FINANCIAL ANALYSIS IN

OPERATIONS
MANAGEMENT
Reporter:
Mara Shaira A. Siega, CPA
 LEARNING OBJECTIVES
 Introduce various cost definition and demonstrate how they are
applied in operations management.
 Understand the concept of activity-based costing and its
significance in operations management.
 Determine the types of economic and investment decisions
 Identify methods of evaluating and ranking investments
 Discuss the effects of taxes and interest rates and its relation to
operations management
 COST DEFINITIONS
 Relevant Costs – costs that are useful in making decision
 Controllable Cost – costs are those which incurrence or non-
incurrence, can be influenced or decided upon by a manager.
 Opportunity Costs – costs given up in favor of another choice.
They are not recorded in the accounting system.
 Out-of-pocket Costs – costs that are incurred and are paid in cash.
 COST DEFINITIONS
 Sunk Costs – costs that have been incurred in the past and can no
longer be changed.
 Fixed Costs – costs that remain constant regardless of the change in
production and sales, but changes on a per unit basis.
 Variable Costs – costs that changes in total in direct proportion to
changes in production and sales but is constant on a per unit basis.
 ACTIVITY-BASED COSTING
 Costs are accumulated not with their relationship with the product
but based on their relationship with the process and the activities in
the process.
 This is an overhead allocation system that allocates overhead cost. It
is observed that overhead costs are incurred or not incurred based on
activity drivers.

 Activity Drivers – also called cost driver, causes costs to change or

not to change. These can be grouped into different processing levels.
 ABC PROCESS
 Set-up the ABC system.
This is done through the establishment of the activity-based
management (ABM) system which serves as the linkage of product
costing and the continuous improvement of processes.
 Identify the resource drivers.
These are factors that cause changes in the costs of an activity.
 Identify the activity drivers.
 TRADITIONAL VS ACTIVITY-BASED
COSTING
Traditional Costing Activity-Based Costing

Total Overhead Total Overhead

Labor-hour Pooled based
allocation on activities
End product costs Cost pools
Cost-driver
allocation
End product costs
 TYPES OF ECONOMIC AND INVESTMENT
DECISIONS
 Make or buy decisions
 Accept or reject special orders
 Drop or continue a division
 Sell-as-is or process further
 Continue operations or temporary shutdown
 Optimization of scarce resources
 Sell now or later
 Replace or retain an old asset
 Scrap or rework a defective unit
 CAPITAL BUDGETING

Major concerns:
 Net cost of investment
How much money is needed?
 Net returns
How should the investment be returned
 Cost of capital
How much is the cost of using the funds?
 Project Evaluation Techniques (PET)
Which investment proposal would give the highest return on
investment, profitability-wise and liquidity wise?
 PROJECT EVALUATION TECHNIQUES

Traditional Methods:
 Payback Period – refers to the length of time an investment is
recovered
 Payback Reciprocal – it represents the percentage of annual net cash
returns provided by an investment
 Payback Bailout – residual value is considered in determining the
total cash provided by project
 Accounting Rate of Return – measures the profitability of a
proposed project
 PROJECT EVALUATION TECHNIQUES

Discounted Methods:
 Net Present Value – determines the cash inflows and outflows at the
same time period
 Internal Rate of Return – is the breakeven rate of return
 Profitability Index – used to rank projects that are acceptable
 Net Present Value Index – used to rank projects that are acceptable
 Discounted Payback Method – considers the time value of money in
recoupment of investment
 TAX SAVINGS ON DEPRECIATION EXPENSE

Sources:
 Depreciation as a tax-deductible expense
Tax savings on depreciation expense = Depreciation
expense x Marginal tax rate
 Present value of tax savings using accelerated method of
depreciation
Tax savings on depreciation = Change in
depreciation expense x Tax rate x PVF
 TYPES OF DEPRECIATION

 Straight-line
 Sum-of-the-Years’-Digits (SYD)
 Declining Balanced Method
 Double Declining Balanced Method
 Depreciation-by-Use Method
 TIME VALUE OF MONEY
 Interest – is a charge for borrowing money
1. Simple Interest
2. Compound interest
 Present Value – is an amount today that is equivalent to a future
payment, or series of payments, that has been discounted by an
appropriate discount interest rate
 Future Value – is the amount of money that an investment with a
fixed, compounded interest rate will grow by some future date.
 TIME VALUE OF MONEY
 Annuity Payments – annuity is a series of equal payments or
receipts that occur at evenly spaced intervals
1. Ordinary Annuity – payments or receipts occur at
the end of each period
2. Annuity Due – payments or receipts occur at the
beginning of each period