BASIC CONCEPTS RELEVANT COSTING

Financial Accounting Management Accounting  Make or Buy

Emphasis on reliability Relevance [timeliness] ↳ includes opportunity cost for Maximum Purchase Price
Aggregated and simplified Detailed and extensive  Accept or Reject
↳ Full Capacity: Minimum selling price = Regular SP + FC
Basic Management Functions ↳ Excess Capacity: Minimum selling price = VC + FC
 PLANNING – road mapping, goal setting  Continue or Shutdown
 ORGANIZING – Directing, motivating; staffing, subordinating ↳ Segment margin is the basis
 CONTROLLING – monitoring, feedback mechanism ↳ Product elimination
► Shutdown point = (FC – SD Cost) ÷ Unit CM
Controller ► Deduct SD Cost only if it is unavoidable, what remains is
 Financial reporting, cost and management accounting, AIS, the avoidable/relevant cost
financial analysis, special studies, etc.  Sell or Process Further
 Primarily staff function, has line authority to subordinates ↳ SELL = Sales value at Split-off
over his own department ↳ PROCESS = Final sales value – FPC [also called NRV]
↳ Joint cost is irrelevant

Line Function
Authority to give orders
(VP Ops → Ops Manager)
Direct downward authority
over line departments
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Staff Function  Scrap or Rework
Authority to advice but not ↳ Joint cost is a sunk cost, irrelevant
to command  Best Product Combination
Commonly exercise ↳ Ranking is based on CM per Activity (ex. CM per hour)
laterally or upward  Change in Profit

Directly involved in
achieving company
objectives
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Staff managers supports
other managers thru advice
► Fixed costs are irrelevant unless it became avoidable
or assistance
► Variable costs are relevant (includes DM, DL, VFOH)

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► Opportunity costs are relevant (sacrificed, not realized)
COST BEHAVIOR
Linear Programing – quantitative technique
Cost Estimation ↳ Used to achieve the best outcome [maximum profits or

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 High Low Method lowest costs] in linear representations
Cost YH – YL ↳ Handles multiple constraint, as opposed to relevant costing
VC =
LE HActivity XH – XL ↳ Objective function: Maximize Z = UCM1A + UCM2B
 Graphic/Scatter Graph/Scatter Diagram ↳ Non-negativity Constraint: A, B ≥ 0
↳ Draws straight line through plotted points
 Least-Square Regression
↳ “Line of best fit” most accurate
BUDGETING
↳ ∑Y = Na + b∑X; ∑xy = ∑xa + b∑x2
SA by
 Operating Budget – revenues and expenses
 Financial Budget – assets, liabilities, equity (usually: cash)
Correlation Analysis
 Capital Expenditure Budget – long-term goals
 Measure strength of linear relationships of variables
 Authoritative (top-down) – prepared by top management
 Can be seen through scatter graph
↳ Long-range planning
 Does not establish cause-effect relationship
 Participatory (bottom-up) – top management and
 Coefficient of Determination (r2)
personnel; promotes better management support
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↳ Degree which the behavior of IV predicts DV

 Fixed (Static) Budget – single activity
↳ The closer r2 is to 1.0, the better; more confidence
 Flexible (Variable/Dynamic) – series of budgets
 Coefficient of Correlation (r)
↳ Uses standard cost (comparison of actual vs budget)
↳ Facilitates better cost control
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r Linear Relationship Scatter Diagram

 Zero-based – encourage periodic re-examination of costs
+1.0 Direct/Positive Upward sloping line to the right (/)
 Kaizen – continuous improvement
0 none No pattern. Random points
 Budgetary slack – underestimating revenues, over
-1.0 Inverse/Negative Downward sloping line to the right
estimating costs to make targets easily achievable

COST-VOLUME-PROFIT ANALYSIS
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Master Budget [in order]

I. Sales Forecast (FAQ: starting point)
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Limitations and Assumptions II. Sales Budget (FAQ: most difficult)

 Sales and costs are linear III. Production Budget
 Constants IV. Inventory Budget
↳ Selling price i. Raw Materials Operating Budget
↳ Variable cost per unit ii. Direct Labor
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↳ Fixed Costs iii. Overhead

↳ Sales mix V. Cost of Sales
 No changes in inventory levels (Sales = Production) VI. Marketing and Admin Expense
 Volume affects sales, VC, and profit VII. Cash Budget
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VIII. Working Capital Budget Financial Budget

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 Time value of money, ignored

IX. Projected (Pro-forma) FS
i. Income statement
Break-Even With Target
ii. Financial Position
Fixed Cost Sales Units FC + TP iii. Cash Flow (FAQ: last prepared)
BEP Units =
Unit CM (W/ target profit) Unit CM

Fixed Cost Sales Peso FC + TP GROSS PROFIT VARIANCE ANALYSIS

BEP Peso =
CM Ratio (W/ target profit) CM Ratio
Actual (Current) GP vs. Budget (Previous) GP
BEP With target profit Fixed Cost
BEP Ratio =
Sales ratio CMR - PR ↑F GP Variance ↑UF GP Variance

Price Factor
Margin of Safety Sales Mix
 Sales – BEP Sales  Sales Price Variance = AQ (Actual SP – Budget SP)
 Profit ÷ CM Ratio Fixed Cost  Sales Price Variance = Actual Sales – AQ @ Budget SP
Overall BEP Units =
WACM Cost Factor
Indifference Point  Cost Price Variance = AQ (Actual CP – Budget CP)
Fixed Cost .
Profit based:  Cost Price Variance = Actual CGS – AQ @ Budget CP
CMu x % + CMu x %
FC + (VCu x X) Volume Factor
Fixed Cost  Sales Volume Variance = (AQ – BQ) x Budgeted SP
Cost based: Overall BEP Peso =
WACM Ratio  Cost Volume Variance = (AQ – BQ) x Budgeted CP
(CMu x X) - FC
Alt: AQ @ Budgeted SP or CP - Budgeted Sales or CGS
 STANDARD COSTING  Profit center – cost and revenues
↳ Uses variance analysis and segmented income statement
↳ Parts department, college department, etc.
Direct Materials  Investment center – cost, revenue, investments
AQ ✖ AP 1MPV*: a.k.a. ↳ Uses variance, segmented IS, ROI, RI and EVA
MPV1 ↳ Branches, product divisions, etc.
AQ ✖ SP DM Variance  Spending variance
MQV2
SQ ✖ SP  Rate variance
 Money variance Segmented Income Statement
Sales
Actual Quantity Less: Variable Manufacturing Cost
2MQV: a.k.a.
Actual Price Manufacturing Contribution Margin
Standard Quantity  Usage variance Less: Variable Non-Manufacturing Cost
Standard Price  Efficiency variance CONTRIBUTION MARGIN
*Use the actual quantity purchased in case of doubt. Less: Controllable Direct Fixed Cost
Controllable or Performance Margin1
Less: Non-controllable Direct Fixed Cost2
Direct Labor
Segment Margin3
AH ✖ AR 1LRV: a.k.a. Less: Allocated Common Cost
LRV1

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AH ✖ SR DL Variance  Price variance Profit
LEV2
SH ✖ SR  Spending variance 1
Used to evaluate the performance of the manager.
 Money variance 2
Committed cost, or controlled by higher authority.
Actual Hours
3
Used to evaluate the performance of the segment.

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2LEV*: a.k.a.
Actual Rate
 Usage variance Controllable
Standard Hours
Direct Costs Non-controllable
Standard Rate  Quantity variance
Indirect Costs Non-controllable
*not including IDLE TIME – an unfavorable cost

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Return on Investment
Mix and Yield Variance: ROI = Margin × Turnover
AQ ✖ AP ↓ ↓ ↓
Material Price Variance

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AQ ✖ SP
Material Mix Variance* DM Variance Income Income Sales
TAQ ✖ ASP = ×
Material Yield Variance* Assets Sales Assets
SQ ✖ SP LE H
Total Actual Quantity ✖ Average Standard Price ↓ ↓ ↓
*MMV + MYV = Materials Quantity Variance [MQV] ROA = RoS × ATo
“Du Pont Technique”
Sample Illustration: Material Mix Variance
SA by
SQ: 500, 400, 100 Residual Income = Income – Required Income
↳ Required Income = Assets x Minimum ROI
AQ ✖ SP
Material A: 60,000 3 EVA = Income after tax – Required Income
Material B: 30,000 4 350,000 ↳ Required Income = (TA – CL) x WACC
Material C: 10,000 5 10,000 F
TAQASP 100,000 3.6 = 360,000 ROI vs RI
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*
3(50%) 4(40%) 5(10%) = 3.6  ROI: Accepts investments that exceed ROI
 RI: Accepts investments as long as it earns in excess of
Factory Overhead: minimum rate of return (minimum ROI)
1-way: AFOH – SFOH ↳ PROS: better measure than ROI;
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2-way: [Con-Vol] encourages investments that ROI will reject

AFOH – Actual FOH ↳ CONS: cannot be used to compare divisions with different
Controllable sizes; favors larger divisions (larger amounts)
BASH – Budget Adjusted for Std Hrs
SHSR - Standard FOH [SFOH] Volume
*BASH = Budgeted FFOH + (SH x VFOH Rate) ABSORPTION VS. VARIABLE COSTING
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3-way: [S-E-Vol]
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AFOH – Actual FOH Spending Comparison

BAAH – Budget Adjusted for Act Hrs. Direct Materials (a variable cost)
Efficiency
BASH – Budget Adjusted for Std Hrs Direct Labor (a variable cost) Variable Absorption
SHSR - Standard FOH [SFOH] Volume Variable Factory Overhead Costing Costing
Fixed Factory Overhead*
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*BAAH = Budgeted FFOH + (AH x VFOH Rate)

4-way: [S-S-E-Vol] Total Manufacturing Cost
AFOH – Actual FOH Spending *their difference is the Fixed FOH
BAAH – Budget Adjusted for Act Hrs.
Efficiency (v)
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BASH – Budget Adjusted for Std Hrs ABSORPTION COSTING VARIABLE COSTING
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SHSR - Standard FOH [SFOH] Volume (f) Also known as Full costing; GAAP Costing Direct/Marginal costing
Fixed Factory Overhead Product/Inventoriable cost Period cost
*Variable Spending: BAAH = Actual Hours x VFOH Rate ↳ how is it considered? Part of COGS when sold Fully expensed
*Fixed Spending: BAAH = Budgeted FFOH Inventory cost HIGHER [includes FFOH] LOWER
Matching principle Compliant Non-compliant
Notes Purpose External-Financial Reporting Internal–Decision making
 SFOH = Applied OH so, AFOH > SFOH = under-applied
 Volume variance is also capacity variance
 Volume variance is only fixed, no such thing is variable Key: P S ; A𝑦 V𝑦 ; EI BI [P.S. Ay ♡you pero AmBaho]
 VFOH Efficiency alternative = (AH – SH) x VR  If the Produced goods are greater than Sold, the
There is no such fixed efficiency and variable volume Absorption profit (𝑦) is also greater, as well as the
RESPONSIBILITY ACCOUNTING Ending Inventory. [Also applies if less than or equal]
 Decentralization – must avoid sub-optimization  FAQ: Net income of AC or VC:
(managers decide in favor of their own unit at the Step 1: Determine the FFOH rate
expense of the entire organization) Total FFOH !!! Use the key
÷ Produced units to know which
Responsibility Centers
FFOH % income is higher
 Cost Center
↳ Uses variance analysis
↳ assembly department, accounting dept, etc. Step 2: Determine the difference (FFOH)
 Revenue Center FFOH %
↳ Uses variance analysis × Ending/Unsold units [Production – Sales]
↳ ticket outlets, convenience store, etc. Difference in income
 TRANSFER PRICING MPC + MPS = 100%
MPC = △ Consumption ÷ △ Disposable Income
MPS = △ Savings ÷ △ Disposable Income
Goal Congruence – (to prevent sub-optimization) division
managers = consistent with goals and objectives of the
Demand – relationship between price and quantity supplied
organization as a whole
 Quantity Demanded – plan to sell at a particular price
 Market Price – best transfer price if:
 HIGHER PRICE, greater quantity supplied:
↳ Competitive market exist
 Supply Curve – Positive relationship of P and QS
↳ Divisions are independent of each other
↳ Positively sloped [/]
 Cost-based Price – easy to understand, convenient to use
↳ Increase in supply = shift rightwards
↳ Based on selling division’s variable or full cost, or cost-plus
 Negotiated Price – no market exist, or subject to fluctuation
Effects on Supply
↳ Max (buying): market price Production cost INVERSE Cost ⬆ ⬇ Supply
↳ Min (selling): outlay [VC] + opp cost [CM of external sales] Number of producers DIRECT Producers ⬆ ⬆ Supply
 Arbitrary Price – imposed by higher authorities [no basis] Price of Substitute INVERSE Returns ⬆ ⬆ Other products
Price of Complementary DIRECT Complement ⬆ ⬆ Curve: Rightward
BALANCED SCORECARD Expected future prices
Technology
DIRECT
DIRECT
Future price ⬆ ⬆ Production
Advancement increases supplies

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Government subsidies DIRECT Reduces production costs
Four Perspectives Tax and Tariffs INVERSE Increases production costs
INTERNAL LEARNING
FINANCIAL CUSTOMER BUSINESS AND
PROCESS GROWTH
Equilibrium – demand and supply are in balance [like BEP]

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 ROI  Level of  Employee D S
 Operating returns  MCE training
8 Market Surplus

Price
Margin  Complaints  EE satisfaction 4 Equilibrium
Non-controllable Factors Controllable Factors 6 Market Shortage
Lagging 2

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Leading Indicators
indicator 2 4 6 8
Quantity

Receipt Start of Shipment Market Surplus – QS exceeds QD

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of order Production of Goods ↳ PRICE FLOOR set above equilibrium price
Market Shortage – QD exceeds QS
LE H Wait

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Process + Inspection + Move + Queue

Manufacturing Cycle
↳ PRICE CEILING set below equilibrium price

Factors of Production
MCE =
MC (Throughput Time) ↳ LAND (natural) – land, water, mineral, timber
↳ LABOR (human) – skills, works, efforts
SA by
Delivery Cycle
↳ CAPITAL (financial and man-made) –savings, equipment, etc.
(Lead Time)
*Value-Added
Gross Domestic Product – MV of all final goods and services
Output → Finished Goods or Sales produced by a country, not including intermediate goods.
Productivity =
Input → DM, DL, FOH
Expenditure Approach: C + I + G + (X - M) = GDP
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Household Consumption; Business Investments; Government

ECONOMICS Spending; Exports, Imports
(Filtered)
Demand – relationship between price and quantity demanded Income Approach: WIRIPIT DAF = GDP
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 Quantity Demanded – plan to buy at a particular price Wages; Self-employment Income; Rent; Interest; Profits;
 HIGHER PRICE, lower quantity demanded: Indirect Business; Taxes (ex. VAT); Depreciation and
↳ Substitution effect – raises opportunity cost, people buy Amortization; Income from Foreigners
less, other goods have lower price
Nominal GDP – value of final goods at current MV
↳ Income effect – reduces amount of goods people can afford
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Real GDP - value of final goods at a certain year, valued at

 Demand Curve – Inverse relationship of P and QD
constant price (adjustment that eliminates inflation effects)
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↳ Negatively sloped [\]

↳ Increase in demand = shift rightwards
Recession – decline in REAL GDP
Economic Growth – increase in REAL GDP
Effects on Demand
Price of Substitute DIRECT ex. Price of pork ⬆ Demand for beef ⬆
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Price of Complementary INVERSE ex. Price of gas ⬆ Demand of cars ⬇

Expected future prices DIRECT Future price ⬆ Demand now ⬆ Inflation
Consumer wealth or DIRECT Normal goods: Income ⬆ Demand ⬆ Demand Pull – too much demand: not met by supply increase
income INVERSE Inferior goods: Income ⬇ Demand ⬆ Cost Push – increase in production cost (wage/material price)
Population growth DIRECT Increase of potential buyers Consumer Price Index
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Market size DIRECT Market size expands, Demand ⬆ Inflation Rate = (CPIcurrent – CPIlast year) ÷ CPIlast year
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Consumer preference/taste Indeterminate GDP Deflator

Substitute – In place of another (ex. pencil and pen)
Complementary – cannot function without the other
Inferior goods – ex. instant noodles, sardines
Elasticity of Demand (ED)
△% in Quantity Demanded ➝ QD ÷ Average Quantity
△% in Price ➝ Price ÷ Average Price
GDP Deflator = Nominal GDP ÷ Real GDP
Unemployment – inverse with inflation
 Cyclical – changes in business cycle; increases in recession
 Frictional – normal workings; new graduates, resignation
 Structural – mismatch between kind and job skills

Effect of Price Increase to QD and Total Revenue

ED Elasticity Quantity Demanded Total Revenue Fiscal/Monetary Policy – counters recession or inflation
>1 Elastic Reacts MORE Decrease Fiscal Policies – action by government [⬆GDP - Expansion]
=1 Unitary Proportionate - ↳ Reduction of taxes – increases disposable income
<1 Inelastic Reacts LESS Increase ↳ Increased spending – ex. subsidies
0 Perfectly Inelastic No reaction Increase *Otherwise is Contraction
*Luxury goods: more ELASTIC vs. basic/staple goods
*Badly needed goods: PERFECTLY INELASTIC

Disposable Income – amount after paying taxes

 Marginal Propensity to Consume – how much will be spent
↳ Marginal Propensity to Save – how much will be saved
 CAPITAL BUDGETING  PAYBACK BAIL-OUT:
o Length of time to recover investment
Characteristics: Decisions: o Cash recoveries include salvage value
 INDEPENDENT PROJECT Sample Problem: Bailout Period [Investment: 1,400]
Difficult to reverse  Unrelated projects Cash inflows SV
 Cash flows are cumulative
Uncertainties (risk)  Accept or Reject Year 1: 500 800
Large fund Year 2: 700 600
 Salvage value is current
Long-term  MUTUALLY EXCLUSIVE Year 3: 850 400
↳ ex. PPE, expansion  Acceptance of one
Year 1 Year 2 Year 3
rejects the other: Cash flows (cumulative) 500 1,200
It is an investing activity ↳ Lease or own Investment . 1,400 1,400 ×bailed-
rather than financing. ↳ Repair or replace Unrecovered investment (900) (200)
out×
Salvage value . 800 600
Recovery (100) 400
Evaluation Methods (Unrecovered portionY1 – Salvage valueY2) ÷ CFATY2 = 1.43 years
NON-DISCOUNTED DISCOUNTED

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Payback Period Net Present Value  ACCOUNTING RATE OF RETURN:
Payback Reciprocal Profitability Index o aka. book rate of return; unadjusted rate of return
Bail-out Payback Discounted Payback o Accept if ARR is HIGHER ✓ than cost of capital
Accounting Rate of Return Internal Rate of Return Advantages Disadvantages

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👍 Easy to use
Important Considerations (Cornerstones) 👍 IFRS Compliant
 Net Investment: TOWA-RAT [Start; Year 0] 👍 Emphasis on profitability
Tax on gain*
👎 IGNORES:
- time value of money
- cash flows after payback

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Other incidental costs Resale/trade-in value of (old) Annual Net Income After Tax1
Working capital1 Avoidable costs (after tax) Average/Original Investment2
Acquisition cost . Tax on loss . 1before adding back the depreciation (ACFAT + depre)

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Cash outflow - Cash inflow 2use average if silent: (Cost + Salvage Value) ÷ 2

= Net investment
*Resale value ↑ – CA of old = Gain↑ × Tax = Tax on G/L
LE H DISCOUNTED TECHNIQUES
Gain – tax = Proceeds of sale of old asset  NET PRESENT VALUE:
o Measures true income using discounted cash flows
 Net Returns: Cost savings/Increased Revenues [During useful life] o Accept if NPV is POSITIVE ✓ [MORE THAN 0]
Cash cost (old)↑ o Cost of capital as reinvestment rate [disc rate]
SA by
L: Cash cost (new) PV of ACFAT [Net cash inflow]
Cash savings↑ × (100%-Tax) xx Less: PV of TCFAT [Net cash outflow]
L: Depreciation . × (Tax) + xx [tax shield]
Net Income Before Tax ACFAT*  PROFITABILITY INDEX: [NPV Index]
L: Tax . o Makes NPV comparable
Net Income After Tax o Peso earned per peso invested
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A: Depreciation (non-cash expense is added back) o Accept if PI is MORE THAN 1 ✓

Annual Cash Flow After Tax* PV of ACFAT [Net cash inflow]
PV of TCFAT [Net cash outflow]
 Termination Cash Flow After Tax : CWTS [End of Life]
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Cost to remove, net → an OUTFLOW Relationship of NPV and PI

Working capital1 → an INFLOW PV of ACFAT [IN] PI = PF of CFAT
Tax on Loss (Gain) → CA – Salvage Val(new) × Tax L: PV of TCFAT [OUT] Net investment
Salvage value (new) → an INFLOW PV of CFAT
TCFAT PI
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L: Net Investment NPVI = NPV .

1Additional working capital will reverse at end of life NPVI
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Net Present Value Net investment

NON-DISCOUNTED TECHNIQUES  INTERNAL RATE OF RETURN: [Reinvestment rate]

 PAYBACK PERIOD: o aka. time-adjusted rate of return
o Length of time to recover investment o Use interpolation to find IRR.
N st

o Accept if payback period is SHORTER ✓ o Conditions:

Advantages Disadvantages  That PV of CFAT is = to Net Investment
👍 Easy to use, less risky 👎 IGNORES:  NPV is 0; and PI is 1
👍 Measures liquidity: - time value of money
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Advantages Disadvantages
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PB < UL = Liquid - profitability 👍 Reveals true return 👎 Reinvestment rate is not

PB > UL = not recover - cash flows after payback 👍 Emphasis on cash flows realistic if the project has
Payback Period; Useful Life - salvage value 👍 Considers time-value negative earnings.

Formula: Even cash flows  DISCOUNTED PAYBACK PERIOD: [use cost of capital]
Net Investment o Same as payback period, but discounted.
Net Cash Inflows [or ACFAT]
INVESTMENT RISKS AND RETURNS
Sample Problem: Uneven cash flows [Payback schedule]
Investment: 90,000 NInvt: 90,000  The standard deviation [risk] is compared with the
Cash flows: Year 1: (40,000)1year expected return [return], and the relationship is the
Y1: 40,000 50,000 coefficient of variation.
Y2: 35,000 Year 2: (35,000)1year 2.5 years Standard Deviation
Y3: 30,000 15,000 Coefficient of Var =
Expected Return
Y4: 20,000 Year 3: (15,000)0.5 year
Other formulas:
 PAYBACK RECIPROCAL:  Variance = ER – Cash flow × (Probability %)
o Good estimate of IRR
 SD = √Variance
o Cash flows are even [uniform throughout the life]
o Useful life is atleast twice the payback  The higher the CV, the riskier the investment.
 COST OF CAPITAL  LIQUIDITY RATIOS: to meet short-term obligations
Net Working Capital Current Assets – Current Liabilities
Also known as: Used for decision in: Current Ratio Current Assets
 Minimum required  Capital budgeting (Working Capital Ratio) Current Liabilities
rate of return  Long-term financing
 Hurdle rate  Capital structure Quick Ratio Quick Assets
 Desired rate maintenance [optimal]
(Acid Test Ratio)Current Liabilities
*excluding inventories

Cost of Capital Formula  SOLVENCY RATIOS: Leverage ratio [long-term]

Long-Term Debt:
Preferred shares:
Common shares:
Retained Earnings:
KD: Cost of Debt
 Use the effective interest rate as yield rate:
Yield rate – Tax Total Liabilities
Debt Ratio
Yield rate (fixed, no growth) Total Assets
Yield rate + Growth rate Total Equity
Yield rate + Growth rate Equity Ratio
Total Assets
Total Liabilities
Debt-to-Equity Ratio
Total Equity

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(Annual Interest ÷ Current Market Price) Time Interest Earned EBIT
 Other way is the use of Yield-to-Maturity: (Interest Coverage Ratio) Interest Payments
YTM [Simple Average] YTM [Weighted Ave (60:40 Method)] 1
Equity Multiplier*
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Interest +/- Amortization of Disc.(Prem) Interest +/- Amortization of Disc.(Prem) Equity Ratio
(Net proceeds + Face Value) ÷ 2 Net proceeds (60%) + Face Value (40%) *aka: Equity Ratio Reciprocal [Assets ÷ Equity]

KP: Cost of Preferred Shares

 PROFITABILITY RATIOS: Performance ratio

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 Use the dividend yield as yield rate, computed as:
Gross Profit
Dividend Per Share Gross Profit Margin
Sales
Market Value Per Share*
*should be net of floatation or issue cost (spread, expenses, etc.) EBIT
Operating Profit Margin

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Sales
KE: Cost of Equity (Common stock and RE)
LE H Net Profit
 Also use the dividend yield [DPS + ÷ MVPS] Net Profit Margin
Sales
Dividend Per Share + Growth Rate1
Market Value Per Share2 Income
Return on Sales
1
includes growth rate → expected dividend [Gordon Growth Model] Sales
2
floatation costs are ignored
SA by
 Other way is the use of Capital Asset Pricing Model Income
Return on Assets
KE = KRF + β (KM – KRF) Average Assets
KRF: Risk free rate (ex. T-Bills, gov’t issued, no risk) Income
Return on Equity*
KM : Market return (KM – KRF = Market risk premium) Average Equity
β : Beta-coefficient (volatility/sensitivity/systematic risk) *alternative: RoA ÷ Equity Ratio
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β>1 SP is more volatile than MP Stock price (A) ; Stock market (a)  ACTIVITY/EFFICIENCY RATIOS: Asset Utilization Ratio
β=1 SP is as volatile as MP Stock price (A) ; Stock price (A)
SP is less volatile than MP
TURNOVER AGE CCC
β<1 Stock price (a) ; Stock price (A)
Stock Price ; Market Price COGS Conversion 360
ITo = Age of Inv
FO nu

Ave. Inv Period ITo Normal

Operating
NON-DIVERSIFIABLE RISKS (deals with CAPM) Cr. Sales Collection 360 Cycle
 non-controllable, systematic, market-related RTo Ave. AR Period RTo
= Age of Recv

 risks-caused by “outside world” (market, interest

Cr. Purch Payable 360
rates, purchasing power) PTo Ave. AP Period PTo
= Age of Pybl (Age of Pybl)
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Cash Conversion Cycle

DIVERSIFIABLE RISKS
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 controllable, unsystematic, company-related Sales

 risks-caused by internal matters (business risk, Asset Turnover
Average Total Assets
liquidity risk, borrowers’ defaults)
Sales
Fixed Asset Turnover
N st

Average Fixed Assets

LEVERAGE
 PROFITABILITY RATIOS: Performance ratio
Sales Degree of Degree of Net Income – PS Dividends
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L: VC . Operating Financial Earnings Per Share

Weighted Ave Number of OS Outs
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CM Leverage Leverage
L: FC . DOL  risk of not covering  risk of not covering Market Price per Share
Price-Earnings Ratio
EBIT DTL operating costs (fixed financial costs (returns EPS
costs) to ordinary sh’s)
L: FFC . DFL CM1 EBIT Dividend Per Share
Profit Dividend Yield
EBIT EBIT – FFC1 Market Price per Share
EBIT = CM - fixed FFC = Interests +
operating costs Preferred Dividends Dividend Per Share
(before tax) Dividend Payout
DTL = DOL × DFL EPS
or or
1or: CM÷(EBIT – FFC) Retention Ratio 100% - Dividend Payout
2or: ∆ % in EBIT ∆ % in EPS2 (Plowback Ratio)
∆ % in EPS
∆ % in Sales2 ∆ % in EBIT  ADDITIONAL FUNDS NEEDED: [AFN]
∆ % in Sales
o aka. External Funds Needed
Variable Assets
∆ in Variable Assets = × ∆ Sales
FS ANALYSIS Old Sales
Variable Liabs
Horizontal Analysis Vertical Analysis Less: ∆ in Variable Liab = × ∆ Sales
Old Sales
 TREND ANALYSIS [△%]  COMMON SIZE [single pd]
Less: Retained Profit (Earnings – Dividends)
Current Value – Base Value  Total assets for BS items
Additional Funds Needed
Base Value  Total sales for IS items
 WORKING CAPITAL MANAGEMENT Delivery Based
↳ Without safety [LD QTY]: Ave. Usage x Normal Lead Time
 Policies ↳ With safety [Reorder Pt]: Ave. Usage x Max Lead Time
↳ Conservative – “relaxed policy”
Usage Based
► Minimize liquidity risk → high working capital
↳ Without safety [LD QTY]: Nor. Usage x Lead Time
► Less profitable → reliance on long-term financing
↳ With safety [Reorder Pt]: Max Usage x Lead Time
↳ Aggressive – “restricted policy”
► Risky → reliance on short-term financing
Short-term Financing
► Enhances profitability → minimum working capital  Increases liquidity risk [technical insolvency]
↳ Moderate – “balanced” not too high. not too low  Factors to consider for short term funds [AIR C]
↳ Matching – “self-liquidating/hedging” ↳ Availability, Influence, Requirement, Cost
► Maturity is matched with asset’s useful life  Cost of trade credit: caused by foregoing discounts (opp cost)
► Current assets → Current liabilities Discount % 360
x
100%-Discount % Cr Pd – Disc Pd
 Transaction [liquidity motive] – normal transactions
 Precautionary [contingent motive] – buffer against
contingencies, cash held beyond normal cycle OTHER TOPICS

es
 Speculative – profit-making opportunities (sudden price drop)
 Contractual – held as required (compensating balance) Learning Curve: Sample Problem
80% learning curve. First unit requires 20 hours to complete
Cash Management Units Cumulative ave. time per unit Total Hrs Hours used
Helps shorten Cash Conversion Cycle 1 20 201 20

ul
 Accelerating collections: Lockbox system [early collection] 2 16 32 122
 Reducing precautionary cash: Line of credit 4 12.8 51.2 19.23
 Slowing disbursements: Zero-balance accounts (use checks) 1
Hours used to produce the first unit
2
Hours used to produce the second unit

rc
Optimal Cash Balance/Economic Cash Quantity [Baumol] 3
Hours used to produce the third and fourth unit
*ECQ ÷ 2 = Average cash balance Labor efficiency – directly affected by learning curve
2DT *D ÷ ECQ = No. of transactions
O

e
Annual Demand for Cash Financial Markets
Cost per Transaction [FC]
LE H *(ECQ ÷ 2) x O = Opport. Costs  Money Markets
Opportunity cost *(D ÷ ECQ) x T = Trans. Costs ↳ Short-term debt securities
↳ Dealer-driven markets
Other Techniques: BEP, NOC, CCC [CVP, FS Analysis] ↳ Low default risk
↳ Usually considered as substitute to cash
Float: helps shorten Cash Conversion Cycle  Capital Markets
SA by
 Positive/Disbursement Float: Bank balance > Book ↳ Long-term debt and equity securities
↳ Outstanding checks are not yet cleared ↳ Primary markets – new securities; larger investors (IPO)
 Negative/Collection Float: Book balance > Bank ► Normally can be sold only once
↳ Mail Float: Customer – mailed ; Seller – not yet received ► Investor deals directly with the issuing entity
↳ Processing Float: Seller – received, but not deposited ↳ Secondary – existing (exchange); small investors (PSE)
↳ Clearing Float: Deposited, but not yet cleared ► No limit to number of times can be traded
R te

*negative float: Opportunity cost if exceeds 30 days ► Traded entities after entities

Good cash management: ~Nothing follows~

↳ Positive/Payment float: MAXIMIZED [Lengthen]
↳ Negative/Collection float: MINIMIZED [or eliminated]
FO nu

“Hasten, O God, to save me;

O LORD, come quickly to help me”
Receivable Management
 Normally non-interest bearing Certified Public Accountant 2023
 Risk of non-collection
 Short average collection period = low opportunity cost and
i

risk of delinquency and default

O M

 5C’s
↳ Character – willingness to pay
↳ Capacity – ability to generate cash flows
↳ Capital – financial resources
↳ Conditions – current economy/business condition
N st

↳ Collateral – pledge to secure debt

Cost of Forgoing Discount

Discount Rate 360 .
x
La

100% - Discount Payment Pd – Disc Pd

T

Basically: P x R x T

Inventory Management

*EOQ ÷ 2 = Average inventory

2DO
C
Annual Demand or usage
Cost of placing one Order
Cost of Carrying one unit
When used for production: D
*D ÷ EOQ = No. orders per year
*(EOQ ÷ 2) x C = Carrying costs
*(D ÷ EOQ) x O = Ordering Costs
= Production; O = Setup cost

Assumptions:
 Demand occurs evenly throughout the year
 Lead time is constant [sales/demand, CC, OC]
 Unit costs are constant
 Inventories are received one at a time
 Inventory size is unlimited

Stock-out Costs: lost sales (opportunity cost)

Reorder Point = *Lead quantity + Safety stock
*
also called as Delivery Time Stock