Management Accounting Detail-home

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First Module: Definition and scope of Management accounting

1. What is Management Accounting?

Management accounting or managerial accounting is concerned with the provisions and use of

accounting information to managers within organizations, to provide them with the basis to make informed

business decisions that will allow them to be better equipped in their management and control functions.

“Management accounting is the process of identifying, measuring, analyzing, interpreting, and

communicating information in pursuit of an organization’s goals” !onald ". #ilton

$ccording to the %hartered &nstitute of Management $ccountants '%&M$(, “Management $ccounting is

"the process of identification, measurement, accumulation, analysis, preparation, interpretation and

communication of information used by management to plan, evaluate and control within an entity and to

assure appropriate use of and accountability for its resources. Management accounting also comprises the

preparation of financial reports for non-management groups such as shareholders, creditors, regulatory

agencies and tax authorities" '%&M$ )fficial *erminology(”.

*he &nstitute of Management $ccountants '&M$( recently updated its definition as follows

"management accounting is a profession that involves partnering in management decision making,

devising planning and performance management systems, and providing expertise in financial reporting

and control to assist management in the formulation and implementation of an organization's strategy" .

. Management accounting is helpful in decision making- discuss the statement. )r Management accounting

is helpful in decision making do you support this /ive arguments and mention the tools of decision

making.

Management accounting is the process of identifying, measuring, analyzing, interpreting, and

communicating information in pursuit of an organization’s goals. 0o, Management accounting helps in

decision making in the following ways+-

i. 1efining the problems+ 2irst steps of decision making are to determine the problems. &n business

organization, to taking decision first to identify the problem. &f problem is determine then to

identify the solution of the problem. Management accounting provides the information about the

organization and base on these information problems is determined.ii. #elping the problem analysis+ *he second steps to take decision are to analysis the problem

Management accounting provides the various information to analysis the problem and how tosolve the problem.

iii. #elping the searching or developing alternatives+ *o solve the problems of an organization, first

to setup the how many alternatives ways have 3ase on the management accounting information

determine the several alternatives.iv. 0electing the best alternatives+ *hen selecting the best alternative to solve the problem base on

the managerial accounting informationv. 4utting decision into action+ *hen taking different steps to implement the action.

vi. #elping the following up decisions+ 2inally, managerial accounting provide the information to

follow up the decision action plan and if deviation, take necessary step to solve the problem.

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03. Discuss the goal or objecties of Managerial Accounting.

Managerial accounting is an integral part of the management process and managerial accountantsare important strategic partners in an organization’s management team. &n pursuing goals, an organizationacquires resources, hires people, and then engages in an organized set of activities. &t is up to themanagement team to make the best use of the organization’s resources, activities, and people in achievingthe organization’s goals. Managerial accounting actiit! adds alue to an organi"ation b! pursuingfie major objecties:

4roviding information for decision making and planning, and proactively participating as

part of the management team in the decision making and planning processes. $ssisting managers in directing and controlling operational activities.

Motivating managers and other employees toward the organization’s goal.

Measuring the performance of activity, subunits, managers and other employees within the

organization. $ssessing the organization’s competitive position, and working with other managers to

ensure the organization’s long term competiveness in its industry.

56. 7arrate the functions of Managerial $ccounting.

Managerial accounting is an integral part of the management process and managerial accountants

are important strategic partners in an organization’s management team. &n pursuing goals, an organizationacquires resources, hires people, and then engages in an organized set of activities. &t is up to the

management team to make the best use of the organization’s resources, activities, and people in achieving

the organization’s goals. *he day-to-day work of the management team comprises basic four activities+

i. 1ecision makingii. 4lanning

iii. 1irecting operational activities andiv. %ontrolling.

)thers $ctivities are-

Modification of date.

$nalysis and interpretation of data.

2acilitating management control.

8se of qualitative information.

&dentifying the problems.

59. 1iscuss the planning, controlling and directing : motivating the management accounting.

#lanning:

#lanning involves establishing a basic strategy, selecting a course of action, and specifying how the actionwill be implemented. $n important part of planning is to identify alternatives and then to select fromamong the alternatives the one that best fits the organization’s strategy and ob;ectives. $ll importantalternatives considered by management in the planning process impact revenues or costs, and managementaccounting data are essential in estimating those impacts.

$ontrolling%ontrolling involves ensuring that the plan is actually carried out and is appropriately modified as

circumstances change. Management accounting information plays a vital role in these basic managemenactivities


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1irecting and motivating involves mobilizing people to carry out plans and run routine operations.&n addition to planning for the future, managers oversee day-to-day activities and try to keep theorganization functioning smoothly. *his requires motivating and directing people. Managers assign tasks toemployees, arbitrate disputes, answer questions, solve on-the-spot problems, and make many smaldecisions that affect customers and employees. &n effect, directing is that part of a manager’s ;ob that dealswith the routine and the here and now. Managerial accounting data, such as daily sales reports, are oftenused in this type of day-to-day activity.

5@. 1iscuss the role of managerial accounting in efficient and effective management or management

accounting is useful in banking operation- comment=( 2orecasting( 4lanning>( )rganizing6( Motivation9( %o-ordination@( %ontrollingA( %ommunicationB( 1ecision making.

5A. 1istinguish between Management accounting and financial accounting.

Management accounting is the process of identifying, measuring, analyzing, interpreting, andcommunicating information in pursuit of an organization’s goals and financial accounting is the use of

accounting information for reporting to parties outside the organization. Management accounting differs in

several ways from 2inancial accounting process. *here are also some important differences are -

0C

7o

1imension Management $ccounting 2inancial accounting

= 0tructure ?erities according to the use of information 8niform structure

0ource of

principle

"hatever is useful to the management /$$4 is a statutory obligations

> 7eed )ptional 0tatutory

6 *ime

orientation

#istorical and estimates to the future #istorical

9 !eport entity !esponsibility centers )verall organization

@ 4urpose $ means to the end of assisting Management DEternal reporting F statement for the

outside users

A 8sers !elatively small group+ Gnown identity !elatively large group+ mostly unknown

identity

B &nformation

centers

Monetary and non-monetary 4rimary Monetary

H &nformation

perception

Many approEimately 2ew approEimately

=5 !eport

frequency

?aries with the purpose+ Mostly monthly and

weekly

Iuarterly and annually

== !eporttimeliness

!eport issued promptly after the end of periodcovered

1elay of weeks and even month

= Ciability

potential

?irtually none 2ew lawsuits and tread is always present

=> !eport to !eports to those inside the organization for+

4lanners

1irectors and motivators

%ontrollers

4erformance evaluators

!eports to those outside the organization+

)wners

Cenders

*aE authorities

!egulators

=6 Dmphasizes Dmphasizes decisions affecting the future.

Dmphasizes relevance.

Dmphasizes financial consequences of past

activities.


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Dmphasizes timeliness.

Dmphasizes detailed segment reports about departments,

products, customers, and employees.

Dmphasizes ob;ectivity and verifiability.

Dmphasizes precision.

Dmphasizes summary data concerning the

entire organization.

=9 /$$4 7eed not follow /$$4. Must follow /$$4.

=@ DEternal report 7ot mandatory. Mandatory for eEternal reports

5B. %omparison between Management accounting and financial accounting.

Management accounting is the process of identifying, measuring, analyzing, interpreting, andcommunicating information in pursuit of an organization’s goals and financial accounting is the use ofaccounting information for reporting to parties outside the organization. %omparison between managementaccounting and financial accounting are-

a. !elevance of 1ata+ 2inancial accounting data should be ob;ective and verifiable and Managerialaccounting should be fleEible enough to provide whatever data are relevant for a particular decision.

b. Cess Dmphasis on 4recision+ Making sure that dollar amounts are accurate down to the last dollar or penny takes time : effort and managerial accountants often place less emphasis on precision thanfinancial accountants do.

c. 0egments of an )rganization+ 2inancial accounting is primarily concerned with reporting for thecompany as a whole. 3y contrast, managerial accounting focuses much more on the parts, orsegments% of a company. *hese segments may be product lines, sales territories, divisionsdepartments, or any other categorization that management finds useful. 2inancial accounting doesrequire some breakdowns of revenues and costs by ma;or segments in eEternal reports, but this is asecondary emphasis. &n managerial accounting, segment reporting is the primary emphasis.

d. Generally Accepted Accounting Principles (GAAP): Financial accounting statements prepared foreEternal users must comply with generally accepted accounting principles '/$$4(. DEternal usersmust have some assurance that the reports have been prepared in accordance with a common set ofground rules. *hese common ground rules enhance comparability and help reduce fraud andmisrepresentation, but they do not necessarily lead to the type of reports that would be most usefulin internal decision making. Managerial accounting is not bound by /$$4. Managers set theirown rules concerning the content and form of internal reports. *he only constraint is that theeEpected benefits from using the information should outweigh the costs of collecting, analyzing,and summarizing the data. 7evertheless, as we shall see in subsequent chapters, it is undeniably truethat financial reporting requirements have heavily influenced management accounting practice.

e. Managerial $ccounting


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>. $ccounting method+ Management accounting does not follow the cost eEpenditure method and it

analysis and interpretation the information. %ost accounting follows the double entry system of accounting

and cost ledger.

6. *ime+ Managerial accounting is implemented in future time and cost accounting is implemented

in current time.

9. 1etermining method+ Managerial accounting follows the several strategy and methods and %ost

accounting follows the pre-determining method and strategy.

=5. &mportance !ole or service of managerial accounting.

Cisted below are the primary tasksF services performed by management accountants. *he degree of

compleEity relative to these activities is dependent on the eEperience level and abilities of any one

individual.

•

!ate and volume analysis• 3usiness metrics development

• 4rice modeling

• 4roduct profitability

• /eographic vs. &ndustry or client segment reporting

• 0ales management scorecards

• %ost analysis

• %ostbenefit analysis

• %ost-volume-profit analysis

• Cife cycle cost analysis

• %lient profitability analysis

• &* cost transparency

• %apital budgeting

• 3uy vs. lease analysis

• 0trategic planning

• 0trategic management advice

• &nternal financial presentation and communication

•

0ales forecasting• 2inancial forecasting

• $nnual budgeting

• %ost allocation

==. !ole or 2unction or importance or service of cost and managerial accounting.

i. %ollection, classification, analysis and presentation of financial date.ii. $scertainment, reduction and control of costs.

iii. 4roduct pricingiv. 4reparation of statement of cost and other necessary statement.

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v. 4reparation of master plan or development of industry.vi. !ole of cost and managerial accounting is financial management in industry.

vii. Dfficiency analysisviii. 4lanning and decision making.

=. Management accounting is considered as a very useful tool for decision making-1iscuss in short four

management accounting tools that can effectively applied in management decision making process by

banks with eEample.

Managerial accounting follows the various method and strategy to determine the future action plan base on the organization current information. Managerial accounting’s method and strategy means the

evaluation method that analysis, interpret, eEplicate, supply information to the accounting. 0o, a single

method does not the management need. 2or this, several method or strategy need. 2or eEample- 7eed for

long and short term funds and statement of collected fund from the various sources is the tools of

management. &f production is changed, then variable cost is changed on the basis of marginal cost. 2or that,

in short time only marginal cost is changed not fiEed cost- this is the strategy of marginal cost strategy. 0o,

base on these strategies monument take decision for future action.

*ools of management accounting are-

i. 2inancial 4lanning

ii. 2und 2low and cash 2low statementiii. 0tandard costingiv. 3udgetary control.

=>. 0tate in short the relationship between management accounting and management information system

'M&0(.

i. Management accounting helps to prepare the plan, direct, coordinate and control the organization

for future action and M&0 helps to supply this information to take decision.ii. Management accounting helps to set up the short and long term forecasting and planning to meet

the organizational ob;ectives and M&0 helps to supply this information to take decision.iii. M&0 helps to supply this information to take decision to meet the vast managerial arena.

iv. Management accounting analysis interpreted and evaluates the M&0 information to determine thefuture course of action.v. Management accounting follows the additional method and strategy in which M&0 follows the

formal method and strategy.

=6. 1iscuss the utility of Management accounting over the financial accounting.i. !elated to past activities and past data.

ii. #elping the usable time.iii. 4resentation of suitable mediaiv. #elping the consideration of alternatives

v. #elping in field of applicationvi. #elping in failure to solve critical problem.

=9. 1iscuss the necessity of management accounting to a banker.

i. %ollection, classification, analysis and presentation of financial data.ii. 0ystematic and reliable planning

iii. $scertainment, reduction and control of costsiv. 4roduct pricingv. Measurement of work performance

vi. 4reparation of statement of cost and other necessary statement.vii. 4reparation of master plan or development of industry


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viii. !ole of financial management in industry.iE. 2orward workingE. Dfficiency analysis

Ei. #elping the decision making

=@. "hat are the three ma;or activities of a bank manager

i. %ollection of dataii. Modification of raw data into information

iii. 4lanning and forecasting.

Module-3+ %osting and pricing

5= 1efine cost $ccounting.

%ost accounting is an approach to evaluating the overall costs that are associated with conducting

business. /enerally based on standard accounting practices, cost accounting is one of the tools that

managers utilize to determine what type and how much eEpenses is involved with maintaining the

current business model.

%ost accounting is the branch of managerial accounting that systematically assists managers in the

internal balancing of spending and profits, as well as assessing operational costs and budget analyses . %ostaccounting will first measure and record these costs individually, then compare input results to output or

actual results to aid company management in measuring financial performance.

“*he %ost accounting system is a part of the basic accounting system that accumulates cost date for

use in both managerial and financial accounting”-!onald ". #ilton.

“%ost accounting is that branch of accounting dealing with the classification, recording, allocation,

summarization and reporting current and prospective costs”- D.C. Gohler.

“%ost accounting may be defined as that part of accounting system of an organization which is

devoted to ascertaining in as precise a manner as possible, the cost of particular process, batch , ;ob,

services or unit of industrial activity not as an end in itself but as a means of controlling all the factors

which influence costs”-&%M$5. "rite the cost, eEpense and costing.

%ost+ $n amount that has to be paid or given up in order to get something. &n business, cost is usuallya monetary valuation of '=( effort, '( material, '>( resources, '6( time and utilities consumed, '9( risks incurred, and'@( opportunity forgone in production and delivery of a good or service. $ll eEpenses are costs, but not all costs 'suchas those incurred in acquisition of an income-generating asset( are eEpenses. $ cost is the value of money that has been used up to produce something, and hence is not available for use anymore.

DEpenses. DEpenses are the cost of assets consumed or services used in the process of earning

revenue. *hey are decreases in owner’s equity that result from operating the business.

%osting+ 0ystem of computing cost of production or of running a business, by allocating eEpenditure tovarious stages of production or to different operations of a firm.

5>. 1iscuss the ob;ective of cost accounting.i. $scertain cost

ii. %ontrolling costiii. 4ricing of productiv. 3enefit of budgetary control and standard costingv. Making decision

vi. $scertaining profit and loss department of product-wise.vii. )utput and profit planning

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viii. %ost reduction by elimination of waste, inefficiencies and benefits of responsibility accounting.iE. Dmployee benefitE. 3enefit of investors, creditors and public.

56. 7arrate the function of cost accounting or discuss the importance of cost accounting to a banker or discuss

the importance of cost accounting to a banker.

i. !ecording cost dataii. %lassification of cost dataiii. $scertaining costiv. 3udgeting costv. !educing cost

vi. %ontrolling costvii. #elping management in decision making.

59. /ive the classification of cost of different bases.

'=( %lassification on the basis of elements of costs

i. 1irect material cost+ *he materials that go into the final product are called raw materials

*his term is somewhat misleading, since it seems to imply unprocessed natural resources

like wood pulp or iron ore. $ctually, raw materials refer to any materials that are used in the

final productJ and the finished product of one company can become the raw materials of

another companyii. 1irect labor cost+ 1irect labor consists of labor costs that can be easily 'i.e., physically and

conveniently( traced to individual units of product. 1irect labor is sometimes called touch

labor, since direct labor workers typically touch the product while it is being made.iii. 1irect cost+ $ direct cost is a cost that can be easily and conveniently traced to a specified

cost ob;ect.iv. &ndirect costF overhead cost+ $n indirect cost is a cost that cannot be easily and conveniently

traced to a specified cost ob;ect. *hese are three types- '=( Manufacturing overhead, thethird element of manufacturing cost, includes all costs of manufacturing eEcept direcmaterials and direct labor. Manufacturing overhead includes items such as indirect materialsindirect laborJ maintenance and repairs on production equipmentJ and heat and light property taEes, depreciation, and insurance on manufacturing facilities. $ company alsoincurs costs for heat and light, property taEes, insurance, depreciation, and so forthassociated with its selling and administrative functions, but these costs are not included as part of manufacturing overhead '( administrative costs. $dministrative costs include aleEecutive, organizational, and clerical costs associated with the general management of anorganization rather than with manufacturing or selling and '>( 0elling costs include all coststhat are incurred to secure customer orders and get the finished product to the customer.

*hese costs are sometimes called order-getting and order-filling costs.

'( %lassification on the basis of variability or cost behavior of costs.

i. 2iEed costs+ %ost that remains the same in total regardless of changes in the activitylevel. $ fiEed cost does not change in total as activity changes.

i. ?ariable cost+ %ost that vary in total directly and proportionately with changes in theactivity level.

ii. 0emi variable or MiEed cost+ %osts that contain both a variable and a fiEed costelement and change in total but not proportionately with changes in the activity level$ semi variable or miEed cost has both a fiEed and a variable component.


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iii. 0tep cost+ $ step cost is nearly variable but increases in small steps instead ofcontinuously. *he range of the activity indeE over which the company eEpects tooperate during the year is not fiEed and this change of cost is called 0tep cost.

'>( %lassification on the basis of controllability of costs

i. %ontrollable cost+ *he cost that is managed in different action is called controllable cost.ii. 8ncontrollable cost+ *he cost that is not managed in different action is called controllable

cost.

'6( %lassification on the basis of department of costs

i. 4roduction department cost+ 4roduction department costs are those departments which are

directly engaged in the process of production of goods.ii. 0ervice department cost+ 0ervice department costs are those departments which are not

directly involved in production process but they provide services to production cost centers.

'9( %lassification on the basis of time period of costs

i. 4roduct cost+ 2or financial accounting purposes, product costs include all costs involved in

acquiring or making a product. &n the case of manufactured goods, these costs consist ofdirect materials, direct labor, and manufacturing overhead. 4roduct costs “attach” to units of product as the goods are purchased or manufactured and they remain attached as the goodsgo into inventory awaiting sale. 4roduct costs are initially assigned to an inventory accounton the balance sheet.

ii. 4eriod cost+ #eriod costs are all the costs that are not product costs. 2or eEample, salescommissions and the rental costs of administrative offices are period costs. 4eriod costs arenot included as part of the cost of either purchased or manufactured goodsJ instead, periodcosts are eEpensed on the income statement in the period in which they are incurred usingthe usual rules of accrual accounting.

'@( %lassification on the basis of 2unction of costs

i. 4roduction cost+ii. $dministration cost+

iii. Marketing cost+iv. !esearch and development cost+

5@. 1iscuss the method of costing.

i. Kob-order costing+ $ ;ob order costing is used in situation where many different productions

are produced each period. &t is used in large scale production and service industries. &t is two

types- '=( 3atch costing and '( %ontract costing.ii. 4rocess costing+ 4rocess costing is most commonly used in industries the produce

essentially homogenous 'i.e. uniform( products on a continuous basis, such as bricks

cornflake or paper. 4rocess costing is particularly used in companies that convert basic rawmaterials into homogeneous products. $ process costing system is used in situations where

the company produces many units of a single product for long periods. &t is several types-

'=( 0ingle output costing, '( 1epartmental costing, '>( )perating costing and '6( $ssemble

costing and multiple costing or composite costing.iii. 2irm %osting+ 2irm costing in mostly commonly used in agriculture, fishing, mining etc. &t is

consider as a general firming costing.

5A. "hat do you mean by cost statement or what is cost sheet 1iscuss its uses. "hy and how makes to

prepare it


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%ost statement or cost sheet is the combination of related cost that determines the production cost.

$ cost statement or cost sheet is a breakdown of all costs incurred, which is comprised of direct and

indirect eEpenses. "hile the statement can be prepared to calculate the cost of any item from attending a

university to a development pro;ect, it is most commonly used for goods. *he cost statement is the largest

eEpense on the income statement and shows the cost of the product. *he cost for retailers and wholesalers

is the amount paid during the period. *he process for calculating the cost for manufacturers is more

compleE and has many components+ direct material, direct labor, factory and administration overheads, and

selling and distribution overheads. $ cost statement often falls under the managerial accounting section of acompanyLs financial reporting activities. &t contains several different pieces of information for certain

activities.

"hy or use of cost sheet or statement+

i. 1etermine the detail product cost.ii. 1etermine the classification of cost.

iii. 1etermine the direct and indirect costiv. Gnowing the production cost, prime cost and total cost of a product.v. Gnowing the single unit costing

vi. 1etermining the profit by using the cost statement.

vii. 1etermining the selling cost and amount.viii. %oordinate with other costs.iE. !educing the additional cost.E. *ake necessary action if eEcess cost is involved.

#ow to prepare+

2irst step+ 2irst step of preparing the cost statement or sheet is to determining the prime cost. 4rime

cost equal to direct raw material direct labor direct eEpenses.

0econd step+ 0econd step of preparing the cost sheet is to determining the factory cost. 2actory cost

is equal to 4rime cost plus factory overhead cost.

*hird step+ *hird step of preparing the cost sheet is to determining the total cost. *otal cost is equal

to 2actory overhead cost $dministration cost marketing cost.2inal step+ 2inal step of preparing the cost sheep is to determining the selling cost. *he selling cost

is equal to total cost plus profit.

5B. 1efine margin of safety and discuss its implications.

*he margin of safet! is the eEcess of budgeted 'or actual( sales dollars over the break-even volume of salesdollars. &t is the amount by which sales can drop before losses are incurred. *he higher the margin of safetythe lower the risk of not breaking even and incurring a loss.*he formula for its calculation is+Margin of safety N *otal budgeted ' or actual ( sales - 3reakeven sales*he margin of safety can also be eEpressed in percentage form by dividing the margin of safety in dollars by total dollar sales+

Margin of safety percentage N Margin of safety in dollars F*otal budgeted 'or actual( sales in dollars

&mplications are-i. 2orecasting

ii. %ontrollingiii. 3udgetingiv. 4ricing.


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0&. What is the meaning of brea'een Anal!sis and point? Describe three approaches of brea'

een anal!sis (Ma!% )01)*. Discuss the usefulness and assumptions of +rea',een,point Anal!sis.

What are the limitation of +-# anal!sis?

+rea'een Anal!sis:

+rea',-en Anal!sis, one of the tools of %ost-?olume-4rofit $nalysis, determines the break-even

sales which is the units andFor sales dollars where total sales equals total costs 'eEpenses(.

3reak even analysis is a technique of profit planning that has been used for many years byaccountants, business eEecutives and some economists. &t is essential a device for integrating costs

revenues and output of the firm in order to illustrate the probable effects of alternative courses of action

upon net profits. &t is an aid to profit planning. &t has been defined a chart which shows the profitability or

otherwise of an undertaking at various level of activity and as a result indicates the point at which neither

profit nor loss is made. *he 3reak Dven %hart therefore, depicts the following information at various levels

of an activity+

&. ?ariable costs, fiEed costs and total costs.&&. 0ales ?alue

&&&. 4rofit or loss

&?. 3reakeven point, i.e. the point at which total costs ;ust equal or break even with sales. *hisis the activity point at which neither profit is made nor loss is incurred.

+rea'een point:

*he breakeven point is the volume of activity at which an organization’s revenues and eEpenses are

equal- #arold ". #ilton.

3reakeven point of an organizationFenterpriseFfirm is a pint where total revenueFsales proceedsFsale

or output equals total cost. &t indicates that the level of output F sales F sales proceeds F revenue at which the

firm recovers all its costs and neither neither earns a profit nor incurs loss. &n other words, this is a point of

zero profitability. )nce the firmFenterprise cross its breakeven point, its starts earning profit.

3reakeven point can be seen from the following eEample+

)utput *otal %ost *otal !evenueFsalesF0ales proceeds 4rofit

55 units *G-A55.55 *[email protected] -=55

>55 units *G-H55.55 *G-H55.55 5 '3D4(

655 units *G-==55.55 *G-=55.55 =55

7o firmF enterprise can remain satisfied with this level of output. Dach firmFenterprise would like to

move as far from this point as possible. 0imilarly, a firmF enterprise which is lower than the breakeven

point would like to devise strategies firs for reaching the breakeven point and thereafter crossing this pointat the earlier. 3ecause of a firm operates below the breakeven point it cannot survive for a longer time, as it

will then be functioning only with a drain on its aim of any firmFenterprise is to earn more and more profit

each concern would like to operate at the margin of safely and the lower the profit above breakeven point,

the lower is margins of safety. $t breakeven point the margin of softy is nil.

hree approaches of brea' een anal!sis


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i. %ontribution Margin $pproach

*he contribution margin approach to calculate the breakeven 'i.e. the point of zero profit or loss( is

based on the %?4 analysis concepts known as contribution margin and contribution margin ratio

%ontribution margin is the difference between sales and variable costs. %ontribution margin is the

difference between sales and variable costs. "hen calculated for a single unit, it is called unit contribution

margin. %ontribution margin ratio is the ratio of contribution margin to sales.

3D4 in 0ales 8nits+

"e learned that, at break-even point, the %?4 analysis equation is reduced to+ pE N vE 2%,"here p is the price per unit, / is the number of units, is variable cost per unit and F$ is total

fiEed cost.

0olving the above equation for E 'i.e. 3reak-even sales units(

3reak-even 0ales 8nits N E N 2% O ' p v(

0ince unit contribution margin '8nit %M( is equal to unit sale price 'p( less unit variable cost 'v(,

0o, 8nit %M N p v

*herefore, 3reak-even 0ales 8nits N E N 2% O 8nit %M,

3D4 in 0ales 1ollars-

3reak-even point in dollars can be calculated via+ 3reak-even 0ales 1ollars N 4rice per 8nit P

3reak-even 0ales 8nitsJ or 3reak-even 0ales 1ollars N 2% O %M ratio.

DEample

%alculate the break-even point in units and in sales dollars when sales price per unit is Q>9, variable

cost per unit is QB and total fiEed cost is QA,555.

0olution

%ontribution Margin per 8nit N ' Q>9 R QB ( N QA

3reak-even 4oint in 8nits N QA,555 O QA N =,555

3reak-even 4oint in 0ales 1ollars N =,555 P Q>9 or QA,555 O 5S N Q>9,555

ii. raphical Approach *he graphical approach has an T-aEis 'horizontal( that represents 8nits 'volume( and a U-aEis 'vertical(

that represents 1ollars and contains lines for+

&. 0ales&&. ?ariable costs 'DEpenses(

&&&. *otal %osts ' DEpenses(

*he point on the graph where the 0ales and *otal %ost 'DEpense( Cines intersect is the breakeven point.

$nother graph that is often used to compare how alternatives on pricing, variable costs, or fiEed costs

may affect net income 'profit( as volume changes is called a 4F? %hart or 4rofit-?olume /raph.

iii. -uation Approach$n alternative approach to finding the breakeven point is based on the profit equation. &ncome 'or

4rofit( is equal to sales revenue minus eEpenses. &f eEpenses are separated into variable and fiEed eEpenses,

the essence of the income 'profit( statement is captured by the following equation.

0ales revenue-variable eEpenses-fiEed eEpensesN profit*his equation can be restated as follows+V'8nit sales price( P'sales volume in units( W-V'8nit variable eEpense( P '0ales volume in

units(WN4rofit.


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V'8nit sales price( P'sales volume in units( W-V'8nit variable eEpense( P '0ales volume in

units(W- '2iEed eEpenses( N 3D4.

he usefulness of +rea',een Anal!sis.

3reakeven analysis provides useful information to management and lending institutions 'banks( in most

lucid and precise manner. &t is an effective and efficient reporting tool of financial management. *he

usefulness or importance of breakeven analysis can be enumerated as under+

i. 2air knowledge about the breakeven analysis can be help the banking to eEamine loan

proposal of a firmFenterprise.ii. 3reakeven analysis helps the bankers in assessing working capital requirement of a unitJ it

comes in handy to measure the future cost and revenue relationship and also helps to

determine the level of production. $s and when this level is known, the enterprise can also

play its future working capital requirements for the enterprises.iii. *his analysis helps in revealing clear pro;ections of profit planning of an enterprise at

different production level visavis the financial needs. &t also helps to find rate of return on

investment of capital at varying levels of production.iv. &t helps the banker in studying the pro;ection cost of production and profitability statement

of a unit prepared to show net position at a given level of output. 3elow breakeven point, the

average loss per unit increases as the volume of output declines. "hen the unit functions

above breakeven point they can maintain their profitability and be in a position to meet their

commitments and debt obligations. &n other words, when once a unit breakeven from the

onwards repayments of debt may begin for the terms loans granted by them. 8sually, till a

unit reaches the breakeven level of production repayment holding is granted by banks.v. 3reakeven analysis is a useful diagnostic tool. &t indicates the management the causes of

increasing breakeven point and falling profit. *he analysis of these causes will reveal to

management what action should be taken. $s a practical matter, a knowledge of where

breakeven lies can be quite useful to management in determining the need for action.

he assumptions of +rea',een Anal!sis.

3reak even analysis is based on certain assumption. *hese are as follows+

i. 2iEed %osts will tend to remain constant. &n other words, there will not be any change in cost factor

such as, change in property taE rate, insurance rate, salaries of staff etc. or in management policy.ii. 4rice of variable cost factors, i.e. wage rates, price of materials, supplies, services etc. will remain

unchanged so that variable costs are truly variable.iii. 4roduct specification and methods of manufacturing and selling will not undergo a change.iv. )perating efficiency will not increase or decrease.

v. *here will not be any change in pricing policy due to change in volume, competition etc. &n otherword, selling prices will remain unchanged as the volume eEpands.

vi. *he number of units of sales will coincide with the units produced so that there is no closing or

opening stock. $lternatively, the changes in opening and closing stocks are insignificant and that

they are valued at the same price, or at variable cost.

2imitation of brea'een anal!sis


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3reakeven analysis is a simple and useful concept. 3ut, it is based on certain assumptions which have

been discussed earlier. *hese assumptions may lit the utility and general applicability of breakeven

analysis. *herefore, the analysis should recognize these limitations and ad;ust the date wherever possible to

get meaningful results. 3reakeven analysis suffers from the following limitations+

i. &t may be difficult to segregate cost into fiEed and variable components.ii. &t is not correct to assumption that total fiEed cost into fiEed and variable components.

iii. *he assumptions of content unit variable cost are not valid.

iv. 0elling price may not remain unchanged over a period of time.v. 3reakeven analysis is a short run concept and has a limited use in long range planning.

$lthough breakeven analysis suffers from a number of limitations, yet are still remains as an important

tool of profit planning. "hat is needed is that the financial analysis should understand the underlying

assumptions and their corresponding limitations and ad;ust his F her data appropriately to suit his or her

need.

=5. 1efinition of cost-volume-profit analysis. 8ses and assumptions of %?4 analysis. 1iscuss the %?4

analysis as on aid to the management and what are the limitations of %?4 analysis have.

%ost-volume-profit '%?4( analysis is a powerful tool that helps managers understand the

relationships among cost, volume, and profit. %?4 analysis focuses on how profits are affected by thefollowing five factors+

=. 0elling prices.. 0ales volume.>. 8nit variable costs.6. *otal fiEed costs.9. MiE of products sold.

3ecause %?4 analysis helps managers understand how profits are affected by these key factors, it isa vital tool in many business decisions. *hese decisions include what products and services to offer, what prices to charge, what marketing strategy to use, and what cost structure to implement. %?4 analysis is based on a simple model of how profits respond to prices, costs, and volume.

%?4 analysis is a study of the relationships between sales volume, eEpenses, revenue and profit.

'!onald ". #iston.(

8ses of %?4 are-

i. 4lanning+ %?4 analysis uses to determining the production, sales and miEed product

planning.ii. $bility of earning profit+ analysis the cost-amount-profit determines the ability to

earn profit.iii. %ontrolling+ %?4 analysis control the additional cost by using several methods.iv. 0tability of earning profit.v. 1ecision making.

$ number of assumptions commonly underlie %?4 analysis+=. 0elling price is constant. *he price of a product or service will not change as volume changes.. %osts are linear and can be accurately divided into variable and fiEed elements. *he variable element is constant

per unit, and the fiEed element is constant in total over the entire relevant range.>. &n multiproduct companies, the sales miE is constant.6. &n manufacturing companies, inventories do not change. *he number of units produced equals the number of units

sold.

$id to the management+


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i. !educing the additional cost and maintain the lowest eEpenses.ii. 1etermining the amount of sales to earn profit.

iii. %hanging the cost, eEpense and amount determine the changing the profit.iv. %hanging the sales and miEed determining the changing the profit.v. %hanging the sales, eEpense and amount determining the breakeven point.

vi. %hanging the sales miEed determining the breakeven point.vii. 1etermining the new equipment and technology affects the cost-amount-profit.

viii. 1etermining what product or service is more profitable.

iE. 1etermining what product or service is stopped in production.

Cimitation of %?4 analysis+i. &t may be difficult to segregate cost into fiEed and variable components.

ii. &t is not correct to assumption that total fiEed cost into fiEed and variable components.iii. *he assumptions of content unit variable cost are not valid.iv. 0elling price may not remain unchanged over a period of time.v. %?4 analysis is a short run concept and has a limited use in long range planning.

vi. 8nchanged of production technology uses.vii. &f a single unit is change may not determining the change of %?4.

viii. 0elling and production is same.

iE. $ll cost is determining the fiEed and variable cost.E. *arget scale of production of fiEed cost is unchanged.

Module-c + 3udgeting and eEpenditure

5=. "hat do you mean by budget


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$ budget is a monetary and F or quantitative eEpression of business plans and policies, prepared in advance,

to be pursued in the future period of time.

$ccording to certified institute of management accountants, “$ budget is a financial and F or quantitative

statement prepared prior to a defined period of time, of the policy to be pursued during that period for the purpose of

attaining the ob;ective”.

“$ budget is quantitative plan for acquiring and using resources over a specified time period”-/arrison,

7oreen and brewer.

&n brief, it is a systematic plan for utilization of manpower and other resources. &t acts as a barometer of a

business as it measures the success from time to time, against the standard set for achievement.

3udgeting is a technique for formulating budget.

5. "hat are the %haracteristics of a budget

*he main characteristics of a budget are-

i $ comprehensive business plan showing what the enterprise wants to achieve .ii 4repared in advance

iii 2or a definite period of timeiv DEpressed in quantitative form, physical or monetary terms or bothv 2or achieving a given ob;ective

vi $ proper system of accounting is essential

vii 0ystem of proper fiEation of authority and responsibility has to be in place.

5>. "hat are the benefits of budgeting

)rganizations realize many benefits from budgeting including-

• 3udget communicates management’s plans throughout the organization.

• 3udget force managers to think about and plan for the future. &n the absence of the necessity to prepare a

budget, many managers would spend all of their time dealing with daily emergencies.

• *he budgeting process provides a means of allocating resources to those parts of the organization where they

can be used most effectively.

• *he budgeting process can uncover potential bottlenecks before they occur.

• 3udgets coordinate the activities of the entire organization by integrating the plan of its various parts.

3udgeting helps to ensure that everyone in the organization is pulling in the same direction.

• 3udgets define goals and ob;ectives that can serve as benchmarks for evaluating subsequent performance.

56. "hat are the principles of budgeting

0tate the principles of budgeting+

i Management sponsorshipii )rganization structure

iii 3udget center


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iv 3udget periodv !eality

vi 2leEibilityvii 2ulfillness

viii %onsultative 1irectioniE DconomyE Cimiting factor

Ei !ectificationEii *raining

59. 7arrate the steps of budgeting or what are the steps involved in the construction of a cash budget

i 0etting up ob;ectives and principlesii 4reparation of forecast

iii 4reparation of draft budgetiv $pproved of draft budgetv 4reparation of final budget

vi $pproved of the budget andvii )rder issuance

5@. 1efine of the cash budget. 1iscuss the utility of cash budget as a tool of the cash

management.

$ cash budget is an estimate of cash receipts and disbursements during a future period. *he anticipated cash

receipts from various sources are taken into account. 0imilarly, the amount to be spent on various heads, both

revenue and capital, are taken into cash budget. &n short, it is a summary of cash intake and outlay.

“%ash budget is the forecasting the future cash flow” ?an #orne.

“%ash budget is the comparative forecasting of cash receipts and disbursement of specific time period” /ohen : robins.

%ash budget is a tool of the cash management+

i. %ash budget provides the information when it is need.ii. %ash budget indicate the product life cycle and management takes proper action for future

action.iii. %ash budget estimates the taEes amount, dividend amount, Coan amount, 4reference share

capital amount and pension funds.iv. $t a certain time, organization can know the fund for short or long term investment or other

activities.

5A. 0tate the differences between cash budget and cash flow statement.

$ cash budget is an estimate of cash receipts and disbursements during a future period. *he anticipated cash

receipts from various sources are taken into account. 0imilarly, the amount to be spent on various heads, both

revenue and capital, are taken into cash budget. &n short, it is a summary of cash intake and outlay.

$ cash flow statement is a statement, which describes the inflows 'sources( and outflows 'uses( of cash and

cash equivalents during a specified period. &t is a summary of cashbook. $ cash flow statement eEplains the causes of

changes in cash position of a business enterprise between two dates of balance sheets. %ash flow statement is a tools

that is available to the management to assess, monitor and control the liquidity available in the enterprise. %onversion

of cash into cash equivalents and vice versa does not constitute cash flows because they are not part of operating,financing and investing activities. %ash management includes the investment of cash into cash equivalents and vice

versa. $ cash flow statement may be defined as “a financial statement that summarizes the cash receipts and

payments and net changes resulting from operating, financing and investing activities of an enterprise during a given

period of time.

5B. "hat do you understand by Master 3udget #ow a master budget can be used as a control tool

&n an organization, the term master budget refers to a summary of a company’s plans including specific

targets for sales, production, and financing activities. *he master budget which culminates in a cash budget, a

budgeted income statement, and a budgeted balance sheet-formally lays out the financial aspects of management’s

plans for the future and assists in monitoring actual eEpenditures relative to those plans.


18/50

3udgets are used for two distinct purposes- planning and controlling. 4lanning involves developing goals

and preparing various budgets to achieve those goals. %ontrol involves the steps taken by management to increase the

likelihood that all parts of the organization are working together to achieve the goals set down at the planning stage.

*o be effective, a good budgeting system must provide for the both planning and control. /ood planning without

effective control is a waste of time and effort.

$ master budget can be used as a control tool-

i 4repare planningii 8se as a standard

iii $ctual resultiv %omparative analysisv %oordinate and control.

5H. "hat is budgetary control

3udgetary control is the process of determining various budgeted figures for the enterprise and then

comparing the actual performance with the budgeted figures for calculating the variances, if any. &n this process, first

budgets are to be prepared. 0econd, actual results are to be recorded. *hird, comparison is to be made between the

actual with the planned action for calculating the variances. )nce the discrepancies are known, remedial measures

are to be taken, at proper time. *hen only, planned results can be achieved. $ budget is a means and budgetary

control gives the end result.

“ *he establishment of budgets relating to the responsibilities of eEecutives to the requirements of a policy,

and the continuous comparison of the actual with the budgeted result, either to secure by individual action the

ob;ective of the policy or to provide a basis its revision” *he %hartered &nstitute of Management $ccountants,

Condon.

*hus, establishment of budgetary control involves the following+

i Dstablishment of budgets.ii %ontinuous comparison of actual with the budgets for achievement of targets and fiEing the

responsibility for failure to achieve the budget figures.iii !evision of budget in the light of changed circumstances.

=5. )b;ectives of budgetary control.

*he main ob;ectives of budgetary control are as under-i *o coordinate the activities of different department

ii *o operate various cost centers and departments with efficiency and economy.iii 2iEation of responsibility of various individuals in the organization.iv *o ensure a system for correction of deviations from established standards.v *o centralize the control system and

vi *o ensure planning for future by setting up various budgets.

==. !equisites for successful budgetary control system

*he following requites are essential for effective budgetary control system.

i 1etermination of the ob;ectives+ *here should be clear perspective of the ob;ectives to be achieved

through the budgetary control system. &n most of the cases , the basic ob;ective is to achieve

desiredFincreased profits. *o achieve, the following problems are to be sorted out. '=( Caying down


19/50

the plan for implementation to achieve the ob;ectives and '( 3ringing coordination amongst the

different department and controlling each function so as to bring the best possible results.ii 4roper delegation of authority and responsibility+ *he first step is to have clear organization chart

eEplaining the authority and responsibility of each individual eEecutives. *here should be no

uncertainty regarding the point when the ;urisdiction of one authority ends and that another begins.iii 4roper communication system+ *he flow of information should be quick so that the budgets are

implemented. *wo way communications is important.iv 4articipation of all employees+ 3udget preparation and control are done at the top level. #owever

involvement of all persons, including at the lower level, is necessary in framing the budget and itsimplementation for the success of budgetary control.

v 2leEibility+ 2uture is uncertain. 1espite the best planning and foresight, still there may be

occurrences that may require ad;ustment. 3udgets should work in the charged circumstances

2leEibility in budgets is required to make them work under changed circumstances.vi Motivation+ 3udgets are eEecuted by human beings. *here should be incentive in achieving the

required targets. $ll persons should be motivated to improve their working to achieve the goals set in

the budgets.

=. Dssential steps for installation of budgetary control systems.

&n order to have effective budgetary control system, it is appropriate to take the following steps+

i. 3udget Manual+ *his is a written document specifying the ob;ectives and procedures of budgetarycontrol. &t helps out the duties and responsibilities of eEecutives. *he budget manual defines the

sanctioning powers of the various authorities.ii. 3udget centers+ $ budget center is that part of organization for which the budget is prepared. 3udget

center can be a department, section of a department or any other part of department. 3udget centers

are necessary for the purpose of ascertaining cost, performance and its control.iii. 3udget committee+ &n a large concern, all the functional heads are the members of the budget

committee. *hey discuss their respective budgets and finalize the budget, after collective decisions.

*he committee is responsible for its eEecution and achievement of the goals set.iv. 3udget officers+ *he chief eEecutive appoints some person as the budget officer. $s the convener of

the budget committee, his function is coordination to ensure the achievement of the budgeted targets.

v. 3udget period+ $ budget period is the length of the period for which budget is prepared.vi. 1etermination of key factor+ 3udgets are prepared for all the functional areas such as production

sales, purchases, finance, human resources and research : development and so the budgets are. $

factor, which influences all other budgets, is known as key factor or principal factor.

=>. "hat is the importance’s or advantages of budgetary control 1iscuss briefly the importance of

budgetary control system with special reference to banking organization.

3udgetary control acts as an important tool for the management to economize costs and maEimize profit. *he

system helps the management to set the goals. *he current performance is compared with the pre-planned

performance to ascertain deviations so that corrective measures are taken. "ell at the right time. &n this way

budgetary control system acts as a friend, philosopher and guide to the management. *he following are the

advantages of budgetary control system.

i. 4rofit maEimization+ *he resources are put to best possible use, eliminating wastage. 4roper control

is eEercised both on revenue and capital eEpenditure. *o achieve this, proper planning and

coordination of various function is undertaken. 0o, the system helps in reducing losses and

increasing profits.ii. %oordination+ the budgets of various departments have a bearing with each other, as activities are

inter-related. $s the size of operations increases, coordination amongst the different departments for

achieving a common goal assumes more importance. *his is possible through budgetary control

system.


20/50

iii. %ommunication+ $ budget serves as a means of communicating information throughout the

organization. $ sales manager for a district knows what is eEpected of his performance. 0imilarly,

production manager knows the amount of material, labor and other eEpenses that can be incurred by

him to achieve the goal set to him. 0o, every department knows the performance eEpectation and

authority for achieving the same.iv. *ools for measuring performance+ 3udgetary control system provides a tool for measuring the

performance of various departments. *he performance of each department is reported to the top

management.

v. Dconomy+ 4lanning at each level brings efficiency and economy in the working of the businessenterprise. !esources are put to optimum use to achieve economy. $ll this leads to elimination of

wastage and achievement of overall efficiency.vi. 1etermining weaknesses+ $ctual performance is compared with the planned performance

periodically, and deviations are found out. *his shows the variances highlighting the weakness

where concentration for action is needed.vii. %onsciousness+ 3udgets are prepared in advance. 0o, every employee knows what is eEpected of him

and they are made aware of their responsibility. *hey do their ;ob uninterrupted for achieving what is

set to him to do.viii. *imely corrective action+ *he deviations will be reported to the attention of the top management as

well as functional heads for suitable corrective action, in time.

iE. Motivation+ 0uccess is measured by comparing the actual performance with the planning performance.

E. Management by eEeception+ *he management is required to eEercise action only when there are

deviations. 0o, long as the plans as achieved, management need not be alerted. *his system enables

the introduction of management by eEception for effective delegation and control.

=6. Mention the limitations of budgetary control.

i. 8ncertainty of future.ii. 4roblem of coordination

iii. 7ot a substitute for managementiv. 1iscourages efficiency

v. *imely revision requiredvi. %onflict among different departments

vii. 1epends upon support of top management.

=9. 1efine capital budgeting. "hat are the importance features of %apital budgeting 1iscuss the use of

the time value of money in capital budgeting.

$ capital eEpenditure may be defined as an eEpenditure, the benefit of which is spending over a

period eEceeding one year. *he main feature of a capital eEpenditure is that the heavy eEpenditure is

incurred at one period of time while the benefits of the eEpenditure are spread at different points of time, in

future.

*he investment decisions of a firm are generally known as capital budgeting or capital eEpenditure

decisions. *he capital budgeting is concerned with allocation of the firm’s scarce financial resources in the

long-term pro;ects, the benefits occur over a future period. %apital budgeting may be defined as the firm’s

decision to invest current funds in long-term assets to get the benefits over the years.


21/50

“%apital budgeting is a process of evaluating selection among proposed capital investment”-Golb $

3arton.

%haracteristics+

i. %ost of long term capitalii. 2orecasting

iii. Carge volume of investmentiv. %onsidering $ssetsv. %ash flow

vi. !isk

*he use of the time value of money in capital budgeting+

&nvestment decisions are of great importance to any concern. *hese decisions involve commitment

of a large sum of money. *hey affect the profitability of the enterprise, greatly. *hese decisions are difficult

to make. *he need, significance or importance of these decisions is due to the following reasons+i. Carge investments+ 2unds are limited and opportunities are abundant. %apital eEpenditure

decisions involve commitment of large sums of money. &f funds are committed to one

pro;ect, other pro;ects are denied. 0o, a great deal of planning is necessary before the capital

eEpenditure.ii. /rowth and profitability+ *he direction of growth is set by the capital eEpenditure. &f the

eEpenditure goes in the right direction, the organization gets a boost in the profitability. &f

the decision is wrong, it is fatal for its growth or at times, even the profitable concern may

suffer due to their heavy financial implications.iii. &rreversible nature+ Most investment decisions are irreversible. )nce these assets are

acquired, their disposal is difficult as there is no ready market and, often, results in heavy

losses. 1ue to this long term implications, decisions are taken after careful planning. More

often, the decisions cannot be reversed, without substantial loss.iv. 1ifficulties of investment decisions+ *he impact of investment decision is not limited for

one year. &ts influence spreads over a series of years. 2uture is uncertain and so it is difficultto forecast its impact over the period of the life of the assets. &t is difficult to estimate the

future cash flows, accuratelyJ economic, political, social and technological forces cause the

uncertainty of the cash flows.v. !isk+ Cong term commitment of funds changes the risk profile of the firm. $doption of a

profitable investment increases the earnings per share but causes a change in the earning

pattern. $s future is uncertain, there is no guarantee for the continuation of the same earning

positively. *hus, investment decisions shape the basic character of the firm.

=9. 1iscuss the techniques of capital budgeting.

%apital budgeting techniques are, broadly, divided into two categories. *hey are discounted and non-discounted techniques.

'=( 1iscounted techniques+

i. 7et present value '74?(ii. &nternal rate of return '&!!(

iii. 4rofitability &ndeE '4&(iv. 1iscounted payback period '144(

'(7on-discounted techniques+

i. 4ayback period '43(ii. $ccounting rate of return '$!!(


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#ow we can achieve control of business operations of a bank through budget and standard costing

techniques

Net present value (NPV): the best method for evaluation of investment proposals is

the net present value method or discounted cash ow technique. The net present value

technique explicitly recognizes the time value of money. This technique recognizes the cash

ows, arising at dierent time periods, diers in value and is comparable only when their

present values are found out. It is the measure of rm!s protability. It increases the value ofthe rm!s share price and contributes to the maximization of the shareholders! wealth.

Internal rate of return method" The internal rate of return #I$$% method is another

discounted cash ow technique which ta&es into account the magnitude and timing of cash

ows. I$$ is simple to understand, in case of one'period pro(ect. In I$$ technique, the future

cash ows are discounted in such a way that their total present value is (ust equal to the

present value of the total cash ows. The time schedule of occurrence of the future cash

ows is &nown, but the discount rate is not &nown. The discount rate is present ascertained

by the trial and error method, where the present value of future inows is equal to the

present value of outows, which is &nown as internal rate of return.

#rofitabilit! nde/ '4&( is a measure of investment efficiency. &t is a good tool for ranking pro;ects

because it allows you to clearly identify the amount of value created per unit of investment, thus if you are

capital constrained you wish to invest in those pro;ects which create value most efficiently first.

4rofitability &ndeE N '7et 4resent ?alue &nitial &nvestment( F &nitial &nvestment ... where the &nitial

&nvestment is the 7et %ost at installation 'year 5(

Protability Index = Present Value of Future Cash Flos !enerated by the

Pro"e#t$Initial Investment in the Pro"e#t%

A discounted pa!bac' period: $ capital budgeting procedure used to determine the profitability of

a pro;ect. &n contrast to an 74? analysis, which provides the overall value of an pro;ect, a discounted

payback period gives the number of years it takes to break even from undertaking the initial eEpenditure

2uture cash flows are considered are discounted to time Xzero.X *his procedure is similar to a payback

periodJ however, the payback period only measure how long it take for the initial cash outflow to be paid

back, ignoring the time value of money.

Payba#& period method:

The paybac& period method #)*% is one of the most popular and widely recognizedtraditional methods of evaluating investment proposals. )aybac& method is dened as the

number of years required to recover the original cash outlay invested in a pro(ect. If the

pro(ect gives constant annual cash ows, the paybac& period can be calculated by dividing

cash outlay by the annual cash inow. The formula for calculation of paybac& period, when

the cash inows are constant is as follows"

)aybac& period+ initial investment annual cash inow.


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The accounting rate of return:

*he accounting rate of return is used in capital budgeting to estimate whether you should proceed

with an investment. *he calculation is the accounting profit from the pro;ect, divided by the initial

investment in the pro;ect. Uou would then accept a pro;ect if the measure yields a percentage that eEceeds a

certain hurdle rate used by the company as its minimum rate of return

*he formula for the accounting rate of return is N $verage annual accounting profit F &nitial

investment

The accounting rate of return #-$$% is a very simple #in fact overly simple% rate of

return. -ccounting rate of return #-$$% + average prot average investment.

+asic formulae 4

"hat types of proposals or pro;ect for capital budgeting+

i !eplacementii DEpansion

iii 1iversificationiv !esearch and developmentv Miscellaneous.

1iscuss the steps of capital budgeting process.

i 4ro;ect generation

ii Dvaluate the finance

What is liuidit!? 5r define liuidit!.

*he ability of an asset to be converted into cash quickly and without any price discount is called

liquidity. Ciquidity refers to how quickly and cheaply an asset can be converted into cash. Money 'in the

form of cash( is the most liquid asset. $ssets that generally can only be sold after a long eEhaustive search

for a buyer are known as illiquid.

1efinition of Ciquidity is+

http://www.accountingtools.com/overview-of-capital-budgetinghttp://www.accountingtools.com/overview-of-capital-budgetinghttp://www.accountingtools.com/profit-definitionhttp://www.accountingtools.com/hurdle-ratehttp://www.investorwords.com/273/asset.htmlhttp://www.investorwords.com/747/cash.htmlhttp://www.investorwords.com/3807/price.htmlhttp://www.investorwords.com/1471/discount.htmlhttp://www.accountingtools.com/overview-of-capital-budgetinghttp://www.accountingtools.com/profit-definitionhttp://www.accountingtools.com/hurdle-ratehttp://www.investorwords.com/273/asset.htmlhttp://www.investorwords.com/747/cash.htmlhttp://www.investorwords.com/3807/price.htmlhttp://www.investorwords.com/1471/discount.html


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= *he degree to which an asset or security can be bought or sold in the market without affecting the

assetLs price. Ciquidity is characterized by a high level of trading activity. $ssets that can be easily

bought or sold are known as liquid assets. *he ability to convert an asset to cash quickly. $lso known as XmarketabilityX.

*here is no specific liquidity formulaJ however, liquidity is often calculated by using liquidity ratios.

&n accounting, liquidity 'or accounting liquidity( is a measure of the ability of a debtor to pay their

debts as and when they fall due. &t is usually eEpressed as a ratio or a percentage of current liabilities

( 6o7 the liuidit! position can be measured? 5r ho7 do the 7a! of liuidit! condition measured?*

2or a corporation with a published balance sheet there are various ratios used to calculate a measure ofliquidity. *hese include the following+

i *he current ratio, which is the simplest measure and is calculated by dividing the total current assets by the total current liabilities. $ value of over =55S is normal in a non-banking corporation.#owever, some current assets are more difficult to sell at full value in a hurry.

ii *he quick ratio - calculated by deducting inventories and prepayments from current assets and thendividing by current liabilities - gives a measure of the ability to meet current liabilities from assetsthat can be readily sold. $ better way for a trading corporation to meet liabilities is from cash flows,

rather than through asset sales, soJiii *he operating cash flow ratio can be calculated by dividing the operating cash flow by current

liabilities. *his indicates the ability to service current debt from current income, rather than throughasset sales.

What is liabilit! management?

8se and management of liabilities, such as customer deposits, by a bank in order to facilitate

lending and allow for balanced growth. Management of money accepted from depositors as well as funds

secured from other institutions constitute liability management. &t also involves hedging against changes in

interest rates and controlling the gap between the maturities of assets and liabilities.

&n banking, asset and liability management 'often abbreviated $CM( is the practice of managing

risks that arise due to mismatches between the assets and liabilities 'debts and assets( of the bank. *his can

also be seen in insurance.

3anks face several risks such as the liquidity risk , interest rate risk , credit risk and operational risk .

$sset liability management '$CM( is a strategic management tool to manage interest rate risk and liquidity

risk faced by banks, other financial services companies and corporations.

3anks manage the risks of asset liability mismatch by matching the assets and liabilities according

to the maturity pattern or the matching of the duration, by hedging and by securitization.

Modern risk management now takes place from an integrated approach to enterprise risk

management that reflects the fact that interest rate risk , credit risk , market risk , and liquidity risk are all

interrelated.

What t!pes of sources can use of liabilit! management?, 8arrate in short.

http://en.wikipedia.org/wiki/Accountinghttp://en.wikipedia.org/wiki/Accountinghttp://en.wikipedia.org/wiki/Debtorhttp://en.wikipedia.org/wiki/Ratiohttp://en.wikipedia.org/wiki/Percentagehttp://en.wikipedia.org/wiki/Liability_(accounting)http://en.wikipedia.org/wiki/Balance_sheethttp://en.wikipedia.org/wiki/Current_ratiohttp://en.wikipedia.org/wiki/Current_ratiohttp://en.wikipedia.org/wiki/Quick_ratiohttp://en.wikipedia.org/w/index.php?title=Operating_cash_flow_ratio&action=edit&redlink=1http://en.wikipedia.org/wiki/Operating_cash_flowhttp://en.wikipedia.org/wiki/Current_liabilitieshttp://en.wikipedia.org/wiki/Current_liabilitieshttp://en.wikipedia.org/wiki/Current_liabilitieshttp://en.wikipedia.org/wiki/Riskhttp://en.wikipedia.org/wiki/Riskhttp://en.wikipedia.org/wiki/Liquidity_riskhttp://en.wikipedia.org/wiki/Interest_rate_riskhttp://en.wikipedia.org/wiki/Interest_rate_riskhttp://en.wikipedia.org/wiki/Credit_riskhttp://en.wikipedia.org/wiki/Operational_riskhttp://en.wikipedia.org/wiki/Operational_riskhttp://en.wikipedia.org/wiki/Strategic_managementhttp://en.wikipedia.org/wiki/Bankhttp://en.wikipedia.org/wiki/Bankhttp://en.wikipedia.org/wiki/Corporationhttp://en.wikipedia.org/wiki/Corporationhttp://en.wikipedia.org/wiki/Asset_liability_mismatchhttp://en.wikipedia.org/wiki/Assethttp://en.wikipedia.org/wiki/Liabilitieshttp://en.wikipedia.org/wiki/Securitizationhttp://en.wikipedia.org/wiki/Risk_managementhttp://en.wikipedia.org/wiki/Risk_managementhttp://en.wikipedia.org/wiki/Interest_rate_riskhttp://en.wikipedia.org/wiki/Interest_rate_riskhttp://en.wikipedia.org/wiki/Credit_riskhttp://en.wikipedia.org/wiki/Market_riskhttp://en.wikipedia.org/wiki/Market_riskhttp://en.wikipedia.org/wiki/Liquidity_riskhttp://en.wikipedia.org/wiki/Accountinghttp://en.wikipedia.org/wiki/Debtorhttp://en.wikipedia.org/wiki/Ratiohttp://en.wikipedia.org/wiki/Percentagehttp://en.wikipedia.org/wiki/Liability_(accounting)http://en.wikipedia.org/wiki/Balance_sheethttp://en.wikipedia.org/wiki/Current_ratiohttp://en.wikipedia.org/wiki/Quick_ratiohttp://en.wikipedia.org/w/index.php?title=Operating_cash_flow_ratio&action=edit&redlink=1http://en.wikipedia.org/wiki/Operating_cash_flowhttp://en.wikipedia.org/wiki/Current_liabilitieshttp://en.wikipedia.org/wiki/Current_liabilitieshttp://en.wikipedia.org/wiki/Riskhttp://en.wikipedia.org/wiki/Liquidity_riskhttp://en.wikipedia.org/wiki/Interest_rate_riskhttp://en.wikipedia.org/wiki/Credit_riskhttp://en.wikipedia.org/wiki/Operational_riskhttp://en.wikipedia.org/wiki/Strategic_managementhttp://en.wikipedia.org/wiki/Bankhttp://en.wikipedia.org/wiki/Corporationhttp://en.wikipedia.org/wiki/Asset_liability_mismatchhttp://en.wikipedia.org/wiki/Assethttp://en.wikipedia.org/wiki/Liabilitieshttp://en.wikipedia.org/wiki/Securitizationhttp://en.wikipedia.org/wiki/Risk_managementhttp://en.wikipedia.org/wiki/Risk_managementhttp://en.wikipedia.org/wiki/Interest_rate_riskhttp://en.wikipedia.org/wiki/Credit_riskhttp://en.wikipedia.org/wiki/Market_riskhttp://en.wikipedia.org/wiki/Liquidity_risk


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i *ime certificate of deposit+ &n $merica from the =H@5 the main sources of the liability

liquidity management is time certificate of deposit of commercial banks. &t is salable and

transferable. *his certificate is H5 days or = year and interest rate is determined comparing

the treasure bills and other instrument.ii Coan from other commercial bank+ *he second liability is the loan from other commercial

banks.iii Coan from the central bank.

iv &ssue shares.v Coan from the reserve fund.

What do !ou mean b! ratio anal!sis?

enition of /$atio -nalysis/

$ tool used by individuals to conduct a quantitative analysis of information in a companyLs financial

statements. !atios are calculated from current year numbers and are then compared to previous years, other

companies, the industry, or even the economy to ;udge the performance of the company. !atio analysis is

predominately used by proponents of fundamental analysis.

*here are many ratios that can be calculated from the financial statements pertaining to a companyLs

performance, activity, financing and liquidity. 0ome common ratios include the price-earnings ratio, debt-

equity ratio, earnings per share, asset turnover and working capital.

What do !ou mean b! financial anal!sis?

*he term financial analysis is also known as analysis and interpretation of financial statement.

“2inancial analysis is the process of identifying the financial strengths and weaknesses of the firm, by

properly establishing the relationships between the items contained in balance sheet and profit and loss

account”-%$.%. !ama /opal.

2inancial analysis 'also referred to as financial statement analysis or accounting analysis or $nalysis of

finance( refers to an assessment of the viability, stability and profitability of a business, sub-business or

pro;ect. &t is performed by professionals who prepare reports using ratios that make use of information

taken from financial statements and other reports. *hese reports are usually presented to top management as

one of their bases in making business decisions.

i %ontinue or discontinue its main operation or part of its businessJii Make or purchase certain materials in the manufacture of its productJ

iii $cquire or rentFlease certain machineries and equipment in the production of its goodsJiv &ssue stocks or negotiate for a bank loan to increase its working capitalJv Make decisions regarding investing or lending capitalJ

vi )ther decisions that allow management to make an informed selection on various alternatives in theconduct of its business.

http://en.wikipedia.org/wiki/Businesshttp://en.wikipedia.org/wiki/Projecthttp://en.wikipedia.org/wiki/Financial_statementshttp://en.wikipedia.org/wiki/Stockshttp://en.wikipedia.org/wiki/Stockshttp://en.wikipedia.org/wiki/Loanhttp://en.wikipedia.org/wiki/Working_capitalhttp://en.wikipedia.org/wiki/Working_capitalhttp://en.wikipedia.org/wiki/Businesshttp://en.wikipedia.org/wiki/Projecthttp://en.wikipedia.org/wiki/Financial_statementshttp://en.wikipedia.org/wiki/Stockshttp://en.wikipedia.org/wiki/Loanhttp://en.wikipedia.org/wiki/Working_capital


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*he goals of the financial analysts often assess the following elements of a firm+

= 4rofitability - its ability to earn income and sustain growth in both the short- and long-term.

$ companyLs degree of profitability is usually based on the income statement, which reports

on the companyLs results of operationsJ

0olvency - its ability to pay its obligation to creditors and other third parties in the long-

termJ

> Ciquidity - its ability to maintain positive cash flow, while satisfying immediate obligationsJ

6 0tability - the firmLs ability to remain in business in the long run, without having to sustain

significant losses in the conduct of its business. $ssessing a companyLs stability requires the

use of the income statement and the balance sheet, as well as other financial and non-

financial indicators.

*he method of financial analysts often compares financial ratios 'of solvency, profitability, growth, etc.(+

i 4ast 4erformance - $cross historical time periods for the same firm 'the last 9 years for eEample(,ii 2uture 4erformance - 8sing historical figures and certain mathematical and statistical techniques,

including present and future values, *his eEtrapolation method is the main source of errors infinancial analysis as past statistics can be poor predictors of future prospects.

iii %omparative 4erformance - %omparison between similar firms.

*hese ratios are calculated by dividing a 'group of( account balance's(, taken from the balance sheet

and F or the income statement, by another, for eEample +

7et income F equity N return on equity '!)D(

7et income F total assets N return on assets '!)$(

0tock price F earnings per share N 4FD ratio

What are the comparison of financial and ratio anal!sis?

%omparing financial ratios is merely one way of conducting financial analysis. 2inancial ratios face several

theoretical challenges+

i *hey say little about the firmLs prospects in an absolute sense. *heir insights about relative performance require a reference point from other time periods or similar firms.

ii )ne ratio holds little meaning. $s indicators, ratios can be logically interpreted in at least two ways.)ne can partially overcome this problem by combining several related ratios to paint a morecomprehensive picture of the firmLs perfo

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