Financial Management

CAIIBMODULE D

Presentation byProf. S.D.Bargir

Joint Director,IIBF

Module D topics Marginal Costing Capital Budgeting Cash Budget Working Capital

COSTING Cost accounting system provides

information about cost Aim : best use of resources and

maximization of returns cost = amount of expenditure

incurred( actual+ notional) Purposes +profit from each job/product,

division, segment+pricingdecision+control+profit planning +inter firm comparison

Marginal costing

Marginal costing distinguishes between fixed cost and variable cost

Marginal cost is nothing bust variable cost of additional unit

Marginal cost= variable cost MC= Direct Material + Direct Labour

+Direct expenses

Marginal costing problems

Sales (-) variable cost (=) contribution

Contribution(/ divided by) sales (=) C.S. Ratio

Contribution=Fixed cost (=)Break even point

Fixed Cost (/ divided by) contribution per unit = break even units

Basic formulaSales price (-) variable cost= contribution

SP less VC = Contribution

10 6 = 4

9 6 = 3

8 6 = 2

7 6 = 1

6 6 = 0

5 6 = (1)

4 6 = (2)

Marginal costing problems

SP = Rs.10, VC =Rs.6 Fixed Cost Rs.60000

Find- Break even point (in Rs. & in units)- C/S ratio- Sales to get profit of Rs.20000

Marginal costing problems

Sales Rs.100000 Fixed Cost Rs.20000 B.E.Point Rs.80000 What is profit ?

Management decisions- assessing profitability CONTRIBUTION/SALES=C.S.RATIO

Product

sp vc Contribtion

c/s Ratio % ranking

A 20 10 10 10/20 50% 1

B 30 20 10 10/30 33% 2

C 40 30 10 10/40 25% 3

DECISION when limiting factors

SP Rs.14 Rs.11

VC 8 7

ContributionPer unit

6 4

Labour hr. pu 2 1

Contri.per hr 3 4

DECISIONS

Make or buy decisions Close department Accept or reject order Conversion cost pricing

CAPITAL BUDGETING

It involves current outlay of funds in the expectation of a stream of benefits extending far into the future

Year Cash flow

0 (100000)

1 30000

2 40000

3 50000

4 50000

Types of capital investments

New unit Expansion Diversification Replacement Research & Development

Significance of capital budgeting

Huge outlay Long term effects Irreversibility Problems in measuring future cash

flows

Facets of project analysis

Market analysis Technical analysis Financial analysis Economic analysis Managerial analysis Ecological analysis

Financial analysis

Cost of project Means of finance Cost of capital Projected profitability Cash flows of the projects Project appraisal

Methods of capital investment appraisal

DISCOUNTING NON-DISCOUNTING

Net present value (NPV)

Pay back period

Internal rate of return (IRR)

Accounting rate of return

Profitability Index or Benefit cost ratio

Present value of cash flow stream- (cash outlay Rs.15000)@ 12%

Year Cash flow PV factor @12%

PV

1 1000 0.893 893

2 2000 0.799 1594

3 2000 0.712 1424

4 3000 0.636 1908

5 3000 0.567 1701

6 4000 0.507 2028

7 4000 0.452 1808

8 5000 0.404 2020 13376

Present value of cash flow stream- (cash outlay Rs.15000 )@10%

Year Cash flow PV factor @10%

PV

1 2000 0.909 1818

2 2000 0.826 1652

3 2000 0.751 1502

4 3000 0.683 2049

5 3000 0.621 1863

6 4000 0.564 2256

7 4000 0.513 2052

8 5000 0.466 233015522

CALCULATION NPV/IRR

Outlay PV @10% PV @ 12% NPV

15000 15522 - 522

15000 - 13376 (1624)

Difference - - 2146

IRR continued

IRR= LR +( NPV by LR/ difference between NPV) x (HR-LR)

LR= 10% NPV by LR= 522Difference between NPV= 2146HR less LR= 12 (-) 10 = 2IRR= 10%+ (522/2146)X2IRR=10%+0.49IRR=10.49%

The timing of the cash flows is critical for determining the Project's value.below the line for cash investments orabove the line for returns.

Rs.51 Lakh Rs.51 Lakh Rs.61 Lakh

Year 1 Year 2 Year 3Rs.102 lakh

Year 0

Net Present ValueYear Cash Flow Dis. Factor Present

@10% Value

0 -102 1 -1021 51 0.91 46.362 51 0.83 42.153 61 0.75 45.83

NPV 32.34

@27% Value0 -102 1 -1021 51 0.78740 402 51 0.62000 323 61 0.48818 30

NPV 0

The evaluation of any projectdepends on the magnitude of thecash flows, the timing and thediscount rate.The discount rate is highlysubjective. The higher the rate , theless a rupee in the future would beworth today.The risk of the project shoulddetermine the discount rate.

Internal Rate of Return(IRR)IRR is the rate at whichthe discounted cash flowsin the future equal thevalue of the investmenttoday. To find the IRR onemust try different ratesuntil the NPV equals zero.

PRICING DECISIONS

Full cost pricing Conversion cost pricing Marginal cost pricing Market based pricing

BUDGET

Quantitative expression of management objective

Budgets and standards Budgetary control Cash budget

PROFIT PLANNING

Budget & budgetary control Marginal costing CVP and break even point Comparative cost analysis ROCE

PRICING DECISIONS

Full cost pricing Conversion cost pricing Marginal cost pricing Market based pricing

Operating leverageFinancial leverage

OL= amount of fixed cost in a cost structure. Relationship between sales and op. profit

FL= effect of financing decisions on return to owners. Relationship between operating profit and earning available to equity holders (owners)

BUDGET

Quantitative expression of management objective

Budgets and standards Budgetary control Cash budget

PROFIT PLANNING

Budget & budgetary control Marginal costing CVP and break even point Comparative cost analysis ROCE

PRICING DECISIONS

Full cost pricing Conversion cost pricing Marginal cost pricing Market based pricing

Operating leverageFinancial leverage

OL= amount of fixed cost in a cost structure. Relationship between sales and op. profit

FL= effect of financing decisions on return to owners. Relationship between operating profit and earning available to equity holders (owners)

Working capital

Current assets less current liabilities = net working capital or net current assets

Permanent working capital vs. variable working capital

Working capital cycle

cash> Raw material > Work in progress > finished goods > Sales > Debtors > Cash>

Operating cycle – it is a length of time between outlay on RM /wages /others AND inflow of cash from the sale of the goods

Examples from book P-369 P-375 P-377 P-379 P-380 P-385 P-387 P-393

Examples from book

P-413 P-414 p-415 P-417

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THANK YOUWISH YOU BEST OF LUCK

sudaaba@iibf.org.in***