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Managing financial principles and techniques

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The business success is driven by many factors that are often intricate enough to elude the
managerial grip in real life organizations. Yet management experts and academicians have
developed several analytical tools and methods that managers use in the real life management of
the companies. The financial management is one area under which several different analytical
tools and methods are used by the financial manager to assess the financial performance of

Pricing is an important concept which drives revenues. The pricing produces revenues and
profits but at the same time it also affects the competitive position of a company in the
marketplace. The pricing strategies and methods are either cost based or market based. The
design and choice of an appropriate costing system is equally important for an organization as
the competing companies may have better costing systems. Therefore a continuous review and
evaluation of the costing system is also called upon so that the costing system that best serves an
organizations needs may be put in place.

For a short range business planning, forecasting techniques are employed which can be used to
forecast revenues and costs. The application of the state of the art forecasting methods is the
need of the hour as well.

Budgeting processes are important processes in the organizations and they deal with numbers as
well as with humans. Setting master budgets and then employing the best budgetary process are
equally important. A continuous review and monitoring of the budgets and their comparisons to
the actual figures reflect on the budgetary accuracy and the accuracy of the budgetary system an
organization has.

Cost reductions are also an important part of todays business strategies and the systems of
costing and to review of costs with a view to achieve cost reduction are also important for the
corporate financial managers today.

We will touch upon each of these aspects in the following pages.

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1.1. Explain The Importance Of Costs In The Pricing Strategy Of An Organization

Pricing decisions are important for the organizations and they depend on the costing systems and
methods and approaches. Murthy; Gurusamy, (2009, p.mcb4) outline features of these two
systems. Here we will discuss similarities and differences between two alternative costing
methods i.e absorption costing and marginal costing.

1. Firstly in the absorption costing the fixed costs and variable costs are charged to the
production whereas in the marginal costing only variable costs are charged to the
production and fixed costs are recovered from the contribution margins.

2. Secondly in the absorption costing valuation of work in progress is carried out by valuing
the stocks in fixed and variable costs whereas in marginal costing they are valued on
variable of foxed costs only.

3. Thirdly the absorption costing under or over absorption of overheads occurs because of
apportionment of fixed costs in advance whereas in marginal costing this does not
happen. Atkinson (2007, p.86) says that allocation of overheads or support costs to the
products is one of the biggest challenges faced by organizations of today.

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4. Fourthly in marginal costing the managerial decision of profitability is guided by the
contribution margin whereas in absorption costing the profitability decisions are seen in
the light of the estimated profit figures.

5. Fifthly absorption costing is more suited for the long term pricing decisions whereas
marginal costing is more suited for the short term pricing decisions.

6. Sixthly the absorption costing emphasizes production whereas marginal costing emphasis

In the light of the above discussion we can see that the marginal costing is easier and modern
way of costing and it impacts the pricing strategy more realistically by apportioning the costs in
the light of the revenue generated by the product. The absorption costing on the other hand is
more traditional costing method driving the costing and pricing more traditionally. The
absorption costing is more long term and marginal costing has a more short term focus on pricing
strategy and pricing decisions.

1.2. Design A Costing System For Use Within An Organization

Blocher (2006, p.52-3) identifies several classifications of costing systems which include:

(i) Cost accumulation methods job or process costing
(ii) Cost measurement method Actual, normal and standard costing system
(iii) Overhead assignment methods traditional or activity based costing methods

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Bolcher (p.53) further explains the choice of a costing system depends on the nature of industry
and the nature of product / service, the firms strategy and the information needs and the cost of
acquiring the information, cost of designing, modifying and implementing a specific costing
system. Accuracy of costing system is identified through calculation and measurement of
variances or variance analysis that explains how accurately a specific costing system predicts the
actual cost of a product or service.

We will take the example of a ball pen manufacturing company which manufactures ball pens in
a process whereby the manufacturing process runs in three steps i.e manufacture of caps, barrels
and the plugs. The costing system proposed is one based on the cost accumulation method
whereby the cost of the manufacture is estimated in a process of manufacturing. The
estimated/assumed costs of 100 pens is as under:

Materials cost Pounds 70.00
Labor costs Pounds 30.0
Overheads cost 10.0
Total cost per 100 pens 110.0

This costing system involves costing of materials used in the manufacture of caps, barrels and
end plugs. Added to that is the labor cost of manufacturing. The overhead cost is added as part of
the cost of production as a percentage of the material and labor cost which is 10% of the cost of
material and labor cost.

The costing system is standard costing system whereby the standardized estimates of costs are
calculated on annual basis and the same estimates of material, labour cost and overheads costs
are applied to calculate the cost of the products. The actual costs data is then compared to the
standard costs to calculate the variances and track down and correct the causes of such variances.

1.3. Propose improvements to the costing and pricing systems used by an organization

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There are several bases on which a costing system can be conceived and designed. The major
costing system classifications are:

Nature: e.g. materials, labour, expenses
Functions: e.g. production, selling, distribution, administration, R&D, development,
Direct/Indirect: e.g. direct and indirect
Variable/fixed: e.g. fixed, variable, and semi-variable
Controllability: e.g. controllable, uncontrollable

Usually businesses have specific costing divisions which handle costs. They are normally called
the cost centres. Examples of such cost centre are the R&D departments, marketing and customer
service. There are different ways companies may choose to establish the responsibility of the
costing in the organization. Companies may choose to establish strategic business units as profit
centres, cost centres, investment centres or else may simply assign them the responsibility of cost
and profit making standalone unit.

The improvement in the above costing system can be made by way to regular comparisons of
standard costs with the actual costs and calculating the variances to adjust the variances and the
costing estimates or standards on regular basis. This will enable the costing department to
incorporate the changes in actual costs into the standard costs of the products calculated through
the standard costing system.


2.1. Apply Forecasting Techniques To Make Cost And Revenue Decisions In An

Here we are concerned with the application of forecasting technique to make cost and revenue
decisions in an organization.

Let us assume that the ABC enterprises have a costing and revenue data for the entire year 2013
and wants to make a forecast of the same for the 6 months of Jan June 2014.

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Let us further assume that the costing data shows a monthly rise of 10% and revenue data is a
twice the size of costs for each relevant month

Using the above assumptions, we present the scatter plot and the regression line as follows:

Past Data on Costs and Revenue

Time Cost Revenue
2013 Jan 1 1000 2000

Feb 2 1100 2200

Mar 3 1210 2420

Apr 4 1331 2662

May 5 1464 2928

June 6 1611 3221

Jul 7 1772 3543

Aug 8 1949 3897

Sept 9 2144 4287

Oct 10 2358 4716

Nov 11 2594 5187

Dec 12 2853 5706

Scatter plot of data on Cost and revenue

Now we present the Regression coefficients of cost and Revenue in table 5 as follows:

Table 5

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Regression Co efficient Cost Revenue
Intercept 701.53 1403
Slope 166.22 332.45

Using the above regression parameters, we obtained the following projected cost and revenue
data for Jan- June 2014 which is presented in table 6 below with a relevant scatter plot as well.

Table 6

Time Cost Revenue
2014 Jan 13 2863 5725
Feb 14 3029 6057
Mar 15 3195 6390
Apr 16 3361 6722
May 17 3527 7055
June 18 3694 7387

Scatter Plot of Actual vs Forecast data on costs and Revenues

As we can see that the trend forecast reveals that the cost and revenue for the months of Jan
June 2014 will be rising steadily as they did over the past 12 months.
Actual Data

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2.2. Assess The Sources Of Funds Available To An Organization For A Specific

Funding in the organisation is meant to provide financial resources in monetary shape or it can
take other forms like time, human resources, assistance from private or public institution. The
funds can be raised for short term or long term purposes.

The main sources of funds in organisations can be distinguished as:
1. Profits earned by the organisation
2. Credit arranged through private or public institutions, e.g bank, etc.
3. Funds raised in the shape of donations
4. Grants received from the government
5. Funds from the shareholders who buy the shares of the company when they get listed on
stock market.


3.1. Select appropriate budgetary targets for an organization

Setting of budgetary targets must be guided by at least one of the following criteria:

Comparison to previous years: The selection of targets for the next fiscal or financial year calls
upon using criteria which must at least be responsive to the needs of the organization for the
period under review. The budgetary targets can be set in line with the last years budget plus
additional sums earmarked for the growth estimated for the following year/s. This comparison
must be made realistically and reflect the organizational needs.

Link between targets: Secondly there must be a link between the targets spelt out for the
following year. This link can be defined in terms of the growth estimated for the following years,
the ratio or proportion of the productivity achieved or aimed for the next year or some other link
between sales and production. If the sales are estimated to grow by 20 percent in the following

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year, there must be a corresponding increase in the budgetary allocations for the sales and
distribution expenses.

Realistic: The targets must also be realistic so that they may be achieved in practice. The realism
calls upon keeping things close to the reality so that the budgetary target may not go too far out
of line with what is realistically possible.

Organizational objectives: The budgetary targets can also be set in line with what the
organizational targets for the following year are. If the organization wants to achieve a major
growth in the following year, it may aim to set higher budgets and vice a versa.

3.2. Participate In The Creation Of A Master Budget For An organization
A master budgets is an integrated set of operating, investing and financing budget.

Vanderbeck (2012, p.349) believes that in many organizations, a major share of the annual
planning takes place under annual budgeting.

The master budgets is an important exercise for the management as it is a consolidated budget
showing an overall consensus of the management as it depicts the investing financing and
operating allocations over the coming financial year.

The process begins with setting a sales budget which is translated into production budgets and
into cost of goods sold budgets moving right up to setting up an income statement budget or
budgeted income statement.

The process of setting this budget is also very important for the management as this process
usually starts early in the preceding year whereby the managers and heads of strategic business

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unit set the overall vision and translate the same into financial estimates in terms of the operating
expenses, the financial and investment estimates of their planned projects and ventures. The
financial managers and CEO set run the process of consolidating the master budget and create a
consensus within the organization. The process usually runs from top down/bottom up fashion
whereby the top management sets the overall strategic goals and functional managers who run
the departments of strategic business units or subsidiary businesses submit their financial
estimates to the immediate bosses who compile these estimates to create a master budget.

Master budget has a relationship with cost and quality control as it drives the overall
organizational resources and it sets out to delineate the resource utilization of the entire
organization. Eventually the Master budget also sets the profitability target is subjected to
rigorous monitoring and control. The master budget is usually created with the help of computer-
assisted processes running far and wide in the organization.

It must be emphasized that budgeting is a more of behavioral work undertaken by people in the
organization rather than a mere statistical work. This calls upon understanding the behavior traits
of people and the political process of the organization.

3.3. Compare actual expenditure and income to the master budget of an organization

Here we are concerned with calculating the variance analysis of the income and expenses as
outlined in a master budget with the actual income and expenses.

Let us assume that ABC enterprises set up a master budget of income and expenses a

Master Budget
Variance Variance %
Total revenue 1000 1200 200 20%

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Cost of Sales 600 900 300 50%
Gross profit 400 300 100 -25%
Operating Costs 200 200 - -
Operating Margin 200 100 -100 -50%

As we can see from the above example, the master budget is over estimated and
underestimated from the actual income and expenses. The variance analysis indicates that the
budget was under estimated in the case of total revenue by 20%. The budget was over estimated
as far as the gross profit is concerned and so on so forth. In this way by way of making a
comparison, we can create a variance analysis and the same analysis can guide us whether or not
our master budget was a realistic one or did it reflect the business reality and was it set close to
the actual business volumes.

3.4. Evaluate Budgetary Monitoring Processes In An organization
Here we are concerned with the budget monitoring process as to how should an ideal process of
budget monitoring be run in an organization.

The budget monitoring process must be a continuous process whereby the management calls
upon regular reports from the strategic business units who submit their monitoring reports as to
what variances from the budgeted or planned master budget figures on each items have occurred
and why and who is responsible for each of such variances. The monitoring is carried out on the
basis of actual versus planned or budgeted figures of revenue and costs and sales and production
volumes. The monitoring includes the variance analysis and attribution of such variances to
relevant departments or employees who have to submit their explanation on why such variances
have occurred and what plans do they have to restore these variances so that the master budget
allocations and estimates of revenue and costs and sales and production are achieved to enable
the organization to achieve its targeted volumes of sales, production, profitability and


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4.1. Recommend processes that could manage cost reduction in an organization

Bhar (1976) defines standard costing as a system of costing under which the standard costing
system, the costs are calculated and estimated as per the standard estimates of costs and they are
then compared to the actual costs and variances are calculated with identification of sources of
variances with suggestions of remedial measures to correct the variances.

As Berk (2010, p.139) identified, following cost reduction opportunities prevail in most

1. Work flow improvements
2. Setup time reductions
3. Material handling improvements
4. Scrape and rework reductions
5. Work centre cleanliness and organization

Better work flow management can help in reducing the wastages at the workflow level. Similarly
the set up time reductions can also help reduce the wastages and so can the material handling
improvements. Scrap and rework reductions and work centre cleanliness can also help reduce
wastages and improve eventually can help an organization in achieving greater cost reductions.

4.2 Evaluate the potential for the use of activity-based costing

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Baker (1998) suggests that under ABC costing system costs are identified and traced by activities
across departments or cost centers. ABC costing has two major dimensions i.e cost measures
and performance measures of activities, resources and cost objects, says Baker (1998, p. 2).
The activity based costing has a huge application potential as it is a just approach where the
activity are measured in terms of their cost and performance which addresses the issue of costing
in a just manner. This suggests that the potential for the use of activity based costing is huge in
organizations and many organizations actually apply this costing system on regular basis.

5.1. Apply Financial Appraisal Methods To Analyze Competing Investment Projects In
The Public And Private Sector

Let us assume that there are two competing projects that need to be compared by ABC
Enterprises. We want to compare them in order to decide which one deserves a favorable
investment decision.

Suppose that the investments needed and cash flows generated by the two project X and Y is as

Estimated cash flows
Year Investment 1 2 3 4 5 Total
Project x -80000 18000 20000 25000 38000 45000
Project y -120000 30000 50000 50000 50000 15000

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Net present value
Year 0 1 2 3 4 5 Total
Project X -80000 18000 20000 25000 38000 45000
Project Y -120000 30000 50000 50000 50000 15000
PV Factor at 10% 1 0.909 0.826 0.751 0.683 0.621

Project X -80000 16362 16520 18775 25954 27945 25556
Project Y -120000 27270 41300 37550 34150 9315 29585

Since the net present value of future cash flows generated by project Y is greater than the same
parameter of project X, we reckon that project B offers more returns on the investment. We
also want to comment that both the projects are feasible since their cash flows produce as
Positive net present value.

Now we will compare the two projects using Discounted Payback Period method:

Discounted payback period
Year 0 1 2 3 4 5 Total
Project X -80000 18000 20000 25000 38000 45000
Project Y -120000 30000 50000 50000 50000 15000
PV Factor at 10% 1 0.909 0.826 0.751 0.683 0.621

Project X -80000 16362 16520 18775 25954 27945 25556
Cumulative Cash flow -80000 -63638 -47118 -28343 -2389 25556
Project Y -120000 27270 41300 37550 34150 9315 29585
Cumulative Cash flow -120000 -92730 -51430 -13880 20270 29585

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5.2. Make A Justified Strategic Investment Decision For An Organisation Using
Relevant Financial Information

On the basis of our calculations as shown above, Cumulative cash flows of project Y generate
extra cash flows in year 4 and that of project X in year 5. Therefore the discounted payback
calculations show project B pays earlier than project X and thus project B has a better in
payback terms.

Internal rate of return (IRR):
The internal rate of return (IRR) is that discount rate that gives a net present value (NPV) of
zero. It is a commonly used criterion of making investment decisions.
The formula for irr is: rl + npvl / (npvl - npvh) * (rh rl)
Project x:
: 10% + 25556/ (25556-(-256)) (20%-10%)
: 10% + 25556/25801 (10%)
: 20%
Project y:
: 10% + 29585/30815 (10%)
: 19.54%
project Y has a lower internal rate of return than project X. We advise that both of the projects
are feasible however, project Y is slightly safer on the basis of payback period and NPV ABC
should choose project Y.

5.3. Report On The Appropriateness Of A Strategic Investment Decision Using
Information From A Post Audit Appraisal

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On the basis of payback period, almost equal IRR and a better NPV of project Y, We reckon that
the project Y is better investment opportunity. It seems more feasible for the investment
purposes. Therefore we recommend that ABC enterprises must go for project Y.


6.1. Analyze Financial Statements To Assess The Financial Viability Of An

Lusthaus (2002) identifies three dimensions to assess the financial viability of a firm. The first
one is the organizations ability to generate enough cash to pay its bills. This means short term
and long term ability to generate cash that can be utilized to pay the organizations bills.

The inability of the organization to pay its bills create an uncertainty for the creditors of the
organization to receive their bills. In the case of ABC Exports, the short term and long term
profitability and solvency ratios indicate that the organization has enough ability to generate
enough amount of cash to pay its bills in the short term as its current and quick ratios have both
strengthened indicating that the organizations short term liquidity position is strong enough and
thus it is able to pay its bills in the short term. The long term ability to pay its bills is indicated by
the organizations long term solvency and structure of the fiancs of the organization which
indicate that the organization now has a stronger financial structure to pay its long term

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The second one is the sources and types of revenues on which the organization basis its costs
Lusthaus (2002). This criteria requires that ABC Exports has the type of sources of revenues that
are characteristically matching costs.

The third dimension as Lusthaus (2002) mentions is the ability of the organization to live within
its allocations which means that if an organization is able to live within the allocated budgets
and funds to meet its desired goals and targets, it is viable and if an organization can not live
within its desired means and allocations to meet its goals and targets without seeking additional
funds from other sources, the organization is not viable.

6.2. Apply Financial Ratios To Improve The Quality Of Financial Information In An
Organizations Financial Statements
Ratio analysis: analysis of financial statements:
Ratios are indicators of financial performance. Thukaram (2007, p.81) suggests that ratios should
be interpreted as indicators of a companys performance.

Here we are concerned with the application of financial statement ratios to improve the quality of

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financial information. Let us assume that ABC Enterprises is involved in selling diamonds. In
2010, the board of directors reviewed the financial performance of the company. The results of
the financial analysis are as follows:

The financial analysis of ABC Enterprises revealed that the company has shown prosperity
achieved in all areas i.e growth in sales, profits and assets.

The ratio analysis reveals that the companys profitability situation has improved as the net profit
ratio has improved from 30% in 2009 to 32% in 2010 with a net 2% increase in the net profit
ratio showing a higher level of profitability. The Return on equity ratio also shows an
improvement from 7% in 2009 to 10% in 2010 and we can see that the companys profitability
levels have improved during 2010.

Table 1
Profitability Ratios

Graph 1

Ratio 2009 2010
Net Profit ratio 30% 32%
ROE 7% 10%

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The companys liquidity position has been evaluated by current ratio and acid test ratio. Both
ratios have increased showing that the company has gained stringer liquidity position during
2010 over 2009 as the current ratio has increased from 7 to 10 during 2009-10 and the acid test
ratio has increased from 6 to 8 during the 2010 over the year 2009. This shows that the company
has gained better position in liquidity thus is able to better meet its short term liabilities.

Table 2
Liquidity Ratios

Graph 2

The activity ratios of the company involve Inventory turnover ratio which shows that the
company has managed its assets better in 2010 over 2009. As the inventory turnover ratio has
increased from 110% in 2009 to 130% in 2010.

Table 3
Ratio 2009 2010
Current Ratio 7 10
Acid test Ratio 6 8
Ratio 2009 2010

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Graph 3

ABCs financial structure ratios measure that the companys long term stability of financial
structure as measured by Debt to Equity ratio has been stable at 10% during the year 2010 and

Graph 4
Table 4

Inventory turnover Ratio 110% 122%
Ratio 2009 2010
Debt to Equity Ratio 10% 10%

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6.3. Make recommendations on the strategic portfolio of an organisation based on its
financial information

The strategic portfolio of an organization must be based on the long term profit potential that
different organizational units, domains and activities carry. The organization must divest from such
domains, units and activities which generate relatively lower returns and invest in or increase the
investment value in such domains, product lines or activities where it can generate relatively greater
amount of returns on investment.

Based on the foregoing discussions we can conclude that the business success is driven by many
factors that are often intricate. I the area of pricing we see that pricing drives revenues. The pricing
strategies depend on costs and an appropriate costing system. Therefore a continuous review and
evaluation of the costing system is also called upon so that the costing system that best serves an
organizations needs may be put in place.

We also saw that forecasting techniques can be employed to project future revenues and costs.

We also saw that budgeting is important process and it deals with numbers as well as with humans.
Setting master budgets and then monitoring of the budgets through comparisons to the actual
figures reflect on the accuracy of the budgetary system of an organization.

We also saw that cost reductions can be achieved in a number of manners which we discussed

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1. Murthy; Gurusamy, S. Cost accounting 3 edition Tata McGraw-Hill Education
2. Blocher (2006) Cost Management: A Strategic Emphasis. Tata McGraw-Hill Education
3. Lusthaus, C. (2002) Organizational Assessment: A Framework for Improving Performance.
4. Beenhakker , H. (1996) Investment Decision Making in the Private and Public Sectors.
Greenwood Publishing Group
5. Bhar, B. K (1976) Cost Accounting: Methods and Problems. Academic Publishers.
6. Baker, J, J. (1998). Activity-based Costing and Activity-based Management for Health Care.
Jones & Bartlett Learning.
7. Berk, J. (2010) Cost Reduction and Optimization for Manufacturing and Industrial
Companies. John Wiley & Sons
8. Atkinson (2007) Management Accounting Pearson Education India,
9. Thukaram, Rao M.E. (2007)Management Accounting New Age International
10. Vanderbeck, E. (2012) Principles of Cost Accounting. Cengage Learning.