Accounting or accountancy is the measurement, processing, and communication of financial and non financial information about economic entities such as businesses and corporations.
Accounting ratios are calculated from the financial statements to arrive at meaningful conclusions pertaining to liquidity, profitability, and solvency. Ratios are regarded as a test of earning capacity, financial soundness and operating efficiency of a business organisation. The use of ratios in accounting and financial management analysis helps the management to know the profitability, financial position (liquidity and solvency) and operating efficiency of an enterprises.
The main aim of an enterprise is to earn profit which is necessary for the survival and growth of the business enterprise. It is earned with the help of amount invested in business. It is necessary to know how much profit has been earned with the help of the amount invested in the business. This is possible through profitability ratios. These ratios examine the current operating performance and efficiency of the business concern. These ratios are helpful for the management to take remedial measures if there is a declining trend.
The term ‘solvency’ refers to the ability of a concern to meet its long term obligations. The long-term liability of a firm is towards debenture holders, financial institutions providing medium and long term loans and other creditors selling goods on credit. These ratios indicate firm’s ability to meet the fixed interest and its costs and repayment schedules associated with its long term borrowings.
Activity ratios measure the efficiency or effectiveness with which a firm manages its resources. These ratios are also called turnover ratios because they indicate the speed at which assets are converted or turned over in Revenue from operations (sales). These ratios are expressed as ‘times’ and should always be more than one.
The term liquidity refers to the ability of the company to meet its current liabilities. Liquidity ratios assess capacity of the firm to repay its short term liabilities. Thus, liquidity ratios measure the firms’ ability to fulfill short term commitments out of its liquid assets.
Financial statements give complete information about assets, liabilities, equity, reserves, expenses and profit & loss of an enterprise. They are not readily understandable to interested parties like creditors, shareholders, investors, etc. Thus, various techniques are used for analysing and interpreting the financial statements.
Business is mainly concerned with the financial activities. In order to ascertain the financial status of the business every enterprise prepares certain statements, known as financial statements. Financial statements are mainly prepared for decision making purposes. But the information as provided in the financial statements is not adequately helpful in drawing a meaningful conclusion. Thus, an effective analysis and interpretation of financial statements is required.
The statements, prepared to know the result of the business and the financial position of the business, are called financial statements. The statement prepared for ascertain gross profit or loss is called Trading Account. The statement prepared to ascertain the net profit is called Profit and Loss Account. Trading and Profit and Loss Account taken together is called the Income Statement. Statement prepared to know the financial position of the business is called the Balance Sheet.
An amount which is kept aside from our current income to meet the unexpected happening in the future is the reserve. Future is uncertain, in the business there are a lot of happenings which may happen unexpectedly. For this, arrangement of funds in a well planned manner is necessary. Some amount of total earned fund in a year is needed to set aside as a reserve.
In daily routine life, the events which are about to happen in the future are planned in the present with the help of available resources. In the same way these things are followed in a business also. When there are certain expected losses or expenses, these are planned to be managed in advance from the current year’s profits or surplus. The amount which is kept separately to meet such expected losses or expenses is called a Provision.
Under this method, as the value of asset goes on diminishing year after year, the amount of depreciation charged every year goes on declining. The amount of depreciation is calculated as a fixed percentage of the diminishing value of the asset shown in the books at the beginning of each year. Under this method the value of an asset never comes to zero.
Under this method, the amount of depreciation is uniform from year to year. For example, if an asset costs INR 1,00,000 and depreciation is fixed at 10%, then INR 10,000 would be written off every year. This method is also called ‘Fixed Installment Method’ or ‘Original Cost Method’.
Agreement of the trial balance is not a conclusive proof of the accuracy of the accounts. There may be certain errors which might have been crept into the accounts but do not affect the agreement of the trial balance.
Numerous transactions take place in business everyday. They are first recorded in books of original entry - Journal or one of its sub-divisions. Then, they are posted to the appropriate accounts in the ledger. Each ledger account is balanced periodically so as to ascertain the net effect of various transactions posted therein.
All transactions related to a head of account are recorded in different books. To know the total volume and value of transactions pertaining to a particular account these have to be brought at one place. The book in which all accounts are maintained is called Ledger. It contains the complete set of accounts for a business entity. The process of preparing necessary ledger accounts and transferring the information recorded in day books to these accounts according to accounting rules is called ledger posting.
Journal is a book of accounts in which all day to day business transactions are recorded in a chronological order - in the order of occurrence. Transactions when recorded in a journal are known as ‘entries’. It is the book in which transactions are recorded for the first time. Journal is also known as ‘Book of Original Record’ or ‘Book of Primary Entry’.
The double entry system of bookkeeping is defined as the system of recording transactions having two fundamental aspects - one involving the receiving of a benefit and the other giving the benefit - in the same set of books. In this theory, as the two fold aspects of each transaction are recorded, therefore it is called ‘double entry system’.
The recording of business transaction in books of accounts is based on a fundamental equation called Accounting Equation. Whatever business possesses in the form of assets is financed by proprietor or by outsiders. This equation expresses the equality of assets on one side and the claims of outsiders (liabilities) and owners or proprietors (capital) on the other side.
Accounting conventions refer to common practices which are universally followed in recording and presenting accounting information of the business entity. These are followed like customs or traditions. Accounting conventions are evolved through the regular and consistent practice over the years to facilitate uniform recording in the books of accounts.
The objective of Book-keeping is to maintain records of business transactions. Accounting aims at maintaining business records, calculation of business income, and depiction of financial Position and communication of business results.
With the help of accounting records the business is able to ascertain the profit or loss and the financial position of the business at the end of a given period and communicate such information to all interested parties. The function of accounting is to provide quantitative information, primarily of financial nature, about economic entities, that is needed to be useful in making economic decisions.