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Assignment

Title: Managing Financial Principles and Techniques

Student Name: Rahul Nangare

Student ID: IND/LCMPG 710/0141

Course : EDEXCEL PGD

Assessor: David pierce

Word Count :
13.1
13.1.1
Price of a product is a major element of the marketing mix. Pricing is one of the most important
strategic issue because it is related to the product positioning. The price goes in hand with the other
marketing mix elements such as product promotion, channel decisions and its features.

13.1.2
For a developing the pricing of a new product, there can be a general sequence of steps that can be
followed by the organisation which may vary from other organisations. The main area of focus will
however be same for all the organisations. The different steps can be as follows.

Develop marketing strategy - perform marketing analysis, segmentation, targeting, and positioning.

Make marketing mix decisions - define the product, distribution, and promotional tactics.
Estimate the demand curve - understand how quantity demanded varies with price.
Calculate cost - include fixed and variable costs associated with the product.
Understand environmental factors - evaluate likely competitor actions, understand legal constraints,
etc.
Set pricing objectives - for example, profit maximization, revenue maximization, or price
stabilization.
Determine pricing - using information collected in the above steps, select a pricing method, develop
the pricing structure, and define discounts.[1]
13.1.3
The various pricing strategies for products include, competition based pricing, cost-plus pricing,
creaming or skimming, limit pricing, loss leader, market oriented pricing, penetration pricing, price
discrimination, premium pricing, predatory pricing, contribution margin based pricing,
psychological pricing, dynamic pricing, price leadership, target pricing, absorption pricing, high-
low pricing, premium decoy pricing, marginal cost pricing, value based pricing. For each and every
pricing strategies has its own reasons and market reach.

At the end of the assignment, we can observe the various methodologies and techniques an
organisation adopts in managing the finances using the pricing centric point of view.
The factors that influence how a consumer perceives a given price and how price-sensitive a
consumer is likely to be with respect to different purchase decisions[2]

 Reference Price Effect Buyer’s price sensitivity for a given product increases the higher the
product’s price relative to perceived alternatives. Perceived alternatives can vary by buyer
segment, by occasion, and other factors.
 Difficult Comparison Effect Buyers are less sensitive to the price of a known / more
reputable product when they have difficulty comparing it to potential alternatives.
 Switching Costs Effect The higher the product-specific investment a buyer must make to
switch suppliers, the less price sensitive that buyer is when choosing between alternatives.
 Price-Quality Effect Buyers are less sensitive to price the more that higher prices signal
higher quality. Products for which this effect is particularly relevant include: image
products, exclusive products, and products with minimal cues for quality.
 Expenditure Effect Buyers are more price sensitive when the expense accounts for a large
percentage of buyers’ available income or budget.
 End-Benefit Effect The effect refers to the relationship a given purchase has to a larger
overall benefit, and is divided into two parts: Derived demand: The more sensitive buyers
are to the price of the end benefit, the more sensitive they will be to the prices of those
products that contribute to that benefit. Price proportion cost: The price proportion cost
refers to the percent of the total cost of the end benefit accounted for by a given component
that helps to produce the end benefit (e.g., think CPU and PCs). The smaller the given
components share of the total cost of the end benefit, the less sensitive buyers will be to the
component's price.
 Shared-cost Effect The smaller the portion of the purchase price buyers must pay for
themselves, the less price sensitive they will be.
 Fairness Effect Buyers are more sensitive to the price of a product when the price is outside
the range they perceive as “fair” or “reasonable” given the purchase context.
 The Framing Effect Buyers are more price sensitive when they perceive the price as a loss
rather than a forgone gain, and they have greater price sensitivity when the price is paid
separately rather than as part of a bundle.
Cost systems
The cost systems may be classified into different groups based on the common
characteristics and nature of costs they cover. The important ways of classification of costs are:

By nature or element: materials, labour, expenses


By functions: production, selling, distribution, administration, R&D, development,
By traceability: direct and indirect
By variability: fixed, variable, semi-variable
By controllability: controllable, uncontrollable
By normality: normal, abnormal

In each and every business, a division specific to cost centre exists that adds to the cost of an
organization, but only indirectly adds to its profit. Typical examples of such cost centre include
research and development, marketing and customer service.

Companies may choose to classify business units as cost centres, profit centres, or investment
centres.[3] There are some significant advantages to classifying simple, straightforward divisions as
cost centres, since cost is easy to measure. However, cost centres create incentives for managers to
under-fund their units in order to benefit themselves, and this underfunding may result in adverse
consequences for the company as a whole.

13.2
13.2.1
Forecasting techniques

In forecasting costs we should analyse the organisation's costs and make out, how they relate to
sales.
Fixed costs are largely independent of the level of sales. The costs may be not affected on the sales
turnover or number of sales in the organisation. Variable costs depend on turnover or number of
sales. For example, distribution costs might be a percentage of turnover, a cost per sale, or a
combination of the two. Semi-variable costs contain both fixed and variable components. For
example, your power costs might include both a fixed component, the electrical equipments like
tubes and bulbs, the heaters, fan or air conditioners and a variable component. Furthermore, the
historical data of the organisation needs to be analysed, the suppliers too can be contacted for
quotes. Here while forecasting the costs, the uncertain costs needs to be controlled. The costs which
can be incurred in the organisation due to disasters and calamities, be it natural or human made,
should be controlled. This can be done by means of insuring the organisation. If the suppliers are of
good nature in terms of business, enter into long-term supply contracts or use forward foreign
exchange contracts.
13.2.2
Funds
Funding in the organisation is to provide resources, usually in form of money or can be other
resources like effort, time, human, help from other private or public institution. The funds can be
raised based on short term or long term purposes.

The main sources of funding in an organisation are


 The profits made by the organisation can be utilised for further growth.
 The organisation can take credit from other private or public institutions, like bank, etc.
 The organisation can benefit funds in form of donations, which has a very less certainty.
 The organisation can get grants from the government, if the organisation provides some
means of government support.
 The organisation if had a good reputation in the market with it's products and demands, can
go into listing and thus generate funds from the shareholders who invest resources.
13.3
13.3.1
Budgetary process
A budget process refers to the process by which the organisation creates and approves a
budget. The various departments in the organisation work on the process of budgeting, with
different departments dealing with different aspects of the business.
The Financial Service Department prepares worksheets to assist the department head in preparation
of department budget estimates.
The Administrator calls a meeting of managers and they present and discuss plans for the following
year’s projected level of activity.
The managers can work with the Financial Services, or work alone to prepare an estimate for the
departments coming year.
The completed budgets are presented by the managers to their
Executive
Officers for review and approval. Justification of the budget request may be required in writing. In
most cases, the manager talks with their administrative officers about budget requirements.
Adjustments to the budget submission may be required as a result of this phase in the process.

13.3.2
Typically, in every organisation, the budget cycles occurs in four phases.[4]

The first requires policy planning and resource analysis and includes revenue estimation.
The second phase is referred to as policy formulation and includes the negotiation and planning of
the budget formation.
The third phase is policy execution which follows budget adoption is budget execution—the
implementation and revision of budgeted policy.
The fourth phase encompasses the entire budget process, but is considered its fourth phase. This
phase is auditing and evaluating the entire process and system.

The budgetary process involves the use of historical data of the organisation. The objectives and
targets of the organisation in the business proposal is taken into account while creating the budget.
The existing economy in the nation also plays an important role in reviewing the budget. The
previous years finance allocated, used and the profits generated in the process also plays a role in
further allocation of revenue for the upcoming project.

13.3.3
The general types of budgets include master, operating (for income statement items comprised of
revenue and expenses), financial (for balance sheet items), cash, static (fixed), flexible, capital
expenditure (facilities), and program (appropriations for specific activities such as research and
development, and advertising). These budgets are briefly explained below.

Master Budget
A master budget is an overall financial and operating plan for a forthcoming calendar or fiscal year.
It is usually prepared annually or quarterly. The master budget is really a number of subbudgets tied
together to summarize the planned activities of the business. The format of the master budget
depends on the size and nature of the business.

Operating and Financial Budgets


The operating budget deals with the costs for merchandise or services produced. The financial
budget examines the expected assets, liabilities, and stockholders' equity of the business. It is
needed to see the company's financial health.
Cash Budget
The cash budget is for cash planning and control. It presents expected cash inflow and outflow for a
designated time period. The cash budget helps management keep cash balances in reasonable
relationship to its needs and aids in avoiding idle cash and possible cash shortages. The cash budget
typically consists of four major sections:
1. Receipts section, which is the beginning cash balance, cash collections from customers, and other
receipts
2. Disbursement section, comprised of all cash payments made by purpose
3. Cash surplus or deficit section, showing the difference between cash receipts and cash payments
4. Financing section, providing a detailed account of the borrowings and repayments expected
during the period

Static (Fixed) Budget


The static (fixed) budget is budgeted figures at the expected capacity level. Allowances are set forth
for specific purposes with monetary limitations. It is used when a company is relatively stable.
Stability usually refers to sales. The problem with a static budget is that it lacks the flexibility to
adjust to unpredictable changes.
13.3.4
In industry, fixed budgets are appropriate for those departments whose workload does not have a
direct current relationship to sales, production, or some other volume determinant related to the
department's operations. The work of the departments is determined by management decision rather
than by sales volume. Most administrative, general marketing, and even manufacturing
management departments are in this category. Fixed appropriations for specific
projects or programs not necessarily completed in the fiscal period also become fixed budgets to the
extent that they will be expended during the year.
Examples are appropriations for capital expenditures, major repair projects, and specific advertising
or promotional programs.[5]

13.4
The Activity-based costing(ABC)

The Activity-based costing (ABC) is a type costing model that identifies activities in an
organization which assigns the cost of each activity resource to all products and services according
to the actual consumption by each. The main concept of this model is to assign more of the indirect
costs into direct costs. Indirect costs are costs that are not directly accountable to a cost object, such
as a particular function or product. Indirect costs may be either fixed or variable. Indirect costs
include taxes, administration, personnel and security costs, and are also known as overhead, which
is nothing but the cost incurred for operating any kind of business.

So in this costing model an organisation can precisely estimate the cost of individual
products and services so they can identify and eliminate those that are unprofitable and lower the
prices of those that are overpriced. In a business organization, the ABC methodology assigns an
organization's resource costs through activities to the products and services provided to its
customers. It is generally used as a tool for understanding product and customer cost and
profitability. As such, ABC has predominantly been used to support strategic decisions such as
pricing, outsourcing, identification and measurement of process improvement initiatives.

The different uses of the ABC model is as follows

 It helps to identify inefficient products, departments and activities


 It helps to allocate more resources on profitable products, departments and activities
 It helps to control the costs at an individual level and on a departmental level
 It helps to find unnecessary costs
 It helps fixing the price of a product or service scientifically

Yes, the ABC model does has it's limitations. Even in activity-based costing, some overhead costs
are difficult to assign to products and customers, such as the chief executive's salary. These costs are
termed 'business sustaining' and are not assigned to products and customers because there is no
meaningful method. This lump of unallocated overhead costs must nevertheless be met by
contributions from each of the products, but it is not as large as the overhead costs before ABC is
employed.

Although some may argue that costs untraceable to activities should be "arbitrarily allocated" to
products, it is important to realize that the only purpose of ABC is to provide information to
management. Therefore, there is no reason to assign any cost in an arbitrary manner.
Production Overhead Cost Budget

$
Machining costs 380,000
Set-up costs 258,500
Purchasing costs 340,000
Total production overheads 978,500

Details relating to the manufacture of two products lines: L and M.

Data Total Product J Product S


Machine hours 95,000 2 per unit 1 per unit
No. of prod runs 235 20 5
Purchase orders 5,000 100 100
Production Qty's 5,000units 20,000 units

Budgeting and Preparation


Budget is the approach of planning the cost required to run the business, budget is planning
all the resources required to run the business (financial, labour, material, physical resources,
and other resources) (Underdown, 2001).
Preparation of Budget:

May- Aug- Nov-


Jan-11 Feb-11 Mar-11 Apr-11 11 Jun-11 Jul-11 11 Sep-11 Oct-11 11 Dec-11
Number of
castings 200 240 230 300 280 220 240 400 350 300 250 230
10080 12600 11760 10080 16800 14700 12600 10500
Sales 84000 0 96600 0 0 92400 0 0 0 0 0 96600
Labour 30000 36000 34500 45000 42000 33000 36000 60000 52500 45000 37500 34500
Material 20000 24000 23000 30000 28000 22000 24000 40000 35000 30000 25000 23000
Rent 2000 2400 2300 3000 2800 2200 2400 4000 3500 3000 2500 2300
Heat and
Light 2000 2400 2300 3000 2800 2200 2400 4000 3500 3000 2500 2300
Depreciati
on 2000 2400 2300 3000 2800 2200 2400 4000 3500 3000 2500 2300
Purchasin 3000 3600 3450 4500 4200 3300 3600 6000 5250 4500 3750 3450
g
Electricty 4000 4800 4600 6000 5600 4400 4800 8000 7000 6000 5000 4600
Delivery
and
Packing 2000 2400 2300 3000 2800 2200 2400 4000 3500 3000 2500 2300
Managem
ent and
Marketing 4000 4800 4600 6000 5600 4400 4800 8000 7000 6000 5000 4600
Before
tax profit 15000 18000 17250 22500 21000 16500 18000 30000 26250 22500 18750 17250
Tax 750 900 862.5 1125 1050 825 900 1500 1312.5 1125 937.5 862.5
16387 24937 17812 16387
After Tax 14250 17100 .5 21375 19950 15675 17100 28500 .5 21375 .5 .5
Capital of 1000000 has been invested in buying moulding
machines
Remainin 40000 40142 40313 40477 40691 40890 41047 41218 41503 41752 41966 44310
g capital 00 50 50 38 13 63 38 38 38 75 50 63
40142 40313 40477 40691 40890 41047 41218 41503 41752 41966 42144 42308
cash flow 50 50 38 13 63 38 38 38 75 50 63 50
Budget for Advanced Casting Company-2011.

13.5
13.5.1
Investment
Investment is putting money into something with the expectation of profit. More
specifically, investment is the commitment of money or capital to the purchase of financial
instruments or other assets so as to gain profitable returns in the form of interest, dividends, or
appreciation of the value of the instrument (capital gains).[6]
13.5.2
It is related to saving or deferring consumption. Investment is involved in many areas of the
economy, such as business management and finance whether for households, firms, or governments.
An investment involves the choice by an individual or an organization, such as a pension fund, after
some analysis or thought, to place or lend money in a vehicle, instrument or asset, such as property,
commodity, stock, bond, financial derivatives (e.g. futures or options), or the foreign asset
denominated in foreign currency, that has certain level of risk and provides the possibility of
generating returns over a period of time.[7]

Capital and Revenue expenditure.

Expenditure refers to spending on goods or services. Business expenditure may be classified


as capital or revenue in nature. Capital expenditure refers to spending on long-term assets. Long-
term assets are mainly fixed assets which are used in business operations over several periods.
Expenditure on plant, equipments and buildings are examples of capital expenditure. Capital
expenditure is recorded in long-term asset accounts instead of in expense accounts.
Revenue expenditure differs from capital expenditure. Revenue expenditure refers to
expenditure on goods and services which are expected to be used up within an accounting period.
Such expenditure is treated as expenses and is charged to the profit and loss account. Examples of
revenue expenditure being rent, wages, utilities, and cost of goods sold.
When an item of expenditure is capitalised, it is treated as a fixed asset and is shown in the
balance sheet. However, if the same item is 'expensed', it affects the profit or loss for the period.

13.5.3
Investment appraisal
Investment appraisal, also known as capital budgeting is the planning process used to
determine whether an organisation's long term investments such as new machinery, replacement
machinery, new plants, new products, and research development projects are worth pursuing. It is
budget for major capital, or investment, expenditures.[8]

The internal rate of return (IRR) is defined as the discount rate that gives a net present value
(NPV) of zero. It is a commonly used measure of investment efficiency.
The IRR method will result in the same decision as the NPV method for (non-mutually exclusive)
projects in an unconstrained environment, in the usual cases where a negative cash flow occurs at
the start of the project, followed by all positive cash flows. In most realistic cases, all independent
projects that have an IRR higher than the hurdle rate should be accepted. Nevertheless, for mutually
exclusive projects, the decision rule of taking the project with the highest IRR - which is often used
- may select a project with a lower NPV.
13.6
Interpretation and limitations of ratio analysis
13.6.1
A financial ratio (or accounting ratio) is a relative magnitude of two selected numerical values taken
from an enterprise's financial statements. Often used in accounting, there are many standard ratios
used to try to evaluate the overall financial condition of a corporation or other organization.
Financial ratios may be used by managers within a firm, by current and potential shareholders
(owners) of a firm, and by a firm's creditors. Security analysts use financial ratios to compare the
strengths and weaknesses in various companies.[9]
13.6.3
Financial statement analysis evaluates the financial strengths and weaknesses of a business. When
the company prepares ratios for a banker, liquidity is of prime concern, since the business must be
liquid if the debt is to be repaid. If a long-term obligation is involved, earning power and operating
efficiency of the borrower are emphasised. After the ratio is computed, it is compared with related
ratios of the company, the same ratios from prior years, and the ratios of the competitive firms. The
comparisons reveal trends over a period of time and hence the ability of the company to compete
with others in the industry. Ratio comparisons do not mark the end of the analysis of the business,
but rather point to areas requiring further investigation.

The various limitations inherent in ratio analysis may include[10]


 It is often difficult to identify the industry group to which the company belongs. This makes
the industry comparisons a problem.
 Diversity among the companies in applying GAAP may result in disorted ratios and
comparisons. An example is a company using LIFO while another uses FIFO to value
inventory.
 Published industry norms are only approximations.
 The historical cost of an asset may differ form its current value. An example being land.
 The ratio does not reveal its components. For instance, the current ratio may be high but
inventory may be composed of obsolete merchandise and receivables may include accounts
owed from a politically unstable foreign country.
 A company may “window dress”, making its financial picture look better than really it is.
 Liabilities may be understand from an analytical sense.
 Liabilities may be overstated from an analytical sense.

Bibliography and references

[1] NetMBA. (2010). Pricing. Available: http://www.netmba.com/marketing/pricing/. Last accessed


02/05/2011.
[2] Nagle, Thomas T and Holden, Reed (2002). The Strategy and Tactics of Pricing. Prentice Hall.
USA: Prentice Hall. P84-104.
[3] Oxford University Press. Cost Center. Available: http://www.highbeam.com/doc/1O18-
costcentre.html. Last accessed on 02/05/2011.
[4]Smith, Robert W. and Thomas D. Lynch. (2004) Public Budgeting in America. 5th Edition.
Pearson; Upper Saddle River, New Jersey. P37
[5]Jae K. Shim, Joel G. Siegel. (2008) Budgeting Basics and Beyond. 3rd Edition. John Wiley and
Sons; p4-10.
[6]Sullivan, arthur; Steven M. Sheffrin (2003). Economics: Principles in action. Upper Saddle
River, New Jersey 07458: Pearson Prentice Hall. p-271
[7]Graham, Benjamin, and David Dodd (1951). Security Analysis. McGraw-Hill Book Company.
[8]Sullivan, arthur; Steven M. Sheffrin (2003). Economics: Principles in action. Upper Saddle
River, New Jersey 07458: Pearson Prentice Hall. P375
[9]Groppelli, Angelico A.; Ehsan Nikbakht (2000). Finance, 4th ed. Barron's Educational Series,
Inc.. p-433.
[10]Joel G. Siegel, Jae K. Shim 2006. Accounting handbook fourth edition. p260-261