Costing and Finance

P R UPADHYAY
Outline
2

• Business & Accounting • Risk analysis

terminology • Demand analysis and
• Cost classification & sales forecasting
analysis • Engineering Economy
• Cost-benefit analysis
• Interest & time value of
money
• Investment decision

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Business & Accounting terminology
3

 Covered in General Accounting Principles

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Cost
4

• Cost is the amount of expenditure, actual or

notional, relating to a specific thing or
activity.
• The special thing or activity may be a
product, job, service, process or any other
activity.
• Cost is expressed in monetary terms.

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Cost classification
5

 It is the process of grouping costs according to their

common characteristics.
 Cost classification serves the following objectives:
 Determining product cost
 Planning
 Decision making
 Control

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Different Cost classifications
6

 On the basis of nature of cost:

 Direct material

 Direct labour

 Direct expenses

 Factory/ works overhead

 Administrative overhead

 Selling & distribution overhead

 On the basis of behavior of cost:

 Fixed

 Variable

 Mixed (Semi-variable or semi-fixed)

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Different Cost classifications
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 On the basis of degree of traceability to the product:

 Direct cost

 Indirect cost

 On the basis of association with the product:

 Product cost

 Period cost

 On the basis of function:

 Manufacturing cost

 Administrative cost

 Selling & distribution cost

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Different Cost classifications
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 On the basis of relationship with the accounting

period:
 Capital cost
 Revenue cost
 On the basis of decision making and planning:
 Opportunity cost

 Sunk cost

 Relevant cost

 On the basis of controllability:

 Controllable and uncontrollable cost

 Standard cost

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Cost analysis
9

 Cost analysis is the identification of the costs, as per

their required classification, for the purpose of
planning, decision making and controlling.

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Cost-benefit analysis
10

 It analyses the cost and expected benefit there from.

 Helps in decision making relating to level of
production.
 Following techniques are used:
 Break-even analysis
 Cost-volume-profit analysis

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Interest and time value of money
11

 Interest is the amount of return of investment in

money market.
 Money has time value therefore specific cash inflow
and outflow are analysed for decision making.
 To determine the time value of money, following
techniques are used:
 Discounting
 Compounding
 Equivalence

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Investment decision
12

 It is fully based on time value of money.

 It analyses the feasibility of an investment project
from financial aspects.
 Following methods are used:
 Pay back period (PBP)
 Discounted pay back period
 Net present value (NPV)
 Internal rate of return (IRR)
 Profitability Index (PI)

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Risk analysis
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 It focuses on:
 identification of risk relating to project or business operation,

 assessment of the impact of such risk,

 prioritization of risk on the basis of their impact on business

and project; and
 using the methods of mitigation or avoidance.

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Demand analysis and sales forecasting
14

 Demand analysis and sales forecasting try to identify

the expected demand of the product or services to be
produced or delivered and the expected volume of
sales to be made
 Helps in determining the level of production
required, expenditures to be made and resources to
be used.
 Takes the help of various environmental factors,
production capacity and customers behaviors.

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 What is Engineering Economy?
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 Economic decision making for engineering systems is called engineering
economy.

 Engineers are the people who are familiar with all the technicalities of
machinery and production therefore they are the best judges of the useful
lives of an asset and they also have the technical knowledge to calculate the
number of units a proposed plant would produce when operational.

 In today’s competitive world of business it has become essential that

engineers should practice financial project analysis for engineering projects
and make rational decisions.

 Engineering economy also includes the study of accounting practices for

manufacturing concerns. Unique features of accounting for manufacturing
concerns are process costing, batch costing, cost allocation.
 Engineering economy deals with justification and selection of projects.
 What is Engineering Economy?
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 Engineering economy
systematic evaluation of the economic merits of
proposed solutions to engineering problems
 Principles:
– Develop the alternatives
• Alternatives need to be identified and defined.
– Focus on the difference
• Only the differences in expected future
outcomes among the alternatives will effect the
decision.
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 What is Engineering Economy?
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– Use a consistent viewpoint

• Prospective outcomes should be developed
from a consistent, defined viewpoint.
– Consider all relevant criteria
– (try to) Use a common unit of measure
– Make uncertainty explicit
• Uncertainty is inevitable. Identify and explore
it in analyses.
– Revisit your decisions

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Engineering Economic Analysis - Seven Steps

1. Recognition and formulation of the problem.

2. Development of the feasible alternatives.
3. Development of the net cash flows (and other
prospective outcomes) for each alternative.
4. Selection of a criterion (or criteria) for determining the
preferred alternative.
5. Analysis and comparison of the alternatives.
6. Selection of the preferred alternative.
7. Performance monitoring and post-evaluation.
 Engineering Economy
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 Objective – Evaluation
– How to compare the economic value of alternative design
options?
 Basis – Cash Flow Analysis
– One is indifferent between investments with equivalent
cash flows
 Key issues
– Time value of money
– Cash flows occurring at different times
– “Designs” with different durations

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 20

Thank You

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