Financial Management CAIIB -MODULE D Presentation by S

Financial Management CAIIB -MODULE D Presentation by S. D. Bargir Joint Director, IIBF

Module D topics o o Marginal Costing Capital Budgeting Cash Budget Working Capital

COSTING o o 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 o o 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 o o 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 formula Sales price (-) variable cost= contribution SP less VC = Contribution 30 18 = 12 28 18 = 10 26 18 = 8 24 18 = 6 20 18 = 2 18 18 = 0 17 18 = (1)

Marginal costing problems SP = Rs. 30, VC =Rs. 18 Fixed Cost Rs. 102000 Find - Break even point (in Rs. & in units) - C/S ratio - Sales to get profit of Rs. 66000 o

Solution to problem o SP = Rs. 30, VC =Rs. 18 Fixed Cost Rs. 102000 Find Break even point (in Rs. & in units) C/S Ratio, Sales to get profit of Rs. 66000 o Contribution per unit = Rs. 30 less Rs. 18 =Rs. 12 o C/S Ratio = 12/30 =0. 40 =40% o BEP units = 102000/ 12=8500 o BEP sales (in Rs. ) =8500 X 30 =255000 o o o 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 o o Sales Rs. 150000 Fixed Cost Rs. 30000 B. E. Point Rs. 60000 What is profit ?

Management decisions- assessing profitability CONTRIBUTION/SALES=C. S. RATIO Produ ct sp vc Contrib ution 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 Contribution Per unit Labour hr. pu 6 4 2 1 Contri. per hr 3 4

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

CAPITAL BUDGETING o It involves current outlay of funds in the expectation of a stream of benefits extending far into the future Year 0 1 2 3 4 Cash flow (100000) 30000 40000 50000

Types of capital investments o o o New unit Expansion Diversification Replacement Research & Development

Significance of capital budgeting o o Huge outlay Long term effects Irreversibility Problems in measuring future cash flows

Facets of project analysis o o o Market analysis Technical analysis Financial analysis Economic analysis Managerial analysis Ecological analysis

Financial analysis o o o 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 2 3 4 5 6 7 8 1000 2000 3000 4000 5000 0. 893 0. 799 0. 712 0. 636 0. 567 0. 507 0. 452 0. 404 893 1594 1424 1908 1701 2028 1808 2020 13376

Problem Year Cash flow PV factor @15% PV 0 1 2 3 4 5 6 7 (50000) 10000 20000 30000 20000 1 (50000)

Solution to Problem Year Cash flow PV factor @15% 0 1 2 3 4 5 6 7 (50000) 10000 20000 30000 20000 1 0. 870 0. 756 0. 658 0. 572 0. 497 0. 432 0. 376 PV (50000) 8696 15123 19725 17153 14915 8647 3759 38018

Present value of cash flow stream(cash outlay Rs. 15000)@ 12% Year Cash flow PV factor @12% PV 1 2 3 4 5 6 7 8 1000 2000 3000 4000 5000 0. 893 0. 799 0. 712 0. 636 0. 567 0. 507 0. 452 0. 404 893 1594 1424 1908 1701 2028 1808 2020 13376

Present value of cash flow stream(cash outlay Rs. 15000 )@10% Year Cash flow PV factor @10% PV 1 2 3 4 5 6 7 8 2000 3000 4000 5000 0. 909 0. 826 0. 751 0. 683 0. 621 0. 564 0. 513 0. 466 1818 1652 1502 2049 1863 2256 2052 2330 15522

CALCULATION NPV/IRR Outlay 15000 Difference PV @10% 15522 - PV @ 12% NPV 13376 - 522 (1624) 2146

IRR continued IRR= LR +( NPV by LR/ difference between NPV) x (HR-LR) LR= 10% NPV by LR= 522 Difference between NPV= 2146 HR less LR= 12 (-) 10 = 2 IRR= 10%+ (522/2146)X 2 IRR=10%+0. 49 IRR=10. 49%

IRR o o o 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 o We will see more problems immediately after discussion of other topics

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

Full cost pricing o o o 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 o o Direct Labour and Direct Overhead cost is considered ignoring material cost Selling price higher for product having greater conversion cost

Marginal cost pricing o o o 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 o o 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 o o Quantitative expression of management objective Budgets and standards Budgetary control Cash budget

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

Working Capital o o o Definition- Excess of CA over CL Existing company- new capital outlayaddl. W. C requirement Sources of W. C. n n o Long term Short term- OD, Trade credit Components of WC o o Permanent Variable ( seasonal)

Working capital cycle o o 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 o o The longer the operating cycle – the more fin. Resources How to keep the cycle shorter o o Debtors- quick collection Finished goods- turnover rapidly Raw Material – reduce stock level Work in progress- shorten the period

Working Capital Assessment o Projected Balance Sheet Method o o Cash Forms I, III, IV, VI Financial follow up Report (FFR-I- quarterly) Financial follow up Report (FFR-II- half yearly) Budget Method- construction company o Turnover Method- SSI Seasonal industry/

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

Examples from book o o P-413 P-414 p-415 P-417

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