Financial Accounting

• Books of Accounts: (3 types)

1. Journal: Recording of each and every business transaction in at least two places (double entry). E.g.,
when you generate a sale for cash, these increases both the revenue account and the cash account. E.g.,-
2 - If you buy goods on account, this increases both the accounts payable account and the inventory
account
2. Ledger: Classification of the accounting entries into multiple heads like Cash, Account Receivables,
Inventory, Accounts Payable, etc. The accounting ledger is used for the preparation of the three financial
statements.
3. Trial Balance: In simple terms, it is basically the summary of the Ledgers. The balances of all the ledger
accounts are compiled under tow heads (i.e., debit and credit) and their combined final amount is equal.

• Books of Accounts is for internal use by the firm whereas the financial statements are for public/shareholders
use.
• Concepts are rules and regulations for forming the financial reports of the firm (i.e., legal and conceptual
framework), Whereas Conventions are methods and procedures which are followed while preparation of
the financial reports.
• Capital Expenditure: purchase of PPE, Software, furniture’s, etc., (show up in the Non-Current Asset
Section)
• Debenture: Loan which is taken from general public. , Convertible debenture are one which can be
converted into any other security after its maturity
• Preference Share Capital: The share Capital for which the rate of dividend is fixed.
• Cash Flow Statement: Gives information regarding all the cash inflows and outflows for a firm existing
day to day activities.
CFO: Generally, takes into account: Current Assets and Current Liabilities
For a firm, CFO should be positive as it shows the firm’s ability to generate cash out of its day to day
operations.
CFI: Generally, takes into account: Non-Current Assets
CFI negative means the firm is looking for growth prospects and is investing in various projects or PPE.
CFF: Generally, takes into account: Non-Current Liabilities. (borrowing a loan, raising share capital,
dividends paid/received, etc.)
Positive CFI means: the firm is raising funds from the market- securities issue, loans, etc. (inflow of cash)
Negative CFI means: Repayment of borrowing/ long term debt, etc., (outflow of cash)
• WDV (written down value method) is accelerated method of depreciation. (In initial years depreciation is
higher, whereas it decreases with time).
• Goodwill is not subject to amortization, it is subject to impairment losses (FSAV)
• Ratios (See Questions Sheet)
 Cost Accounting

• Financial accounting is basically for shareholders, whereas the Cost Accounting is for managers (i.e.,
product costing, Comparing weather my product cost is higher/lower as compared to the competitors.
• Cost of material Consumed = Opening Raw Material (+) Purchases (–) Closing raw material
• Cost of Goods Manufactured = Opening inventory of WIP (+) total manufacturing cost (-) Ending inv. of
WIP
• COGS = Opening inventory of FG (+) Cost of goods manufactured (-) End inventory of FG
• Prime Cost: Material Cost (+) Labor Cost
• Conversion Cost: Labor Cost (+) Manufacturing OH cost
• Prime Cost & Conversion Cost helps in comparison of the efficiencies of the firm. (manufacturing
efficiency)
High conversion cost shows weak manufacturing efficiency and vice versa.
• BEP (Break Even Point): point when we are able to cover our fixed cost fully. Every single unit that is
sold after the break even gives me profit. BEP = Fixed Cost/Contribution , where contribution is Sales (-)
Variable cost.
If VC increases, then contribution margin decreases and thus BEP rises
• Margin of Safety: The range after the break even point is reached is margin of safety as every unit sakes
after the break even will give me profit
• Total Fixed cost remain same; Fixed cost per unit varies; whereas, VC per unit remains same; Total VC
changes as number of units increases.
• EPS = Net profit/ No. of shares outstanding; P/E = Market Price/EPS
• Current Market price > (EPS * P/E) --→ Overvalued
Current Market price < (EPS * P/E) --→ undervalued
• Different types of Pricing:
o Market Based Pricing: Fixing price based on market situation, competitors, etc.
o Cost Based Pricing: Pricing based on the markup that a firm wish to charge over its cost of
production
o Value Engineering: Gradually changing the price with time and technology
o Life Cycle Based Pricing: Revenue is calculated based on the complete life cycle of the product,
rather than considering the initial days only. There are possibilities of incurring losses in the initial
years and thus the profit is calculated for based on the complete life cycle.
E.g., Revenue for 1st 5 years: 1000, 2000, 4500, 5500, 6000; Cost for 1st five years: 1500, 2500, 3500, 4500,
5000 ; then total life cycle gain/loss is: (-500) + (-500) + 1000 + 1000 + 1000 = 2000

Why Life Cycle based pricing is important: It helps management to decide weather to continue with the
product or not.
• Goal Congruence: Situation in which people at multiple levels of the organization share the same goals.
• MBO (Management by objective): Strategic Management model that aims to improve organizational
performance by clearly defining objectives

Financial Management

• Single Period: FV = PV*(1+r) PV = FV/(1+r)

Multiple Period: FV = PV*(1+r)^t PV = FV/(1+r)^t
• NPV: It is the present value of all the expected future cash flow minus the initial cost of investment.
It helps one decide whether to invest in a particular venture or not.
If NPV +ve = we can invest in that firm; If NPV -ve : non investible venture
Case: Two projects have positive NPV- then which one will you choose:
If they are mutually exclusive: Then the project with higher NPV will be selected.
If they are independent (with no budget constraint): Choose both projects as they have +ve NPV
• Normal Payback Period: The number of years required to cover a project’s cost.
Major disadvantage: Ignores the time value of money and project acceptance decision is taken only on the
basis of NPV (+ve)
• Discounted Payback Period: time taken to cover the cost of the project based on the discounted cash flow
(i.e., present value of future cash flow)
• IRR (Internal Rate of Return): It is the rate at which, sum of PV of FCF is equal to the initial investment
. NPV in such case is zero
If IRR > discount rate – Accept the project
If IRR < Discount rate – Reject the project
• Profitability Index: Sum of PV of FCF / Initial Investment
If PI > 1 – Accept the project as its NPV will be positive
• Sensitivity Analysis: This helps us analyze which variable has maximum impact on the NPV (Variables
like: Sales, Salvage Value and Cost of Equity) .The major advantage of it is, help us in determining, which
variable is a dangerous variable (i.e., which variable has a great impact on the project). Disadvantage: in
practical implications, multiple variables change at a given point of time, whereas we consider only one
variable change.
• Scenario Analysis: It is done to overcome the disadvantage of the Sensitivity Analysis. Mostly, three
scenarios considered: Base case (normal), Best Case, Worst Case.
• Monte Carlo Simulation: It is a technique used to estimate the large number of possible outcomes of an
uncertain event. It is used as a decision-making tool when there is uncertainty in the cash flow. If there are
higher probability of positive NPV then we go for the project, or else not opt for it.
• CAPM: Cost of Equity: It tells us the required return for a particular level of risk as measured by Beta. It
is the minimum return that the shareholder’s expect for their investments made. It is calculated by taking
into consideration the risk free rate (i.e., equivalent to the 10 years bond rate) , market return and beta (i.e.,
measure of volatility as compared to the market). CAPM = Rf + B*(Rm- Rf)
• WACC: It is the return that the shareholders expects to receive for providing capital to the firm. It represents
the firm’s average after-tax cost of capital from multiple sources. Also it serves as a discount rate for
calculating the NPV of the firm/business. It takes into account the weight of debt and equity as well as the
tax rate.
WACC = Wd*Rd*(1-T) + We*Re
• Sharpe Ratio: It helps investors understand the return on investment compared to the risk. Higher the
Sharpe Ratio- Higher is the risk adjusted return. Sharpe Ratio = Risk free Rate/Std. Dev.
• Types of Risk:
Systematic risk/unavoidable risk/undiversifiable risk: This is the minimum amount of risk associated
with the investment, which cannot be diversified or mitigated. (e.g., government policies, economic
conditions, global concerns, foreign exchange rates, etc.)
Unsystematic Risk: The risk which can be mitigated. As we increase the umber of assets in the portfolio,
the risk decreases. Similar is the case in stock portfolio
• Beta: It is a measure of risk associated. It tells us how riskier a stock is as compared to the market. A beta
value pf greater than 1 shows the stock is more risker to invest in as compared to the market, whereas a beta
pf less than 1 shows that the stock is less volatile/riskier as compared to the market.
• Working Capital Management: Management of funds required for managing day to day operating
activities
• Operating Cycle: No of days its takes for the firm to convert its raw material into cash.
= inventory days + accounts receivable period
• Cash Cycle: It shows the number of days a firm invest its own cash in the day to day operating activities.
= operating cycle (-) accounts payable period
= AR + Inventory – AP period
Negative Cash cycle shows that the firm is utilizing its debtors money in the business and paying its creditors
at a later date.

• Dividend Paying Decisions: (When should a company pay dividends):

If the firm is able to generate return greater than the discount rate, then the firm can think of paying
dividends.
 Also Anticipating how much money should keep aside for investment opportunities, the firm must go for
paying out dividends.
• A firm should retain money rather than paying dividends, if they have positive NPV projects to invest in.
A firm should pay dividends, when it does not have positive NPV projects to invest in.
• If a firm is paying irregular dividends, then there are chances that the firm is investing in different projects.
• Money Market: Short term trades (< 1 year) – Derivatives, Commercial Papers, Debt instruments
• Capital Market: Long term Trades (> 1 year) – bonds, equity, derivatives
• Derivatives: Those assets which derive their value from other underlying assets (debt or equity)
e.g., Futures, Contracts, Options
• Discounted Cash Flows: Consist of 3 things: Dividend Discount Model, FCFE, FCFF
• Dividend Discount Model: Here the Cash flows are dividends, instead of normal cash flows
• FCFE: It includes the impact of interest and net debt into consideration
= net income + depreciation – capital expenditure – WC changes – Principal repayment + New
debt issues
• FCFF: It does not take into account the impact of interest and net debt
= NOPAT + Depreciation – changes in WC – Capex investments
• YTM: It is basically the market return or the discount rate
YTM > Coupon rate → Bond Value < Face Value
YTM < Coupon Rate → Bond Value > Face Value
YTM = Coupon Rate → Bond Value = FV
• Jenson’s Alpha: It reflects how an investment performed relative to the market index:
Alpha = Actual return - Required Return
Alpha = +ve → Actual Return > Required Return → stock underpriced
Alpha = -ve → Actual Return < Required Return → stock overpriced
Alpha = 0 → Actual Return = Required Return → stock rightly priced

FSAV
• Financial decisions that need to be looked at before starting or financing any business:
1. Investment Decision: Find out the essential assets that would be required in the business, i.e., PPE, etc.
2. Financing Decision: How these assets can be purchased and who will finance for these assets. Why will
one finance for such assets?
3. Working capital: How will the firm manage the day-to-day funds requirements (i.e., working capital)
• Fair Value: It refers to the actual price/value of an asset (product, stock or security) that is agreed upon by
both the buyer and the seller.
• IFRS vs. US-GAAP vs. IND-AS:
o US-GAAP & IFRS starts with the income statement, whereas IND-AS starts with the balance sheet.
 o US-GAAP shows equity at the end of the liability section whereas in IND-AS and IFRS, it is at the beginning
of the liability section.
o IND-AS doesn’t have a separate comprehensive income statement (it is either included in the P/L, or in the
notes to P/L, whereas in US-GAAP and IFRS, there is a separate Comprehensive Income statement.
o IFRS and IND-AS = NCA – CA – Equity – NCL - CL
US-GAAP = CA – NCA – CL – NCL – Equity
• Goodwill on Consolidation: When one firm acquires another firm, then the firm has to include the
financials of both the firms and also has to ay an extra amount for the goodwill of the firm (intangible
goodwill). This extra amount paid by the firm is known as goodwill on consolidation.
• Capitalization of assets: Cost incurred for implementation/ putting an asset to use.
It is basically accounting an asset over the period of time (i.e., till the asset is put to use) rather than
accounting it in the period the cost was originally incurred.
• Diluted EPS: Takes into account all the possible dilution (i.e., convertible debentures) that would occur if
convertible securities were exercised or options were converted to stocks.
• Provisions: Funds set aside by the firm, anticipating certain future expenses ( mainly for anticipated future
losses)
• Reserves: keeping aside certain amount of funds for some specific purpose
• Surplus: Keeping aside certain portion of PAT, so that it can add value to the equity weightage and thus
help in raising debt (borrowing funds) in future.
• Financial Analysis: Includes: Income Growth, Profit (EBITDA, EBIT, PBT, PAT), Profitability (ROA,
ROS, ROE), Du-Pont Analysis, Liquidity (Current ration and Quick ratio), Capital Structure (Debt to equity
ratio), Market Perception (EV, PEG, PE ratio) and Valuation (NPV and Intrinsic Value)
• Du-Pont Analysis: It shows the relationship between the various categories of ratios and how they all
influence the return on investment of the owner. It helps organization to analyze which are to focus on for
improving the ROE
o PAT/PBT- Represents Tax Burden on the organization
o PBT/EBIT- Interest Burden on the Organization
o EBIT/Income - Operating Margin of the organization
o Income/Total Assets - Asset Turnover Ratio of the organization
o Total Assets/Equity - Owned Assets of the organization
• Company valuation helps us to predict the future development and risk of an enterprise with the help of
data obtained from the financial statements.
• EV: Market Cap. + Net Debt; If EV> BS size = Stock overvalued; If EV < BS size = undervalued
• Net Debt: Long term + Short term borrowings + preference share capital – Bank and cash balance
• Intrinsic Value: The price that an investor is willing to pay for an investment for a given amount of risk.
It can also be said as the price or present value of all the discounted expected future cash flow upon + the
cash balance – the debt upon the number of shares outstanding
If Intrinsic Value > Market price = Stock undervalued
 If Intrinsic Value < Market Price = Stock Overvalued
• Valuation:
o EBITDA – Depreciation = EBIT
o EBIT – Tax = NOPAT
o NOPAT + depreciation – investments in fixed assets – changes in WC = FCF
o PVFC or EV = Sum of all the discounted FCF + Discounted Terminal Value
o EV + Cash – debt = Equity value
o Equity value / outstanding shares = Intrinsic value

For Discounting – we use WACC, the calculation of which is similar to the one mentioned above.

• We take the terminal growth rate lower than the Revenue growth rate because, we calculate the valuation
till perpetuity, and also, we cannot forecast the growth rate till perpetuity. In some cases the terminal growth
rate is taken equal to or slightly less than the GDP growth rate.

Financial Modelling
• Common size Analysis: (vertical Analysis): Expression of majority of the factors as a percentage of total
assets or revenue (for income statement and balance sheet)
• Horizontal Analysis: Calculation of YOY change for based on past data (3-5 years)
• Ratio Analysis: Quantitative method of gaining insights about a company’s liquidity, profitability, and
operational efficiency by studying the financial statements of the firm.

(Majorly in Financial Modelling we use forecasted values of the income statement and the balance sheet to
forecast the cash flow statement and to calculate the forecasted ratios. Similarly, for valuation, we use the
forecasted values and use similar approaches as that used in FSAV)

SAPM
• Efficient Market Hypothesis: It says that the share price of the firm reflects all the relevant information
about the firm. But sometimes this theory is contradictory, as it is not always necessary that all the
information related to the firm get reflected through the share price. Sometimes stock price are high due to
market perception, news, etc.
• The biggest assumption of EMH is that the financial market is always priced correctly.
• Weak Form EMH: All the past information like historical pricing and volume data is reflected in the MP
Semi Strong EMH: All publicly available information is reflected in the current MP
Strong Form EMH: All public and private information, as well as non public information (i.e., insider
information) is reflected in the current market price.
• Types of Portfolio Management: Active and Passive
• Active Portfolio Management: Selling and Buying of funds with an aim to outperform the benchmark
index. It involves in depth research of the firm, forecasting the market trend closely, following the changes
in economy and political landscape, etc. These are generally not for longer time duration since investments
are bought and sold regularly.
• Passive Portfolio Management: It involves constructing the portfolio as similar to the market index as it
involves lower risk and is created for a longer time frame.
• Styles of investing: Value Investing, Growth Investing, Dividend Investing
Value Investing: Generally investing in undervalued stocks (low PE, Low EBITDA, Low Price to BV).
Growth Investing: Mainly focused on increasing the investor’s wealth. Investment is generally made in
those stocks whose prices to expected to increase at an above average rate like penny stocks, high PE stocks,
momentum stocks, etc.
Dividend Investing: investing in stocks which generally pay high dividends, in order to receive a regular
income stream from the investments.
• Pledge Percentage: Taking loan against the share of the firm. Generally banks give pledge upto 50% of the
market price of the share. E.g., If a firm needs 50 lakh, and the share price is Rs.100, then the firm has to
pledge minimum of 1 lakh share.
• Fundamental Analysis: Building the portfolio based on the past data (i.e., ROE, B/S, P/L, etc.)
This method holds that the fundamental elements influencing the economy, industry, and firm, such as
earnings per share, DIP ratio, competition, market share, and management quality, among others, determine
a company's share price.
5 factors were used for shortlisting the stocks in this report:
1. Cash flow from operations is in alignment with the operating profit or not
2. Other income as a percentage of net profit (other income should nit be a very high percentage of net
profit, optimally should be less than 30%)
3. The difference between Cash flow from operations and Cash flow from Investing (in general
scenario, it should be positive)
4. Dividend paying firm or not
5. Consistency in Tax Rate
• Technical Analysis: Helps to predict the direction of price movement in the future, by use of past price
pattern and technical charts.
2 Techniques has been taught during the course curriculum:
1. Moving average line (20 days MA – for short term, 50 days MA- for medium term, 100 days MA- for
long term) - At least two must be in uptrend (i.e., MA 20 > 50,100 – uptrend || MA 20 > 50 but < 100 –
sideways || MA 20 < 50,100 – Downtrend)
2. Bollinger Band: Technical tool which shows a band of two standard deviation (positive and
negative) away from the 20 days simple moving average.
Price near lower Bollinger band = Buy
Prices near upper Bollinger band = chances of reversal- then sell
• Fundamental Analysis Approaches: Top down and bottom up
 Top-down Approach: This approach generally goes from a narrow perspective (general perspective) to a
more specific one. In terms of investing we look at a macroeconomic picture, and what are the factors that
can affect the prices of the shares in a bigger perspective.
Bottom-Up Approach: This approach generally goes form a specific perspective to a narrow or general
perspective. Here we focus mainly on the fundamentals of a firm, and identify the probable opportunities.
It is basically dealing with the microeconomic factors.

• Capital Allocation: It is basically distribution, re distribution and investment of financial resources to

maximize shareholder’s profit. It is mainly the decision regarding how and where to spend the money that
the firm has earned. (generally, a top management decision). E.g., Returning cash via dividends, repurchase
of stocks, increasing R&D budget, etc.
• Asset Allocation: it is the process of deciding where to invest, or on which assets to invest in. It aims to
balance the risk and reward by appropriate portfolio balancing. The three min assets classes are – Equities,
Cash and cash equivalents and Fixed income sources.
Appropriate asset selection depends the risk-taking capability (risk appetite) of the investors
• Security Selection: It is the process of determining which stocks/securities are to be included in the
portfolio. This requires understanding the stock performance via use of both fundamental and technical
analysis.