Managing Financial Principles And Techniques
SUBMITTED TO: SIR EDWARD ANYAEJI
STUDENT ID: C343
EXTENDED DIPLOMA IN STRATEGIC MANAGEMENT AND LEADERSHIP (QCF)
C343 2 1.1 Explains the important of cost in the pricing strategy of the organization of your choice.
Organization is worked with competitive and continually environment so that time every decision is very crucial even if that organization is to survive or even be profitable so collection of past cost and projection of future costs is an important area in management accounting. Management account classify cost into different categories according to the nature of the cost as following 1) Production cost 2) Administration cost 3) Selling and Distribution. Production cost divided in three elements like material cost which include cost of the raw material than labour cost including wages, salaries and bonuses and last one direct expenses which include like some equipment which is hire. Total three elements are called the prime cost of production. There is another cost which is indirect cost which does not fall into the category of direct cost. As well as the nature of cost it is necessary to consider cost behavior there are three classes of behavioral classification: fixed cost which include incurred by the organization, variable cost that means which is opposite from fixed cost that always change by activity, and semi-variable costs which change when level of output change but not directly. Another is Revenue which is similar way as a variable cost. And the other cost classification which are committed, controllable, discretionary, irrelevant, incremental etc...And last thing which is influences on pricing strategy that means that take into view factors such as a firm’s overall marketing objective, consumer demand, product attributes, competitors pricing. And here main pricing policies are Premium pricing which include us high rate where there is a uniqueness about the product and service, Penetration pricing that means you change price temporary for gain market share and Economy pricing that means this is a low price for the lower end of the market.
C343 3 1.2 Design a job costing system for use within the organization that you have chosen. Your job costing system must also show your required mark up and margin.
Opportunity cost represents income which is forgone by deciding to specific alternatives. In the process of Decision making to consider any income that will be lost by rejecting a specific alternative. Job costing is about to where work takes from of individual jobs undertaken to a customer’s requirement. Here we divide cost into direct cost, manufacturing overheads and administration, selling and distribution overheads. Now from the following example provides us with the information we need to construct a job costing statement in which we calculate prime cost, factory cost and total cost. Let’s see practical exam from Ratnamani Metals & Tubes LTD. And evaluate the job costing system for it. For that we also have relevant data about that.
RELEVANT DATA : ESTIMATED 1800 DIRECT LABOUR DIRECT MATERIAL time Rate ph PREPARATION 18 hours £ 5.40 27 kg at £ 3.90 per kg 2700 1800 FINISHING 9 hours £ 4.50 PACKAGING 3 hours £ 3.60
ANNUAL TOTAL 5400 OVERHEAD LABOUR BUDGET HOURS OVER 9000 HEAD
Now the cost operating system first step to find out direct material. A) Direct materials: Cost for material: 27 kgs *£ 3.90 = 105.3
B) Direct wages: Preparation: 18 hours *5.40 £ = 97.2 £ Finishing : 9 hours*4.50 £ = 40.5 £ Packing : 3 hours*3.60 £ = 10.8 £
Preparation: Overhead / total hours *hours = 9000/5400 = 1.67 , 1.67 * 18 = £ 30.06 per unit
Finishing: 7200 / 2700 = 2.67, 2.67 * 9 = £ 24.03 per unit Packing: 4500 / 1800 = 2.5 , 2.5 * 3 =£ 7.5 per unit
D) Operating statement:
Direct Material Direct labour Preparation Finishing Packing Prime cost Preparation Finishing Packing Total factory cost Administration o/h (10% of 315.39) Selling and distribution o/h(25% of 253.8) Total cost Selling Price Profit
Working note A B
97.2 40.5 10.8 C 30.06 24.03 7.5
61.59 315.39 31.54 63.45 94.99 410.38 615.57 205.19
E) Mark –Up and Margin: As we decide to make 50% of profit so as mark - up Cost price: 410.38 Mark-up (50% *410.38) : 205.19 Selling price : 615.57
The selling price is 615.57 and if the margin is 33.33% then cost price will be 410.41 Cost price : 410.41 Margin (33.33% of 615.57) : 205.16 Selling price : 615.57 F) Batch costing : Cost per unit: The total batch cost / total no. of units produced in batch
G) Process Costing: Cost per unit: total cost of period / total production of period (liters or kilos)
activity ration. Next one is accountable management is a theory of management which is centre of company which have all responsibility and all decision power.
It’s very important to improve cost and pricing in any organization. For that there are some criteria to see which effect to bring change in our organization. And budget control that is one type of expects to spend and earn over a time period.C343 6 1. Third one is profit centers here you have to separate your profit part to another part which don’t make profit. And financial audit that ratio of your company like liquidity ratio. Another factor is cost center is about location which you select and cost units are sub-division of the cost centre. First factor is responsibility and control of system in this factor you have to understand how much cost to runs various factor. debts ratio. And last factor which bring change is planning and control in this method you have to do financial control that helps to find out your income and expense like balance sheet and income statement. There are number of factor which effect to our organization. Justify your recommendation by stating the benefits that your proposed improvements would bring to the organization. profitability ratio.
.3 Proposing improvements to the costing and pricing system used in the organization of your choice.
Source of finance has three ways to come finance. Your response should demonstrate that you have researched a range of possibilities for funding. Business Angels 1.C343 7
2. It’s naturally high risk for the investor. Venture capital: It means when you money provide by investors to establish up firms and small business with perceived long term growth potential. 1.
. It’s very key source of funding for bring into being that does not have access to capital markets.2 Assess the sources of funds available to your company for a specific project. Venture Capital 2. Business Growth 3. but it has the potential for above-average returns.
new share issue. (http://www. There is two type of factor one is Internal and another is External. Want to increase his business in metals and tubes so first of all in 1985 company start production of Stainless Steel Welded Pipes & Seamless Tubes.com )
. It’s listed on 10 Rs. as twin small-scale units. right issue. debenture etc… in short time bank loans. In 1991 they Established facilities for manufacturing Stainless Steel Electric Fusion Welded Pipes. trade credit. Here they do merger and tack over. Business Growth: Business growth is about any firm whose business generates significant positive cash flows or earnings. overdraft.
Ratnamani Metals & Tubes LTD. sales of assets. That time they want to start him production so they issued 4. In internal factor there is generating increasing sales.C343 8
2. Business Angels: Business owners often report that company finance can be very difficult to obtain – even from traditional source such as bank and venture capitalists.959 share in market. 74. After that they want to increase him strength of production so they listed in BSE and ASE. use of retained profit. And another hand in external factors has Long Term which is ordinary shares. Per share.ratnamani. loan. Its big milestone for company after that they increase him strength. 63. factoring etc… 3. which increase at significantly faster rates than the overall economy. preference shares.
how. and many questions must be answered. A cash budget is extremely important. managers in every department justify the resources they need to achieve their goals. Managers decide the most effective ways to perform each task. IN BUDGETARY PLANNING.
. They ask whether a particular activity should still be performed and.1 Select appropriate budgetary targets for an organization. Many decisions are involved. They explain to their superiors the scope and volume of their activities as well as how their tasks will be performed. It’s used to assess the entity has sufficient cash to fulfill regular operation otherwise too much cash in being left in unproductive capacities.C343 9
3. (http://www. In order to make effective decisions and coordinate the decisions and actions of the various departments.
Cash budget means an estimation of the cash inflow and outflow for a business or individual for specific period of time. Control: Actual results are compared against the budget and action is taken to control expenses and to allocate resources effectively.com ) A) Purpose of budgets: Department managers in a business make decisions every day that affect the profitability of the business. IT NEEDS THE FOLLOWING Communication: In the budgeting process. a business needs to have a plan for its operations. if so. Old plans and processes are question as well as new plans and processes. Planning the financial operations of a business is called budugeting. because it allows a company to determine how much credit it can extend to customers before it begins to have liquidity problems.investopedia. The communication between superiors and subordinates helps affirm their mutual commitment to company goals Planning: A budget is ultimately the plan for the operations of an organization for a period of time. especially for small businesses.
. It does improve managers to improve but can give more accurate forecast. This may motive managers to improve financial performance. Did the manager reach the target revenue within the constraints of the targeted expenditures? Such as market and general economic conditions. Rewards can be given for operating within the budgeted expenditure or exceed the budgeted revenues. One is expectation budget that means this budget is set at current achievable levels. C) Cash budgeting A cash budget shows Cash revenue Cash expenses Opening balances Closing cash balances
Cash budgets are usually prepared on a monthly basis. And another hand there is aspirations budget that means this is a budget set at a level which exceeds the level currently achieved.
Motivation: The budget can be used as a target for managers to aim for. They are also used to forecast the amount of cash available or the overdraft required.C343 10
Evaluation: One way to evaluate a manager is to compare the budget with actual performance. affect a manager’s performance. B) Budgeting targets: Budgeting targets will assist motivation if they are at the right level. Whether a manager achieves targeted goals is an important part of managerial responsibility.
months to 31st May and comment on it.000.000.200 per month and is paid in cash each month. it is imperative that these business owners take the steps necessary to budget and effectively manage the funds they do have available.000
Ratnamani Metals & Tubes LTD.
. Wages of £1. Company car costs £9.000 £4. business:
Makes estimates for the first 3 months of
In March. The rent is £2.000 £20. March Sales Purchases £9.500 a month will be paid. Therefore. The three
Prepare a cash budget for Ratnamani Metals & Tubes LTD. Importance of budgeting to management: In this time of economic hardship.00. small businesses and micro-businesses are among those being hardest hit – particularly with their inability to access lines of credit to help maintain effective cash-flow.500 April £24.000 May £40. plan to start trading on 1st March and a bank account will be opened with an initial opening balance of £1. April and May. paid in three instalments from April. the company will rent a small office.000 is required and will be paid for in three equal monthly instalments in March.000 £12. Ratnamani Metals & Tubes LTD. Equipment costing £60.2 Participate in the creation of a master budget for an organization.C343 11
400 6.000 9.500 4.000 12.100 2.
. Buy second hand equipment.700 63.00.600 60.000 April £ 24.000 3.000 4.000 3.100 56. Spread the repayment of the equipment over 6 or 12 months instead of the 3 months within the cash budget.200 1.200 -22.700 77.000 9. April and May.700 -14. which could end up cheaper.500 38.200 20.200 20.C343 12
Cash Budget: Jones & Son March £ Cash Receipts: Cash Sales Total Receipts Cash Payments: Rent Equipment Car Stock Purchases Wages Total Payments Net Cash Flow Opening Balance Closing Balance 2.500 1.800 2.000 77.000 3.000
Comments on resource utilisation within Jones & Son’s budget: • • • • Receipts are less than payments in March.000 73.000 1.600 43.000 20.000 May £ 40.16.200 20. Possibly look for cheaper suppliers of stock. Obtain a loan for first few months to assist with negative cash flow.000 40.000 24.600 9.000 1.500 46.000 36.500 31.700 -6.500 1.800 63.000 Total £ 73.
3 Compare actual expenditure and income to the master budget of an organisation.
Disadvantages of zero-based budgeting: • • • It a complex time consuming process Short term benefits may be emphasized to the detriment of long term planning Affected by internal politics . Budgets are then built around what is needed for the upcoming period. Determine the impact of these funding levels on the decision packages Rank the “decision packages”
.can result in annual conflicts over budget allocation
Implementation of zero-based budgeting: • • • Identify two alternate funding levels for each activity (decision package). Advantages of zero-based budgeting: • • • • • • Forces budget setters to examine every item. Zero-based budgeting: A method of budgeting in which all expenses must be justified for each new period.C343 13
3. Zero-based budgeting starts from a “zero base” and every function within an organization are analyzed for its needs and costs. regardless of whether the budget is higher or lower than the previous one. Encourages managers to look for alternatives. Allocation of resources linked to results and needs. The funding levels that we will choose would be a zero based level and the current funding level. Develops a questioning attitude. Prevents creeping budgets based on previous year’s figures with an added on percentage. Wastage and budget slack should be eliminated.
16.200 20.700 -14.700 -6.000 20. because of their skills.000 1. Equipment .000 9.2) £ Cash Receipts: Cash Sales 9.000 1.600 43.200 1.000 3.000 36.200 20. Rent – We decide to stay in our current premises instead of renting a cheaper premises of £800 per month.000 73.000 Total Receipts Cash Payments: Rent Equipment Car Stock Purchases Wages Total Payments Net Cash Flow Opening Balance Closing Balance 2.200 20.We decide the alternative option to repay over 12 months instead of the 3 months as previously budgeted Car – We decided to buy an alternative £6.500 4.000
2.200 -22.000 12.400
6.100 56.000 3.700 77.000 4.5x the sale price.800 63. which may reduce our sales April May Total
CashBudget: Ratnamani March Metals & Tubes LTD.000 24.500 31.000 car and pay within the first month of trading.800 9.2. instead of 2x the sale price within the previous budget. (LO 3. This will cost 20% more but we can sell the product for 2.100
£ 24.000 3.000
£ 40.500 1.00. Wages – We decide to stick with our staff instead of reducing our staff. The cheaper premises is not in a good location.500 38.500 46.700 63.C343 14
Ratnamani Metals & Tubes LTD.500 1.000 40.000
£ 73.600 60.000 77. – Zero based budget • • • • • Purchases – We have chosen a supplier of better quality products than the previous one in LO 3.
700 13.000 5.200
Zero Based CashBudget: March Ratnamani Metals & Tubes LTD.500 37.500
2.800 76.12.000 1.200 5.800 76.500 22.800 89.500 23.600 32.000 1.500 Total Receipts Cash Payments: Rent Equipment Car Stock Purchases Wages Total Payments Net Cash Flow Opening Balance Closing Balance 2.00.12.700 -10.700 28.800 12. £ Cash Receipts: Cash Sales 12.000 9.500
£ 37.500 33.000 4.500 1.000 47.200 5.000 89.000 15.000 9.200 5.500 62.000 1.16.000 35.000 25.500 1.400
£ 62.600 15.200 1.000
000 25.700 -10. £ Cash Receipts: Cash Sales 12.500 33.500
£ 37.200 5.500
£ Times 2.800 76.500 23.700 28.000 15.800 12.500 Total Receipts Cash Payments: Rent Equipment Car Stock Purchases Wages Total Payments Net Cash Flow Opening Balance Closing Balance 2.00.500 22.000 9.5 of purchases
2.000 1.800 89.200 5.700 13.000 5.000 89.000
2.000 1.000 47.500 37.200 5.500 62.500
£ 62.200 1.C343 16
Zero Based CashBudget: March Ratnamani Metals & Tubes LTD.200
Same ÷ by 4 Cheaper Times 20% Same
.800 76.000 1.
2a. If the results are better than expected. the variance is adverse (A) It is important to explain the meaning of the variance and identify possible causes for the variance.C343 17
3. material and salaries. Basic variances can be calculated for sales. A number of basic variances can be calculated. the variance is favorable (F) If the results are worse than expected.4 evaluate budgetary monitoring processes in an organization Basic variance analysis: • • • • • Variance analysis is the process by which the total difference between standard and actual results is analyzed. Sales variances:
Variance Sales price
Favourable (F) Unexpected price increase due to: • • Higher than anticipated customer demand An improvement in the quality of the product
Adverse (A) Unexpected price decrease due to: • • Lower than anticipated customer demand A reduction in the quality of the product
Budgeted sales = 73000 Actual sales = Variance 112500 39500 (F)
£ 37. Variance of Ratnamani Metals & Tubes LTD.000
£ 1.C343 18
2b.2) £ Cash Receipts: Cash Sales 9.
CashBudget: Ratnamani March Metals & Tubes LTD. (LO 3.000
Zero Based CashBudget: March Ratnamani Metals & Tubes LTD.500
£ 73. £ Cash Receipts: Cash Sales 12.12.000
15.3) Cash Receipts: Stock Purchases
5. (LO 3. Variance of Jones & Sons materials purchases (a) Previous Cash Budget: Ratnamani Metals & Tubes LTD.2) Cash Receipts: Stock Purchases March April May Total
(b) Actual Zero-based Cash Budget: Ratnamani Metals & Tubes LTD.000
3a Materials variances Causes of materials price variances
Variance Material price Favourable (F) Unexpected price increase due to: • • • Poor quality materials Change to a cheaper supplier Discounts given for buying in bulk Adverse (A) Unexpected price decrease due to: • • • Higher quality materials Change to an expensive supplier Unexpected price increase
1.2) Cash Receipts: Wages March April May Total
1. Salary variances Causes of salary rate variances:
Variance Salary rate Favourable (F) Lower skilled staff: • Cut in overtime / bonuses Adverse (A) • Higher skilled staff
Increase in overtime / bonus Unforeseen wage increase
1. Variance of salaries rates (a) Previous Cash Budget: Ratnamani Metals & Tubes LTD.C343
Budgeted purchases = 36500 Actual purchases = 35000
purchase in bulk.500
1. Prompt and corrective action • • • Adverse sales variances – To counter this. Adverse salary rate variances – you could reduce staff. recruit cheaper staff etc.500
1. Adverse materials price variances – To counter this. you can increase sales prices.500
4. choose alternative products etc. advertising. sales incentives etc.3) Cash Receipts: Wages £ April May Total
. you can choose a cheaper supplier. (LO 3.500
Budgeted salaries = 4500 Actual salaries = 4500
(b) Previous Cash Budget: March Ratnamani Metals & Tubes LTD. reduce salaries / bonuses / commission.
because every situation has its share of unpredictable factors. Budgetary control covers as a whole in terms of revenue and expenditures such as purchases. or customer satisfaction?" Also called value engineering. Standard costing: An estimated or predetermined cost of performing an operation or producing a good or service.C343 22
4. and a continuous monitoring and adjustment of performance against them. 2.
. Standard costing is related to a product and its cost only. materials. They almost always vary from actual costs. without diminishing the effectiveness.1 recommend processes that could manage cost reduction in an organization. It proceeds by repeatedly asking "can the cost of this item or step be reduced or eliminated. and systems. its objectives are (1) to distinguish between the incurred costs (actual use of resources) and the costs inherent (locked in) in a particular design (and which determine the incurring costs). Standard costing is a system of costing which makes a comparison between standard costs of each product or service with its actual cost. and (2) to minimize the locked-in costs. Manufacturing: Systematic analysis that identifies and selects the best value alternatives for designs.
Value analysis here two different things about value analysis which are different in different place. under normal conditions. production. Standard costs are used as target costs (or basis for comparison with the actual costs). and are developed from historical data analysis or from time and motion studies. Difference between standard costing and budgetary control 1. sales. finance etc. processes. Budgetary control deals with the operation of a department or the business as a whole in terms of revenue and expenditure. Budgetary control: Methodical control of an organization's operations through establishment of standards and targets regarding income and expenditure. required quality. 1.
maintenance. Internal and external failure costs are incurred because defects are produced despite efforts to prevent them therefore these costs are also known as costs of poor quality. but they can and do expect to be free of defects. which did not affect the quality of the product. Unnecessary cost is Cost which provides neither use. • Harm to value-Serious decreases in prices can genuinely mischief an outfit's capability to keep handling value items or utilities. nor customer features. These four groups are also termed as four (4) types of quality costs. nor life. Two of these groups are known as prevention costs and appraisal costs. The purchasers of economy cars cannot expect their cars to be as richly as luxury cars. If an economy car is free of defects. The straight error of an improvement or finish would not be considered value engineering. Purchasing: Examination of each procurement item to ascertain its total cost of acquisition.
. As another definition: Value Engineering can be defined as an organized approach to the identification and removal of unnecessary cost. Difficulties with introducing cost reduction programmers • Lowered worker assurance-Employees are alternate feeling that their enterprises are unappreciated • Lack of arranging-can in fact the price lessening practice more unreasonable. wherever feasible. to replace it with a more cost effective substitute.C343 23
2. it can have a quality of conformance that is just as high as defect-free luxury car. nor quality. These are incurred in an effort to keep defective products from falling into the hands of customers. Quality costs can be broken down into four broad groups. and usage over its useful life and. The other two groups of costs are known as internal failure costs and external failure costs. From the beginning the idea of value engineering was seen to be cost validation exercise. Also called value-in-use analysis.
Value engineering Value Engineering can be defined as an organized approach to providing the required functions at the lowest cost. nor appearance. Quality costs A product that meets or exceeds its design specifications and is free of defects that spoil its appearance or degrade its performance is said to have high quality of conformance.
Prevention costs support activities whose purpose is to reduce the number of defects. Appraisal costs. This approach along with designing products to be easy to manufacture properly. In a Just in time system. As a result. There are no stockpiles of parts. the part cannot be used and the order for the ultimate customer cannot be filled in time. training. Hence every part received from suppliers must be free from defects. Unfortunately performing review activates doesn't keep defects from happening again and most managers realize now that maintaining an army of inspectors is a costly and ineffective approach to quality control.C343 24
Quality costs (a) Prevention & appraisal costs Generally the most effective way to manage quality costs is to keep away from having defects in the first place. (b) Appraisal costs Any defective parts and products should be caught as early as possible in the production process. It is much less costly to prevent a problem from ever happening than it is to find and correct the problem after it has occurred. parts are delivered from suppliers just in time and in just the correct quantity to fill customer orders. and a variety of tools from total quality management (TQM). Particularly in Just in time systems. Companies employ many techniques to prevent defects for example statistical process control. companies that use Just in time often require that their supplier use stylish quality control programs such as statistical process control and that their suppliers certify that they will deliver parts and materials that are free of defects. If a defective part is received from a supplier. Employees are increasingly being asked to be responsible for their own quality control. Some companies provide technical support to their suppliers as a way of preventing defects. allows quality to be built into products rather than relying on inspections to get the defects out. such support to suppliers is vital. which are sometimes called inspection costs. quality engineering. are incurred to identify defective products before the products are shipped to customers.
Internal failure costs result from identification of defects before they are shipped to customers. which can be devastating. Such costs can decimate profits. This is the price that is paid to avoid incurring external failure costs. Internal failure costs. (d) External failure costs When a defective product is delivered to customer. Failure costs can be either internal or external.
(c) Internal & external failure costs Failure costs are incurred when a product fails to conform to its design specifications. Missing a deadline or other quality problems can be intangible costs of quality. External failure costs usually give rise to another intangible cost. External failure costs include warranty. external failure cost is the result. alteration of defective units. These intangible costs are hidden costs that involve the company's image. external failure costs and intangible costs that impair the goodwill of the company occur due to a poor quality so these costs are also known as costs of poor quality by some persons. and downtime caused by quality problem. They can be three or four times greater than tangible costs. rejected products. liability arising from legal actions against a company. repairs and replacements. The more effective a company's appraisal activities the greater the chance of catching defects internally and the greater the level of internal failure costs. These costs include scrap. and lost sales arising from a reputation for poor quality. product recalls.
ABB provides opportunities to align activities with objectives streamline costs and improve business practices. It does not represent just a new set of overhead allocation rules or techniques to value inventory. after which the costs of the activities needed are used to create the budget.C343 26
Method of Activity-based costing:
Methodology of ABC focuses on cost allocation in operational management. It allows leaders to examine non-value-added activities and make rational decisions to eliminate them. Activity Based Management (ABM) is a natural extension of ABC. which cause costs to exist. Activities are then tied to strategic goals. cost-based budgeting practices in which a prior period's budget is simply adjusted to account for inflation or revenue growth. companies must change the way they report and manage costs.2 Evaluate the potential for the use of activity-based costing
To compete successfully. A method of budgeting in which activities that invite costs in every functional area of an organization are recorded and their relations are defined and analyze. ABC represents a way to look at operating costs and provides methods to dissect the underlying activities. Activity Based Costing (ABC) is a managerial accounting system which determines the cost of activities without distortion and provides management with relevant and timely information. ABM relies on the Activity Based Costing system to specify where non-value-added activities exist and to value the monetary benefits associated with their elimination. This means replacing old institutions of cost accounting and inventory valuation. ABC helps to separate
Fixed cost Variable cost Overhead cost
. As such. Activity based budgeting stands in contrast to traditional.
For example. That is. but it is more difficult to directly allocate indirect costs to products. maintenance. performance measurement Calculating costs more exactly Ensuring product /customer success Evaluating and justifying investments in new technologies Improving product quality by better product and process design Increasing competitiveness or coping with more competition Management Managing costs Providing behavioral incentives by creating cost awareness among employees Responding to an increase in overheads Responding to increased pressure from regulators Supporting other management innovations such as TQM and JIT systems
Reasons for implementing activity-based costing. if achieved. the driver is likely to be machine operating hours. Direct labor and materials are quite easy to trace directly to products. The cost driver is a factor that creates or drives the cost of the activity.C343 27
The split of cost helps to identify cost drivers. machine operating hours drive labour. some sort of weighting is needed in the cost allocation process. the cost of the activity of bank tellers can be credited to each product by measuring how long each product's transactions (cost driver) takes at the counter and then by measuring the number of each type of transaction.
Better Management Budgeting. Where products use common resources in a different way. and power cost during the running machinery activity. For the activity of running machinery.
and entered into the system. Costs assigned to products. Before making any significant decision using activity based costing data. Reports generated by this system do not conform to generally accepted accounting principles (GAAP). Activity based costing data can be easily misinterpreted and must be used with care when used in making decisions. Integrates fit with Six Sigma and other continuous improvement programs. distribution channels. Supports performance management and scorecards Enables costing of processes. customers and other cost objects are only potentially relevant. which are odds with the numbers produced by traditional costing systems.C343 28
Benefits of Activity-based costing (ABC)
More accurate costing of products/services. managers must identify which costs are really relevant for the decisions at hand. Makes visible waste and non-value added activities. Utilizes unit cost rather than just total cost. an organization involved in activity based costing should have two cost systems one for internal use and one for preparing external reports
. SKUs. Better understanding overhead. supply chains. checked. ABC produces numbers such as product margins. customers. and value streams Activity Based Costing mirrors way work is done Facilitates benchmarking
Limitations of activity-based costing • • Implementing an ABC system is a major project that requires substantial resources. Data relating to numerous activity measures must be collected. Consequently. Once implemented an activity based costing system is costly to maintain. Easier to understand for everyone. But managers are used to to using traditional costing systems to run their operations and traditional costing systems are often used in performance evaluations.
particularly about overheads. zero based budgeting and continuous budgeting
. in as far as running your business more efficiently is concerned. because it permits the identification of value-adding activities and their cost drivers. and also let you appreciate its strategic role as a cost and management tool. It requires you to establish all activities that earn costs in each function of your business and then define the relationships between those activities. ABB provides you with greater detail. implementing and maintaining an activity based system Managers may be overwhelmed with information may be de-motivating. This page will show to you the difference between ABB and other commonly used forms of financial forecasting.C343 29
Activity-based budgeting Activity based budgeting is a modern approach to financial planning connected directly to organizational strategy. The information you get will guide your decision on how much resource you should allocate to each activity. rather than looking at the bigger picture More effective methods such as. Benefits of activity-based budgeting (ABB) • • • • Can identify opportunities for improvement and cost reduction Relates costs to performance data Enables assessment of processes that are effective in serving customers
Limitations of activity-based budgeting
Time consuming to set up have to understand the activities that drives the budget Costly buying.
2 Apply financial appraisal methods to analyse competing investment projects in the public and private sector make a justified strategic investment decision for an organization using relevant financial information.000 50.000 80.10.1& 5.000) 1.000 is expected to generate the Following net cash flows for the next five years. A method of assessing the potential profitability of two or more competing strategies.C343 30
5.00.000 50. Year 1 2 3 4 5 6 Cash Flow (4.000
What is the payback period for the project?
. Decision rule • Only select projects which pay back within your required time period • Choose between your options on the basis of the fastest payback
Payback method – Question 1 An investment of £3.100.000 90. based on the assessment of the period of time required before the financial returns from the strategy recoup the original investment.
10.000) 2.000 Cumulative cash flow (4.10.00.C343 31
Payback method – Answer 1 Year 1 2 3 4 5 Cash Flow (4. • 0.000) 80.000) (2.80. which is 3.000
• Payback is between the end of year 3 and the end of year 4.5 months 3.000 1.90.2 years = 2.000 1.10. The return on capital employed compares earnings with capital invested in the company. Return on capital employed (ROCE):
This is also known as accounting rate of return. This is expressed as a percentage ROCE = Average annual profits before interest & tax / Initial capital costs *100
Decision rule • If the expected ROCE for the investment is greater than the target rate (as decided by the management) then the project should be accepted.8 x 12).2 years.00.000 1.000 1. plus £20000/£100000 of year 4. payback of the investment is 3 years 2.000) (20. • The payback will be 3 years. • Therefore.5 months (0.
5 70.000 is written off over 7 years) = £10.000
2 20.000 .000 .000 • Average annual profit (a – b): £30.000
ROCE – Answer 2 (a) Average annual cash flows: £210.000/£90.C343 32
ROCE – Question 2
A projects requires an initial investment of £90.000
3 20.£20. the assets initially purchased will be sold for £20.000 ROCE = Average annual profits/Initial capital costs X 100%
ROCE = £20.£10.000 and then earns the following net cash flows:
YEAR CASH FLOW £
4 50. at the end of the seven-year project.000 ÷ 7 = £30.000 = £20.000) ÷ 7 (£70.22%
.000 X 100% = 22.000
7 20.000 (b) Average annual depreciation: (£90.
06 = £224. To compound a sum.49 in four years at an interest rate of 6%.06 = £212 Value after two years: 212 x 1. The formula is as follows: FV = PV(1 + r) n • FV = Future value after n periods • PV = Present or initial value • r = Rate of interest per period • n = Number of periods
Compounding – Question 3 An investment of £200 is to be made today.06) 4 = £252.
. What is the value of the investment in four years if the interest rate is 6%? Compounding – Answer 3
Value after one year: 200 x 1.74 Value after three years: 224.74x 1.06 = £252.20 Value after four years: 238.C343 33
3. Compounding calculates the future value of a given sum invested today for a number of years.20 x 1.49 FV = PV(1 + r) n £200(1 + 0.06 = £238. the figure is increased by the amount of interest it would earn over a period. Compounding A sum invested today will earn interest.49 The £200 is worth £252.
06-1 = £188 Value after two years: 188 x 1.C343 34
Discounting PV = FV(1 + r) .06-1 = £166 Value after four years: 166 x 1.n • PV = Present or initial value • FV = Future value after n periods • r = Rate of interest per period • -n = Number of periods to the present Discounting – Question 4 What is the Present Value of £200 receivable in four years’ time if the discount rate (interest rate) is 6%? Discounting – Answer 4 Value after one year: 200 x 1.06) 4 = £156 The £100 is worth £156 in four years at an interest rate of 6%.
.06-1 = £177 Value after three years: 177x 1.06-1 = £156 FV = PV(1 + r) n £100(1 + 0.
88999644 0.972 5237.943396226 0.716 7128.492
Internal Rate of Return (IRR) Where: L = Lower rate of interest H = Higher rate of interest NL = NPV at the lower rate of interest NH = NPV at the higher rate of interest
Net Present Value – Question 5 year 0 1 2 3 4 Cash flow £ (25000) 10000 8000 6000 9000
Net Present Value – Using Excel
year 0 1 2 3 4 Cash Flow £ -25000 10000 8000 6000 9000 Discount factor @ 6% 1 0.839619283 0.792093663 PV
9433.962 7119.843 3720.
£20.000 at a discount rate of 15%.
IRR = L + (NL / NL – NH X (H – L)) Where: L = Lower rate of interest H = Higher rate of interest NL = NPV at the lower rate of interest NH = NPV at the higher rate of interest IRR= 10% +(90000/90000-(-20000)*(15%-10%))
IRR =50.000 at a discount rate of 10% and . The company’s required rated of return is 13%.C343 36
Internal Rate of Return – Question 6 The potential cash flows for an investment give an NPV of £90.90%
Since the payback method focuses on short-term profitability.3 report on the appropriateness of a strategic investment decision using information from a post-audit appraisal
Appropriateness of Payback: The payback is another method to evaluate an investment project. the more desirable is the investment. The payback period is the length of time that it takes for a project to get back its initial cost out of the cash receipts that it generates. When the net annual cash inflow is the same every year.
. A project could have an acceptable rate of return but still not meet the company's required minimum payback period. the following formula can be used to calculate the payback period. with most of the return not happening until well into the future. The payback method focuses on the payback period. Most major capital expenditures have a long life span and continue to provide income long after the payback period. Rapid payback • leads to rapid company growth • minimises risk • maximizes the cash available to the company Disadvantages of Payback The payback method ignores the time value of money. The cash inflows from a project may be unequal. an attractive project could be overlooked if the payback period is the only consideration. The payback period is expressed in years. This period is sometimes referred to as" the time that it takes for an investment to pay for itself. The payback model does not consider cash inflows from a project that may occur after the initial investment has been recovered.C343 37
5." The basic premise of the payback method is that the more quickly the cost of an investment can be recovered.
Requires an estimate of the cost of capital in order to calculate the net present value. not as a percentage.C343 38
Appropriateness of Net Present Value NPV compares the value of a dollar today to the value of that same dollar in the future. However. NPV may not give correct decision when the projects are of unequal life. It is difficult to calculate the appropriate discount rate. If the NPV of a prospective project is positive.
. taking inflation and returns into account. Expressed in terms of dollars. NPV cannot give accurate decision if the amount of investment of mutually exclusive projects is not equal. it should be accepted. the project should probably be rejected because cash flows will also be negative. Disadvantages of Net Present Value • • • • • • NPV is difficult to use. if NPV is negative.
55534.10 100.50 0.30 26.00 8224.80 7757.00 7583.1 Analyze financial statements to assess the financial viability of an organization.70 22.00 7.50 19.
31-Mar10(12) Profit / Loss A/C Net Sales (OI) Material Cost Increase Decrease Inventories Personnel Expenses Manufacturing Expenses Gross Profit Administration Selling and Distribution Expenses EBITDA Depreciation Depletion and Amortisation EBIT Interest Expense Other Income Pretax Income Provision for Tax Extra Ordinary and Prior Period Items Net Net Profit Adjusted Net Profit Dividend – Preference Dividend – Equity Rs mn 503.00 31-Mar08(12) Rs mn 151.00 1.60 13.50 4789.85 48986.90 39.15
.13 -0.40 176.07 19335.43
73855.00 0.15 3.17 8695.24 0.94 18879.60 18.08 -5.20 11.40 12.70 9.87 10356.60 %OI 0.51 18436. It shows the level of profit or loss made.80 54.40 -183.88 5.36 21264.00 5.70 10908.29
26202.05 0.70 75.70 6.00
93255.00 31-Mar09(12) Rs mn 299.50 0.C343 39
6.19 1.90 %OI 0.00 1.12
15112.77 8700.90 4.00 1.90 %OI 0.40 0.30 4972.11 0. Profit and Loss Account: • • • It shows the flow of sales and expenses over a period.41 0.00 1548.90 100.60 19.70 -6416.50 15.28 26026.00 13552.40 124.25 13732.61 5.14 -0.80 19.70 35.00 1754.53
34598.21 16152.40 -161.00 5.88 22428.47 122906.00 6.96 0.90 6378.80 0.26 54366.20 1405.49 3.20 9.42 48026.13 134161.30 25. usually one year.80 100. It shows what has been done with the profit or loss.39 70250.20 19.40 7.22 0.30 36.29 13428.00 1651.57 136105.70 41.40 0.80 52.87 35487.90 11.00 6717.30
23703.22 8.10 14.74 30549.21
25864.50 4353.90 0.60 13.87 0.
21 0.83 42.90 100.60 160806.35 2.90 26763.61 3.40 17386.30 37.00
.00 919593.10 6.12 31-Mar-08 10320.80 244782.18 0.95 57814.20 5351.50 19.10 494668.06 0.10 3.10 0.30 38.70 93654.00 318986.79 7.C343 40
• • • A snapshot of the firm’s position at a point in time Shows what a company owns (assets) and what it owes (liabilities) Balance Sheet shows what assets a company has (use of funds) and where the money came from to acquire those assets (source of funds)
Balance Sheet 31-Mar-10 Equity Capital Preference Capital Share Capital Reserves and Surplus Loan Funds Current Liabilities Provisions Current Liabilities and Provisions Total Liabilities and Stockholders Equity (BT) Tangible Assets Net Intangible Assets Net Net Block Capital Work In Progress Net Fixed Assets Investments Inventories Accounts Receivable Cash and Cash Equivalents Other Current Assets Current Assets Loans & Advances Miscellaneous Expenditure Other Assets Total Assets (BT) 10320.50 0.20 306124.10 0.30 33868.10 %BT 1.41 3.61 202864.00 2012.10 1926.99 12.00 2531.90 72077.60 40304.83 0.60 15.24 35.56 0.66 3.00
10.56 29.00 %BT 1.06 148834.10 175618.88 313647.00
24.00 2983.50 5619.29 3.20 33.63 42.00
842005.00 563646.02 10.70 2.34 0.80 71175.58 227105.70 170280.50 0.90 19.60 38.10 0.28 1.94 26.40 0.00 563646.59 24.40 173296.00 10320.90 34.40 100.94 0.20 10932.93 4.40 14822.00 10320.26 138458.12 0.61 0.00 919593.15 168876.80 16835.90 100.58 0.90 35839.30 6.00 36438.30 821.00 1.70 145318.10 %BT 1.20 100.36 314077.80 5571.12 240051.36 350516.64 30.00 1.40 14872.96 12.40 100.80 36.20 322960.15 19.18 112381.23 0.20 100.40 28324.36 1.60 34.00 0.00 2.80 58365.60
55.60 1.08 0.30 0.10 29.96 20041.09 238080.00
20.07 309036.00 17.00 10320.10 0.75 506583.23 31-Mar-09 10320.60
842005.11 138441.40 92233.00 1.
such as comparative statements. And on assets side current assets was also increase up to 3. Gross profit is 39. Profit before interest and tax was gone -5. and ratios analysis.36 (2010) it’s increase from 38. There are various methods or techniques that are used in analyzing financial statements.93% in 2010 so that bad for company which liabilities were increase.18 (2010) and fixed assets was shows 38.C343 41
Analyses of financial Statement: Financial statement analysis is defines as the process of identifying financial strengths and weaknesses of the firm by properly establishing relationship between the items of the balance sheet and the profit and loss account.22 in 2010 from 11.
.87 (2009) so it’s very bad position.94% in 2009 which is reduced by 18. Balance sheet saws that current liabilities was 6.29% in 2009 which increased up to 6. Horizontal analysis is facilitated by showing changes between years in both dollar and percentage form.12 (2009). funds analysis. or trend analysis.90 but in last year it was 35.25% 2010.29. trend analysis. schedule of changes in working capital. Comparison of two or more year's financial data is known as horizontal analysis. As per profit and loss account it’s clearly show that on 2010 profit is reduce. In net profit they increase profit 3. common size percentages.
7 22428.80 0. Profit and Loss Account
31-Mar-10(12) Profit / Loss A/C Net Sales (OI) Turnover Gross Profit Administration Selling and Distribution Expenses Operating Profit Depreciation Depletion and Amortisation Profit before interest and tax Interest Expense Other Income Profit before tax Provision for Tax Extra Ordinary and Prior Period Items Net Net Profit Adjusted Net Profit Dividend – Preference Dividend – Equity Rs mn 122906.60 13732.00 1754.40 -183.50 4789.40
.20 1405.70 10908.80 6378.C343 42
6.90 23703.40 -6416.10 100477.30 4972.2 Apply financial ratios to improve the quality of financial information in an organisation’s financial statements.90 8695.70 15112.
.40 145318.00 318986.00 2983.40 173296.00 10320.20 322960.00 0.80 16835.00 842005.80 5571.10 0.80 244782.30 33868.40 92233.80 58365.10 494668.60 160806.20 306124.30 821.C343 43
BALANCE SHEET OF ORGANIZATION
31-Mar-10 Equity Capital Preference Capital Share Capital Reserves and Surplus Loan Funds Current Liabilities Provisions Current Liabilities and Provisions Total Liabilities and Stockholders Equity (BT) Tangible Assets Net Intangible Assets Net Net Block Capital Work In Progress Net Fixed Assets Investments Inventories Accounts Receivable Cash and Cash Equivalents Other Current Assets Current Assets Loans & Advances Miscellaneous Expenditure Other Assets Total Assets (BT) 10320.70 842005.40 17386.
30/10320.40% (c) Profit margin: X 100%
Profit margin = Operating profit Turnover =8695.70/10908.80% (b) Return on equity (ROE): ROE = Profit after tax X 100% Shareholders funds = 4789.10 * 100 =61.1*100 = 7.797 times
.10*100 = 46.20/10320. Profitability ratios: (a) Return on capital employed (ROCE) : ROCE = Profit before interest and tax Capital Employed =6378.90 = 0.075% (d) Interest cover:
Profit margin = Operating profit Debt interest = 8695.70/122906.C343 44
2. Liquidity ratios: (a) Current ratio: Current ratio = Current assets Short term liabilities =26763.4 = 79% 3.40-0 33868.38 Times
.stock Short term liabilities =26763.1/322960.40/33868.40
= 79% (b) Acid test ratio: Acid test ratio = Current assets . Efficiency ratios: (a) Fixed asset turnover ratio: Fixed assets turnover ratio = Turnover Fixed assets
00+ 26763.C343 46
(b) Asset turnover ratio : Assets turnover ratio = Turnover Fixed assets + Current Assets
122906.40 = 0.35
(a) Return on capital employed (ROCE) :
Return on Capital Employed (ROCE) is a measuring tool that method the efficiency and profitability of capital investments undertaken by a corporation. A firm acquires capital assets such as trucks. cut down on costs and realize greater profits or acquire more market share.) Shareholder's equity does not include preferred shares.
ROE is expressed as a percentage and calculated as: Return on Equity = Net Income/Shareholder's Equity Net income is for the full fiscal year (before dividends paid to common stock holders but after dividends to preferred stock. computers. etc to help makes its business operations more efficient.3 Make recommendations on the strategic portfolio of an organisation based on its financial information. and the higher the percentage. the better. It is spoken in the form of a percentage. Return on Capital Employed ratio also indicates whether the company is earning enough revenues and profits in order to make the best use of its capital assets.C343 47
6. Return on equity measures a corporation’s profitability by revealing how much profit a company generates with the money shareholders have invested. Firms can increase their Return on Capital Employed Ratio by:
Cutting costs so as to increase the Profit Margin ratio Buying raw material and other goods at cheaper costs
(b) Return on equity (ROE) : The amount of net income returned as a percentage of shareholders equity.
The lower the ratio.
(d) Interest cover:
A ratio used to determine how easily a company can pay interest on outstanding debt. An interest coverage ratio below 1 indicates the company is not generating sufficient revenues to satisfy interest expenses. A higher profit margin indicates a more profitable company that has better control over its costs compared to its competitors. or net profits divided by sales. its ability to meet interest expenses may be questionable. a 20\% profit margin.5 or lower.C343 48
(c) Profit margin: A ratio of profitability calculated as net income divided by revenues. the more the company is burdened by debt expense.20 for each dollar of sales.
. for example. means the company has a net income of $0. It measures how much out of every dollar of sales a company actually keeps in earnings. The interest coverage ratio is calculated by dividing a company's earnings before interest and taxes (EBIT) of one period by the company's interest expenses of the same period. When a company's interest coverage ratio is 1. Profit margin is very useful when comparing companies in similar industries. Profit margin is displayed as a percentage.
it means current assets are highly dependent on inventory.000.C343 49
2.000 divided by $8. The acid-test ratio is far more strenuous than the working capital ratio.000.000.000.000. then the company may have problems meeting its short-term obligations. Liquidity ratios: A. which is equal to 1. then that company is generally considered to have good short-term financial strength. primarily because the working capital ratio allows for the inclusion of inventory assets. Furthermore. If the current assets of a company are more than twice the current liabilities.
. XYZ Company would be in relatively good short-term financial standing B. then its current ratio would be $10. if the acid-test ratio is much lower than the working capital ratio. For example.000.000. if XYZ Company's total current assets are $10. Calculated by:
Companies with ratios of less than 1 cannot pay their current liabilities and should be looked at with extreme caution. Current ratio: An indication of a company's ability to meet short-term debt obligations the higher the ratio. and its total current liabilities are $8. Current ratio is equal to current assets divided by current liabilities. Acid test ratio: A tough indicator that determines a firm has enough short-term assets to cover its direct liabilities without selling inventory. If current liabilities exceed current assets. the more liquid the company’s. Retail stores are examples of this type of business.25.
Efficiency ratios: Ratios are naturally used to analyze how company uses its assets and liabilities internally. efficiency ratios are important because an improvement in the ratios usually translate to improved profitability. These ratios are important when compared to peers in the same industry and can identify businesses that are better managed relative to the others. Some common ratios are accounts receivable turnover. sales to net working capital. the repayment of liabilities.C343 50
3. the quantity and usage of equity and the general use of inventory and machinery. fixed asset turnover.
. Efficiency Ratios can calculate the turnover of receivables. accounts payable to sales and stock turnover ratio. Also. sales to inventory.
. http://www.investopedia. Cash flow available on (http://www.com/terms/a/abb.asp#axzz1VkmZC6fs) assessed from 15th august 2011. 2. Actibe based budgeting available on th (http://www. 4.wikipedia.com) assessed from 15th august 2011.asp#ixzz1Vlb4l6Tm) assessed on 19 august 2011.investopedia. 3.C343 51
Reference: 1. Ratnamani company information available on (http://www.ratnamani.com/terms/c/cashbudget.