Management Accounting and Ratio Analysis- Fin I.pptx

1. Management Accounting
Dr. Mangesh M. Bhople,
Asst. Professor,
MBA Finance, NET, Ph.D.
MAEER’s MIT Arts Commerce and Science
College Alandi D Pune
Management Accounting
Ratio Analysis and Marginal Costing

2. Introduction
Accounting information is important for every business which will serve the
needs of variety of interested parties. To satisfy the needs of all interested parties
a sound accounting system is very necessary. Accounting may be divided into
three parts
i. Financial Accounting - Financial accounting is mostly concerned to record
the business transactions in books of accounts so that final accounts can be
prepared.
ii. Cost Accounting - Cost accounting developed to help the internal
management in decision making. The information provided by cost accounting
acts as a managerial tool so that business can utilize the available resources at
optimum level.
iii. Management Accounting - Management accounting is an extension of
management aspects of cost accounting. It provides the information to
management so that planning, organizing, directing and controlling of business
operations can be done in an orderly manner.
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3. In every business enterprise, various transactions and events take place every day.
E.g sales are effected, purchases are made, expenses are met or incurred, payments are received and made,
assets are sold and acquired.
Most of these transactions and events have money values or can be measured and expressed in money
values. Since they affect the operation and position of the enterprise, they need to be measured, recorded,
analyzed and reported to the management, so that the management can evaluate their effect upon the
enterprise.
As compared with financial accounting and cost accounting, management accounting is a later development.
Management accounting links management with accounting. All such information that is useful to the
management is the subject matter of management accounting. Any information required for decision
making is the concern of management accounting. Management accounting, unlike financial accounting,
provides information for internal users, though the basic data come from the same accounting system i.e.,
financial accounting and cost accounting systems.
Management accounting collects and provides accounting, cost accounting, economic and statistical
information to the men at various managerial levels to assist them in the performance of managerial
functions and their evaluations.
It is the development and application of various techniques of recording, analysis, interpretation and
presentation, making the financial, costing, and other data active and effective in the performance of
managerial functions, viz., planning, decision-making and control. It should be noted that management
accounting makes use of not only accounting techniques but also of statistical and mathematical techniques.
Management accounting is forward looking and should, therefore, be able to treat economic information
and data to make it suitable for use by the management.
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Management Accounting

4. Management Accounting
Ratio Analysis and Marginal Costing
Ratio Analysis
Ratio analysis is used to evaluate relationships
among financial statement items. The ratios are
used to identify trends over time for one
organization or to compare two or more
organizations at one point in time.

5. Ratio Analysis
The relationship
between the two
figures expressed
arithmetically is called a
ratio. The ratio between
4 and 10 is 0.4 or 40%
or 2:5. “0.4", ”40%" and
“2:5" are ratios.
Accounting ratios are
relationships, expressed
in arithmetical terms,
between figures which
have a cause and effect
relationship or which
are connected with
each other in some
other manner.
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6. Ratio Analysis
Interpretation of ratios form the core part of
ratio analysis.
The computation of ratio is simply a clerical
work but the interpretation is a taste requiring
art and skill.
The usefulness of ratios dependent on the
thoughtful interpretations.
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7. Examples of Ratio Analysis Categories
1. Liquidity Ratios
Liquidity ratios measure a company's ability to pay off its short-term debts as they become due, using the
company's current or quick assets. Liquidity ratios include the current ratio, quick ratio, and working
capital ratio.
2. Solvency Ratios
Also called financial leverage ratios, solvency ratios compare a company's debt levels with its assets, equity,
and earnings, to evaluate the likelihood of a company staying afloat over the long haul, by paying off its
long-term debt as well as the interest on its debt. Examples of solvency ratios include: debt-equity ratios,
debt-assets ratios, and interest coverage ratios.
3. Profitability Ratios
These ratios convey how well a company can generate profits from its operations. Profit margin, return on
assets, return on equity, return on capital employed, and gross margin ratios are all examples
of profitability ratios.
4. Efficiency Ratios
Also called activity ratios, efficiency ratios evaluate how efficiently a company uses its assets and liabilities to
generate sales and maximize profits. Key efficiency ratios include: turnover ratio, inventory turnover, and
days' sales in inventory.
5. Coverage Ratios
Coverage ratios measure a company's ability to make the interest payments and other obligations associated
with its debts. Examples include the times interest earned ratio and the debt-service coverage ratio.
6. Market Prospect Ratios
These are the most commonly used ratios in fundamental analysis. They include dividend yield, P/E ratio,
earnings per share (EPS), and dividend payout ratio. Investors use these metrics to predict earnings and
future performance.
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8. USES OF
RATIO
ANALYSIS
A comparative study of the relationship, between various items of
financial statements, expressed as ratios, reveals the profitability,
liquidity, solvency as well as the overall financial position of the
enterprises.
Ratio analysis helps to analyse and understand the financial health
and trend of a business, its past performance makes it possible to
have forecast about future state of affairs of the business.
Inter-firm comparison and intra-firm comparison becomes easier
through the analysis. Past performance and future projections could
be reviewed through the ratio analysis easily. Management uses the
ratio analysis in exercising control in various areas viz. budgetary
control, inventory control, financial control etc. and fixing the
accountability and responsibility of different departmental heads
for accelerated and planned performance.
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9. Types of Ratios – Liquidity Ratios
A firm needs liquid assets to meet day to day
payments. Therefore, liquidity ratios highlight the
ability of the firms to convert its assets into cash.
If the ratios are low then it means that money is
tied up in stocks and debtors. Thus, money is not
available to make payments. This may cause
considerable problems for firms in the short run.
It is often viewed that a value less than 1.5
implies that the company may run out of money
as its cash is tied up in unproductive assets.
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10. Liquidity ratio helps in assessing the firm’s ability to meet
its current obligations.
i) Current ratio;
ii) Quick ratio;
iii) Net Working Capital Ratio.
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11. Current Ratio
The following formula is used to compute this ratio:
Current Assets
Current Ratio = --------------------------------
Current Liabilities
The current ratio shows the relationship between the current assets and the
current liabilities.
Current assets include cash in hand, cash at bank and all other assets which
can be converted into cash in the ordinary course of business, for instance,
bills receivable, sundry debtors (good debts only), short-term investments,
stock etc.
Current liabilities consists of all the obligations of payments that have to be
met within a year.
They comprise sundry creditors, bills payable, income received in advance,
outstanding expenses, bank overdraft, short-term borrowings, provision for
taxation, dividends payable, long term liabilities to be discharged within a
year.
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12. Quick Ratio
Quick Assets
Quick Ratio =-----------------------------------
Current Liabilities
Quick Assets = Current Assets-Inventories – Prepaid expenses
The acid test ratio is similar to the current ratio as it highlights the
liquidity of the company.
A ratio of 1:1 (i.e., a value of approximately 1) is satisfactory.
However, if the value is significantly less than 1 it implies that the
company has a large amount of its cash tied up in unproductive
assets, so the company may struggle to raise money in the short
term.
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13. Net Working Capital Ratio
Net Working Capital
Net Working Capital Ratio =------------------------------------------------------
Total Assets
Net Working Capital = Current Assets -Current Liabilities
Generally a working capital ratio of 2:1 is regarded as desirable.
However, the circumstances of every business vary and you should consider how your business operates and
set an appropriate benchmark ratio.
A stronger ratio indicates a better ability to meet ongoing and unexpected bills therefore taking the pressure
off your cash flow.
Being in a liquid position can also have advantages such as being able to negotiate cash discounts with your
suppliers.
A weaker ratio may indicate that your business is having greater difficulties meeting its short-term
commitments and that additional working capital support is required.
Having to pay bills before payments are received may be the issue in which case an overdraft could assist.
Alternatively building up a reserve of cash investments may create a sound working capital buffer.
Ratios should be considered over a period of time (say three years), in order to identify trends in the
performance of the business.
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15. Solution: Current Assets
i) Current ratio =---------------------------------
Current Liabilities
Current Assets = Cash Rs. 1000 + Bank Rs. 2000 + Securities Rs.
12000+ Prepaid expenses Rs. 2000 + Sundry Debtors Rs.
7000+ Stock Rs. 8000= Rs. 32,000.
Current Liabilities = Outstanding expenses Rs. 1000 + Provision
for taxation Rs. 1000 + Bills payable Rs. 2000 + Bank
overdraft Rs. 1000 + Sundry creditors Rs. 11,000 = Rs.
16,000.
Current Assets 32,000
∴ Current ratio = ---------------------------- = ------------- = 2 :1
Current Liabilities 16,000
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16. Quick Assets
ii) Quick ratio = ------------------------
Current Liabilities
Quick Assets = Cash Rs. 1000 + Bank Rs. 2000 + Securities Rs.
12,000
+ Sundry Debtors Rs. 7,000 = Rs. 22,000.
Current Liabilities = Sundry creditors Rs. 11,000 + Bills payable
Rs. 2000 +
Outstanding expenses Rs. 1000 + Provision for Taxation Rs.
1000 + Bank overdraft Rs. 1000 = Rs. 16,000
Quick Assets 22,000
Quick ratio= ---------------------- = --------------- = 1.37 : 1
Current Liabilities 16,000
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17. Net Working Capital
iii. Net Working capital ratio = -----------------------
Total Assets
Net Working Capital = Current Assets ---- Current
Liabilities = Rs. 32,000 ---- Rs. 16,000 = Rs.
16,000
16,000
Net Working capital ratio =-------------- = 1:2
32,000
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18. Unit 3 - Marginal Costing
Marginal Costing- Meaning, definition of marginal
cost and marginal costing,
Advantages and limitations of marginal costing,
Contribution,
Profit volume ratio (P/V Ratio),
Breakeven Point (BEP),
Margin of Safety,
problems on contribution, P/Ratio, BEP and MOS
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19. Costs may be
Variable
Semi
Variable
Fixed
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20. Marginal Costing- Meaning, definition
of marginal cost and marginal costing
The marginal cost of an item is its variable cost. The marginal production cost of an item is
the sum of its direct materials cost, direct labour cost, direct expenses cost (if any) and
variable production overhead cost. So as the volume of production and sales increases total
variable costs rise proportionately.
Fixed costs, in contrast are cost that remain unchanged in a time period, regardless of the
volume of production and sale.
Marginal production cost is the part of the cost of one unit of production service which
would be avoided if that unit were not produced, or which would increase if one extra unit
were produced.
From this we can develop the following definition of marginal costing as used in
management accounting:
Marginal costing is the accounting system in which variable costs are charged to cost units
and fixed costs of the period are written off in full against the aggregate contribution.
Note that variable costs are those which change as output changes - these are treated
under marginal costing as costs of the product. Fixed costs, in this system, are treated as
costs of the period.
Marginal costing is also the principal costing technique used in decision making. The key
reason for this is that the marginal costing approach allows management's attention to be
focussed on the changes which result from the decision under consideration.
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21. The term marginal cost implies the additional
cost involved in producing an extra unit of
output, which can be reckoned by total variable
cost assigned to one unit.
It can be calculated as:
Marginal Cost = Direct Material + Direct Labor +
Direct Expenses + Variable Overheads.
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22. 22

23. 23
Marginal Costing Approach

24. The difference between product costs and period
costs forms a basis for marginal costing technique,
wherein only variable cost is considered as the
product cost while the fixed cost is deemed as a
period cost, which incurs during the period,
irrespective of the level of activity
Eg. Labor cost , Raw Material Cost – Marginal Cost
Rent, Depreciation, Interest – Period Cost
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25. • Marginal cost is the change in the total cost when the quantity
produced is incremented by one. That is, it is the cost of producing
one more unit of a good. For example, let us suppose:
• Variable cost per unit = Rs 25
• Fixed cost = Rs 1,00,000
• Cost of 10,000 units = 25 × 10,000
= Rs 2,50,000
• Total Cost of 10,000 units = Fixed Cost + Variable Cost
= 1,00,000 + 2,50,000
= Rs 3,50,000
• Total cost of 10,001 units = 1,00,000 + 2,50,025
= Rs 3,50,025
• Marginal Cost = 3,50,025 – 3,50,000 = Rs 25
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27. Need for Marginal Costing
• Variable cost per unit remains constant; any increase
or decrease in production changes the total cost of
output.
• Total fixed cost remains unchanged up to a certain
level of production and does not vary with increase or
decrease in production. It means the fixed cost
remains constant in terms of total cost.
• Fixed expenses exclude from the total cost in marginal
costing technique and provide us the same cost per
unit up to a certain level of production.
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28. Features of Marginal Costing
Marginal costing is used to know the impact of variable cost on the volume of production or output.
Break-even analysis is an integral and important part of marginal costing.
Contribution of each product or department is a foundation to know the profitability of the
product or department.
Addition of variable cost and profit to contribution is equal to selling price.
Marginal costing is the base of valuation of stock of finished product and work in progress.
Fixed cost is recovered from contribution and variable cost is charged to production.
Costs are classified on the basis of fixed and variable costs only. Semi-fixed prices are also converted
either as fixed cost or as variable cost.
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29. Characteristics of Marginal Costing
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30. Advantages of Marginal Costing
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31. Limitations of Marginal Costing
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32. The contribution concept
The contribution concept lies at the heart of marginal costing. Contribution can be
calculated as follows.
Contribution = Sales price - Variable costs
The idea of profit is not a particularly useful one as it depends on how many units are sold.
For this reason, the contribution concept is frequently employed by management
accountants.
Contribution gives an idea of how much 'money' there is available to 'contribute' towards
paying for the overheads of the organization.
At varying levels of output and sales, contribution per unit is constant.
At varying levels of output and sales, profit per unit varies.
Total contribution = Contribution per unit x Sales volume.
Profit = Total contribution - Fixed overheads
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33. Ascertainment of Profit under Marginal
Cost
‘Contribution’ is a fund
that is equal to the selling
price of a product less
marginal cost.
Contribution may be
described as :
Contribution = Selling Price –
Marginal Cost
Contribution = Fixed Expenses +
Profit
Contribution – Fixed Expenses =
Profit
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35. Income Statement
For the year ended 31-03-2018
Particulars Amount Total
Sales 25,00,000
Less: Variable Cost:
Cost of goods manufactured 12,00,000
Variable Selling Expenses 3,00,000
Variable Administration Expenses 50,000
15,50,000
Contribution 9,50,000
Less: Fixed Cost:
Fixed Administration Expenses 70,000
Fixed Selling Expenses 1,30,000
2,00,000
Net Profit 7,50,000
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Income Statement under Marginal Costing

36. • Thank You!
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