Vote on Account

Definition: The Vote on Account is the special provision given to the government to obtain the vote of Parliament to withdraw money when the budget for the new financial year is not released or the elections are underway, and the caretaker government is in place.

Simply, the approval given by the parliament to withdraw a certain sum of money from the consolidated funds of India is called as Vote on Account.

The vote on account represents the expenditure side of the government’s budget; the i.e. government gives the estimate of the funds required during the first three to four months of election financial year until the new government takes its place.

According to the Article 266 of the Constitution, it is mandatory for the government to seek approval from the parliament before raising any funds from the consolidated funds of India.

A vote on account stays valid for two months but however, it can be extended if the year is an election year and it is anticipated that the main demand and the appropriation bill will take longer to be passed by the house.

One of the essential features of a vote on account is that it cannot alter the Direct Taxes since these need to be passed by the Financial Bill.

Capitalized Cost

Definition: A Capitalized Cost is the cost incurred in the purchase and financing of fixed assets. It includes not only the price paid for an asset but also the expenses incurred on its installation and transportation.

A capitalized cost is added to the fixed assets and is shown on the assets side of the balance sheet. These costs are not deducted from revenues during the period in which these are incurred, but, however, the deductions are made over a period of time in the form of depreciation, depletion, amortization.

Initially, a capitalized cost is recorded as assets and thereafter is treated as an expense. The expenses that can be capitalized by the companies are acquisition and installation of assets, labor charges incurred in building an asset, interest paid on finance taken for the construction purposes, materials used to construct an asset, transportation cost incurred in bringing the asset to the site, etc.

By Capitalizing these expenses, a firm gets a clear picture of a total amount incurred on investment in assets and helps in determining the revenue earned over a period of time. The expenses reduce the net income, so a company capitalizes more and more of expenses thereby having more profits. But however, more profits attract more taxes, so a small company does not capitalize more expenses and try to maintain a balance between the costs incurred.

Sunk Cost

Definition: A Sunk Cost is the cost already incurred by the firm and cannot be recovered or refunded. The cost which was incurred in the past and is now permanently lost is called as a Sunk Cost.

Suppose, a firm has spent Rs 50,000 in the construction of a building, but due to some government law the construction has to be stopped, then the amount spent till date is a sunk cost.

A sunk cost is considered irrelevant for making the business decisions, and hence, the economists consider only the future cost, that will be incurred in the future, while taking the decisions for a particular project.

Suppose a company spent thousands of rupees on the installation of an ERP system, but however, the system installed is inadequate to meet the current needs of an organization. Hence, the management will look out for the ways to improve the system on the basis of cost that will be incurred on improvisation. Thus, the cost already spent on the system does not play any role in the decision-making process.

A sunk Cost is only considered to justify the choices made in the past, i.e. whether the amount spent in the past fulfilled the purpose and if not, then how much more amount is to be spent or if the project is to be withdrawn, such decisions are made.

Liquidity Ratios

Definition: Liquidity Ratios are calculated to determine the capacity of a firm to pay off its short-term obligations when they become due. In other words, firm’s cash balance or the readiness to convert its asset into cash, to pay off its current debt is called as liquidity and the ratios that compute it are called as liquidity ratios.

Following are the Important liquidity ratios:

  • Current Ratio
  • Acid-test Ratio
  • Cash Ratio

Generally, the firm having a liquidity ratio greater than 1 is considered to be financially sound and is able to meet its short-term obligations with ease. Higher the liquidity ratio, higher will be the margin of safety. The liquidity ratios are concerned with the current assets and the current liabilities.

Turnover Ratios

Definition: The Turnover Ratios measure the efficiency of investments made by the firm in the form of revenues and the cost of sale generated during a period of time. These ratios show the relationship between the revenues or cost of sales generated due to the investment activities undertaken.

Some important Turnover Ratios are:

  • Inventory Turnover Ratio
  • Debtors Turnover Ratio
  • Average Collection period
  • Fixed Asset Turnover Ratio
  • Total Assets Turnover Ratio
  • Capital Employed Turnover Ratio

The turnover ratios are also called as activity ratios or asset management ratios; that shows a relationship between sales and assets. These ratios are expressed in terms of integers or times.

Profitability Ratios

Definition: The Profitability Ratios measure the overall performance of the company in terms of the total revenue generated from its operations. In other words, the ratios that measure the capacity of a firm to generate profits out of the expenses and the other cost incurred over a period are called the profitability ratios.

Profit Margin Ratios and the Rate of Return Ratios are the two types of Profitability Ratios.The Profit Margin Ratio shows the relationship between the profit and sales and whereas the Rate of Return Ratios shows the relationship between the profits and the investments.

I Profit Margin Ratios

The most popular ratios are:

  • Gross Profit Margin Ratio
  • Operating Profit Margin Ratio
  • Net Profit Margin Ratio

II Rate of Return Ratios

The most popular ratios are:

  • Return on Assets Ratio
  • Return on Equity Ratio
  • Return on Capital Employed

Generally, the ratios with the higher value are favorable as it indicates that the company is doing well.

Gross Profit Margin Ratio

Definition: The Gross Profit Margin Ratio shows how efficiently the company has generated revenues from the sale of its inventories and merchandise. Simply, this ratio measures the amount of profit generated after meeting the direct expenses related to the production of goods and services.

The gross profit is the difference between the revenues generated and the cost of goods sold. This ratio shows the margin left after meeting the manufacturing cost. The manufacturing cost includes the material cost, employee benefits cost, manufacturing expenses, etc.

The gross profit margin ratio measures the efficiency of production and pricing and is very useful for comparing the current gross margins with that of the previous years. Formula to calculate Gross Profit Margin Ratio is:

Gross Profit Margin Ratio = Gross Profit/Net Sales

Where, Gross Profit = Revenues – Cost of goods sold

Higher ratio value shows that the company is selling its inventory and the merchandise at a high-profit percentage, and therefore, higher ratios are more favorable.

Example, Suppose a firm has a net sales of Rs 5,00,00 and its Cost of Goods Sold is Rs 2,00,000. Then the Gross profit will be 3,00,000 (5,00,000-2,00,000) and the Gross profit margin ratio will be:

= 3,00,000/5,00,000 = 0.6 or 60%

Operating Profit Margin Ratio

Definition: The shows the proportion of revenues left after making the payment for the operations unrelated to the direct production of goods and services. It is also referred to as income from operations and shows the margin left after paying the overhead expenses, manufacturing expenses, selling and distribution expenses, administrative expenses, etc.

The operating profit margin ratio act as a key indicator for the creditors and the investors because it helps them to evaluate the effectiveness of company’s operations.The formula to compute this ratio is:

Operating Profit Margin Ratio = Operating Profit/Net Sales

Where, Operating Profit = Revenue – (Operating Expenses, Depreciation, Amortization, etc.)

The higher value of the operating profit margin ratio shows that the company is making enough profits from its operations to pay for the variable as well the fixed expenses.

Example, Suppose a firm has a net sales of Rs 4,00,000 and its cost of goods sold is Rs 2,00,000. The other expenses such as Wages, Rent and Operating expenses are Rs 50,000, Rs 10,000 and Rs 20,000 respectively. Then the operating profit margin will be:

= [4,00,000 – (2,00,000 + 50,000 + 10,000+ 20,000)] / 4,00,000
= 0.3 or 30%

Net Profit Margin Ratio

Definition: The Net Profit Margin Ratio shows the net income earned from the sale of goods and services or simply, how much profits are generated at a certain level of sales. This ratio shows the earnings or the revenues left for the shareholders, both equity and preference shareholders, after making the payment of all the operating expenses, interest, taxes, etc.

The net profit margin is all about how much a company can save from the sale of one unit. The overall success of the company can be measured by this ratio. The high value of net profit margin ratio shows that the company is following the correct pricing policy and is efficiently controlling the cost of production.

To assess the performance of the company, its net profit margin should be compared with the other companies within the same industry since these will have the same business environment and the common customer base. The formula to compute this ratio is:

Net Profit Margin Ratio = Profit after tax/Net Sales

Higher the ratio, better is the ability of a firm to pay a profit share to the shareholders and pay off the loans taken from the creditors.

Example: Suppose a firm has net sales of Rs 3,00,000, and the net profit is Rs 30,000. Then the net profit margin ratio will be:

Net Profit Margin Ratio = 30,000/3,00,000 = 0.1 or 10%

Return on Assets Ratio

Definition: The Return on Assets Ratio shows how well a company can convert its investment in assets into profits or simply, it is the ratio that measures the ability of a company to convert the money spent on purchasing the assets into net income and profits.

It is also referred to as Return on Investments, i.e. how much profit a firm is generating out of the investments. Ideally, it is better to compare the company’s current ROA with that of the previous years or with the ROA of a similar company, since the industry standards can vary. The formula to calculate this ratio is:

Return on Assets Ratio: Profit after tax/ Average Total Assets

Where, Average total assets = (Assets in the beginning+ Assets at the end of the financial year) / 2

The Higher value of ratio shows that firm is able to earn more with fewer investments and hence is able to utilize its assets more efficiently.

Example: Suppose a firm has a net profit of Rs 50,000 and the total assets as on 1 July 2014 and 30 June 2015 were Rs 2,00,000 and 3,00,000 respectively. Then Return on Assets Ratio will be:

Return on Assets Ratio= 50,000/2,50,000 = 0.2 or 20%
[Average Assets = (200000+300000) /2 = 250000)]

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