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Basic Finance - Day 2 PDF
Basic Finance - Day 2 PDF
Day 2
By Cost Elements
By Directness
Costs & their revenue linkages
Fixed vs. Variable
Elements of Cost
Material
Labour
Expenses
Cost classification by Directness
Direct Cost
Costs which can be economically traced to a Cost Object
Indirect Costs
Costs which cannot be economically traced to a Cost
Object
Combination of elements &
directness
Direct Material
Direct Labour
Direct Expenses
Overheads
Indirect Material
Indirect Labour
Indirect Expenses
Cost Elements & Final Product
Product 1
Material
Product 2
Labour
Product 3
Expenses
Cost Center 1 Product 4
Overheads
Cost Center 2 Product 5
Examples :
Negotiating for a lower price
Substitution of raw materials or change in mix without
change in quality
Alternate sourcing of raw materials
Technological breakthrough
Improved efficiency in energy utilization
Improvement in input-output ratio
Realizing higher value for by-products or wastages
Marginal Cost
Aggregate
Costs Fixed
Costs
Per Unit
Fixed
Costs
Activity/ Volume
Management of Fixed Costs
Sales/ Revenue
(-) Variable Costs
Contribution (1)
(-) Fixed Cost
Profit Before Interest and Tax
or Operating Income (2)
(-) Interest
Profit Before Tax (3)
(-) Tax
Profit After Tax (4)
Contribution Margin %
Contribution
____________________ X 100
Total Revenue
Break Even Point (BEP)
2500
Costs and Revenue ( Rs. )
2000
Variable Costs
1500
BEP Fixed Costs
FC + VC
1000 Revenues
500
0
0 250 500 750 1000
Output
Calculation of Break Even Point
Contribution 150
Fixed Costs 50 O/L
Contribution 150
Fixed Costs 50
Earnings Before Interest & Taxes 100 T/L
Less : Interest 20
Earnings (Profit) Before Tax 80
Operating Leverage = 150/100 = 1.50
Financial leverage = 100 / 80 = 1.25
Total Leverage = 1.50 x 1.25 = 1.875
This can also be arrived at as = 150 /80
Direct & Absorption Costing
Strategic Emergence of
Environment Clarity Action Plans
Assessment & their
ownership
ABC
Target Costing
Interest
Present Future
Discount
Present & Future Values
Future Value:
Equal to Principal X (1 + r)n
N = Number of periods, R = Rate of interest
Present Value:
Equal to Principal / (1 + r)n
N = Number of periods, R = Rate of interest
Rs. 10,000
Rate of Interest 9%
ANNUAL
Rs. 10,900 Rs. 11,881 Rs. 12,950
QTRLY
Rs. 10,931 Rs. 11,948 Rs. 13,060
Rs. 10,000
Rate of Interest 9%
ANNUAL
Rs. 10,900 Rs. 11,881 Rs. 12,950
QTRLY
Rs. 10,931 Rs. 11,948 Rs. 13,060
MNTHLY
Rs. 10,938 Rs. 11,964 Rs. 13,086
DAILY Rs. 10,942 Rs. 13,099
Rs. 11,972
Annuity
Equity Debt
Equity Debentures
Convertible CP
Debentures Leasing
Foreign Cy.
Borrowings
Principles in financing
Contribution 150
Fixed Costs 50
Earnings Before Interest & Taxes 100
Less : Interest 20
Earnings (Profit) Before Tax 80
Operating Leverage = 150/100 = 1.50
Financial leverage = 100 / 80 = 1.25
Total Leverage = 1.50 x 1.25 = 1.875
This can also be arrived at as = 150 /80
20% increase in contribution
Contribution 180
Fixed Costs 50
Earnings Before Interest & Taxes 130*
Less : Interest 20
Earnings (Profit) Before Tax 110**
Contribution 120
Fixed Costs 50
Earnings Before Interest & Taxes 70*
Less : Interest 20
Earnings (Profit) Before Tax 50**
Preference:
Indicative returns
Only out of profits
Preference in payment of dividend
Preference in repayment of capital
Can be of various types: cumulative, non-cumulative,
participating, non-participating
Securitized loan
Fixed or floating rates
Publicly offered or privately placed
Convertible Debentures
WACC = Wi . Ci
Weighted Average CoC
Post-tax computations
Implicit cost as reflected in current market values is recognized
rather than just the agreed coupon rate
Incidental costs relating to sourcing of finance also relevant
Average cost calculated with reference to market values
Cost of Debt
Reserves are not free since they are built into the equity
price
Cost of reserves treated the same as cost of equity
except that issue cost is not required to be taken into
account
Determining proportions
Book Values
Readily available
Does not reflect market determined values
EVA is calculated by reducing from Net Operating Profit After Taxes (NOPAT),
the cost of capital. NOPAT is calculated as follows:
Revenue
Less: Operating Costs
_________________________
Operating Profit Before Tax
Less : Taxes
_________________________
Net Operating Profit After Tax
Investment Criteria
The net present value of a project is the sum of the present values of all the cash
flows- positive as well as negative that are expected to occur over the life of a
project
n
NPV of project = Ct
- Initial Investment
t=1 (1+r)t
The net present value represents the net benefit over and above the
compensation for time and risk
Internal Rate of Return (IRR)
The internal rate of return (IRR) of a project is the discount rate which
makes its NPV equal to zero
Discount rate which equates the present value of future cash flows with the
initial investment
It is the value of r in the equation
n
Ct
Investment =
t=1 (1+r)t
Ct = cash flow at the end of year t
r = internal rate of return (IRR)
n = life of the project
In the IRR calculation, we set the NPV equal to zero and determine the
discount rate that satisfies this condition
Payback Period
Payback period is the period within which the return from the project will
be sufficient to cover investment
In case of a project having equal annual inflows, it is calculated as :
Cash Outflow
Payback Period =
Annual Inflows