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Building Economics and Cost Control

Dr. Sarbesh Mishra
Finance Area, NICMAR Hyderabad – 500 084.

About Myself
Name :

Dr Sarbesh Mishra
2. Post-graduate in Commerce

Qualifications 1. B.Com (Hons) 3. M.Phil in Commerce 4. Ph.D. (Commerce)

Experience : Joined University of Delhi, as a Lecturer in Commerce in 2001 and continued till 2005 and then joined Army Institute of Management, NOIDA as Senior Faculty, Finance prior to current appointment at NICMAR.

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Related to Cost (Thoughts)

The most successful man in the life is the man who has the best information.
Benjamin Disraeli, 19th. Century PM of England

Even if you’re on right track, you’ll get run over if you just sit there.
Will Rogers, Certified Cost Analyst

He who controls the past controls future.
George Orwell, Certified Public Accountant

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Contd….

You can’t get caught up in things that you can’t control…….we can’t control our selling price. We can control our cost of manufacturing. We can control our efficiencies. We can control our waste.
Steven Appleton, CEO of Micro Technology

If you don’t know where you’re going, it doesn’t matter how you get there.
Prof. Sarbesh Mishra, NICMAR, Hyderabad
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Capital Expenditure (CAPEX)
Expenditure expended for the purpose of obtaining long term advantage for the business. Examples  Expenditure incurred in increasing the quality fixed assets e.g. Purchase of additional furniture, Plant, Building for permanent use in Business.

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Revenue Expenditure
“An expenditure that arises out of and in the course of regular business of a concern is termed as revenue expenditure”.

Example Expenditure incurred in the normal course of running the business e.g. expenses of administration, maintaining of facilities viz. Electricity, Telephone etc. cost incurred in manufacturing & selling the products, repairs, Depreciation, Interest on loan.

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Importance of Investment Decision

 

Influence the firm’s growth in longterm They affect the risk of the firm They involve commitment of large volume of funds They are irreversible, or reversible at substantial loss They are among most difficult decisions to make.
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Investment Evaluation Criteria

Estimation of Cash flows. Estimation of required rate of return (Opportunity cost of capital) Application of decision making the choice rule for

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Cash Flows

1. 2.

Cash inflows or outflows occur at three stages of capital investment project Project Initiation (For beginning operations,
Working Capital needs, Replacement of asset)

Project Operation

(Operating Expenditure, Addl. Working capital need, inflow of cash generated by the investment)

3.

Final Project Disposal

(Cash inflows or outflows related to investment’s disposal, Cash inflows from the release of working capital no longer committed to the investment)

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Investment appraisal Techniques
Traditional Techniques  Payback Period Method  Accounting Rate of return Method Discounted Cash flow Technique 1. Net Present Value method (NPV) 2. Internal Rate of Return Method (IRR) 3. Profitability Index Method (PI)
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Traditional Techniques
Payback Period Method  Payback is the number of years required to recover the original cash outlay invested in a project.

Payback =

Initial Investment

Annual Average Cash Flows

Project would be accepted if its payback period is less than the maximum or standard payback period set by management.
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Accounting Rate of Return (ARR)

This measures the profitability of an investment.

ARR = Average Income Average Investment Projects with higher ARR over the minimum rate established by the management will be accepted.

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DCF Techniques

It explicitly recognizes the time value of money. Cash flows arising at different time periods differ in their value and are comparable when their present values are found out. The compound interest rate is used for discounting cash flows is also called as the discount rate.
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Net Present Value Method (NPV)

Cash flows of the invested projects should be forecasted based on realistic assumptions. Appropriate discount rate should identified to discount the forecasted cash flows. Present value of cash flows should be calculated using the opportunity cost of capital as the discount rate. Net Present Value is found out by subtracting present value of cash inflows.

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NPV Formula
n NPV = Ct

t=1 (1+k)t

Ʃ

- C0

C1, C2 ….. Represent cash inflow in year 1,2 …., k is the opportunity cost of capital C0 is the initial cost of investment n is the expected life of the investment * k is assumed to be known and is constant

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Acceptance Rule
1.

Accept the project when NPV is positive Reject the project when NPV is negative May accept the project when NPV is zero.

2.

3.

Higher the NPV, the better it is.

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Meaning of Budget

 1.

A budget is a detailed plan of operations for some specific future period. According to CIMA, London “a financial statement, prepared prior to a defined period of time”. Essentials budget includes: It is prepared in advance & is based on future plan of actions.

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Contd….
2.

3.

It relates to future period & is based on objectives to be attained. It is a statement expressed in monetary and/or physical units prepared for the implementation of policy formulated by management. Different types of budgets are prepared for different types of purposes e.g. sales budget, Manufacturing Cost budget & at the end Master Budget is prepared.

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Classification & Types of Budget
Classification According to Time  Long-term budgets.  Short-term budgets.  Current budgets. Classification on the Basis of Flexibility  Fixed budget.  Flexible budget
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Budget, Budgeting & Budgetary Control

Budget – Individual objectives of a department etc. Budgeting – The process/act of building budgets. Budgetary Control – “It embraces all the above & includes the science of planning the budgets themselves & the utilization of such budgets to effect an overall management tool for the business planning & Control”
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Activity Based Budgeting

Activities that incur costs in every functional area of an organization are recorded and their relationships are defined and analyzed. Activities are then tied to strategic goals, after which the costs of the activities needed are used to create the budget.
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Eliminate Muda
Japanese Waste Management  MUDA means waste, but the word carries a deeper connotation. Any non-value activity or obstruction to smooth flow of an activity is Muda.  Muda exists in many forms and is to be eliminated. Less Muda = More happy clients (as it
impacts quality, cost and delivery of products and services)

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Example

Overproduction and Inventory, items not immediately needed Defective products requesting repair or scraping Motion; unnecessary movement and energy used to perform tasks Process imposing inefficient and/or unnecessary tasks, fail to synchronize systems
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Contd….

Idling; by excessive set-up or equipment breakdowns Transport, poor timing; too frequent or infrequent movement of goods and deliveries.

Turning loss into profit by muda elimination is one of the easiest ways for a company to improve its operations
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THANK YOU

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