BVRIT HYDERABAD College of Engineering for Women

Department of Electronics and Communication Engineering

Hand Out

Subject : Business Economics & Financial Analysis

Prepared by : . Ms.B.Pramoda,
Asst.Professor, BS & H

Year and Sem, Department: II Year- II Sem, ECE

Unit – I: Introduction to Business and Economics

Important Points / Definitions:

Business Firm:

A commercial organization that operates on a for-profit basis and participates in selling goods
or services to customers.

Structure of Business Firm:

Theory of the firm

The theory of the firm consists of a number of economic theories that explain and predict the
nature of the firm, company, or corporation, including its existence, behaviour, structure, and
relationship to the market.
The theory of the firm aims to answer these questions:

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 1. Existence. Why do firms emerge? Why are not all transactions in the economy
mediated over the market?
2. Boundaries. Why is the boundary between firms and the market located exactly there
with relation to size and output variety? Which transactions are performed internally
and which are negotiated on the market?
3. Organization. Why are firms structured in such a specific way, for example as to
hierarchy or decentralization? What is the interplay of formal and informal
relationships?
4. Heterogeneity of firm actions/performances. What drives different actions and
performances of firms?

Types of theories:
 Transaction Cost Theory
 Managerial Theories
 Behavioural Theories

Types of Business Entities:

 Sole Proprietorship: Sole Proprietorship from of business organisation refers to a

business enterprise exclusively owned, managed and controlled by a single person
with all authority, responsibility and risk.
 Partnership Firm: Partnership is an association of two or more persons who pool
their financial and managerial resources and agree to carry on a business, and share its
profit. The persons who form a partnership are individually known as partners and
collectively a firm or partnership firm.
 Joint Hindu Family Business: The Joint Hindu Family (JHF) business is a form of
business organisation run by Hindu Undivided Family (HUF), where the family
members of three successive generations own the business jointly. The head of the
family known as Karta manages the business. The other members are called co-
parceners and all of them have equal ownership right over the properties of the
business.
 Cooperative Society: The Section 4 of the Indian Cooperative Societies Act 1912
defines Cooperative Society as “a society, which has its objectives for the promotion
of economic interests of its members in accordance with cooperative principles.”

Sources of Finance

1. Long term finance: Long term finance available for a long period say five years and
above. The long term methods outlined below are used to purchase fixed assets such
as land and buildings, plant and so on.
a) Own capital : Money invested by the owners, partners or promoters is permanent and
will stay with the business throughout the life of business.
b) Share capital : Normally in the case of a company, the capital is raised by issue of
shares. The capital so raised is called share capital. The share capital can be of two
types, preference share capital and equity share capital.
c) Debentures: Debentures are the loans taken by the company. It is a certificate or
letter by the company under its common seal acknowledging the receipt of loan. A

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 debenture holder is the creditor of the company. A debenture holder is entitled to a
fixed rate of interest on the debenture amount.
d) Government grants and loans: Government may provide long term finance directly
to the business houses or by indirectly subscribing to the shares of the companies.

Medium term finance

a. Bank loans: Bank loans are extended at a fixed rate of interest. Repayment of the loan
and interest are scheduled at the beginning and are usually directly debited to the
current account of the borrower. These are secured loans.
b. Hire purchase: It is a facility to buy a fixed asset while paying the price over a long
period of time. In other words , the possession of the asset can be taken by making a
down payment of a part of the price and the balance will be repaid with a fixed rate of
interest in agreed number of instalments.
c. Leasing or renting: where there is a need for fixed assets, the asset need not be
purchased. It can be taken on lease or rent for specified number of years. Venture
capital: this form of finance is available only for limited companies. Venture capital is
normally provided in such projects where there is relatively a higher degree of risk.

Short Term Finance

a. Commercial paper: It is new money market instrument introduced in India in recent

times. Cps are issued in large denominations by the leading, nationally reputed, highly
rated and credit worthy, large manufacturing and finance companies in the public and
private sector.
b. Bank overdraft: This is special arrangement with the banker where the customer can
draw more than what he has in his saving/ current account subject to a maximum
limit. interest is charged on a day to day basis on the actual amount overdrawn .
c. Trade credit: This is short term credit facility extended by the creditors to the debtors,
normally, it is common for the traders to buy the materials and other supplies from the
suppliers on credit basis.

Business Economics:

Business Economics, also called Managerial Economics, is the application of economic

theory and methodology to business.

Significance of Business Economics:

1. Business economic is concerned with those aspects of traditional economics which are
relevant for business decision making in real life..
2. It also incorporates useful ideas from other disciplines such as psychology, sociology, etc.
If they are found relevant to decision making.
3. Business economics helps in reaching a variety of business decisions in a complicated
environment. Certain examples are : (i) What products and services should be produced? (ii)
What input and production technique should be used? (iii) How much output should be

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produced and at what prices it should be sold? (iv) What are the best sizes and locations of
new plants? (v) When should equipment be replaced? (vi) How should the available capital
be allocated?
4. Business economics makes a manager a more competent model builder. It helps him
appreciate the essential relationship Characterising a given situation.
5. At the level of the firm. Where its operations are conducted though known focus functional
areas, such as finance, marketing, personnel and production, business economics serves as an
integrating agent by coordinating the activities in these different areas.
6. Business economics takes cognizance of the interaction between the firm and society, and
accomplishes the key role of an agent in achieving the its social and economic welfare goals.

Micro and Macro Economics:

Micro-economics – The term ‘micro’ means small. Therefore, micro-economics deals with
the economic actions of individuals and groups of individuals and firms. This can be stated in
another way that microeconomics presents the economic microscopic view of the company.

Macro-economics– The term ‘macro’ means large. Macro-economics is concerned with the
economic behaviour of the whole nation (or economy) in terms of allocation of productive
resources, consumption pattern, distribution of income etc.

National Income:

National income of a country means the sum total of incomes earned by the citizens of that
country during a given period, say a year .It should be noted that national income is not the
sum of all incomes earned by all citizens, but only those incomes which accrue due to
participation in the production process.

Importance of National Income:

 Economic Policy
 Economic Planning
 Inflationary and Deflationary Gaps
 Budgetary Policies
 National Expenditure
 Standard of Living Comparision
 Defence and Development
 Public Sector

Inflation:
Inflation refers to General rise in Prices Measured against a Standard Level of Purchasing
Power.

Money Supply and Inflation:

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The money supply measures the total amount of money in the economy at a particular time. It
includes actual notes and coins and also any deposits which can be quickly converted into
cash.

Monetarists believe there is a strong link between the money supply and inflation. If the
money supply increases faster than real output, then prices will increase causing inflation.
This is known as the quantity theory of money (MV=PT)

However, other economists believe this link between the money supply and inflation is more
complicated.

Business Cycles:

The alternating periods of expansion and contraction in economic activity has been called
business cycles. They are also known as trade cycles. J.M. Keynes writes, “A trade cycle is
composed of periods of good trade characterized by rising prices and low unemployment
percentages with periods of bad trade characterized by falling prices and high unemployment
percentages.”

Features of Business Cycles:

 Business cycles occur periodically

 Business cycles are synchronic
 Thirdly, it has been observed that fluctuations occur not only in level of production
but also simultaneously in other variables such as employment, investment,
consumption, rate of interest and price level.
 Another important feature of business cycles is that investment and consumption of
durable consumer goods such as cars, houses, refrigerators are affected most by the
cyclical fluctuations.
 Another important feature of business cycles is that profits fluctuate more than any
other type of income.

Phases of Business Cycles:

 Expansion (Boom, Upswing or Prosperity)

 Peak (upper turning point)
 Contraction (Downswing, Recession or Depression)
 Trough (lower turning point)

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Nature of Business Economics:

Traditional economic theory has developed along two lines; viz., normative and positive.
Normative focuses on prescriptive statements, and help establish rules aimed at attaining the
specified goals of business. Positive, on the other hand, focuses on description it aims at
describing the manner in which the economic system operates without staffing how they
should operate. The emphasis in business economics is on normative theory. Business
economic seeks to establish rules which help business firms attain their goals, which indeed
is also the essence of the word normative. However, if the firms are to establish valid
decision rules, they must thoroughly understand their environment. This requires the study of
positive or descriptive theory. Thus, Business economics combines the essentials of the
normative and positive economic theory, the emphasis being more on the former than the
latter.

Scope of Business Economics :

As regards the scope of business economics, no uniformity of views exists among various
authors. However, the following aspects are said to generally fall under business economics.
1. Demand Analysis and Forecasting
2. Cost and production Analysis.
3. Pricing Decisions, policies and practices.
4. Profit Management.
5. Capital Management.

Role and Responsibilities of Business Economists

The role of Business Economist becomes increasingly important in view of the different
objectives of the firm. He has a significant role to play in assisting the management of the
firm in decision-making and forward planning by using specialized skills and techniques. In
advanced countries, large companies employ Business Economist or Managerial Economist
to assist the management.

 Business Economists should study the Environment

It is the primary duty of Business Economists to make extensive study of the business
environment and the external factors affecting the firm’s interest, viz., general prices, national
income and output, volume of trade, etc.

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  Business Economists should make decisions regarding Business Operations
The Business Economist can help the management in making decisions regarding the internal
business operations by studying and analyzing the following:
1. What should be the production schedule and inventory policies for the coming year?

2. What should be the appropriate price and wage policies?

3. How much cash will be available in the coming months and how should it be invested?

Questions

1.Define Business? State the factors governing choice of form of business organization.
2.Write short notes on Theory of Firm?
3.What do you mean by sole proprietorship? Explain its meant and limitations.
4.Define partnership from of business. Explain its salient features
5.Define a joint stock company & explain its basic features, advantages & disadvantages
6.Write short notes on
(a) Commercial Papers (b) Hire Purchase.
7.Define Business Cycle? Explain various Phases of Business Cycle?
8.Discuss the relationship of Money Supply with Inflation?
9. Discuss the nature & Scope of Business economics?
10.Evaluate the Multidisciplinary nature of Business Economics?
11. Explain the role and responsibilities of a Business Economist?

Objective Questions
1. Which subject studies the behaviour of the firm in theory and practice? ( )
(a) Micro Economics (b) Macro Economics (c) Managerial Economics (d) Welfare
Economics
2. Business Economics is close to_________Economics ( )
(a) National (b) Business (c) Micro (d) Industrial
3. The theory of firm also called as_____________. ( )
(a) Welfare Economics (b) Industrial Economics (c) Micro Economics (d) None
4. “Any activity aimed at earning or spending money is called ____activity”. ( )
(a) Service activity (b) Accounting activity (c) Economic activity (d) None

5. “One man one vote” Principle is adopted in ______. ( )

(a) Partnership firms (b) Company (c) Co-operative enterprises (d) Hindu family business
6. The management of ‘Joint Hindu Family’ business vests in the eldest member of the
family, called _____. ( )
(a) Director (b) Grand father (c) Kartha (d) Manager
7. Minimum Two and maximum ____ members are permitted in Private limited company. ( )
(a) Un-limited (b) 20 (c) 50 (d) 10
8. Minimum ___ and maximum ____ members are permitted in Public limited company. ( )
(a) 50 ; Un-limited (b) 20 ; 50 (c) 7 ; Un-limited (d) 7 ; 50
9. Liability of sole proprietor is _______________. ( )
(a) Limited (b) Minimum (c) Un-limited (d) None
10. Liability of Shareholder _______________. ( )
(a) Un-limited (b) Maximum (c) Limited to the share capital (d) None
11. Certificate of commencement of business should be obtained by ___ company to start its
functions. ( )

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(a) Private (b) Statutory (c) Public (d) Chartered
12. Company operates in more than one Country is called as _____. ( )
(a) Private company (b) Government company (c) Multinational company (d) Indian
company

Unit – II: Demand and Supply Analysis

Elasticity of Demand:

Elasticity of demand explains the relationship between a change in price and

consequent change in amount demanded. “Marshall” introduced the concept of elasticity of
demand. Elasticity of demand shows the extent of change in quantity demanded to a change
in price.

In the words of “Marshall”, “The elasticity of demand in a market is great or small according
as the amount demanded increases much or little for a given fall in the price and diminishes
much or little for a given rise in Price”

Elastic demand: A small change in price may lead to a great change in quantity demanded.
In this case, demand is elastic.

In-elastic demand: If a big change in price is followed by a small change in demanded then
the demand in “inelastic”.

Types of Elasticity of Demand:

There are three types of elasticity of demand:

1. Price elasticity of demand

2. Income elasticity of demand
3. Cross elasticity of demand
4. Advertising elasticity of demand
Price elasticity of demand:

Elasticity of demand in general refers to price elasticity of demand. In other words, it refers to
the quantity demanded of a commodity in response to a given change in price. Price elasticity
is always negative which indicates that the customer tends to buy more with every fall in the
price, the relationship between the price and the demand is inverse.

Proportionate change in the quantity demand of commodity

Price elasticity = ------------------------------------------------------------------
Proportionate change in the price of commodity

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 Q2 - Q1/ Q1
Edp = ----------------
P2 – P1 /P1

Where:

Q1 = quantity demand price before change

Q2 = quantity demand price after change

P1 = price before change

P2 = price after change

Income elasticity of demand:

Income elasticity of demand refers to the quantity demand of a commodity in response to a

given change in income of the consumer.

Proportionate change in the quantity demand of commodity

Income Elasticity = ------------------------------------------------------------------
Proportionate change in the income of the people

Q2 - Q1/ Q1
EdI = ----------------
I2 – I1 /I1
Where:
Q1 = quantity demand price before change
Q2 = quantity demand price after change
I1 = income before change
I2 = income after change

Cross elasticity of demand:

Cross elasticity of demand refers to the quantity demanded of a commodity in response to a

change in the price of a related good, which may be substitute or complement.

Proportionate change in the quantity demand of commodity “X”

Cross elasticity = -----------------------------------------------------------------------

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 Proportionate change in the price of commodity “Y”

Q2 - Q1/ Q1

EdP = ----------------

P2 – P1 /P1

Where:

Q1 = quantity demand price before change

Q2 = quantity demand price after change

P1 = price before change

P2 = price after change

Advertising elasticity of demand:

It refers to increase in the sales revenue because of change in the advertising

expenditure. In other words, there is a direct relationship between the amount of money spent
on advertising and its impact on sales. Advertising elasticity is always positive.

Proportionate change in the quantity demand of product “X”

Advertising elasticity = ----------------------------------------------------------------------

Proportionate change in advertisement costs.

Q2 - Q1/ Q1
EdP = ----------------
A2 – A1 /A1
Where:
Q1 = quantity demand price before change
Q2 = quantity demand price after change
A1 = advertising before change
A2 = advertising after change

Demand:

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Demand in common parlance means the desire for an object. But in economics demand is
something more than this. According to Stonier and Hague, “Demand in economics means
demand backed up by enough money to pay for the goods demanded”. This means that the
demand becomes effective only it if is backed by the purchasing power in addition to this
there must be willingness to buy a commodity.

Every want supported by the willingness and ability to but constitutes demand for a particular
product or services. In other words, if I want a car and I cannot pay for it, there is no demand
for the cat from my side

A product or services is said to have demand when three conditions are satisfied:

 Desire on the part of the buyer to buy

 Willingness to pay for it
 Ability to pay the specified price for it.
Demand Determinants
1. Price of the product:

Demand for a product is inversely related to its price. In other words, if price
rises, the demand falls and vice versa. This is the price demand function showing the
price effect o demand.
2. Income of the consumer:

As the income of the consumer or the household increases, there is tendency to

but more and more up to a particular limit. The demand for product x is directly
related to the income of the consumer.
3. Prices of substitutes or complementary :

The demand for product x is determined by the price of its related products:
substitutes or complementary. If there is an increase in the price of a substitute, the
demand for product x will go up and vice versa. Similar, if the price of
complementary goods ( to product x) goes up, the demand for product x will fall.
4. Tastes and preferences:

If the tastes and preferences of the consumers changes, then there is change in
the product demanded also. Most of the companies keep changing their products and
services, as and when the customer’s tastes and preferences change. In some case the
companies take advantage of technological changes and upgrade their product and
services.

Demand function
Demand function is a mathematical expression of relation between the quantity demanded
and its determinants. It can be expressed as follows

QD = F( P, I, Psc, T, A)
Where

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Qd = quantity demand
F = functional relational between input
P = price of the product
I = income of the consumer
Psc= price of substituted or complementary
T = taste and preference
A = advertisement

Law of Demand

Law of demand states the relationship between price and quantity demanded. As per the law
when price is increased demand will decrease, and similarly, when price is decrease demand
will increase, this law assumed that, other things remaining constant, the change in price will
inversely affect demand, thus the relationship between price and demand is inverse, the law
of demand may be explained with the help of demand schedule,

Price of Appel (In. Rs.) Quantity Demanded

10 1

8 2

6 3

4 4

2 5

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Exceptions of the law of demand.
1. Where there is a shortage of necessities feared:

If the customer fear then there could be shortage of necessities, then this law does
not hold good. They may tend to buy more than what they require immediately, even
if the price of the product increases.

2. Where the product is such that it confers distinction:

Products such as jewels, diamonds and so on, confer distinction on the part of the
user. In such a case, the consumer tends to buy even though there is increase in its
price. Such products are called Veblen good.

3. Giffen paradox:

People whose incomes are low purchase more of a commodity such as broken rice,
bread etc, when its price rises, conversely when its price falls, instead of buying more,
they buy less of this commodity and use the savings for the purchase of better goods
such as meat, this phenomenon is called giffen paradox and such goods are good
inferior or giffen goods.

4. In case of ignorance of price changes:

At times, the customer may not keep track of changes in price. In such a case, he
tends to buy even if there is increase in price.

Measurement and Significance of Elasticity of Demand

1. Perfectly elasticity of demand
2. Perfectly inelasticity of demand
3. Relatively elasticity of demand
4. Relatively inelasticity of demand
5. Unity elasticity of demand

Perfectly elasticity of demand:

When any quantity can be sold at a given price, and when there is no need to reduce price, the
demand is said to be perfectly elastic. In such cases, even a small increase in price will lead to
complete fall in demand.

Perfectly inelasticity of demand:

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When a significant degree of change in price leads little or no change in the quantity
demanded, then the elasticity is said to be perfectly inelasticity. In other words, the demand
is said to be perfectly inelasticity when there is no change in the quantity demanded even
though there is a big change in the price.

Relatively elasticity of demand

The demand is said to be relatively elasticity when the change in demand is more then
the change in the price.

Relatively inelasticity of demand:

The demand is said to be relatively inelasticity when the change in demand is less than the
change in the price.

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Unit elasticity:

The elasticity in demand is said to be unity when the change in demand is equal to the change
in price.

Significance of Elasticity of Demand

a. Price of factors of production: The factors of production are land, labour, capital,
organizations and technology. These have a cost; we have to pay rent, wages, interest,
profits and price for these factors of production.
b. Price fixation:
The manufacturer can decide the amount of price that can be fixed for his product based on
the concept of elasticity, if there is no competition, in other words in the case of a monopoly,
the manufacture is free to fix his price as long as it does not attract the attention of the
government, when there are close substitutes, the product is such that its consumption can be
postponed, it cannot be put to alternative uses and so on, then the price of the product cannot
be fixed very highly.

c. Government policies

1. Tax policies: government extensively depends on this concept to finalize its

polices relating to taxes and revenues. Where the product is such that the people
cannot postpone its consumptions, the government tends to increase its, price,
such as petrol and diesel, cigarettes, and so on.

2. Raising bank deposits : if the government wants to mobilize larger deposits from
the consumer it propose to raise the rates of fixed deposits marginally and vice
versa.
3. Public utilities: government uses the concept of elasticity in fixing charges for the
public utilities such as elasticity tariff, water charges, ticket fare in case of road or
rail transport .

d. Forecasting demand:

Income elasticity is used to forecast demand for a particular product or

services. The demand for the products can be forecast at a give income level. The

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 trader can estimate the quantity of goods to be sold at different income levels to
realize the targeted revenue.

e. Planning the levels of output and price:

The knowledge of price elasticity is very useful to producers. The producer

can evaluate whether a change in price will bring in adequate revenue or not. In
general, for items whose demand is elastic, it would benefit him to charge relatively
low price. On the other hand, if the demand for the product is inelastic, a little higher
price may be helpful to him to get huge profits without losing sales.

Demand Forecasting
Demand forecasting refers to an estimate of future demand for the product. It is an objective
assessment of the future course of demand, in recent times, forecasting plays an important
role in business decision – making. The survival and prosperity of a business firm depend on
its ability to meet the consumer’s needs efficiently and adequately. Demand forecasting has
an important influence on production planning. It is essential for a firm to produce the
required quantities at the right time.
It is also essential to distinguish between forecasting of demand and forecast of sales, sales
forecasts are important for estimating revenue, cash requirements and expenses whereas,
demand forecasting relate to production, inventory control, timing, reliability of forecast etc.
however, there is not much difference between these terms.

Methods of Demand Forecasting

1. Survey methods
2. Statistical methods
3. Expert opinion methods
4. Test marketing
5. Controlled experiments
6. Judgmental approach

Statistical Methods
Statistical method is used for long run forecasting. In this method, statistical and
mathematical techniques are used to forecast demand. This relies on past data.
1. Trend projection method: these are generally based on analysis of past sales
patterns.
These methods dispense with the need for costly market research because the necessary
information is often already available in company files. This method is used in case the sales
data of the firm under consideration relate to different time periods, i.e., it is a time – series
data. There are five main techniques of mechanical extrapolation.
a. Trend line by observation: this method of forecasting trend is elementary, easy and
quick. It involves merely the plotting of actual sales data on a chart and them
estimating just by observation where the trend line lies. The line can be extended
towards a future period and corresponding sales forecast is read form the graph.

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 b. Least squares methods: this technique uses statistical formulae to find the trend line
which best fits the available data. The trend line is the estimating equation, which can
be used for forecasting demand by extrapolating the line for future and reading the
corresponding values of sales on the graph.
c. Time series analysis: where the surveys or market tests are costly and time –
consuming, statistical and mathematical analysis of past sales data offers another
methods to prepare the forecasts, that is, time series analysis.
d. Moving average method: this method considers that the average of past events
determine the future events. In other words, this method provides consistent results
when the past events are consistent and unaffected by wide changes.
e. Exponential smoothing: this is a more popular technique used for short run
forecasts. This method is an improvement over moving averages method, unlike in
moving averages method, all time periods here are given varying weight, that is ,
value of the given variable in the recent times are given higher weight and the values
of the given variable in the distant past are given relatively lower weights for further
processing.

f. Barometric Technique: Simple trend projections are not capable of forecasting

turning paints. Under Barometric method, present events are used to predict the
directions of change in future.
g. Simultaneous equation method: in this method, all variable are simultaneously
considered, with the conviction that every variable influence the other variables in an
economic environment.
h. Correlation and regression methods: correlation and regression methods are
statistical techniques. Correlation describes the degree of association between two
variable such as sales and advertisement expenditure. When the two variable tend to
change together, then they are said to be correlated.
Expert opinion methods:

Well informed persons are called experts; experts constitute yet another source of
information. These persons are generally the outside experts and they do not have any vested
interest in the results of a particular survey. As expert is good at forecasting and analysis the
future trend in a give product or service at a given level of technology. The service of an
expert could be advantageously used when a firm uses general economic forecasting or
special industry fore casting prepared outside the firm.

Test marketing:

It is likely that opinions given by buyers, salesman or other experts may be, at times,
misleading. This is the reason why most of the manufactures favour to test their product or
service in a limited market as test – run before they launch their product nationwide.

Controlled experiments: Controlled experiment refer to such exercise where some of the
major determinants of demand are manipulated to suit to the customers with different tastes

17
 and preferences, income groups, and such others, it is further assumed that all other factors
remain the same.

Judgmental approach:

When none of the above methods are directly related to the given product or service, the
management has no alternative other than using its own judgment. Even when the above
methods are used, the forecasting process is supplemented with the factor of judgment for the
following reasons

 Historical data for significantly long period is not available

 Turning point in terms of policies or procedures or causal factors cannot be precisely
determined
 Sale fluctuation are wide and significant
 The sophisticated statistical techniques such as regression and so on, may not cover
all the signing.

Demand Forecasting Methods

SURVEY OTHER METHODS

METHODS STATISTICAL METHODS
1. Expert opinion methods
2. Test marketing
3. Controlled experiments
Survey of sale
4. Judgmental approach
force

1. Trend projection methods

Survey of buyers a. Trend line by observation
intentions b. Least square method
c. Time series analysis
d. Moving averages method
e. Exponential smoothing

2. Barometric techniques

Sample method
3. Simultaneous equations
method
Census methods 4. Correlation and regression 18
method
 Factors Governing Demand Forecasting
a) Functional nature of demand: market demand for a particular product or service is
not a single number but it is a function of a number of factors, for instance, higher
volumes of sales can be realized with higher levels of advertising or promotion
efforts.

b) Types of forecasting: based on the period under forecast, the demand forecast can be
of two types1) short – run forecasting and 2) long – run forecasting. Short run
forecasts cover a period of one year whereas long- run forecasting any period ranging
from one year to 20 years.

c) Forecasting level: The forecasting can be made at the firm level, industry level,
national level or at the global level.
1. Firm level: firm level means estimating the demand for the products and services
offered by a single firm

2. Industry level: the aggregate demand estimated for the good and service of all the
firms constitutes the industry level forecast. The total estimate of different trade
associations can also be view as industry level forecast.

3. National level : national level forecasting is for the whole economy, national
level forecasts are worked out based on the levels of income, savings of the
consumers.

4. Global level: globalization and deregulation , the entrepreneurs have started

exploring the foreign markets for which the global level forecasts are utilized.

d) Degree of orientation: demand forecasts can be worked out based on total sales or
product or service wise sales for a given time period. Forecasting in terms of total
sales can be viewed as general forecast whereas product or service – wise or region or
customer segment – wise forecast is referred is referred to as specific forecast.

e) New product: it is relatively easy to forecast demand for established products or

products which are currently in use. The new product in consideration can be
analyzed as a substitute for some existing product. Assess the demand through a
sampled or total survey of consumers intentions over the new product features and
price.
f) Nature of good: The goods are classified into producer goods, consumer goods,
consumer durables and services. The patterns of forecasting in each of these differ.
g) Degree of competition: there may be a single trader or a few traders depending upon
the nature of goods and services

Supply Analysis
Law of Supply:

The law of supply shows a direct relationship between price and supply of a commodity. The
law states that as the price of commodity increases, the quantity of the commodity supplied
per unit of time increases and vice-versa, assuming all other factors influencing supply

19
remain unchanged. In this statement, change in price is the cause and change in supply is the
effect. Thus, price rise leads to supply rise and not otherwise.

The relationship between price and supply can be shown by drawing the supply curve. The
supply curve for a product depicts the direct relation between the price of that commodity and
the quantity, producers wish to supply at that price.

This curve can be drawn by preparing supply schedule, which is a tabular statement that gives
different prices of a commodity and the quantities which a producer is willing to supply per
unit of time, at each price, assuming other factors affecting the supply to be constant. A
hypothetical supply schedule is given in the following table.

Supply curve based on this imaginary data is shown below (Fig. 3.1)

This curve is drawn on the assumption that all other factors (other than the price of the
commodity) that affect the supply remain same. Supply curve conveys the same information
as a supply schedule.

Determinants of Supply

Supply can be influenced by a number of factors that are termed as determinants of supply.
Generally, the supply of a product depends on its price and cost of production. In simple
terms, supply is the function of price and cost of production.

20
Some of the factors that influence the supply of a product are described as follows:
i. Price:
Price is the main factor that influences the supply of a product to a greater extent. Unlike
demand, there is a direct relationship between the price of a product and its supply. If the
price of a product increases, then the supply of the product also increases and vice versa.
Change in supply with respect to the change in price is termed as the variation in supply of a
product.
ii. Cost of Production:
Implies that the supply of a product would decrease with increase in the cost of production
and vice versa. The supply of a product and cost of production are inversely related to each
other.

iii. Natural Conditions:

Implies that climatic conditions directly affect the supply of certain products. For example,
the supply of agricultural products increases when monsoon comes on time. However, the
supply of these products decreases at the time of drought.

iv. Technology:
Refers to one of the important determinant of supply. A better and advanced technology
increases the production of a product, which results in the increase in the supply of the
product.

v. Transport Conditions:
Refer to the fact that better transport facilities increase the supply of products. Transport is
always a constraint to the supply of products, as the products are not available on time due to
poor transport facilities.

vi. Factor Prices and their Availability:

The inputs, such as raw material man, equipment, and machines, required at the time of
production are termed as factors. If the factors are available in sufficient quantity and at lower
price, then there would be increase in production. This would increase the supply of a product
in the market.

vii. Government’s Policies:

Policies of government, such as fiscal policy and industrial policy, has a greater impact on
the supply of a product
viii. Prices of Related Goods:

21
The prices of substitutes and complementary goods also affect the supply of a product. For
example, if the price of wheat increases, then farmers would tend to grow more wheat than
nee. This would decrease the supply of rice in the market.

Supply Function:

Supply function is the mathematical expression of law of supply. In other words, supply
function quantifies the relationship between quantity supplied and price of a product, while
keeping the other factors at constant. The law of supply expresses the nature of relationship
between quantity supplied and price of a product, while the supply function measures that
relationship.

The supply function can be expressed as:

Sx = f (Px)

Where:
Sx = Quantity supplied for product X

Px = Price of product X

f = Constant representing change produced in Sx with one unit change in Px

Questions

1. Explain in law of demand with the help of an Illustration?

2. What is meant by elasticity of demand? How do you measure it? What are determinates of
elasticity of demand?

3. Describe briefly various types of Elasticity of Demand with the help of Graphs?

4. What is cross elasticity of demand? Is it positive for substitute or complements? Show in a

diagram relating to the demand for coffee to the price of tea?

5. What is Demand Forecasting. Explain various Demand Forecasting Techniques?

6. Discuss Briefly various factors determining Demand Forecasting?

7. Define Supply and explain Law of Supply?

Objective Questions

1. Who explained the “Law of Demand”? ( )

22
(a) Joel Dean (b) Cobb-Douglas (c) Marshall (d) C.I.Savage & T.R.Small
2. Demand Curve always ________ sloping. ( )
(a) Positive (b) Straight line (c) Negative (d) Vertical
3. Giffen goods, Veblan goods and speculations are exceptions to___. ( )
(a) Cost function (b) Production function (c) Law of Demand (d) Finance function
4. Who explained the “Law of Demand”? ( )
(a) Cobb-Douglas (b) Adam smith (c) Marshall (d) Joel Dean
5. When PE =  (Price Elasticity of Demand is infinite), we call it ___. ( )
(a) Relatively Elastic (b) Perfectly Inelastic (c) Perfectly Elastic (d) Unit Elastic
6. Income Elasticity of demand when less than ‘O’ (IE =  O), it is termed as ______. ( )
(a) Income Elasticity less than unity (b) Zero income Elasticity (c) Negative Income
Elasticity (d) Unit Income Elasticity
7. The other name of inferior goods is _______. ( )
(a) Veblen goods (b) Necessaries (c) Geffen goods (d) Diamonds
8. Estimation of future possible demand is called ______. ( )
(a) Sales Forecasting (b) Production Forecasting (c) Income Forecasting (d) Demand
Forecasting
9. When a small change in price leads great change in the quantity demand, We call it
________. ( )
(a) Inelastic Demand (b) Negative Demand (c) Elastic Demand (d) None
10. When a great change in price leads small change in the quantity demand, We call it
________. ( )
(a) Elastic Demand (b) Positive Demand (c) Inelastic Demand (d) None
11. “Coffee and Tea are the ________ goods”. ( )
(a) Relative (b) Complementary (c) Substitute (d) None
12. When PE = 0 (Price Elasticity of Demand is Zero), we call it ___. ( )
(a) Relatively Elastic demand (b) Perfectly Elastic demand (c) Perfectly Inelastic demand (d)
Unit Elastic demand

23
 UNIT- III Production, Cost, Market Structures & Pricing

Production Function:

Samuelson define the production function as “the technical relationship which reveals the
maximum amount of output capable of being produced by each and every set of inputs”

Michael define production function as “ that function which defines the maximum amount of
output that can be produced with a given set of inputs”.

The production function expresses a functional relationship between physical inputs and
physical outputs of a firm at any particular time period. The output is thus a function of
inputs. Mathematically production function can be written as

Q = F(L1,L2,C,O,T)

Where Q is the quantity of production, F explains the functions, that is, the type of
relation between inputs and outputs , L1,L2,C,.O,T refer to land, labout, capital, organization
and technology respectively. These inputs have been taken in conventional terms. In reality,
material also can be included in a set of inputs.

A manufacturer has to make a choice of the production function by considering his

technical knowledge, the process of various factors of production and his efficiency level to
manage. He should not only select the factors of production but also should work out the
different permutations and combinations which will mean lower cost of inputs for a given
level of production.

With change in industry and the requirements the production function also needs to be
modified to suit to the situation.

Production Function with One Variable Input

The laws of returns states that when at least one factor of production is fixed or factor
input is fixed and when all other factors are varied, the total output in the initial stages will
increase at an increasing rate, and after reaching certain level or output the total output will
increase at declining rate. If variable factor inputs are added further to the fixed factor input,
the total output may decline. This law is of universal nature and it proved to be true in
agriculture and industry also. The law of returns is also called the law of variable proportions
or the law of diminishing returns.

Definition According to F. Benham

“As the proportion of one factor in a combination of factors is increased, after a point, first
the marginal and then the average product of that factor will diminish”.

Units of Total Marginal Average Stages

24
labour production(tp) product product
(mp) (ap)
0 0 0 0
1 10 10 10 Stages 1
2 22 12 11
3 33 11 11
4 40 7 10 Stages 2
5 45 5 9
6 48 3 8
7 48 0 6.85 Stages 3
8 45 -3 5.62

From the above graph the law of variable proportions operates in three stages. In the
first stage, total product increases at an increasing rate. The marginal product in this stage
increases at an increasing rate resulting in a greater increase in total product. The average
product also increases. This stage continues up to the point where average product is equal to
marginal product. The law of increasing returns is in operation at this stage. The law of
diminishing returns starts operating from the second stage awards. At the second stage total
product increases only at a diminishing rate. The average product also declines. The second
stage comes to an end where total product becomes maximum and marginal product becomes
zero. The marginal product becomes negative in the third stage. So the total product also
declines. The average product continues to decline.

Production Function with Two Variable Inputs

Production process that requires two inputs, capital© and labour (L) to produce a
given output(Q). There could be more than two inputs in a real life situation, but for a simple
analysis, we restrict the number of inputs to two only. In other words, the production function
based on two inputs can be expressed as

Q = f( C,L)

25
Where C= capital , L = labour,

Normally, both capital and labour are required to produce a product. To some extent, these
two inputs can be substituted for each other. Hence the producer may choose any
combination of labour and capital that gives him the required number of units of output, for
any one combination of labour and capital out of several such combinations. The alternative
combinations of labour and capital yielding a given level of output are such that if the use of
one factor input is increased , that of another will decrease and vice versa. How ever, the
units of an input foregone to get one unit of the other input changes, depends upon the degree
of substitutability between the two input factors, based on the techniques or technology used,
the degree of substitutability may vary.

Iso - Quants

The term Isoquants is derived from the words ‘iso’ and ‘quant’ – ‘Iso’ means equal
and ‘quent’ implies quantity. Isoquant therefore, means equal quantity. Isoquant are also
called isopridcut curves, an isoquant curve show various combinations of two input factors
such as capital and labour, which yield the same level of output.

As an isoquant curve represents all such combinations which yield equal quantity of output,
any or every combination is a good combination for the manufacturer. Since he prefers all
these combinations equally , an isoquant curve is also called product indifferent curve.

An isoquant may be explained with the help of an arithmetical example

Combinations Labour (units) Capital (Units) Output (quintals)

A 1 10 50

B 2 7 50

C 3 4 50

D 4 4 50

E 5 1 50

Combination ‘A’ represent 1 unit of labour and 10 units of capital and produces ‘50’
quintals of a product all other combinations in the table are assumed to yield the same given
output of a product say ‘50’ quintals by employing any one of the alternative combinations of
the two factors labour and capital. If we plot all these combinations on a paper and join them,
we will get continues
and smooth curve called Iso-
product curve as shown
below.

26
 Labour is on the X-axis and capital is on the Y-axis. IQ is the ISO-Product curve
which shows all the alternative combinations A, B, C, D, E which can produce 50 quintals of
a product

Features of Isoquant

1.Downward sloping: isoquant are downward sloping curves because , if one input increase,
the other one reduces. There is no question of increase in both the inputs to yield a given
output. A degree of substitution is assumed between the factors of production

2. Convex to origin: isoquant are convex to the origin. It is because the input factors are not
perfect substitutes. One input factor can be substituted by other input factor in a diminishing
marginal rate. If the input factors were perfect substitutes , the isoquant would be a falling
straight line.

3. Do not intersect: two isoquant do not intersect with each other. It is because, each of these
denote a particular level of output. If the manufacturer wants to operate at a higher level of
output, he has to switch over to another isoquant with a higher level of output and vice versa.

4. Do not axes: the isoquant touches neither X-axis nor Y- axis, as both inputs are required to
produce a given product.

Iso Cost

Iso cost refers to that cost curve that represent the combination of inputs that will
cost the producer the same amount of money. In other words, each isocost denotes a
particular level of total cost for a given level of production. If the level of production
changes, the total cost changes and thus the isocost curve moves upwards, and vice verse.

Iso cost line shows various combinations of labour and capital that the firm can buy
for a given factor prices. The slope of iso cost line = PL/Pk. In this equation , PL is the price
of labour and Pk is the price of capital. The slope of iso cost line indicates the ratio of the
factor prices. A set of isocost lines can be drawn for different levels of factor prices, or
different sums of money. The iso cost line will shift to the right when money spent on factors
increases or firm could buy more as the factor prices are given.

With the change in the factor prices the slope of Isocost line will change. If the price of
labour falls the firm could buy more of labour and the line will shift away from the origin.
The slope depends on the prices of factors of production and the amount of money which the
firm spends on the factors.

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Marginal Rate Of Technical Substitution

The marginal rate lof technical substitution (MRTS) refers to the rate at which one
input factor is substituted with the other to attain a given level of output. In other words, the
lesser units of one input must be compensated by increasing amounts of another input to
produce the same level of output.

Isoquants are typically convex to the origin reflecting the fact that the two factors are
substitutable for each other at varying rates. This rate of substitutability is called the
“marginal rate of technical substitution” (MRTS) or occasionally the “marginal rate of
substitution in production”. It measures the reduction in one input per unit increase in the
other input that is just sufficient to maintain a constant level of production. For example, the
marginal rate of substitution of labour for capital gives the amount of capital that can be
replaced by one unit of labour while keeping output unchanged.

To move from point A to point B in the diagram, the amount of capital is reduced
from Ka to Kb while the amount of labour is increased only from La to Lb. To move from
point C to point D, the amount of capital is reduced from Kc to Kd while the amount of
labour is increased from Lc to Ld. The marginal rate of technical substitution of labour for
capital is equivalent to the absolute slope of the isoquant at that point (change in capital
divided by change in labour). It is equal to 0 where the isoquant becomes horizontal, and
equal to infinity where it becomes vertical.

The opposite is true when going in the other direction (from D to C to B to A). In this
case we are looking at the marginal rate of technical substitution capital for labour (which is
the reciprocal of the marginal rate of technical substitution labour for capital).

It can also be shown that the marginal rate of substitution labour for capital, is equal
to the marginal physical product of labour divided by the marginal physical product of
capital.

28
 In the unusual case of two inputs that are perfect substitutes for each other in
production, the isoquant would be linear (linear in the sense of a function ). If,
on the other hand, there is only one production process available, factor proportions would be
fixed, and these zero-substitutability isoquants would be shown as horizontal or vertical lines.

Law of Returns to Scale

There are three laws of returns governing production function. They are

1. Law of increasing returns to scale

This law states that the volume of output keeps on increasing with every increase in
the inputs,. Where a given increase in inputs leads to a more than proportionate
increase in the output, the law of increasing returns to scale is said to operate.
2. Law of constant returns to scale
When the scope for division of labour gets restricted, the rate of increase in the total
output remains constant, the law of constant returns to scale is said to operate, this law
states that the rate of increase/decrease in volume of output is same to that of rate of
increase/decrease in inputs.
3. Law of decreasing returns to scale
Where the proportionate increase in the inputs does not lead to equivalent increase in
output, the output increases at a decreasing rate, the law of decreasing returns to scale
is said to operate. This results in higher average cost per unit.

These laws can be illustrated with an example of agricultural land. Take one acre of land. If
you till the land well with adequate bags of fertilizers and sow good quality seeds, the volume
of output increases the following table illustrates further

Capital Labor( % of increase Output(in % of Law applicable

(in units) in in both inputs units) increase in
units) output

29
1 3 --- --- --- ---
2 6 100 120 140 Law of increase returns to scale
4 12 100 240 100 Law of constant returns to scale
8 24 100 360 50 Law of decrease returns to scale

Internal and External Economies of Scale

Internal Economies refer to the economies introduction costs which accrue to the firm alone
when it expands its output. The internal economies occur as a result of increase in the scale of
production.

a. Managerial Economics: As the firm expands, the firm needs qualified managerial
personnel to handle each of its functions marketing, finance, production, human
resources and others in a professional way. Functional specialization ensures
minimum wastage and lowers the cost of production in the long –run.
b. Commercial Economics: The transaction of buying and selling raw material and
other operating supplies such as spares and so on will be rapid and the volume of each
transaction also grows as the firm grows, there could be cheaper savings in the
procurement, transportation and storage cost, this will lead to lower costs and
increased profits.
c. Financial Economics: The large firm is able to secure the necessary finances either
for block capital purposes or for working capital needs more easily and cheaply. It can
barrow from the public, banks and other financial institutions at relatively cheaper
rates. It is in this way that a large firm reaps financial economies.
d. Technical Economies: Technical economies arise to a firm from the use of better
machines and superior techniques of production. As a result, production increases and
per unit cost of production falls. A large firm, which employs costly and superior
plant and equipment, enjoys a technical superiority over a small firm.
e. Marketing Economies: The large firm reaps marketing or commercial economies in
buying its requirements and in selling its final products. In the matter of buying they
could enjoy advantages like preferential treatment, transport concessions, cheap
credit, prompt delivery and fine relation with dealers.
f. Risk Bearing Economies: The large firm produces many commodities and serves
wider areas. It is, therefore, able to absorb any shock for its existence
g. Economics of Larger Dimension: large – scale production is required to take
advantage of bigger size plant and equipment.
h. Economics of Research and Development: Only such firms with a strong research
and development base can cope with competition globally.

External Economics:

External economics refer to all the firms in the industry, because of growth of the industry as
a whole or because of growth of ancillary industries, external economics benefit al the firms

30
in the industry as the industry expands. This will lead to lowering the cost of production and
thereby increasing the profitability. The external economics can be grouped under three
types:

A). Economies of Concentration: When an industry is concentrated in a particular area, all

the member firms reap some common economies like skilled labour, improved means of
transport and communications, banking and financial services, supply of power and benefits
from subsidiaries. All these facilities tend to lower the unit cost of production of all the firms
in the industry.

B) Economics of Research And Development: all the firms can pool resources to finance
research and development activities and thus share the benefits of research. There could be a
common facility to shares journals, newspapers and other valuable reference material of
common interest.

C) Economics of Welfare: there could be common facilities such as canteen, industrial

housing, community halls, schools and colleges, employment bureau, hospitals and so on,
which can be used in common by the employees in the whole industry.

Cost Analysis

The institute of cost and management accountants (ICMA) has define cost as “ the amount
expenditure, actual or notional, incurred on or attributable to a specified thing or activity”. It
is the amount of resources sacrificed to achieve a specific objective. cost refer to the
expenditure incurred to produce a particular product or services. Cost refers to the amount of
expenditure incurred in acquiring something. In business firm, it refers to the expenditure
incurred to produce an output or provide service. Thus the cost incurred in connection with
raw material , labour, other heads constitute the overall cost of production.

Cost Concepts :

A managerial economist must have a clear understanding of the different cost concepts for
clear business thinking and proper application.. The various relevant concepts of cost are:

Opportunity Cost:

In simple terms, it is the earning from the second is alternative. It represents the maximum
possible alternative income that was have been earned if the resources were put to alternative
use.

Opportunity cost can be distinguished from outlay costs based on the nature of sacrifice.
Outlay costs are those costs that involve cash outflow at sometime and hence they are
recorded in the book of account. Opportunity cost refers to earnings/profits that are foregone
form alternative ventures by using gives limited facilities for a particular purpose.

Fixed Cost Vs Variable Cost

31
Fixed cost is that cost which remains constant for a certain level to output. It is not affected
by the changes in the volume of production. But fixed cost per unit decrease, when the
production is increased. Fixed cost includes salaries, Rent, Administrative expenses
depreciations etc.

Variable is that which varies directly with the variation is output. An increase in total output
results in an increase in total variable costs and decrease in total output results in a
proportionate decline in the total variables costs. The variable cost per unit will be constant.
Ex: Raw materials, labour, direct expenses, etc

Explicit and Implicit Costs:

Explicit costs are those expenses that involve cash payments. These are the actual or business
costs that appear in the books of accounts. These costs include payment of wages and
salaries, payment for raw-materials,

Implicit costs are the costs of the factor units that are owned by the employer himself. These
costs are not actually incurred but would have been incurred in the absence of employment of
self – owned factors.

Short – Run and Long – Run Costs:

Short-run is a period during which the physical capacity of the firm remains fixed. Any
increase in output during this period is possible only by using the existing physical capacity
more extensively. So short run cost is that which varies with output when the plant and
capital equipment in constant.

Long run costs are those, which vary with output when all inputs are variable including plant
and capital equipment. Long-run cost analysis helps to take investment decisions.

Out-Of Pocket and Books Costs:

Out-of pocket costs also known as explicit costs are those costs that involve current cash
payment. Book costs also called implicit costs do not require current cash payments.
Depreciation, unpaid interest, salary of the owner is examples of back costs.

But the book costs are taken into account in determining the level dividend payable during a
period. Both book costs and out-of-pocket costs are considered for all decisions. Book cost is
the cost of self-owned factors of production.

Market Structures

Market:

Market is a place where buyer and seller meet, goods and services are offered for the sale and
transfer of ownership occurs. A market may be also defined as the demand made by a certain

32
group of potential buyers for a good or service. For business purpose we define a market as
people or organizations with wants (needs) to satisfy, money to spend, and the willingness to
spend it. Broadly, market represents the structure and nature of buyers and sellers for a
commodity/service and the process by which the price of the commodity or service is
established.

Market Structures
Market structure describes the competitive environment in the market for any good or service

Perfect Competition
Perfect competition refers to a market structure where competition among the sellers
and buyers prevails in its most perfect form. In a perfectly competitive market, a single
market price prevails for the commodity, which is determined by the forces of total demand
and total supply in the market.
A market structure in which all firms in an industry are price takers and in which there
is freedom of entry into and exit from the industry is called perfect competition. The market
with perfect competition conditions is known as perfect market.

Features of perfect competition

1. A large number of buyers and sellers: The number of buyers and sellers is large and
the share of each one of them in the market is so small that none has any influence on
the market price.
2. Homogenous products or services: the products and services of each seller should
be homogeneous. They cannot be differentiated from that of one another. Freedom to
enter or exit the market:.
3. Prefect information available to the buyers and sellers: each buyer and seller has
total knowledge of the prices prevailing in the market at every given point of time,
quantity supplied, costs, demand, nature of product, and other relevant information.
4. Perfect mobility of factors of production: there should not be any restrictions on the
utilization of factors of production such as land , labour, capital and so on. In words,

33
 the firm or buyer should have free access to the factors of production. Whenever
capital or labour is required, it should instantly be made available.
5. Each firm is a price taker: an individual firm can alter its rate of production or sales
without significantly affecting the market price of the product, a firm in a perfect
market cannot influence the market through its own individual actions. It has no
alternative other than selling its products at the price prevailing in the market. It
cannot sell as much as it wants at its own set price

Monopoly

The word monopoly is made up of two syllables, Mono and poly. Mono means single
while poly implies selling. Thus monopoly is a form of market organization in which there is
only one seller of the commodity. There are no close substitutes for the commodity sold by
the seller. Pure monopoly is a market situation in which a single firm sells a product for
which there is no good substitute.

Features of monopoly
1. Single person or a firm: A single person or a firm controls the total supply of the
commodity. There will be no competition for monopoly firm. The monopolist firm is
the only firm in the whole industry.
2. No close substitute: The goods sold by the monopolist shall not have closely
competition substitutes. Even if price of monopoly product increase people will not
go in far substitute. For example: If the price of electric bulb increase slightly,
consumer will not go in for kerosene lamp.
3. Large number of Buyers: Under monopoly, there may be a large number of buyers
in the market who compete among themselves.
4. Price Maker: Since the monopolist controls the whole supply of a commodity, he is a
price-maker, and then he can alter the price.
5. Supply and Price: The monopolist can fix either the supply or the price. He cannot
fix both. If he charges a very high price, he can sell a small amount. If he wants to sell
more, he has to charge a low price. He cannot sell as much as he wishes for any price
he pleases.
6. Downward Sloping Demand Curve: The demand curve (average revenue curve) of
monopolist slopes downward from left to right. It means that he can sell more only by
lowering price.

Monopolistic competition
Monopolistic competition is said to exist when there are many firms and each one produces
such goods and services that are close substitutes to each other. They are similar but not
identical. Product differentiation is the essential feature of monopolistic. Products can be
differentiated by means of unique facilities, advertising, brand loyalty, packaging, pricing,
terms of credit, superior maintenance services, convenient location and so on

Features of Monopolistic Competition

34
 1. Existence of Many firms: Industry consists of a large number of sellers, each one of
whom does not feel dependent upon others. Every firm acts independently without
bothering about the reactions of its rivals.
2. Product Differentiation: Product differentiation means that products are different in
some ways, but not altogether so. The products are not identical but the same time
they will not be entirely different from each other. It really means that there are
various monopolist firms competing with each other.
3. Large Number of Buyers: There are large number buyers in the market. But the
buyers have their own brand preferences. So the sellers are able to exercise a certain
degree of monopoly over them.
4. Free Entry and Exist of Firms: As in the perfect competition, in the monopolistic
competition too, there is freedom of entry and exit. That is, there is no barrier as
found under monopoly.
5. Selling costs: Since the products are close substitute much effort is needed to retain
the existing consumers and to create new demand. So each firm has to spend a lot on
selling cost, which includes cost on advertising and other sale promotion activities.
6. Imperfect Knowledge: Imperfect knowledge about the product leads to monopolistic
competition. If the buyers are fully aware of the quality of the product they cannot be
influenced much by advertisement or other sales promotion techniques.
7. The Group: Under perfect competition the term industry refers to all collection of
firms producing a homogenous product. But under monopolistic competition the
products of various firms are not identical through they are close substitutes

Pricing Methods
Cost – Based Pricing Pricing Methods

Cost plus pricing: This is also called full cost or mark up pricing. Here the average cost
normal capacity of output is ascertained and then a conventional margin of profit is added to
the cost to arrive at the price. In other words, find out the product unit’s total cost and add
percentage of profit to arrive at the selling price.

Marginal cost pricing : In marginal cost pricing, selling price is fixed in such a way that it
covers fully the variable or marginal cost and contributes towards recovery of fixed costs
fully or partly, depending upon the market situations.

Competition – Oriented Pricing:

Some commodities are priced according to the competition in their markets. Thus we have
the going rate method of price and the sealed bid pricing technique. Under the former a firm
prices its new product according to the prevailing prices of comparable products in the
market.

a. Sealed bid pricing: This method is more popular in tenders and contracts. Each
contracting firm quotes its price in a sealed cover called tender. All the tenders are

35
 opened on a scheduled date and the person who quotes the lowest prices, other things
remaining the same, is awarded the contract.
b. Going rate pricing: here the price charged by the firm is in tune with the price
charged in the industry as a whole. In other words, the prevailing market price at a
given point of time is the guiding factor.

Demand – Oriented Pricing

The higher the demand, the higher can be the price. Cost is not the consideration here.
The key to pricing here is the value as perceived by the consumer. This is a relatively modern
marketing concept.

a. Price discrimination: Price discrimination refer to the practice of charging different

prices to customers for the same good. The firm uses its discretion to charge
differently the different customer. It is also called differential pricing.
b. Perceived value pricing: perceived value pricing refers to where the price is fixed on
the basis of the perception of the buyer of the value of the product.

Strategy – Based Pricing:

1. Market skimming: when the product is introduced for the first time in the market,
the company follows this method. Under this method, the company fixes a very high
price for the product. The main idea is to charge the customer maximum possible.
2. Market penetration: Here the price of the product is fixed so low that the company
can increase its market share. the company attains profits with increasing volumes and
increase in the market share.

Breakeven Analysis/ Cost-Volume-Profit Analysis

A business is said to break even when its total sales are equal to its total costs. It is a point of
No Profit No Loss. Break even analysis is defined as analysis of costs and their possible
impact on revenues and volume of the firm. Hence, it is also called the cost – volume- profit
analysis. A firm is said to attain the BEP when its total revenue is equal to total cost.

Assumptions:

1. All costs are classified into two – fixed and variable.

2. Fixed costs remain constant at all levels of output.
3. Variable costs vary proportionally with the volume of output.
4. Selling price per unit remains constant in spite of competition or change in the volume
of production.
5. There will be no change in operating efficiency.
6. There will be no change in the general price level.
7. Volume of production is the only factor affecting the cost.
8. Volume of sales and volume of production are equal. Hence there is no unsold stock.
9. There is only one product or in the case of multiple products. Sales mix remains
constant.

36
 10. All the goods produced are sold. There is no closing stock.
Significance of BEA

 To ascertain the profit on a particular level of sales volume or a given capacity of

production
 To calculate sales required to earn a particular desired level of profit.
 To compare the product lines, sales area, methods of sales for individual company
 To compare the efficiency of the different firms
 To decide whether to add a particular product to the existing product line or drop one
from it
 To decide to “make or buy” a given component or spare part
 To decide what promotion mix will yield optimum sales
 To assess the impact of changes in fixed cost, variable cost or selling price on BEP
and profits during a given period.

Limitations of BEA

 Break – even - point is based on fixed cost, variable cost and total revenue.
 A change in one variable is going to affect the BEP
 All cost cannot be classified into fixed and variable costs. We have semi-variable
costs also
 In case of multi-product firm, a single chart cannot be of any use. Series of charts
have to be made use of..
 It is based on fixed cost concept and hence holds good only in the short – run.
 Total cost and total revenue lines are not always straight as shown in the figure. The
quantity and price discounts are the usual phenomena affecting the total revenue line.
 Where the business conditions are volatile, BEP cannot give stable results

Determination of Break Even Point

1. Fixed cost
2. Variable cost
3. Contribution
4. Margin of safety
5. Angle of incidence
6. Profit volume ratio

Fixed cost: Expenses that do not vary with the volume of production are known as fixed
expenses. Eg. Manager’s salary, rent and taxes, insurance etc. It should be noted that fixed
changes are fixed only within a certain range of plant capacity.

Variable Cost: Expenses that vary almost in direct proportion to the volume of production of
sales are called variable expenses. Eg. Electric power and fuel, packing materials consumable
stores. It should be noted that variable cost per unit is fixed.

37
Contribution: Contribution is the difference between sales and variable costs and it
contributed towards fixed costs and profit. It helps in sales and pricing policies and
measuring the profitability of different proposals.
Contribution = Sales – Variable cost

Contribution = Fixed Cost + Profit.

Margin of safety: Margin of safety is the excess of sales over the break even sales. It can be
expressed in absolute sales amount or in percentage. It indicates the extent to which the sales
can be reduced without resulting in loss. A large margin of safety indicates the soundness of
the business. The formula for the margin of safety is:

Profit
Present sales – Break even sales or
P. V. ratio

Angle of incidence: This is the angle between sales line and total cost line at the Break-even
point. It indicates the profit earning capacity of the concern. Large angle of incidence
indicates a high rate of profit; a small angle indicates a low rate of earnings.
Profit Volume Ratio is usually called P. V. ratio. It is one of the most useful ratios for
studying the profitability of business. The ratio of contribution to sales is the P/V ratio. It may
be expressed in percentage. Therefore, every organization tries to improve the P. V. ratio of
each product by reducing the variable cost per unit or by increasing the selling price per unit.
The concept of P. V. ratio helps in determining break even-point, a desired amount of profit
etc.
Questions
1. Define production function, explain is equate and is cost curves.
2. Why does the law of diminishing returns operate? Explain with the help of a diagram.
3.Explain and illustrate Law of Returns to scale.
4. (a) Explain Cobb-Douglas Production function.
(b) Internal and External Economies
5.. Explain the following with reference to production functions
(a) MRTS
(b) Isocosts

6. Explain Cost/Output relationship in the short run

7.What is a market? Explain, in brief, the different market structures.

8. Explain how a firm attains equilibrium in the short run and in the long run under
conditions of perfect competition.

38
 9. Define monopoly. How is price under monopoly determined?
10. Describe the BEP with the help of a diagram and its uses in business decision making

11. What cost concepts are mainly used for management decision making? Illustrate.

12. Explain the various methods of strategy-based pricing.

13. Explain different Characteristics of Oligopoly?

14. A Company reported the following results for two period Sales Profit I Rs. 20,00,000
Rs. 2,00,000 II Rs. 25,00,000 Rs. 3,00,000 Ascertain the BEP, PV ratio, fixes cost and
Margin of Safety.
15. If sales in 10000 units and selling price Rs. 20/- per unit. Variable cost is Rs. 10/- per
unit and fixed cost is Rs. 80000. Find out BEP in Units and sales revenue what is profit
earned? What should be the sales for earning a profit of Rs. 60000/-
16. Sales are 1,10,000 producing a profit of Rs. 4000/- in period I, sales are 150000
producing a profit of Rs. 12000/- in period II. Determine BEP & fixed expenses.

Objective Questions

1. Conversion of inputs in to output is called as _________________. ( )

(a) Sales (b) Income (c) Production (d) Expenditure
2. How many stages are there in ‘Law of Variable Proportions’? ( )
(a) Five (b) Two (c) Three (d) Four
3. When a firm expands its Size of production by increasing all factors, It secures certain
advantages, known as ( )
(a) Optimum Size (b) Diseconomies of Scale (c) Economies of Scale (d) None
4. When producer secures maximum output with the least cost combination Of factors of
production, it is known as_______ ( )
(a) Consumer’s Equilibrium (b) Price Equilibrium (c) Producer’s Equilibrium (d) Firm’s
Equilibrium
5. The ‘Law of Variable Proportions’ is also called as ____________. ( )
(a) Law of fixed proportions (b) Law of returns to scale (c) Law of variable proportions
(d) None
6. _________ Is a ‘group of firms producing the same are slightly Different products for the
same market or using same raw material’. ( )
(a) Plant (b) Firm (c) Industry (d) Size

39
 7. When proportionate increase in all inputs results in an equal Proportionate increase in
output, then we call____________. ( )
(a) Increasing Returns to Scale (b) Decreasing Returns to Scale (c) Constant Returns to
Scale (d) None
8. When different combinations of inputs yield the same level of output Known as
___________. ( )
(a) Different Quants (b) Output differentiation (c) Isoquants (d) Production
differentiation
9. When Proportionate increase in all inputs results in more than equal Proportionate increase
in output, then we call _____________. ( )
(a) Decreasing Returns to Scale (b) Constant Returns to Scale (c) Increasing Returns to
Scale (d) None
10. When Proportionate increase in all inputs results in less than Equal Proportionate
increase in output, then we call _____________. ( )
(a) Increasing Returns to Scale (b) Constant Returns to Scale (c) Decreasing Returns to
Scale (d) None
11. A curve showing equal amount of outlay with varying Proportions of Two inputs are
called ________________. ( )
(a) Total Cost Curve (b) Variable Cost Curve (c) Isocost Curve (d) Marginal Cost Curve

12. The cost of best alternative forgone is_______________ ( )

(a) Outlay cost (b) Past cost (c) Opportunity cost (d) Future cost
13. If we add up total fixed cost (TFC) and total variable cost (TVC), we get__ ( )
(a) Average cost (b) Marginal cost (c) Total cost (d) Future cost
14. _____cost is the additional cost to produce an additional unit of output. ( )
(a) Incremental (b) Sunk (c) Marginal (d) Total
15. _______ costs are the costs, which are varies with the level of output. ( )
(a) Fixed (b) Past (c) Variable (d) Historical
16. The price of a product is determined by the ______of that product ( )
(a) Place and time (b) Production and sales (c) Demand and supply (d) Cost and
income
17. The price at which demand and supply of a commodity equal is ( ) Known as
(a) High price (b) Low price (c) Equilibrium price (d) Marginal price
18. ___________________is a form of market organization in which There is only one seller
of the commodity. ( )

40
 (a) Perfect Competition (b) Duopoly (c) Monopoly (d) Oligopoly
19. The firm is said to be in equilibrium, when it’s Marginal Cost (MC) Equals to___ . ( )
(a) Total cost (b) Total revenue (c) Marginal Revenue (d) Average Revenue
20. Charging very high price in the beginning and reducing it gradually is called ( )
(a) Differential pricing (b) Sealed bid pricing (c) Skimming pricing (d) Penetration
pricing

21. What is the formula for Margin of Safety? ( )

(a) Break Even sales – Actual sales (b) Maximum sales – Actual sales (c) Actual sales –
Break Even sales (d) Actual sales – Minimum sales

22. ‘Contribution” is the excess amount of Actual Sales over ______. ( )

(a) Fixed cost (b) Sales (c) Variable cost (d) Total cost

UNIT-IV Financial Accounting

Accounting :

Accounting is the science of recording and classifying business transactions and events
primarily of financial character, and the art of making significant, summaries, analysis and
interpretations of those transaction and events, and communicating the results to persons
who must make decisions or form judgment.

Accounting concepts and Conventions:

Concepts are the basic ideas, the theories on how and why certain categories of transactions
should be treated in a particular manner.
Once the theories have been established and tested and proved to be acceptable, the task of
the Conventions is to set out the limit of their applications.

Accounting Concepts :

1. Business entity concept: A business and its owner should be treated separately as far as
their financial transactions are concerned.
2. Money measurement concept: Only business transactions that can be expressed in
terms of money are recorded in accounting, though records of other types of transactions
may be kept separately.
3. Dual aspect concept: For every credit, a corresponding debit is made. The recording of
a transaction is complete only with this dual aspect.
4. Going concern concept: In accounting, a business is expected to continue for a fairly
long time and carry out its commitments and obligations. This assumes that the business
will not be forced to stop functioning and liquidate its assets at “fire-sale” prices.
5. Cost concept: The fixed assets of a business are recorded on the basis of their original
cost in the first year of accounting. Subsequently, these assets are recorded minus

41
 depreciation. No rise or fall in market price is taken into account. The concept applies
only to fixed assets.
6. Accounting year concept: Each business chooses a specific time period to complete a
cycle of the accounting process—for example, monthly, quarterly, or annually—as per a
fiscal or a calendar year.
7. Matching concept: This principle dictates that for every entry of revenue recorded in a
given accounting period, an equal expense entry has to be recorded for correctly
calculating profit or loss in a given period.
8. Realisation concept: According to this concept, profit is recognised only when it is
earned. An advance or fee paid is not considered a profit until the goods or services have
been delivered to the buyer.
Accounting Conventions

There are four main conventions in practice in accounting:

Conservatism is the convention by which, when two values of a transaction are available, the
lower-value transaction is recorded. By this convention, profit should never be overestimated,
and there should always be a provision for losses.
Consistency prescribes the use of the same accounting principles from one period of an
accounting cycle to the next, so that the same standards are applied to calculate profit and
loss.

Materiality means that all material facts should be recorded in accounting. Accountants
should record important data and leave out insignificant information.

Full disclosure entails the revelation of all information, both favourable and detrimental to a
business enterprise, and which are of material value to creditors and debtors.

Accounting Equation:

Accounting equation describes that the total value of assets of a business is always equal to
its liabilities plus owner’s equity. This equation is the foundation of modern double entry
system of accounting being used by small proprietors to large multinational corporations.
Other names used for accounting equation are balance sheet equation and fundamental
or basic accounting equation.

Accounting equation is simply an expression of the relationship among assets, liabilities and
owner’s equity in a business. The general form of this equation is given below:

Assets = Liabilities + Owner’s Equity

Rules for maintaining Books of Accounts

Personal Account: these are the accounts of natural persons such as ram account, gopal
account. Artificial person such as udayltd, syndicate bank. And representative personal
account.

Rule: “Debit----The Receiver

Credit---The Giver”
42
Real Accounts: accounts relating to properties or assets of a trader are known as real
accounts. It includes tangible assests such as buildings, furniture,. Cash, etc and also
intangible assets such as goodwill, trade marks, patent rights.

Rule: “Debit----What comes in

Credit---What goes out”

Nominal Accounts : account dealing with expenses, losses, gains and incomes are called
nominal accounts, eg. Salaries, wages commission account etc.

Rule: “Debit----All expenses and losses

Credit---All incomes and gains”

Journal
Journal means a daily record of business transactions. Journal being a book of
original entry. The transaction is first written in the journal from which it is posted to the
ledger. The transactions will be recorded as and when they occur and in the order in which
they occur.

Date Particular LF Debit credit

Cash a/c----------------------------DR 20,000
To ram a/c 20,000

( narration )

Where: ledger folio . in this column the pages numbers on which the various accounts
appear in the ledger are entered.

Narration : an explanation of the entry in the particular column

Ledger
Ledger:
Ledger is a book in which various accounts such as personal, real and nominal account are
opened. Every transaction is first recorded in the journal, and from it, transferred to the
concerned account in the ledger. This process of transferring the transaction from the journal
to the ledger is called posting.

Dr ledger a/c
Cr
43
Date Particular JF Amount Date Particular JF Amount

Note:

Dr means debit side it is always start with TO, Cr means credit side it is always start with By

Balancing an account: after all transaction have been posted and the various accounts
prepared they are balanced. The procedure for balancing ledger accounts is as follows.

1. Take the totals of the two sides of the account on a rough sheet.
2. Ascertain the difference between the totals of two sides . the difference is called
“balance”
3. Enter the difference in the amount column of the side showing less total. If the credit
side total is less , write in the particulars column on the credit side of the account , By
balance c/d. similarly if the debit side is less , write on the debit side of the account To
balance c/d.

Trail Balance

The first step in the preparation of final accounts is the preparation of trail balance. In the
double entry system of book keeping, there will be credit for every debit and there will not be
any debit without credit. When this principle is followed in writing journal entries, the total
amount of all debits is equal to the total amount all credits.

A trail balance is a statement of debit and credit balances. It is prepared on a particular date
with the object of checking the accuracy of the books of accounts. It indicates that all the
transactions for a particular period have been duly entered in the book, properly posted and
balanced.

Thus a trail balance is a list of balances of the ledger accounts’ and cash book of a business
concern at any given date

PROFORMA FOR TRAIL BALANCE:

Trail balance for MR…………………………………… as on …………

NO NAME OF ACCOUNT DEBIT CREDIT

AMOUNT(RS.) AMOUNT(RS.)
(PARTICULARS)

44
 Final Accounts

In every business, the business man is interested in knowing whether the business has
resulted in profit or loss and what the financial position of the business is at a given time. In
brief, he wants to know (i)The profitability of the business and (ii) The soundness of the
business.

The trader can ascertain this by preparing the final accounts. The final accounts are prepared
from the trial balance. Hence the trial balance is said to be the link between the ledger
accounts and the final accounts. The final accounts of a firm can be divided into two stages.
The first stage is preparing the trading and profit and loss account and the second stage is
preparing the balance sheet.

1. Trading account
2. Profit and loss account
3. Balance sheet.

Trading account

Trading account is a part of profit and loss account . trading account is prepared for
ascertaining Gross profit or gross loss. The difference between the sales and the cost of the
goods sold is gross profit. Cost of good sold can be ascertained by adding opening stock ,
purchases, direct expenses for purchase of goods and deduction there from closing stock and
sales.

Proforma of Trading Account

Trading account of ------------- for the year ended 31 march ----

Particular Amount Particular Amount

To opening stock Xxxx By Sales
xxxxx Xxxx
To Purchase Less; Sales return
xxxx Xxxx xxxxx
Less: purchase return
xxxx

To carriage inwards Xxx By closing stock Xxxx

To wage Xxxx
To freight , duty clearing charges Xxxx
To fuel and power Xxxx
To coal, gas, and water Xxxx
To motive power Xxxx

45
To factory rent Xxxx
To manufacturing expenses Xxxx
To direct expenses Xxxx
To factory lighting Xxxx
To gross profit Xxxx
Xxxxxxx xxxxxxx

Profit and Loss Account

Profit and loss account is prepared to ascertain the net profit or net loss of the business
for a particular period. All indirect expenses such as management and office expenses,
financial expenses, selling and distribution expenses are taken on the debit side. Gross profit
and other items of incomes such as interest received , discount received, etc. are taken on
credit side. The different between two sides is either net profit or net loss which is transferred
to capital account.

The business man is always interested in knowing his net income or net profit.Net
profit represents the excess of gross profit plus the other revenue incomes over
administrative, sales, Financial and other expenses. The debit side of profit and loss account
shows the expenses and the credit side the incomes. If the total of the credit side is more, it
will be the net profit. And if the debit side is more, it will be net loss.

Proforma of Profit and Loss Account

Profit and loss of --------------- for the year ended 31 march xxx

Particular Amount Particular Amount

To Salaries By gross profit Xxx
xxx Xxx
Add : outstanding salaries
xxx
To Rent Xxx By Discount receive Xxx
To Discount allowed Xxx By Interest receive Xxx
To Office expenses Xxx By Commission receive Xxx
To Rate and tax Xxx
To Lighting Xxx
To Printing and stationery Xxx
To Postage and telegrams Xxx
To Telephone charges Xxx
To Legal expenses Xxx
To Telephone charges Xxx
To Audit fee Xxx
To General expenses Xxx
To Advertisement Xxx
To Insurance xxx
To interest on capital Xxx
To deprecation on assets( Xxx
machinery , building , furniture,

46
land.etc)
To repair Xxx
To carriage outward Xxx
To written off bad debts Xxx
To travelling expenses Xxx
To interest on loan Xxx
To net profit Xxx
Xxxxxx xxxxxx

Balance Sheet:

The second point of final accounts is the preparation of balance sheet. It is prepared
often in the trading and profit, loss accounts have been compiled and closed. A balance sheet
may be considered as a statement of the financial position of the concern at a given date.

DEFINITION: A balance sheet is an item wise list of assets, liabilities and proprietorship of
a business at a certain state.

J.R.botliboi: A balance sheet is a statement with a view to measure exact financial position of
a business at a particular date.

Thus, Balance sheet is defined as a statement which sets out the assets and liabilities
of a business firm and which serves to as certain the financial position of the same on any
particular date. On the left-hand side of this statement, the liabilities and the capital are
shown. On the right-hand side all the assets are shown. Therefore, the two sides of the
balance sheet should be equal. Otherwise, there is an error somewhere.

PROFORMA OF BALANCE SHEET

Balance sheet of Mr.------------------------------ for the year ending on 31 march xxxxx

Liabilities Amoun Assets Amount

t
Capital Plant and machinery
xxxx Xxx Xxx
Add: interest on capital Less: depreciation on plant machinery
xxxx xxx
Net profit Xxx
xxxx Building
Xxx xxx Xxx
------ Less : depreciation on building
xxx
Xxxx Land

47
Less: drawings xxx
xxxx Less ; depreciation on land
Net loss xxx
xxxx
Sundry creditor xxx Sundry debtor
xxx Xxx
Less : written of bad debts
xxx
Bank overdraft Xxx Cash in hand Xxx
Outstanding expenses Xxxx Cash at bank Xxx
Reserves Xxx Investment Xxx
Long term loans Xxx Bill receivable Xxxx
Bill payable Xxx Prepaid expenses Xxx
Prepaid expenses Xxx
Vehicle Xxx
Closing stock Xxx
Xxxxx xxxxx

Advantages: The following are the advantages of final balance .

1. It helps in checking the arithmetical accuracy of books of accounts.

2. It helps in the preparation of financial statements.
3. It helps in detecting errors.
4. It serves as an instrument for carrying out the job of rectification of entries.
5. It is possible to find out the balances of various accounts at one place.

Final Accounts -- Adjustments

We know that business is a going concern. It has to be carried on indefinitely. At the

end of every accounting year. The trader prepares the trading and profit and loss account and
balance sheet. While preparing these financial statements, sometimes the trader may come
across certain problems .The expenses of the current year may be still payable or the
expenses of the next year have been prepaid during the current year. In the same way, the
income of the current year still receivable and the income of the next year have been received
during the current year. Without these adjustments, the profit figures arrived at or the
financial position of the concern may not be correct. As such these adjustments are to be
made while preparing the final accounts.

The adjustments to be made to final accounts will be given under the Trial Balance. While
making the adjustment in the final accounts, the student should remember that “every
adjustment is to be made in the final accounts twice i.e. once in trading, profit and loss
account and later in balance sheet generally”. The following are some of the important
adjustments to be made at the time of preparing of final accounts:-

48
1.Closing Stock :-

(i)If closing stock is given in Trail Balance: It should be shown only in the balance sheet
“Assets Side”.

(ii)If closing stock is given as adjustment :

1. First, it should be posted at the credit side of “Trading Account”.

2. Next, shown at the asset side of the “Balance Sheet”.
2.Outstanding Expenses :-

(i)If outstanding expenses given in Trail Balance: It should be only on the liability side of
Balance Sheet.

(ii)If outstanding expenses given as adjustment :

1. First, it should be added to the concerned expense at the

debit side of profit and loss account or Trading Account.
2. Next, it should be added at the liabilities side of the
Balance Sheet.

3.Preapid Expenses :-

(i)If prepaid expenses given in Trial Balance: It should be shown only in assets side of the
Balance Sheet.

(ii)If prepaid expense given as adjustment :

1. First, it should be deducted from the concerned expenses at the debit side of profit and
loss account or Trading Account.
2. Next, it should be shown at the assets side of the Balance Sheet.
4.Income Earned But Not Received [Or] Outstanding Income [Or] Accured Income:-

(i)If incomes given in Trial Balance: It should be shown only on the assets side of the
Balance Sheet.

(ii)If incomes outstanding given as adjustment:

1. First, it should be added to the concerned income at the credit side of profit and loss
account.
2. Next, it should be shown at the assets side of the Balance sheet.

5. Income Received In Advance: Unearned Income: -

(i)If unearned incomes given in Trail Balance : It should be shown only on the liabilities side
of the Balance Sheet.

(ii)If unearned income given as adjustment :

49
 1. First, it should be deducted from the concerned income in the credit side of the profit
and loss account.
2. Secondly, it should be shown in the liabilities side of the
Balance Sheet.

6.Depreciation: -

(i)If Depreciation given in Trail Balance: It should be shown only on the debit side of the
profit and loss account.

(ii)If Depreciation given as adjustment

1. First, it should be shown on the debit side of the profit and loss account.
2. Secondly, it should be deduced from the concerned asset in the Balance sheet assets
side.
7.Interest On Loan [Or] Capital:-

(i)If Interest On Loan (Or) Capital Given In Trail Balance :It should be shown only on debit
side of the profit and loss account

(ii)If Interest On Loan (Or)Capital Given As Adjustment :

First, it should be shown on debit side of the profit and loss account.
Secondly, it should added to the loan or capital in the liabilities side of the Balance Sheet.

8.Bad Debts:-

(i)If bad debts given in Trail balance :It should be shown on the debit side of the profit and
loss account.

(ii)If Bad Debts Given As Adjustment:

1. First, it should be shown on the debit side of the profit and loss account.
2. Secondly, it should be deducted from debtors in the assets side of the Balance Sheet.

9.Interest On Drawings :-

(i)If interest on drawings given in Trail balance: It should be shown on the credit side of the
profit and loss account.

(ii)If interest on drawings given as adjustments :

1. First, it should be shown on the credit side of the profit and loss account.
2. Secondly, it should be deducted from capital on liabilities
side of the Balance Sheet.

10.Interest on Investments :-

50
(i)If Interest on The Investments Given In Trail Balance :It should be shown on the credit side
of the profit and loss account.

(ii)If interest on investments given as adjustments

1. First, it should be shown on the credit side of the profit and loss account.
2. Secondly, it should be added to the investments on assets side of the Balance Sheet.

Questions

1.Define Accounting. Desribe briefly Accounting Concepts and Accounting Conventions?

2. Explain various types of Accounts and their Rules with examples?

3. State the advantages of Double Entry system of Accounting?

4. Write short notes on

(a) Journal (b) Assets (c) Expenditure

5.Draw the proforma of Trial Balance?

6. What is Trial Balance? Why it is prepared?

7. Journalise the following transactions and post them to ledger.

i. Ram invests Rs.10,000 in cash.

ii. He bought goods worth Rs. 2,000 from Shyam.

iii. He bought a machine for Rs. 5,000 from Lakshman on account

iv. He paid to Lakshman Rs. 2,000

v.He sold goods for cash Rs.3,000

vi. He sold goods to A on account Rs. 4,000

vii. He paid to Shyam Rs.1,000

viii. He received amount from A Rs.2,000

8.In the books of Kishore, prepare Trading and profit and loss account for the year ended
30th June, 2003:

Stock (1.7.2002) 1,06,000 Purchases 3,00,000 Wages 2,50,000 Office salaries 60,000
Discount on sales 20,000 Carriage inwards 20,000 Carriage outwards 60,000 Stationery
3,000 Rent (¾ to Factory) 48,000 Postage 3,500 Transport and conveyance 25,000 General
charges 3,500 Commission 26,000 Power 55,000 Rebate on purchases 10,000 Sales
10,00,000.

51
 9. Following figures have been extracted from the records of Fancy Stores a proprietary
concern as on 31- 12-2003: Furniture 15,000 Insurance 6,000 Proprietors capital a/c
54,000 Rent 22,000 Cash in hand 3,000 Sundry debtors 60,000 Opening stock 50,000
Sales 6,00,000 Fixed deposit 1,34,600 Advertisement 10,000 Drawings 5,000
Postages and Telephone 3,400 Provision for bad debts 3,000 Bad debts 2,000 Cash at
bank 10,000 Printing and stationery 9,000 Purchases 3,00,000 General charges 13,000
Salaries 19,000 Sundry creditors 40,000 Carriage inwards 41,000 Deposit from
Customers 6,000

Prepare Trading, Profit and loss account and balance sheet after taking into consideration
the following information.

Objective Questions

1.In which Book-keeping system, business transactions are recorded as two separate accounts
at the same time? ( )

(a) Single entry (b) Triple entry (c) Double entry (d) None

2. In which Concept “Business is treated separate from the Proprietor? ( )

(a) Cost concept (b) Dual aspect concept (c) Business entity concept (d) Matching concept

3. When a deduction allowed from the gross or catalogue price to traders; then it is called as
____. ( )

(a) Cash discount (b) Credit discount (c) Trade discount (d) None

4. “Out standing wages” is treated as _________. ( )

(a) Asset (b) Expense (c) Liability (d) Income

5. How many types of accounts are maintained to record all types of business transactions? ( )

(a) Five (b) four (c) Three (d) Two

6. Which connects the link between Journal and Trial Balance? ( )

(a) Trading Account (b) Profit & Loss account (c) Ledger (d) Balance sheet

7.Which assets can be converted into cash in short period? ( )

(a) Fixed Assets (b) Intangible Assets (c) Current Assets (d) Fictious Assets

8. “Bank over draft” is a ________. ( )

(a) Asset (b) Expense (c) Liability (d) Income

9. Profit and Loss account is prepared to find out the business ____. ( )

(a) Gross result (b) Financial position (c) Net result (d) Liquidity position

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10.The statement of “Debit and credit balances of Ledger accounts” is called as ________( )

(a) Journal (b) Ledger (c) Trial balance (d) Balance sheet

11. ______ is called as ‘Book of Original Entry’. ( )

(a) Ledger (b) Trial Balance (c) Journal (d) Trading account

12. Debit what comes in; Credit what goes out is ____ account principle? ( )

(a) Nominal (b) Personal (c) Real (d) None

13. The process of entering transactions in to Ledge accounts known as __. ( )

(a) Journal entry (b) First entry (c) Posting (d) None

14. Debit Expenses and Losses; Credit Incomes and Gains is ___ account Principle ( )

(a) Personal (b) Real (c) Nominal (d) None

15. “Prepaid Insurance Premium” is treated as _________. ( )

(a) Gain (b) Income (c) Asset (d) Liability

Unit -V Financial Analysis through Ratios

Concept of Ratio Analysis, Liquidity Ratios, Turnover Ratios, Profitability Ratios,

Proprietary Ratios, Solvency, Leverage Ratios (simple problems).

Introduction to Fund Flow and Cash Flow Analysis (simple problems).

Ratio Analysis

Ratio analysis is used to evaluate relationships among financial statement items. The ratios
are used to identify trends over time for one company or to compare two or more companies
at one point in time.

Types of Ratios

Liquidity ratios measure the ability of a company to repay its short‐term debts and meet
unexpected cash needs.

Current ratio: The current ratio is also called the working capital ratio, as working capital is
the difference between current assets and current liabilities. This ratio measures the ability of
a company to pay its current obligations using current assets. The current ratio is calculated
by dividing current assets by current liabilities

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This ratio indicates the company has more current assets than current liabilities

Acid‐test ratio. The acid‐test ratio is also called the quick ratio. Quick assets are defined as
cash, marketable (or short‐term) securities, and accounts receivable and notes receivable, net
of the allowances for doubtful accounts. These assets are considered to be very liquid (easy to
obtain cash from the assets) and therefore, available for immediate use to pay obligations.
The acid‐test ratio is calculated by dividing quick assets by current liabilities.

The traditional rule of thumb for this ratio has been 1:1. Anything below this level requires
further analysis of receivables to understand how often the company turns them into cash

Inventory Turnover Ratio: The inventory turnover ratio measures the number of times the
company sells its inventory during the period.

Profitability ratios

Profitability ratios measure a company's operating efficiency, including its ability to generate
income and therefore, cash flow.

Earnings per share. Earnings per share (EPS) represents the net income earned for each share
of outstanding common stock. In a simple capital structure, it is calculated by dividing net
income by the number of weighted average common shares outstanding.

Price‐earnings ratio. The price‐earnings ratio (P/E) is quoted in the financial press daily. It
represents the investors' expectations for the stock. A P/E ratio greater than 15 has
historically been considered high.

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Solvency Ratios

Solvency ratios are used to measure long‐term risk and are of interest to long‐term creditors
and stockholders.

Debt to total assets ratio. The debt to total assets ratio calculates the percent of assets
provided by creditors. It is calculated by dividing total debt by total assets. Total debt is the
same as total liabilities.

Introduction to Funds Flow and Cash Flow Analysis

Funds Flow Analysis

One of the most fundamental objectives of business is to make a profit. Long run survival
requires that the business must be able to deal with any liquidity problems which arise in the
short term.
Along with the information about the assets and liabilities as well as the profit and loss, it is
equally important to know what funds became available during the accounting year and how
such funds were applied. This information may be obtained by preparing a statement of
source and application of funds. This statement demonstrates the movement of funds into and
out of the business during the course during the accounting period.

Concept of “Fund’’: The term ‘fund’ has been defined and interpreted differently by
different experts. Broadly the term ‘fund’ refers to all the financial resources of the company.
On the other extreme, fund has been understood as ‘cash’ only. According to the International
Accounting Standard No. 7, the term generally refers to cash, to working capital and to cash
and cash equivalents (long term financial sources).

Concept of Fund Flow:

The term "Flow of Funds" refers to changes or movement of funds or changes in working
capital in the normal course of business transactions.. In other words, any increase or
decrease in working capital when the transactions take place is called as "Flow of Funds." If
the components of working capital results in increase of the fund, it is known as Inflow of
Fund or Sources of Fund. Similarly, if the components of working capital effects in
decreasing the financial position it is treated as Outflow of Fund.

Specimen of Funds Flow Statement

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 Analysis of Cash Flow

A cash flow statement is a financial report that describes the sources of a company's cash and
how that cash was spent over a specified time period. It does not include non-cash items. The
cash flow statement is a cash basis report on three types of financial activities: operating
activities, investing activities, and financing activities. Non-cash activities are usually
reported in footnotes. This makes it useful for determining the short-term viability of a
company, particularly its ability to pay bills. Because the management of cash flow is so
crucial for businesses and small businesses in particular, most analysts recommend that an
entrepreneur should study a cash flow statement at least every quarter. The cash flow
statement is similar to the income statement in that it records a company's performance over a
specified period of time. The difference between the two is that the income statement also
takes into account some non-cash accounting items such as depreciation.

Classification of Cash Flow Transactions:

Cash flows result from operating, financing, and investing activities. You must be able to
distinguish among these types of cash flows. These activities are explained as follows.
 Operating activities: Cash flows from operating activities include all cash flow
transactions that are not classified as investing or financing activities. Operating
activities are related to the primary operations of the company in generating revenues
and incurring related expenses.
 Investing activities: In general, investing activities are transactions for purchasing
and selling capital assets and other productive assets. Capital assets are acquired in
order to increase productive capacity. Cash needed for this expansion may come from
the sale of existing assets that are less productive.
 Financing activities: Financing activities affect a business’ capital structure, its debt
and equity. Financing activities include the use of cash to pay dividends to
shareholders, the borrowing or payment of debt, and the issue or repurchase of shares.

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 Questions
1.Define Ratio and State its advantages?
2. Discuss briefly various types of Ratios?
3. What do you mean by the term Fund? Explain the significance of Funds Flow Analysis?
4. Draw the format of Cash Flow Statement?
5. The following are the extracts from the financial statements of Blue and Red Ltd., as on
31st March 2001 and 2002 respectively 31 March 2001 31 March 2002 .
Stock 10,000 25,000 Debtors 20,000 20,000 Bills receivables 10,000 5,000 Cash in hand
18,000 15,000 Bills payable 15,000 20,000 Bank overdraft --- 2,000 9% debentures 5,00,000
5,00,000 Sales for the year 3,50,000 3,00,000 Gross profit 70,000 50,000

Compute for both the years the following: a) Current ratio b) Liquidity ratio c) Stock turnover
ratio. Also interpret the results.
6. A firm has current assets for Rs 1,25,000 including an inventory for Rs 63,000. The
current liabilities, on the other hand, amount to Rs 68,000. Find out the current ratio
and the quick ratio, with a given industry norm of 2/1 and 1/1 respectively.
7. Distinguish Funds Flow with Cash Flow Statement?

Objective Questions

1.A company’s ‘return on investment’ indicates its ____. ( )

(a) Solvency (b) Stock turnover (c) Profitability (d) Debtors collection
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2. Which would a business be most likely to use its ‘solvency’ ( )
(a) Gross profit ratio (b) Debtors collection period (c) Debt – Equity ratio (d) Current ratio
3. Higher ‘Assets turnover ratio’ explains ____. ( )
(a) More profitability (b) Higher sales turnover (c) Better utilization of assets (d) large
liability base
4.Which of the following measures company’s liquidity position ( )
(a) Stock Turnover ratio (b) Debtor’s collection period (c) Current ratio (d) Net profit ratio
5. The difference between current assets and current liabilities is called___. ( )
(a) Cost of goods sold (b) Outsiders funds (c) Working capital (d) Shareholders funds
6. Debtor’s is a current asset, where as creditor’s is ________. ( )
(a) Fixed Asset (b) Fixed Liability (c) Current Liability (d) Long-term Liability
7. What is the Desirable current Ratio ______? ( ) (a) 1:2 (b) 3:2 (c) 2:1 (d) 1:1
8. Long-term stability of an enterprise indicates by ____ ratios. ( )
(a) Liquidity (b) Profitability (c) Solvency (d) Turnover
9. The Liquidity ratios assess the capacity of the company to repay Its_____________
Liability. ( )
(a) Long-term (b) Profitability (c) Solvency (d) Turnover

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