Basic Concepts of Business: capital, profit, budget

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Financial Accounting (Mgt-101)

Lesson-2

Learning Objective

The evolution of accounting started in the previous lecture continues with a slight emphasis on how

actual record keeping started. In addition, some basic concepts like capital, profit, and budget are

introduced.

Different Types of Business Entities

Commercial Organizations (Profit Oriented)

o Sole proprietor

o Partnership

o Limited companies

Non-Commercial Organizations (Non-Profit Oriented)

o NGO's (Non-government Organizations)

o Trusts

o Societies

The Basic Concept of Record Keeping

We can maintain a diary of transactions and note the daily transactions like sale, purchase etc. in it.

Problems Faced in Maintaining Diary of Transactions

How will we come to know the income and expenses from various sources?

We only have a sheet / page on which daily transactions are listed.

We do not know which product is selling better and which is not.

Available Alternate

One can go through all the transactions at the end of the month and note the different types of

transactions on different pages.

So that every page gives total for a different type of transaction like sales of different products and

expenses of different types

Financial Accounting (Mgt-101)

Diary of Transactions

Transactions of Jan 20--

P a r t i c u l a r s

Rs.

Sold 5 nos. of Item A

1,000

Purchased 10 nos. of Item B

( 15,000 )

Sold 1 no. of Item C

2,000

Electricity bill paid

( 1,500 )

Sold 1 no. of Item A

500

Sold 2 nos. of Item B

4,000

Sold 5 nos. of Item A

1,000

Purchased 10 nos. of Item B

( 15,000 )

Sold 1 no. of Item C

2,000

Telephone bill paid

( 1,000 )

Salary paid

( 1,500 )

Now try to go through these transactions and separate, transactions of different types.

But what if the number of transactions is large?

Is it really possible to go through hundreds or thousands of transactions at the month end and

analyse them to obtain required results.

Cash and Credit Transactions

Sales and purchase are not always for cash. Some times the payment / receipt is delayed to a future

date (Sale/purchase for "UDHAR")

The diary that we have discussed above, records cash transactions only.

The "UDHAR" (credit) transactions may be noted in separate diary.

Now we have two diaries. One for cash and one for credit.

We need to know total sales and purchases (both cash and credit) and other information like the

amount that is payable and receivable.

How will we get our required results now?

Do we need another diary to combine information from both these diaries?

But when we receive or pay cash for the credit transactions will we again record the transactions on

the day, when cash is received or paid? If so, where?

So the problems keep on increasing with the size or volume of business. But one thing is becoming

certain and that is that an accurate reflection of business transacted can only be obtained if both

cash and credit transactions are recorded in such a manner that there is no duplication and yet the

transactions are completely recorded. This is possible only under Commercial Accounting.

Commercial Accounting

· Commercial Accounting is done through a system that is known as Double entry book keeping.

Financial Accounting (Mgt-101)

Single Entry and Double Entry Accounting

Single entry accounting/Cash accounting.

This system records only cash movement of transactions and that too up to the extent of

recording one aspect of the transactions.

This means that only receipt or payment of cash is recorded and no separate record is

maintained (about the source of receipt and payment) as to from whom the cash was

received or to whom it was paid.

Double entry book keeping/Commercial accounting.

Double entry or commercial accounting system records both aspects of transaction i.e.

receipt or payment and source of receipt or payment.

It also records credit transactions. Example of Electricity Bill

This concept will be explained in detail in the next lectures but for the time being it should be noted

that in cash accounting date of receipt / payment of actual cash is important while in commercial

accounting the date on which the expense is caused, whether paid or not, as well as the spreading of

the cost of certain items over their useful life becomes important.

Capital

No business can run without money or resources being invested therein.

Whatever money or resources from ones' own pocket are put in a business is referred to as

CAPITAL.

This capital or investment must earn a return or profit on its use even if it is coming out of ones'

pocket.

This return is also known as PROFIT. So no capital should be without a profit or a return.

Also, no Capital even if coming from the business owner can be without cost. Why? Because if the

same sum that was used in a business was put in the bank or used to buy Defence Savings or

National Savings Certificates, a certain amount of profit would have been earned. By putting this

money in business, a return must be expected.

Money Value of Time

Another important concept to remember in all businesses is that of MONEY VALUE OF TIME.

Time spend by the owner also has value; he should be remunerated for it.(The time of the

proprietor or business persons spent on the business is also a business cost and must be paid for by

the business in addition to the profit)

· Why? Because if the business person had employed somebody else in his place, the person would be

paid a salary.

· Therefore, a business person's time and money both have costs attached to them. Nothing is free

nor should be expected to be free of cost.

Goodwill

Then there is something called GOODWILL.

This is simply the value attached to the good reputation earned through good, clean conduct of

business over a number of years.

This good reputation also has a value and becomes part of investment in business

Is Cash in Hand Our Profit?

Financial Accounting (Mgt-101)

Not unless we have deducted from

it the total amount of expenses that are accrued or are on

credit and added to it the sale made on credit for which cash is to be received at a later date. The

simple equation for calculation of profit would thus be:

Cash Sale-Cash Payment + (Credit Sale-Credit Expense)

Also remember that certain items have a long life and will be used during that time to earn more

money for business. The cost of such items will as be spread over their life and also accounted for

accordingly in the above equation.