Finance & Accounting Fundamentals
1. Where Unit 5 Fits
Teaching order: Unit 1 → 2 → 5 → 4 → 3. We jump ahead to Unit 5 (finance), then go backwards: 5 → 4 (operations) → 3 (marketing). HRM / management roles (Unit 1–2 area) are already done.
Four departments: however big the business (even a multinational) it only ever has 4 departments → HR · Marketing · Finance · Operations.
- Org. grows ⇒ number of employees ↑ (employees = one way to measure business size) ⇒ structure grows.
- Structure grows vertically, not horizontally (small shop: owner + 3–4 staff, simple structure).
Finance = the oldest / most traditional department. Even a tiny paan stall (khoka) or kiryana shop has a finance function:
- daily cash handling: sale → cash in; purchase → cash out; monthly stall rent paid to the authority (KMC etc.)
- …but no HR, marketing or operations department.
- Large firm → finance dept has accountants, auditors, cash handling.
What AS Finance contains
| Part | Content |
|---|---|
| ① Theory | what is finance · purposes of finance · internal vs external sources of finance · factors to consider when raising finance |
| ② Accounting (calculations) | costs & classification · break-even · costing statements · budget variances |
2. What is Business Finance?
✓ a sound-quality definition — every keyword earns the mark
Keywords unpacked
- every business = all-inclusive → small / large, sole trader, partnership, company, international, private sector, public sector. Finance is a need of every business.
- monetary amount = money needed.
- start · run · expand = the 3 basic purposes of finance. Without it the business can't start, run or expand.
① To start — entrepreneur sets up the business → needs an initial amount of investment = start-up capital.
- Usually comes from the owner's savings (put at financial risk).
- Why not a bank / investors? Banks won't lend — you don't meet the criteria; investors aren't attracted — new business = high risk.
- e.g. restaurant: rent / buy the premises, kitchen equipment, renovation, legal formalities, hiring workers, initial marketing & promotion.
② To run — business is now operational → must meet operational costs: rent, staff salaries, utility bills ⇒ needs working capital (money for day-to-day expenses).
③ To expand — business is profitable + sees potential to grow ⇒ decides to expand ⇒ needs finance for growth.
3. Expenditure: Revenue vs Capital
Expenditure = expense (expense is the short form). Whenever a business makes a payment ⇒ cash outflow. Two types:
| Revenue expenditure | Capital expenditure | |
|---|---|---|
| Amount needed | lower | higher |
| Time span | short-term — occurs multiple times in an accounting year | long-term — once a year, or once in a few years (not regular) |
| Examples | rent, wages, salaries, utility bills, fuel & regular maintenance | buying machinery, factory / building, new tyres on a car |
| Also called | operational costs / day-to-day expenses | — |
| Recorded in | Income Statement (under operating expenses) | SOFP (as an asset) |
| Suitable source | internal (e.g. profit) | external (e.g. bank loan, issue shares) |
Why is it called "revenue" expenditure?
Say you operate from rented premises:
- Don't pay rent for 1–2 months → landlord won't let you work in month 3.
- Don't pay salaries / wages → workers leave.
- No premises + no workers ⇒ business not operational ⇒ no revenue.
So these are the expenses you must meet to keep the revenue activity going — hence revenue expenditure. They are incurred whenever the business is operational.
Car example: fuel + regular maintenance = revenue exp. (just keeps the car running). New tyres → car's life & value improve = capital exp.
Reason 1 — different accounting treatment
Revenue exp. → Income Statement (operating expenses) · Capital exp. → SOFP as an asset. The income statement shows financial performance for the year; SOFP shows the financial worth of the business.
Fail to distinguish ⇒ mistreat (everything in one place, or capital in income statement & revenue in SOFP) ⇒ values under- / over-stated ⇒ no true and fair picture ⇒ accounts less reliable.
Reason 2 — different sources of finance for different needs
Revenue = small amount, short term → use internal source (e.g. profit). Capital = large amount, long term → use external source (bank loan, issue shares).
Can't tell them apart ⇒ wrong source: e.g. a bank loan to pay the rent ✗ · issuing shares to pay utility bills (a PLC would just use profits) ✗ · but a loan / shares for a factory or large machinery purchase ✓.
Decision depends on the amount and time period needed, i.e. on the purpose.
4. Why Finance is Important
Finance is significant to a business because it lets the business:
- Stay liquid — liquidity = ability to pay off current liabilities & short-term debts. e.g. a supplier giving you credit (pay after 20–30 days) checks your liquidity. No cash / current assets ⇒ can't pay suppliers or meet deadlines.
- Be financially competitive — conditions never stay the same. e.g. COVID: only financially fit firms survived. Companies don't pay out all profit as dividends — they keep reserves / retained profit for bad times (recession, crisis). Also when competition gets tough → more promotion, tech upgrades (rivals adopt technology too).
- Kick-start the operations — i.e. to start: initial investment needed.
- Fund expansion & growth — internal or external growth, product development, market development: all need finance. Plus more working capital for the larger operation.
- Meet operational costs — day-to-day expenses (= revenue expenditure).
5. Responsibility Centres
Centre = a division / department in the organization. Responsibility centre = a division that is responsible for something (a particular cost, revenue or investment) — like a teacher being responsible for 2 classes a week and finishing the syllabus on time.
First, what is "cost"? Cost = the monetary amount that is incurred during the production of goods and services. e.g. sir teaching a class: electricity, internet, gadgets (mic, iPad, laptop) · factory: wages, material · office: rent, salaries, utility bills.
① Cost centre
- HR dept — makes no sales, but without it who monitors, appraises, trains, motivates & hires workers?
- Accounting dept — record keeping, cash handling, controlling costs & expenses. No accounts ⇒ no book-keeping / monitoring ⇒ business eventually fails.
- Admin office / reception of a school or coaching centre — guides parents & students, deals with enquiries. Gets a salary (cost) but sells nothing directly.
- Hotel reception — pure cost, but without it tourists/guests get no guidance, calls aren't connected.
② Profit centre
- Classrooms in a coaching centre — students pay fees (revenue); but teachers' pay, electricity bill, cleaning, room set-up are costs ⇒ revenue − cost = profit. (The admin desk of the same centre = cost centre.)
- Marketing / sales dept — promotes, raises awareness, makes sales, but also spends on marketing.
- Restaurant in a hotel — meals sold (revenue); preparing meals costs money. (Hotel reception = cost centre.)
③ Investment centre (not in syllabus — just awareness)
Division responsible for investments & growth — when and where to invest, how to grow / develop. e.g. the board of directors and operations units deciding on further investment.
| Cost centre | Profit centre | |
|---|---|---|
| Revenue? | not directly | directly |
| Cost? | incurs cost | incurs cost too |
| Role | helps organization run effectively | maximizes profit |
| Examples | HR, accounts, reception, admin | classes, sales / marketing, hotel restaurant |
6. Classification of Cost
A business incurs many different costs at the same time (material, labour, rent, salaries, utility bills). They are classified in different ways:
- by nature → fixed / variable
- by traceability → direct / indirect
- plus the idea of semi-variable cost (later)
A. By nature — Fixed vs Variable
- Incurred at zero, minimum or maximum output — all through the year, produce or not.
- Factory rent: Rs 5 lakh/month → Jan, Feb … Jun, Jul — same amount every month.
- Coaching centre rent Rs 2 lakh/month: classes run Aug → May (peak Oct–Dec, crash courses in Jan) but in Jun–Jul there is zero volume and no classes — rent is still Rs 2 lakh.
- Salary: teachers' / manager's fixed salary even in winter vacations, off-season, low or high demand.
Example — a highlighter we produce (plastic + ink = material):
| Units made | Material @ $2/unit | Labour @ $0.5/unit |
|---|---|---|
| 10 | $20 | $5 |
| 100 | $200 | $50 |
| 1000 | $2000 | $500 (same pattern) |
Cost rises and falls with output ⇒ variable. Typical: material, labour (paid per unit).
Fixed = constant, doesn't change with output | Variable = varies with the level of output / activity.
B. By traceability — Direct vs Indirect
- Pen: plastic body and nib — visibly on this unit.
- Kurta: buttons and fabric are directly applied. More kurtas stitched ⇒ more buttons & fabric ⇒ direct variable.
- Material and direct labour = classic direct costs.
- Thread in a kurta — exact amount used per kurta can't be measured.
- Glue in furniture — applied on the product, but exact amount per chair / table differs. Nails — carpenter breaks some, uses more on some.
- ⇒ applied directly yes, but not easy to trace ⇒ management treats it as indirect / overheads.
- Factory office rent — office has sales, purchases, accountant, supervisors → serves overall operations, not the kurta line ⇒ indirect fixed.
- Showroom rent — accountant, display unit, visiting customers, sales persons, designer ⇒ indirect fixed.
| FIXED | VARIABLE | |
|---|---|---|
| DIRECT | rented stitching machines (Rs 50,000/month) · production plant used only for the product | fabric & buttons for kurtas · material & labour for a pen |
| INDIRECT | factory-office rent · showroom rent | thread · glue · nails (amount used moves with output) |
7. Total, Average & Semi-variable Cost
Total cost
Add all costs — overheads, direct, indirect, fixed, variable — and you get the total cost.
Average cost (cost per unit)
(sir slipped "10,000" → corrected himself to 1,000; 1,000 ÷ 100 = 10.)
Why calculate total cost? No total-cost information ⇒ can't calculate average cost per unit ⇒ can't set the selling price (is one pen costing Rs 10 or Rs 12 to make?).
Semi-variable cost
- Salary + commission (call-centre / sales staff): fixed salary Rs 20,000 always paid; commission depends on number of sales → 30,000, 25,000, 60,000 … ⇒ total pay moves.
- Electricity bill: line rent is fixed (you pay it even if you're away a month) + charge for units consumed varies. Summer (AC) ⇒ bill ↑; winter ⇒ consumption ↓, only line rent + a few units.
A cost that is both fixed and varying ⇒ semi-variable cost.
8. Why Accurate Cost Information Matters
Accurate cost data / information is necessary — without it the business is making decisions blind. It is important for:
- Setting an effective selling price — no accurate total cost ⇒ no accurate average cost (total cost depends on knowing fixed + variable costs) ⇒ you set an ineffective price.
- Making operational decisions —
- location: operate at A, B or C? Each has different costs → compare cost & profitability → choose.
- production: many products — which to make, which not, which to make more of? e.g. clutch / technical pencil or pen → compare costs (costing statements), then decide.
- Calculating profit and loss — no cost data ⇒ you won't know whether you're making a profit or a loss.
- Setting effective budgets — e.g. spend this much on promotion, this much on material & labour. Past costs guide the new budget: "last year material cost X ⇒ give purchase dept budget Y".
- Controlling / reviewing performance — to see which costs are being incurred, where cost is too high and why, what to cut down and what to control.
Pick any two from the list above and develop each one (e.g. price: no per-unit cost ⇒ price may be too low (loss) or too high (lose customers)).
Answer pattern: reason → what the cost data lets you do → what goes wrong without it.
9. Full Chapter Cheat-Sheet
- Business finance = monetary amount required by every business to start, run or expand.
- Start → start-up capital (owner's savings) · Run → working capital · Expand → investment + more working capital.
- Importance: stay liquid · financial competitiveness · kick-start ops · fund growth · meet operational costs.
- Revenue exp.: small, short-term, repeated (rent, wages, utilities) → income statement → internal source.
- Capital exp.: large, long-term (machinery, factory; anything raising life/value of a non-current asset) → SOFP → external source.
- Must distinguish: ① correct accounting treatment (else under/over-statement, not true & fair) ② right source of finance.
- Cost centre: incurs cost, no direct revenue (HR, accounts, reception). Profit centre: revenue − cost = profit (classes, sales, hotel restaurant). Investment centre: invests / grows (not in AS).
- Cost = monetary amount incurred in producing goods & services.
- Fixed = doesn't change with output (rent, salary) · Variable = changes with output (material, labour).
- Direct = traceable to product, can be fixed or variable · Indirect (overheads) = hard to trace, overall operations, can be fixed or variable.
- TC = TFC + TVC · AC = TC ÷ units · Semi-variable = fixed + variable parts (salary + commission, electricity bill).
- Accurate cost info → selling price · operational decisions (location, production) · profit/loss · budgets · control & review.
- Next up: break-even → costing statements.