Financial Management

CAIIB -MODULE DPresentation by

S.D.BargirJoint 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, pricing decision, control, prevent wastages, basis for tenders, effective use of resources, 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 = Contribution30 18 = 1228 18 = 1026 18 = 824 18 = 620 18 = 218 18 = 017 18 = (1)

Marginal costing problems SP = Rs.30, VC =Rs.18 Fixed Cost

Rs.102000Find- Break even point (in Rs. & in units)- C/S ratio- Sales to get profit of Rs.66000

Solution to problem SP = Rs.30, VC =Rs.18 Fixed Cost

Rs.102000Find Break even point (in Rs. & in units) C/S Ratio, Sales

to get profit of Rs.66000 Contribution per unit = Rs. 30 less Rs.18 =Rs.12 C/S Ratio = 12/30 =0.40 =40% BEP units = 102000/ 12=8500 BEP sales (in Rs.) =8500 X 30 =255000 contribution= FC+ target profit= 102000+66000=168000 Unit to get profit of Rs.66000= 168000/12 =14000 Sales to get profit of Rs.66000=14000 x 30 =420000

Marginal costing problems Sales Rs.150000 Fixed Cost Rs.30000 B.E.Point Rs.60000 What is profit ?

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

sp vc Contribution

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 factorsSP 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 futureYear Cash flow0 (100000)1 300002 400003 500004 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 appraisalDISCOUNTING 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% PV1 1000 0.893 8932 2000 0.799 15943 2000 0.712 14244 3000 0.636 19085 3000 0.567 17016 4000 0.507 20287 4000 0.452 18088 5000 0.404 2020

13376

Problem Year Cash flow PV factor

@15% PV0 (50000) 1 (50000)1 100002 100003 200004 200005 300006 200007 10000

Solution to Problem Year Cash flow PV factor

@15% PV0 (50000) 1 (50000)1 10000 0.870 86962 20000 0.756 151233 30000 0.658 197254 30000 0.572 171535 30000 0.497 149156 20000 0.432 86477 10000 0.376 3759

38018

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

@12% PV1 1000 0.893 8932 2000 0.799 15943 2000 0.712 14244 3000 0.636 19085 3000 0.567 17016 4000 0.507 20287 4000 0.452 18088 5000 0.404 2020

13376

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

@10% PV1 2000 0.909 18182 2000 0.826 16523 2000 0.751 15024 3000 0.683 20495 3000 0.621 18636 4000 0.564 22567 4000 0.513 20528 5000 0.466 2330

15522

CALCULATION NPV/IRROutlay PV @10% PV @ 12% NPV15000 15522 - 52215000 - 13376 (1624)Difference - - 2146

IRR continuedIRR= 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

Year Cash Flow Dis. Factor Present@20% Value

0 -102 1 -1021 51 0.833 42.482 51 0.694 35.393 61 0.578 35.26

NPV 11.14

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

NPV 0

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.

IRR

The evaluation of any project depends on the magnitude of the cash flows, the timing and the discount rate.

The discount rate is highly subjective. The higher the rate , the less a rupee in the future would be worth today.

The risk of the project should determine the discount rate.

Problems We will see more problems

immediately after discussion of other topics

PRICING DECISIONS Full cost pricing Conversion cost pricing Marginal cost pricing Market based pricing

Full cost pricing It is cost plus profit e.g. if variable plus fixed

cost is Rs.30 per unit and if the profit expected is 25% ,then the selling price would be Rs.37.50 (30+7.50)

Suitable when product is differentiated and product is not subject to competition.

It cannot be applied when no of products are more than one as % of profit differs with the product

Conversion cost pricing Direct Labour and Direct Overhead

cost is considered ignoring material cost

Selling price higher for product having greater conversion cost

Marginal cost pricing SP=VC = contribution Short term pricing decisions Pricing decision in export market Pricing decision in different market Pricing to tide over surplus capacity Accepting additional order at lower

price

Market based pricing Works on variable principle which

means that price is based on ‘value to the customer’ It is a premium price for specialized goods and services

It can be based on the price charged by the competitors

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

Working Capital Definition- Excess of CA over CL Existing company- new capital outlay-

addl. W.C requirement Sources of W.C.

Long term Short term- OD, Trade credit

Components of WC Permanent Variable ( seasonal)

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

OPERATING CYCLE The longer the operating cycle – the

more fin. Resources How to keep the cycle shorter

Debtors- quick collection Finished goods- turnover rapidly Raw Material – reduce stock level Work in progress- shorten the period

Working Capital Assessment Projected Balance Sheet Method

Forms I, III, IV, VI Financial follow up Report (FFR-I- quarterly) Financial follow up Report (FFR-II- half yearly)

Cash Budget Method- Seasonal industry/ construction company

Turnover Method- SSI

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***