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The marketing financial analysis circle
Financial analysis can be used to serve many purposes in an organisation but in the area of marketing it has four main functions: a) to gauge how well marketing strategy is working (situation analysis) b) to evaluate marketing decision alternatives c) to develop plans for the future d) to control activities on a short term or-day to-day basis. In effect these four functions comprise what can be called the " arketing Financial !nalysis "ircle" (see figure #.#) Figure 1.1 The marketing-financial analysis circle
Activities associated with marketing financial analysis functions
For each of the four functional areas where financial analysis is useful in marketing$ there are a number of associated activities vi%: a) Financial situation analysis (how well marketing strategy is working) &his involves the study of: • the study of trends • comparative analysis
• assessment of present financial strengths and limitations for the whole business$ brand or component of the business$ e.g. transportation. b) Financial evaluation of alternatives &his involves the study of a number of factors like the market place$ competitors etc.$ and is used for decisions whether to: • introduce new products'delete mature products • e(pand the sales force or do more advertising • delete a market operation e.g. close a )airy *oard depot or increase the sales fleet • move into a new market or markets • build a new grain depot or silo. c) Financial planning (pro+ections concerning activities which marketing management has decided to undertake) Financial planning is used for a number of activities like: • the introduction of a new range of products • the forecasting of sales and costs • market liberalisation. d) Financial control (actual compared to planned results) &his activity is mainly centered around keeping plans on course.
Methods involved in marketing financial analysis
&here are a variety of methods used in each of the four functional areas. ,ome of these include the following: a) Financial situation analysis • -atio analysis • .rofit and contribution analysis • ,ales and cost analysis. b) Financial evaluation of alternatives • ,ales and costs analysis • *reak even analysis • .rofit contribution$ cash flow analysis$ profit pro+ections • -eturn on investment
• -eturn on capital employed • ,ustainable growth rates. c) Financial planning • ,ales and costs forecasts • *udgets • .roforma income statements. d) Financial control • ,ales and costs forecasts • !ctual results compared to budgets (analysis of variance) • .rofit performance.
What is analysed in marketing financial analysis
&wo factors influence the choice of unit of analysis: a) the purpose of the analysis b) the cost of the information needed to perform the analysis. ,everal possible units can be used in marketing financial analysis and cost or sales data can be used. &hese units are listed in table #.#. which is by no means e(haustive. /nits can be chosen which suit the particular situation or organisation. Table 1.1 - Alternative units in financial analysis
Market &otal arket
rganisation "ompany ,egment')ivision'/nit arketing department
arket segment (s) .roduct mi( 0eographical areas .roduct line - demographics - product - characteristics
,pecific product ,ales unit - brand - model -egions )istrict'*ranch
87 .e. (i) "urrent ratio (should be greater than #) .roperty and e3uipment 5$777 :et worth 1ther assets &otal assets .. the productivity and efficiency of the organisation.ales person Basic financial analysis methods &hese will be e(panded on in later chapters$ so this section serves as an introduction only. &aking li3uidity analysis only$ this has a bearing on new product planning$ marketing budgets and the marketing decisions. how is it financed and its "activities"$ i. can it pay its bills$ its "leverage"$ i.e.tock &otal current assets 567 877 577 967 "urrent .shape 1ffice'.tore .si%e .e.: " "ash !ccounts receivable . 4i3uidity analysis is drawn from the balance sheet$ e.hort term debt 4ong term debt &otal liabilities " #57 #77 #$677 #$957 #$.g. !se of ratios -atios can be used to +udge the organisation2s "li3uidity"$ i.77 8$#67 &otal liabilities and net worth 8$#67 #urrent and $uick ratios &hese are used to +udge a firm2s short term capacity to meet its financial responsibilities.
5# (4ong &erm )ebt > :et @orth) #$677'5$A87<7. .87<#.67 %ebt ratios &hese are used to measure long term li3uidity ("urrent 4iability > . *reakeven is calculated by the formula: *y rearranging the formula breakeven costs or sales can be calculated. Bowever$ with a higher or lower price$ the breakeven point will be lower or higher respectively. rent$ rates$ whereas variable costs do vary with increased or decreased output$ e.g.ales and cost information are used to calculate the breakeven point.# ii) =uick ratio (minus stock) 667'557<5. In other words$ it is the point where costs of production and sales volume are e3ual. @ithout getting into the argument as to what constitutes fi(ed or variable costs$ fi(ed costs are defined as those which do not vary with output e. *reakeven assumes fi(ed costs are constant$ variable costs vary at a constant rate and there is only one selling price. .6# &his ratio shows the e(tent of leverage (debt) in total capitalisation. Profit analysis *reakeven analysis is a method used to estimate the number of units (volume) or sales value re3uired to make neither profit or losses.967'557<8. :ote that profit level intentions should be added to the fi(ed costs as this is a "charge" to the company..hort &erm )ebt > 4ong &erm debt) should be ?# #$957'#$. labour$ materials.g.
& Formula and gra'hical solution for breakeven analysis i( Formula . Figure 1.D.& )ra'hical solution .!lso$ if one wishes to recover all new investment (value) immediately it should be added to fi(ed cost.5 shows an e(ample of both. *reakeven can be calculated by the formula or by graphical methods. Figure #.rice'/nit < C #.E Fariable cost'/nit < C 7.9E9 Fi(ed costs < C97.777 < E6$ 777 units (volume) or C#57$ 777 Figure 1.
roduct2s net income 67 :ote: Chapter 5 provide !"rther e#pla$atio$ o! a) a$d %)& Figure 1.VARIABLE COSTS .#ontribution analysis* @hen performance of products$ market segments and other marketing units is being analysed$ an e(amination of the profit contribution generated by a unit is often very useful to management.+ < SALES (REVENUE) . 4H.. For e(ample$ suppose a product is generating a positive contribution margin. Figure #. In the e(ample below if G was eliminated$ C67$ 777 of product net income would be lost. &he profit and loss statement is useful for reporting performance to stockholders and to compute ta(es.8. If the product is dropped$ the remaining products would have to cover fi(ed costs that are not directly traceable to it. Bowever$ marketing e(ecutives should be familiar with the calculation of gross and net profit margins$ which is useful to gauge company and business unit financial performance and to budget for future operations. )ross and net 'rofit margins* "ontribution margin is useful for e(amining the financial performance of products$ market segments and other marketing$ planning and control units. # +T. gives an e(ample Figure 1.!4H.: Fi(ed cost traceable to product G 577 #67 H=/!4.3 -llustrative 'rofit and loss statement .o$ contribution represents the amount of money available to cover fi(ed costs and the e(cess available is net income.-B!T. If the product was retained the C67$ 777 could be used to contribute to other fi(ed costs and'or net income (see figure #.: ..: "ontribution margin 4H.).: Fariable manufacturing costs 677 577 1ther variable costs traceable to product G #77 H=/!4.. -llustrative contribution margin for 'roduct / 01112s( " ..
.el a$d -e t+ott (./01) " "ost of goods sold #5$777 1perating e(penses 8$E77 ." ..77 67 #$577 Financial analysis models .tocks #E$677 8$577 !ccounts receivable 8$967 "ash .repaid e(penses Fi(ed assets .77$777 . -HFH:/H 4H. e(penses 577$777 :et profit before ta( &a( :et profit 577$777 D7$777 #57$777 "onsider the following sample data taken from Ro'e( )a o$( *i+..: H=/!4.ales .: 4H.!4H.: 4H. H=/!4.: "ost of goods sold 0ross profit margin #$577$777 D77$777 .: H=/!4.elling and admin.
1ne of the advantages of computer based models is that one can work "backward" or "forward" through the model$ setting desired levels of cost or outcomes and calculating the results. 1ne such programme is the )upont !nalysis &he model allows e(ecutives to input data into blank bo(es and by manipulating any figure find the resulting outcome. Figure 1.any models$ often computerised$ have been developed to aid marketers see the effects on the "bottom line" of a change in an organisation.4 5am'le 'rintout of the %u'ont analysis Other performance measures Farious other performance measures can be usedI these include productivity measures$ which$ say$ for a supermarket would be: 1ther measures include inventory turnover: .
In all figures watch for inflation and information gaps (use appro(imation).E shows an e(ample of a spreadsheet used in accounting. &he power of these systems is that the data held in any one cell can be made dependent on that held in other cells and changing a value in one cell can set (if wanted) a chain reaction of changes through other related cells. It can be used$ for e(ample$ to evaluate the effect of changing the sales commission rate. . Into these cells may be entered numbers$ te(t and formulae. b) Pro forma financial statement !nnual profit and loss statement$ ne(t year pro forma'3uarter$ current year budget'3uarter$ last year actual'3uarter$ annual revision of 6 year pro forma profit and loss statement (e(pense detail for broad categories). :.Budgeting and forecasting &hese two activities are essential to marketing planning and are often done via pro forma statements. ! term often used to describe spreadsheets is "what if software". &his means that a model can be built in which the effect of changing key parameters may be observed.6 A sam'le s'readsheet A # 5 8 5alesman B # % 7 F 8uarterly sales figures 1st 8tr &nd 8tr .*. Figure #. 5'readsheets .preadsheets are often used in budgeting and forecasting e(ercises.rd 8tr 3th 8tr Total .imply entering a new value in the commission rate cell will lead to the automatic re-calculation of all dependent cells. Figure 1.preadsheets use the memory of a computer as if it were a large piece of paper divided up into a matri( of cells. a) Marketing budgets Field sales e(pense$ advertising e(pense$ product development e(pense$ market research e(pense$ distribution e(pense (trade and administration)$ promotion e(pense (trade$ consumer). .
.77 DE56.96 #D "hris "ooke D.67 #58.77 D967.77 8D9.77 A677. . .77 9 "hris "ooke 6E56.77 9677./ (column or row)I the borders showing column letters and row numbers may be omitted. In addition$ programming facilities such as IF.67 #58.67 ##5.preadsheets are powerful personal decision support tools.. 6 !lan !dams 6E77.77 E *rian *rown 6567.6J #8 #.77 D )on )avis A #7 &otal ## #5 "ommission #..#6 Note2 &he formatting of the 2cells2 to display numerical fields to two decimal places'values for commission in the lower half are found by multiplying the sales figures by #.5.77 87D96.67 .96 #69.77 56D#7.77 D677.H4.DD #7D..77 #59.77 .5.6JI totals are stored as the .E8 5alesman 1st 8tr &nd 8tr .77 A677.56 #5A.77 E677.6D6.77 D567.77 8#696.77 88867.8D .77 #A )on )avis ED. #6 #E !lan !dams D.67 6777.77 E677.77 9577.H greatly e(tend the control that may be built into the model.56 ##5.E8.77 #7677.rd 8tr 3th 8tr Total 5#7E7.77 D577.9D A9..&BH:.#8 #..67 #.8D #8#..98.77 #9 *rian *rown 9D.
rofit analysis -atio analysis .tocks and work-in-progress &he interpretation of company accounts-ratio analysis &he main types of ratio 1ther useful ratios Financial measures of business unit performance Key terms &he two principle statements which form a set of accounts are:a) The pro!it a$d to given period.tructure of the chapter &he basic principles /se of the accounting e3uation to find profit anufacturing account &rading account &he profit and loss account &he balance sheet .Key terms *udgeting and forecasting "ontribution analysis )upont analysis model Financial control Financial evaluation of alternatives Financial planning Financial situation analysis 0ross and net profit margins arketing financial analysis circle . a++o"$t defined as a summary of a business2s transactions for a b) The %ala$+e heet defined as a statement of the financial position of the business at a given date (usually the end of that period).Financial9 managerial accounting and re'orting "hapter ob+ectives . 1ther less important statements are the ma$"!a+t"ri$3 a++o"$t and the tradi$3 a++o"$t& It is absolutely essential to any marketer to understand what the profit and loss statement .preadsheets #ha'ter & .
*. arketing *oard (". *oth documents are vital$ not only to show the corporate health of the organisation$ but also as an indication to various shareholders of how well or badly the organisation is performing$ as proof to potential investors or lenders for the raising of capital and as a statutory record for ta(ation and other purposes. a) First 'rinci'le* %ual effect Hvery transaction has two effects$ not one$ e. Chapter ob ectives &his chapter is intended to provide: • !n introduction to the basic principles of the accounting e3uation • !n introduction to$ and the construction of$ manufacturing$ trading and profit and loss accounts and their use • !n understanding of the principles and construction of a balance sheet and its interpretation • ! detailed e(planation of the interpretation of company accounts using ratio analyses and the uses of these.) . -atio analysis is a particularly powerful techni3ue aimed at helping marketers to compare sets of figures over time and between companies. !tructure of the chapter &his chapter is structured in a logical way$ building up from the basic tenets of financial analysis . From this$ the chapter looks at the construction of manufacturing$ trading and profit and loss accounts and the drawing up of a balance sheet.the dual effect and the accounting e3uation.and balance sheet mean. If the )airiboard "ompany of Limbabwe sells milk to a retailer$ it has: • less stock • an amount owed by the customer if he does not pay immediately. . &his is dealt with in considerable detail. The basic principles !ll aspects of accounts are governed by these two principles. if a "erial purchases grain it has: • more stock • less cash.g.
%ra. &his consists of: #a'ital: (amount proprietor invested in the business) pl" Profits* (funds generated by the business) or mi$" :osses: (funds lost by the business) mi$" %ra. !n e(planation of the terms is as followsI • Net a et are defined as a business2s total assets less total liabilities. an obligation to pay money at a future date.e.roprietor2s funds then an i$+rea e i$ $et a et 6 a$ i$+rea e i$ a proprietor5 !"$d & "onsidering what causes an increase in the proprietor2s funds$ we can say that I:"-H!. • 4roprietor5 !"$d represents the total amount which the business owes to its owner or proprietor.roprietor2s funds is the ultimate accounting e3uation. . • ! lia%ility is defined as the amount owed by the business$ i. +et Assets < .ings* (amounts taken out of the business). Hvery transaction has two effectsI these two are e3ual and balance each other. If: +et assets < .ings during the same period. ca'ital introduced < Profit . "se of the accounting e#uation to find profit @e normally arrive at a business2s profit or loss by means of a profit and loss account$ but where information about income and e(penditure is lacking$ the accounting e3uation can be a useful way of finding profit. &hus$ at any given moment the net assets of a business are e3ual to the funds which the owner or proprietor has invested in the business. • !n a et is defined as something owned by a business$ available for use in the business.H&. If three of these four amounts are known$ the fourth can be calculated.b) 5econd 'rinci'le* The accounting e$uation &he second principle stems from the first. (from the beginning of a period to the end) is e3ual to: +e..H I: :H& !.
a fertiliser company uses phosphates$ ammonia and so on to produce finished fertiliser pellets.roduction cost of completed goods carried down to trading account ( (( ((( . &he main or direct costs are those of raw materials and labour which together are known as the prime cost$ although any e(pense which can be traced directly to any unit of production is also a direct cost. &hese costs will include the general factory overheads such as light$ heat and power$ rent$ rates$ insurance$ depreciation of production machinery$ etc. &he only ma+or difference is that$ in the trading account$ the entry for purchases is replaced by the cost of manufacture. b) The effect of stocks 1ne complication in constructing the manufacturing account is to remember that there may be opening and closing stocks of raw materials and opening and closing values to attach to partly completed items (work in progress). &he indirect costs are those associated with production but cannot be traced directly to a particular production unit. "ertain labour costs$ such as supervision by foremen or factory managers$ will also be indirect costs because they are not directly traceable to a production unit but are absorbed as a general overhead. Figure &.g.Manufacturing account &here are many firms$ whether parastatal$ sole trader$ partnership or limited company$ which manufacture the final product to be sold from raw materials$ e. &he cost of manufacture is calculated using a manufacturing account.urchases ( . &he manufacturing organisation will still need a trading and profit and loss account. In this instance$ a manufacturing account is re3uired in order to arrive at the final cost of manufacture. 7+%7% 1>/? 1pening stock of raw materials . &wo important factors need to be taken into account: a) %ifferent ty'es of cost &he costs needed to prepare a manufacturing account can be broken down into two main categories known as direct and indirect costs.1 Pro forma manufacturing account =7A.
# and 5. (see figure 5.) .rod. ((( &hese ad+ustments can be seen in the pro forma manufacturing account which follows.4ess closing stock of raw materials "ost of raw materials consumed )irect manufacturing wages . machinery ( ( ( ( ( ( ( (( (( (( 1pening work in progress ( ((( 4ess closing work in progress ( ((( :ow attempt e(ercise 5.5.rime cost Factory overheads: -ent and rates$ light$ heat and power Indirect wages )epreciation of .#.
7@ercise &.ith an adAustment of . stock of raw materials #$677 8# )ecember #AG. #$877 #$D77 #7$777 #9$777 E77 A$777 5$7D7 E.1 A sim'le manufacturing account &he following are details of production costs of Aroma 4vt Ltd for the year ended 8# )ecember #AG6.7 ED7 #$767 " Manuary #AG. stock of raw materials 5$967 # Manuary #AG.repare a manufacturing account for the year ended 8# )ecember #AG6.7@ercise &. " # Manuary #AG6$ stock of raw materials 8# )ecember #AG6$ stock of raw materials .ork-in-'rogress. work in progress DE7 .urchase of raw materials anufacturing (direct) wages -oyalties Indirect wages -ent of factory (e(cluding administration and selling and distribution departments) Factory rates 0eneral indirect e(penses )epreciation of work machinery .& A manufacturing account .
a) &he first step is to transfer the balance on the sales account to the trading account: %r* 5ales A/c #r* Trading A/c. @ages: direct indirect -aw materials purchased . 0ross profit is the difference between the sale proceeds of goods and what those goods cost the seller to buy$ or cost of sales. the carriage inwards of those goods. Pre'aring a trading account &he trading account is calculated by using a se3uence of steps.8# )ecember #AG. work in progress For the year ended 8# )ecember #AG.$7E7 #6$977 #$757 EE7 #$767 957 8. .ower fuel )irect e(penses "arriage inwards on raw materials )epreciation of factory machinery Insurance of factory buildings 0eneral factory e(penses A.e.7 977 Trading account &he purpose of the trading account is to show the gross profit on the sale of goods. &he cost of sales for this purpose includes the amount which has been debited for them to the purchases account plus the cost of getting them to the place of sale$ which is usually the seller2s premises$ i.7 E$. It is essential that these steps are carried out in the order indicated.67 .
c) &he balance on the purchases account is then transferred to the trading account and added to the opening stock figure: %r* Trading A/c #r* Purchases A/c.b) :e(t$ debit the trading account with the cost of goods sold$ starting with the opening stock: %r* Trading A/c #r* 5tock A/c. !ny item deducted from the debit side of an account is$ in effect$ credited to the account. @e have now arrived at the cost of sales. d) &ransfer any balance on the carriage inwards account to the trading account: %r* Trading A/c #r* #arriage -n.ards A/c. gross profit$ which is carried down to the profit and loss account.e. . . @hen the opening stock is credited to the stock account in the ne(t period$ it will balance off the stock account. e) )educt the value of closing stock from the cost of goods available for sale. !dd the carriage to the total arrived at in c) above. &his gives the total cost of goods available for sale. )educting closing stock from the debit side of the trading account is therefore crediting it to that account. f) &he balance on the trading account will be the difference between sales and cost of sales$ i.oint to :ote: &he debit to stock account for closing stock is the value of the current asset of closing stock which will be included in the balance sheet$ as we shall see later. &he corresponding double entry will therefore be to the debit of stock account: %r* 5tock A/c #r* Trading A/c (by deduction from the debit side). &he opening stock is obviously the same as the closing stock of the previous periodI in the first year of trading$ of course$ there will be no opening stock.
Figure &. In this way$ we show the net sales for the year. . &his must be transferred to the trading account$ otherwise the sales and gross profit in that account will both be overstated. 0oods which have been returned to suppliers must not be included in the cost of sales.reparation of trading account) !ppendi( I shows a sample trading account for the "erial arketing *oard$ Limbabwe. . :et sales are known as turnover.ales returns must be deducted from salesI purchases returns must be deducted from purchasesI carriage inwards$ if any$ must be debited in the account before closing stock is deducted.oint to :ote: &he order of items is most important. . .roduction cost of completed goods b'd (from manufacturing account) "losing stock of finished goods "ost of sales 0ross profit c'd ( . Following the same reasoning that allows us to deduct closing stock on the debit side of the trading account$ we may deduct the debit balance on the sales returns account from the sales credited in the trading account.5 shows a pro forma trading account. Figure 5.ales ( ((( (( (( (( (( ((( 0ross profit ((( *'d N&B& ! trading account is prepared very much like a manufacturing account but substituting the production cost of completed goods for the usual purchasing figure (see e(ercise 5.imilarly$ we show the credit balance on the purchases returns account as a deduction from purchases in the trading account to show the net cost of purchases.& Pro forma trading account 1pening stock of finished goods .+et sales 0turnover( and net 'urchases* 0oods which have been returned by customers are represented by a debit balance on the sales return account.8: .
7@ercise &.tock at 8#'#5'#AGD 6$777 The profit and loss account -ntroduction* &he remaining nominal accounts in the ledger represent non-trading income$ gains and profits of the business in the case of credit balances$ e.uch a statement is generally developed on a monthly$ 3uarterly and yearly basis. &he profit and loss statement enables a marketer to e(amine overall and specific revenues and costs over similar time periods and analyses the organisation2s profitability.ales . " . )ebit balances represent e(penses and losses of the business and are known as overheads$ e. &he profit and loss (income) statement presents a summary of the revenues and costs for an organisation over a specific period of time. &hese must now be transferred to the profit and loss account so that we can calculate the net profit of the business from all its activities. .repare a trading account from the following balances included in the trial balance of 7& Smith at 8# )ecember #AGD.:ow attempt e(ercise 5. salaries and wages$ rent and rates payable$ lighting$ heating$ cleaning and sundry office e(penses.8. onthly and 3uarterly statements enable the firm to monitor progress towards goals and revise performance standards if necessary.#AGD "arriage inwards 8$777 #$777 #E$777 8$777 #r.tock at #.ales returns . " 56$777 5$677 .g.urchases returns . rent$ discount and interest receivable. Pre'aration of trading account . .. %r.g.#.urchases .
&he balance sheet shows that the profit for an accounting period increases proprietor2s funds. • )ross margin (profit) . Figure 5. Figure &.the difference between sales and the cost of goods sold: consists of operating e(penses plus net profits • 'erating e@'enses . Trading9 'rofit and loss a/c for the year ended .the total resources generated by the firm2s products and services • +et sales . For manufacturers the cost of goods sold involves the cost of manufacturing products (raw materials$ labour and overheads).8 shows a pro forma trading and profit and loss account. &he trading and profit and loss account shows$ in detail$ how that profit or loss has arisen.1 %ec 1>/1 " " 5ales 4ess: cost of goods sold stock$ at a cost on # Manuary (2opening stock2) !dd: purchases of goods 4ess: stock$ at a cost on 8# )ec (2closing stock2) ( ( (() ( 0ross profit ( " (( . &he profit and loss statement consists of these ma+or components:• )ross sales .the revenues received by the firm after subtracting returns and discounts (such as trade$ 3uantity$ cash) • #ost of goods sold .the profit earned after all costs have been deducted.the costs of running a business$ including marketing • +et 'rofit before ta@es . For retailers$ the cost of goods sold involves the cost of merchandise purchased for resale (purchase price plus freight charges).the cost of merchandise sold by the manufacturer or retailer.@hen e(amining a profit and loss statement$ it is important to recognise one difference between manufacturers and retailers..
ostage Insurance .tationery 1ffice salaries )epreciation !ccounting and audit fees *ank charges and interest )oubtful debts ( ( ( ( ( ( ( ( ( ( ( ( .5undry income* )iscounts received "ommission received -ent received ( ( ( ( (( :ess* administration e@'enses -ent -ates 4ighting and heating &elephone .
&he following provides an e(planation. ! retailer$ for e(ample$ will purchase various items from various suppliers$ and add a profit margin.%istribution costs* )elivery costs Fan running e(penses !dvertising )iscount allowed ( ( ( ( ( ( (() :H& . • In a complicated manufacturing industry and in service industries$ different definitions of "goods"$ "net profit" and "cost of sales" may e(ist. "ost of goods sold is calculated by: 'ening 5tock < 'ening Purchases (for year or period) . &his will give him the selling price of the goods and this$ minus the cost of goods sold$ will be the gross profit.ales and cost of goods sold should relate to the same number of units. • &he trading account shows the gross profit generated by the business. ((( .-1FI& 7@'lanations It is essential that the difference between a trading and profit and loss account is clearly understood.#losing 5tock (cost of goods unsold at the end of the same period). &his gives the cost of goods which were sold. • &he profit and loss account shows items of income or e(penditure which although earned or e(pended by the business are incidental to it and not part of the actual manufacturing$ buying or selling of goods. . &his is done by comparing sales to the costs which generated those sales.
cash . &he following is a summary of the transactions for the first year: " "apital introduced on # !ugust #AGE .#a'ital and revenue e@'enditure 1nly revenue e(penditure (e.g... &he amount of revenue e(penditure charged against the profits for the year or period is the amount incurred whether cash has or has not been paid. the purchase of a new plant) is not. "apital e(penditure is not charged to the profit and loss account as the benefits are spread over a considerable period of time. heating bills) is charged to the profit and loss accountI capital e(penditure (e. repairs)I It is well to note that "cash" need not be paid or received to be accounted for. Hven if cash for sales has not been received in the year or period under review$ sales will be included in the trading account. :ow attempt e(ercise 5. a) -evenue e(penditure is e(pended on: • ac3uiring assets for conversion into cash (resale goods) • manufacturing$ selling and distribution of goods and day-to-day administration of the business • maintenance of fi(ed assets (e. 7@ercise &.3 Trading and 'rofit and loss account Ni3el )"$yati and his friends opened a small scale horticultural "co-operative" in "oncession$ growing and retailing. b) "apital e(penditure is e(pended on: • start up of the business • ac3uisition of fi(ed assets (not for resale) • alterations or improvements of assets to improve their revenue earning capacity.g.stocks 57$777 #5$777 . &his is the "accruals" concept.g. &his applies with sales as well. &he business started on # !ugust #AGE.
tock of goods at the end of the year -ent -ates @ater and light .e. @hen comparing business performance$ therefore$ a number of years and time periods may be more suitable.$777 Nou are re3uired to prepare a trading and profit and loss account for the year ended 8# Muly #AG9.alesmen2s commissions$ not yet paid *ank charges 1ffice wages &elephone and postal charges !dvertising )rawings during the year ##$777 5$677 D77 677 .$777 E77 #57 . It is$ therefore$ only a "snapshot" in time."ash paid to suppliers !mounts owed to suppliers at 8 Muly #AG9 -eceived from customers in respect of sales 5D$777 #. the accounting e3uation.77 #67 #$777 . The balance sheet -ntroduction* &he balance sheet is a statement of the financial position of a business at a given date. .alesmen2s salaries . &he balance sheet is the accounting e3uation but set out in a vertical form in order to be more readily$ understood i.$777 67$777 !mounts owed by customers at 8# Muly #AG9 #7$777 .
. Figure &.%ra. shows a pro forma balance sheet.ings e(pressed in the form of a balance sheet is as follows:- " !ssets Le 2 liabilities :et assets -epresenting: "apital G G G G . Figure 5.:iabilities B #a'ital < Profit .roprietor2s funds G &his is a simplified formI in reality the assets and liabilities will be further sub-divided and analysed to give more detailed information.rofit for the year G G Le 2 drawings G .Assets .3 Pro forma balance sheet *alance sheet at 8# )ecember #AG7 # % +et value #ost %e'reciation 0#-%( " !) Fi(ed assets " " .
Freehold factory achinery otor vehicles ( ( ( ( ( ( ( ( ( ( ( ( *) "urrent assets .tocks and work in progress )ebtors and prepayments "ash at bank "ash in hand ( ( ( ( ( ") "urrent liabilities &rade creditors !ccrued charges (() (() (() ( )) :et current assets H) #6J loan (( (() ((( F) -epresenting: .
e."apital at # Manuary . • Fi@ed assets *epre+iatio$ is an amount charged in the accounts to write off the cost of an asset over its useful life. H) :oans* funds provided for the business on a medium to long term basis by an individual or organisation other than the proprietor. the e(tent of his investment in the business. ") #urrent liabilities* amounts owed by the business$ payable within one year. @ithin these main headings the following items should be noted. 0) &his total is the total of proprietor2s funds$ i. F) &his total is the total of the business2s net assets. )) +et current assets* funds of the business available for day-to-day transactions. &hey are normally valued at cost less accumulated depreciation.roprietor2s fund 7@'lanations (() ((( !s with trading and profit and loss accounts$ the balance sheet has its own nomenclature.rofit for the year ( ( ( 4ess: drawings 0) . . &his can also be called working capital. &hese are fi(ed accounts$ current accounts$ current liabilities and funds: !) Fi@ed assets: assets ac3uired for use within the business with a view to earning profits$ but not for resale. • #urrent assets *e%tor are people who owe amounts to the business. *) #urrent assets: assets ac3uired for conversion into cash in the ordinary course of businessI they should not be valued at a figure greater than their net realisable value.
D77 @orking capital 6$D77 @orking capital is important because it is the fund of ready resources that a business has in e(cess of the amount re3uired to pay its current liabilities as they fall due. :ote: -or.i$3 +apital& Thi i a term 3ive$ to $et +"rre$t a et ( or total +"rre$t a et le total +"rre$t lia%ilitie ( e&3& " "urrent assets 9$E77 4ess current liabilities #.cash 57$777 .4repayme$t are items paid before the balance sheet date but relating to a subse3uent period.4 Balance sheet . @orking capital is importantI lack of it leads to business failure.6. :ow attempt e(ercise 5.repare a balance sheet for year ended 8# Muly #AG9 for Ni3el )"$yati5 horticultural cooperative. !ppendi( i shows a sample balance sheet and a full set of accounts for the "erial arketing *oard of Limbabwe. A++r"ed +har3e are amounts owed by the business$ but not yet paid$ for other e(penses at the date of the balance sheet. • #urrent liabilities Trade +reditor are those suppliers to whom the business owes money. " "apital introduced on # !ugust #AGE . 7@ercise &.
In an agricultural business$ these may be fertilisers$ chemicals$ produce$ etc.$777 E77 #57 ..alesmen2s commissions$ not yet paid *ank charges 1ffice wages &elephone and postal charges !dvertising )rawings during the year ##$777 5$677 D77 677 .tock of goods at the end of the year -ent -ates @ater and lights .$777 67$777 !mounts owed by customers at 8# Muly #AG9 #7$777 .stocks "ash paid to supplier !mounts owed to suppliers at 8# Muly #AG9 -eceived from customers in respect of sales #5$777 5D$777 #.77 #67 #$777 .alesmen2s salaries . !ccounting for stocks presents a problem$ because stocks in hand at the end of the financial year are regarded as current assets$ whereas stocks used during the year form part of the .$777 !tocks and work$in$progress Accounting for stocks* !lmost every company carries stocks of some sort.
77 (#7 February) C577 O C5.67 #$867 " #$7D7 . &his method is often used to calculate the cost of low value items$ e.g.g.7 units: F-F trading account " . i) Average cost "ost is calculated by taking the average price computed by dividing the total costs of production by the total number of units produced. "onsider the following e(ample comparing the effect of valuing stock of 5.urchases C8E7 O C8.company2s costs. a 2bin2 system$ where purchases are added to the top and sales will be removed from the top.g. &hree common alternatives are average cost$ first in first out (Fifo) and last in first out (4ifo).77 (7# February) C577 O C5. a greengrocer will obviously wish to sell the oldest stocks first. &here are many methods of establishing the value of stocks. Bence$ stocks (assets) appear in the balance sheet$ and stocks (used) must be accounted for in the trading and profit and loss account. iii) :ast in first out 0:ifo( &he calculation of the cost of stocks and work-in-progress is on the basis that the stocks in hand represent the earliest purchases or production$ as it is assumed that the latest stocks into store are the first to be taken out$ e.56 (#6 February) C577 O C5. in the manufacture of nails.ales ( arch) . &his average price may be derived by means of a continuous update$ a periodic calculation$ or a moving period calculation. ii) First in first out 0Fifo( &he calculation of the cost of stocks and work-in-progress is on the basis that the stocks in hand at the year end represent the latest purchases or production$ as the items going into stock at the earliest date are assumed to leave first$ e. Caluation of stocks* Faluing closing stocks has always been a problem and a source of disagreement.
If net realisable value is higher than cost$ then cost is taken$ as valuing stocks at a higher value would not be prudent$ i.77 (bought #7 Feb) . The lo.56 #$867 " #$7D7 DE7 557 Note2 In both cases$ there are 5.56 (#6 February) C577 O C5.er of cost and net realisable value* &he most fundamental accounting concept with regards to the valuation of stocks and work-in-progress is that they need to be stated at cost$ or if lower$ at net realisable value.ales ( arch) .A7 C . .77 (bought #7 Feb) 6A7 C .4ess: "losing stock (bought #6 Feb) C577 O C5. :et realisable value is the amount at which it is e(pected that items of stock and work-in-progress could be sold after allowing for the costs of completion and disposal. It is important to check against the net realisable value to ensure that the current asset$ stock$ is not stated at a figure above that for which it could be realised at the balance sheet date.7 O C5.7 O C5.7 items in stock.56 9E7 857 :-F trading account " .e.urchases C8E7 O C8. profit would have been taken into account before it is actually earned.77 (7# February) C577 O C5. Faluing stocks using the latest prices$ the gross profit is C857$ whereas using the earliest prices the figure is C557.77 (#7 February) C577 O C5.67 4ess: "losing stock (bought #6 Feb) C577 O C5.
urchases of peanuts were made as follows: Price 'er ton 1>/6 Tons " 7# Muly #6 !ugust E7 .6 Caluation of stocks 7"%i *'ili began business as a small scale peanut importer in Muly #AGE.5tock 'rovision* If it is decided to reduce the value of certain items of stock from cost to net realisable value$ e.D87 87 .77 AE7 5E.eptember . 7@ercise &.g. Nou are re3uired to calculate the value of closing stock and to prepare the trading account on the following bases: a) first in first out b) last in first out c) average cost. &he full amount is deducted from stock in the balance sheet$ but only the decrease between the beginning and end of a period is shown in that period2s trading and profit and loss account.677 E..77 #.77 #$577 5.77 A67 67. obsolete$ slow moving or unsaleable stocks$ this is done by means of a provision.tock is reduced in value$ and a charge is made against profits. &he total proceeds of the sale were CD$677. :ow attempt e(ercise 5.77 #$767 8D. .7 " 57.77 #$#97 86. . .6 #5 1ctober 87 5A :ovember 56 ## )ecember 87 587 1n #7 1ctober$ #77 tons of peanuts were sold and on 8# )ecember 97 tons were sold.E.
. ! "one off" ratio is often useless . • -atios by themselves provide no informationI they simply indicate by e(ceptions where further study may improve company performance. &herefore$ "profit ma(imisation" entails the most efficient allocation of resources by management$ and "profitability ratios" when compared to others in the industry will indicate how well management has performed this task. a) Profitability In most organisations profits are limited by the cost of production and by the marketability of the product. Dhich areas are used for analysis Four key areas are generally used for analysis: • profitability • li3uidity • leverage (capital structure) • activity or management effectiveness (efficiency). 1ften the same ratios of like firms are used to compare the performance of one firm with another. 7ey 8"e tio$ to %e ide$ti!ied i$ pro!ita%ility a$aly i i$+l"de2 • )oes the company make a profitP • Is the profit reasonable in relation to the capital employed in the businessP • !re the profits ade3uate to meet the returns re3uired by the providers of capital$ for the maintenance of the business and to provide for growthP • Bow are sales and trading profit split among the ma+or activitiesP .The interpretation of company accounts$ratio analysis Dhy ratios* -atios are the means of presenting information$ in the form of a ratio or percentage$ which enables a comparison to be made between one significant figure and another. . anagement can compare current performance with previous periods and competing companies. • Financial ratio analysis is helpful in assessing an organisation2s internal strengths and weaknesses.trends need to be established by company ratios over a number of years. • &he great volume of statistics made available in the annual accounts of companies must be simplified in some way.otential suppliers will$ for e(ample$ want to +udge credit worthiness.resent and potential investors can therefore 3uickly assess whether the company is a good investment or not.
7ey 8"e tio$ to %e ide$ti!ied i$ li8"idity a$aly i i$+l"de2 • Bas the business sufficient li3uid resources to meet immediate demands from creditorsP .hould any of these items be regarded as part of the ordinary business of the companyP • )o any items tend to recur year after yearP • Is it clear which items have been transferred directly to reserves without going through the profit and loss accountP • Is such treatment appropriate in each caseP b) :i$uidity "4i3uidity measures" are based on the notion that a business cannot operate if it is unable to pay its bills. 1n the other hand$ because most short term assets do not produce any return$ a strong li3uidity position will be damaging to profits. &herefore$ management must try to keep the firm2s li3uidity as low as possible whilst ensuring that short term obligations will be met. ! sufficient amount of cash and other short-term assets must be available when needed. &his means that industries with stable and predictable conditions will generally re3uire smaller current ratios than will more volatile industries.• &o what e(tent are changes due to price changeP • &o what e(tent does volume changeP • )oes inter-company transfer pricing policy distort the analysisP • Bas the appropriate proportion of profit been taken in ta( chargedP • @hat deferred ta(ation policy is being followedP • Bas the share of profit (or loss) attributable to minority interests in subsidiaries changedP If so$ is it clear whyP • !re profits and losses on sales of fi(ed assets: -treated as ad+ustments of depreciation chargesP -disclosed separately "above the line" in the profit and loss accountP -treated as "below the line" items in the profit and loss accountP -transferred directly to reservesP • @hat has been included in H(traordinary ItemsP • .
7ey 8"e tio$ to %e ide$ti!ied i$ levera3e a$aly i i$+l"de2 • @hat sort of capital has the company issuedP • @ho owns the capitalP • @hat is the cost of capital in terms of interest or dividendP • @hat proportions of the capital have a financed return (gearing or leverage)P • Is the mi( of capital optimum for the companyP • Is further capital available if re3uiredP • Is total capital employed analysed among different classes of businessP • If so$ can return on capital be calculated for each classP • Bas issued 1rdinary share capital increased during the periodP • If so$ whyP e.hould it beP .g. &hus$ the leverage of an organisation has to be considered with respect both to its profitability and the volatility of the industry. -ights issueP *onus (scrip) issueP !c3uisitionP • !re "per share" figures calculated using appropriately weighted number of sharesP • !re prior years2 figures comparableP • @hat individual items have caused significant movements on -eservesP • )o any of them really belong in the profit and loss accountP • Is any long term debt convertible into ordinary sharesP • 1n what termsP • "alculate appropriate measures on "fully diluted • basis • Is any long term debt repayable within a short periodP • If so$ should it be treated as a current liabilityP • !re there significant borrowings in foreign currenciesP • !re they matched by foreign assetsP • Bow are e(change losses and gains thereon treatedP • Is there any preference capitalP • Is short term borrowing included in capital employedP . creditors payable within one yearP • Bas the business sufficient resources to meet the demands of its fi(ed asset replacement programme and its commitments to providers of long-term capital falling due for repayment in say$ the ne(t five yearsP c) :everage "4everage ratios" show how a company2s operations are financed. &oo much e3uity in a firm often means the management is not taking advantage of the leverage available with long-term debt.e. 1n the other hand$ outside financing will become more e(pensive as the debt-to-e3uity ratio increases.• Bas the business sufficient resources to meet the re3uirements of creditors due for payment in the ne(t #5 months i.
i) Lo$3-term tre$d i$ the %" i$e • !re profits increasing or decreasingP .• Is the treatment of pensions appropriateP Is information revealedP • @ould capitalising leases significantly affect long term debt and gearing ratiosP d) Activity "!ctivity ratios" are used to measure the productivity and efficiency of a firm.imilarly$ the inventory turnover ratio will indicate whether the company used too much inventory in generating sales and whether the company may be carrying obsolete inventory. 7ey 8"e tio$ to %e ide$ti!ied i$ a+tivity a$aly i are2 • )oes management control the costs of the business wellP • @hich costs$ if any$ have changed significantly$ thus reducing or improving apparent profitabilityP • )oes management control the investment in assets wellP • !re fi(ed assets sufficient for the current level of activityP !re they replaced on a regular basis and ade3uately maintainedP • !re the stock levels ade3uate for the level of activity$ or e(cessiveP • !re debts collected promptlyP • !re creditors paid within a reasonable period of timeP • !re surplus cash resources invested to increase overall returnsP • Bow variable are the profits before interest and ta(P • Bow many times can the interest be paid from the available profitP • Bow many times can the e(isting dividend be paid from the available profitP e) ther 1ther 3uestions can be asked in interpreting final accounts.g. @hen compared to the industry average$ the fi(ed-asset turnover ratio$ for e(ample$ will show how well the company is using its productive capacity. &hese may relate to long-term trends in the business or to fi(ed assets$ e. .
hown as an assetP -@ritten off against reservesP -*eing amortised by charges against profitP • Bow does the book value of goodwill compare with the estimated surplus of the current value of fi(ed assets over their net book valueP • Bas the status of any investments changed during the periodP .ubsidiariesP !ssociated companiesP &rade investmentsP :on-consolidated subsidiariesP • !re investments in associated companies shown by the "cost" method or by the "e3uity" methodP .• Is the si%e of the business growing faster or slower than inflationP • Bow has past growth been financedP • !re the levels of stocks$ debtors and creditors consistent with the long-term growth of the businessP • !re dividends increasingP • Bave any radical changes occurred in the past$ giving rise to ma+or changes in the businessP ii) 9i#ed a et • @here fi(ed assets are shown "at historical cost": -Bow old are theyP @hat is their estimated current valueP -Bow would revaluation affect the depreciation chargeP • @here fi(ed assets are shown "at valuation": -@hen was the valuation made$ and on what basisP -Bow have values changed since that dateP .ight the assets be more valuable if used for other purposesP • @hat method of depreciation is used for valuationP • @hat asset lives are usedP !re different lives used for "urrent "ost !ccountingP • Bas ade3uate provision been made for technological obsolescenceP • !re any assets leasedP @hat is their valueP • Bow much are the annual rentalsP Bow long is the commitmentP • Is goodwill: -.
Figure &.4 Frame. Figure 5. &hese time series can also be used to pro+ect the future financial performance of the company.6 shows an e(ample of how a time series analysis can be used to back financial and business ob+ectives.trategies (.I . c) Absolute standards ost organisations have some minimum re3uirements for corporate performance regulations of the particular industry$ e.rofit Impact of arketing .g. &he danger is that when industry averages include companies with different products or markets$ averages can be misleading. the long-term debt-to-e3uity ratio should not e(ceed one.ork for linking financial business obAectives The main types of ratio 1( Profitability a) 0ross profit margin or profit margin on sales: or . a) -ndustry com'arisons )ata are used$ such as that provided by commercial firms like )un and *radstreet and . ! thorough financial analysis usually is a condition of these three approaches. b) Time series analysis -atios for several periods are used to determine whether significant changes have occurred.)$ are used for comparing the company with others of about the same si%e$ that serve the same market and have similar products.• @hat is the difference between cost and market value of 3uoted investmentsP Is market value used if it is lower than costP • !re there any long-term debtorsP Bow have they been treated in the balance sheetP Methods used to evaluate organisational 'erformance &o evaluate the performance of a company with respect to these ratios$ three methods are used$ namely industry comparisons$ time series analysis and absolute standards.
e. :et asset turnover G profit margin < return on assets &( :i$uidity a) "urrent ratio b) =uick (li3uidity or acid test ratio): c) )efensive interval ratio: d) Inventory to net working capital: .b) :et profit margin: c) -eturn on assets: d) -eturn on e3uity :ote that: :!F < :et asset value i.
interest cover d) Interest coverage: e) "umulative interest coverage: 3( Activity 0efficiency ratios( a) )ebtors turnover: b) "reditors turnover: c) Inventory turnover: ..8(i) :everage 0coverage ratios or gearing( .debt cover a) "onventional leverage: b) urphy .russman 0earing: c) /. measure of leverage: (ii) :everage ..
rofits per employee: Other useful ratios 1( 5tock market ratios a) Harnings per share: b) .rice earnings ratio: c) )ividend yield (net): d) )ividend cover: .d) @ages turnover: e) :et asset turnover: f) .
&his$ however$ understates the true cost of capital employed$ because the interest is a charge for only the debt portion of capital. c) "ash flow ("F) .) -1.trategic *usiness /nits (.*/ manager2s ability to use assets efficiently$ account should be taken of whether cash is centrally controlled or head3uarters determines both credit and payment policies.total liabilities In using any of these measures to assess an .*/2s)$ then the following measures can be computed$ provided that balance sheet and income statement data are available at the divisional or . b) -eturn on investment (-1I)$ return on net assets (-1:!) and return on e3uity (-1H) Note2 NET ASSETS < TOTAL ASSETS.ome argue that interest e(penses and ta( should not be considered as they are outside the .*/ manager2s control.%inancial measures of business unit performance If an organisation is made up of multiple divisions or .TOTAL LIABILITIES Note2 1wner2s e3uity < total assets . is computed by dividing net income (:I)$ or profit (.*/ level.*/2s and'or their management. &hese analyses enable corporate management to assess the performance of divisions$ .) before or after interest and ta(es$ by total revenue: . Bowever$ interest may be added to show managers that invested funds are not a free resource. a) -eturn on sales (-1. If the latter$ then cash receivables or payables or both should be omitted from the investment base.
"ash flow is not the same as net income (:I) or profit (. #F < :et Income (or .g. &he changes in (∆) are calculated by the company2s balance sheet entries for two consecutive periods. It differs in two ways: i) "ash flow includes depreciation$ as this is a bookkeeping transaction$ and ta($ because ta( is a cash cost.g. increase in accounts receivable or additions to fi(ed assets (F!)$ e. &hus$ #F B :I (or .tock pl" or mi$" ∆ !ccounts receivable pl" or mi$" ∆ !ccounts payable (and other short-term liabilities) H(ample: Balance sheet 1>/4/6 1>/6/? "01112s( "01112s( .) after ta( and depreciation ii) "ash flow is affected by balance sheet changes$ e.rofit) after ta( pl" )epreciation mi$" changes in F! and mi$" changes in @" Note2 If no ta( is paid or if ta( is deferred$ use :et Income (or . @orking "apital < ∆ "ash pl" or mi$" ∆ .rofit) before ta(.77 8D7 .rofit 4l" )epreciation "ash flow from operations Le #57 657 #56 676 .). plant and e3uipment and changes in working capital (@").
57) (#76) (57) :et cash generated or (/sed) 67 d) . -eal .*/ which includes a +ustified assignment of the proportion of the total corporate short-run liabilities and long-run debt.0-$ then the organisation can consider a number of strategic actions which affect the "productivity" side of the 3uest for increased profits ("productivity" as opposed to "volume" strategies to increase profits). ii) @orking capital increase solely due to inflation re3uires financing. &hese are: i) reduce investment intensity (cut stocks and'or receivables) ii) reduce dividends . @hat is re3uired is a balance sheet for the .is reduced by 5. 1nce accomplished$ the ma(imum sustainable growth rate (a measure of the ability of the business to fund the new assets needed to support increased sales) is estimated by: where: p 6 profit margin after ta(es d < dividend payout ratio (for a business unit this is computed from the corporate overhead charge plus any dividend paid to corporateP) L 6 debt to e3uity ratio t 6 ratio of assets (physical plant and e3uipment plus working capital) to sales. If the actual growth rate e(ceeds .5J for every 6J of inflation for two reasons: i) )epreciation charges based on historical costs overstate ta(able income because they fail to fully recover the economic value of depreciating assets. &he growth rate is e(pressed in nominal terms.0.0-) &his is a measure of the ability of the business to grow within the constraints of its current financial policies.Increase in @orking capital Increase in Fi(ed !ssets (8D7) (A7) (.ustainable growth rate (.
7 - . he introduced fresh capital into the business): Profit and :oss account for the year to .7 896 4essI "losing stock 0ross profit 4ess: H(penses 4oan interest :et . 7@ercise &. .#6 E.atio analysis Ni3el )"$yati5 horticultural business continued to flourish.ales (all on credit) 4ess: "ost of goods sold: 1pening stock .iii) obtain in+ections of "e3uity" from the corporate body iv) increase debt.7 6E6 E76 E6 D76 D97 .7 #76 E7 67 #7 97 66 E7 #87 #7# .7 .7 886 E6 6.1 March 1>/1 1>/1 "01112s( 1>/& .i( years later his condensed financial accounts for the last three years are summarised below (:.6 DD6 .? .*.7 ##6 966 D7 67 . :ow attempt e(ercise 5.9.urchases 86 8.rofit Balance 5heet as at .1 March 1>/1 1>/1 0" 1112s( Fi(ed assets DA A8 1>/& .
E 5."urrent assets .EE #5 #7. a) gross profit on sales b) gross profit on cost of goods sold c) stock turnover d) return on capital employed e) current ratio f) li3uidity (or 3uick) ratio g) debtor collection period h) working capital .7 #77 66 #57 E7 #. E #A8 Financed by: "apital Add& :et profit for the year 4ess: )rawings (all on 8# 4oan "urrent liabilities "reditors *ank overdraft 99 #85 99 #9. #9D #85 #7 #DD 595 .7 65 E6 #7D ##6 567 #9A 595 8E6 .tocks &rade debtors "ash at *ank .EE arch) .7 #ED ##7 "ompute the following ratios for #AG7$ #AG# and #AG5. #E 86 57 8D 55 ##E #.
rofit . Key terms !ctivity ratio !verage cost *alance sheet "apital e(penditure "ost of goods sold "redit balances "urrent liabilities )ebit balances )irect and indirect costs )ual effect First-In-first-out Fi(ed and current assets 0ross margin 0ross sales 4ast-in-first-out 4everage 4i3uidity ratios 4oans anufacturing account :et profit :et sales :et sales and net purchases 1pening and closing stock 1verheads .i) ratio of current assets to total assets +) ratio of cash to current liabilities "omment briefly on the results of the business over the last three years.rofit and loss account -atio analysis -evenue e(penditure &rading account &he accounting e3uation @orking capital @ork-in-progress .rofitability ratios .
tructure of the chapter !im of a cash flow statement . .g. .#ash flo.hareholders might believe that if a company makes a profit after ta( of say C#77$777$ then this is the amount which it could afford to pay as a dividend. .tatements of source and application of funds Funds use and credit planning Key terms It can be argued that 2profit2 does not always give a useful or meaningful picture of a company2s operations. -eaders of a company2s financial statements might even be misled by a reported profit figure.#ha'ter . accounting "hapter ob+ectives . Chapter ob ectives &his chapter is intended to provide an e(planation of: • &he aim$ use and construction of cash flow statements • &he meaning and calculation of the source and application of funds statement and their importance to business • ! discussion on credit and types of loans available to businesses • !n e(planation of the cost of funds and capital • &he importance and calculation of ownership costs$ including depreciation$ interest$ repair$ ta(es and insurance.uch payments might include 2profit and loss2 items such as material purchases$ wages$ interest and ta(ation etc$ but also capital payments for new fi(ed assets and the repayment of loan capital when this falls due (e. on the redemption of debentures). . /nless the company has sufficient cash available to stay in business and also to pay a dividend$ the shareholders2 e(pectations would be wrong.urvival of a business depends not only on profits but perhaps more on its ability to pay its debts when they fall due. .
1 Pro forma cash flo.# shows a pro forma cash flow statement. It can be positive$ or negative$ which is obviously a most undesirable situation.. &he chapter develops the concept of cash flow and then shows how the funds can be used in the business. Figure . statement Figure 8. -ndirect method cash flo.!tructure of the chapter ""ash flow" is one of the most vital elements in the survival of a business.1 %ecember 1>/3 " Net +a h i$!lo' !rom operati$3 a+tivitie Ret"r$ o$ i$ve tme$t a$d ervi+i$3 o! !i$a$+e Interest received Interest paid )ividends paid Net +a h i$!lo': (o"t!lo') !rom ret"r$ o$ i$ve tme$t a$d ervi+i$3 o! !i$a$+e G (G) (G) G G " . 5tatement For The =ear 7nded . Aim of a cash flow statement &he aim of a cash flow statement should be to assist users: • to assess the company2s ability to generate positive cash flows in the future • to assess its ability to meet its obligations to service loans$ pay dividends etc • to assess the reasons for differences between reported and related cash flows • to assess the effect on its finances of ma+or transactions in the year. &he statement therefore shows changes in cash and cash e3uivalents rather than working capital. statement #ash Flo. Funds are not only generated internallyI they may be e(ternally generated$ and so the chapter finishes with a discussion of e(ternally generated funds.
B F41@ .Ta#atio$ "orporation ta( paid Ta# paid I$ve ti$3 a+tivitie . 1: &BH "!.ayments to ac3uire tangible fi(ed assets -eceipts from sales of tangible fi(ed assets Net +a h i$!lo': (o"t!lo') !rom i$ve ti$3 a+tivitie Net +a h i$!lo' %e!ore !i$a$+i$3 9i$a$+i$3 Issue of ordinary capital -epurchase of debenture loan H(penses paid in connection with share issues Net +a h i$!lo': (o"t!lo') !rom !i$a$+i$3 I$+rea e: (*e+rea e) i$ +a h a$d +a h e8"ivale$t :1&H.&!&H H:& #.ayments to ac3uire intangible fi(ed assets . Re+o$+iliatio$ o! operati$3 pro!it to $et +a h i$!lo' !rom operati$3 a+tivitie G (G) (G) G or (G) G (G) (G) G G or (G) G (G) (G) " 1perating profit G .
A$aly i o! +ha$3e i$ !i$a$+e d"ri$3 the year . A$aly i o! +ha$3e i$ +a h a$d +a h e8"ivale$t d"ri$3 the year *alance at # Manuary #AG. G 8.)epreciation charges 4oss on sale of tangible fi(ed assets Increase'(decrease) in stocks Increase'(decrease) in debtors Increase'(decrease) in creditors :et cash inflow from operating activities (G) (G) G G G . 5. #hange in year " "ash at bank and in hand G . :et cash inflow G G *alance at 8# )ecember #AG. A$aly i o! the %ala$+e o! +a h a$d +a h e8"ivale$t a ho'$ i$ the %ala$+e heet 1>/3 1>/..hort term investments *ank overdrafts G (G) G G G (G) G " (G) G (G) G " .
rincipal revenue-producing activities of the company and other activities that are not investing or financing activities. b) "ash e3uivalents: . "ash inflow'(outflow) from financing G G %ebenture loan " G (G) (G) . "ash inflows from these sources includes: i) interest received$ also any related ta( recovered$ and ii) dividends received. G G Note2 !ny transactions which do not result in a cash flow should not be reported in the statement.5hare ca'ital " *alance at # Manuary #AG. &he reconciliation between the operating profit reported in the profit and loss account and the net cash flow from operating activities must show the movements in stocks$ debtors and creditors related to operating activities. d) -eturns on investments and servicing of finance.rofit on repurchase of debenture loan for less than its book value *alance at 8# )ecember #AG. c) 1perating activities: .hort term$ highly li3uid investments that are readily convertible to known amounts of cash and which are sub+ect to an insignificant risk of changes in value. "ash need not be physical moneyI it can take other forms: a) "ash in hand and deposits repayable on demand with any bank or financial institution. ovements within cash or cash e3uivalents should not be reported. 7@'lanations It is often difficult to conceptualise +ust what is "cash" and what are "cash e3uivalents". "ash outflows from these sources includes: i) interest paid ii) dividends paid iii) interest element of finance lease payments. .
#.e) &a(ation: &hese cash flows will be those to and from the ta( authorities in relation to the company2s revenue and capital profits$ i. :ow attempt e(ercise 8..e. "ash receipts include: i) receipts from sales or disposals of fi(ed assets (or current asset investments) ii) receipts from sales of investments in subsidiary undertakings net of any cash or cash e3uivalents transferred as part of the sale iii) receipts from sales of investments in other entities iv) receipts from repayment or sales of loans made to other entities. g) Financing: activities that result in changes in the si%e and composition of the e3uity capital and borrowings of the enterprise.1 #ash flo. Financing cash outflows include: i) repayments of amounts borrowed ii) the capital element of finance lease rental payments iii) payments to re-ac3uire or redeem the entity2s shares. corporation ta(. 7@ercise . f) Investing activities: the ac3uisition and disposal of long term assets and other investments not included in cash e3uivalents. statement . "ash payments includeI i) payments to ac3uire fi(ed assets ii) payments to ac3uire investments in subsidiary net of balances of cash and cash e3uivalents ac3uired iii) payments to ac3uire investments in other entities iv) loans made and payments to ac3uire debt of other entities. Financing cash inflows include: i) receipts from issuing shares or other e3uity instruments ii) receipts from issuing debentures$ loans$ notes and bonds and so on.
rofit after ta(ation )ividends . 1>/4 F"2111 57$E.77 (6$577) #6$577 (#77) (5$777) (E$777) 9$#77 58$A77 #7$967 .lant$ machinery and e3uipment at cost 4ess: accumulated depreciation #9$E77 A$677 (#77) #$777) (8$777) 5$577 A$.7 (5D7) . F-T A+% : 55 A## !+T5 F .5 T 1>/3 F"2111 1perating profit Interest paid Interest received .77 #77 A$677 (8$577) E$877 ..1 %7#7MB7.7 57$.rofit before ta(ation &a(ation . and #AG6.et out below are the accounts for T47 4vt Ltd as at 8# )ecember #AG. P. TE7 =7A. Fi(ed !ssets .reference (paid) 1rdinary: interim (paid) final (proposed) -etained profit for the year BA:A+#7 5E77T5 A5 AT .1 %7#7MB7.
5$#77 #E$577 #7$777 #$777 6$577 E$777 8D$.repayments "ash at bank and in hand 6$777 D$E77 877 E77 #.tocks &rade debtors .77 .77 #E$D67 6$777 #$777 #7$#77 .$677 "urrent liabilities *ank overdraft &rade creditors !ccruals &a(ation )ividends E$777 D77 8$577 8$577 8$777 A$E77 .hare capital 1rdinary shares of C# each #7J preference shares of C# each .D$#77 "urrent !ssets .rofit and loss account 6$777 #$777 8$777 #8$#67 #6$777 5E$977 .
. . For this reason$ it is necessary to e(amine funds flow statements.repare a cash flow statement for the year to 8# )ecember #AG6. 5ources of funds that increase cash .tep (a) involves comparing two relevant *alance sheets side by side and then computing the changes in the various accounts.ome businesses or industries will continue to find fund flow statements useful and informative.ources of funds which increase cash are as follows: • a net decrease in any asset other than cash or fi(ed assets • a gross decrease in fi(ed assets • a net increase in any liability • proceeds from the sale of preferred or common stock • funds provided by operations (which usually are not e(pressed directly in the income statement).A$777 4oans #6J debenture stock E77 A$E77 . Funds statement on a cash basis Funds statements on a cash basis can be prepared by classifying and'or consolidating: a) net balance sheet changes that occur between two points in time into changes that increase cash and changes that decrease cash b) from the Income statement and the surplus (profit and loss) statement$ the factors that increase cash and the factors that decrease cash and c) this information in a sources and uses of funds statement form. . #E$#77 967 #E$D67 !tatements of source and application of funds !lthough cash flow statements have now superseded statements of source and application of funds$ funds flow statements may not disappear entirely.
!pplication of funds of a company usually include: • a $et i$+rea e in any asset other than cash or fi(ed assets • a 3ro i$+rea e in fi(ed assets • a $et de+rea e in any liability • a retirement or purchase of stock and • the payment of cash dividends. In other words$ suppose we have: :et income after ta(es of a company$ being < C967$777 and depreciation (non-cash e(pense)$ being < C#77$677 D67$677 &hen$ the funds provided by operations of such a company will be obtained by adding the values of the two above items$ i.8 7@ercise . *ut then$ depreciation is not a source of funds$ since funds are generated only from operations. .5 and 8. If the residual is positive$ it represents a use of fundsI if it is negative$ it represents a source of funds.& 5ource and a''lication of funds 0iven below are some different sources and applications of funds finance items purposely scattered for an !gribusiness "ompany K for the year ended 8# )ecember #AGD.in this case by C#77$677.&o determine funds provided by operations$ we have to add back depreciation to net income after ta(es. CD67$677. 1nce all sources and applications of funds are computed$ they may be arranged in statement form so that we can analyse them better. &hus$ the net income of a company usually understates the value of funds provided by operations by the value of the depreciation .e. &o avoid double counting$ we usually compute gross changes in fi(ed assets by adding depreciation for the period to net fi(ed assets at the ending financial statement date and subtract from the resulting amount the net fi(ed assets at the beginning financial statement date. &hus$ if a company sustains an operating loss before depreciation$ funds are not provided regardless of the magnitude of the depreciation charges.. :ow attempt e(ercises 8. &he residual represents the gross change in fi(ed assets for the period.
ources of funds on the left and the !pplications on the right of a tabulated statement for the said period. " Increase in cash position < )ecrease in debtors < Increase in long term debt < Increase in stocks < #5$777 D$777 5$677 5E$677 Increase in ta( prepayments < 5$777 :et profit < Increase in other accruals < !dditions to fi(ed assets < "ash dividends < Increase in bank loans < 86$777 8$777 .#) Identify them as sources and applications of funds$ and arrange them in a proper manner with the . 5) "omment briefly on some of the uses of the tabulated statement.$677 #6$777 57$777 Increase in prepaid e(penses < 5$677 Increase in investments < Increase in creditors < )ecrease in accrued ta(es < A$777 6$777 D$777 )epreciation < E$777 :ote: &he above figures are based on the balance sheet and income statement of "ompany K$ which are not shown in this e(ercise. .
&hese are: a) competitive environment b) strategic thrust . In general$ this re3uires the application of what$ in strategic company management$ has come to be known as the strategic four-factor model called "5 .1-. Funds may be broadly categorised into operating (or working) capital (difference between current assets and current liabilities)$ and ownership (or investment) capital. 1n the other hand$ investment capital (or funds) refers to durable resources like machines and buildings in which money invested is tied up for several years. In general terms$ . Funds are generally 3uantified in monetary value terms.trategic control 05(. 'erating ca'ital in a company or firm usually refers to production inputs that are normally used up within a production year.5 summarises the simplified matri( of interacting factors and component parts that make up 2.. %unds use and credit planning Funds (or capital) is a collective term applied to the assortment of productive inputs that have been produced. &he letters that make up . stand for:• ..trategic planning 05( • 1rganisational planning 0 ( • -esource re3uirements 0.5".2.( • . Figure 8.7@ercise . Funds use$ especially borrowed capital$ is usually influenced by many factors$ namely: the alternative demands for itI the availability of credit as and when neededI the time and interest rate payable on itI the types of loans that might be needed to generate itI and the cost of funds and business ownership cost.1-.1-. &hese four factors interact to create four interrelated components which normally determine the success or failure of any given company. &hus$ careful credit planning is essential in the successful operations of any company. is influenced or determined by four ma+or factors: the e(ternal environment$ the internal environment$ organisational culture and resource (especially funds) availability. 5ources and a''lications of funds -/sing the data and information in the annual reports (especially the balance sheet and income statements) of "erial arketing *oard provided for #AA8 and #AA5: a) compute and identify the sources and applications of funds of the parastatal for the years #AA5 and #AA8 and b) arrange them into a sources and applications of funds statement for #AA8.
&he pressure on businesses to grow is likely to continue$ and these businesses are likely to grow faster than will be permitted by each reinvesting its own annual savings from net income alone. "redit provision to a company means that the business is allowed the use of a productive good while it is being paid for. It is the right to incur debt for goods and'or services and repay the debt over some specified future time period. .. &his book attempts to cover all these areas. &he purpose of this te(t is not to cover all the components summarised in figure 8.#. 1bviously$ this does not all have to be owned capital. Hvaluation of successful businesses has found that many of them operate with 67 percent or more rented or borrowed capital. Figure . &hus$ because demand for credit will continue to e(pand$ careful credit planning and credit use decisions are of paramount importance to marketing companies in any country. Alternative uses of funds )ealing with alternatives is what management is all about. #redit and ty'es of loans "redit is the capacity to borrow. ! proper and pragmatic manipulation of these four component parts re3uires: • assessing the e(ternal environment • understanding the internal environment • adopting a leadership strategy • strategically planning the finances of the company. &his$ in strategic management$ re3uires a sound financial analysis backed by strategic funds programming$ baseline pro+ections (or budgeting)$ what-if (decision tree) analysis$ and risk analysis. For instance$ a C67$777 e(penditure may be ma+or to one company and of little significance to another.c) product'market dynamics d) competitive cost position and restructuring.ome of the tools for evaluating alternatives (e.& The strategic four-factor model !lmost everyone is familiar with the substantial capital or funds demand in all forms of business. .g. Instead$ the ma+or concern is to have a proper understanding of financial analysis for strategic planning. Bowever$ highlighted are some of these points throughout the book$ since company backgrounds differ and what is considered "ma+or capital use decisions" varies with the si%e of businesses. partial budgets$ cash flow budgets and financial statements)$ are covered in this te(t. It is assumed that most people are already familiar with the analysis that usually leads to ma+or capital use decisions in various companies.
instalment versus single payment • i$ period-o!-payme$t term ( e. For instance$ a company that puts up C#$777 and borrows an additional C. *orrowed funds are generally referred to as loans. &here are various ways of classifying loans$ namely: • i$ payme$t term ( e. 4oans for operating production inputs e. 4oans for family living e(penses are not at all self-li3uidating and must come out of net cash income after all cash obligations are paid. 1n the basis of the above classification$ there are twelve common types of loans$ namely: short-term loans$ intermediate-term loans$ long-term loans$ unsecured loans$ secured loans$ instalment loans$ single payment loans$ simple-interest loans$ add-on interest loans$ discount or front-end loans$ balloon loans and amortised loans. -ntermediate-term 0-T( loans are credit e(tended for several years$ usually one to five years.g.g.hort term loans are usually used in financing the purchase of operating inputs$ wages for hired labour$ machinery and e3uipment$ and'or family living e(penses.g.g. In other words$ although the inputs are used up in the production$ the added returns from their use will repay the money borrowed to purchase the inputs$ plus interest.$777 is using D7J leverage. after the e(pected production output has been sold. . short-term versus intermediate-term or long-term • i$ the ma$$er o! it e+"rity term ( e.torage "ompany of Limbabwe (". !stute managers are also e(pected to have figured in a risk premium and a return to labour management.1ther than the fact that funds generated within a business are usually inade3uate to meet e(panding production and other activities$ credit is often used in order to: • increase the returns on e3uity capital • allow more efficient labour utilisation • increase income. &his type of credit is normally used for purchases of buildings$ e3uipment and . simple interest versus add-on$ versus discount$ versus balloon. /sing the leverage provided by someone else2s capital helps the user business go farther than it otherwise would. &he ob+ective is to increase total net income and the return on a company2s own e3uity capital.g.g. 1n the other hand$ loans for investment capital items like machinery are not likely to be self-li3uidating in the short term. secured versus unsecured • i$ i$tere t payme$t term ( e.")$ are assumed to be self-li3uidating. 5hort-term loans are credit that is usually paid back in one year or less. &he process of using borrowed$ leased or "+oint venture" resources from someone else is called leverage. /sually lenders e(pect shortterm loans to be repaid after their purposes have been served$ e. cotton for the "otton "ompany of Limbabwe ("1&"1) and beef for the "old .
87 days$ A7 days$ . &his type of loan is sometimes called the "flat rate" loan and usually results in an interest rate higher than the one specified. . months and 5 days$ #5 years and one month). &he borrower does not have to put up collateral and the lender relies on credit reputation. &he resulting sum of the principal and interest is then divided e3ually by the number of payments to be made. *ecause the company must eventually pay the debt in full$ it is important to have the self-discipline and professional integrity to set aside money to be able to do so. :ong-term loans are those loans for which repayment e(ceeds five to seven years and may e(tend to .ome land improvement programmes like land levelling$ reforestation$ land clearing and drainage-way construction are usually financed with long-term credit. &hus$ the borrower is re3uired to pay interest only on the actual amount of money outstanding and only for the actual time the money is used (e.7 years. -nstalment loans are those loans in which the borrower or credit customer repays a set amount each period (week$ month$ year) until the borrowed amount is cleared. &he company is thus paying interest on the face value of the note although it has use of only a part of the initial balance once principal payments begin. @ith this plan$ the borrower usually knows precisely how much will be paid and when. Add-on interest loans are credit in which the borrower pays interest on the full amount of the loan for the entire loan period. 5im'le interest loans are those loans in which interest is paid on the unpaid loan balance. Interest is charged on the face amount of the loan at the time it is made and then "added on". &he lender re3uires security as protection for its depositors against the risks involved in the use planned for the borrowed funds. &his type of credit is usually e(tended on assets (such as land) which have a long productive life in the business.other production inputs that re3uire longer than one year to generate sufficient returns to repay the loan. &he borrower may be able to bargain for better terms by putting up collateral$ which is a way of backing one2s promise to repay. 5ingle 'ayment loans are those loans in which the borrower pays no principal until the amount is due. 5ecured loans are those loans that involve a pledge of some or all of a business2s assets. . Instalment credit is similar to charge account credit$ but usually involves a formal legal contract for a predetermined period with specific payments. !nsecured loans are credit given out by lenders on no other basis than a promise by the borrower to repay. /nsecured loans usually carry a higher interest rate than secured loans and may be difficult or impossible to arrange for businesses with a poor credit record.g. &his type of loan is sometimes called the "lump sum" loan$ and is generally repaid in less than a year.
%iscount or front-end loans are loans in which the interest is calculated and then subtracted from the principal first. &he C#$. . &he proper procedure for deriving a schedule as in table 8.5.$677 to start with$ and the C6$777 debt would be paid back$ as specified$ by the end of a year. 1n a discount loan$ the lender discounts or deducts the interest in advance. In some cases a principal payment is made each time interest is paid$ but because the principal payments do not amortise (pay off) the loan$ a large sum is due at the loan maturity date. &he repayment schedule for a #7 year standard amortised loan of C#7$777 at 9J is presented in table 8. &hus$ the effective interest rates on discount loans are usually much higher than (in fact$ more than double) the specified interest rates. Balloon loans are loans that normally re3uire only interest payments each period$ until the final payment$ when all principal is due at once. and multiplying that by C#7$777$ the face value of the loan. &he constant annual payment feature of the amortised loan is similar to the "add on" loan described above$ but involves less interest because it is paid only on the outstanding loan balance$ as with simple interest. &he standard plan of amortisation$ used in many intermediate and long-term loans$ calls for e3ual payments each period$ with a larger proportion of each succeeding payment representing principal and a small amount representing interest.. &hey are sometimes referred to as the "last payment due"$ and have a concept that is the same as the single payment loan$ but the due date for repaying principal may be five years or more in the future rather than the customary A7 days or E months for the single payment loan. For e(ample$ a C6$777 discount loan at #7J for one year would result in the borrower only receiving C.#.# is to: a) first read off the amortisation factor from an amortisation table for a given interest rate against the given year the loan is e(pected to last b) calculate the total payment at the end of each year c) then$ on a year-by-year basis$ calculate the annual interest payable on the balance of the principal d) obtain the annual principal payment by subtracting the calculated annual interest from the total end-of-year payment.#. !mortisation tables are used to determine the regular payment for an amortised loan.5. Amortised loans are a partial payment plan where part of the loan principal and interest on the unpaid principal are repaid each year.77 annual payment for the #7 year loan was determined by using the amortisation factor (!F) of 7.
& Amortisation of a "119111 loan in 11 years by e$ual annual instalments G ?H interest =ear !n'aid 'rinci'al at beginning of year 0"( Payment at the end of the year -nterest 0"( Princi'al 0"( Total 0"( # 5 8 .77 95.77 #7$777. (Bint: the !F is 7.67 5E#.87 6A6..5..77 #$. 1btain an amortisation schedule to show how the )airiboard of Limbabwe 4td will pay off the resulting amortised loan.87 9$E95. :ow attempt e(ercise 8.77 #$7#6.uppose a new machine is being financed by the )airiboard of Limbabwe 4td with an #D year C56$777 loan at a AJ interest rate.5..5.5...##.7D..5.77 .77 #$.67 #$#E5..5. 6 E 9 D A #7 &otal #7$777.E7 889...77 A$59E.77 #$85D.77 D$67#..#7 ..77 7@ercise ...7...$D5#..77 #$.7.77 .5.7 #D220.127.116.11 D5D.7 #$7DE.77 #$.#7 689..77 #$.77 #$.A.5.$5.#7 8$98.A7 DDE..77 A8.E7 5$695.67 6$D8E.A7 A... Table .E7 #$5.77 E.$5.7 E$9D6.77 #$88#.A.77 #$.77 977..67 .77 #. #ost of funds .3 Amortised loan .77 #$.5).-epeat the procedure for each of the years involved.77 #$.77 #$..96.77 99.
&he most appropriate rate is the firm2s cost of capital. &he two basic sources of capital are borrowed funds from lending institutions and ownership or internal capital representing profits reinvested in the business. !nd since many of these lenders2 rates are keyed to money market conditions$ predicting costs of borrowed capital through time is imprecise.&he cost of funds (capital) is crucial to investment analysis. &his rate$ when determined$ provides a yardstick for testing the acceptability of any investmentI those that have a high probability of achieving a rate of return in e(cess of the firm2s cost of capital are acceptable. /sually$ the present value measures of an investment2s economic worth depend on the use of an appropriate discount rate (or rate of return). 0enerally$ the guide for selecting an appropriate ownership cost of capital is to use the condition that the cost of e3uity or ownership capital should be e3ual to or greater than the cost of borrowed capital. Average cost of ca'ital . #ost of o.nershi' 07$uity( ca'ital "ost of ownership capital is more difficult to determine than that of borrowed capital. ! firm2s cost of capital may be estimated through: a) the use of the interest rate attainable by "investing" in lending institutions (deposits or securities) before ta(es as an estimate of opportunity cost of capital and b) the determination of the weighted average after-ta( cost of capital$ which reflects the cost of all forms of capital the firm uses.ed ca'ital 4enders2 interest rates vary by type of lender. #ost of borro. &heoretically$ one knows that the cost of ownership capital is the opportunity cost of placing the owner2s funds elsewhere in comparable risk situations. &o estimate the weighted average cost of capital$ one needs to determine: a) the present cost of borrowed or leased funds from each source b) an average cost of internal capital as reflected by the percentage of e3uity in business and risks being taken and c) an ad+ustment for income ta( effect. 4ess difficulty e(ists when borrowers have considerable long-term borrowings at fi(ed rates. :ormally$ a rough idea of the average cost of borrowed capital for a firm is obtained by dividing the total interest paid by the company by the capital borrowed by the same company.
/sing a balance sheet or other information$ one can estimate the percentage of the sources of capital in a business. !ssuming that a company has a 67J e3uity (or will average about half borrowed and half owned capital over the investment period) the average cost of capital is estimated as follows: Table ..& Average cost of ca'ital
5ources of ca'ital
01( H of #a'ital 0&( H of cost Deighted cost 01( @ 0&( 7.#7 7.7A 7.7D 6.77 8.E7 7.D7 A.;7
H3uity capital borrowed 67 *ank Insurance company &1&!4 Business o;nershi' costs ;7 #7
&here are five ownership costs that every company incurs$ namely: depreciation costs$ interest costs$ repair costs ta(es$ and insurance costs. &hey are commonly referred to as the ")I-&I 6". a) %e'reciation &his is a procedure for allocating the used up value of durable assets over the period they are owned by the business or until they are salvaged. *y depreciating an asset$ an allowance is made for the deterioration in the asset2s value as a result of use (wear and tear)$ age and obsolescence. 0enerally$ property is depreciable if it is used in business or to earn incomeI$ wears out$ decays$ gets used up or becomes obsolete$ and has a determinable useful life of more than one year. &he proportion of the original cost to be depreciated in any one year is largely a matter of +udgement and financial management. :ormally$ the depreciation allowance taken in any given year should reflect the actual decline in value of the asset - whether it is designed to influence income ta(es or the undepreciated value of an asset reflecting the resale value of the asset. &here are four main and acceptable methods of calculating depreciation$ namely: • the accelerated cost recovery system (!"-,) method • the straight line method • the declining balance method • the sum of the years-digits method.
The accelerated cost recovery system method is a relatively new method of calculating depreciation for tangible property. It came into use effectively in #AD#. !s a method !"-, generally gives much faster write off than other methods because it has ta( savings as its primary ob+ective. It usually gives little consideration to actual year-to-year change in value. &hus$ for accounting purposes$ other methods are more appropriate. For ta( purposes$ property is classified as follows:i) < year property - automobiles and light-duty trucks used for business purposes and certain special tools$ and depreciable property with a midpoint life of ; years or less. ii) 5 year property - most farm e3uipment$ grain bins$ single purpose structures and fences$ breeding beef and dairy cattle$ office e3uipment and office furniture. iii) .= year property- includes depreciable property with an e(pected life between #7 and #5.; years. iv) .5 year property - buildings. The straight line method computes depreciation$ )s$ as follows:
where: 1" < 1riginal cost or basis ,F 6 ,alvage value 4 < e(pected useful life of the asset in the business. %eclining balance method calculates depreciation as:%d < RV ( R where: -F < undepreciated value of the asset at the start of the accounting period such that$ in year #$ -F < 1"$ and in succeeding years$ -Fi < Q-Fi-# - )d$i-#R ( - (with salvage value not being deducted from original value before computing depreciation)$ - < the depreciation rate$ which may be up to twice the rate of decline$ #'4$ allowed under straight line method. 5um of the year-digits method estimates the depreciation of an asset as follows:-
where: -N < estimated years of useful life remaining , < sum of the numbers representing years of useful life (i.e. for an asset with 6 years useful life$ , would be #>5>8>;>6 < #6). b) -nterest costs 0rates( are incurred by a company when owned or borrowed funds are invested in durable assets$ because such money is tied up and cannot be used for other purposes. 1n borrowed money$ there will be a regular interest payment$ a standing obligation which must be met regardless of the level of use of the asset purchased with the borrowed money. !lso$ an interest charge should be calculated on e3uity capital. In this case$ the charge would be an opportunity interest cost. !n annual charge should be made because the money invested has alternative productive uses$ which may range from earning interest on a savings account to increasing production. c) ,e'airs costs are principally variable costs incurred on assets because of the level of use of the assets through wear and tear. ,ome durable assets$ however$ deteriorate with time even though they are not used. Fences$ buildings and some moving parts on machinery and e3uipment are prime e(amples$ although they deteriorate even more rapidly with use. d) Ta@es are fi(ed costs that are usually incurred on machinery$ buildings and some other durable assets. &a(es are usually not related to the level of use or productive services provided. &hus$ any investment analysis that ignores the annual ta( obligation associated with the proposed investment will be incomplete. e) -nsurance costs are also fi(ed costs that are incurred when a financed asset is purchased and has to be protected against fire$ weather$ theft$ etc. /sually$ lenders re3uire that a financed asset be insured as a meant of security for the loan. ,ome operators$ particularly those with low e3uity$ also insure some of their more valuable assets because of the strain the loss of those assets would place on the financial condition of the business. In this country$ the ma+or insurance companies are 1ld utual Insurance and 0eneral !ccident Insurance$ inet Insurance$ .rudential Insurance$ etc. :ow attempt e(ercise 8.6. 7@ercise ..4 #om'utation of de'reciation /sing the straight line$ declining balance$ and sum of the year-digits methods$ compute and tabulate the depreciation of a C#$777 asset with an estimated #7 years2 life and pro+ected salvage value of #7J of the original cost. (!ssume for the declining balance method a depreciation rate calculated as 57J of the value at the beginning of the year.
&his chapter concentrates on budgetary control only.1-./sually the rate may not be greater than twice the rate which would be used under the straight line method).Budgetary control "hapter ob+ectives .ource and application of funds . .ro forma cash flow statement -epair costs -eturns on investment and servicing of finance . Key terms !verage cost of capital *usiness ownership costs "ash "ash e3uivalents "ash flow statement "ash payments "ost of borrowed capital "ost of e3uity capital )epreciation )I-&I 6 Financing Funds use Insurance costs Interest rates Investing activities 1perating activities . *udgetary control is defined by the Institute of "ost and anagement !ccountants ("I !) as: .trategic four-factor model &a(ation &a(es #ha'ter 3 .tructure of the chapter *udgetary control methods anagement action and cost control Lero base budgeting (L**) Key terms &here are two types of control$ namely budgetary and financial. &his is because financial control was covered in detail in chapters one and two.
"&he establishment of budgets relating the responsibilities of e(ecutives to the re3uirements of a policy$ and the continuous comparison of actual with budgeted results$ either to secure by individual action the ob+ective of that policy$ or to provide a basis for its revision".
Chapter ob ectives
&his chapter is intended to provide: • !n indication and e(planation of the importance of budgetary control in marketing as a key marketing control techni3ue • !n overview of the advantages and disadvantages of budgeting • !n introduction to the methods for preparing budgets • !n appreciation of the uses of budgets.
!tructure of the chapter
1f all business activities$ budgeting is one of the most important and$ therefore$ re3uires detailed attention. &he chapter looks at the concept of responsibility centres$ and the advantages and disadvantages of budgetary control. It then goes on to look at the detail of budget construction and the use to which budgets can be put. 4ike all management tools$ the chapter highlights the need for detailed information$ if the techni3ue is to be used to its fullest advantage.
Budgetary control methods
a) Budget* • ! formal statement of the financial resources set aside for carrying out specific activities in a given period of time. • It helps to co-ordinate the activities of the organisation. !n e(ample would be an advertising budget or sales force budget. b( Budgetary control* • ! control techni3ue whereby actual results are compared with budgets. • !ny differences (variances) are made the responsibility of key individuals who can either e(ercise control action or revise the original budgets.
Budgetary control and res'onsibility centresI &hese enable managers to monitor organisational functions. A res'onsibility centre can be defined as any functional unit headed by a manager who is responsible for the activities of that unit. &here are four types of responsibility centres: a) Reve$"e +e$tre 1rganisational units in which outputs are measured in monetary terms but are not directly compared to input costs. b) E#pe$ e +e$tre /nits where inputs are measured in monetary terms but outputs are not. c) 4ro!it +e$tre @here performance is measured by the difference between revenues (outputs) and e(penditure (inputs). Inter-departmental sales are often made using "transfer prices". d) I$ve tme$t +e$tre @here outputs are compared with the assets employed in producing them$ i.e. -1I. Advantages of budgeting and budgetary control &here are a number of advantages to budgeting and budgetary control: • "ompels management to think about the future$ which is probably the most important feature of a budgetary planning and control system. Forces management to look ahead$ to set out detailed plans for achieving the targets for each department$ operation and (ideally) each manager$ to anticipate and give the organisation purpose and direction. • .romotes coordination and communication. • "learly defines areas of responsibility. -e3uires managers of budget centres to be made responsible for the achievement of budget targets for the operations under their personal control. • .rovides a basis for performance appraisal (variance analysis). ! budget is basically a yardstick against which actual performance is measured and assessed. "ontrol is provided by comparisons of actual results against budget plan. )epartures from budget can then be
investigated and the reasons for the differences can be divided into controllable and noncontrollable factors. • Hnables remedial action to be taken as variances emerge. • otivates employees by participating in the setting of budgets.
• Improves the allocation of scarce resources. • Hconomises management time by using the management by e(ception principle. Problems in budgeting @hilst budgets may be an essential part of any marketing activity they do have a number of disadvantages$ particularly in perception terms. • *udgets can be seen as pressure devices imposed by management$ thus resulting in: a) bad labour relations b) inaccurate record-keeping. • )epartmental conflict arises due to: a) disputes over resource allocation b) departments blaming each other if targets are not attained. • It is difficult to reconcile personal'individual and corporate goals. • @aste may arise as managers adopt the view$ "we had better spend it or we will lose it". &his is often coupled with "empire building" in order to enhance the prestige of a department. -esponsibility versus controlling$ i.e. some costs are under the influence of more than one person$ e.g. power costs. • anagers may overestimate costs so that they will not be blamed in the future should they overspend. #haracteristics of a budget ! good budget is characterised by the following: • .articipation: involve as many people as possible in drawing up a budget. • "omprehensiveness: embrace the whole organisation. • ,tandards: base it on established standards of performance.
! budget centre may encompass several cost centres.g. c) B"d3et O!!i+er2 "ontrols the budget administration &he +ob involves: • liaising between the budget committee and managers responsible for budget preparation • dealing with budgetary control problems • ensuring that deadlines are met • educating people about budgetary control. Functions of the budget committee include: • "oordination of the preparation of budgets$ including the issue of a manual • Issuing of timetables for preparation of budgets • . d) B"d3et ma$"al2 &his document: • charts the organisation • details the budget procedures • contains account codes for items of e(penditure and revenue • timetables the process • clearly defines the responsibility of persons involved in the budgeting system. Budget 're'aration . Budget organisation and administration* In organising and administering a budget system the following characteristics may apply: a) B"d3et +e$tre 2 /nits responsible for the preparation of budgets. • !nalysis of costs and revenues: this can be done on the basis of product lines$ departments or cost centres. Hvery part of the organisation should be represented on the committee$ so there should be a representative from sales$ production$ marketing and so on. departmental heads and e(ecutives (with the managing director as chairman). b) B"d3et +ommittee2 &his may consist of senior members of the organisation$ e. • Feedback: constantly monitor performance.rovision of information to assist budget preparations • "omparison of actual results with budget and investigation of variances.• Fle(ibility: allow for changing circumstances.
ales budget: this involves a realistic sales forecast.g. sales$ material or labour. b) . &his is prepared in units of each product and also in sales value.roduction budget: e(pressed in 3uantitative terms only and is geared to the sales budget. a) . Factors influencing a) and b) include: .Firstly$ determine the principal budget factor. • &he materials purchases budget is both 3uantitative and financial. &he production manager2s duties include: • analysis of plant utilisation • work-in-progress budgets. ethods of sales forecasting include: • sales force opinions • market research • statistical methods (correlation analysis and e(amination of trends) • mathematical models. In using these techni3ues consider: • company2s pricing policy • general economic and political conditions • changes in the population • competition • consumers2 income and tastes • advertising and other sales promotion techni3ues • after sales service • credit terms offered. &his limits output$ e. &his is also known as the key budget factor or limiting budget factor and is the factor which will limit the activities of an undertaking. If re3uirements e(ceed capacity he may: • subcontract • plan for overtime • introduce shift work • hire or buy additional machinery • &he materials purchases budget2s both 3uantitative and financial. c) -aw materials and purchasing budget: • &he materials usage budget is in 3uantities.
. e) "ash budget: a cash plan for a defined period of time.g. It summarises monthly receipts and payments. stock and debtors • to enable a firm to take precautionary measures and arrange in advance for investment and loan facilities whenever cash surpluses or deficits arises • to show the feasibility of management2s plans in cash terms • to illustrate the financial impact of changes in management policy$ e.g. change of credit terms offered to customers. &his is influenced by: • production re3uirements • man-hours available • grades of labour re3uired • wage rates (union agreements) • the need for incentives. d) 4abour budget: is both 3uantitative and financial. Bence$ it highlights monthly surpluses and deficits of actual cash. 5te's in 're'aring a cash budget .• production re3uirements • planning stock levels • storage space • trends of material prices. -eceipts of cash may come from one of the following: • cash sales • payments by debtors • the sale of fi(ed assets • the issue of new shares • the receipt of interest and dividends from investments.ayments of cash may be for one or more of the following: • purchase of stocks • payments of wages or other e(penses • purchase of capital items • payment of interest$ dividends or ta(ation. Its main uses are: • to maintain control over a firm2s cash re3uirements$ e.
*elow is a suggested layout. Month 1 Month & Month . " Ca h re+eipt -eceipts from debtors .tep #: set out a pro forma cash budget month by month.roceeds from share issues !ny other cash receipts Ca h payme$t .i) .ales of capital items 4oans received .ayments to creditors @ages and salaries 4oan repayments "apital e(penditure &a(ation )ividends !ny other cash e(penditure Re+eipt le payme$t @ G N " " Ope$i$3 +a h %ala$+e %:! .
roduction budget aterials budget 4abour budget !dmin. Figure 3.1 #om'osition of a master budget P7.tep 5: sort out cash receipts from debtors iii) . budget .: sort out cash payments to suppliers v) .Clo i$3 +a h %ala$+e +:! G N L ii) .'4 acc: get: .tep 8: other income iv) .AT-+) B!%)7T F-+A+#-A: B!%)7T consists of:*udget .tep 6: establish other cash payments in the month Figure . consists of "ash budget *alance sheet Funds statement .tocks budget f) 1ther budgets: &hese include budgets for: • administration • research and development • selling and distribution e(penses • capital e(penditures • working capital (debtors and creditors).# shows the composition of a master budget analysis.tep ..
7@ercise 3.7 8#7 5E7 567 d) -aw materials cost C6'unit. AP.77 8A7 . 1f this 67J is paid in the same month as production and 67J in the month following production. MA= J!+ J!: A!) 57P 1>/.77 5E7 567 "ash is received for sales after 8 months following the sales.77 877 867 . :ow attempt e(ercise .roduction in units: 5. c) . h) achinery costing C5$777 to be paid for in 1ctober #AG5. 1>/& 5ales at "&1 'er unit MA.#) illustrates this..&he master budget (figure . f) Fariable e(penses are C5'unit. #T + C %7# JA+ F7B 5E7 577 857 5A7 . g) Fi(ed e(penses are C. An e@am'le ! sugar cane farm in the 4owveld district may devise an operating budget as follows: • "ultivation • Irrigation . a) 1pening "ash C #$577.1 Budgeting )raw up a cash budget for *& Sithole showing the balance at the end of each month$ from the following information provided by her for the si( months ended 8# )ecember #AG5..77'month payable each month. i) @ill receive a legacy of C 5$677 in )ecember #AG5. 1f this D7J is paid in the month of production and 57J after production.#. e) )irect labour costs of CD'unit are payable in the month of production.7 597 877 857 867 897 8D7 8. +) )rawings to be C877'month.
Baving identified cost centres$ the ne(t step will be to make a 3uantitative calculation of the resources to be used$ and to further break this down to shorter periods$ say$ one month or three months. .• Field maintenance • Barvesting • &ransportation.-and depends on individual +udgement of which is the best unit to use.rd $uarter 3th $uarter nil nil nil nil A$777 tonnes #E$777 tonnes #7$777 tonnes 877 man days . &herefore$ for e. harvesting$ these may include four resources$ namely: • 4abour: -cutting -sundry • &ractors • "ane trailers • Implements and sundries.67 man days .& 8uantitative harvesting budget Earvesting 4abour "utting .67 man days E87 hours #$#77 hours 977 hours A$777 tonnes #E$777 tonnes #7$777 tonnes A$777 tonnes #E$777 tonnes #7$777 tonnes Imp$ S sundries nil Hach item is measured in different 3uantitative units . @ith each operation$ there will be costs for labour$ materials and machinery usage. Figure 3. &he 3uantitative budget for harvesting may be calculated as shown in figure .undry &ractors "ane trailers 1st $uarter &nd $uarter .g..tonnes of cane$ man days etc. &he length of period chosen is important in that the shorter it is$ the greater the control that can be e(ercised by the budget but the greater the e(pense in preparation of the budget and reporting of any variances.5.
67 per hour C7.e.67 per hour .ome of the costs are fi(ed$ e. Figure 3.77 #$677 6$567 Imp. Earvesting cost budget -tem harvesting 4abour "utting !nit cost 1st $uarter &nd $uarter . fuel and oil.machines like tractors have a whole range of costs like fuel and oil$ repairs and maintenance$ driver$ licence$ road ta( and insurance and depreciation.g.$956 #$#56 D$567 #$#56 6$567 8$777 #D$556 "ane &railers - #$867 5$.an estimated figure based on past e(perience.. S sundries C7. in the first instance making an internal 2profit2 and in the second a 2loss2..rd $uarter 3th $uarter Total C7.undry &ractors C5. . #harge out costs In table .o$ overall operating cost of the tractor for the year may be budgeted as shown in figure .5.96 per tonne - E$967 #5$777 9$677 5E$567 .67 per day C9.$777 5$677 D$967 - C#6$D56 C59$996 C#9$D96 CE#$. .#6 per tonne - 967 .1nce the budget in 3uantitative terms has been prepared$ unit costs can then be allocated to the individual items to arrive at a budget for harvesting in financial terms as shown in table .5 tractors have a unit cost of C9... depreciation and insurance$ whereas some vary directly with use of the tractor$ e. If the tractor is used for more than #$777 hours then there will be an over-recovery on its operational costs and if used for less than #$777 hours there will be under-recovery$ i.g..56 per tonne - 5$567 .96 .. 1ther costs such as repairs are unpredictable and may be very high or low .
77 #ost 'er annum 019111 hours( 0"( 5$777.rd $uarter 3th $uarter Total " -evenue from cane 4ess: "osts "ultivation 89$5E# .77 8.77 9.67 &he master budget for the sugar cane farm may be as shown in figure .#E #D8$8#8 #87$777 567$777 #57$777 677$777 .77 E77.77 :o.77 per month #$577.77 per annum E77.77 577.5$8ED 66$. &he budget represents an overall ob+ective for the farm for the whole year ahead$ e(pressed in financial terms..4 'erating budget for sugar cane farm 1>/3 1st $uarter &nd $uarter .6.3 Tractor costs !nit rate 0"( Fi(ed costs )epreciation 5$777.77 4icence and insurance 577.77 per hour 5$777.77 )river -epairs Fariable costs Fuel and oil aintenance #77. of hours used "ost per hour Master budget #$777.D$5ED .Figure 3.77 5.77 9$677.77 per 577 hours #$677. Table 3.
&his statement will calculate the difference between the 2budgeted2 and the 2actual2 cost$ which is called the 2variance2.DE A6$#99 ##$85A 9$5E5 #9$D96 #6$967 #79$E85 A.$5E7 #.#$69D ##5$5.$967 #5A$869 ##5$5. ii.7 5.Irrigation Field maintenance Barvesting &ransportation 9$59D .9D$6E9 A7$5A7 8DD$599 ###$958 5E$7.e'orting back )uring the year the management accountant will prepare statements$ as 3uickly as possible after each operating period$ in our e(ample$ each 3uarter$ setting out the actual operating costs against the budgeted costs. *alance sheet at the end of the year.A$8E6 #6$5A9 #5$A58 #6$D56 #..$#77 #7E$.9$889 #75$EE8 9$. .$E77 8A5$9E9 D6$D77 .98 #6$AA# 59$996 5.7 #5A$88D EE$577 9$8E# (E$EAA) #D$.#$775 E#$.$5E7 57#$DA5 A7$5A7 ###$E75 D$8AD 6$85# 8$799 65$899 .96 6. D6$E9A !dd: 1pening valuation D6$D77 #86$#E6 4ess: "losing valuation #86$#E6 :et crop cost 0ross surplus 4ess: 1verheads :et profitless) 6$D9E (6$D9E) 1nce the operating budget has been prepared$ two further budgets can be done$ namely: i.$D5E . It is of great importance that the business has sufficient funds to support the planned operational budget. "ash flow budget which shows the amount of cash necessary to support the operating budget.#$6A9 A.#8 #86$#E6 5. .
"utting .$777 #8$677 #5$A96 (656) 5$676 8$967 E$6#8 E$567 #$5. ! variance between the actual cost of an item and its budgeted cost may be due to . If the actual production was much higher than budgeted then these costs represent a very considerable saving$ even though only a marginal saving is shown by the variance.A7 whilst the cumulative figure for the year to date shows an overall saving of C.8$#E5 ..$597 . Figure 3. Price and $uantity variances Must to state that there is a variance on a particular item of e(penditure does not really mean a lot.the 3uantity used and the price per unit.rd $uarter -tem Earvesting =ear to date Actual Budget Cariance Actual Budget Cariance 4abour .E.rd $uarter 1>/3 .A7) . It appears that actual costs are less than budgeted costs$ so the harvesting operations are proceeding within the budget set and satisfactory.8D.8D Bere$ actual harvesting costs for the 8rd 3uarter are C5D$5E6 against a budget of C59$996 indicating an increase of C. #$D96 5A# A$896 D$567 #$E9D 5$.actual costs against budget costs Management accounts for sugar cane farm . ost costs are composed of two elements .imilarly$ if the actual tonnage was significantly less than budgeted$ then what is indicated as a marginal saving in the variance may$ in fact$ be a considerable overspending.77 .&here are many ways in which management accounts can be prepared.8$E77 . &o continue with our e(ample of harvesting on the sugar cane farm$ management accounts at the end of the third 3uarter can be presented as shown in figure . .6 Management accounts . &he budget was based on a cane tonnage cut of #E$777 tonnes in the 8rd 3uarter and a cumulative tonnage of 56$777. If these tonnages have been achieved then the statement will be satisfactory.5 #$#56 8D8 (#$#56) 955 (597) #A$7E7 #D$967 (8#7) #$6D.6 (5E8) 5D$5E6 59$996 (. Bowever$ a further look may reveal that this may not be the case..undry &ractors "ane trailers Imp S sundries #5$577 #5$777 (577) 9.
ii) aterial 3uantity variance: arises when the actual amount of material used is greater or lower than the amount specified in the budget$ e. :abour &he difference between actual labour costs and budgeted or standard labour costs is known as direct wages variance. &his variance may arise due to a difference in the amount of labour used or the price per unit of labour$ i. For e(ample$ say it is budgeted to take 877 man days at C8. Materials &he variance for materials cost could also be split into price and usage elements: i) aterial price variance: arises when the actual unit price is greater or lower than budgeted. ii) 4abour efficiency variance: arises when the actual time spent on a particular +ob is higher or lower than the standard labour hours specified$ e.rice and usage variances for ma+or items of e(pense are discussed below. !pparent similarity between budgeted and actual costs may hide significant compensating variances between price and usage. .e. the wage rate.77 per man day . verheads !gain$ overhead variance can be split into: i) 1verhead volume variance: where overheads are taken into the cost centres$ a production higher or lower than budgeted will cause an over-or under-absorption of overheads.one or both of these factors. &he direct wages variance can be split into: i) @age rate variance: the wage rate was higher or lower than budgeted$ e.g. using more unskilled labour$ or working overtime at a higher rate.a favourable usage variance but a very unfavourable price variance. breakdown of a machine. a budgeted fertiliser at 867 kg per hectare may be increased or decreased when the actual fertiliser is applied$ giving rise to a usage variance. &he actual cost on completion was CD96.77. "ould be due to inflation$ discounts$ alternative suppliers etc. .77. ii) 1verhead e(penditure variance: where the actual overhead e(penditure is higher or lower than that budgeted for the level of output actually produced. Further investigations may reveal that the +ob took 567 man days at a daily rate of C8. anagement may therefore need to investigate some significant variances revealed by further analysis$ which a comparison of the total costs would not have revealed.giving a total budgeted cost of CA77.g.g.77$ showing a saving of C56.67 .
1ther variances might prove to be much more difficult$ and sometimes impossible$ to control. .67 per day.77 per day to complete the task costing C5$777. "alculate: i) .ome variances can be identified to a specific department and it is within that department2s control to take corrective action. . &here are five parts to an effective cost control system. Management action and cost control . It will be very wasteful if the information once produced is not put into effective use.roducing information in management accounting form is e(pensive in terms of the time and effort involved.5.rice variance ii) /sage variance "omment briefly on the results of your calculation.rice variance < (budgeted price .77$ being #67 man days at C#5.& #om'utation of labour variances It was budgeted that it would take 577 man days at C#7.77 when the actual cost was C#$D96. !ction(s) that can be taken when a significant variance has been revealed will depend on the nature of the variance itself. 7@ercise 3. &hese are: a) preparation of budgets b) communicating and agreeing budgets with all concerned c) having an accounting system that will record all actual costs d) preparing statements that will compare actual costs with budgets$ showing any variances and disclosing the reasons for them$ and e) taking any appropriate action based on the analysis of the variances in d) above.#alculation of 'rice and usage variances &he price and usage variance are calculated as follows: ..actual 3uantity) G budgeted price :ow attempt e(ercise .actual price) G actual 3uantity /sage variance < (budgeted 3uantity .
Bence$ some companies carry out the full process every five years$ but in that year the business can almost grind to a halt. &his might not include any field sales force$ or a different-si%ed team$ and the company then has to plan how to implement this new strategy. Hven using such an analytical base$ some businesses find that historical comparisons$ and particularly the current level of constraints on resources$ can inhibit really innovative changes in budgets. &hus$ an alternative way is to look in depth at one area of the business each year on a rolling basis$ so that each sector does a %ero base budget every five years or so.rice and 3uantity variance -esponsibility centres Lero based budgeting . For e(ample$ in the sales area$ the current e(isting field sales force will be ignored$ and the optimum way of achieving the sales ob+ectives in that particular market for the particular goods or services should be developed. Bowever$ they can be used to influence managerial action in future periods. In fact this is part of the financial analysis discussed so far$ but the proper analysis process takes into account all the changes which should affect the future activities of the company. 1ne way of breaking out of this cyclical budgeting problem is to go back to basics and develop the budget from an assumption of no e(isting resources (that is$ a %ero base). &hey show what happened last month or last 3uarter and no amount of analysis and discussion can alter that. &ero base budgeting '&BB( !fter a budgeting system has been in operation for some time$ there is a tendency for ne(t year2s budget to be +ustified by reference to the actual levels being achieved at present. &his means all resources will have to be +ustified and the chosen way of achieving any specified ob+ectives will have to be compared with the alternatives. &hus$ if changes are not started in the budget period$ it will be difficult for the business to make the progress necessary to achieve longer term ob+ectives.Fariances revealed are historic. &he obvious problem of this %ero-base budgeting process is the massive amount of managerial time needed to carry out the e(ercise. &his can cause a severe handicap for the business because the budget should be the first year of the long range plan. Key terms *udgeting *udgetary control *udget preparation anagement action and cost control aster budget .
! 23uantitative2 decision$ on the other hand$ is possible when the various factors$ and relationships between them$ are measurable. Bence$ the manager will have to make 23ualitative2 +udgements$ e.#ha'ter 4 . . &his chapter will concentrate on 3uantitative decisions based on data e(pressed in monetary value and relating to costs and revenues as measured by the management accountant.tructure of the chapter Hlements of a decision -elevant costs for decision making 1pportunity cost . .hutdown problems Key terms &he need for a decision arises in business because a manager is faced with a problem and alternative courses of action are available.-nformation for decision making "hapter ob+ectives . In deciding which option to choose he will need all the information which is relevant to his decisionI and he must have some criterion on the basis of which he can choose the best alternative. Chapter ob ectives &his chapter is intended to provide: • !n overview of the elements re3uired for manager to make informed decisions among alternative courses of action • !n e(planation of the relevant costs for decision making purposes • &he construction of "ost-Folume-. in deciding which of two personnel should be promoted to a managerial position.ome of the factors affecting the decision may not be e(pressed in monetary value.g.rofit analyses and *reakeven charts and their usefulness in decision making • &he factors affecting the economic choice of whether to make components in-house or buy from outside • Bow to make decisions on shutdown$ additions or deletions to product lines or ranges$ important to marketing managers.
. c) A range of alternative courses of action under consideration. the calculation of e(pected profit or contribution$ and the ranking of alternatives. limited raw materials$ labour$ etc. ma(imisation of profit or minimisation of total costs.ometimes referred to as 2choice criterion2 or 2ob+ective function2$ e. *elevant costs for decision making &he costs which should be used for decision making are often referred to as "relevant costs". d) Forecasting of the incremental costs and benefits of each alternative course of action. It is therefore common to find an ob+ective that will ma(imise profits sub+ect to defined constraints. &he chapter e(amines the techni3ues useful in helping to make decisions in these areas. &he chapter looks at the relevant elements of cost for decision making$ then looks at the various techni3ues including breakeven analysis. e) A''lication of the decision criteria or ob+ective function$ e. 1ther important business decisions are whether to source components internally or have them brought in from outside$ and whether to continue with operations if they appear uneconomic. "I ! defines relevant costs as 2costs appropriate to aiding the making of specific management decisions2. Bowever$ "internal" sources are +ust as important$ none more so than financial information. For e(ample$ in order to minimise costs of a manufacturing operation$ the available alternatives may be: i) to continue manufacturing as at present ii) to change the manufacturing method iii) to sub-contract the work to a third party.!tructure of the chapter 1ften "information" is interpreted by marketers as being "e(ternal" market based information.ast costs are irrelevant$ as we cannot affect them by current decisions and they are common to all alternatives that we may choose.g.g.g. b) #onstraints any decision problems have one or more constraints$ e. )lements of a decision ! 3uantitative decision problem involves si( parts: a) An obAective that can be $uantified . &o affect a decision a cost must be: a) Future: . f) #hoice of preferred alternatives.
Opportunity cost -elevant costs may also be e(pressed as opportunity costs. c) "ash flow: H(penses such as depreciation are not cash flows and are therefore not relevant. In using the leather on the book$ however$ the company will lose the opportunities of either disposing of it for CD77 or of using it to save an outlay of CA77 on desk furnishings.b) Incremental: 2 eaning$ e(penditure which will be incurred or avoided as a result of making a decision. rent or rates on a factory would be incurred whatever products are produced. e) . &he leather e(ists and could be used on the book without incurring any specific cost in doing so. f) "ommitted costs: ! future cash outflow that will be incurred anyway$ whatever decision is taken now$ e. &he cost was incurred in the past for some reason which is no longer relevant. It has in stock the leather bought some years ago for C#$777.g.imilarly$ the book value of e(isting e3uipment is irrelevant$ but the disposal value is relevant. contracts already entered into which cannot be altered. .g. 1ther terms: d) "ommon costs: "osts which will be identical for all alternatives are irrelevant$ e. 7@am'le ! company is considering publishing a limited edition book bound in a special leather. dedicated fi(ed assets$ development costs already incurred.unk costs: !nother name for past costs$ which are always irrelevant$ e. !ny costs which would be incurred whether or not the decision is made are not said to be incremental to the decision. &he better of these alternatives$ from the point of view of benefiting from the leather$ is the latter.g. . "4ost opportunity" cost of CA77 will therefore be included in the cost of the book for decision making purposes. !n opportunity cost is the benefit foregone by choosing one opportunity instead of the ne(t best alternative. In calculating the likely profit from the proposed book before deciding to go ahead with the pro+ect$ the leather would $ot be costed at C#$777. &he company has no plans to use the leather for other purposes$ although it has considered the possibilities: a) of using it to cover desk furnishings$ in replacement for other material which could cost CA77 b) of selling it if a buyer could be found (the proceeds are unlikely to e(ceed CD77). &o buy an e3uivalent 3uantity now would cost C5$777.
e.&he relevant costs for decision purposes will be the sum of: i) 2avoidable outlay costs2$ i. The assum'tions in relevant costing . "alculate the relevant costs of material for deciding whether or not to accept the contract.1 . 7@ercise 4.. :ow attempt e(ercise 6.ealisable .67 ) 577 577 #. :o other use could be found for material "$ but the units of material ) could be used in another +ob as a substitute for 877 units of material H$ which currently costs C#6 per unit (of which the company has no units in stock at the moment). those costs which will be incurred only if the book pro+ect is approved$ and will be avoided if it is not ii) the opportunity cost of the leather (not represented by any outlay cost in connection to the pro+ect). &his total is a true representation of 2economic cost2.77 #A. &he +ob would re3uire the following materials.elevant costs and o''ortunity costs >im3la I$d" trie Ltd& has been approached by a customer who would like a special +ob to be done for him$ and is willing to pay CE7$777 for it.77 #E. b) aterials " and ) are in stock due to previous over-buying$ and they have restricted use. Nou must carefully and clearly e(plain the reasons for your treatment of each material.77 #5.77 #6.77 #.e'lacement cost value "/unit "/unit ! * " #777 #777 #777 #E.77 #8.ome of the assumptions made in relevant costing are as follows: . Material Total units re$uired !nits already in stock 7 E77 977 - Book value of units in stock "/unit - .67 #5.#.77 a) aterial * is used regularly by Limglass Industries 4td$ and if units of * are re3uired for this +ob$ they would need to be replaced to meet other production demands.77 #5..
It is also known as 2breakeven analysis2.ales mi( decisions$ to determine in what proportions each product should be sold. the contribution per unit. #ost-volume-'rofit 0#CP( analysis "F. analysis is based on the assumption of a linear total cost function (constant unit variable cost and constant fi(ed costs) and so is an application of marginal costing principles. c) &he ob+ective of decision making in the short run is to ma(imise 2satisfaction2$ which is often known as 2short-term profit2. &he principles of marginal costing can be summarised as follows: a) . analysis involves the analysis of how total costs$ total revenues and total profits are related to sales volume$ and is therefore concerned with predicting the effects of changes in costs and sales volume on profit. The basic 'rinci'les of #CP analysis "F. d) &he information on which a decision is based is complete and reliable. c) . c) &he additional profit earned by making and selling one e(tra unit is the e(tra revenue from its sales minus its variable costs$ i.eriod fi(ed costs are a constant amount$ therefore if one e(tra unit of product is made and sold$ total costs will only rise by the variable cost (the mar3i$al +o t) of production and sales for that unit. d) )ecisions that will affect the cost structure and production capacity of the company.e. &he volume of sales re3uired to make a profit (breakeven point) and the 2safety margin2 for profits in the budget can be measured. if a department closes down$ the attributable fi(ed cost savings would be known.ricing and sales volume decisions. &he techni3ue used carefully may be helpful in the following situations: a) *udget planning.a) "ost behaviour patterns are known$ e. . b) !lso$ total costs will fall by the variable cost per unit for each reduction by one unit in the level of activity. b) . b) &he amount of fi(ed costs$ unit variable costs$ sales price and sales demand are known with certainty.g.
&he variable cost is C8'unit and the variable cost of selling is C#'unit. -evenue G Fariable cost of sales (G) "1:&-I*/&I1: Fi(ed "osts .-1FI& G (G) G 7@am'le* breakeven charts and P/C charts Sa%re 4rod"+t Ltd& makes and sells a single product. . budgets to make and sell 8$E77 units in the ne(t year.roducts 4td. 5olution* ! breakeven chart records the amount of fi(ed costs$ variable costs$ total costs and total revenue at all volumes of sales$ and at a given sales price as follows: Figure 4. &his is the e(tra contribution from the e(tra output and sales.'F graph$ each showing the e(pected amount of output and sales re3uired to breakeven$ and the safety margin in the budget.1 Breakeven chart . Fi(ed costs total CE$777 and the unit sales price is CE. )raw a breakeven chart$ and a . e) &he total profit in a period is the total revenue minus the total variable cost of goods sold$ minus the fi(ed costs of the period.abre .d) !s the volume of activity increases$ there will be an increase in total profits (or a reduction in losses) e3ual to the total revenue minus the total e(tra variable costs.
) E77 !s a percentage of budgeted salesI the < #E.&he 2breakeven point2 is where revenues and total costs are e(actly the same$ so there is no profit or loss.abre . .E9J. -eading from the graph$ the breakeven point is 8$777 units of sale and C#D$777 in sales revenue. &he 2margin of safety2 is the amount which actual output'sales may fall short of the budget without a loss being made$ often e(pressed as a percentage of the budgeted sales volume. It is a rough measure of the risk that . It may be e(pressed in terms of units of sale or in terms of sales revenue.roducts might make a loss if it fails to achieve its budget. In our e(ample$ the margin of safety is calculated as follows: !nits *udgeted sales *reakeven point 8$E77 8$777 argin of safety ( 1.
& The 'rofit/volume 0P/C( gra'h &he breakeven point may be read from the graph as C#D$777 in sales revenue$ and the margin of safety is C8$E77 in sales revenue or #E.'F graph is similar to the breakeven chart$ and records the profit or loss at each level of sales$ at a given sales price. The Profit/Colume 0P/C( gra'h &he .! high margin of safety shows a good e(pectation of profits$ even if the budget is not achieved.!'graph would look like this: Figure 4. analysis a) &o calculate the breakeven point the following formula applies: 5 < V? 9 at the breakeven point$ where: . It is a straight line graph$ drawn by recording the following: i) the loss at %ero sales$ which is the full amount of fi(ed costs ii) the profit'(loss) at the budgeted sales level. In our e(ample above$ the .E9J budgeted sales revenue. &he arithmetic of "F. &he two points are then +oined up.
-e3uired: "alculate the volume of sales that would be re3uired to achieve the following: a) *reakeven b) Harn a profit of at least CE$777. b) &o calculate the amount of sales needed to achieve a target profit the following formula applies: 5<V?9?4 &herefore$ 05 . .. ratio.F) must be sufficient to cover fi(ed costs plus the amount of profit re3uired (F > . :ow attempt e(ercise 6.).ince costs and sales revenues are linear functions$ the "'. &herefore: (S . . manufactures a single product$ which has a variable cost of sale of CD'unit and a sales price of C#5'unit. 7@ercise 4. *udgeted fi(ed costs are C5. It is used sometimes as a measure of performance or profitability$ and in "F. !s an alternative method of calculation$ the breakeven point in sales revenue is calculated as follows: .F) e3uals the amount of fi(ed costs (F).5. ratio) &he "'. < sales revenue F < variable costs F < fi(ed costs (so that F > F < total costs).C( B (9 ? 4) &o earn a target profit$ the total contribution (. ratio shows how much contribution is earned per C# of sales revenue earned. analysis to calculate the sales re3uired to breakeven or earn a target profit or the e(pected total contribution at a given volume of sales and with a given "'.V ) < F !t the breakeven point$ total contribution (. ratio is constant at all levels of output and sales. .& Arithmetic of #CP analysis :dlovu 4td.$777. &he contribution'sales ratio ("'.
imilarly$ the sales volume needed to achieve a target profit is calculated as follows: In e(ercise 6.uppose for e(ample$ that )a a$@" Ltd& make four components$ @$ G$ N and L$ with e(pected costs for the coming year as follows: D . ratio is a) &he breakeven point is therefore -e3uired sales to breakeven < C95$777 or divided by C#5 < E$777 units b) &o achieve a target profit of CE$777 the re3uired sales are calculated asI < CA7$777 or divided by #5 < 9$677 units Make or buy decisions ! company is often faced with the decision as to whether it should manufacture a component or buy it outside.$777 8$777 . .5$ the "'..roduction (units) / = F #$777 5$777 .
# 9 C ./nit marginal costs )irect materials )irect labour C . E 5 #5 Fariable production overheads 5 #.ubcontracting will result in some savings on fi(ed cost. should make or buy the components. respectively. D " / " = " F " . )irect fi(ed costs'annum and committed fi(ed costs are as follows: Incurred as a direct conse3uence of making @ #$777 Incurred as a direct conse3uence of making G 6$777 Incurred as a direct conse3uence of making N E$777 Incurred as a direct conse3uence of making L D$777 1ther committed fi(ed costs 87$777 67$777 ! subcontractor has offered to supply units @$ G$ N and L for C#5$ C5#$ C#7 and C#. D C 6 A 8 #9 C 5 . 5olution and discussion a) &he relevant costs are the differential costs between making and buying. &hey consist of differences in unit variable costs plus differences in directly attributable fi(ed costs. . )ecide whether )a a$@" 4td.
. 5 !nnual re3uirements in units #$777 5$777 ./nit variable cost of making /nit variable cost of buying #. #5 (5) #9 5# -. c) In this e(ample$ relevant costs are the variable costs of in-house manufacture$ the variable costs of sub-contracted units$ and the saving in fi(ed costs.8. 7@ercise 4. :ow attempt e(ercise 6. 9 #7 5 #5 #. In practice$ this may not materialise. d) 1ther important considerations are as follows: i) If components @ and L are sub-contracted$ the company will have spare capacity. Make or buy . Bowever$ for product L$ the decision to buy rather than make would only be financially attractive if the fi(ed cost savings of CD$777 could be delivered by management. Bow should that spare capacity be profitably usedP !re there hidden benefits to be obtained from sub-contractingP @ill there be resentment from the workforceP ii) @ould the sub-contractor be reliable with delivery times$ and is the 3uality the same as those manufactured internallyP iii) )oes the company wish to be fle(ible and maintain better control over operations by making everything itselfP iv) !re the estimates of fi(ed costs savings reliableP In the case of product @$ buying is clearly cheaper than making in-house.$777 8$777 H(tra variable cost of buying per annum (5$777) D$777 #5$777 E$777 Fi(ed cost saved by buying H(tra total cost of buying #$777 6$777 E$777 D$777 (8$777) 8$777 E$777 (5$777) b) &he company would save C8$777'annum by sub-contracting component @$ and C5$777'annum by sub-contracting component L.
g. It is possible for shutdown problems to be simplified into short run decisions$ by making one of the following assumptions . b) Indicate the level of production re3uired that would make 0oya decide in favour of manufacturing the . a) )etermine whether 0oya manufacture it in-house. b) If the decision is to shut down$ whether the closure should be permanent or temporary. &here will be lump sums payments involved which must be taken into consideration.67 is considered to be competitive$ and the supplier has maintained good 3uality service over the last five years. . &he variable cost per unit produced is estimated at C#.57 and additional annual fi(ed costs that would be incurred if the . should continue to purchase the .ip or anufacturing 4td.ip$ a component used by Aoya )a$"!a+t"ri$3 Ltd&( is incorporated into a number of its completed products.&he . &he . !hutdown problems . e) Hmployees affected by the closure must be made redundant or relocated$ perhaps even offered early retirement. property$ might have a substantial sale value.hutdown problems involve the following types of decisions: a) @hether or not to close down a factory$ department$ product line or other activity$ either because it is making losses or because it is too e(pensive to run. &he shutdown decision would involve an assessment of the net capital cost of closure (C# million) against the annual benefits (C#77$777 per annum). d) "losure results in release of some fi(ed assets for sale. .ip itself. For e(ample$ suppose closure of a regional office results in annual savings of C#77$777$ fi(ed assets sold off for C5 million$ but redundancy payments would be C8 million. anufacturing 4td. has submitted a proposal to manufacture the . &he production engineering department at 0oya anufacturing 4td.67 per component and some 57$777 are used annually in production.ip is purchased from a supplier at C5. &he price of C5.hutdown decisions often involve long term considerations$ and capital e(penditures and revenues.ip were manufactured are estimated at C57$D77.ip in-house. c) ! shutdown should result in savings in annual operating costs for a number of years in the future.ome assets might have a small scrap value$ but others$ e.
:ow attempt e(ercise 6..wans$ )ucks and "hicks. In these circumstances the financial aspects of shutdown decisions would be based on short run relevant costs. &he present net annual income from each item is as follows: 5. a) !dvise *rass 4td. C6$777 of the fi(ed costs of )ucks are direct fi(ed costs which would be saved if production ceased.7$777 E7$777 #67$777 Fariable costs 87$777 56$777 86$777 A7$777 "ontribution Fi(ed costs . whether or not to cease production of )ucks.a) Fi(ed asset sales and redundancy costs would be negligible.uppose$ however$ it were possible to use the resources realised by stopping production of )ucks$ and switch to produce a new item$ Hagles$ which would sell for C67$777 and incur variable costs of C87$777 and e(tra fi(ed costs of CE$777..ans %ucks #hicks Total " . b) Income from fi(ed asset sales would match redundancy costs and so these items would be self-cancelling. It is felt that selling prices cannot be increased or lowered without adversely affecting net income. b) .3 Adding or deleting 'roducts Bra Ltd& manufactures three products$ . !ll other fi(ed costs will remain the same.ales " " " 67$777 . 7@ercise 4. @hat will the new decision beP . is concerned about its poor profit performance$ and is considering whether or not to cease selling )ucks.rofit'(loss) 57$777 #6$777 56$777 E7$777 #9$777 #D$777 57$777 66$777 8$777 (8$777) 6$777 6$777 *rass 4td.
Key terms *reakeven analysis "ontribution'sales ratio "ost-volume-profit analysis )ecision making ake or buy decisions 1pportunity costs . &ypical investment decisions include the decision to build another grain silo$ cotton gin or cold store or invest in a new distribution depot. Chapter ob ectives &his chapter is intended to provide: .-nvestment decisions .tructure of the chapter "apital budgeting versus current e(penditures &he classification of investment pro+ects &he economic evaluation of investment proposals :et present value vs internal rate of return !llowing for inflation Key terms "apital budgeting is vital in marketing decisions. It could be much more profitable putting the planned investment money in the bank and earning interest$ or investing in an alternative pro+ect.hutdown #ha'ter 6 . /nless the pro+ect is for social reasons only$ if the investment is unprofitable in the long run$ it is unwise to invest in it now. )ecisions on investment$ which take time to mature$ have to be based on the returns which that investment will make. !t a lower level$ marketers may wish to evaluate whether to spend more on advertising or increase the sales force$ although it is difficult to measure the sales to advertising ratio. 1ften$ it would be good to know what the present value of the future investment is$ or how long it will take to mature (give returns).rofit-volume charts -elevant costs .#a'ital budgeting "hapter ob+ectives .
!s a result$ most medium-si%ed and large organisations have developed special procedures and methods for dealing with these decisions. ! systematic approach to capital budgeting implies: a) the formulation of long-term goals b) the creative search for and identification of new investment opportunities c) classification of pro+ects and recognition of economically and'or statistically dependent proposals .• !n understanding of the importance of capital budgeting in marketing decision making • !n e(planation of the different types of investment pro+ect • !n introduction to the economic evaluation of investment proposals • &he importance of the concept and calculation of net present value and internal rate of return in decision making • &he advantages and disadvantages of the payback method as a techni3ue for initial screening of two or more competing pro+ects. Bowever$ it seeks to build on the concept of the future value of money which may be spent now. &he sub+ect matter is difficult to grasp by nature of the topic covered and also because of the mathematical content involved. !tructure of the chapter "apital budgeting is very obviously a vital activity in business. It does this by e(amining the techni3ues of net present value$ internal rate of return and annuities. &he timing of cash flows are important in new investment decisions and so the chapter looks at this "payback" concept.. &he chapter ends by showing how marketers can take this in to account. Fast sums of money can be easily wasted if the investment turns out to be wrong or uneconomic. 1ne problem which plagues developing countries is "inflation rates" which can$ in some cases$ e(ceed #77J per annum. Capital budgeting versus current e+penditures ! capital investment pro+ect can be distinguished from current e(penditures by two features: a) such pro+ects are relatively large b) a significant period of time (more than one year) elapses between the investment outlay and the receipt of the benefits.
g. e) *y type of cash flow • "onventional cash flow: only one change in the cash flow sign e. b) *y type of benefit to the firm • an increase in cash flow • a decrease in risk • an indirect benefit (showers for workers$ etc). The classification of investment pro ects a) *y pro+ect si%e .mall pro+ects may be approved by departmental managers. c) *y degree of dependence • mutually e(clusive pro+ects (can e(ecute pro+ect ! or *$ but not both) • complementary pro+ects: taking pro+ect ! increases the cash flow of pro+ect *. • substitute pro+ects: taking pro+ect ! decreases the cash flow of pro+ect *.d) the estimation and forecasting of current and future cash flows e) a suitable administrative framework capable of transferring the re3uired information to the decision level f) the controlling of e(penditures and careful monitoring of crucial aspects of pro+ect e(ecution g) a set of decision rules which can differentiate acceptable from unacceptable alternatives is re3uired. d) *y degree of statistical dependence • .tatistical independence.ositive dependence • :egative dependence • . ore careful analysis and *oard of )irectors2 approval is needed for large pro+ects of$ say$ half a million dollars or more. &he last point (g) is crucial and this is the sub+ect of later sections of the chapter. -'>>>> or >'----$ etc .
. ii) &he risk of the capital sum not being repaid. FC consists of: i) the original sum of money invested$ and ii) the return in the form of interest. oney can be used to earn more money. &he earlier the money is received$ the greater the potential for increasing wealth. iii) Inflation: money may lose its purchasing power over time. &his uncertainty re3uires a premium as a hedge against the risk$ hence the return must be commensurate with the risk being undertaken. *orrowing is only worthwhile if the return on the loan e(ceeds the cost of the borrowed funds. &hus$ to forego the use of money$ you must get some compensation. If the lender receives no compensation$ he'she will be worse off when the loan is repaid than at the time of lending the money. The economic evaluation of investment proposals &he analysis stipulates a decision rule for: I) accepting or II) re+ecting investment pro+ects The time value of money -ecall that the interaction of lenders with borrowers sets an e3uilibrium rate of interest. &he interest rate received by the lender is made up of: i) &he time value of money: the receipt of money is preferred sooner rather than later.• :on-conventional cash flows: more than one change in the cash flow sign$ e. a) Future values/com'ound interest Future value (FF) is the value in dollars at some point in the future of one or more investments.g. 4ending is only worthwhile if the return is at least e3ual to that which can be obtained from alternative opportunities in the same risk class. &he lender must be compensated for the declining spending'purchasing power of money. >'-'>>> or -'>'-'>>>>$ etc.
< r(n *y denoting Co by PC we obtain: FCn B PC 0.5 7@ercise 6.#7 at the end of 6 yearsP . :ow attempt e(ercise E.< r(n we derive: -ationale for the formula: !s you will see from the following e(ercise$ given the alternative of earning #7J on his money$ an individual (or firm) should never offer (invest) more than C#7. :ow attempt e(ercise E.#.77 to obtain C##.< r(n by dividing both sides of the formula by 0.F) by using the formula: FCn < Co 0.&he general formula for computing Future Falue is as follows: FCn < Vo (l ? r)$ where Fo is the initial sum invested r is the interest rate n is the number of periods for which the investment is to receive interest.& Present value i) @hat is the present value of C##. 7@ercise 6.77 at the end of one yearP ii) @hat is the .77 with certainty at the end of the year.F of C#E.1 Future values/com'ound interest i) @hat is the future value of C#7 invested at #7J at the end of # yearP ii) @hat is the future value of C#7 invested at #7J at the end of 6 yearsP @e can derive the .resent Falue (. &hus we can compute the future value of what Fo will accumulate to in n years when it is compounded annually at the same rate of r by using the above formula.
&he discount factor r can be calculated using: H(amples: N&B& !t this point the tutor should introduce the net present value tables from any recognised published source.F is positive (>): a++ept the proBe+t If :.. 7@ercise 6.F is negative(-): reBe+t the proBe+t :ow attempt e(ercise E.8. +et 'resent value . )ecision rule: If :.F method is used for evaluating the desirability of investments or pro+ects. )o that now.b) +et 'resent value 0+PC( &he :. where: "t < the net cash receipt at the end of year t Io < the initial investment outlay r < the discount rate'the re3uired minimum rate of return on investment n < the pro+ect'investment2s duration in years.
FF!t.! firm intends to invest C#$777 in a pro+ect that generated net receipts of CD77$ CA77 and CE77 in the first$ second and third years respectively..DED < CAA.A7A#) > C.95 !lternatively$ ..96#8) < C. 0"( 7 # 5 -D77 .F < CAA.77 .D5E.CD77.D5E.65 < CAA. c) Annuities N&B& Introduce students to annuity tables from any recognised published source.77(7. > C887.77(7.77 .95 . > 7..6E > C877.i) (8$7$#7) < C.hould the firm go ahead with the pro+ectP !ttempt the calculation without reference to net present value tables first.F of an annuity 6 C.77(7.A7A# > 7.96#8) < C8E8. .95 :.95 ..77 < C#A.77 (.) > C.77 8 .. H(ample: =ear #ash Flo.E.77 (7. ! set of cash flows that are e3ual in each and every period is called an annuity.77 ( 5.F < C.
CD77. It is an e3ual sum of money to be paid in each period forever.$EEE.olution: . . where: C is the sum to be received per period r is the discount rate or interest rate H(ample: Nou are promised a perpetuity of C977 per year at a rate of interest of #6J per annum.95 .:.77 < C#A...95 d) Per'etuities ! perpetuity is an annuity with an infinite life.F < CAA.F) should you be willing to pay for this incomeP < C.E9 ! perpetuity with growth: . @hat price (.ubtract the growth rate from the discount rate and treat the first period2s cash flow as a perpetuity.uppose that the C977 annual income most recently received is e(pected to grow by a rate 0 of 6J per year (compounded) forever. Bow much would this income be worth when discounted at #6JP .
F for a pro+ect e3uals %ero.( -efer students to the tables in any recognised published source. • &he I-. H(ample: @hat is the I-. • &he I-.#7 < C9$867 e) The internal rate of return 0-.< "n).is the break-even discount rate..is found by trial and error..is the discount rate at which the :.of an annuity: where: 8 0n9r( is the discount factor -o is the initial outlay # is the uniform annual receipt ("# < "5 <.. • &he I-.J Hconomic rationale for I--: . &his rate means that the present value of the cash inflows for the pro+ect would e3ual the present value of its outflows.< C986'7.of an e3ual annual income of C57 per annum which accrues for 9 years and costs C#57P <E From the tables < .. 'here r 6 IRR I-.
of this pro+ect for a firm with a 57J cost of capital: =7A..e.electing one pro+ect does not preclude the choosing of the other.F and I-.or :. Figure 6.3 -nternal rate of return Find the I-.FP a) +PC vs -. :ow attempt e(ercise E. 7@ercise 6. #A5E F: D " 7 # -#7$777 D$777 5 E$777 a) &ry 57J b) &ry 59J c) &ry 5AJ .. @ith conventional cash flows (-T>T>) no conflict in decision arisesI in this case both :.methods are closely related because: i) both are time-ad+usted measures of profitability$ and ii) their mathematical formulas are almost identical. it is profitable to undertake.e(ceeds cost of capital$ pro+ect is worthwhile$ i.F and I-.o$ which method leads to an optimal decision: I-.* -nde'endent 'roAects Independent pro+ect: .If I-. .et present value vs internal rate of return -nde'endent vs de'endent 'roAects :.1 +PC vs -. -nde'endent 'roAects ..lead to the same accept're+ect decisions.
* %e'endent 'roAects :.F < 7 then .ince the numerators "t are identical and positive in both instances: • implicitly'intuitively .F lead to the same decision in this case. is the I--.< k: the company is indifferent to such a pro+ectI • Bence$ I-.F is negative and I-.F clashes with I-. H(ample: .must be greater than k (.imilarly for the same pro+ect to be acceptable: where . . . b) +PC vs -. If cash flows are discounted at k5$ :. athematical proof: for a pro+ect to be acceptable$ the :.F must be positive$ i.and :.? k#: accept pro+ect.? k)I • If :.F is positive and I-.U k5: re+ect the pro+ect.e.where mutually e(clusive pro+ects e(ist..If cash flows are discounted at k#$ :.
.ro+ect * -#6$777 utlay +et -nflo.E.5#-# therefore -.ro+ect ! -A$677 . at the =ear 7nd ##$677 #D$777 !ssume k < #7J$ which pro+ect should !grite( undertakeP < CA6.A* C##$677 < CA$677 (# >-!) < #... *oth pro+ects are of one-year duration: -.A < 5#J -.66 < C#$8E8.!grite( is considering building either a one-storey (.B* C#D$777 < C#6$777(# > -*) . &he following information is available: -nitial -nvestment .ro+ect !) or five-storey (..ro+ect *) block of offices on a prime site.
F* (C#$8E8.method: I--! (5#J) ? I--* (57J): !grite( should choose ..< #. If we use the I-.F* are both positive I--! ? k !:) I--* ? k @hich pro+ect is a "better option" for !grite(P If we use the :.E..ro+ect !.5.ee figure E.F! and :.66): !grite( should choose .* %e'endent 'roAects /p to a discount rate of ko: pro+ect * is superior to pro+ect !$ therefore pro+ect * is preferred to pro+ect !.) ? :. . Figure 6..5-# therefore -.& +PC vs -.B < 57J )ecision: !ssuming that k < #7J$ both pro+ects are acceptable because: :.F method: :. .F! (CA6.ro+ect *.
A < 8EJ (from the tables) -.$777 < C8$.*eyond the point ko: pro+ect ! is superior to pro+ect *$ therefore pro+ect ! is preferred to pro+ect * &he two methods do not rank the pro+ects the same..D9 < C8$987.67 .B B . +PCA < C#$677 ( .C#. H(ample: =ears 1 1 & .ro+ect ! -5$677 #$677 #$677 #$677 ..may give conflicting decisions where pro+ects differ in their scale of investment.A B < #.D9 < C#9$.$777 9$777 9$777 9$777 !ssume k< #7J.. .77.ro+ect * -#.F and I-.. &herefore -.77 < C#$587.7A . -.67..FF! at #7J for 8 years < C#$677 ( 5.C5$677.7A. %ifferences in the scale of investment :.E9.FF! at #7J for 8 years < C9$777 ( 5. +PCB << C9$777 ( .
F is superior to the I-- ..7 &herefore -.77 5#J ..ro+ect ! C 8$987.prefers ! to * +PC -.ro+ect * C#9$.77.67 8EJ .F prefers *$ the larger pro+ect$ for a discount rate below 57J ii) the :. 5cale of investments &o show why: i) the :.< 5.8.ee figure E..F prefers * to ! • I-. . Figure 6.B < 5#J )ecision: "onflicting$ as: • :.
:. e) &he I--"* minus !" on the incremental cash flow is 57J. the I-. 1 . )isadvantage of I--: • It e(presses the return in a percentage form rather than in terms of absolute dollar returns$ e. .ro+ect * .F! .##$677 6$677 6$677 6$677 I--"* < 5.7A < 57J c) "hoosing * is e3uivalent to: ! > (* . indifferent to pro+ects ! and *.e.ro+ect ! 1 & .g. Bowever$ most inus !" .$777 9$777 9$777 9$777 .5$677 #$677 #$677 #$677 "* minus !" . g) *ut$ if k were greater than the I-.!") the company should accept pro+ect !. i) If k < 57J (I-.of "* .!) < * d) "hoosing the bigger pro+ect * means choosing the smaller pro+ect ! plus an additional outlay of C##$677 of which C6$677 will be realised each year for the ne(t 8 years.a) /se the incremental cash flow approach$ "* minus !" approach b) "hoosing pro+ect * is tantamount to choosing a hypothetical pro+ect "* minus !". h) !t the point of intersection$ :.(57J) on the incremental "F$ then re+ect pro+ect.F: • It ensures that the firm reaches an optimal scale of investment.will prefer 677J of C# to 57J return on C#77.F* or :. f) 0iven k of #7J$ this is a profitable opportunity$ therefore must be accepted.F* < 7$ i.F criterion.#. • &his +ustifies the use of :.F! < :. !dvantage of :.
7J #7. target sales figure of C5.o$ the decision is to accept !$ that is * > (! . .#77 57 #56.companies set their goals in absolute terms and not in J terms$ e.. :ote that initial outlay Io is the same.prefers * to ! even though both pro+ects have identical initial outlays.56 . .. &he I-.D7 DD.*) < !.ee figure E.7J #E.ro+ect ! .E I-.ro+ect ! . .AJ "! minus *" 7. Figure 6.3 Timing of the cash flo. .ro+ect * 1 & ..9 56.may give conflicting decisions where the timing of cash flows varies between the 5 pro+ects. The timing of the cash flo.77 . 1 .g.6 million.ro+ect * #9.#6 "! minus *" 7 !ssume k < #7J +PC -.#77 #77 8#.8 57.
#9.. +PC -. .F and I-.ro+ect ! -#77 #57 . 3 ..rankings are contradictory. .ro+ect ! A .ro+ect * -#77 !ssume k < #7J . 1 1 &..ro+ect * #A )ecision: 57J #6J ..The horiKon 'roblem :.ro+ect ! earns C#57 at the end of the first year while pro+ect * earns C#9. at the end of the fourth year.
7 #$777 #.Io < 7 .I of #.prefers ! to *.ro+ect * #$677 )ecision: -o 67 P5.6 "hoose option * because it ma(imises the firm2s profitability by C#$677.F < 7$ we have: :. H(ample: PC of #F .I ? #I accept the pro+ect . )ecision rule: .5 means that the pro+ect2s profitability is 57J. The 'ayback 'eriod 0PP( . )isadvantage of .F method.F < .P&his is a variant of the :.F < Io )ividing both sides by Io we get: .F prefers * to ! I-.it is a percentage and therefore ignores the scale of investment. The 'rofitability inde@ .I: 4ike I-.ro+ect ! #77 .:.I U #I re+ect the pro+ect If :.F .
e.um of money to be recovered by end of 8rd year < C#7$777 .ro+ect * . 3 . @hen deciding between two or more competing pro+ects$ the usual decision is to accept the one with the shortest payback.C9$677 < C5$677 . . years H(ample 5: =ears 1 1 & . . H(ample #: =ears 1 1 & .ayback period lies between year 5 and year 8.ayback is often used as a "first screening method".ro+ect ! #$777$777 567$777 567$777 567$777 567$777 567$777 For a pro+ect with e3ual annual receipts: < .&he "I ! defines payback as 2the time it takes the cash inflows from a capital investment pro+ect to e3ual the cash outflows$ usually e(pressed in years2.$777 #$777 .#7$777 6$777 5$677 .um of money recovered by the end of the second year < C9$677$ i. (C6$777 > C5$677) . *y this$ we mean that when a capital investment pro+ect is being considered$ the first 3uestion to ask is: 2Bow long will it take to pay back its costP2 &he company might have a target payback$ and so it would re+ect a capital pro+ect unless its payback period were less than a certain number of years. 3 4 .
:ote that net annual profit e(cludes depreciation. • It may lead to e(cessive investment in short-term pro+ects. If it e(ceeds a target rate of return$ the pro+ect will be undertaken. !ssuming straight-line depreciation of C#77$777 per year: . &his means that it does not take into account the fact that C# today is worth more than C# in one year2s time. !n investor who has C# today can either consume it immediately or alternatively can invest it at the prevailing interest rate$ say 87J$ to get a return of C#. • It ignores the time value of money. • It is unable to distinguish between pro+ects with the same payback period.E56 years )isadvantages of the payback method: • It ignores the timing of cash flows within the payback period$ the cash flows after the end of payback period and therefore the total pro+ect return. !dvantages of the payback method: • . The accounting rate of return .ayback can be important: long payback means capital tied up and high investment risk..87 in a year2s time. &he method also has the advantage that it involves a 3uick$ simple calculation and an easily understood concept.( &he !-.method (also called the return on capital employed (-1"H) or the return on investment (-1I) method) of appraising a capital pro+ect is to estimate the accounting rate of return that the pro+ect should yield. H(ample: ! pro+ect has an initial outlay of C# million and generates net receipts of C567$777 for #7 years.< 5.0A.
• It is appropriate in situations where risky investments are made in uncertain markets that are sub+ect to fast design and product changes or where future cash flows are particularly difficult to predict. The 'ayback and A. • It is based on accounting profits and not cash flows.< #6J < 87J )isadvantages: • It does not take account of the timing of the profits from an investment. methods in 'ractice )espite the limitations of the payback method$ it is the method most widely used in practice. • It implicitly assumes stable cash receipts over time. • It takes no account of the length of the pro+ect. • It is a relative measure rather than an absolute measure and hence takes no account of the si%e of the investment. • it ignores the time value of money.. . !ccounting profits are sub+ect to a number of different accounting treatments. &here are a number of reasons for this: • It is a particularly useful approach for ranking pro+ects where a firm faces li3uidity constraints and re3uires fast repayment of investments.
..6. .$777 Hstimated scrap value at the end of Near .$677 . . *elta Corporatio$ is considering two capital e(penditure proposals.$677 5$677 . *oth proposals are for similar products and both are e(pected to operate for four years.• &he method is often used in con+unction with :. 7@ercise 6.$777 )epreciation is charged on the straight line basis.roblem: a) "alculate the following for both proposals: .F or I-.rofit #. • It provides an important summary method: how 3uickly will the initial investment be recoupedP :ow attempt e(ercise E. • it is easily understood by all levels of management.method and acts as a first screening device to identify pro+ects which are worthy of further investigation.E$777 . &he following information is available: Profit/0loss( Pro'osal A Pro'osal B " Initial investment Near # Near 5 Near 8 Near .$677 4oss #$677 . 1nly one proposal can be accepted.4 Payback and A.E$777 E$677 8$677 #8$677 " .
If it invested C#7$777 for one year on # Manuary$ then on 8# )ecember it would re3uire a minimum return of C.7J under the present conditions.i) the payback period to one decimal place ii) the average rate of return on initial investment$ to one decimal place. For e(ample$ one might be happy with a return of #7J with %ero inflation$ but if inflation was 57J$ one would e(pect a much greater return.$777. @ith the initial investment of C#7$777$ the total value of the investment by 8# )ecember must increase to C#. . !s inflation rate increases$ so will the minimum return re3uired by an investor.hould Keymer Farm go ahead with the pro+ectP 4et us take a look at Keymer Farm2s re3uired rate of return. @e can restate the amount received on 8# )ecember in terms of the purchasing power of the dollar at # Manuary as follows: !mount received on 8# )ecember in terms of the value of the dollar at # Manuary: . H(ample: 7eymer 9arm is considering investing in a pro+ect with the following cash flows: A#T!A: #A5E F: D5 T-M7 F" 7 # 5 8 (#77$777) A7$777 D7$777 97$777 Keymer Farm re3uires a minimum return of . Inflation is particularly important in developing countries as the rate of inflation tends to be rather high. Inflation is currently running at 87J a year$ and this is e(pected to continue indefinitely. )uring the year$ the purchasing value of the dollar would fall due to inflation. Allowing for inflation .o far$ the effect of inflation has not been considered on the appraisal of capital investment proposals.$777.
6#7 31H PC " (#77$777) E. " 7 # 5 (#67$777) A7$777 D7$777 #. In Keymer Farm2s case$ the cash flows are e(pressed in terms of the actual dollars that will be received or paid at the relevant dates.8) < #. In the e(ample$ (# > 7..7) < (# > 7. b) If the cash flows are e(pressed in terms of the value of the dollar at time 7 (i.7J is a money rate of return (sometimes known as a nominal rate of return).$5E7 .< C#7$9EA In terms of the value of the dollar at # Manuary$ Keymer Farm would make a profit of C9EA which represents a rate of return of 9.9#.79EA) ( (# > 7. &he re3uired rate of . &he two rates of return and the inflation rate are linked by the e3uation: (# > money rate) < (# > real rate) ( (# > inflation rate) where all the rates are e(pressed as proportions. &herefore$ we should discount them using the money rate of return. &he money rate measures the return in terms of the dollar$ which is falling in value.e. 7. T-M7 #A5E F: D %-5# !+T FA#T . &his is known as the real rate of return.777 7.7 .o$ which rate is used in discountingP !s a rule of thumb: a) If the cash flows are e(pressed in terms of actual dollars that will be received or paid in the future$ the money rate for discounting should be used. in constant price level terms)$ the real rate of discounting should be used.EAJ in "today2s money" terms.7$D77 .. &he real rate measures the return in constant price level terms.
&he pro+ect has a positive net present value of C87$6;7$ so Keymer Farm should go ahead with the pro+ect. &he future cash flows can be re-e(pressed in terms of the value of the dollar at time 7 as follows$ given inflation at 87J a year:
T-M7 A#T!A: #A5E F: D #A5E F: D AT T-M7 1 P,-#7 :7C7: " 7 # (#77$777) A7$777 (#77$777) EA$58# "
&he cash flows e(pressed in terms of the value of the dollar at time 7 can now be discounted using the real value of 9.EAJ.
T-M7 #A5E F: D %-5# !+T FA#T , " 7 # (#77$777) EA$58# #.777 ?.6>H
PC " (#77$777) E;$5;E
87$6;7 &he :.F is the same as before. 7@'ectations of inflation and the effects of inflation @hen a manager evaluates a pro+ect$ or when a shareholder evaluates his'her investments$ he'she can only guess what the rate of inflation will be. &hese guesses will probably be wrong$ at least to some e(tent$ as it is e(tremely difficult to forecast the rate of inflation accurately. &he only way in which uncertainty about inflation can be allowed for in pro+ect evaluation is by risk and uncertainty analysis. Inflation may be 3e$eral( that is$ affecting prices of all kinds$ or pe+i!i+ to particular prices. 0eneralised inflation has the following effects: a) Inflation will mean higher costs and higher selling prices. It is difficult to predict the effect of higher selling prices on demand. ! company that raises its prices by 87J$ because the general rate of inflation is 87J$ might suffer a serious fall in demand. b) Inflation$ as it affects financing needs$ is also going to affect gearing$ and so the cost of capital. c) ,ince fi(ed assets and stocks will increase in money value$ the same 3uantities of assets must be financed by increasing amounts of capital. If the future rate of inflation can be predicted with some degree of accuracy$ management can work out how much e(tra finance the company will need and take steps to obtain it$ e.g. by increasing retention of earnings$ or borrowing. Bowever$ if the future rate of inflation cannot be predicted with a certain amount of accuracy$ then management should estimate what it will be and make plans to obtain the e(tra finance accordingly. .rovisions should also be made to have access to 2contingency funds2 should the rate of inflation e(ceed e(pectations$ e.g. a higher bank overdraft facility might be arranged should the need arise. any different proposals have been made for accounting for inflation. &wo systems known as ""urrent purchasing power" ("..) and ""urrent cost accounting" (""!) have been suggested.
".. is a system of accounting which makes ad+ustments to income and capital values to allow for the general rate of price inflation. ""! is a system which takes account of specific price inflation (i.e. changes in the prices of specific assets or groups of assets)$ but not of general price inflation. It involves ad+usting accounts to reflect the current values of assets owned and used. !t present$ there is very little measure of agreement as to the best approach to the problem of 2accounting for inflation2. *oth these approaches are still being debated by the accountancy bodies. :ow attempt e(ercise E.E. 7@ercise 6.6 -nflation &! Boldings is considering whether to invest in a new product with a product life of four years. &he cost of the fi(ed asset investment would be C8$777$777 in total$ with C#$677$777 payable at once and the rest after one year. ! further investment of CE77$777 in working capital would be re3uired. &he management of &! Boldings e(pect all their investments to +ustify themselves financially within four years$ after which the fi(ed asset is e(pected to be sold for CE77$777. &he new venture will incur fi(ed costs of C#$7;7$777 in the first year$ including depreciation of C;77$777. &hese costs$ e(cluding depreciation$ are e(pected to rise by #7J each year because of inflation. &he unit selling price and unit variable cost are C5; and C#5 respectively in the first year and e(pected yearly increases because of inflation are DJ and #;J respectively. !nnual sales are estimated to be #96$777 units. &! Boldings money cost of capital is 5DJ. Is the product worth investing inP
!ccounting rate of return !nnuities "apital budgeting "ash flow "lassification of investment pro+ects "ompound interest "urrent cost accounting (""!) "urrent purchasing power ("..) )ependent pro+ects Independent pro+ects
:ormally$ such developments are financed internally$ whereas capital for the ac3uisition of machinery may come from e(ternal sources. . &raditional areas of need may be for capital asset ac3uirement . &he development of new products can be enormously costly and here again capital may be re3uired.erpetuity .ources of funds 1rdinary (e3uity) shares 4oan stock -etained earnings *ank lending 4easing Bire purchase 0overnment assistance Fenture capital Franchising Key terms .Inflation Interest rate Internal rate of return Investment decision :et present value .new machinery or the construction of a new building or depot.ayback period .5ources of finance "hapter ob+ectives .tructure of the chapter .resent value -ates of return &he time value of money #ha'ter ? . Interest rates can vary from organisation to organisation and also according to purpose. In this day and age of tight li3uidity$ many organisations have to look for short term capital in the way of overdraft or loans in order to provide a cash flow cushion.ourcing money may be done for a variety of reasons.
&hese alternatives include bank borrowing$ government assistance$ venture capital and franchising. &hey have a nominal or 2face2 value$ typically of C# or 67 cents. &he market value of a 3uoted company2s shares bears . Ordinary 'e#uity( shares 1rdinary shares are issued to the owners of a company. Bowever$ whilst these may be "traditional" ways of raising funds$ they are by no means the only ones. !ources of funds ! company might raise new funds from the following sources: • &he capital markets: i) new share issues$ for e(ample$ by companies ac3uiring a stock market listing for the first time ii) rights issues • 4oan stock • -etained earnings • *ank borrowing • 0overnment sources • *usiness e(pansion scheme funds • Fenture capital • Franchising. &here are many more sources available to companies who do not wish to become "public" by means of share issues. !tructure of the chapter &his final chapter starts by looking at the various forms of "shares" as a means to raise new capital and retained earnings as another source.Chapter ob ectives &his chapter is intended to provide: • !n introduction to the different sources of finance available to management$ both internal and e(ternal • !n overview of the advantages and disadvantages of the different sources of funds • !n understanding of the factors governing the choice between different sources of funds. !ll have their own advantages and disadvantages and degrees of risk attached.
shares issues ! company seeking to obtain additional e3uity funds may be: a) an un3uoted company wishing to obtain a . +e.tock H(change 3uotation . ii) If the number of new shares being issued is small compared to the number of shares already in issue$ it might be decided instead to sell them to new shareholders$ since ownership of the company would only be minimally affected. c) &he company might issue new shares to the shareholders of another company$ in order to take it over. ! new issue of shares might be made in a variety of different circumstances: a) &he company might want to raise more cash.imply retaining profits$ instead of paying them out in the form of dividends$ offers an important$ simple low-cost source of finance$ although this method may not provide enough funds$ for e(ample$ if the firm is seeking to grow. Foting rights might also differ from those attached to other ordinary shares.no relationship to their nominal value$ e(cept that when ordinary shares are issued for cash$ the issue price must be e3ual to or be more than the nominal value of the shares. b) &he company might want to issue shares partly to raise cash$ but more importantly to float2 its shares on a stick e(change. 1rdinary shareholders put funds into their company: a) by paying for a new issue of shares b) through retained profits. If it issues ordinary shares for cash$ should the shares be issued pro rata to e(isting shareholders$ so that control or ownership of the company is not affectedP If$ for e(ample$ a company with 577$777 ordinary shares in issue decides to issue 67$777 new shares to raise cash$ should it offer the new shares to e(isting shareholders$ or should it sell them to new shareholders insteadP i) If a company sells the new shares to e(isting shareholders in proportion to their e(isting shareholding in the company$ we have a ri3ht i "e& In the e(ample above$ the 67$777 shares would be issued as a one-in-four rights issue$ by offering shareholders one new share for every four shares they currently hold. %eferred ordinary shares are a form of ordinary shares$ which are entitled to a dividend only after a certain date or if profits rise above a certain amount. .
b) . @hen companies 2go public2 for the first time$ a 2large2 issue will probably take the form of an offer for sale. 1ffers for sale: !n offer for sale is a means of selling the shares of a company to the public. &he methods by which an un3uoted company can obtain a 3uotation on the stock market are: a) an offer for sale b) a prospectus issue c) a placing d) an introduction. a) !n un3uoted company may issue shares$ and then sell them on the . @hen this occurs$ the company is not raising any new funds$ but +ust providing a wider market for its e(isting shares (all of which would become marketable)$ and giving e(isting shareholders the chance to cash in some or all of their investment in their company. . ! smaller issue is more likely to be a placing$ since the amount to be raised can be obtained more cheaply if the issuing house or other sponsoring firm approaches selected institutional investors privately.hareholders in an un3uoted company may sell some of their e(isting shares to the general public.tock H(change$ to raise cash for the company. .ights issues ! rights issue provides a way of raising new share capital by means of an offer to e(isting shareholders$ inviting them to subscribe cash for new shares in proportion to their e(isting holdings.b) an un3uoted company wishing to issue new shares$ but without obtaining a . ! company making a rights issue must set a price which is low enough to secure the acceptance of shareholders$ who are being asked to provide e(tra funds$ but not too low$ so as to avoid e(cessive dilution of the earnings per share. !ll the shares in the company$ not +ust the new ones$ would then become marketable. For e(ample$ a rights issue on a one-for-four basis at 5D7c per share would mean that a company is inviting its e(isting shareholders to subscribe for one new share for every four shares they hold$ at a price of 5D7c per new share.tock H(change wishing to issue additional new shares.tock H(change 3uotation c) a company which is already listed on the .
. • &he issue of preference shares does not restrict the company2s borrowing power$ at least in the sense that preference share capital is not secured against assets in the business. Bolders of loan stock are therefore long-term creditors of the company.ince they do not carry voting rights$ preference shares avoid diluting the control of e(isting shareholders while an issue of e3uity shares would not. Furthermore$ for preference shares to be attractive to investors$ the level of payment needs to be higher than for interest on debt to compensate for the additional risks.reference shares have a fi(ed percentage dividend before any dividend is paid to the ordinary shareholders. From the company2s point of view$ preference shares are advantageous in that: • )ividends do not have to be paid in a year in which profits are poor$ while this is not the case with interest payments on long term debt (loans or debentures). -oan stock 4oan stock is long-term debt capital raised by a company for which interest is paid$ usually half yearly and at a fi(ed rate. For the investor$ preference shares are less attractive than loan stock because: • they cannot be secured on the company2s assets • the dividend yield traditionally offered on preference dividends has been much too low to provide an attractive investment compared with the interest yields on loan stock in view of the additional risk involved. &he arrears of dividend on cumulative preference shares must be paid before any dividend is paid to the ordinary shareholders. -edeemable preference shares are normally treated as debt when gearing is calculated. Bowever$ dividend payments on preference shares are not ta( deductible in the way that interest payments on debt are. • . • &he non-payment of dividend does not give the preference shareholders the right to appoint a receiver$ a right which is normally given to debenture holders. !s with ordinary shares a preference dividend can only be paid if sufficient distributable profits are available$ although with 2cumulative2 preference shares the right to an unpaid dividend is carried forward to later years.Preference shares . • /nless they are redeemable$ issuing preference shares will lower the company2s gearing.
ecurity would be related to a specific asset or group of assets$ typically land and buildings.4oan stock has a nominal value$ which is the debt owed by the company$ and interest is paid at a stated "coupon yield" on this amount. &hey may be attractive to both lenders and borrowers when interest rates are volatile. %ebentures .ith a floating rate of interest &hese are debentures for which the coupon rate of interest can be changed by the issuer$ in accordance with changes in market rates of interest. The redem'tion of loan stock 4oan stock and debentures are usually redeemable. &he company would be unable to dispose of the asset without providing a substitute asset for security$ or without the lender2s consent. &hey are issued for a term of ten years or more$ and perhaps 56 to 87 years.tock 5779'7A is redeemable$ at any time between the earliest specified date (in 5779) and the latest date (in 577A). If the debentures pay #DJ nominal interest and the current rate of interest is lower$ say #7J$ the company may try to raise a new loan at . &he rate 3uoted is the gross rate$ before ta(. )ebentures are a form of loan stock$ legally defined as the written acknowledgement of a debt incurred by a company$ normally containing provisions about the payment of interest and the eventual repayment of capital. 5ecurity 4oan stock and debentures will often be e+"red& . For e(ample$ #DJ )ebenture . For e(ample$ if a company issues #7J loan stocky the coupon yield will be #7J of the nominal value of the stock$ so that C#77 of stock will receive C#7 interest each year. &he company would be able$ however$ to dispose of its assets as it chose until a default took place. &he decision by a company when to redeem a debt will depend on: a) how much cash is available to the company to repay the debt b) the nominal rate of interest on the debt. In the event of a default$ the lender would probably appoint a receiver to run the company rather than lay claim to a particular asset. &he issuing company can choose the date. b) Floating chargeI @ith a floating charge on certain assets of the company (for e(ample$ stocks and debtors)$ the lender2s security in the event of a default payment is whatever assets of the appropriate class the company then owns (provided that another lender does not have a prior charge on the assets). !t the end of this period$ they will "mature" and become redeemable (at par or possibly at a value above par). ost redeemable stocks have an earliest and latest redemption date.ecurity may take the form of either a !i#ed +har3e or a !loati$3 +har3e& a) Fi@ed chargeI .
. If$ for e(ample$ because of ta(ation considerations$ they would rather make a capital profit (which will only be ta(ed when shares are sold) than receive current income$ then finance through retained earnings would be preferred to other methods. !nother factor that may be of importance is the financial and ta(ation position of the company2s shareholders. !s far as companies are concerned$ debt capital is a potentially attractive source of finance because interest charges reduce the profits chargeable to corporation ta(. &he ma+or reasons for using retained earnings to finance new investments$ rather than to pay higher dividends and then raise new e3uity for the new investments$ are as follows: a) &he management of many companies believes that retained earnings are funds which do not cost anything$ although this is not true. 1n the other hand$ if current interest rates are 57J$ the company is unlikely to redeem the debt until the latest date possible$ because the debentures would be a cheap source of funds. Bowever$ it is true that the use of retained earnings as a source of funds does not lead to a payment of cash. "ompanies place the title deeds of freehold or long leasehold property as security with an insurance company or mortgage broker and receive cash on loan$ usually repayable over a specified period. c) &he use of retained earnings as opposed to new shares or debentures avoids issue costs. *etained earnings For any company$ the amount of earnings retained within the business has a direct impact on the amount of dividends. From their standpoint$ retained earnings are an attractive source of finance because investment pro+ects can be undertaken without involving either the shareholders or any outsiders. d) &he use of retained earnings avoids the possibility of a change in control resulting from an issue of new shares. ortgages are a specific type of secured loan.#7J to redeem the debt which costs #DJ. . ost organisations owning property which is unencumbered by any charge should be able to obtain a mortgage up to two thirds of the value of the property. &here is no guarantee that a company will be able to raise a new loan to pay off a maturing debt$ and one item to look for in a company2s balance sheet is the redemption date of current loans$ to establish how much new finance is likely to be needed by the company$ and when.rofit re-invested as retained earnings is profit that could have been paid as a dividend. b) &he dividend policy of the company is in practice determined by the directors.
A &he amount of the loan. &he customer must state e(actly how much he wants to borrow.Term . . &he banker must verify$ as far as he is able to do so$ that the amount re3uired . Bank lending *orrowings from banks are an important source of finance to companies.epayment . edium-term loans are loans for a period of from three to ten years. . !t the same time$ a company that is looking for e(tra funds will not be e(pected by investors (such as banks) to pay generous dividends$ nor over-generous salaries to owner-directors. ! loan at a variable rate of interest is sometimes referred to as a !loati$3 rate loa$& 4ongerterm bank loans will sometimes be available$ usually for the purchase of property$ where the loan takes the form of a mortgage.Amount .T5. ! loan may have a fi(ed rate of interest or a variable interest rate$ so that the rate of interest charged will be ad+usted every three$ si($ nine or twelve months in line with recent movements in the *ase 4ending -ate.! company must restrict its self-financing through retained profits because shareholders should be paid a reasonable dividend$ in line with realistic e(pectations$ even if the directors would rather keep the funds for re-investing. 4ending to smaller companies will be at a margin above the bank2s base rate and at either a variable or fi(ed rate of interest.hort term lending may be in the form of: a) an overdraft$ which a company should keep within a limit set by the bank. 4ending on overdraft is always at a variable rate. Interest is charged (at a variable rate) on the amount by which the company is overdrawn from day to dayI b) a short-term loan$ for up to three years. @hen a banker is asked by a business customer for a loan or overdraft facility$ he will consider several factors$ known commonly by the mnemonic PA. *ank lending is still mainly short term$ although medium-term lending is 3uite common these days.Purpose .. &he rate of interest charged on medium-term bank lending to large companies will be a set margin$ with the si%e of the margin depending on the credit standing and riskiness of the borrower.5ecurity P &he purpose of the loan ! loan re3uest will be refused if the purpose of the loan is not acceptable to the bank.
4eased assets have usually been plant and machinery$ cars and commercial vehicles$ but might also be computers and office e3uipment. 'erating leases 1perating leases are rental agreements between the lessor and the lessee whereby: a) the lessor supplies the e3uipment to the lessee b) the lessor is responsible for servicing and maintaining the leased e3uipment c) the period of the lease is fairly short$ less than the economic life of the asset$ so that at the end of the lease agreement$ the lessor can either i) lease the e3uipment to someone else$ and obtain a good rent for it$ or ii) sell the e3uipment secondhand. ! finance house will agree to act as lessor in a finance leasing arrangement$ and so will purchase the car from the dealer and lease it to the company.to make the proposed investment has been estimated correctly. ! car dealer will supply the car. 4easing is$ therefore$ a form of rental. &here are two basic forms of lease: "operating leases" and "finance leases". &he lessor owns a capital asset$ but allows the lessee to use it. Bow will the loan be repaidP @ill the customer be able to obtain sufficient income to make the necessary repaymentsP T @hat would be the duration of the loanP &raditionally$ banks have offered short-term loans and overdrafts$ although medium-term loans are now 3uite common. 5 )oes the loan re3uire securityP If so$ is the proposed security ade3uateP -easing ! lease is an agreement between two parties$ the "lessor" and the "lessee". . Finance leases Finance leases are lease agreements between the user of the leased asset (the lessee) and a provider of finance (the lessor) for most$ or all$ of the asset2s e(pected useful life. &he lessee makes payments under the terms of the lease to the lessor$ for a specified period of time.uppose that a company decides to obtain a company car and finance the ac3uisition by means of a finance lease. &he company will take possession of the car from the . .
!t the end of the lease$ the lessor would not be able to lease the asset to someone else$ as the asset would be worn out. Be will also get capital allowances on his purchase of the e3uipment. • &he lessor invests finance by purchasing assets from suppliers and makes a return out of the lease payments from the lessee. !lternatively$ the lessee might be allowed to sell the asset on the lessor2s behalf (since the lessor is the owner) and to keep most of the sale proceeds$ paying only a small percentage (perhaps #7J) to the lessor. 1perating leases have further advantages: . &he e3uipment is sold to the lessor$ and apart from obligations under guarantees or warranties$ the supplier has no further financial concern about the asset. b) &he lease has a primary period$ which covers all or most of the economic life of the asset. . &he lessor must$ therefore$ ensure that the lease payments during the primary period pay for the full cost of the asset as well as providing the lessor with a suitable return on his investment. 1ther important characteristics of a finance lease: a) &he lessee is responsible for the upkeep$ servicing and maintenance of the asset. &he lessor is not involved in this at all. c) It is usual at the end of the primary lease period to allow the lessee to continue to lease the asset for an indefinite secondary period$ in return for a very low nominal rent. • 4easing might be attractive to the lessee: i) if the lessee does not have enough cash to pay for the asset$ and would have difficulty obtaining a bank loan to buy it$ and so has to rent it in one way or another if he is to have the use of it at allI or ii) if finance leasing is cheaper than a bank loan.rovided that a lessor can find lessees willing to pay the amounts he wants to make his return$ the lessor can make good profits. &he cost of payments under a loan might e(ceed the cost of a lease. Dhy might leasing be 'o'ular &he attractions of leases to the supplier of the e3uipment$ the lessee and the lessor are as follows: • &he supplier of the e3uipment is paid in full at the beginning.car dealer$ and make regular payments (monthly$ 3uarterly$ si( monthly or annually) to the finance house under the terms of the lease.
For e(ample$ the Indigenous *usiness )evelopment "orporation of Limbabwe (I*)") was set up by the government to assist small indigenous businesses in that country. Bire purchase is similar to leasing$ with the e(ception that ownership of the goods passes to the hire purchase customer on payment of the final credit instalment$ whereas a lessee never becomes the owner of the goods. i) &he supplier sells the goods to the finance house. • &he e3uipment is leased for a shorter period than its e(pected useful life. In the case of high-technology e3uipment$ if the e3uipment becomes out-of-date before the end of its e(pected life$ the lessee does not have to keep on using it$ and it is the lessor who must bear the risk of having to sell obsolete e3uipment secondhand.ire purchase Bire purchase is a form of instalment credit. Bowever$ . ! businessman starting up a new business will invest venture capital of his own$ but he will probably need e(tra funding from a source other than his own pocket. 0enture capital Fenture capital is money put into an enterprise which may all be lost if the enterprise fails. iii) &he hire purchase arrangement e(ists between the finance house and the customer. &he finance house will always insist that the hirer should pay a deposit towards the purchase price. ii) &he supplier delivers the goods to the customer who will eventually purchase them. &he si%e of the deposit will depend on the finance company2s policy and its assessment of the hirer. .• &he leased e3uipment does not need to be shown in the lessee2s published balance sheet$ and so the lessee2s balance sheet shows no increase in its gearing ratio. &his is in contrast to a finance lease$ where the lessee might not be re3uired to make any large initial payment. @ith industrial hire purchase$ a business customer obtains hire purchase finance from a finance house in order to purchase the fi(ed asset. Bire purchase agreements usually involve a finance house. !n industrial or commercial business can use hire purchase as a source of finance. /overnment assistance &he government provides finance to companies in cash grants and other forms of direct assistance$ as part of its policy of helping to develop the national economy$ especially in high technology industries and in areas of high unemployment. 0oods bought by businesses on hire purchase include company vehicles$ plant and machinery$ office e3uipment and farming machinery. &he lessee will be able to deduct the lease payments in computing his ta(able profits.
&here is a serious risk of losing the entire investment$ and it might take a long time before any profits and returns materialise.ervices 4td. ! venture capital organisation will only give funds to a company that it believes can succeed$ and before it will make any definite offer$ it will want from the company management: a) a business plan b) details of how much finance is needed and how it will be used c) the most recent trading figures of the company$ a balance sheet$ a cash flow forecast and a profit forecast d) details of the management team$ with evidence of a wide range of management skills e) details of ma+or shareholders f) details of the company2s current banking arrangements and any other sources of finance g) any sales literature or publicity material that the company has issued. ! venture capital organisation will not want to retain its investment in a business indefinitely$ and when it considers putting money into a business venture$ it will also consider its "e(it"$ that is$ how it will be able to pull out of the business eventually (after five to seven years$ say) and realise its profits. *ut there is also the prospect of very high profits and a substantial return on the investment.the term 2venture capital2 is more specifically associated with putting money$ usually in return for an e3uity stake$ into a new business$ a management buy-out or a ma+or e(pansion scheme. H(amples of venture capital organisations are: erchant *ank of "entral !frica 4td and !nglo !merican "orporation . . ! venture capitalist will re3uire a high e(pected rate of return on investments$ to compensate for the high risk. &he institution that puts in the money recognises the gamble inherent in the funding. &he directors of the company must then contact venture capital organisations$ to try and find one or more which would be willing to offer finance. @hen a company2s directors look for help from a venture capital institution$ they must recognise that: • the institution will want an e3uity stake in the company • it will need convincing that the company can be successful • it may want to have a representative appointed to the company2s board$ to look after its interests.
For suitable businesses$ it is an alternative to raising e(tra capital for growth. /nder a franchising arrangement$ a franchisee pays a franchisor for the right to operate a local business$ under the franchisor2s trade name.1 5ources of finance 1utdoor 4iving 4td. !lthough the franchisor will probably pay a large part of the initial investment cost of a franchisee2s outlet$ the franchisee will be e(pected to contribute a share of the investment himself. . &he advantage of a franchise to a franchisee is that he obtains ownership of a business for an agreed number of years (including stock and premises$ although premises might be leased from the franchisor) together with the backing of a large organisation2s marketing effort and e(perience.#. • &he image of the business is improved because the franchisees will be motivated to achieve good results and will have the authority to take whatever action they think fit to improve the results. &he advantages of franchises to the franchisor are as follows: • &he capital outlay needed to e(pand the business is reduced substantially. %ranchising Franchising is a method of e(panding business on less capital than would otherwise be needed. &he franchisee is able to avoid some of the mistakes of many small businesses$ because the franchisor has already learned from its own past mistakes and developed a scheme that works.! high percentage of re3uests for venture capital are re+ected on an initial screening$ and only a small percentage of all re3uests survive both this screening and further investigation and result in actual investments. 7@ercise ?. Franchisors include *udget -ent-a-"ar$ @impy$ :ando2s "hicken and "hicken Inn. &he franchisor must bear certain costs (possibly for architect2s work$ establishment costs$ legal costs$ marketing costs and the cost of other support services) and will charge the franchisee an initial franchise fee to cover set-up costs$ relying on the subse3uent regular payments by the franchisee for an operating profit. &he franchisor may well help the franchisee to obtain loan capital to provide hisshare of the investment cost. arket research indicates the possibility of a large volume of demand and a significant amount of additional capital will be needed to finance production. :ow attempt e(ercise 9.$ an owner-managed company$ has developed a new type of heating using solar power$ and has financed the development stages from its own resources. &hese regular payments will usually be a percentage of the franchisee2s turnover.
and the provider of funds.reference shares -etained earnings -ights issue . on: a) the advantages and disadvantages of loan or e3uity capital b) the various types of capital likely to be available and the sources from which they might be obtained c) the method(s) of finance likely to be most satisfactory to both 1utdoor 4iving 4td.. +otes 1>>. .!-&.ources of funds Fenture capital A''endi@ BA:A+#7 5E77T .!dvise 1utdoor 4iving 4td.1 March 1>>. "1112s 1>>& "1112s . Key terms *ank lending "apital markets )ebentures )eferred ordinary shares Franchising 0overnment assistance Bire purchase 4oan stocks :ew share issue 1rdinary shares .
5 A5 9DE 1&BH.F/:).41NH) 41!: "!. H .. &1&!4 F/:).D. "/--H:& !.4/.ocieties FI:!:"H .tores )ebtors "ash on hand *ank balance &otal current assets "/--H:& 4I!*I4I&IH.-1FI)H) F-1 "apital -eserve &-!)I:0 . . 995 A57 578 7...A #87 7.H&..41N H:& 1F F/:).I&!4 0overnment -H)HH !*4H 41!:.hort-term advances D98 757 8#9 D67 E 9 E77 5#9 #E# 5#A ## . .. 656 # E95 #5. 7DD 6.8 589 6 #6A 9./-.tocks and .5 86 E. . 59E 8 58 95 5 ##7 A99 ED 779 .D #7 7AE 8. . 69 . H .41NH) H . *uilding .E 57. FIGH) !.1/-"H.H&.
A 65A ..41N H:& 1F F/:). #97 EE. 7DD #9# 677 . (#DE) 59D # .5 7A6 #5. D 895 EE5 579 .6 ED5 65 68. .#9 # 59A 4ocal realisations &otal sales. 59E MA-F7 T.AA D87 # 677 #7D 59 E7D .for the year ended .E.& 1F .66 . E.!4H.7 AE5 # 7. A5 5A# 587 (.tock at 8#'8'A5 E6 # E6. 1>>& 1112s 1112s " Tonnes .1 March9 1>>.. "1.A%-+) A## !+T.76) (8 .95 9E5) (#D5 #76) 6#9 #7D 57.5 (. # E66 H(port realisation "ost of transport 1ther e(port costs # 1>>.A5 # 5.8#) DD . 1112s Tonnes 1112s " .!4H."reditors &otal current liabilities :et current liabilities 01FH-: H:& &rading deficit ai%e meal subsidy &1&!4 H .
6.4/.urchases after out-turn ad+ustments #9E E.FI:!:"H "B!-0H.) .local .tock at 8#'8'A8 &otal cost of sales 0-1. 58D 86 7A7 8A 876 9 686 #D 9AE #77 AE.7D 5 5E6 88 5E8 #D7 875 (9E6 D7. #D 96# #79 #66 . E../-.'()HFI"I&) !F&H..9 E#9 D8 D7D D8 .78 6## # 59A #56 A7E ..6 # A55 5E9 # E66 9 6#6 5 5.hort term loan interest .'()HFI"I&) FI:!:"H "B!-0H.imports #5 # D.torage and capital loan interest !dministration &otal board costs :H& .D (6.4/.. 8EE 67 .'()HFI"I&) A./-..&. E #D9 "ollection Bandling Internal transport . *1!-) "1.4/. .6 ##8 5 5D7 58E 586 6DD 5 7./-.1 March9 1>>.8# ##A # 8. .7) BA:A+#7 5E77T.7 6E5 (6D6 675) . 59 E7D E6 ..
D #7 7AE 8. FIGH) !..ocieties FI:!:"H .41NH) 41!: "!. *uilding .41NH) H .D..A #87 7. 995 A57 6 #6A 9.5 86 E.1/-"H.E 57.H&. &1&!4 F/:).4/. 7DD 8 58 95 5 ##7 A99 1>>& "1112s ED 779 6.8589 . ./-. 656 # E95 #5. H .. .5 1&BH. 69 . 59E A5 9DE 578 7.tocks and . "/--H:& !.1>>..-1FI)H) F-1 "apital -eserve &-!)I:0 .I&!4 0overnment -H)HH !*4H 41!:.. .41N H:& 1F F/:).tores )ebtors "ash on hand *ank balance &otal current assets E 9 E77 5#9 #E# 5#A ## .H&. +otes "1112s F/:). H .
A%-+) A## !+T . 6#9 #7D 57.for the year ended .6 ED5 656 8.!4H.5 (.E.A 65A .5 7A6 #5..#9 # 59A 4ocal realisations &otal sales # E6. 7DD #9# 677 . 1>>& 1112s 1112s " Tonnes .7 AE5 # 7.hort-term advances "reditors &otal current liabilities :et current liabilities 01FH-: H:& &rading deficit ai%e meal subsidy" &1&!4 H .1 March. # E66 587 H(port realisation "oat of transport 1ther e(port costs # 1>>. A55A# (. 59E D D98 757 895 EE5 8#9 D67 579 . (#DE) 59D # ."/--H:& 4I!*I4I&IH. 1>>.66 .A5 # 5. 1112s Tonnes 1112s " .AA D87 # 677 #7D .41N H:& 1F F/:).95 9E5) (#D5 #76) MA-F7 T. .8#) DD .76) (8.
8EE 67 . E.D (6.4/. "ollection Bandling Internal transport .FI:!:"H "B!-0H.4/.6 ##8 5 5D7 58E 586 6DD 5 7./-.../-.local .&.6 # A55 5E9 # E66 9 6#6 5 5.!4H.78 6## # 59A #56 A7E ...& 1F . *1!-) "1. 588 86 7A7 8A 876 9 686 #D 9AE #77 AE. 59 E7D E6 . E.7) E6 59 E7D .7D 5 5E6 88 5E8 #D7 875 .9 E#9 D8 D7D D8 .hort term loan interest . #D96# #79 #66 . .imports #5 # D.8# ##A # 8.'()HFI"I&) FI:!:"H "B!-0H.tock at 8#'8'A5 .tock at 8#'8'A8 &otal cost of sales 0-1."1.'()HFI"I&) !F&H..urchases after out-turn ad+ustments #9E E. 6. #97 EE.torage and capital loan interest !dministration &otal board costs A.7 6E5 (6D6 675) . .
For the year ended .5# 9. 5#E EE# 8. #8# 95# 56D #7 .. 65D #75 6#6 #9D #E9 69A 867 .tock at 8#'8'A8 &otal cost of sales 0-1.E5 5AA 5D6 AD 8DA 597 7A.A%-+) A## !+T .imports 6D 57# .89 .A 5#A . 8A9 E9./-.5 5E5 7A7 . ./-. #89 # H(port realisations 4ocal realisations &otal sales "1.A 5#E 9AD 867 #75 6#6 69 #. FI:!:"H "B!-0H.local ..4/.9 #55 . 1>>& 1112s 1112s " Tonnes . #9D 8. 1>>.rior year ad+ustment .!4H..urchases after out-turn ad+ustments #89 9AD 5E7 696 .E #D9 :H& .'()HFI"I&) (9E6 D7.4/.) DE7AT T.1 March9 1>>.!4H..& 1F . A8 8. 8. 1112s 1112s Tonnes " 8A9 E9.tockI at 8#'8'A5 .
6 6.hort term loan interest .A%-+) A## !+T .8 6 6A# 8# #56 5 E6. # E#7 9 (.&.7 88 99A .!4H.6 88 6DA 8E 9E# T.4/. H(port realisation "ost of transport - 1>>.# .DE) # #5.1 March9 1>>.# # 5E7 D . .9 # D6.!4H.FI:!:"H "B!-0H./-. 1>>& 1112s 1112s " Tonnes . 1112s 1112s Tonnes " - .& 1F .8 #7 E. !F&H. #6 6.#6 .AP L Bandling Internal transport . #8E # 4ocal realisations &otal sales "1.4/.for the year coded .. *1!-) "1.torage and capital loan interest !dministration &otal board costs :H& ./-. 5D 78A 97 867 A D77 ## DA# 8 D.
) FI:!:"H "B!-0H.7 # .tock at 8#'8'A5 .78 #7 (5) . A9 A #75 E# 5EA (E#8) Bandling Internal transport .tock at 8#'8'A8 &otal cost of sales 0-1.D9 D # .urchases after out-turn ad+ustments - # D. ()HFI"I&'.for the year ended .4/.7 # E # D 85 DE7AT T.# .&.) - # .4/. *1!-) "1.. ##D (8.rior year ad+ustment .local - # # .1 March9 1>>.A%-+) A## !+T ./-. .4/. - .hort term loan interest ./-. !F&H./-..torage and capital loan interest !dministration &otal board costs :H& ()HFI"I&'.) .FI:!:"H "B!-0H.DE D (55E) .
8A9 E9. 8..5 5E5 7A7 . .!4H.7 88 99A . #8# 95# 56D #7 . #9D 8.. 1>>. 65D #75 6#6 #9D #E9 69A 867 .1>>& 1112s 1112s " Tonnes .FI:!:"H "B!-0H.tock at 8#'8'A5 .& 1F . 1112s 1112s Tonnes " 8A9 E9.A 5#E 9AD 867 #75 6#6 69 #. 5#E EE# 8.imports 6D 57# . .local . FI:!:"H "B!-0H.hort term loan interest .4/..E5 5AA 5D6 AD 8DA 5D 78A 97 867 .5# 9.9 #55 . #89 # H(port realisations 4ocal realisations &otal sales "1.urchases after out-turn ad+ustments #89 9AD 5E7 696 597 7A./-.89 A8 8.. !F&H.4/.A 5#A . #6 .rior year ad+ustment .!4H..tock at 8#'8'A8 &otal cost of sales 0-1./-.
#6 6./-.!4H.tock at 8#'8'A5 .4/.6 88 6DA 8E 9E# T.for the year ended . 1112s 1112s Tonnes " - .DE) # #5.A%-+) A## !+T .# .*1!-) "1. A D77 ## DA# 8 D.1 March9 1>>. # .rior year ad+ustment H(port realisation "ost of transport - 1>>.AP L Bandling Internal transport .78 #7 (5) .9 # D6. 6 6.!4H. # E#7 9 (.& 1F .torage and capital loan interest !dministration &otal board costs :H& . #8E # 4ocal realisations &otal sales "1.&. 1>>& 1112s 1112s " Tonnes .# # 5E7 D # .8 #7 E. .8 6 6A# 8# #56 5 E6.
.urchases after out-turn ad+ustments D; - local ,tock at 8#'8'A8 &otal cost of sales 0-1,, ()HFI"I&',/-.4/,) FI:!:"H "B!-0H, ##D (8;;) ,hort term loan interest ,/-.4/, !F&H- FI:!:"H "B!-0H, *1!-) "1,&, A9 A #75 E# 5EA (E#8) Bandling Internal transport ,torage and capital loan interest !dministration &otal board costs :H& ()HFI"I&',/-.4/,) # E # D 85 ;7 # # ;7
# ;D9 D # -
# ;DE D (55E)
5 =AB7A+ T,A%-+) A## !+T - for the year ended .1 March 1>>.
1>>& 1112s 1112s " Tonnes
1>>. 1112s Tonnes 1112s "
,!4H, 96 96# ##5 96 96# ##5 4ocal realisations &otal ale "1,& 1F ,!4H, 9D# 5 ,tock at 8#'8'A5 .urchases after out-turn ad+ustments E8 5;; ### - local - imports ;8 #6A 578 ,tock at 8#'8'A8 &otal cost of sales 0-1,, ,/-.4/, FI:!:"H "B!:0H, ; E#7 9 9E9 ,hort term loan interest ,/-.4/, !F&H- FI:!:"H "B!-0H, *1!-) "1,&, ;9 8 ;E7 5 675 "ollection Bandling Internal transport 9 ;5D 8 D76 5A 5DA 5 E79 ##8 A7 ;7 ;6D 58; D87 596 A8A #97 E5E #76 8#8 8# DAE # E6# A7 A7 #89 57A #89 57A
E; 756 ##8 E6# #
E8 89; ##5 #5 899
# 76D 5 7## A 79D (# 8##)
,torage and capital loan interest !dministration &otal board costs :H& )HFI"I&
# 89; 5 EE; #6 59# (#5 EE;)
# FF77 T,A%-+) A## !+T - for the year ended .1 March9 1>>.
1>>& 1112s 1112s " Tonnes ,!4H, D8 #D5 #5 (# 6;7) (#;;) D# ;AD # 689 # 4ocal realisations &otal sales "1,& 1F ,!4H, 5E E99 9 ,tock at 8#'8'A5 .urchases after out-turn ad+ustments DA 5D# #5 ##6 A6D #A - local 6 ## E 9 H(port realisation "ost of transport 1ther e(port costs 9
1>>. 1112s 1112s Tonnes "
;; 6AA (ADA) (875) ;8 87D # ;#6 ;; 958
D8 786 #8
#D 8E; 68 9#A
9. (8 9. 9 #5 776 .tock at 8#'8'A8 &otal cost of sales 0-1. #58 (9 8A9) 5 =AB7A+ T.6) Bandling Internal transport .# 9#.for the year ended .85 . 1>>& 1112s 1112s " Tonnes .!4H.) .5) .FI:!:"H "B!-0H.torage and capital loan interest !dministration &otal board costs :H& )HFI"I& 8 .86 866 E D7 E78 #8 5 . *1!-) "1./-.hort term loan interest )HFI"I& !F&H. . 96 96# ##5 96 96# ##5 4ocal realisations &otal ale A7 A7 1>>. E 5D8 (8 59.1 March9 1>>.4/.86A 696 AA # 797 E #78 (A D. 8 77A E #9.A%-+) A## !+T . . 1112s Tonnes 1112s " #89 57A #89 57A .&.. FI:!:"H "B!-0H. 5D7 #9A #A7 .
##5 #5 899 ."1. FI:!:"H "B!:0H. E#7 9 9E9 .6D 58.FI:!:"H "B!-0H./-. #6 59# 5A 5DA 5 E79 ##8 A7 . 9D# 5 .hort term loan interest .4/.E7 5 675 # 76D 5 7## A 79D "ollection Bandling Internal transport .&.!4H.8 #6A 578 .9 8 . . 5 EE.4/. D87 596 A8A #97 E5E #76 8#8 8# DAE # E6# E.. ### -local -imports .tock at 8#'8'A8 &otal cost of sales 0-1.5D 8 D76 # 89.torage and capital loan interest !dministration &otal board costs 9 .tock at 8#'8'A5 ..urchases after out-turn ad+ustments E8 5. .& 1F . 756 ##8 E6# # E8 89.7 ./-. *1!-) "1. !F&H. .
958 D8 786 #8 86 866 #D 8E. D8 #D5 #5 (# 6. 1>>& 1112s 1112s " Tonnes .tock at 8#'8'A8 &otal cost of sales 0-1. 5E E99 9 .7) (#./-.1 March9 1>>.85 .tock at 8#'8'A5 .urchases after out-turn ad+ustments DA 5D# #5 ##6 A6D #A 86 866 E D7 E78 #8 5 .# 9#.(# 8##) :H& )HFI"I& (#5 EE..4/.for the year ended .AD # 689 # 4ocal realisations &otal sales "1. 9 E 9 H(port realisation "ost of transport 1ther e(port costs 9 1>>.!4H..) # FF77 T.8 87D # ...) D# .#6 . 6AA (ADA) (875) .A%-+) A## !+T .& 1F . . . 68 9#A #5 776 . 8 77A . 1112s 1112s Tonnes " .!4H.local 6 ## .
5 A97 688 5 #9E 5#8 6A6 57D 1>>& "1112s ## #56 5 67# # 575 9A A77 #56 . 1>>.+ .roceeds on disposal of fi(ed assets . "1112s .hort term loan interest )HFI"I& !F&H.1 March 1>>.FI:!:"H "B!-0H.&.other &rading deficit recovered from 0overnment . E #9.silo pro+ects .9. (8 9.1/-"H 1F F/:). *1!-) "1. . 5D7 #9A #A7 .6) Bandling Internal transport .) 5TAT7M7+T F 5 !.for the year ended E 5D8 (8 59. #58 (9 8A9) F F!+%5 .5) . 0overnment loans )onor aid .FI:!:"H "B!-0H.#7 A+% APP:-#AT.torage and capital loan interest !dministration &otal board costs :H& )HFI"I& 8 .86A 696 AA # 797 E #78 (A D.
H)'I: "-H!.E6 5#7 #7 #E6 (E A7A) 6E 579 E.ocieties .4I"!&I1: 1F F/:). )eficit on trading (including subsidies) Interest on accumulated deficits !d+ustment for items not involving the movement of funds: .)epreciation :et deficit from operations H(change losses -epayment of redeemable loans .95 AED - 8D 856 5.urchase of fi(ed assets &otal application of funds ()H"-H!.&otal source of funds !. D68 .A 9. 9#.H in working capital -epresented by: Increase'()ecrease) in stocks and stores (Increase)')ecrease in short term borrowings Increase in creditors Increase m debtors$ cash$ and bank balances 56A . 667 #8D 5A #8 58D #88 95# (5A7 E6E) (8D DED) 8A9 #ED (#D6 579) (666 #EA) #D5 D67 (#E6 #97) (66 DDA) 85 6#6 #A 89D (5A7 66E) (8D DED) .9 .D5 A..*uilding . 5. 9A# (9 96#) .
)H*&1-. . Foreign H(change 4osses #8 568 #. &rade 859 #E5 5# #A8 !. #E# 5#A #87 7.. D. 6A6 6 E#5 5 D. &rade #8D #D8 DE 6ED "offee . "-H)I&1-.new sacks .roducers2 &rading )eficit #5 9#8 E 566 "offee .!.tarpaulins and dunnage . !:) . D A#5 E77 5#9 578 7. "1112s E.used sacks . 1>>.A 9#A . .for the year ended .&1"K.A A 69D # 5A6 ## D5. 0rain .A 9.1 March9 1>>.roducers 1ther #59 #7 858 89 7A.+ T75 T TE7 F-+A+#-A: 5TAT7M7+T5 .&1-H.other 1>>& "1112s 66A 7#E #ED EEA 57 A#E #.tores .
#7 A+% APP:-#AT.. F F!+%5 -for the year ended 1>>.1ther 85 5.silo pro+ects . 0overnment loans )onor aid .roceeds on disposal of fi(ed assets &otal source of funds !.4I"!&I1: 1F F/:). "1112s .9 8E 6D7 895 EE5 579 .A5 5TAT7M7+T F 5 !.)epreciation :et deficit from operations H(change losses (9 96#) .1/-"H 1F F/:).other &rading deficit recovered from 0overnment . D68 8D 856 5.E6 5#7 #7 #E6 .1 March 1>>. 9A# (E A7A) 6E 579 E. )eficit on trading (including subsidies) Interest on accumulated deficits !d+ustment for items not involving the movement of funds: .D5 1>>& "1112s ## #56 5 67# # 575 9A A77 #56 A.95 AED .+ .9 .5 A97 688 5 #9E 5#8 6A6 57D 56A . 5.
tarpaulins and dunnage 1>>& "1112s 66A 7#E #ED EEA 57 A#E #. 6A6 6 E#5 5 D. .H)'I: "-H!. 9#. "1112s E.H in working capital -epresented by: Increase'()ecrease) in stocks and stores (Increase)')ecrease in short term borrowings Increase in creditors Increase m debtors$ cash$ and bank balances 8A9 #ED (#D6 579) .1 March9 1>>.tores .urchase of fi(ed assets &otal application of funds ()H"-H!. !:) . 0rain .A 9.A A 69D # 5A6 .new sacks .used sacks .*uilding .for the year ended .-epayment of redeemable loans .ocieties . 1>>.&1-H.&1"K. 667 #8D 5A #8 58D #88 95# (5A7 E6E) (8D DED) (666 #EA) #D5 D67 (#E6 #97) (66 DDA) 85 6#6 #A 89D (5A7 E6E) (8D DED) + T75 T TE7 F-+A+#-A: 5TAT7M7+T5 .
&rade #8D #D8 DE 6ED "offee .A 9#A 1ther 85 5. &rade 859 #E5 5# #A8 !.&1"K.) #AA8 .&1"K.roducers 1ther #59 #7 858 89 7A.A5 + T75 T TE7 F-+A+#-A: 5TAT7M7+T5 . (7772s &1::H. D. =7:: D MA-F7 0-!I: . D A#5 E77 5#9 578 7.I"!4 .9 8E 6D7 895 EE5 579 . 6 #89 676 .A 9.other ## D5.1 March9 1>>. #E# 5#A #87 7. 597 DE7AT # FF77 TE7. .!..for the year ended ..BN. T TA: A. Foreign H(change 4osses #8 568 #. )H*&1-. "-H)I&1-.roducers2 &rading )eficit #5 9#8 E 566 "offee .
.F/&/-H 41.-10-H.7 E6D 895 ## A89 9.1 March9 1>>.H. *ulk 0rain )epot #7 867 777 #6 777 777 #5 E77 777 Actual 7@'enditure " Balance #arried For.for the year ended . .) (7772s &1::H. *ulk 0rain )epot 8. #.ard " #7 7E9 777 .) #AA8 #AA5 6 #9D E . .. (8) (#) - (#) (6) 5E9 A8 .I1: F1.BN.F/&/-H 41..&1"K .H.7 . - 56E (8) E6 .-1FI.H.7 5D5 8#9 (56 E6D 895) EE5 5E7 .&1"K .-1FI..!-& I: @1-K I: .' (41.I"!4 .hipment 5.&-!)I:0 !""1/:& #AA5 . A''roved Budget " ..&1"K 1/&-&/-: 0!I:. #8E 677 EE (#) #D7 (5) E - .H.I1: F1. 568 - - (E) (#) #AP-TA: B!%)7T 7/P7+%-T!.
6A 7E9 # DA8 9..5 8 A58 58# 8D8 A79 777 .!-& II: :H@ @1-K.abi 8 967 777 8 .!-& I . 4aboratory A. D75 # 5. . #8. . .ham 5& iddle . *ag )epot 9. )epot Improvements . uma 67 777 67 777 # 677 777 # 567 777 5 777 777 5 777 777 E D67 777 # #9. #.7 9A5 #. E86 8 5EE 65.9E 67 777 67 777 856 #AD A 57D # D69 .ara 8. achinery and I.taff Bousing E.taff Bousing ##. 5. .8D 9.!-& II .D8 A9. 777 # 5A7 A88 # 67E 56D AAE 799 A75 E#9 E67 777 E6 777 #D 777 E 777 E. )epot Improvements #7.D5 777 9.77 777 # 777 777 # #8.56#9 # 756 8E6 8 6D8 ..# 9# 5D9 56D E6 8A8 E# 56A (#A #65 56D) &1&!4 .lant @orks #5. !dditional )epot Facilities D. )ecentralisation &1&!4 . ..lant and achinery 6. . and &raining otor Fehicles #AA 777 5 677 777 65 #86 777 #88 E79 5 . 777 E67 777 A95 777 677 777 inor D7 777 5 .
D5A 6A7 5 5.>. D97 98. *eans .1 March9 1>>. 4ocal "ontrolled products Imports -ice @heat 0roundnuts ..1-&.alaries @ages 5. . 97E 7EA 59 #66 886 . " #. &1&!4 .!-& I !:) II 5TAT7M7+T 6D AD6 777 9. (#6 DD6 98..for the year ended .6 ##8 5E7 5 9A.H.H. Actual 7@'enditure to .5# 5E5 7A7 89# #9 E6A . B!:)4I:0 .oyabeans ai%e &1&!4 I . A65 799 5 A5D DD8 A85 A6 5A9 87# E7E 67.-1)/"&. 5.&1&!4 ..86 58.7C7+!7 7/P7+575 . .orghum H.1.8 D6. DA# #88 A8# D66 86 56A ./-"B!./-"B!. 669 6## 579 56E 1>>& " .) F .
.A 5EA 6D9 (# .. A./:)-N -HFH:/H # 7D6 565 # 9.acks S &wine )epreciation "apital loan interest .9A) (E96 A85) 6A 9DA 88# 5 . 8.ack handling 4H.8 58.5 E #DD 778 - .9 89A . .& .6D ./:)-N -HFH:/H &1&!4 . #5D A9E AEA 67.ockets ..AD 959 8E. E55 959 . #85 5.) .# (55.: .# 8.&1-!0H !:) "!.5D #5 7. A5E (.. #8A DE. 8DE) # 5#5 69D E 7EA #. 56# DA9 EE8 8 8#5 .I&!4 41!: I:&H-H.: .torage accommodation and material Insurances .lant working e(penses 4H.lant working e(penses Bandling by agents )epreciation .99 (88A A8E) #55 A5# 86# # 69A 9A5 # E8D 899 D8.75 # #A. A5A .Fumigation e(penses Hstablishment and other e(penses &ravelling e(penses &ransport$ staff$ laboratory and e3uipment .D E #DE . 9E# # A#7 76# 9 EA9 D.66 97E ..
&1&!4 &1&!4 ..77 8A 567 95A 8 D86 87A 69..#7 D59 98 577 #6D F . 59A D65 ADA 5E6 875 #. &ransport H(port "osts ...5 6.for the year ended . .A 8 A59 A#8 5.E. &ransport H(port "osts "offee Inter &ransport H(t.orghum Inter &ransport H(t. " 8. D## 5E 59E # 8. ai%e Inter &ransport Import &ransport H(t. 686 # ED.79 687 #DE 8E. Actual 7@'enditure to .E D#6 #8 . &ransport H(port "osts 0roundnuts Inter &ransport 67 .BI. &-!:.1-& !:) .7 D6A 56A 1>>& " .1.7C7+!7 7/P7+575 .&.1 March9 1>>. #5A 7.>.&1-!0H !:) B!:)4I:0 5TAT7M7+T E #56 .I:0 "1. &ransport H(t.
.Import &ransport H(port "osts .79 &1&!4 I:&H-:!4 &-!:. 9# 97. *eans hunga @heat Inter &ransport Inter &ransport Inter &ransport Import &ransport .8D 95...rovision for )emurrage 8 D7.AE 5 67# 6AE #5 #D# ## DA# 789 .8 99E - &1&!4 &-!:. D9A #7 E.D6 9D5 D7 A#9 E9 #56 9#.1-& 97 55E E5A ADA 5E6 .&.unflower -apoko Inter &ransport Inter &ransport Import &ransport H(port "osts -ice Inter &ransport Import &ransport . D 655 .9 579 A#5 A5# 6 E#6 5#E 8## - #88 .BI... .1-& &1&!4 HG&H-:!4 &-!:.1-& !:) . &ransport H.oyabeans Inter &ransport Import &ransport H(t.I:0 "1. 6A E.
1-& "1.& "ontribution to !. 858 96.D# A8D E9 #56 9#. # 857 #DD 5 .1 March9 1>>..&-!&I1: !:) I:&H-H.A9 #95 975 868 #9# 66D #56 #7 698 .79 9 .. F .!. Actual 7@'enditure to .55 96A # 75.7C7+!7 7/P7+575 .. 5TAT7M7+T .&. " .&.taff training 6## 9#9 #8 5D6 7. . E7D 58# 565 7DD # 87# #86 # D5# E55 E DDA 67# # 89D 5E6 1>>& " .rinting and stationery .ostage and telephones !udit fee )ata processing charges -ents payable 1ther administration e(penses &ravelling e(penses !dvertising and promotion .&1&!4 HG. !) I:I. &1&!4 &-!:.5D E9E ##5 D86 766 5 7E8 .>.for the year ended ..1.alaries @ages .9 98. .69 6 898 868 E.9 E . 78A 8E9 #7. .1-& "1.DD 6#8 9# 97.
A5 .undry revenue : ..!. 9A# 777) 9D #76 AE6 D9 .ED 7A7 #66 5#D7#8 ## 7D# 8../-"B!. .56) (8# 8DD) ##5 D#5 #AD #8 675 56E 57A (96 6.& 5 A5D DD8 A85 #5A 7. .H:)I&/-H 6.1-& /:/.D# A8D D9 .ublic relations )epreciation 4ess: . &1&!4 HG.&.5) (#98 9E6) 98 . HG"B!:0H 41../!4 F1-HI0: HG"B!:0H 41. . # .. EE.&1-!0H I:&H-:!4 &-!:..&-!&I1: !:) I:&H-H.1-& !) I:I.1-& "1.A 8E6 A#5 8D6 96A .99 99D ## 7D# 8.69 E7E 67.&-!&I1: !:) I:&H-H. 6#5 (5.A 8E6 876 DD# 575 HG.top order fees !dd: Interest on short-term borrowings and bank charges 4ess: Interest charged to trading reserve fund &1&!4 !) I:I.& !. B!:)4I:0 !:) .6 8E9 767 6D7 . !:) &-!:.6 8 5A6 A8. E86 9A7 87E DA6 (AD .8 998 9D #76 AE6 5#7 A.H./ !-N 6. 669 98 577 #68 6A E.Bandling and investment costs ..A DAA 9 .E D#6 97 55E E5A #66 5#D 7#8 86.
8 5A6 A8. &his te(t$ Ba i+ !i$a$+e !or mar. &he te(t contains worked and unworked e(amples$ e(ercises and a glossary of the key terms used. . &his knowledge will assist them in the evaluation of current and alternative marketing activities. 6#5 A#5 8D6 96A &his is one of series of four te(ts on marketing and agribusiness prepared by an F!1 pro+ect for use in universities and colleges teaching agricultural marketing$ agribusiness studies.eter $ introduces the basic principles and techni3ues of finance and accounting to enable marketers to be aware of the financial implications of decision-making.