Management Accounting

- the application of appropriate techniques and concepts in processing the historical and projected
economic data of an entity to assist management in establishing a plan for reasonable economic
objectives and in the making of rational decisions with a view towards achieving these objectives.
- defies attempts at comprehensive, concise definition; it changes constantly to adapt to
technological changes, changes in manager’s needs, and new approaches to other functional areas of
business – marketing, production, finance, organizational behavior, and corporate strategy.
- includes the methods and concepts necessary for effective planning, for choosing alternative business
actions and for control through the valuation and interpretation of performance (The American
Accounting Association).
- The essential aim of management accountant is to assist management in decision making and control
(Brown and Howard).

FINANCIAL ACCOUNTING VS. MANAGERIAL ACCOUNTING

Differences Financial Accounting Managerial Accounting

They serve different audiences serves persons outside the firm such insiders
as creditors, customers, government
units and investors.

Differ in source and nature
reports are developed from the basic
accounting system , which captures
data about completed transactions.
reports incorporate information that is
not found in the financial accounting
system; such information might relate
to expected future transactions (such
as budgeted sales and costs) or
alternatives to past transactions
(such as showing what income would
have been if we had sold more units
at a lower price)

As to purpose Financial accounting reports are Managerial accounting reports are

general purpose specifically designed for a particular
user or a particular decision.

Financial accounting reports Managerial accounting reports often

concentrate on the results of past concentrate on what is likely to
decisions. happen in the future

financial accounting has to adhere to Managerial accounting has no

GAAP. external restrictions such as the
generally accepted accounting
principles (GAAP)

Managerial Functions and their Relationship to Accounting

Planning – setting goals and developing strategies and tactics to achieve them
Decision Making - use of analytical techniques
Control - determining whether goals are being met, and if not, what can be done.
Performance evaluation - how well operations are being controlled

Objectives of Management Accounting

Main objective: to supply the required data to perform the internal management functions.
The ff. are some of the functions:
1. Collection of data – for preparation of plans
 2. Evaluation of plans – ascertaining the defects if any and brought to the notice of the managers
immediately.
3. Observing the performance – comparing the actual with the standards
4. Observing the reports – analyzing the uses of various types of statements in the organization and
suggesting their improvement.
5. Coordination among persons – showing organizational relations among people
6. Financial analysis
7. Timely decisions
8. Peaceful atmosphere
9. Coordination
10. Submission of reports – for performance evaluation

Role of Managerial Accounting within an Organization

Boeing – “ Less transactional and more decision-support type of work. More analytical, more option analysis”
US West – “ From a historical role to a much more collaborative business partner, doing a lot more analysis,
saying here’s what we need to do in the business. A business partner. It’s how we run the business and what
are the financial impacts of doing that.”
Caterpillar - “Accountants evolve to become more of a team player and being involved in major projects and
being looked to as a business advisor or consultant to help leverage our expertise
on profitability of certain products or outsourcing decisions and then helping the team develop strategy and
focus the team all the way through recommendation and implementation.” Activities of Managerial
Accountants
Assist in the design of the organization’s information system
● Ensuring that the system performs adequately
● Periodically reporting information to interested managers
● Undertaking special analyses

III - Profit Planning

Cost-Volume-Profit Analysis – a systematic examination of the relationships among costs, activity levels
or volume, and profit.
Cost – refers to amount of resources given up in exchange for some goods or services

Classification of cost
1. Fixed – remain the same in total over a wide range of volume
2. Variable – change in total in direct proportion to changes in volume

Example:

Exeter Company
Selling price of backpacks P20.00
Cost of backpacks from manufacturers P10.00
Variable cost to pack and ship 1.00
Sales commission at 5% of P20.00 1.00
Total Variable Cost P12.00
Fixed Costs (rent, salaries, insurance, etc.) P40,000
Contribution Margin – the difference between selling price per unit and variable cost per unit
𝐶𝑀 = 𝑆𝑒𝑙𝑙𝑖𝑛𝑔 𝑃𝑟𝑖𝑐𝑒 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡 − 𝑉𝑎𝑟𝑖𝑎𝑏𝑙𝑒 𝐶𝑜𝑠𝑡 𝑝𝑒𝑟 𝑈𝑛𝑖𝑡

Contribution margin percentage – per-unit contribution margin divided by selling price

𝐶𝑀/𝑢𝑛𝑖𝑡
𝐶𝑀% = 𝑆𝑒𝑙𝑙𝑖𝑛𝑔 𝑃𝑟𝑖𝑐𝑒

a. In our example, how much is the contribution margin per unit and what is the contribution margin
percentage?

What is the total cost?

𝑇𝑜𝑡𝑎𝑙 𝐶𝑜𝑠𝑡 = 𝑓𝑖𝑥𝑒𝑑 𝑐𝑜𝑠𝑡 + (𝑣𝑎𝑟𝑖𝑎𝑏𝑙𝑒 𝑐𝑜𝑠𝑡 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡 𝑥 𝑢𝑛𝑖𝑡 𝑣𝑜𝑙𝑢𝑚𝑒)
(Assume units sold, 6000 units)
Determine profit:
𝑃𝑟𝑜𝑓𝑖𝑡 = (𝑠𝑒𝑙𝑙𝑖𝑛𝑔 𝑝𝑟𝑖𝑐𝑒 𝑥 𝑢𝑛𝑖𝑡 𝑠𝑎𝑙𝑒) − 𝑡𝑜𝑡𝑎𝑙 𝑣𝑎𝑟𝑖𝑎𝑏𝑙𝑒 𝑐𝑜𝑠𝑡 − 𝑓𝑖𝑥𝑒𝑑 𝑐𝑜𝑠𝑡

Achieving Target Profits

Break-Even Point – the point at which profits are zero because total revenues equal total costs

BEP = Total sales = Total costs = 0 Profit

A. In units
𝑇𝑜𝑡𝑎𝑙 𝐹𝑖𝑥𝑒𝑑 𝐶𝑜𝑠𝑡𝑠
𝐵𝐸𝑃 𝑖𝑛 𝑈𝑛𝑖𝑡𝑠 = 𝐶𝑀 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡
40,000
𝐵𝐸𝑃 𝑖𝑛 𝑈𝑛𝑖𝑡𝑠 = 20−12
40,000
𝐵𝐸𝑃 𝑖𝑛 𝑈𝑛𝑖𝑡𝑠 = 8
𝐵𝐸𝑃 𝑖𝑛 𝑈𝑛𝑖𝑡𝑠 = 5, 000 𝑏𝑎𝑐𝑘𝑝𝑎𝑐𝑘𝑠

B. In Pesos
𝑇𝑜𝑡𝑎𝑙 𝐹𝑖𝑥𝑒𝑑 𝐶𝑜𝑠𝑡𝑠 + 0
𝐵𝐸𝑃 𝑖𝑛 𝑃𝑒𝑠𝑜𝑠/ 𝐵𝑟𝑒𝑎𝑘 − 𝑒𝑣𝑒𝑛 𝑆𝑎𝑙𝑒𝑠 = 𝐶𝑀 %
40,000
𝐵𝐸𝑃 𝑖𝑛 𝑃𝑒𝑠𝑜𝑠/ 𝐵𝑟𝑒𝑎𝑘 − 𝑒𝑣𝑒𝑛 𝑆𝑎𝑙𝑒𝑠 = 40%
𝐵𝐸𝑃 𝑖𝑛 𝑃𝑒𝑠𝑜𝑠/ 𝐵𝑟𝑒𝑎𝑘 − 𝑒𝑣𝑒𝑛 𝑆𝑎𝑙𝑒𝑠 = 100, 000

Target Profit
At the BEP, total contribution margin equals total fixed costs. We can therefore find the volume required to
achieve a target profit by finding the sales required to earn a total contribution margin equal to the sum of total
fixed costs and the target profit.
Formula:
𝐹𝑖𝑥𝑒𝑑 𝐶𝑜𝑠𝑡𝑠 + 𝑇𝑎𝑟𝑔𝑒𝑡 𝑃𝑟𝑜𝑓𝑖𝑡
𝑇𝑎𝑟𝑔𝑒𝑡 𝑃𝑟𝑜𝑓𝑖𝑡 (𝑠𝑎𝑙𝑒𝑠 𝑖𝑛 𝑢𝑛𝑖𝑡𝑠) = 𝐶𝑀
Suppose Exeter wishes to earn a profit of P5,000 per month. How many backpacks must it sell?
40,000 +5,000
𝑇𝑎𝑟𝑔𝑒𝑡 𝑃𝑟𝑜𝑓𝑖𝑡 (𝑠𝑎𝑙𝑒𝑠 𝑖𝑛 𝑢𝑛𝑖𝑡𝑠) = 20−12
45,000
𝑇𝑎𝑟𝑔𝑒𝑡 𝑃𝑟𝑜𝑓𝑖𝑡 (𝑠𝑎𝑙𝑒𝑠 𝑖𝑛 𝑢𝑛𝑖𝑡𝑠) = 8
𝑇𝑎𝑟𝑔𝑒𝑡 𝑃𝑟𝑜𝑓𝑖𝑡 (𝑠𝑎𝑙𝑒𝑠 𝑖𝑛 𝑢𝑛𝑖𝑡𝑠) = 5, 625 𝑢𝑛𝑖𝑡𝑠
Sales, in pesos, to achieve target profit
𝐹𝑖𝑥𝑒𝑑 𝐶𝑜𝑠𝑡𝑠 + 𝑇𝑎𝑟𝑔𝑒𝑡 𝑃𝑟𝑜𝑓𝑖𝑡
𝑇𝑎𝑟𝑔𝑒𝑡 𝑃𝑟𝑜𝑓𝑖𝑡 (𝑠𝑎𝑙𝑒𝑠 𝑖𝑛 𝑝𝑒𝑠𝑜𝑠) = 𝐶𝑀%
40,000 +5,000
𝑇𝑎𝑟𝑔𝑒𝑡 𝑃𝑟𝑜𝑓𝑖𝑡 (𝑠𝑎𝑙𝑒𝑠 𝑖𝑛 𝑢𝑛𝑖𝑡𝑠) = 40%
𝑇𝑎𝑟𝑔𝑒𝑡 𝑃𝑟𝑜𝑓𝑖𝑡 (𝑠𝑎𝑙𝑒𝑠 𝑖𝑛 𝑢𝑛𝑖𝑡𝑠) = ₱112, 500

Target Return on Sales (ROS)

Formula:
𝐹𝑖𝑥𝑒𝑑 𝐶𝑜𝑠𝑡𝑠
𝑇𝑎𝑟𝑔𝑒𝑡 𝑅𝑂𝑆 (𝑠𝑎𝑙𝑒𝑠 𝑖𝑛 𝑝𝑒𝑠𝑜𝑠) = 𝐶𝑀% − 𝑡𝑎𝑟𝑔𝑒𝑡 𝑅𝑂𝑆
Problem:
Suppose that Exeter wishes to earn a 15% ROS.
40,000
𝑇𝑎𝑟𝑔𝑒𝑡 𝑅𝑂𝑆 (𝑠𝑎𝑙𝑒𝑠 𝑖𝑛 𝑝𝑒𝑠𝑜𝑠) = 40% − 15%
40,000
𝑇𝑎𝑟𝑔𝑒𝑡 𝑅𝑂𝑆 (𝑠𝑎𝑙𝑒𝑠 𝑖𝑛 𝑝𝑒𝑠𝑜𝑠) = 25%
𝑇𝑎𝑟𝑔𝑒𝑡 𝑅𝑂𝑆 (𝑠𝑎𝑙𝑒𝑠 𝑖𝑛 𝑝𝑒𝑠𝑜𝑠) = ₱160, 000

To check:

Pesos Percentage

Sales ₱160,000 100%

Variable Cost 96,000 60%

CM 64,000 40%

Fixed Cost 40,000 25%

Income 24,000 15%

Target Selling Prices

Formula:
𝐹𝑖𝑥𝑒𝑑 𝐶𝑜𝑠𝑡𝑠 + 𝑇𝑎𝑟𝑔𝑒𝑡 𝑃𝑟𝑜𝑓𝑖𝑡
𝑇𝑎𝑟𝑔𝑒𝑡 𝑆𝑒𝑙𝑙𝑖𝑛𝑔 𝑃𝑟𝑖𝑐𝑒𝑠 = 𝑈𝑛𝑖𝑡 𝑉𝑜𝑙𝑢𝑚𝑒
+ 𝑈𝑛𝑖𝑡 𝑉𝑎𝑟𝑖𝑎𝑏𝑙𝑒 𝐶𝑜𝑠𝑡
Problem:
Exeter’s target is P10,000 per month and it expects to sell 6,000 backpacks per month. Remember that
Exeter’s variable costs are P10.00 to purchase a backpack and P1.00 for packing and shipping and a 5% sales
commission. Thus, per unit variable cost is P11.00 plus 5% of selling price.
₱40,000 + ₱10,000
𝑇𝑎𝑟𝑔𝑒𝑡 𝑆𝑒𝑙𝑙𝑖𝑛𝑔 𝑃𝑟𝑖𝑐𝑒𝑠 = 6,000
+ ₱11 + (5% 𝑥)
𝑇𝑎𝑟𝑔𝑒𝑡 𝑆𝑒𝑙𝑙𝑖𝑛𝑔 𝑃𝑟𝑖𝑐𝑒𝑠 = ₱8. 33 + ₱11 + (5% 𝑥)
95% 𝑥 = ₱8. 33 + ₱11
₱19.33
.95
𝑇𝑎𝑟𝑔𝑒𝑡 𝑆𝑒𝑙𝑙𝑖𝑛𝑔 𝑃𝑟𝑖𝑐𝑒𝑠 = ₱20. 35

Target Costing
Some companies use a planning technique called target costing to help decide whether to enter a new market
or bring out a new product.
The essence of target costing is to determine how much the company can spend to manufacture and market a
product, given a target profit. The price and volume are estimated first, then the costs. Target costing is useful
especially in deciding whether to enter an established market where selling prices are relatively stable.

For instance, if the managers agree on a target profit of P300,000 and that unit volume of 100,000 is
achievable at a P20.00 price, the total allowable cost is:

Revenue (100,000 x P20 ) P2,000,000

Target profit 300,000
Total allowable cost P1,700,000

If managers expect total fixed costs to be P1,200,000, total variable costs can be P500,000 or P5.00 per unit.
The P5.00 along with the P1,200,000 fixed cost, becomes an objective for the managers responsible for
designing and manufacturing the product.

To illustrate, consider Cruz Co. Its managers decide to introduce a new product. They expect to sell 20,000
units at P10.00. They can make the product in either two manufacturing processes:

Process A uses a great deal of labor and has a variable cost of P7.00 per unit and annual fixed costs of
P40,000.00.

Process B uses more machinery, with unit variable costs of P4.00 and annual fixed costs of P95,000.00.

Process A Process B

Sales (20,000 x 10) ₱200,000 ₱200,000

Variable Cost (₱ 7 and ₱4) 140,000 80,000

CM (₱3 and ₱6) 60,000 120,000

Fixed Cost 40,000 95,000

Profit 20,000 25,000

1. Finding the BEP

𝑇𝑜𝑡𝑎𝑙 𝐹𝑖𝑥𝑒𝑑 𝐶𝑜𝑠𝑡𝑠
𝐵𝐸𝑃 𝑖𝑛 𝑈𝑛𝑖𝑡𝑠 = 𝐶𝑀 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡
40,000
𝑃𝑟𝑜𝑐𝑒𝑠𝑠 𝐴 = 3
= 13, 333 𝑢𝑛𝑖𝑡𝑠
95,000
𝑃𝑟𝑜𝑐𝑒𝑠𝑠 𝐵 = 6
= 15, 833 𝑢𝑛𝑖𝑡𝑠
The higher the break-even, the riskier. Managers often express risk by referring to the Margin of Safety
(MOS).

2. Margin of Safety
- The decline in volume from the expected level of sales to the break-even point is called the margin of
safety (MOS).
Formula:
𝑀𝑂𝑆 𝑖𝑛 𝑝𝑒𝑠𝑜 = ( 𝐸𝑥𝑝𝑒𝑐𝑡𝑒𝑑 𝐿𝑒𝑣𝑒𝑙 𝑜𝑓 𝑆𝑎𝑙𝑒𝑠 𝑥 𝑆𝑃) − 𝐵𝐸𝑃 (𝑖𝑛 𝑝𝑒𝑠𝑜)
𝑀𝑂𝑆 = 𝐸𝑥𝑝𝑒𝑐𝑡𝑒𝑑 𝐿𝑒𝑣𝑒𝑙 𝑜𝑓 𝑆𝑎𝑙𝑒𝑠 − 𝐵𝐸𝑃 (𝑖𝑛 𝑢𝑛𝑖𝑡𝑠)
𝑃𝑟𝑜𝑐𝑒𝑠𝑠 𝐴 = 20, 000(𝑒𝑥𝑝𝑒𝑐𝑡𝑒𝑑) − 13, 333 𝑢𝑛𝑖𝑡𝑠
𝑃𝑟𝑜𝑐𝑒𝑠𝑠 𝐴 = 6, 667 𝑢𝑛𝑖𝑡𝑠 𝑜𝑟 ₱ 66, 670 (6, 667 𝑥 ₱10) 𝑜𝑟 33. 33% (6, 667/20, 000)

𝑃𝑟𝑜𝑐𝑒𝑠𝑠 𝐵 = 20, 000 − 15, 833 𝑢𝑛𝑖𝑡𝑠

𝑃𝑟𝑜𝑐𝑒𝑠𝑠 𝐵 = 4, 167 𝑢𝑛𝑖𝑡𝑠 𝑜𝑟 ₱41, 670 (4, 167 𝑥 ₱10) 𝑜𝑟 20. 80% (4, 167/ 20, 000)
Generally the higher the MOS, the lower the risk.

3. Indifference Point
- the level of volume at which total costs and,hence profits, are the same under both structures.
- at unit volumes below the indifference point, the alternative with the lower fixed cost gives higher profits;
at volumes above the indifference point, the alternative with the higher fixed cost is more profitable.
𝑡𝑜 𝑔𝑒𝑡 𝑥:
𝑃𝑟𝑜𝑐𝑒𝑠𝑠 𝐴 𝐹𝐶 − 𝑃𝑟𝑜𝑐𝑒𝑠𝑠 𝐵 𝐹𝐶 = 𝑇𝑜𝑡𝑎𝑙 𝐹𝐶
𝑃𝑟𝑜𝑐𝑒𝑠𝑠 𝐴 𝐶𝑀 − 𝑃𝑟𝑜𝑐𝑒𝑠𝑠 𝐵 𝐶𝑀 = 𝑇𝑜𝑡𝑎𝑙 𝐶𝑀

To check:
(𝐶𝑀)𝑥 − 𝐹𝐶

𝑇𝑜𝑡𝑎𝑙 𝐶𝑜𝑠𝑡 𝑓𝑜𝑟 𝑃𝑟𝑜𝑐𝑒𝑠𝑠 𝐴 = 𝑇𝑜𝑡𝑎𝑙 𝐶𝑜𝑠𝑡 𝑜𝑓 𝑃𝑟𝑜𝑐𝑒𝑠𝑠 𝐵

𝐹𝑖𝑥𝑒𝑑 𝐶𝑜𝑠𝑡 + 𝑉𝑎𝑟𝑖𝑎𝑏𝑙𝑒 𝐶𝑜𝑠𝑡 = 𝐹𝑖𝑥𝑒𝑑 𝐶𝑜𝑠𝑡 + 𝑉𝑎𝑟𝑖𝑎𝑏𝑙𝑒 𝐶𝑜𝑠𝑡
₱40, 000 + ₱7𝑥 = ₱95, 000 + ₱4𝑥
₱3𝑥 = ₱55, 000
₱3𝑥= ₱55,000
3
𝑥 = 18, 333

At volume below 18,333 units, Process A gives lower total costs (and higher profits); above 18,333 units,
Process B gives higher profits.

Assumptions and Limitations Underlying CVP Analysis

● All costs are classifiable as either fixed or variable.
● Fixed costs remain constant within the relevant range.
● The behavior of total revenues and total costs will be linear over the relevant range i.e. will appear as a
straight line on the BE chart.
● In case of multiple-product companies, the selling prices, costs and proportion of units (sales mix) sold
will not change.
● There is no significant change in the inventory levels during the period under review.
● Unit selling prices will remain constant
● Unit variable cost will not change
● There will be no change inefficiency and productivity
● The design of the product will not change

Uses of Cost-Volume-Profit Analysis

1. Planning – CVP Analysis is a useful tool for planning future operations.
2. Control – CVP Analysis may be used to control operations. Actual results are studied, analyzed and
compared with the projected or planned data.
 3. Analysis – both projected and actual data may be analyzed using CVP relationships.

Short-Term Decisions and Accounting Information

Making decisions is choosing among alternatives. Should we raise the price of our product, lower it, or leave it
alone? Should we drop a product (or product line) or keep it? Should we add a new product? Should we
make a component of our product in our factory or buy it from another company?
Managers continually evaluate such sets of alternatives.

The Criterion for Short-Term Decisions

The economic criterion for making a short-term decision is simple. Take the action that you expect will give the
organization the highest income (or lowest loss).
Two sub rules are often helpful:
1. The only revenues and costs that are relevant in making decisions are the expected future revenues
and costs that will differ among the available choices(differential revenues and costs) (relevant cost)
(ara sa alternative a, wala sa b, vice versa; if present, irrelevant)
2. Revenues and costs that have already been earned or incurred are irrelevant in making decisions.
Sunk cost – one that has already been incurred and therefore will be the same no matter which alternative a
manager selects.
Opportunity cost – the benefit lost by taking one action as opposed to another.

Example:
Compu Sales recently manufactured 100 specialized workstation monitors for a customer that has since gone
bankrupt. A rival company has offered to buy the monitors for P12,000. The cost to manufacture the monitors
was P17,000. The President says he’d rather throw them away than sell them at a loss of P5,000. Is his
reasoning sound?

Make or Buy Decisions

Suppose XYZ Co now makes a component for its major product. A manager has prepared the following
estimates of costs at the normal volume of 20,000 units.

Materials at ₱2/unit ₱40,000

Direct labor at ₱5/unit 100,000

Variable overhead at ₱3/unit 60,000

Allocated Indirect fixed cost (building, 120,000

depreciation, heat and light, etc.)

Total Cost ₱120,000

An outside supplier offers to supply the component at P14/unit or P280,000 for 20,000 units. Should XYZ
accept the offer?
Make Buy

Materials 40,000 -

Direct Labor 100,000 -

Variable Overhead 60,000 -

 Purchase Price - 280,000

Total 200,000 280,000

Temporary Shut Down

Mr Rene Yap operates a snack counter selling sandwiches and soft drinks. Each unit sale is composed of a
sandwich and a cup of soft drinks which is sold at a lot price of P15.00. Variable cost amounts to P8.00 per
unit. Under normal conditions, Mr. Yap sells an average of 3,000 units per month, during which he incurs the
following fixed costs:
Rent - P3,000
Allocated cost of utilities - 2,000
Salary of sales clerk 1,500
Janitor’s salary 1,000
Security agency’s billing 2,500
Total P10,000

A joint strike of teachers and students decreased the sales of Mr. Yap to only 800 units. Accordingly, the strike
would last for a month. Mr. Yap is considering shutting down his business for a month to avoid incurring losses
due to the reduced sales volume. He noted that if he shut down his operations, the cost of allocated utilities
would be reduced to P500.00 and he could avoid incurring the salary of the sales clerk who would be asked to
take a forced leave without pay while the snack counter is closed. All the other fixed costs would be incurred
despite the discontinuance of operations. Should the snack counter be shut down for one month?

Continue
Unit sales price ₱15 12,000

(Variable Cost) 8 6,400

CM/unit 7 5,600

Multiply: sales in units 800

Total CM 5,600

(Fixed Cost) 10,000

Loss under continued operations ₱ 4,400

Shut Down
CM -

Shut down costs

Rent ₱3,000

Cost of Utilities 500

Janitor’s Salary 1,000

Security agency’s billing 2,500

Loss if operations were shut down ₱7,000

Comprehensive Budgets
A comprehensive budget or a master budget is a set of financial statements and other schedules showing
budgeted, expected, or pro forma results for a future period.
Represents the overall plan of the organization for a given budget period.

Normally contains an income statement, a balance sheet, a cash budget (statement of cash receipts and
disbursements), and schedules of production, purchases, and fixed-asset acquisitions.

Two Major Parts of the Master Budget

Operating Budget – budgeted income statement for a certain budget period
Financial budget – includes the budgeted balance sheet as of the end of a certain budget period, budgeted
statement of changes in financial position, capital expenditure budget, and all other budgets required in
financial management.

Sales Forecasting
Sales forecast is the foundation for the comprehensive budget.
Factors Considered in Making a Sales Forecast:
● company’s past sales volume
● economic and political conditions
● conditions in the industry to which the company belongs
● competition
● market research studies
● pricing policies of the firm as well as those of the competitors
● government control and regulations affecting the company
● company’s own sales force and its planned advertising and promotional activities
● company’s productive capacity and other limitations affecting production
● change in demand for the product due to seasonal variations
Expense Budget
Each manager in an organization is responsible for specific tasks and their costs. So managers should have
budget allowances, or expense budgets, stating the limits for costs they may incur in accomplishing their tasks.

Budgeting in Not-For-Profit Entities

Not-for-profit (NFP) entities, especially governmental units, use budgets in different ways from profit-seeking
companies. NFPs are likely to budget only for cash flows (receipts and expenditures), not for revenues and
expenses the process is more likely to begin with expenditures rather than receipts

Zero-Based Budgeting
starts with the assumption that zero will be spent on each activity.

Tries to help management answer the question “Supposing we are to start our business from scratch, on
what activities would we spend our money and to what activities would we give the highest priority?”

Advantages of Zero Base Budgeting:

● Not based on incremental approach, so it promotes operational efficiency because it requires managers
to review and justify their activities or the funds requested.
● Most appropriate for the staff and support areas
● Considers alternative ways of performing the same job
● Focuses management process on analysis and decision making
 ● Helpful to the management in making optimum allocation of scarce resources
Program Budgeting - requires that a budget indicate not only how the requested funds are to be spent, but
also why the funds are to be spent in those ways.

Analysis of Financial Statements

Horizontal Analysis - Involves comparing figures shown in the financial statements of two or more
consecutive periods. The difference between the figures of the two periods is calculated, and the percentage
change from one period to the next is computed, using the earlier period as the base.

Formula for Percentage Change:

𝑀𝑜𝑠𝑡 𝑅𝑒𝑐𝑒𝑛𝑡 𝑉𝑎𝑙𝑢𝑒 − 𝐵𝑎𝑠𝑒 𝑃𝑒𝑟𝑖𝑜𝑑 𝑉𝑎𝑙𝑢𝑒

𝑃𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒 𝐶ℎ𝑎𝑛𝑔𝑒 = 𝐵𝑎𝑠𝑒 𝑃𝑒𝑟𝑖𝑜𝑑 𝑉𝑎𝑙𝑢𝑒
3,280−2,950
𝑃𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒 𝐶ℎ𝑎𝑛𝑔𝑒 = 2,950
𝑃𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒 𝐶ℎ𝑎𝑛𝑔𝑒 = . 11 𝑜𝑟 11%

Vertical Analysis - process of comparing figures in the financial statements of a single period.
involves converting the figures in the statements to a common base. Accomplished by expressing all the
figures in the statements as a percentage of an important item, such as total assets (in the balance sheet) and
total or net sales (in the income statement). all the figures in the statements would be expressed not in peso
but in percentage terms.These converted statements are called common-size statements, 100 percent
statements or component statements.
Ratio Analysis
Ratios are categorized based on their uses:
Tests of liquidity
Current ratio - also called the working capital ratio or banker’s ratio, measures the number of times that the
current liabilities could be paid with the available current assets.
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡𝑠
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑅𝑎𝑡𝑖𝑜 = 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠
Standard – 1.5:1 - the higher, the better

Acid test ratio - quick ratio; only those assets that are cash or “near cash” (or assets that can be converted to
cash quickly) are included so that the resulting ratio can indicate the firm’s paying liability in the very, very near
term. Similar to the current ratio except that the inventories and prepayments are excluded from the numerator
𝑄𝑢𝑖𝑐𝑘 𝐴𝑠𝑠𝑒𝑡𝑠
𝑄𝑢𝑖𝑐𝑘 𝑅𝑎𝑡𝑖𝑜 = 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠
𝐶𝑎𝑠ℎ + 𝑀𝑎𝑟𝑘𝑒𝑡𝑎𝑏𝑙𝑒 𝑆𝑒𝑐𝑢𝑟𝑖𝑡𝑖𝑒𝑠 + 𝑅𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒𝑠
𝑄𝑢𝑖𝑐𝑘 𝑅𝑎𝑡𝑖𝑜 = 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠
Standard = 1:1 - the higher, the better

Receivable Turnover - the time required to complete one collection cycle – from the time receivables are
recorded, then collected, to the time new receivables are recorded again; the faster the cycle is completed, the
more quickly receivables are converted into cash.
𝑁𝑒𝑡 𝑆𝑎𝑙𝑒𝑠
𝑅𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒𝑠 𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟 = 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑅𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒𝑠
𝐵𝑒𝑔𝑖𝑛𝑛𝑖𝑛𝑔 𝐵𝑎𝑙𝑎𝑛𝑐𝑒 + 𝐸𝑛𝑑𝑖𝑛𝑔 𝐵𝑎𝑙𝑎𝑛𝑐𝑒
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑅𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒𝑠 = 2
Standard: 20 – 60 days - the lower, the better

Inventory Turnover - Measures the number of times that inventory is replaced during the period.
𝐶𝑂𝐺𝑆
𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 𝑡𝑢𝑟𝑛𝑜𝑣𝑒𝑟 = 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑀𝑒𝑟𝑐ℎ𝑎𝑛𝑑𝑖𝑠𝑒 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦
𝐵𝑒𝑔𝑖𝑛𝑛𝑖𝑛𝑔 𝐵𝑎𝑙𝑎𝑛𝑐𝑒 + 𝐸𝑛𝑑𝑖𝑛𝑔 𝐵𝑎𝑙𝑎𝑛𝑐𝑒
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑀𝑒𝑟𝑐ℎ𝑎𝑛𝑑𝑖𝑠𝑒 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 = 2
Standard – 180 days - the lower the better
Net Working Capital
𝑁𝑒𝑡𝑤𝑜𝑟𝑘𝑖𝑛𝑔 𝐶𝑎𝑝𝑖𝑡𝑎𝑙 = 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡𝑠 − 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠
Standard = Positive
Remarks = Positive

Tests of Solvency - Solvency refers to the company’s ability to pay all its debts, whether such liabilities are
current or noncurrent.
𝑁𝑒𝑡 𝐼𝑛𝑐𝑜𝑚𝑒 𝑏𝑒𝑓𝑜𝑟𝑒 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝐸𝑥𝑝𝑒𝑛𝑠𝑒
𝑇𝑖𝑚𝑒𝑠 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝐸𝑎𝑟𝑛𝑒𝑑 = 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝐸𝑥𝑝𝑒𝑛𝑠𝑒
Standard - 2x - the higher, the better

Debt Ratio - indicates the percentage of total assets provided by creditors.

𝑇𝑜𝑡𝑎𝑙 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠
𝐷𝑒𝑏𝑡 𝑅𝑎𝑡𝑖𝑜 = 𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠
𝑥 100
Standard - 50% - the lower, the better

Debt to Equity Ratio

𝑆ℎ𝑜𝑟𝑡 𝑡𝑒𝑟𝑚 𝑑𝑒𝑏𝑡 + 𝐿𝑜𝑛𝑔 𝑡𝑒𝑟𝑚 𝑑𝑒𝑏𝑡 + 𝑜𝑡ℎ𝑒𝑟 𝑓𝑖𝑥𝑒𝑑 𝑝𝑎𝑦𝑚𝑒𝑛𝑡𝑠
𝐷𝑒𝑏𝑡 𝑡𝑜 𝐸𝑞𝑢𝑖𝑡𝑦 𝑅𝑎𝑡𝑖𝑜 = 𝑇𝑜𝑡𝑎𝑙 𝑆ℎ𝑎𝑟𝑒ℎ𝑜𝑙𝑑𝑒𝑟𝑠 𝐸𝑞𝑢𝑖𝑡𝑦
Standard = 4:1 - the lower, the better
 𝐺𝑟𝑜𝑠𝑠 𝑃𝑟𝑜𝑓𝑖𝑡
𝐺𝑟𝑜𝑠𝑠 𝑃𝑟𝑜𝑓𝑖𝑡 𝑀𝑎𝑟𝑔𝑖𝑛 = 𝑁𝑒𝑡 𝑆𝑎𝑙𝑒𝑠
Standard = 10 – 15% The higher, the better

𝑁𝑒𝑡 𝑃𝑟𝑜𝑓𝑖𝑡
𝑁𝑒𝑡 𝑃𝑟𝑜𝑓𝑖𝑡 𝑀𝑎𝑟𝑔𝑖𝑛 = 𝑁𝑒𝑡 𝑆𝑎𝑙𝑒𝑠
Standard = 2 – 20% The higher, the better

𝑁𝑒𝑡 𝑃𝑟𝑜𝑓𝑖𝑡
𝑅𝑒𝑡𝑢𝑟𝑛 𝑜𝑛 𝐸𝑞𝑢𝑖𝑡𝑦 = 𝐸𝑞𝑢𝑖𝑡𝑦
Standard = 5 – 25% The higher, the better

𝑁𝑒𝑡 𝑃𝑟𝑜𝑓𝑖𝑡
𝑅𝑒𝑡𝑢𝑟𝑛 𝑜𝑛 𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠 = 𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠
Standard = 10% The higher, the better

𝐼𝑛𝑐𝑜𝑚𝑒
𝑅𝑒𝑡𝑢𝑟𝑛 𝑜𝑛 𝐼𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡 = 𝐼𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡
Higher than interest rate

𝑇𝑜𝑡𝑎𝑙 𝑃𝑟𝑜𝑗𝑒𝑐𝑡 𝐶𝑜𝑠𝑡

𝑃𝑎𝑦𝑏𝑎𝑐𝑘 𝑃𝑒𝑟𝑖𝑜𝑑 = 𝑁𝑒𝑡 𝐼𝑛𝑐𝑜𝑚𝑒
shall not exceed term of loan

ADDED NOTES:
RATE OF RETURN - the net gain or loss of an investment over a specified time period, expressed as a
percentage of the investment's initial cost. When calculating the rate of return, you are determining the
percentage change from the beginning of the period until the end.
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑉𝑎𝑙𝑢𝑒 − 𝐼𝑛𝑖𝑡𝑖𝑎𝑙 𝑉𝑎𝑙𝑢𝑒
𝑅𝑎𝑡𝑒 𝑜𝑓 𝑅𝑒𝑡𝑢𝑟𝑛 = 𝐼𝑛𝑖𝑡𝑖𝑎𝑙 𝑉𝑎𝑙𝑢𝑒
𝑥 100
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑅𝑒𝑡𝑢𝑟𝑛
𝑅𝑎𝑡𝑒 𝑜𝑓 𝑅𝑒𝑡𝑢𝑟𝑛 = 𝐼𝑛𝑖𝑡𝑖𝑎𝑙 𝐼𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡𝑠
10% or more

AVERAGE AGE OF RECEIVABLES - measures the average number of days it takes to collect receivables
𝐷𝑎𝑦𝑠 𝑖𝑛 𝑎 𝑌𝑒𝑎𝑟 (365)
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐴𝑔𝑒 𝑜𝑓 𝑅𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒𝑠 = 𝑅𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒 𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟

BASIC EARNINGS PER SHARE (EPS) - tells investors how much of a firm's net income was allotted to each
share of common stock.
A higher EPS indicates greater value because investors will pay more for a company's shares if they think the
company has higher profits relative to its share price.
𝑁𝑒𝑡 𝐼𝑛𝑐𝑜𝑚𝑒 − 𝑃𝑟𝑒𝑓𝑒𝑟𝑟𝑒𝑑 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑
𝐵𝑎𝑠𝑖𝑐 𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠 𝑝𝑒𝑟 𝑆ℎ𝑎𝑟𝑒 = 𝑊𝑒𝑖𝑔ℎ𝑡𝑒𝑑 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑁𝑜. 𝑜𝑓 𝐶𝑜𝑚𝑚𝑜𝑛 𝑆ℎ𝑎𝑟𝑒𝑠 𝑂𝑢𝑡𝑠𝑡𝑎𝑛𝑑𝑖𝑛𝑔

Example
A company reports net income of $100 million after expenses and taxes. The company issues preferred
dividends to its preferred stockholders of $23 million, leaving earnings available to common shareholders of
$77 million. The company had 100 million common shares outstanding at the beginning of the year and issued
20 million new common shares in the second half of the year. As a result, the weighted average number of
common shares outstanding is 110 million: 100 million shares for the first half of the year and 120 million
shares for the second half of the year (100 x 0.5) + (120 x 0.5) = 110. Dividing the earnings available to
common shareholders of $77 million by the weighted average number of common shares outstanding of 110
million gives a basic EPS of $0.70.
AVERAGE AGE OF INVENTORIES - average number of days it takes for a firm to sell off inventory. It is a
metric that analysts use to determine the efficiency of sales. The average age of inventory is also referred to as
days' sales in inventory (DSI).
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 𝐵𝑎𝑙𝑎𝑛𝑐𝑒
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐴𝑔𝑒 𝑜𝑓 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑖𝑒𝑠 = 𝐶𝑜𝑠𝑡 𝑜𝑓 𝐺𝑜𝑜𝑑 𝑆𝑜𝑙𝑑
𝑥 365
𝐵𝑒𝑔𝑖𝑛𝑛𝑖𝑛𝑔 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 + 𝐸𝑛𝑑𝑖𝑛𝑔 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 = 2

A COMMON-SIZE FINANCIAL STATEMENT

- displays items on each report as a percentage of a common base figure.
- make it easier to compare a company to its competitors and to identify significant changes in a
company's financials.
- compares the percentages between two or more years to evaluate financial strength, how income is
used, and where cash comes from.
MARGINAL REVENUE
- refers to the incremental change in earnings resulting from the sale of one additional unit.
- Analyzing marginal revenue helps a company identify the revenue generated from each additional unit
sold.
- often shown graphically as a downward sloping line that represents how a company usually has to
decrease its prices to drive additional sales.
- A company that is looking to maximize its profits will produce up to the point where marginal cost
equals marginal revenue.

When marginal revenue falls below marginal cost, firms typically do a cost-benefit analysis and halt production
as it may cost more to sell a unit than what the company will receive as revenue.

𝐶ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑅𝑒𝑣𝑒𝑛𝑢𝑒
𝑀𝑎𝑟𝑔𝑖𝑛𝑎𝑙 𝑅𝑒𝑣𝑒𝑛𝑢𝑒 = 𝐶ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑄𝑢𝑎𝑛𝑡𝑖𝑡𝑦

For example, a company sells its first 100 items for a total of $1,000. If it sells the next item for $8, the marginal
revenue of the 101st item is $8. Marginal revenue disregards the previous average price of $10, as it only
analyzes the incremental change. If it sells a total of 115 units for $1,100, the marginal revenue for units 101
through 115 is $100, or $6.67 per unit.

MANUFACTURING COSTS - separated into three categories: direct materials, direct labor, and manufacturing
overhead.
RAW MATERIALS - materials that go into the final product. Refer to any materials that are used in the final
product; and the finished product of one company can become raw materials of another company.
DIRECT MATERIALS - become an integral part of the finished product and whose cost can conveniently be
traced to the finished product. For example, the seats that Airbus purchased.
DIRECT LABOR - consist of labor that can be easily (physically and conveniently) traced to individual units of
product. Sometimes called touch labor because direct labor typically touches the product.
INDIRECT LABOR - cannot be physically traced. can be traced only at great cost and inconvenience. Indirect
labor includes the labor costs of janitors, supervisors, materials handlers, and night security
guards. Although the efforts of these workers are essential, it would be either impractical or impossible to
accurately trace their costs to specific units of product.
MANUFACTURING OVERHEAD - includes items such as indirect materials; indirect labor; maintenance and
repairs on production equipment; and heat and light, property taxes, depreciation, and insurance on
manufacturing facilities. A company also incurs costs for heat and light, property taxes, insurance,
depreciation, and so forth, associated with its selling and administrative functions, but these costs are not
included as part of manufacturing overhead

PERIOD COSTS
- are all the costs that are not product costs.
For example:
sales commissions and the rental costs of administrative offices are period costs. Period costs are not included
as part of the cost of either purchased or manufactured goods; instead, period costs are expensed on the
income statement in the period in which they are incurred using the usual rules of accrual accounting.

PRIME COST
- is the sum of direct materials cost
𝑃𝑟𝑖𝑚𝑒 𝐶𝑜𝑠𝑡 = 𝑅𝑎𝑤 𝑀𝑎𝑡𝑒𝑟𝑖𝑎𝑙𝑠 + 𝐷𝑖𝑟𝑒𝑐𝑡 𝐿𝑎𝑏𝑜𝑟
Example of How Prime Costs Work
Consider a professional furniture maker who is hired to make a coffee table for a customer. The prime costs for
creating the table include the cost of the furniture maker's labor and the raw materials required to construct the
table, including the lumber, hardware, and paint. Suppose that the cost of the raw materials—lumber,
hardware, and paint—totals $200. The furniture maker charges $50 per hour for labor, and the project takes
three hours to complete. The prime cost to produce the table is $350 ($200 for the raw materials + (50 x 3
hours of labor = $150 in direct labor).

To generate a profit, the table's price must be set above its prime cost. The furniture maker, to be profitable,
must charge at least $351.

CONVERSION COSTS
𝐶𝑜𝑛𝑣𝑒𝑟𝑠𝑖𝑜𝑛 𝐶𝑜𝑠𝑡 = 𝐷𝑖𝑟𝑒𝑐𝑡 𝐿𝑎𝑏𝑜𝑟 + 𝑀𝑎𝑛𝑢𝑓𝑎𝑐𝑡𝑢𝑟𝑖𝑛𝑔 𝑂𝑣𝑒𝑟ℎ𝑒𝑎𝑑 𝐶𝑜𝑠𝑡𝑠
Conversion costs include the direct labor and overhead expenses incurred as raw materials are transformed
into finished products.

OVERHEAD COSTS
- are expenses that cannot be directly attributed to the production process but are necessary for
operations, such as the electricity required to keep a manufacturing plant functioning throughout the
day.

DIRECT LABOR - costs are the same as those used in prime cost calculations.

CONVERSION COSTS - are used to gauge the efficiency of a production process, but conversion cost also
takes into account overhead expenses that are left out of prime cost calculations

Example of How Conversion Costs Work

Consider the example of Company A: The company has a total cost of $50,000 in direct labor and related
expenses, in addition to $86,000 in factory overhead costs, during the month of April.

Suppose that Company A produces 20,000 units during the month of April. Thus, the company's conversion
costs per unit for the month of April are $6.80 per unit ($136,000 of total conversion costs / by 20,000 units
produced = $6.80).
VARIABLE COST - is a cost that varies, in total, in direct proportion to changes in the level of activity. The
activity can be expressed in many ways, such as units produced, units sold, miles driven, beds occupied, lines
of print, hours worked, and so forth. A good example of a variable cost is direct materials

To illustrate this idea, consider the Saturn Division of GM . Each auto requires one battery. As the output of
autos increases and decreases, the number of batteries used will increase and decrease proportionately. If
auto production goes up 10%, then the number of batteries used will also go up 10%.

FIXED COST
- Is a cost that remains constant, in total, regardless of changes in the level of activity.
- Unlike variable costs, fixed costs are not affected by changes in activity.
- As the activity level rises and falls, total fixed costs remain constant unless influenced by some outside
force, such as a price change. Rent is a good example of a fixed cost.

Suppose the Mayo Clinic rents a machine for $8,000 per month that tests blood samples for the presence of
leukemia cells. The $8,000 monthly rental cost will be incurred regardless of the number of tests that may be
performed during the month.

The relevant range is the range of activity within which the assumptions about variable and fixed costs are
valid. For example, the assumption that the rent for diagnostic machines is $8,000 per month is valid within the
relevant range of 0 to 2,000 tests per month.

OPPORTUNITY COST - is the potential benefit that is given up when one alternative is selected
over another

SUNK COST - is a cost that has already been incurred and that cannot be changed by any
decision made now or in the future. Because sunk costs cannot be changed by any decision, they are not
differential costs

VARIANCE - the difference between a forecasted amount and the actual amount. Variances are common in
budgeting, but you can have a variance in anything that you forecast. Basically, whenever you predict
something, you’re bound to have either a favorable or unfavorable variance.
𝑉𝑎𝑟𝑖𝑎𝑛𝑐𝑒 = 𝐹𝑜𝑟𝑒𝑐𝑎𝑠𝑡𝑒𝑑 − 𝐴𝑐𝑡𝑢𝑎𝑙
Favorable variances mean you’re doing better in an area of your business than anticipated.
You can have variances in your:
1. Budget
2. Materials purchased
3. Labor hours
4. Overhead costs
5. Materials produced
6. Number of sales
7. Revenue

Here’s the formula to calculate your variance as a percentage:

𝑉𝑎𝑟𝑖𝑎𝑛𝑐𝑒 = {( 𝐴𝑐𝑡𝑢𝑎𝑙 / 𝐹𝑜𝑟𝑒𝑐𝑎𝑠𝑡) − 1} 𝑥 100

Say you predict to spend $5,000 on inventory. But, there’s a supply shortage that drives up your costs to
$7,000. What’s your variance?

Variance = Forecast – Actual

Variance = $5,000 – $7,000

Use the other variance formula to find out:

Variance = [(Actual / Forecast) – 1] X 100
Variance = [($7,000 / $5,000) – 1] X 100
Your variance is 40%. This shows that your actual cost was 40% greater than your prediction.

Say you predicted you would spend 1,000 hours on Project XYZ. Instead, you only spent 500 hours on the
project. What’s your variance?

Variance = Forecast – Actual

Variance = 1,000 – 500

Your favorable variance is 500, showing you spent 500 fewer hours on the project than you projected. Here’s
that as a percentage:
Variance = [(Actual / Forecast) – 1] X 100
Variance = [(500 / 1,000) – 1] X 100
Your variance is -50%, showing that your actual labor hours were 50% fewer than you predicted.

TREND ANALYSIS
- is a technique used in technical analysis that attempts to predict future stock price movements based
on recently observed trend data. Trend analysis uses historical data, such as price movements and
trade volume, to forecast the long-term direction of market sentiment.

𝐶ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝐴𝑚𝑜𝑢𝑛𝑡 = 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑌𝑒𝑎𝑟 𝐴𝑚𝑜𝑢𝑛𝑡 − 𝐵𝑎𝑠𝑒 𝑌𝑒𝑎𝑟 𝐴𝑚𝑜𝑢𝑛𝑡

𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑌𝑒𝑎𝑟 𝐴𝑚𝑜𝑢𝑛𝑡 − 𝐵𝑎𝑠𝑒 𝑌𝑒𝑎𝑟 𝐴𝑚𝑜𝑢𝑛𝑡
𝑃𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒 𝐶ℎ𝑎𝑛𝑔𝑒 = 𝐵𝑎𝑠𝑒 𝑌𝑒𝑎𝑟 𝐴𝑚𝑜𝑢𝑛𝑡

There are three main types of market trend for analysts to consider:
1. Upward trend: An upward trend, also known as a bull market, is a sustained period of rising prices in a
particular security or market. Upward trends are generally seen as a sign of economic strength and can
be driven by factors such as strong demand, rising profits, and favorable economic conditions.
 2. Downward trend: A downward trend, also known as a bear market, is a sustained period of falling
prices in a particular security or market. Downward trends are generally seen as a sign of economic
weakness and can be driven by factors such as weak demand, declining profits, and unfavorable
economic conditions.
3. Sideways trend: A sideways trend, also known as a range bound market, is a period of relatively
stable prices in a particular security or market. Sideways trends can be characterized by a lack of clear
direction, with prices fluctuating within a relatively narrow range.

Advantages and Disadvantages of Trend Analysis

Advantages
1. offer several advantages for investors and traders. It is a powerful tool for investors and traders as it
can help identify opportunities for buying or selling securities, minimize risk, improve decision-making,
and enhance portfolio performance.
2. be based on a variety of data points, including financial statements, economic indicators, and market
data, and there are several different methods that can be used to analyze trends, including technical
analysis and fundamental analysis. By providing a deeper understanding of the factors that are driving
trends in data, trend analysis can help investors and traders make more informed and confident
decisions about their investments.

Disadvantages
1. have some potential disadvantages as a tool for making investment decisions. One of these
disadvantages is that the accuracy of the analysis depends on the quality of the data being used. If the
data is incomplete, inaccurate, or otherwise flawed, the analysis may be misleading or inaccurate.
2. based on historical data, which means it can only provide a limited perspective on the future. While
trends in data can provide useful insights, it's important to remember that the future is not necessarily
predetermined by the past, and unexpected events or changes in market conditions can disrupt trends.
Trend analysis is also focused on identifying patterns in data over a given period of time, which means
it may not consider other important factors that could impact the performance of a security or market.

REGRESSION
- is a statistical method used in finance, investing, and other disciplines that attempts to determine the
strength and character of the relationship between one dependent variable (usually denoted by Y) and
a series of other variables (known as independent variables).
- a powerful tool for uncovering the associations between variables observed in data, but cannot easily
indicate causation. It is used in several contexts in business, finance, and economics. For instance, it is
used to help investment managers value assets and understand the relationships between factors such
as commodity prices and the stocks of businesses dealing in those commodities.

The two basic types of regression

1. Simple linear regression uses one independent variable to explain or predict the outcome of the
dependent variable
2. Multiple linear regression uses two or more independent variables to predict the outcome (while holding
all others constant).
Sheldon Lee Cooper owns the Golden Dragon Trading which sells two main lines of products, the Blue Caps
and the Red Berets. Due to financial turmoil within the industry, Sheldon decided to maintain only one line of
products and discontinue the other one. The product lines have the following details for 2022
Blue Caps Red Berets

Unit Sales 20,000 units 15,000 units

Selling Price per unit ₱60 ₱75

Variable Cost per unit ₱40 ₱45

Fixed Cost ₱150,000 ₱300,000

1. How much is the contribution margin per unit of Blue Caps and Red Berets? Determine the contribution
margin percentage for each product line
2. Determine the profit of the Blue Caps and Red Berets. Which line is more profitable and by how much?
3. Find the Break-Even Point of Blue Caps and Red Berets. Based on the BEP, which product line will you
recommend to be maintained?
4. How much is the Break-Even Sales of Blue Caps and Red Berets?
5. What is the Safety Margin of each product line (both in units and in pesos?)
6. What is the indifference point?
Requirements: 1. Compute the missing changes in peso amounts and percentages in the above
statements.
Express all of the asset, liability, and sales in trend percentages. (Show percentages for each item.)
Use Year 1 as the base year, and carry computations to one decimal place.
ValuePlus, In., was organized several years ago to develop and market computer software programs.
The company is small but growing, and you are considering the purchase of some of its ordinary
shares as an investment. the following data on the company is available for the past two years:

The president of ValuePlus, Inc., is very concerned. Sales increased by P2.5 million during 2014, yet the
company's net income increased by only P105,000. Also, the company's operating expenses went up in 2014,
even though a major effort was launched during the year to cut costs. Requirements: 1. For both 2013 and
2014, prepare the income statement and the statement of financial position in common-size form. (Round
computations to one decimal place.)
From your work in (l) above, explain to the president why the increase in profits was so small in 2014. Were
any benefits realized from the company's cost-cutting efforts? Explain.
True or false. Write the word "True" if the statement is correct, otherwise write "False".
1. Financial analysis is primarily a matter of making relevant mechanical computations.
2. Percentage changes usually are computed by use of the amounts for the latest accounting period as a base.
3. The peso amount of change during an accounting period for an item appearing in financial statements is
less significant than the change measured as a percentage.
4. A business enterprise's earnings performance and its financial condition are the two primary concerns of the
financial analyst.
5. An increase in sales volume generally is accompanied by a proportionate increase in net income.
6. On a common-size income statement, net income is given an equivalent of 100%.
7. The peso amount of a change during a period in a certain item appearing in financial statements is probably
less significant than the change measured as a percentage.
8. Percentage changes are usually computed by using the latest figure as a base.
9. It is possible that a decrease in gross profit rate may be offset by a decrease in expenses, thus resulting in
an increase in net income.
10. Industry standards tend to place the performance of a company in a more meaningful perspective.
11. Short-term creditors generally are more concerned with vertical analysis than with horizontal analysis
12. Horizontal analysis is possible for both an income statement and a statement of financial position.
13. Common-size financial statements show peso change in specific items from one year to the next.