Module – 1
Introduction to Finance
Fundamentals of Managing Cash
Concept of Time Value of Money (TVM)
The time value of money is a fundamental finance concept asserting that
money available today is worth more than the same amount in the future. This is
due to its potential to earn interest or returns. Key components include present
value (PV), the current worth of a future sum; future value (FV), the future
worth of a present sum; the interest rate (r), which dictates growth or discount;
and the number of periods (n) over which the money is invested or discounted.
TVM is crucial for investment decisions, capital budgeting (e.g., Net Present
Value), loan calculations, and valuing assets by discounting future cash flows.
Risk and Return
Risk and return are inextricably linked in finance; generally, higher potential
returns accompany higher risk. Risk represents the uncertainty or variability of
actual returns compared to expectations, indicating the possibility of loss or
underperformance. It's broadly categorized into systematic risk (market risk),
which is non-diversifiable and affects many assets (e.g., interest rate changes,
economic recessions), and unsystematic risk (specific risk), which is
diversifiable and unique to a particular company or industry (e.g., management
issues, product failure).
Return is the gain or loss on an investment, expressed as a percentage,
comprising income (e.g., dividends, interest) and capital gains/losses (change
in market value). The core principle is the risk-return trade-off, where
investors demand greater expected returns for assuming higher risk. In cash
management, this balance is crucial for liquidity, safety, and optimizing returns
from surplus funds, and for portfolio diversification to mitigate unsystematic
risk.
Fundamentals of Accounting
Accounting is the systematic process of recording, summarizing, analyzing, and
reporting financial transactions1 to provide information for decision-making.2
Golden Rules of Debit-Credit (Traditional Approach)
The foundation of double-entry bookkeeping lies in these rules, ensuring
every debit has an equal and opposite credit:
For Personal Accounts (individuals, firms): Debit the Receiver, Credit
the Giver.
For Real Accounts (assets like cash, land): Debit What Comes In,
Credit What Goes Out.
For Nominal Accounts (expenses, incomes): Debit All Expenses and
Losses, Credit All Incomes and Gains.
Types of Accounts (Modern Approach / Accounting Equation)
Based on the accounting equation Assets = Liabilities + Equity, accounts are
categorized by their effect on this equation:
Assets Accounts (resources owned): Debits increase, credits decrease.
Examples: Cash, Accounts Receivable, Inventory, Equipment.
Liability Accounts (obligations owed): Debits decrease, credits
increase. Examples: Accounts Payable, Loans Payable.
Equity Accounts (owner's stake): Debits decrease (e.g., Drawings,
Expenses), credits increase (e.g., Capital, Revenues).
Revenue/Income Accounts (earnings): Debits decrease, credits
increase. Examples: Sales Revenue, Interest Income.
Expense Accounts (costs incurred): Debits increase, credits decrease.
Examples: Rent Expense, Salaries Expense, Cost of Goods Sold.
Books of Accounts and Financial Statements
Cash Book
A Cash Book is a crucial book of original entry that meticulously records all
cash and bank transactions in chronological order. It functions as both a
journal and a ledger for cash and bank accounts, essential for tracking balances
and bank reconciliation.
Types: Common types include the Single Column (for cash only), Double
Column (for cash and bank), Triple Column (for cash, bank, and discount),
and Petty Cash Book for minor expenses.
Items recorded:
Debit side (Receipts): All cash inflows such as cash sales, capital
introduced, loans received, interest/dividends received, and cash deposits
into the bank (marked as 'C' for contra entry in double/triple column
books).
Credit side (Payments): All cash outflows, including cash purchases,
payments to creditors, salaries, rent, utility bills, owner's drawings, bank
withdrawals for cash (also 'C' contra entry), and bank payments via
cheque or online transfers.
Single Column Cash Book Format:
Double Column Cash Book Format (Cash and Bank):
Reading Final Financial Statements
Final financial statements summarize a business's financial performance and
position at the end of an accounting period. The main statements include the
Trading Account, Profit and Loss Account, and Balance Sheet.
Trading Account
The Trading Account calculates a business's Gross Profit or Gross Loss. It
focuses on direct revenues and expenses related to buying and selling goods.
Items included:
Debit side (Costs): Opening Stock, Purchases (less returns), and Direct
Expenses such as wages, carriage inwards, customs duty, and factory-
related costs (e.g., rent, power).
Credit side (Revenue): Sales (less returns) and Closing Stock. The
resulting Gross Profit or Gross Loss is then transferred to the Profit and
Loss Account.
Trading Account Format:
Profit and Loss Account
The Profit and Loss Account (P&L Account), or Income Statement,
determines the Net Profit or Net Loss for an accounting period by considering
all indirect incomes and expenses.
Items included:
Debit side (Expenses/Losses): Includes Operating Expenses such as
administrative costs (office rent, salaries, stationery, depreciation on
office assets) and selling and distribution expenses (advertising, sales
commission, bad debts). Also includes Non-Operating Expenses/Losses
like interest paid or loss on asset sales.
Credit side (Incomes/Gains): Starts with Gross Profit b/d from the
Trading Account, and includes Non-Operating Incomes/Gains such as
interest received, rent received, and gains on asset sales. The final Net
Profit (or Net Loss) is transferred to the Balance Sheet, affecting capital
or retained earnings.
Profit and Loss Account Format:
Balance Sheet as an Important Document in the Annual Report
The Balance Sheet offers a snapshot of a company's financial position at a
specific point in time, adhering to the accounting equation:
Assets = Liabilities + Owner's Equity
It's a critical document for assessing financial health, liquidity, and solvency.
Key classifications:
Assets (What the company owns):
o Current Assets: Expected to be converted to cash within one year (e.g.,
Cash and Cash Equivalents, Accounts Receivable, Inventories, Short-
Term Investments, Prepaid Expenses).
o Non-Current Assets (Fixed Assets): Held for long-term use (e.g.,
Property, Plant & Equipment (net of depreciation), Intangible Assets
like goodwill, Long-Term Investments).
Liabilities (What the company owes):
o Current Liabilities: Due within one year (e.g., Accounts Payable,
Short-Term Loans, Outstanding Expenses, Unearned Revenue).
o Non-Current Liabilities: Due after one year (e.g., Long-Term Loans,
Bonds Payable, Deferred Tax Liabilities).
Equity (Owner's/Shareholder's Claim): The residual claim on assets
after liabilities. For companies, this includes Share Capital and Reserves
and Surplus (e.g., Retained Earnings).
The Balance Sheet's balance signifies financial equilibrium and is crucial for
various stakeholders to make informed decisions.
Balance Sheet Format
