C343 1

Managing Financial Principles And Techniques

SUBMITTED TO: SIR EDWARD ANYAEJI
STUDENT ID: C343

EXTENDED DIPLOMA IN STRATEGIC MANAGEMENT AND LEADERSHIP (QCF)

C343 2 1.1 Explains the important of cost in the pricing strategy of the organization of your choice.

Organization is worked with competitive and continually environment so that time every decision is very crucial even if that organization is to survive or even be profitable so collection of past cost and projection of future costs is an important area in management accounting. Management account classify cost into different categories according to the nature of the cost as following 1) Production cost 2) Administration cost 3) Selling and Distribution. Production cost divided in three elements like material cost which include cost of the raw material than labour cost including wages, salaries and bonuses and last one direct expenses which include like some equipment which is hire. Total three elements are called the prime cost of production. There is another cost which is indirect cost which does not fall into the category of direct cost. As well as the nature of cost it is necessary to consider cost behavior there are three classes of behavioral classification: fixed cost which include incurred by the organization, variable cost that means which is opposite from fixed cost that always change by activity, and semi-variable costs which change when level of output change but not directly. Another is Revenue which is similar way as a variable cost. And the other cost classification which are committed, controllable, discretionary, irrelevant, incremental etc...And last thing which is influences on pricing strategy that means that take into view factors such as a firms overall marketing objective, consumer demand, product attributes, competitors pricing. And here main pricing policies are Premium pricing which include us high rate where there is a uniqueness about the product and service, Penetration pricing that means you change price temporary for gain market share and Economy pricing that means this is a low price for the lower end of the market.

C343 3 1.2 Design a job costing system for use within the organization that you have chosen. Your job costing system must also show your required mark up and margin.

Opportunity cost represents income which is forgone by deciding to specific alternatives. In the process of Decision making to consider any income that will be lost by rejecting a specific alternative. Job costing is about to where work takes from of individual jobs undertaken to a customers requirement. Here we divide cost into direct cost, manufacturing overheads and administration, selling and distribution overheads. Now from the following example provides us with the information we need to construct a job costing statement in which we calculate prime cost, factory cost and total cost. Lets see practical exam from Ratnamani Metals & Tubes LTD. And evaluate the job costing system for it. For that we also have relevant data about that.

RELEVANT DATA : ESTIMATED 1800 DIRECT LABOUR DIRECT MATERIAL time Rate ph PREPARATION 18 hours 5.40 27 kg at 3.90 per kg 2700 1800 FINISHING 9 hours 4.50 PACKAGING 3 hours 3.60

ANNUAL TOTAL 5400 OVERHEAD LABOUR BUDGET HOURS OVER 9000 HEAD

7200

4500

Now the cost operating system first step to find out direct material. A) Direct materials: Cost for material: 27 kgs * 3.90 = 105.3

C343 4

B) Direct wages: Preparation: 18 hours *5.40 = 97.2 Finishing : 9 hours*4.50 = 40.5 Packing : 3 hours*3.60 = 10.8

C) Overhead:

Preparation: Overhead / total hours *hours = 9000/5400 = 1.67 , 1.67 * 18 = 30.06 per unit

Finishing: 7200 / 2700 = 2.67, 2.67 * 9 = 24.03 per unit Packing: 4500 / 1800 = 2.5 , 2.5 * 3 = 7.5 per unit

D) Operating statement:

Direct Material Direct labour Preparation Finishing Packing Prime cost Preparation Finishing Packing Total factory cost Administration o/h (10% of 315.39) Selling and distribution o/h(25% of 253.8) Total cost Selling Price Profit

Working note A B

105.3

97.2 40.5 10.8 C 30.06 24.03 7.5

148.5 253.8

61.59 315.39 31.54 63.45 94.99 410.38 615.57 205.19

C343 5
E) Mark Up and Margin: As we decide to make 50% of profit so as mark - up Cost price: 410.38 Mark-up (50% *410.38) : 205.19 Selling price : 615.57

The selling price is 615.57 and if the margin is 33.33% then cost price will be 410.41 Cost price : 410.41 Margin (33.33% of 615.57) : 205.16 Selling price : 615.57 F) Batch costing : Cost per unit: The total batch cost / total no. of units produced in batch

G) Process Costing: Cost per unit: total cost of period / total production of period (liters or kilos)

C343 6 1.3 Proposing improvements to the costing and pricing system used in the organization of your choice. Justify your recommendation by stating the benefits that your proposed improvements would bring to the organization.

Its very important to improve cost and pricing in any organization. For that there are some criteria to see which effect to bring change in our organization. There are number of factor which effect to our organization. First factor is responsibility and control of system in this factor you have to understand how much cost to runs various factor. Another factor is cost center is about location which you select and cost units are sub-division of the cost centre. Third one is profit centers here you have to separate your profit part to another part which dont make profit. Next one is accountable management is a theory of management which is centre of company which have all responsibility and all decision power. And last factor which bring change is planning and control in this method you have to do financial control that helps to find out your income and expense like balance sheet and income statement. And financial audit that ratio of your company like liquidity ratio, profitability ratio, debts ratio, activity ration. And budget control that is one type of expects to spend and earn over a time period.

C343 7

2.2 Assess the sources of funds available to your company for a specific project. Your response should demonstrate that you have researched a range of possibilities for funding.

Source of finance has three ways to come finance. 1. Venture Capital 2. Business Growth 3. Business Angels 1. Venture capital: It means when you money provide by investors to establish up firms and small business with perceived long term growth potential. Its very key source of funding for bring into being that does not have access to capital markets. Its naturally high risk for the investor, but it has the potential for above-average returns.

C343 8

2. Business Growth: Business growth is about any firm whose business generates significant positive cash flows or earnings, which increase at significantly faster rates than the overall economy. There is two type of factor one is Internal and another is External. In internal factor there is generating increasing sales, use of retained profit, sales of assets. And another hand in external factors has Long Term which is ordinary shares, preference shares, new share issue, right issue, loan, debenture etc in short time bank loans, overdraft, trade credit, factoring etc 3. Business Angels: Business owners often report that company finance can be very difficult to obtain even from traditional source such as bank and venture capitalists. Here they do merger and tack over.

Ratnamani Metals & Tubes LTD. Want to increase his business in metals and tubes so first of all in 1985 company start production of Stainless Steel Welded Pipes & Seamless Tubes, as twin small-scale units. In 1991 they Established facilities for manufacturing Stainless Steel Electric Fusion Welded Pipes. After that they want to increase him strength of production so they listed in BSE and ASE. Its big milestone for company after that they increase him strength. That time they want to start him production so they issued 4, 63, 74,959 share in market. Its listed on 10 Rs. Per share. (http://www.ratnamani.com )

C343 9

3.1 Select appropriate budgetary targets for an organization.

Cash budget means an estimation of the cash inflow and outflow for a business or individual for specific period of time. Its used to assess the entity has sufficient cash to fulfill regular operation otherwise too much cash in being left in unproductive capacities. A cash budget is extremely important, especially for small businesses, because it allows a company to determine how much credit it can extend to customers before it begins to have liquidity problems. (http://www.investopedia.com ) A) Purpose of budgets: Department managers in a business make decisions every day that affect the profitability of the business. In order to make effective decisions and coordinate the decisions and actions of the various departments, a business needs to have a plan for its operations. Planning the financial operations of a business is called budugeting. IN BUDGETARY PLANNING, IT NEEDS THE FOLLOWING Communication: In the budgeting process, managers in every department justify the resources they need to achieve their goals. They explain to their superiors the scope and volume of their activities as well as how their tasks will be performed. The communication between superiors and subordinates helps affirm their mutual commitment to company goals Planning: A budget is ultimately the plan for the operations of an organization for a period of time. Many decisions are involved, and many questions must be answered. Old plans and processes are question as well as new plans and processes. Managers decide the most effective ways to perform each task. They ask whether a particular activity should still be performed and, if so, how. Control: Actual results are compared against the budget and action is taken to control expenses and to allocate resources effectively.

C343 10
Evaluation: One way to evaluate a manager is to compare the budget with actual performance. Did the manager reach the target revenue within the constraints of the targeted expenditures? Such as market and general economic conditions, affect a managers performance. Whether a manager achieves targeted goals is an important part of managerial responsibility.

Motivation: The budget can be used as a target for managers to aim for. Rewards can be given for operating within the budgeted expenditure or exceed the budgeted revenues. B) Budgeting targets: Budgeting targets will assist motivation if they are at the right level. One is expectation budget that means this budget is set at current achievable levels. It does improve managers to improve but can give more accurate forecast. And another hand there is aspirations budget that means this is a budget set at a level which exceeds the level currently achieved. This may motive managers to improve financial performance. C) Cash budgeting A cash budget shows Cash revenue Cash expenses Opening balances Closing cash balances

Cash budgets are usually prepared on a monthly basis. They are also used to forecast the amount of cash available or the overdraft required.

C343 11
3.2 Participate in the creation of a master budget for an organization. Importance of budgeting to management: In this time of economic hardship, small businesses and micro-businesses are among those being hardest hit particularly with their inability to access lines of credit to help maintain effective cash-flow. Therefore, it is imperative that these business owners take the steps necessary to budget and effectively manage the funds they do have available. Ratnamani Metals & Tubes LTD. plan to start trading on 1st March and a bank account will be opened with an initial opening balance of 1,00,000. March Sales Purchases 9,000 4,500 April 24,000 12,000 May 40,000 20,000

Ratnamani Metals & Tubes LTD. business:

Makes estimates for the first 3 months of

In March, the company will rent a small office. The rent is 2,200 per month and is paid in cash each month. Equipment costing 60,000 is required and will be paid for in three equal monthly instalments in March, April and May. Company car costs 9,000, paid in three instalments from April. Wages of 1,500 a month will be paid. The three

Prepare a cash budget for Ratnamani Metals & Tubes LTD. months to 31st May and comment on it.

C343 12
Cash Budget: Jones & Son March Cash Receipts: Cash Sales Total Receipts Cash Payments: Rent Equipment Car Stock Purchases Wages Total Payments Net Cash Flow Opening Balance Closing Balance 2,200 20,000 3,000 4,500 1,500 31,200 -22,200 1,00,000 77,800 2,200 20,000 3,000 12,000 1,500 38,700 -14,700 77,800 63,100 2,200 20,000 3,000 20,000 1,500 46,700 -6,700 63,100 56,400 6,600 60,000 9,000 36,500 4,500 1,16,600 43,600 9,000 9,000 April 24,000 24,000 May 40,000 40,000 Total 73,000 73,000

Comments on resource utilisation within Jones & Sons budget: Receipts are less than payments in March, April and May. Possibly look for cheaper suppliers of stock. Spread the repayment of the equipment over 6 or 12 months instead of the 3 months within the cash budget. Obtain a loan for first few months to assist with negative cash flow. Buy second hand equipment, which could end up cheaper.

C343 13
3.3 Compare actual expenditure and income to the master budget of an organisation. Zero-based budgeting: A method of budgeting in which all expenses must be justified for each new period. Zero-based budgeting starts from a zero base and every function within an organization are analyzed for its needs and costs. Budgets are then built around what is needed for the upcoming period, regardless of whether the budget is higher or lower than the previous one. Advantages of zero-based budgeting: Forces budget setters to examine every item. Allocation of resources linked to results and needs. Develops a questioning attitude. Wastage and budget slack should be eliminated. Prevents creeping budgets based on previous years figures with an added on percentage. Encourages managers to look for alternatives.

Disadvantages of zero-based budgeting: It a complex time consuming process Short term benefits may be emphasized to the detriment of long term planning Affected by internal politics - can result in annual conflicts over budget allocation

Implementation of zero-based budgeting: Identify two alternate funding levels for each activity (decision package). The funding levels that we will choose would be a zero based level and the current funding level. Determine the impact of these funding levels on the decision packages Rank the decision packages

C343 14

Ratnamani Metals & Tubes LTD. Zero based budget Purchases We have chosen a supplier of better quality products than the previous one in LO 3.2. This will cost 20% more but we can sell the product for 2.5x the sale price, instead of 2x the sale price within the previous budget. Equipment - We decide the alternative option to repay over 12 months instead of the 3 months as previously budgeted Car We decided to buy an alternative 6,000 car and pay within the first month of trading. Wages We decide to stick with our staff instead of reducing our staff, because of their skills. Rent We decide to stay in our current premises instead of renting a cheaper premises of 800 per month. The cheaper premises is not in a good location, which may reduce our sales April May Total

CashBudget: Ratnamani March Metals & Tubes LTD. (LO 3.2) Cash Receipts: Cash Sales 9,000 Total Receipts Cash Payments: Rent Equipment Car Stock Purchases Wages Total Payments Net Cash Flow Opening Balance Closing Balance 2,200 20,000 3,000 4,500 1,500 31,200 -22,200 1,00,000 77,800 9,000

24,000 24,000

40,000 40,000

73,000 73,000

2,200 20,000 3,000 12,000 1,500 38,700 -14,700 77,800 63,100

2,200 20,000 3,000 20,000 1,500 46,700 -6,700 63,100 56,400

6,600 60,000 9,000 36,500 4,500 1,16,600 43,600

C343 15

Zero Based CashBudget: March Ratnamani Metals & Tubes LTD. Cash Receipts: Cash Sales 12,500 Total Receipts Cash Payments: Rent Equipment Car Stock Purchases Wages Total Payments Net Cash Flow Opening Balance Closing Balance 2,200 5,000 9,000 5,000 1,500 22,700 -10,200 1,00,000 89,800 12,500

April

May

Total

37,500 37,500

62,500 62,500

1,12,500 1,12,500

2,200 5,000 15,000 1,500 23,700 13,800 89,800 76,000

2,200 5,000 25,000 1,500 33,700 28,800 76,000 47,200

6,600 15,000 9,000 35,000 4,500 1,16,600 32,400

C343 16

Zero Based CashBudget: March Ratnamani Metals & Tubes LTD. Cash Receipts: Cash Sales 12,500 Total Receipts Cash Payments: Rent Equipment Car Stock Purchases Wages Total Payments Net Cash Flow Opening Balance Closing Balance 2,200 5,000 9,000 5,000 1,500 22,700 -10,200 1,00,000 89,800 12,500

April

May

Total

37,500 37,500

62,500 62,500

Times 2.5 of purchases

2,200 5,000 15,000 1,500 23,700 13,800 89,800 76,000

2,200 5,000 25,000 1,500 33,700 28,800 76,000 47,200

Same by 4 Cheaper Times 20% Same

C343 17

3.4 evaluate budgetary monitoring processes in an organization Basic variance analysis: Variance analysis is the process by which the total difference between standard and actual results is analyzed. A number of basic variances can be calculated. If the results are better than expected, the variance is favorable (F) If the results are worse than expected, the variance is adverse (A) It is important to explain the meaning of the variance and identify possible causes for the variance. Basic variances can be calculated for sales, material and salaries.

2a. Sales variances:

Variance Sales price

Favourable (F) Unexpected price increase due to: Higher than anticipated customer demand An improvement in the quality of the product

Adverse (A) Unexpected price decrease due to: Lower than anticipated customer demand A reduction in the quality of the product

C343 18

2b. Variance of Ratnamani Metals & Tubes LTD.

CashBudget: Ratnamani March Metals & Tubes LTD. (LO 3.2) Cash Receipts: Cash Sales 9,000

April

May

Total

24,000

40,000

73,000

Zero Based CashBudget: March Ratnamani Metals & Tubes LTD. Cash Receipts: Cash Sales 12,500

April

May

Total

37,500

62,500

1,12,500

Budgeted sales = 73000 Actual sales = Variance 112500 39500 (F)

C343 19
3a Materials variances Causes of materials price variances
Variance Material price Favourable (F) Unexpected price increase due to: Poor quality materials Change to a cheaper supplier Discounts given for buying in bulk Adverse (A) Unexpected price decrease due to: Higher quality materials Change to an expensive supplier Unexpected price increase

3b. Variance of Jones & Sons materials purchases (a) Previous Cash Budget: Ratnamani Metals & Tubes LTD. (LO 3.2) Cash Receipts: Stock Purchases March April May Total

4,500

12,000

20,000

36,500

(b) Actual Zero-based Cash Budget: Ratnamani Metals & Tubes LTD. (LO 3.3) Cash Receipts: Stock Purchases

March

April

May

Total

5,000

15,000

25,000

35,000

C343
Budgeted purchases = 36500 Actual purchases = 35000

20

Variance

1500 (A)

4a. Salary variances Causes of salary rate variances:

Variance Salary rate Favourable (F) Lower skilled staff: Cut in overtime / bonuses Adverse (A) Higher skilled staff

Increase in overtime / bonus Unforeseen wage increase

4b. Variance of salaries rates (a) Previous Cash Budget: Ratnamani Metals & Tubes LTD. (LO 3.2) Cash Receipts: Wages March April May Total

1,500

1,500

1,500

4,500

C343 21
(b) Previous Cash Budget: March Ratnamani Metals & Tubes LTD. (LO 3.3) Cash Receipts: Wages April May Total

1,500

1,500

1,500

4,500

Budgeted salaries = 4500 Actual salaries = 4500

Variance

5. Prompt and corrective action Adverse sales variances To counter this, you can increase sales prices, advertising, sales incentives etc. Adverse materials price variances To counter this, you can choose a cheaper supplier, purchase in bulk, choose alternative products etc. Adverse salary rate variances you could reduce staff, reduce salaries / bonuses / commission, recruit cheaper staff etc.

C343 22
4.1 recommend processes that could manage cost reduction in an organization. Standard costing: An estimated or predetermined cost of performing an operation or producing a good or service, under normal conditions. Standard costs are used as target costs (or basis for comparison with the actual costs), and are developed from historical data analysis or from time and motion studies. They almost always vary from actual costs, because every situation has its share of unpredictable factors. Budgetary control: Methodical control of an organization's operations through establishment of standards and targets regarding income and expenditure, and a continuous monitoring and adjustment of performance against them. Difference between standard costing and budgetary control 1. Budgetary control deals with the operation of a department or the business as a whole in terms of revenue and expenditure. Standard costing is a system of costing which makes a comparison between standard costs of each product or service with its actual cost. 2. Budgetary control covers as a whole in terms of revenue and expenditures such as purchases, sales, production, finance etc. Standard costing is related to a product and its cost only.

Value analysis here two different things about value analysis which are different in different place. 1. Manufacturing: Systematic analysis that identifies and selects the best value alternatives for designs, materials, processes, and systems. It proceeds by repeatedly asking "can the cost of this item or step be reduced or eliminated, without diminishing the effectiveness, required quality, or customer satisfaction?" Also called value engineering, its objectives are (1) to distinguish between the incurred costs (actual use of resources) and the costs inherent (locked in) in a particular design (and which determine the incurring costs), and (2) to minimize the locked-in costs.

C343 23
2. Purchasing: Examination of each procurement item to ascertain its total cost of acquisition, maintenance, and usage over its useful life and, wherever feasible, to replace it with a more cost effective substitute. Also called value-in-use analysis.

Value engineering Value Engineering can be defined as an organized approach to providing the required functions at the lowest cost. From the beginning the idea of value engineering was seen to be cost validation exercise, which did not affect the quality of the product. The straight error of an improvement or finish would not be considered value engineering. As another definition: Value Engineering can be defined as an organized approach to the identification and removal of unnecessary cost. Unnecessary cost is Cost which provides neither use, nor life, nor quality, nor appearance, nor customer features. Difficulties with introducing cost reduction programmers Lowered worker assurance-Employees are alternate feeling that their enterprises are unappreciated Lack of arranging-can in fact the price lessening practice more unreasonable. Harm to value-Serious decreases in prices can genuinely mischief an outfit's capability to keep handling value items or utilities. Quality costs A product that meets or exceeds its design specifications and is free of defects that spoil its appearance or degrade its performance is said to have high quality of conformance. If an economy car is free of defects, it can have a quality of conformance that is just as high as defect-free luxury car. The purchasers of economy cars cannot expect their cars to be as richly as luxury cars, but they can and do expect to be free of defects. Quality costs can be broken down into four broad groups. These four groups are also termed as four (4) types of quality costs. Two of these groups are known as prevention costs and appraisal costs. These are incurred in an effort to keep defective products from falling into the hands of customers. The other two groups of costs are known as internal failure costs and external failure costs. Internal and external failure costs are incurred because defects are produced despite efforts to prevent them therefore these costs are also known as costs of poor quality.

C343 24
Quality costs (a) Prevention & appraisal costs Generally the most effective way to manage quality costs is to keep away from having defects in the first place. It is much less costly to prevent a problem from ever happening than it is to find and correct the problem after it has occurred. Prevention costs support activities whose purpose is to reduce the number of defects. Companies employ many techniques to prevent defects for example statistical process control, quality engineering, training, and a variety of tools from total quality management (TQM). Some companies provide technical support to their suppliers as a way of preventing defects. Particularly in Just in time systems, such support to suppliers is vital. In a Just in time system, parts are delivered from suppliers just in time and in just the correct quantity to fill customer orders. There are no stockpiles of parts. If a defective part is received from a supplier, the part cannot be used and the order for the ultimate customer cannot be filled in time. Hence every part received from suppliers must be free from defects. As a result, companies that use Just in time often require that their supplier use stylish quality control programs such as statistical process control and that their suppliers certify that they will deliver parts and materials that are free of defects. (b) Appraisal costs Any defective parts and products should be caught as early as possible in the production process. Appraisal costs, which are sometimes called inspection costs, are incurred to identify defective products before the products are shipped to customers. Unfortunately performing review activates doesn't keep defects from happening again and most managers realize now that maintaining an army of inspectors is a costly and ineffective approach to quality control. Employees are increasingly being asked to be responsible for their own quality control. This approach along with designing products to be easy to manufacture properly, allows quality to be built into products rather than relying on inspections to get the defects out.

C343 25
(c) Internal & external failure costs Failure costs are incurred when a product fails to conform to its design specifications. Failure costs can be either internal or external. Internal failure costs result from identification of defects before they are shipped to customers. These costs include scrap, rejected products, alteration of defective units, and downtime caused by quality problem. The more effective a company's appraisal activities the greater the chance of catching defects internally and the greater the level of internal failure costs. This is the price that is paid to avoid incurring external failure costs, which can be devastating. (d) External failure costs When a defective product is delivered to customer, external failure cost is the result. External failure costs include warranty, repairs and replacements, product recalls, liability arising from legal actions against a company, and lost sales arising from a reputation for poor quality. Such costs can decimate profits. External failure costs usually give rise to another intangible cost. These intangible costs are hidden costs that involve the company's image. They can be three or four times greater than tangible costs. Missing a deadline or other quality problems can be intangible costs of quality. Internal failure costs, external failure costs and intangible costs that impair the goodwill of the company occur due to a poor quality so these costs are also known as costs of poor quality by some persons.

C343 26
4.2 Evaluate the potential for the use of activity-based costing

To compete successfully, companies must change the way they report and manage costs. This means replacing old institutions of cost accounting and inventory valuation. Activity Based Costing (ABC) is a managerial accounting system which determines the cost of activities without distortion and provides management with relevant and timely information. It does not represent just a new set of overhead allocation rules or techniques to value inventory. ABC represents a way to look at operating costs and provides methods to dissect the underlying activities, which cause costs to exist. Activity Based Management (ABM) is a natural extension of ABC. It allows leaders to examine non-value-added activities and make rational decisions to eliminate them. ABM relies on the Activity Based Costing system to specify where non-value-added activities exist and to value the monetary benefits associated with their elimination. A method of budgeting in which activities that invite costs in every functional area of an organization are recorded and their relations are defined and analyze. Activities are then tied to strategic goals, after which the costs of the activities needed are used to create the budget. Activity based budgeting stands in contrast to traditional, cost-based budgeting practices in which a prior period's budget is simply adjusted to account for inflation or revenue growth. As such, ABB provides opportunities to align activities with objectives streamline costs and improve business practices.

Method of Activity-based costing:

Methodology of ABC focuses on cost allocation in operational management. ABC helps to separate

Fixed cost Variable cost Overhead cost

C343 27
The split of cost helps to identify cost drivers, if achieved. Direct labor and materials are quite easy to trace directly to products, but it is more difficult to directly allocate indirect costs to products. Where products use common resources in a different way, some sort of weighting is needed in the cost allocation process. The cost driver is a factor that creates or drives the cost of the activity. For example, the cost of the activity of bank tellers can be credited to each product by measuring how long each product's transactions (cost driver) takes at the counter and then by measuring the number of each type of transaction. For the activity of running machinery, the driver is likely to be machine operating hours. That is, machine operating hours drive labour, maintenance, and power cost during the running machinery activity.

Reasons for implementing activity-based costing.

Better Management Budgeting, performance measurement Calculating costs more exactly Ensuring product /customer success Evaluating and justifying investments in new technologies Improving product quality by better product and process design Increasing competitiveness or coping with more competition Management Managing costs Providing behavioral incentives by creating cost awareness among employees Responding to an increase in overheads Responding to increased pressure from regulators Supporting other management innovations such as TQM and JIT systems

C343 28
Benefits of Activity-based costing (ABC)

More accurate costing of products/services, customers, SKUs, distribution channels. Better understanding overhead. Easier to understand for everyone. Utilizes unit cost rather than just total cost. Integrates fit with Six Sigma and other continuous improvement programs. Makes visible waste and non-value added activities. Supports performance management and scorecards Enables costing of processes, supply chains, and value streams Activity Based Costing mirrors way work is done Facilitates benchmarking

Limitations of activity-based costing Implementing an ABC system is a major project that requires substantial resources. Once implemented an activity based costing system is costly to maintain. Data relating to numerous activity measures must be collected, checked, and entered into the system. ABC produces numbers such as product margins, which are odds with the numbers produced by traditional costing systems. But managers are used to to using traditional costing systems to run their operations and traditional costing systems are often used in performance evaluations. Activity based costing data can be easily misinterpreted and must be used with care when used in making decisions. Costs assigned to products, customers and other cost objects are only potentially relevant. Before making any significant decision using activity based costing data, managers must identify which costs are really relevant for the decisions at hand. Reports generated by this system do not conform to generally accepted accounting principles (GAAP). Consequently, an organization involved in activity based costing should have two cost systems one for internal use and one for preparing external reports

C343 29
Activity-based budgeting Activity based budgeting is a modern approach to financial planning connected directly to organizational strategy. It requires you to establish all activities that earn costs in each function of your business and then define the relationships between those activities. The information you get will guide your decision on how much resource you should allocate to each activity. ABB provides you with greater detail, particularly about overheads, because it permits the identification of value-adding activities and their cost drivers. This page will show to you the difference between ABB and other commonly used forms of financial forecasting, and also let you appreciate its strategic role as a cost and management tool, in as far as running your business more efficiently is concerned. Benefits of activity-based budgeting (ABB) Can identify opportunities for improvement and cost reduction Relates costs to performance data Enables assessment of processes that are effective in serving customers

Limitations of activity-based budgeting

Time consuming to set up have to understand the activities that drives the budget Costly buying, implementing and maintaining an activity based system Managers may be overwhelmed with information may be de-motivating, rather than looking at the bigger picture More effective methods such as, zero based budgeting and continuous budgeting

C343 30
5.1& 5.2 Apply financial appraisal methods to analyse competing investment projects in the public and private sector make a justified strategic investment decision for an organization using relevant financial information. A method of assessing the potential profitability of two or more competing strategies; based on the assessment of the period of time required before the financial returns from the strategy recoup the original investment. Decision rule Only select projects which pay back within your required time period Choose between your options on the basis of the fastest payback

Payback method Question 1 An investment of 3,100,000 is expected to generate the Following net cash flows for the next five years. Year 1 2 3 4 5 6 Cash Flow (4,10,000) 1,00,000 90,000 80,000 50,000 50,000

What is the payback period for the project?

C343 31
Payback method Answer 1 Year 1 2 3 4 5 Cash Flow (4,10,000) 2,00,000 1,90,000 1,00,000 1,00,000 Cumulative cash flow (4,10,000) (2,10,000) (20,000) 80,000 1,80,000

Payback is between the end of year 3 and the end of year 4. The payback will be 3 years, plus 20000/100000 of year 4, which is 3.2 years. 0.2 years = 2.5 months (0.8 x 12). Therefore, payback of the investment is 3 years 2.5 months 3. Return on capital employed (ROCE):
This is also known as accounting rate of return. The return on capital employed compares earnings with capital invested in the company. This is expressed as a percentage ROCE = Average annual profits before interest & tax / Initial capital costs *100

Decision rule If the expected ROCE for the investment is greater than the target rate (as decided by the management) then the project should be accepted.

C343 32
ROCE Question 2
A projects requires an initial investment of 90,000 and then earns the following net cash flows:

YEAR CASH FLOW

1 10,000

2 20,000

3 20,000

4 50,000

5 70,000

6 20,000

7 20,000

In addition, at the end of the seven-year project, the assets initially purchased will be sold for 20,000

ROCE Answer 2 (a) Average annual cash flows: 210,000 7 = 30,000 (b) Average annual depreciation: (90,000 - 20,000) 7 (70,000 is written off over 7 years) = 10,000 Average annual profit (a b): 30,000 - 10,000 = 20,000 ROCE = Average annual profits/Initial capital costs X 100%

ROCE = 20,000/90,000 X 100% = 22.22%

C343 33
3. Compounding A sum invested today will earn interest. Compounding calculates the future value of a given sum invested today for a number of years. To compound a sum, the figure is increased by the amount of interest it would earn over a period. The formula is as follows: FV = PV(1 + r) n FV = Future value after n periods PV = Present or initial value r = Rate of interest per period n = Number of periods

Compounding Question 3 An investment of 200 is to be made today. What is the value of the investment in four years if the interest rate is 6%? Compounding Answer 3

Value after one year: 200 x 1.06 = 212 Value after two years: 212 x 1.06 = 224.74 Value after three years: 224.74x 1.06 = 238.20 Value after four years: 238.20 x 1.06 = 252.49 FV = PV(1 + r) n 200(1 + 0.06) 4 = 252.49 The 200 is worth 252.49 in four years at an interest rate of 6%.

C343 34
Discounting PV = FV(1 + r) - n PV = Present or initial value FV = Future value after n periods r = Rate of interest per period -n = Number of periods to the present Discounting Question 4 What is the Present Value of 200 receivable in four years time if the discount rate (interest rate) is 6%? Discounting Answer 4 Value after one year: 200 x 1.06-1 = 188 Value after two years: 188 x 1.06-1 = 177 Value after three years: 177x 1.06-1 = 166 Value after four years: 166 x 1.06-1 = 156 FV = PV(1 + r) n 100(1 + 0.06) 4 = 156 The 100 is worth 156 in four years at an interest rate of 6%.

C343 35
Net Present Value Question 5 year 0 1 2 3 4 Cash flow (25000) 10000 8000 6000 9000

Net Present Value Using Excel

year 0 1 2 3 4 Cash Flow -25000 10000 8000 6000 9000 Discount factor @ 6% 1 0.943396226 0.88999644 0.839619283 0.792093663 PV

9433.962 7119.972 5237.716 7128.843 3720.492

Internal Rate of Return (IRR) Where: L = Lower rate of interest H = Higher rate of interest NL = NPV at the lower rate of interest NH = NPV at the higher rate of interest

C343 36

Internal Rate of Return Question 6 The potential cash flows for an investment give an NPV of 90,000 at a discount rate of 10% and - 20,000 at a discount rate of 15%. The companys required rated of return is 13%.
_______

IRR = L + (NL / NL NH X (H L)) Where: L = Lower rate of interest H = Higher rate of interest NL = NPV at the lower rate of interest NH = NPV at the higher rate of interest IRR= 10% +(90000/90000-(-20000)*(15%-10%))
IRR =50.90%

C343 37
5.3 report on the appropriateness of a strategic investment decision using information from a post-audit appraisal

Appropriateness of Payback: The payback is another method to evaluate an investment project. The payback method focuses on the payback period. The payback period is the length of time that it takes for a project to get back its initial cost out of the cash receipts that it generates. This period is sometimes referred to as" the time that it takes for an investment to pay for itself." The basic premise of the payback method is that the more quickly the cost of an investment can be recovered, the more desirable is the investment. The payback period is expressed in years. When the net annual cash inflow is the same every year, the following formula can be used to calculate the payback period. Rapid payback leads to rapid company growth minimises risk maximizes the cash available to the company Disadvantages of Payback The payback method ignores the time value of money. The cash inflows from a project may be unequal, with most of the return not happening until well into the future. A project could have an acceptable rate of return but still not meet the company's required minimum payback period. The payback model does not consider cash inflows from a project that may occur after the initial investment has been recovered. Most major capital expenditures have a long life span and continue to provide income long after the payback period. Since the payback method focuses on short-term profitability, an attractive project could be overlooked if the payback period is the only consideration.

C343 38

Appropriateness of Net Present Value NPV compares the value of a dollar today to the value of that same dollar in the future, taking inflation and returns into account. If the NPV of a prospective project is positive, it should be accepted. However, if NPV is negative, the project should probably be rejected because cash flows will also be negative. Disadvantages of Net Present Value NPV is difficult to use. NPV cannot give accurate decision if the amount of investment of mutually exclusive projects is not equal. It is difficult to calculate the appropriate discount rate. NPV may not give correct decision when the projects are of unequal life. Requires an estimate of the cost of capital in order to calculate the net present value. Expressed in terms of dollars, not as a percentage.

C343 39
6.1 Analyze financial statements to assess the financial viability of an organization. Profit and Loss Account: It shows the flow of sales and expenses over a period, usually one year. It shows the level of profit or loss made. It shows what has been done with the profit or loss.
31-Mar10(12) Profit / Loss A/C Net Sales (OI) Material Cost Increase Decrease Inventories Personnel Expenses Manufacturing Expenses Gross Profit Administration Selling and Distribution Expenses EBITDA Depreciation Depletion and Amortisation EBIT Interest Expense Other Income Pretax Income Provision for Tax Extra Ordinary and Prior Period Items Net Net Profit Adjusted Net Profit Dividend Preference Dividend Equity Rs mn 503.90 0.00 6717.90 %OI 0.41 0.00 5.47 122906.10 100.00 31-Mar09(12) Rs mn 299.50 0.00 7583.60 %OI 0.22 0.00 5.57 136105.80 100.00 31-Mar08(12) Rs mn 151.50 0.00 8224.90 %OI 0.11 0.00 6.13 134161.90 100.00

Income Statement

93255.70 75.88 22428.60 18.25 13732.90 11.17 8695.70 -6416.70 10908.90 6378.20 1405.40 -183.50 4789.30 4972.80 0.00 1754.40 7.08 -5.22 8.88 5.19 1.14 -0.15 3.90 4.05 0.00 1.43

73855.80 54.26 54366.90 39.94 18879.60 13.87 35487.30 26.07 19335.10 14.21 16152.20 11.87 10356.80 7757.00 13552.40 124.00 7.61 5.70 9.96 0.09

55534.70 41.39 70250.80 52.36 21264.50 15.85 48986.30 36.51 18436.60 13.74 30549.70 22.77 8700.50 4353.40 176.40 -161.70 6.49 3.24 0.13 -0.12

15112.40 12.30

23703.80 19.29

26202.60 19.53

34598.30 25.42 48026.70 35.29 13428.40 0.00 1651.20 9.87 0.00 1.21

25864.50 19.28 26026.20 19.40 0.00 1548.00 0.00 1.15

C343 40

Balance Sheet:
A snapshot of the firms position at a point in time Shows what a company owns (assets) and what it owes (liabilities) Balance Sheet shows what assets a company has (use of funds) and where the money came from to acquire those assets (source of funds)

Balance Sheet 31-Mar-10 Equity Capital Preference Capital Share Capital Reserves and Surplus Loan Funds Current Liabilities Provisions Current Liabilities and Provisions Total Liabilities and Stockholders Equity (BT) Tangible Assets Net Intangible Assets Net Net Block Capital Work In Progress Net Fixed Assets Investments Inventories Accounts Receivable Cash and Cash Equivalents Other Current Assets Current Assets Loans & Advances Miscellaneous Expenditure Other Assets Total Assets (BT) 10320.10 0.00 10320.10 494668.80 244782.80 58365.30 33868.40 92233.70 145318.60 160806.20 306124.80 16835.20 322960.00 318986.00 2983.40 17386.30 821.80 5571.90 26763.40 173296.00 0.00 %BT 1.23 0.00 1.23 31-Mar-09 10320.10 0.00 10320.10 %BT 1.12 0.00 1.12 31-Mar-08 10320.10 0.00 10320.10 %BT 1.83 0.00 1.83 42.24 35.99 12.79 7.15 19.94 26.41 3.56 29.96 12.63 42.59 24.56 0.36 1.94 0.34 0.00 2.64 30.21 0.00

58.75 506583.10 29.07 309036.10 6.93 4.02 10.95 57814.90 35839.70 93654.60

55.09 238080.20 33.61 202864.30 6.29 3.90 72077.60 40304.00

10.18 112381.60 15.06 148834.50 19.10 3.96 20041.80 71175.60 34.15 168876.30 38.12 240051.90 34.11 138441.40 0.28 1.61 0.58 0.61 3.08 0.00 2012.20 10932.10 1926.60 1.40 14872.30 0.00

842005.40 100.00 919593.90 100.00 563646.20 100.00 17.26 138458.90 19.10 175618.80 36.36 314077.70 2.00 36438.60 38.36 350516.30 37.88 313647.50 0.35 2.06 0.10 0.66 3.18 0.00 2531.40 14822.20 5351.50 5619.40 28324.50 0.00

20.58 227105.60

24.70 170280.60

842005.40 100.00 919593.90 100.00 563646.20 100.00

C343 41
Analyses of financial Statement: Financial statement analysis is defines as the process of identifying financial strengths and weaknesses of the firm by properly establishing relationship between the items of the balance sheet and the profit and loss account. There are various methods or techniques that are used in analyzing financial statements, such as comparative statements, schedule of changes in working capital, common size percentages, funds analysis, trend analysis, and ratios analysis. Comparison of two or more year's financial data is known as horizontal analysis, or trend analysis. Horizontal analysis is facilitated by showing changes between years in both dollar and percentage form. As per profit and loss account its clearly show that on 2010 profit is reduce. Gross profit is 39.94% in 2009 which is reduced by 18.25% 2010. Profit before interest and tax was gone -5.22 in 2010 from 11.87 (2009) so its very bad position. In net profit they increase profit 3.90 but in last year it was 35.29. Balance sheet saws that current liabilities was 6.29% in 2009 which increased up to 6.93% in 2010 so that bad for company which liabilities were increase. And on assets side current assets was also increase up to 3.18 (2010) and fixed assets was shows 38.36 (2010) its increase from 38.12 (2009).

C343 42
6.2 Apply financial ratios to improve the quality of financial information in an organisations financial statements. Profit and Loss Account
31-Mar-10(12) Profit / Loss A/C Net Sales (OI) Turnover Gross Profit Administration Selling and Distribution Expenses Operating Profit Depreciation Depletion and Amortisation Profit before interest and tax Interest Expense Other Income Profit before tax Provision for Tax Extra Ordinary and Prior Period Items Net Net Profit Adjusted Net Profit Dividend Preference Dividend Equity Rs mn 122906.10 100477.7 22428.60 13732.90 8695.70 15112.40 -6416.70 10908.90 23703.80 6378.20 1405.40 -183.50 4789.30 4972.80 0.00 1754.40

C343 43
BALANCE SHEET OF ORGANIZATION
31-Mar-10 Equity Capital Preference Capital Share Capital Reserves and Surplus Loan Funds Current Liabilities Provisions Current Liabilities and Provisions Total Liabilities and Stockholders Equity (BT) Tangible Assets Net Intangible Assets Net Net Block Capital Work In Progress Net Fixed Assets Investments Inventories Accounts Receivable Cash and Cash Equivalents Other Current Assets Current Assets Loans & Advances Miscellaneous Expenditure Other Assets Total Assets (BT) 10320.10 0.00 10320.10 494668.80 244782.80 58365.30 33868.40 92233.70 842005.40 145318.60 160806.20 306124.80 16835.20 322960.00 318986.00 2983.40 17386.30 821.80 5571.90 26763.40 173296.00 0.00 842005.40

C343 44
1. Profitability ratios: (a) Return on capital employed (ROCE) : ROCE = Profit before interest and tax Capital Employed =6378.20/10320.10 * 100 =61.80% (b) Return on equity (ROE): ROE = Profit after tax X 100% Shareholders funds = 4789.30/10320.10*100 = 46.40% (c) Profit margin: X 100%

Profit margin = Operating profit Turnover =8695.70/122906.1*100 = 7.075% (d) Interest cover:

X 100%

Profit margin = Operating profit Debt interest = 8695.70/10908.90 = 0.797 times

C343 45
2. Liquidity ratios: (a) Current ratio: Current ratio = Current assets Short term liabilities =26763.40/33868.40

= 79% (b) Acid test ratio: Acid test ratio = Current assets - stock Short term liabilities =26763.40-0 33868.4 = 79% 3. Efficiency ratios: (a) Fixed asset turnover ratio: Fixed assets turnover ratio = Turnover Fixed assets

=122906.1/322960.00

= 0.38 Times

C343 46
(b) Asset turnover ratio : Assets turnover ratio = Turnover Fixed assets + Current Assets

122906.1 322960.00+ 26763.40 = 0.35

C343 47
6.3 Make recommendations on the strategic portfolio of an organisation based on its financial information.
(a) Return on capital employed (ROCE) :

Return on Capital Employed (ROCE) is a measuring tool that method the efficiency and profitability of capital investments undertaken by a corporation. A firm acquires capital assets such as trucks, computers, etc to help makes its business operations more efficient, cut down on costs and realize greater profits or acquire more market share. Return on Capital Employed ratio also indicates whether the company is earning enough revenues and profits in order to make the best use of its capital assets. It is spoken in the form of a percentage, and the higher the percentage, the better. Firms can increase their Return on Capital Employed Ratio by:

Cutting costs so as to increase the Profit Margin ratio Buying raw material and other goods at cheaper costs

(b) Return on equity (ROE) : The amount of net income returned as a percentage of shareholders equity. Return on equity measures a corporations profitability by revealing how much profit a company generates with the money shareholders have invested.

ROE is expressed as a percentage and calculated as: Return on Equity = Net Income/Shareholder's Equity Net income is for the full fiscal year (before dividends paid to common stock holders but after dividends to preferred stock.) Shareholder's equity does not include preferred shares.

C343 48
(c) Profit margin: A ratio of profitability calculated as net income divided by revenues, or net profits divided by sales. It measures how much out of every dollar of sales a company actually keeps in earnings. Profit margin is very useful when comparing companies in similar industries. A higher profit margin indicates a more profitable company that has better control over its costs compared to its competitors. Profit margin is displayed as a percentage; a 20\% profit margin, for example, means the company has a net income of $0.20 for each dollar of sales.

(d) Interest cover:

A ratio used to determine how easily a company can pay interest on outstanding debt. The interest coverage ratio is calculated by dividing a company's earnings before interest and taxes (EBIT) of one period by the company's interest expenses of the same period.

The lower the ratio, the more the company is burdened by debt expense. When a company's interest coverage ratio is 1.5 or lower, its ability to meet interest expenses may be questionable. An interest coverage ratio below 1 indicates the company is not generating sufficient revenues to satisfy interest expenses.

C343 49
2. Liquidity ratios: A. Current ratio: An indication of a company's ability to meet short-term debt obligations the higher the ratio, the more liquid the companys. Current ratio is equal to current assets divided by current liabilities. If the current assets of a company are more than twice the current liabilities, then that company is generally considered to have good short-term financial strength. If current liabilities exceed current assets, then the company may have problems meeting its short-term obligations. For example, if XYZ Company's total current assets are $10,000,000, and its total current liabilities are $8,000,000, then its current ratio would be $10,000,000 divided by $8,000,000, which is equal to 1.25. XYZ Company would be in relatively good short-term financial standing B. Acid test ratio: A tough indicator that determines a firm has enough short-term assets to cover its direct liabilities without selling inventory. The acid-test ratio is far more strenuous than the working capital ratio, primarily because the working capital ratio allows for the inclusion of inventory assets. Calculated by:

Companies with ratios of less than 1 cannot pay their current liabilities and should be looked at with extreme caution. Furthermore, if the acid-test ratio is much lower than the working capital ratio, it means current assets are highly dependent on inventory. Retail stores are examples of this type of business.

C343 50
3. Efficiency ratios: Ratios are naturally used to analyze how company uses its assets and liabilities internally. Efficiency Ratios can calculate the turnover of receivables, the repayment of liabilities, the quantity and usage of equity and the general use of inventory and machinery. Some common ratios are accounts receivable turnover, fixed asset turnover, sales to inventory, sales to net working capital, accounts payable to sales and stock turnover ratio. These ratios are important when compared to peers in the same industry and can identify businesses that are better managed relative to the others. Also, efficiency ratios are important because an improvement in the ratios usually translate to improved profitability.

C343 51
Reference: 1. Ratnamani company information available on (http://www.ratnamani.com) assessed from 15th august 2011. 2. Cash flow available on (http://www.investopedia.com/terms/c/cashbudget.asp#axzz1VkmZC6fs) assessed from 15th august 2011. 3. Actibe based budgeting available on th (http://www.investopedia.com/terms/a/abb.asp#ixzz1Vlb4l6Tm) assessed on 19 august 2011. 4. http://www.wikipedia.org/