Financial Management

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Financial Management

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

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Module D topics

• Marginal Costing
• Capital Budgeting
• Cash Budget
• Working Capital

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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

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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

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Marginal costing problems

• Sales (-) variable cost () contribution
• Contribution(/ divided by) sales
• () C.S. Ratio
• ContributionFixed cost ()Break even point
• Fixed Cost (/ divided by) contribution per unit
  break even units

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Basic formulaSales 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)
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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

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Solution to problem

• 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
• Contribution per unit Rs. 30 less Rs.18 Rs.12
• C/S Ratio 12/30 0.40 40
• BEP units 102000/ 128500
• BEP sales (in Rs.) 8500 X 30 255000
• contribution FC target profit
  10200066000168000
• Unit to get profit of Rs.66000 168000/12 14000
• Sales to get profit of Rs.6600014000 x 30
  420000

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Marginal costing problems

• Sales Rs.150000
• Fixed Cost Rs.30000
• B.E.Point Rs.60000
• What is profit ?

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Management decisions- assessing profitability
CONTRIBUTION/SALESC.S.RATIO
Product 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
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DECISION when limiting factors
SP Rs.14 Rs.11
VC 8 7
Contribution Per unit 6 4
Labour hr. pu 2 1
Contri.per hr 3 4
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DECISIONS

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

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CAPITAL BUDGETING

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

Year Cash flow
0 (100000)
1 30000
2 40000
3 50000
4 50000
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Types of capital investments

• New unit
• Expansion
• Diversification
• Replacement
• Research Development

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Significance of capital budgeting

• Huge outlay
• Long term effects
• Irreversibility
• Problems in measuring future cash flows

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Facets of project analysis

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

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Financial analysis

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

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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
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Present value of cash flow stream- (cash outlay
Rs.15000)_at_ 12
Year Cash flow PV factor _at_12 PV
1 1000 0.893 893
2 2000 0.799 1594
3 2000 0.712 1424
4 3000 0.636 1908
5 3000 0.567 1701
6 4000 0.507 2028
7 4000 0.452 1808
8 5000 0.404 2020 13376
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Problem
Year Cash flow PV factor _at_15 PV
0 (50000) 1 (50000)
1 10000
2 10000
3 20000
4 20000
5 30000
6 20000
7 10000
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Solution to Problem
Year Cash flow PV factor _at_15 PV
0 (50000) 1 (50000)
1 10000 0.870 8696
2 20000 0.756 15123
3 30000 0.658 19725
4 30000 0.572 17153
5 30000 0.497 14915
6 20000 0.432 8647
7 10000 0.376 3759 38018
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Present value of cash flow stream- (cash outlay
Rs.15000)_at_ 12
Year Cash flow PV factor _at_12 PV
1 1000 0.893 893
2 2000 0.799 1594
3 2000 0.712 1424
4 3000 0.636 1908
5 3000 0.567 1701
6 4000 0.507 2028
7 4000 0.452 1808
8 5000 0.404 2020 13376
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Present value of cash flow stream- (cash outlay
Rs.15000 )_at_10
Year Cash flow PV factor _at_10 PV
1 2000 0.909 1818
2 2000 0.826 1652
3 2000 0.751 1502
4 3000 0.683 2049
5 3000 0.621 1863
6 4000 0.564 2256
7 4000 0.513 2052
8 5000 0.466 2330 15522
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CALCULATION NPV/IRR
Outlay PV _at_10 PV _at_ 12 NPV
15000 15522 - 522
15000 - 13376 (1624)
Difference - - 2146





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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
• IRR100.49
• IRR10.49

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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.

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Problems

• We will see more problems immediately after
  discussion of other topics

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PRICING DECISIONS

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

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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 (307.50)
• 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

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Conversion cost pricing

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

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Marginal cost pricing

• SPVC 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

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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

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BUDGET

• Quantitative expression of management objective
• Budgets and standards
• Budgetary control
• Cash budget

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PROFIT PLANNING

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

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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)

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Working capital cycle

• cashgt Raw material gt Work in progress gt finished
  goods gt Sales gt Debtors gt Cashgt
• Operating cycle it is a length of time between
  outlay on RM /wages /others AND inflow of cash
  from the sale of the goods

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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

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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

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Examples from book

• P-369
• P-375
• P-377
• P-379
• P-380
• P-385
• P-387
• P-393

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Examples from book

• P-413
• P-414
• p-415
• P-417

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• THANK YOU
• WISH YOU BEST OF LUCK
• sudaaba_at_iibf.org.in