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

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

COSTING  Cost accounting system provides information about cost  Aim : best use of resources and maximization of returns  cost = amount of expenditure incurred( actual+ notional)  Purposes =profit from each job/product, division, segment, 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 formula Sales price (-) variable cost= contribution SP lessVC= Contribution 3018= = =8 2418=6 2018=2 =0 1718=(1)

Marginal costing problems  SP = Rs.30, VC =Rs.18 Fixed Cost Rs Find -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 Find Break even point (in Rs. & in units) C/S Ratio, Sales to get profit of Rs  Contribution per unit = Rs. 30 less Rs.18 =Rs.12  C/S Ratio = 12/30 =0.40 =40%  BEP units = / 12=8500  BEP sales (in Rs.) =8500 X 30 =  contribution = FC+ target profit= =  Unit to get profit of Rs.66000= /12 =14000  Sales to get profit of Rs.66000=14000 x 30 =420000

Marginal costing problems  Sales Rs  Fixed Cost Rs  B.E.Point Rs  What is profit ?

Management decisions- assessing profitability CONTRIBUTION/SALES=C.S.RATIO Produ ct spvc Contrib ution C/S Ratio %ranking A /20 50%1 B /30 33% 2 C /40 25%3

DECISION when limiting factors SPRs.14Rs.11 VC87 Contribution Per unit 64 Labour hr. pu21 Contri.per hr34

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

CAPITAL BUDGETING  It involves current outlay of funds in the expectation of a stream of benefits extending far into the future YearCash flow 0(100000)

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

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

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

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

Methods of capital investment appraisal DISCOUNTINGNON-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 12% YearCash flow PV PV

Problem YearCash flow PV PV 0(50000)

Solution to Problem YearCash flow PV PV 0(50000)

Present value of cash flow stream- (cash outlay 12% YearCash flow PV PV

Present value of cash flow stream- (cash outlay Rs YearCash flow PV PV

CALCULATION NPV/IRR 12% NPV (1624) Difference--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)X2 IRR=10%+0.49 IRR=10.49%

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 ( )  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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