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Graduate School of

Governance and Leadership


EXTENDED DIPLOMA IN
STRATEGIC MANAGEMENT
AND LEADERSHIP
Unit 13: Managing Financial
Principles

SYLLABUS AND GENERAL GUIDE

Unit introduction will be sent


seperately
Learning outcomes and
assessment criteria will be
sent seperately
Recommended Textbook will
be sent seperately

SYLLABUS AND GENERAL GUIDE

Unit Content
1. Cost Concepts
2. Forecasting Techniques
3. Budgeting
4. Cost Management
5. Strategic Investments
6. Financial Analysis

SYLLABUS AND GENERAL GUIDE

Assessment
For this unit, learners should
focus on the preparation of a
business plan, for a proposed
business venture (new business,
expansion of an existing
business, or real estate).

SYLLABUS AND GENERAL GUIDE

Assessment
Requirements:
Executive Summary
Business Description
Financial Plan showing budgets,
projected financial statements,
financial analysis, and a
justification of the investment

SYLLABUS AND GENERAL GUIDE

Assessment
The project should be about 10
pages in length. Your response
should incorporateterminology
and concepts presented in the
course as well as supplementary
resources. Each paragraph
should be written in complete
sentences with attention to good

SYLLABUS AND GENERAL GUIDE

Assessment
Using the APA format, please
double-space, use 12 point font,
with one inch margins.Be sure to
cite your resources and provide
the references. Be sure to
include the URL or link to the
sites you researched.

1 COST CONCEPTS

COSTS AND PRICES


In absorption costing, all overhead costs
associated with manufacturing a product
become a part of the products cost base
along with the direct costs. Therefore, all
manufacturing overhead costs must be
allocated to the units produced.

1 COST CONCEPTS

COSTS AND PRICES


Under variable costing (also called
direct costing), fixed factory overheads
are a period cost that are expensed in
the period when they are incurred. This
means that no matter what the level of
sales, all of the fixed factory overheads
will be expensed in the period when
incurred.

1 COST CONCEPTS

COSTS AND PRICES


Variable costing is not GAAP. For
external reporting purposes, GAAP
requires the use of absorption
costing for fixed manufacturing cost
allocation, and therefore variable costing
cannot be used for external financial
reporting. However, many accountants
feel that variable costing is a better tool
to use for internal analysis, and
therefore variable costing is often used

1 COST CONCEPTS

COST SYSTEMS
Opportunity cost is a type of implicit
cost. Opportunity cost is an economics
term, and opportunity cost is considered
an economic cost. It is the contribution
to income that is lost by not using a
limited resource in its best alternative
use. When calculating the opportunity
cost, it includes only the expenditures
that would not be made in the other
available alternatives and/or the

1 COST CONCEPTS

COST SYSTEMS
Process costing is used when many
identical or similar units of a product or
service are being manufactured, such as
on an assembly line. Costs are
accumulated by department or by
process.
Job order costing is used when units of
a product or service are distinct and
separately identifiable. Costs are

1 COST CONCEPTS

COST SYSTEMS
Operation costing is a hybrid, or
combination, of job-order costing
and process costing. In this method of
costing, a company applies the basic
operation of process costing to a
production process that produces
batches of items. These different
batches all follow a similar process, but
the direct materials that are input to
each batch are different.

1 COST CONCEPTS

COST SYSTEMS
Standard cost system assigns
standard, or planned, costs to units
produced. The standard cost of
producing one unit of output is based on
the standard cost for one unit of each of
the inputs required to produce that
output unit, with each input multiplied
by the number of units of that input
allowed for one unit of output. The
inputs include direct materials, direct

1 COST CONCEPTS

RESPONSIBILITY AND CONTROL OF


SYSTEMS
A responsibility center is any part,
segment, or subunit of an organization.
A segment may be a product line, a
geographical area, or any other
meaningful unit. Companies will have
different segments based on their
activities. Responsibility accounting
is an accounting system that measures
accounting results of each responsibility

1 COST CONCEPTS

RESPONSIBILITY AND CONTROL OF


SYSTEMS
A responsibility centers plans are
expressed in its budget, and the actual
results for that responsibility center are
then compared against its budget to
determine how well it is achieving its
plans. The budget is developed by the
responsibility center and approved by
top management. All of the responsibility centers combined make up the

1 COST CONCEPTS

RESPONSIBILITY AND CONTROL OF


SYSTEMS
For instance, a Sales Budget is
developed for each individual
responsibility center and all the
responsibility centers budgets together
make up the consolidated Sales Budget.
Consolidating all the different budgets
for all the different responsibility centers
is part of the process of developing the
Master Budget.

1 COST CONCEPTS

RESPONSIBILITY AND CONTROL OF


SYSTEMS
The main purposes for responsibility
centers and responsibility accounting are
the evaluation of subunits performance
and to contribute to measuring the
performance of the subunits managers.
Manager performance measurement
provides motivation for managers of the
subunits, which in turn benefits the
company as a whole.

1 COST CONCEPTS

RESPONSIBILITY AND CONTROL OF


SYSTEMS
The manager of a responsibility center
should have the ability to control, or at
least significantly influence, the results
of the center over which he or she has
control. For example, a person
responsible for training in a company
should not be granted or denied a bonus
based on the world price of oil because
the training manager has no control over

1 COST CONCEPTS

RESPONSIBILITY AND CONTROL OF


SYSTEMS
The main classifications of centers, listed
in order of the most fundamental (or
basic) to the most complex, are:
1) A Cost Center is responsible only
for the incurrence of costs. A cost
center does not earn any revenue and
therefore generates no profit. An
equipment maintenance department or
an internal ac-counting department is

1 COST CONCEPTS

RESPONSIBILITY AND CONTROL OF


SYSTEMS
A cost center is the least complex type
of center since it has no revenue or
profit. Managers of cost centers are best
evaluated by variance analysis of their
incurred costs. The key standard for
evaluating a cost center is its efficiency
of operations, which measures whether
or not the center has provided the
required services within the budget.

1 COST CONCEPTS

RESPONSIBILITY AND CONTROL OF


SYSTEMS
A Revenue Center is the opposite of a
cost center in that it is responsible only
for revenues. For example, a sales
department is a revenue center. Though
every department will incur some costs,
the costs incurred by a revenue center
are generally immaterial and may not
even be controllable by the center.

1 COST CONCEPTS

RESPONSIBILITY AND CONTROL OF


SYSTEMS
For example, a revenue centers costs
may simply be allocated to them by the
central company. Managers in revenue
centers are evaluated according to the
level of revenue that the center
generates. Effectiveness is the key for
their evaluation.

1 COST CONCEPTS

RESPONSIBILITY AND CONTROL OF


SYSTEMS
A Profit Center is a department
responsible for both revenues and
expenses. A department within a store,
such as the hardware department, is an
example of a profit center because it has
both reve-nues and cost of goods sold.
Because a profit center is responsible for
both costs and revenues, the manager of
a profit center should be evaluated on

1 COST CONCEPTS

RESPONSIBILITY AND CONTROL OF


SYSTEMS
In a profit center, both efficiency and
effectiveness are assessed, but
priority is given to effectiveness. In fact,
the profit can be treated as the goal to
be achieved.

1 COST CONCEPTS

RESPONSIBILITY AND CONTROL OF


SYSTEMS
An Investment Center is responsible for
profit (revenues and costs) and for
providing a return on the capital that has
been invested into it by the larger
organization to which it belongs. Because it
is responsible for a return-on-investment,
this type of department is the most like a
regular and complete business by itself.
However, it is still part of a larger

2 FORECASTING TECHNIQUES

FORECASTING AND BUDGETING


One of the most important parts of the
planning and budgeting process is the
identification of the assumptions that
a company must make about the
future.
Since planning and budgeting involve
looking into the future, the company
must make some assumptions about
the outlook for the environment in
which its business operates

2 FORECASTING TECHNIQUES

FORECASTING AND BUDGETING


When identifying premises, it is
essential that management focus only
on those that will actually impact the
potential success of the business
Focusing on premises that are not a
critical part of the organizations
success wastes valuable time and
resources
Some premises will affect the whole
company, whereas some premises will

2 FORECASTING TECHNIQUES

FORECASTING AND BUDGETING


Different departments will have different
premises because of the unique tasks
and circumstances they face
The finance department may be
concerned about the expected interest
rate, but the interest rate will not impact
the production department in the
fulfillment of its objectives
The rate of growth in the economy and
the rate of inflation expected during the
budget period will probably impact

2 FORECASTING TECHNIQUES

MATHEMATICAL MODELS
Are commonly used in forecasting. A
mathematical model is an equation that
attempts to represent an actual situation.
For example, if a company has a product
that it sells for $1,000 each, and if we use
R to represent total revenue, the total
revenue that the company will earn by
selling x units can be represented by the
following equation or mathematical model:
R = 1,000x For a model to be useful, it
must be a good representation of the real

2 FORECASTING TECHNIQUES

COLLECTING DATA FOR A FORECAST


In forecasting, historical data is used in
various ways. We may look at the past to
discover a pattern for use in predicting the
future or we may look at the past
relationship between two factors to
determine if there has been a cause-andeffect relationship that can be used to
predict future results. Collecting the data is
usually the most difficult step in analysis.
One of the primary challenges in
forecasting costs is finding the cost driver

2 FORECASTING TECHNIQUES

FORECASTING METHODS
1) Time series methods, which look only
at the historical pattern of one variable
and generate a forecast by extrapolating
the pattern using one or more of the
components (or patterns) of the time
series, and
2) Causal forecasting methods, which
look for a cause-and-effect relationship
between the variable we are trying to
forecast (the dependent variable) and
one or more other variables (the

2 FORECASTING TECHNIQUES

FORECASTING METHODS
1) Time series methods, which look only
at the historical pattern of one variable
and generate a forecast by extrapolating
the pattern using one or more of the
components (or patterns) of the time
series, and
2) Causal forecasting methods, which
look for a cause-and-effect relationship
between the variable we are trying to
forecast (the dependent variable) and
one or more other variables (the

2 FORECASTING TECHNIQUES

TIME SERIES ANALYSIS


Time series analysis looks at patterns of
the desired variable over time. These
patterns from the past are then used to
forecast a future result. A time series may
have one or more of four patterns (also
called components) that influence its
behavior over time:
1) Trend
2) Cyclical
3) Seasonal
4) Irregular

2 FORECASTING TECHNIQUES

TIME SERIES ANALYSIS


Trend Pattern
Over a long period of time, the historical
data may exhibit a trend, which is a
gradual shifting to a higher or lower level.
If a long-term trend exists, short-term
fluctuations may take place within that
trend; however, the long-term trend will be
apparent. For example, sales from year to
year may fluctuate but overall they may be
trending upward.

2 FORECASTING TECHNIQUES

TIME SERIES ANALYSIS


Cyclical Pattern
A long-term trend line can still be
established even if the sequential data
fluctuates greatly from year to year due to
cyclical factors. Any recurring fluctuation
that lasts longer than one year is
attributable to the cyclical component of
the time series. The cyclical component is
usually due to the cyclical nature of the
economy.

2 FORECASTING TECHNIQUES

TIME SERIES ANALYSIS


Seasonal Pattern
Time series can fluctuate within the year
due to seasonality in the business. For
example, a swimsuit companys sales
would be highest during the warm summer
months, whereas a retailer of skis would
experience its peak sales in the
wintertime.

2 FORECASTING TECHNIQUES

TIME SERIES ANALYSIS


Seasonal Pattern
Time series can fluctuate within the year
due to seasonality in the business. For
example, a swimsuit companys sales
would be highest during the warm summer
months, whereas a retailer of skis would
experience its peak sales in the
wintertime.

2 FORECASTING TECHNIQUES

TIME SERIES ANALYSIS


Irregular Pattern
A time series can also vary in a random
pattern, not repeating itself in any regular
pattern. This is called the irregular
pattern. It is caused by short-term,
nonrecurring factors, and its impact on the
time series cannot be predicted.

2 FORECASTING TECHNIQUES

USING TIME SERIES IN FORECASTING


ANALYSIS
The objective of time series analysis is to
develop a forecast for future results. We
need to somehow take the past
information and project it into the future. In
order to do this, we need to make
decisions about what weight (amount of
importance) we will give to the past data.
We can understand that a result from 12
years ago is of less value in projecting the
next period than the previous period is.

2 FORECASTING TECHNIQUES

USING TIME SERIES IN FORECASTING


ANALYSIS
Time series methods are used in
forecasting in two ways that try to take
past information and forecast it into the
future.
1) Smoothing (moving averages,
weighted moving averages and
exponential smoothing), and
2) Trend projection (including trends
adjusted for seasonal influence).

2 FORECASTING TECHNIQUES

TREND PROJECTION AND REGRESSION


ANALYSIS
When a time series is consistently
increasing or decreasing, smoothing
methods are not appropriate for
forecasting. Instead, a time series that has
a long-term upward or downward trend can
be forecasted by means of trend
projection. A trend projection is done with
simple regression analysis, which
forecasts values using historical
information from all available past

2 FORECASTING TECHNIQUES

TREND PROJECTION AND REGRESSION


ANALYSIS
Simple linear regression analysis relies on
two assumptions:
Variations in the dependent variable (i.e.,
what we are forecasting) are explained
by variations in one single
independent variable (i.e., the passage
of time, if a time series is what we are forecasting).
The relationship between the
independent variable (time or a specific

2 FORECASTING TECHNIQUES

TREND PROJECTION AND REGRESSION


ANALYSIS
A linear relationship is one in which the
relationship between the independent
variable and the dependent variable can
be approximated by a straight line on a
graph. The regression equation, which
approximates the relationship, will graph
as a straight line.

2 FORECASTING TECHNIQUES

TREND PROJECTION AND REGRESSION


ANALYSIS
The equation of a linear regression line is:
= ax + b
Where:
= the predicted value of y on the
regression line corresponding to each
value of x
a = the slope of the line
b = the y-intercept, or the value of y when
x is zero (0)
x = the value of x on the x-axis that

2 FORECASTING TECHNIQUES

TREND PROJECTION AND REGRESSION


ANALYSIS
Before relying on regression analysis to
develop a forecast, a correlation
analysis should be performed. Correlation
analysis determines the strength of the
linear relationship between the x
values and their related y values. The
results of the correlation analysis tell the
forecaster whether the relationship
between the dependent variable (sales, for
example) and the independent variable

2 FORECASTING TECHNIQUES

TREND PROJECTION AND REGRESSION


ANALYSIS
The coefficient of correlation measures
the relationship between two variables.
The coefficient of correlation is a number
that expresses how closely connected, or
correlated, the two variables are and the
extent to which a change in one variable
has historically resulted in a change in the
other.
The coefficient of correlation,
represented by r (or R), is a numerical

2 FORECASTING TECHNIQUES

TREND PROJECTION AND REGRESSION


ANALYSIS
If r is a positive number close to +1 (such
as 0.83), this indicates that the data points
follow a linear pattern fairly closely and the
pattern is upsloping (for example, in a time
series sales are in-creasing as the time
moves forward). A forecast made from this
data using simple regression analysis
should be fairly accurate.

2 FORECASTING TECHNIQUES

TREND PROJECTION AND REGRESSION


ANALYSIS
If r is a negative number close to 1
(such as 0.77), this indicates that in a
time series the data points follow a linear
pattern and downsloping instead of
upsloping (for example, sales are
decreasing as the time moves forward). A
forecast made from this data using simple
regression analysis would also be fairly
accurate, though not as accurate as the
previous example of an upsloping pattern,

2 FORECASTING TECHNIQUES

TREND PROJECTION AND REGRESSION


ANALYSIS
A moderate correlation coefficient, r,
(generally defined as 0.30 to 0.49)
indicates a lower amount of correlation and
questionable value of the historical data
for forecasting.
A low correlation coefficient, r, (around
0.10) indicates that a forecast made from
this data using simple regression analysis
would not be useful.

2 FORECASTING TECHNIQUES

TREND PROJECTION AND REGRESSION


ANALYSIS
The coefficient of correlation, r, does
nothing to tell us how much of the
variation in the dependent variable is
explained by changes in the independent
variable. It tells us only whether there is a
direct (upsloping) or inverse (downsloping)
relationship between the variables and the
strength of that relationship.

2 FORECASTING TECHNIQUES

TREND PROJECTION AND REGRESSION


ANALYSIS
In a simple linear regression with only one
independent variable, the coefficient of
determination is the square of the
coefficient of correlation. The
coefficient of determination is represented
by the term r2 (or R2) and it is the
percentage of the total amount of
change in the dependent variable (y)
that can be explained by changes in
the independent variable (x)..

2 FORECASTING TECHNIQUES

TREND PROJECTION AND REGRESSION


ANALYSIS
R2 is expressed as a number between 0
and 1. In a regression with a high
coefficient of determination (r2), the data
points will all lie close to the trend line. In a
regression with a low r2, the data points
will be scattered at some distance above
and below the trend line. The higher the
r2, the better the predictive ability of the
linear regression. An r2 above 0.50 (50%)
indicates that the forecast yielded by

2 FORECASTING TECHNIQUES

MULTIPLE REGRESSION AND CAUSAL


FORECASTING
If only one independent variable (such as
advertising expenditures) is affecting the
dependent variable (such as sales) and if
the relationship between them is linear,
regression analysis is called simple linear
regression. However, it is also possible for
the dependent variable such as sales to be
affected by more than one independent
variable. Advertising expenditures, the size
of the sales staff, competition, the

2 FORECASTING TECHNIQUES

MULTIPLE REGRESSION AND CAUSAL


FORECASTING
When more than one independent variable
is known to impact sales and each one can
be expressed numerically, regression
analysis using all of the independent
variables to forecast the dependent
variable is called multiple regression
analysis. Multiple regression analysis is
another type of causal forecasting.

2 FORECASTING TECHNIQUES

MULTIPLE REGRESSION AND CAUSAL


FORECASTING
The equation of this three-dimensional
multiple regression function is: = a1x1
+ a2x2 + b Where:
= the predicted value of y on the
regression line corresponding to each
value of x1 and x2
a1, a2 = variable coefficients, similar to
the slope of the line
b = the constant coefficient, the yintercept, and the value of y when x1 and

2 FORECASTING TECHNIQUES

BENEFITS OF REGRESSION ANALYSIS


Regression analysis is a quantitative
method and as such it is objective. A given
data set generates specific results. The
results can be used to draw conclusions
and make forecasts.
Regression analysis is an important tool
for budgeting and cost accounting. In
budgeting, it is virtual-ly the only way to
compute fixed and variable portions of
costs that contain both fixed and variable
components (mixed costs). The use of

2 FORECASTING TECHNIQUES

LIMITATIONS OF REGRESSION
ANALYSIS
To use regression analysis, historical data
is required for the variable that is being
forecast or for the variables that are causal
to this variable. If historical data is not
available, regression analysis cannot be
used.
Even when historical data is available, its
use is questionable for predicting the
future if a significant change has taken
place in the conditions surrounding that

2 FORECASTING TECHNIQUES

LIMITATIONS OF REGRESSION
ANALYSIS
In causal forecasting, the usefulness of
the data generated by regression analysis
depends upon the choice of independent
variable(s). If the choice of independent
variable(s) is inappropriate, the results can
be misleading.
The statistical relationships that can be
developed using regression analysis are
valid only for the range of data in the
sample.

3 BUDGETING

PLANNING AND BUDGETING


CONCEPTS
The budget is developed in advance of
the period that it covers
It is based on forecasts and assumptions
Budget is not something that is primarily
for the purpose of restricting what can
be done
It is intended as a planning tool and is a
guideline to follow in order to achieve
the companys planned goals and
objectives

3 - BUDGETING

Budget
A budget is a detailed plan for
acquiring and using financial and
other resources over a specified
time period. A budget is the
monetary plan of operation over a
specified period of time, showing
types and amounts of proposed
expenditures, the purpose of

3 - BUDGETING

Budget
It is a future plan expressed in
monetary terms. The act of
preparing a budget is called the
budgeting process, and is a
means of allocating scarce
resources to unlimited demands.

3 - BUDGETING

Personal Budgets
Nearly everyone budgets to some
extent, even though many of the
people who use budgets do not
recognize what they are doing as
budgeting.

3 - BUDGETING

Personal Budgets
For example, making estimates of
income, plan expenditures for
food, clothing, housing, and
restrict spending. Eventhough
theses plans exist in the mind,
they still constitute a budget and
formalized by documentation.

3 - BUDGETING

Not for Profit and Business


Budgets
The budgets of not-for-profit and
business organizations tend to be
more detailed and involve more
work than personal budgets.
Organizational budgets assist in
planning, controlling, predicting
operational results and financial

3 - BUDGETING

Importance of Budgeting
Budgeting is very important to
the organization especially in
monitoring cash flows
Because of high fixed costs,
changes in revenues and
expenses can be monitored by
Budgets
When actual figures fall short of

Importance of Budgeting

Budgets provide a means of


communicating managements
plans throughout the
organization when monetary
standards are set for all to verify
and work within the budget
limits
Budgets force managers to think
about and plan for the future. In
the absence of budgets, many

Importance of Budgeting

The process provides a means of


allocating resources efficiently
and effectively to units of the
organization that will produce
maximum benefits. Additionally,
major bottlenecks can be
uncovered before they occur

Importance of Budgeting

Budgets coordinate the


activities of the entire
organization by integrating the
plans of various parts. Thus,
ensuring that everyone in the
organization is pulling in the
same direction

Importance of Budgeting

Budgets define goals and


objectives that can serve as
benchmarks for evaluating
subsequent performance
Budgets are very important
tools in accounting but not
covered under financial
accounting mainly because of
the uses of information derived
from management accounting

Importance of Budgeting

Budgeting is a tool used by


internal managers in formulating
strategy and directing. Since
budgets provide direction for the
organization, it will not be
prudent to place it within the
reach of those outside the
organization, including
competitors who can make very
important business decision that

Importance of Budgeting

Financial accounting uses


historical data to prepare financial
statements, which lacks the ability
to predict future events. Budgets
are based on financial statement
but with an added feature to
forecast events.

3 - BUDGETING

Time frames for Budgets


Budgets can also be prepared on a
continuous basis. At all times, the
budget covers a set number of
months, quarters, or years into the
future. Each month or quarter, the
month or quarter just completed is
dropped and a new monthly or
quarterly budget is added to the

3 - BUDGETING

Methods of Developing a
Budget
Budget development can be done
using a participative process, an
authoritative process, or a
consultative process.
A participative budget is
developed from the bottom up. All
the people affected by the budget

3 - BUDGETING

Methods of Developing a
Budget
This type of budget development
involves negotiation between
lower-level managers and senior
managers.
An authoritative budget is
developed from the top down.
Senior management prepares all

3 - BUDGETING

Methods of Developing a
Budget
A consultative budget is a
combination of authoritative and
participative budget development
methods. Senior management
asks for input from lower-level
managers but then develops the
budget with no joint decision-

4 COST MANAGEMENT

Cost classifications
In managerial accounting, cost is
used in many ways because there
are different types of cost
depending on the immediate
needs of management. For
example, external financial report
requires historical cost, whereas
decision making may require

4 COST MANAGEMENT

Manufacturing Costs
Most manufacturing companies
divide manufacturing costs into
three broad categories:
Direct materials
Direct labor
Manufacturing overhead

4 COST MANAGEMENT

Direct materials
Are those materials that become
an integral part of the finished
product, and can be physically
and conveniently traced to it. For
example, the seats that Toyota
will purchase from subcontractors,
and install in vehicles.

4 COST MANAGEMENT

Direct labor
Is reserved for those labor cost
that can be physically and
conveniently traced to individual
units of product. For example,
labor cost of carpenters, and
masons in building a house.

4 COST MANAGEMENT

Manufacturing Overhead
Manufacturing overhead includes
items such as indirect materials,
indirect labor, maintenance and
repairs on production equipment.

4 COST MANAGEMENT

Nonmanufacturing Costs
Nonmanufacturing costs into two
broad categories:
Marketing or selling costs
Administrative costs

4 COST MANAGEMENT

Marketing or selling costs


Include all costs necessary to
secure customer orders and get
the finished product into the
hands of the customer. For
example advertising, shipping,
sales travel, sales commission,
and sales salaries.

4 COST MANAGEMENT

Administrative costs
Include all executive,
organizational, and clerical costs
associated with the general
management of the organization.

4 COST MANAGEMENT

Product Costs versus Period


Costs
In addition to manufacturing and
nonmanufacturing cost, another
way to look at costs is the
categorization of:
Product Costs
Period Costs

4 COST MANAGEMENT

Product Costs
Include all the cost that are
involved in the acquiring or
making a product, for example
direct materials, direct labor, and
manufacturing overhead.

4 COST MANAGEMENT

Period Costs
Are all the costs that are not
included in the product costs.
These costs are expensed in the
income statement in the period it
occurs. All selling and
administrative expenses are
considered period costs.

4 COST MANAGEMENT
Overview of Quality Management
To be an effective manager and leader
at any level in an organization:
private, public or mixed sectors of the
economy, one must have a clear
understanding of QM, and its central
role. There is a fulfillment when after
several unsuccessful efforts to solve a
problem, and everything comes
together.

4 COST MANAGEMENT
Why is quality important
Customers expect quality
Organizations function in a
competitive global environment
Cost is lowered when work is
done right the first time
From a personal point of view
Employee responsibility

4 COST MANAGEMENT
Why is quality important
Reduce frustration for
others
Retain job and be rewarded

4 COST MANAGEMENT
Why is quality important
Buzzell and Gale (1987), have
documented the relationship
between excellent quality and
profitability.

4 COST MANAGEMENT
Why is quality important
Quality leads to stronger
customer loyalty
Repeat purchases
Less vulnerability to price wars
Higher relative prices/ market
share
Improvement in share prices
Lower marketing cost

4 COST MANAGEMENT
Why is quality important
To avoid these costs, control is an
important issue in quality
management:
Rules and procedures
Hierarchy of authority
Inspections at end of line
Quality control department
Formal training in quality tools

4 COST MANAGEMENT
Why is quality important
Technology to define work
processes
Productivity reporting

4 COST MANAGEMENT

The Cost of Lack of Quality


Internal: (re-work, scrap, retest, etc)
External failures: (warranty
cost, recalls, loss of goodwill,
returns)
Appraisal costs: independent of
repair cost
Prevention costs: trial and
experimentation

4 COST MANAGEMENT
Activity Based Costing
Activity-based costing (ABC) is
another way of allocating overhead
costs to products, and in ABC the
method of allocation is based on
cost drivers. As with the other
methods, ABC is a mathematical
process of allocation and requires
identification of the costs to be
allocated.

4 COST MANAGEMENT
Activity Based Costing
Followed by some manner of
allocating them to the produced
products. We can use ABC in a
variety of situations and apply it
to both manufacturing and
nonmanufacturing overheads. It
can also be used in service
businesses.

4 COST MANAGEMENT
Activity Based Costing
An activity is an event, task or
unit of work with a specified
purpose. Examples of activities
are designing products, setting
up machines, operating
machines, making orders or
distributing products

4 COST MANAGEMENT
Activity Based Costing
A cost object is anything for
which costs are accumulated
for managerial purposes.
Examples of cost objects are a
specific job, a product line, a
market or certain customers.

4 COST MANAGEMENT
Activity Based Costing
A cost driver is anything (it can
be an activity, an event or a
volume of something) that
causes costs to be incurred each
time the driver occurs. Examples
of cost drivers are set-ups,
moving, number of parts,
casting, packaging or handling.

4 COST MANAGEMENT
Activity Based Costing - Benefits
ABC provides a more accurate
product cost for use in pricing and
strategic decisions
By identifying the activities that
cause costs to be incurred, ABC
enables management to identify
activities that do not add value to
the final product

4 COST MANAGEMENT
Activity Based Costing - Limitations
Not everything can be allocated strictly on
a cost driver basis. This is particularly true
in respect to facility-sustaining costs
ABC is expensive and time consuming to
implement and maintain. Inclusion of
administrative overhead in product costs is
not in compliance with any generally
accepted accounting principles

5 STRATEGIC INVESTMENT
Capital Budgeting
Capital budgeting methods include:
Payback Method
Discounted Payback Method
Discounted Cash flow
Net Present Value
Internal Rate of Return

5 STRATEGIC INVESTMENT
Payback Period/ Payback Method
In using the Payback Method, a company
usually chooses a period of time in which
it wants its investments to pay back
their initial investments
Projects with payback periods of less
than that amount of time are candidates
for further analysis
while projects with payback periods in
excess of that amount of time are
rejected without further consideration.

5 STRATEGIC INVESTMENT
Discounted Payback Method
The Discounted Payback Method (also
called the breakeven time) is an
attempt to deal with the Payback
Methods weakness of not considering
time value of money concepts
The Discounted Payback Method uses
the present value of cash flows
instead of undiscounted cash flows to
calculate the payback period

5 STRATEGIC INVESTMENT

Discounted Payback Method


Each years cash flow is
discounted using an
appropriate interest rate,
usually the companys cost of
capital, and then those
discounted cash flows are used
to calculate the payback period.

5 STRATEGIC INVESTMENT
Discounted Cash Flow
Discounted cash flow (DCF) methods measure
all of the expected future cash inflows and
outflows of a project using time value of
money concepts
Which is that money received today is worth
more than money received in any future
period
In a discounted cash flow analysis, the earlier
that a project is able to generate cash inflows

5 STRATEGIC INVESTMENT
Discounted Cash Flow
Discounted cash flow methods focus
on the actual cash inflows and
outflows from the project rather than
using income as the measurement
basis, as in accrual accounting
Cash flow is used because we are
most interested in the cash return
that we can obtain in the future for a
cash outlay now

5 STRATEGIC INVESTMENT

Discounted Cash Flow


The two main DCF methods that
we will look at in more detail
below are the:
Net Present Value method and
The Internal Rate of Return
method.

5 STRATEGIC INVESTMENT
Net Present Value Method
The Net Present Value (NPV) method
calculates the present value of the
expected monetary gain or loss from a
project by discounting all expected
future cash inflows and outflows to the
present point in time
Using the required rate of return
A projects NPV is the present value of
the projects future expected cash flows
minus the proposals initial cash outflow

5 STRATEGIC INVESTMENT
The Internal Rate of Return
Method
The IRR is the discount rate at which
the NPV of an investment will be
equal to 0
It is the discount rate at which the
present value of the expected cash
inflows from a project equals the
present value of the expected cash
outflows

5 STRATEGIC INVESTMENT

The Internal Rate of Return


Method
If the IRR is higher than the
firms required rate of return,
the investment is acceptable. If
the IRR is lower than the
required rate of return, the
investment should not be made.

5 STRATEGIC INVESTMENT
Capital Budgeting and
Inflation
An investment of 1,000 units of a
product each year for four years,
will yield a net cash inflow of $10
per unit with no inflation. Thus,
we would expect a net cash
inflow of $10,000 per year for the
life of the project

5 STRATEGIC INVESTMENT
Capital Budgeting and
Inflation
However, if we are expecting
inflation during that period, we
need to recognize that we should
instead expect higher cash
inflows in each year. The higher
expected cash inflows are
nominal expected cash flows,

5 STRATEGIC INVESTMENT
Capital Budgeting and Inflation
It is the nominal expected cash flows
that will be recorded in the accounting
system. The net expected cash inflows
of $10,000 are the real expected cash
flows, which are not recorded in the
accounting system.
Often, the real expected cash flows will
need to be converted to nominal
expected cash flows for capital
budgeting purposes.

6 FINANCIAL STATEMENT ANALYSIS

Assets
Assets are things of value
owned by individuals or
corporations. Example include,
cash, land, supplies, equipment,
machinery, tools, buildings,
furniture, and jewelry.

6 FINANCIAL STATEMENT ANALYSIS

Liabilities
Liabilities occur when a firm
may have to borrow money to
buy more assets. This means
the firm is buying assets on
account (buy now, pay later).
Examples include loans and
mortgages.

6 FINANCIAL STATEMENT ANALYSIS

Equities
Equities are the rights or
financial claims to the assets.
They belong to those who
supply the assets. If you are the
only person to supply assets to
the firm, you have the sole right
or financial claim to them.

6 FINANCIAL STATEMENT ANALYSIS

Revenue
A service company earns
revenue when it provides
services to its clients. When
revenue is earned, owners
equity is increased. In effect,
revenue is a subdivision of
owners equity.

6 FINANCIAL STATEMENT ANALYSIS

Revenue
Increases assets. The increase
is in the form of cash if the
client pays right away. If the
client promises to pay in the
future, the increase is called
accounts receivable.

6 FINANCIAL STATEMENT ANALYSIS

Expenses
Expenses are the costs incurred
in carrying on the operations of
an entity in the effort to create
revenue. Expenses are also a
subdivision of owners equity;
when expenses are incurred,
they decrease owners equity.

6 FINANCIAL STATEMENT ANALYSIS

Expenses
Expenses can be paid for in
cash or they can be charged.
Examples of expenses include:
hydro, gas, telephone, salaries,
and office supplies.

6 FINANCIAL STATEMENT ANALYSIS

Net Income/Net loss


When revenue totals more than
expenses, net income is the
result; when expenses total
more than revenue, net loss is
the result.

6 FINANCIAL STATEMENT ANALYSIS

Withdrawal
Withdrawal is when the owner of
a business withdraws cash or
other assets from the business
to pay living or other personal
expenses that do not relate to
the business. Withdrawals
decrease owners equity.

6 FINANCIAL STATEMENT ANALYSIS

The Income Statement


An income statement is an
accounting report that shows
results in terms of revenue and
expenses. If revenues are
greater than expenses, the
report shows net income. If
expenses are greater than

6 FINANCIAL STATEMENT ANALYSIS

The Income Statement


Income statement is prepared
for a period, usually on monthly
basis up to 12 months or a fiscal
year. It does not usually cover
more than a year. The report is
based on all revenues and
expenses throughout the entire

The Income Statement

MARY SMITH GROCERIES

INCOME STATEMENT

YEAR ENDED DECEMBER 31, 2010

Revenue:

Sales

700,000

Operating Expenses:

Wages

60,000

Rent

70,000

Utilities

30,000

160,000

540,000

Total Operating Expenses

Net Income

6 FINANCIAL STATEMENT ANALYSIS

The Statement of Owners


Equity
The statement of owners equity
shows the changes that have
occurred in the capital position
for a certain period of time.

6 FINANCIAL STATEMENT ANALYSIS

The Statement of Owners


Equity
The statement of owners equity
summarizes the effects of all the
subdivisions of owners equity
(revenue, expenses, and
withdrawals) on beginning
capital. The ending capital will

The Statement of Owners Equity

MARY SMITH GROCERIES

STATEMENT OF OWNER'S EQUITY

YEAR ENDED DECEMBER 31, 2010

Capital: January 1, 2010

780,000

Net Income

540,000

Less: Withdrawal in July 23, 2010

20,000

Increase in Capital

520,000

Capital: December 31, 2010

1,300,000

6 FINANCIAL STATEMENT ANALYSIS

The Balance Sheet


The balance sheet reports the
assets, liabilities, and owners
equity at a specific date. The
balance sheet is like a snapshot
of the companys financial
condition at a specific moment
in time. Total assets must equal

The Balance Sheet

MARY SMITH GROCERIES

BALANCE SHEET

DECEMBER 31, 2010

Assets

Cash

830,000

Accounts Receivable

330,000

Office Equipment

210,000

Total Assets

1,370,000

Liabilities

Accounts Payable

45,000

Loans Payable

25,000

Owner's Equity

Capital: December 31, 2010

Total Liabilities and Owner's Equity

1,300,000

1,370,000

6 FINANCIAL STATEMENT ANALYSIS

Statement of Cash flow


The statement of cash flows
summarizes the sources and
uses of funds for operating,
investing, and financing
activities.

6 FINANCIAL STATEMENT ANALYSIS

Operating Activities
Operating activities are closely
related to conducting the
business for which an entity was
established. For example selling
merchandise and services to
customers, paying salaries, and
other expenses needed to
continue earning operating

6 FINANCIAL STATEMENT ANALYSIS

Investing Activities
Investing activities are those
that relate to lending money
and collecting on loans,
acquiring and selling
investments and long-term
assets. Examples include the
purchase and sale of plant and
equipment, shares, bonds, and

STATEMENT OF CASH FLOW

Financing Activities
Financing activities include cash
inflows and outflows relating to
liability and owners equity.
These are activities relating to
raising money from investors
and creditors such as issuance
of bonds and shares, retiring
bonds, and paying dividends.

6 FINANCIAL STATEMENT ANALYSIS

Direct and Indirect Methods


of Cash flows
The operating activities section
of the cash flows statement is
presented using either a direct
or an indirect method.

6 FINANCIAL STATEMENT ANALYSIS

Direct and Indirect Methods


of Cash flows
The direct method presents the
income statement on cashbasis. The indirect method
involves converting the accrualbasis net income of the income
statement to the cash- basis of
the net income.

6 FINANCIAL STATEMENT ANALYSIS

Users of Financial ratios


Users of financial ratios include
commercial loan departments,
corporate controllers, certified
public accountants, and chartered
financial analysts.

6 FINANCIAL STATEMENT ANALYSIS

Types of Financial ratios


Financial ratios are organized into
four building blocks of financial
statement analysis: Liquidity
ratios, long-term debt paying
ability, profitability ratios, and
investor analysis.

6 FINANCIAL STATEMENT ANALYSIS

Liquidity ratios
Liquidity refers to the availability
of cash to meet short-term cash
requirements and debt
obligations. A companys liquidity
position is affected by cash
inflows and outflows and the
ability to sustain its future
performance.

6 FINANCIAL STATEMENT ANALYSIS

Liquidity ratios
Liquidity analysis include: Cash
ratio, Current ratio, Days' sales in
inventory, Inventory turnover,
Operating cash-flow/ Current
Maturities of Long term debt and
current Notes Payable, Sales to
working capital, and Working
capital.

6 FINANCIAL STATEMENT ANALYSIS

Liquidity ratios
Cash ratio = Cash divided by
Current liabilities
(830,000/70,000 = 11.85)
Current ratio = Current assets
divided by Current liabilities
(1,160,000/70,000 = 16.57)
Working capital = Current
assets minus Current

6 FINANCIAL STATEMENT ANALYSIS

Long-term debt paying ability


ratios
Long-term debt paying ability
ratios or Solvency refers to the
long-run financial viability of an
entity and its ability to cover longterm obligations. One of the most
important components of
solvency analysis is the

6 FINANCIAL STATEMENT ANALYSIS

Long-term debt paying ability


ratios
Debt ratio, Operating cashflow/total debt, Debt/equity, and
Times interest earned.
Debt ratio = Total liabilities
divided by Total assets
(70,000/1,370,000 = 5.11%)
Debt/equity ratio = Total

6 FINANCIAL STATEMENT ANALYSIS

Profitability ratios
Profitability ratio analysis relates
to a companys ability to utilize
assets efficiently to produce
profits. The analysis should
include only the income arising
from normal operations of the
business. Thus, discontinued and
extraordinary items are excluded.

6 FINANCIAL STATEMENT ANALYSIS

Profitability ratios
net profit margin, total asset
turnover, return on assets,
operating income margin,
operating asset turnover, return
on operating assets, sales to fixed
assets, return on investments,
return on total equity, net profit
margins and gross profit margins.

6 FINANCIAL STATEMENT ANALYSIS

Profitability ratios
Return on assets = Net
income divided by Total
assets (540,000/1,370,000 =
39.41%)
Net profit margin = Net
income divided by Net sales
(540,000/700,000 = 77.14%)

6 FINANCIAL STATEMENT ANALYSIS

Investor analysis
Investor analysis or Market ratio
measures are useful when
analyzing corporations with
publicly traded stocks and the use
of stock prices in various
computations. Ratios relevant to
investor analysis include: degree
of financial leverage,
price/earnings ratio, percentage