Financial Decision Making

Break-even AnalysisThis concept helps us know at what quantity

of production/sales we incur no loss nor gain any profit.

The formula for Break Even point = Fixed Cost/ Sales price per unit – Variable

cost per unit.

Illustration: Sales price= Rs. 100; Variable cost = Rs.60, Fixed Cost = 25,000/-

Therefore Breakeven quantity = ????

Marginal Revenue PricingThis is extension of Break even analysis.Revenue earned by selling additional unit,

after having covered the fixed expenses, is called Marginal Revenue.

Illustration : Transport operator incurs Rs17,000/ as fixed operating expense per trip. Per passenger variable cost incurred is Rs.50. The ticket fare is Rs.500.Total capacity is 35 seats. Current occupancy is 34. What price you can offer under marginal revenue pricing concept???

Marginal Revenue PricingExercise :Price =20; Variable cost is Rs.10; fixed

overhead per month Rs.10,000/ You are producing 1000 units per month. Break even is achieved. Now additional order of 100 units are ordered by another party for Rs.15/- can we accept? What would be the net effect?

Capital Budgeting – Payback Method

Payback Analysis :The investment which gives back quickly is

generally considered for investments, other things being equal.

How to calculate payback method :Illustration : Entrepreneur wants to invest Rs.

250,000 in one of the below 2 projects, which project should he choose based on Pay Back method

( Cont…..)

Capital Budgeting – Payback Method (Cont..)

Projected Payback :Project A Project B

Year 1 100,000 20,000Year 2 80,000 40,000Year 3 70,000 50,000Year 4 30,000 60,000Year 5 20,000 80,000

Capital Budgeting – Payback Method (Cont..) Project A takes about 3 years to pay back the

investment while Project B takes about 5 years to pay back.

Applying Pay back method the entrepreneur should select Project A as it has shorter pay back period.

Capital Budgeting – Net Present Value

Net Present Value :By this method value of future cash flow is

discounted by a chosen discounting factor, which is represented by interest rate / Inflation rate.

The formula is :

  

Year 125,0000.9091 22,728 Year 220,0000.8264 16,528 Year 315,0000.7513 11,270 Year 41,0000.683 683 Year 55500.6209 341 61,550Present Value of Cash flow 51,549 Initial Investment 50,000 Net Present Value 1,549 You select the project which offers higher

NPV for the same discounting factor.

Capital Budgeting – Net Present Value

Initial Investment 50,000;Cash Flow 10% Discount factor Present value

Y1 25,000 0.9091 22,728

Y2 20,000 0.8264 16,528

Y3 15,000 0.7513 11,270

Y4 1,000 0.683 683 Y5 550 0.6209 341

61,550 Present Value of Cash flow 51,549

Capital Budgeting – Net Present Value

Initial Investment 50,000 Net Present Value 1,549

You select the project which offers higher NPV for the same discounting factor.

Ratio Analysis

Return on Investment (ROI)= Net Income Owner’s Equity

Why this ratio is calculated?

Return on Assets = Net Income Total assets

 

Ratio Analysis

Net profit Margin : = Net Income Sales

Asset Turnover Ratio = Sale/Total Assets

Average Collection period : Accounts Receivable X 365

Annual Credit Sales 

Ratio AnalysisAverage age payables = Average Accounts

Payable x 365 Purchase

Inventory turnover = Cost of Goods Sold Average Inventory

Ratio AnalysisCurrent Ratio = Current Assets

Current liability

Debt Servicing Ratio : Net Income Interest Expenses

Cash Flow to Liabilities : Operating Cash Flow

Total Liabilities