest rate rises, causing people to invest money and hold less in their hands.
27. Monetary policy- The monetary policy refers to controlling the supply of money in the economy. The
task to control the money supply is taken up by the central bank of the country. The monetary policy
can be of two types-
➢ Expansionary monetary policy- The monetary policy is said to be expansionary when the supply
of money is increased by the central bank.
➢ Contractionary monetary policy – The monetary policy is said to be contractionary when the
supply of money is decreased by the central bank.
The central bank controls the supply of money in the economy through the following instruments-
a) Open market operations – It refers to buying and selling of bonds. When the central bank wants to
increase the money supply, it purchases bonds in exchange for cash, and this results in an inflow of
money into the economy. Contrary to this, in case of a contractionary monetary policy, the central bank
sells bonds in exchange for money, thereby reducing the flow of money in the economy.
b) A change in the reserve requirements- As per the directives of the central bank, the commercial
banks are required to maintain a certain proportion of the deposits as reserves. The reserve ratio is
the percentage of reserves a bank is required to hold against deposits. A decrease in the ratio will
allow the bank to hold less money as reserves and lend more, thereby increasing the supply in the
economy. An increase in the ratio would have an opposite impact.
c) A change in the discount rate- Discount rate is the interest rate that the central bank charges the
commercial banks for borrowing additional reserves. An increase in the discount rate would increase
the cost of borrowing for commercial banks, which in turn would cause the banks to increase their
interest rates. This would eventually cause the public to borrow less, which would lead to a decrease
in the money supply. A decrease in the discount rate would have an opposite impact.

28. Fiscal Policy-Fiscal policy refers to the use of government revenue and expenditure to influence the
economy. The term ‘Fiscal deficit’ refers to an excess of government expenditure over its revenue.
There are two types of fiscal policy-
a) Expansionary fiscal policy- The expansionary fiscal policy aims at increasing the aggregate
demand in the economy by putting more money in the hands of the households and businesses. This
policy is pursued usually at the time of a recession. For example- Tax cuts, increased government
spending.
b) Contractionary fiscal policy- Contractionary fiscal policy aims at decreasing the aggregate demand
in the economy. This policy is pursued at the time of inflation. For example-Tax increase, reduced
government spending.
The tools used by the government to implement the fiscal policy (whether expansionary or
contractionary)-
1. Changes in government spending- increased spending on health, welfare, education,

infrastructure, capital goods, etc.
2. Changes in taxation – An increase/ decrease in the personal and corporate tax rates, alter tax
exemptions or tax credits, provide special tax incentives.
3. Automatic stabilizers- increased payments during times of economic downturns, progressive

taxation, etc.
The fiscal policy has a multiplier effect on the economy. The expansionary fiscal policy, for instance,
causes the GDP of the country to increase more than the increase in the spending. Similarly, in case
of a contractionary fiscal policy, the decrease in the GDP is more than the decrease in the government
spending.
29. Government budget – A government budget is an annual statement which represents the anticipated
revenues and expenditures of the government for a specified period of time. There are three terms
associated with the government budget-
a) Deficit Budget- In this case, the government spends more thanthan it receives in the form of tax
revenue. In such a scenario, the government usually borrows to cover the deficit, thereby increasing
the government debt.
b) Surplus budget- In this case, the revenue of the government exceeds its expenditure. In such a
scenario, the government may lend.
c) Balanced budget- In this case, the revenue is equal to the expenditure.
Questions
1. If the U.S. dollar weakens, should interest rates generally rise, fall or stay the same?

Rise. A weak dollar means that the prices of imported goods will rise when measured in U.S. dollars
(i.e., it will take more dollars to buy the same good). When the prices of imported goods rise, this
contributes to higher inflation, which raises interest rates.
2. If U.S. inflation rates fall, what will happen to the dollar?
It will strengthen.
3. If the interest rate in Brazil increases relative to that in the U.S., what will happen to the exchange rate
between the real and the dollar?
The real will strengthen relative to the dollar.
4. If inflation rates in the U.S. fall relative to the inflation rate in Russia, what will happen to the exchange
rate between the dollar and the rouble?
The dollar will strengthen relative to the rouble.

5. What is the difference between currency devaluation and currency depreciation?
Devaluation occurs in a fixed-exchange-rate system, while depreciation occurs when a country allows
its currency to move according to the international currency exchange market.
6. What factors govern foreign exchange rates?
Chiefly: interest rates, inflation, and capital market equilibrium.
7. If the spot exchange rate of dollars to pounds is $1.60/£1, and the one-year forward rate is $1.50/£1,
would we say the dollar is strong or weak relative to the pound?
The forward exchange rate indicates the rate at which traders are willing to exchange
currencies in the future. In this case, they believe that the dollar will strengthen against the pound in
the coming year (that one dollar will be able to buy more pounds one year from now than it can now).
8. Why is some inflation good for the economy?
Low inflation is good for the economy, especially when the economy is not running at capacity, because
it helps in increasing production. Higher prices cause the producers to increase profits by producing
more. This results in an increase in employment, output, and income.
9. How does the central government control inflation through the Repo rate?
Repo rate is the rate at which the central bank lends to the commercial banks. An increase in inflation
may cause the central government to increase the repo rate, which would make it costly for the
commercial banks to borrow from the central bank. This, in turn, causes the commercial bank to
increase the rate at which they lend to the public, thereby increasing the cost of borrowing for the
households and businesses, which leads to less money supply and demand.

10. What impact does depreciation have on the balance of payments?
Depreciation of the domestic currency makes the imports costlier, whereas the exports of the country
cheaper. This results in an increase in the demand for the country's exports, thereby leading to an
improvement in the current account of the balance of payments.
11. What is the inflation target of the RBI?
The inflation target set by the RBI is 2%-6% (4% +/- 2%)
12. What are the problems posed by the rising government debt?
Rising debt may crowd out investment spending, which may impede the long-run economic growth.
High levels of debt may also cause the government to default, resulting in economic and financial
turmoil.
*************

Basics of Accounts - Finance Compendium

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FINANCE COMPENDIUM

A Message from Niveshak

Dear PGP Batch of 2021-2023

NIVESHAK – FINANCE & INVESTMENT CLUB 1

Important Accounting Concepts ………………………………………………………………………..03

Financial Statements …………………………………………………………………………………….06

Statement of Profit and Loss ………………………………………………………………….09

Cash Flow Statement …………………………………………………………………………..11

Ratio Analysis ……………………………………………………………………………………………15

NIVESHAK – FINANCE & INVESTMENT CLUB 2

Assets = Liabilities + Shareholders’ / Owners’ Equity

NIVESHAK – FINANCE & INVESTMENT CLUB 3

The system is based on the fundamental accounting equation i.e.

Assets= Liabilities + Shareholders’ equity

NIVESHAK – FINANCE & INVESTMENT CLUB 4

o Accrual principle: Already discussed above.

NIVESHAK – FINANCE & INVESTMENT CLUB 5

Step 1: Identify the Transactions and preparing the vouchers

Step 2: Recording of the Transactions in the Journal

Step 3: Posting in the Ledger

Step 4: Preparation of Trial Balance and Financial Statements

NIVESHAK – FINANCE & INVESTMENT CLUB 6

• It shows the financial position of an enterprise on a given point of time.

Statement of Profit & Loss:

• It shows the financial performance of an enterprise during a given time period.

NIVESHAK – FINANCE & INVESTMENT CLUB 7

I. EQUITY AND LIABILITIES

NIVESHAK – FINANCE & INVESTMENT CLUB 8

NIVESHAK – FINANCE & INVESTMENT CLUB 9

Accounts / Trade Receivables:

Cash and Cash Equivalents:

Cost of Goods Sold (COGS):

Employee Benefit Expenses:

in order to warrant depreciation.

NIVESHAK – FINANCE & INVESTMENT CLUB 10

And the answer is No. Because

Profit vs. Gain

Cash flow statement

NIVESHAK – FINANCE & INVESTMENT CLUB 11

The sample format is mentioned below:

Sample format of Cash Flow Statement

NIVESHAK – FINANCE & INVESTMENT CLUB 12

o Provisions are added as it is not a payment; hence there is no outflow of cash.

Depreciation is added as it is a non-cash expense.

Certain Important Aspects:

NIVESHAK – FINANCE & INVESTMENT CLUB 13

Similarly, explain the effect of depreciation on all three financial statements?

Similarly, try yourself the treatment of the following items:

• Gain on Sale of Fixed Assets

These users can be classified into two categories:

NIVESHAK – FINANCE & INVESTMENT CLUB 14

What are the limitations of financial statements?

Current Ratio = Current Assets/Current Liabilities

NIVESHAK – FINANCE & INVESTMENT CLUB 15

Or, Quick Ratio = (Current assets - Inventory) / Current liabilities

• Periodic payment of interest during the period of the loan and

Debt Ratio = Total Debt / Total Assets

Debt to Equity Ratio

Debt to Equity Ratio = Total Debt / Shareholders’ Equity

Interest Coverage Ratio:

NIVESHAK – FINANCE & INVESTMENT CLUB 16

Interest Coverage Ratio = EBIT (1-tax rate) / Interest Expense

Inventory Turnover Ratio: