Financial Concepts for Loans and Real Estates

We can say that production is an activity which transforms the input into output. For example, there is need of labour and machinery to manufacture car. It is the technical aspect between input and output. The function of production express the relationship between quantity of output produced and quantity of input required. Production function can be expressed as:

Q = f (L,K)
L = Labour
K = Capital
Q = Output

Production function has four ways:

Law of variable proportion:

We can understand it as:

Total Product (TP), which is produced by a firm; Average Product (AP), it is the divided quantity of variable factors which is used to produce.

AP = TP/Q

AP = Average Product
TP = Total Product
Q = Number of Variable Factors

Marginal Product (MP) – Law of variable proportion is also known as law of diminishing returns. When variable factors are increased in equal doses, keeping the fixed factor constant, the total product will increase.

Law of Variable Proportion is an old economic principle, which was the firs redefined version of Marshall. Most of the examples of production function involve manufacturing sectors and agriculture.

Law of Return to scale:

It is known as long run production function also. The Law of Returns to Scale will show the change in the output when all the factors of production are increased together. It describes the relationship between output and scale of input.

Law of Economies of Scale:

It exists when larger output is associated with low per unit cost. It has been divided into two economies – Internal Economies and External Economies.

At last, economies of scale exist when large output is associated with low per unit cost. Economies of scale have two parts, internal and external economies of scale. Dis-economies of scale arise to a firm beyond optimum level, as the firm may face problem like lack of co-ordination, management, marketing etc. Economies of scope are decline in the average cost due to change in the product mix of output. A production process becomes chapter when there are more than one products produced instead of one as there is more efficiency in distribution of making.

“Managerial Economics” term is very old. The word has taken place in last fifty years or so. Economics is the study of human behaviour in production, distribution and consumption of material goods. Management is the disciplinary work of organizing and allocating a firm’s resources and objectives. So, these two definitions give the appropriate understanding of managerial economics.

Managerial economics is interchangeable with Business Economics. In spite of, there are some differences between these two terms.

Business Economics is known to understand for running any business.

Managerial Economics emphasizes on the function of managerial function of a business firm.

We can take some definition of Managerial Economics to clear its essence. Dean writes in his book Managerial Economics Text book, “Managerial Economics is the use of economic analysis in the formulation of business policies.” So, he emphasizes it as business policies.

On the other hand, Spencer and Seigelman, define it, “the integration of economic theory with business practice to facilitate decision making and forward planning.” So, the definition reveals it as business practices, decision making and forward planning.

Scope of Managerial Economics:

We will conclude it as a manager decision. So, for a manager there is different areas in which decision are required to be taken. These can be classified as:

Decision relating to demand – We already know, every manager is concerned with the demand for his product. So, a manager takes decision regarding the quality and quantity of his product. There are many economic tools which are applied during the decision making – Demand, Elasticity of Demand and Demand Forecasting.

Decision related to cost and production – Every manager has to analyze the cost and various laws governing production that is also a part of managerial economics.

Decision relating to price and market – We can’t escape with market analysis. So, Market analysis is the part of managerial economics. A manager should have various market structures and various pricing policies.

Decision relating to profit management – Maximum profit is the essence of every firm. So, these can be related to profit management.

Macro economic factor – A firm depends on socio-economic environment. So, to understand macro level factors there are needed of macro factors.

Significance of Economic Analysis:

All the economic has been divided into two categories – Macro and Micro. Micro economics are related to consumer products, individual products, whereas Macro is attached with aggregate demand, national income.

The same situation comes in a business man life. There is also needed of priority of business and products. A business man decides market segmentation, product segmentation and takes proper decision.

Definite and indefinite results are the outcome of market. These are inevitable in market society. This can be called as uncertainty.

Financial planning is a process by which funds required for each course of action is decided. It must consider expected business scenario and develop appropriate course of action. A financial plan has to consider capital structure, capital expenditure and cash flow.

Steps in financial planning:

1) Establish corporate objectives: Corporate objectives could be grouped into qualitative and quantitative. For example, a company’s mission statement may specify “create economic value added”. But this qualitative statement has to be stated in quantitative terms such as a 25% ROE or a 12% earnings growth rates. Since business enterprises operate in a dynamic environment, there is a need to formulate both short run and long run objectives.

2) Next stage is formulation of strategies for attaining the objectives set. In this condition connection corporate develops operating plans. Operating plans are framed with a time horizon. It could be a five year plan or a ten year plan.

3) Once the plans are formulated, responsibility for achieving sales target, operating targets, and cost management bench marks, profit targets, etc. is fixed a respective executives.

4) Forecast the various financial variables such as sales, assets required, flow of funds, cost to be incurred and then translate the same into financial statements. Such forecasts help the finance manager to monitor the deviations of actual from the forecasts and take effective remedial measure to ensure that targets set are achieved without any time overrun and cost overrun.

5) Develop a detailed plan for funds required for the plan period under various heads of expenditure.

6) From the funds required plan, develop a forecast of funds that can be obtained from internal as well as external sources during the time horizon for which plans are developed. In this connection legal constrains in obtaining funds on the basis of covenants of borrowing should be given due weight age. There is also a need to collaborate the firm’s business risk with risk implications of a particular source of funds.

7) Develop a control mechanism for allocation of funds and their effective use.

At the time of formulating the plans certain assumptions need to be made about the economic environment. But when plans are implemented economic environment may change. To manage such situations, there is a need to incorporate an inbuilt mechanism which would scales up or scale down operations accordingly.

Is financial statement analysis is only the analysis of facts, figures and statistics? I think financial statement analysis is proceeding from ratio analysis. So, here we should decide some objectives of the chapter.

Objectives of Financial Statement Analysis:

Meaning of Ratio Analysis

Steps in Ratio Analysis

Classification of Ratio

Merits and Demerits of Ratio Analysis

Compute the Different Ratios

At 1st we will discuss about ratio analysis. Normally, ratio is known as the relationship between two or more variable expressed in:

1. Percentage
2. Rate
3. Proportion

In another word we can say that ratio analysis is the important technique of financial analysis.

There are some steps also which involves in the ratio analysis:

a. Collection of information, which are relevant from the financial statements and then to calculate different ratios accordingly.
b. Comparison of computed ratios of the same organization or with the industry ratios.
c. Interpretation, drawing of inference and report-writing.

There are some formulas of Balance Sheet Ratio Analysis:

1. Current Ratio

Current Ratio = Current Assets/Current Liabilities

2. Quick Ratio

It is also known as liquid ratio or acid test ratio

Liquid Ratio = Quick or Liquid Assets/Liquid or Current Liabilities

= Current Assets – (Stock and Prepaid Expenses)/Current Liabilities-Bank Overdraft

3. Net working capital Ratio

Net working capital is used to measure company’s liquid position.

Net working capital Ratio = Net Working Capital/Net Assets

4. Proprietary Ratio

Proprietary Ratio = Shareholder’s Funds/Total Assets or Total Resources

5. Capital Gearing Ratio

Capital Gearing = Fixed Interest Bearing Funds/Equity Share capital

6. Debt Equity Ratio

Debt-Equity Ratio is calculated as follows:

Debt-Equity Ratio = External Equities/Internal Equities

Debt-Equity Ratio = Outsiders’ Funds/Shareholder’s Funds

As a long-term financial ratio it may be calculated as follows:

Debt-Equity Ratio = Total Long-Term Debts/Total Long-Term Funds

Debt-Equity Ratio = Total Long – Term Debts/Shareholders’ Funds

Here I want to share some important terms which will define the ratio:

Net profit ratio is used to measure the overall profitability and hence it is very useful to proprietors.

A higher working capital turnover ratio shows that there is low investment in working capital and vice-versa.

Ratio analysis is a very important and useful tool for financial analysis.

It helps the management accounting of business concern in evaluating its financial position and efficiency of performance.

Management accounting is not only for the record keeping but also it has broader aspects. The managers use the financial statements as resources to make decision in the field of accounting. About the management accounting we can take a look from MBA book of SMU, “Management accounting is the process of identifying, measuring, accumulating, analyzing, preparing, interpreting and communicating information that helps managers to fulfill organizational objectives.”

Here with the definition of management accounting we can say it is for the fulfill of organization objectives by the managers to use all the financial statements and resources.

Objectives of Management Accounting:

Scope of management accounting

Need for financial statements analysis and inter-firm comparisons

Relevance of cost analysis – overhead analysis, job cost analysis and process cost analysis

Relevance of marginal cost and C.V.P. analysis for short-run decision-making

We should know that all the management process single and most upper goal is decision making. So, decision-making is known as the nucleus of management process. Here we will look a chart to understand of decision-making process:

Meaning and Scope of Management Accounting:

About the meaning of management accounting Charles T. Horgren writes, “Management accounting is the process of identifying, measuring, accumulating, analyzing, preparing, interpreting and communicating information that helps managers to fulfill organizations objectives.”

As I have already mentioned that management accounting is not only the process of keeping records. Records keeping is the process of data accumulation however management accounting is the decision making process. So, the management accounting scope has broader then financial statements and record keeping.

About the evaluation of management accounting the history says that it comes with the industrial revolution from the 18th century. Management accounting is the results of capitalist system.

Management accounting has been divided into four parts – book keeping, financial accounting, accounting and cost accounting and social responsibility accounting.

Like this management accounting has one more main part that is MIS (Management Information Systems). MIS for management accounting is most important process because it collects data and gives the right way to analysis that data to take good decisions by managers.

At last we can give some facts which are necessary in functions of management accounting:

Formulation of a business plan

Implementation of the plan

Designed to achieve the goals of the plan

Formulation of business plans

These are the main function of management accounting an organization. However, we have already discussed on the management accounting chapter. Now, I think I will cover some more facts in the next chapter of financial management accounting chapter.