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Investors. Society. Government. Management. Lenders. Employees. Suppliers. Customers. Stake-holders of the Firm. The goal…. Necessary Condition is different from the Ultimate goal of the organisation Making money is not the primary goal of the organisation

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Presentation Transcript
slide1

Investors

Society

Government

Management

Lenders

Employees

Suppliers

Customers

Stake-holders

of the

Firm

the goal
The goal….
  • Necessary Condition is different from the Ultimate goal of the organisation
  • Making money is not the primary goal of the organisation
  • Making money is the ultimate goal of the organisation
  • Firm cannot make money ignoring the necessary condition
  • Firm cannot ignore making money while pursuing the necessary condition

H

for every action there is a financial reaction
For every action there is a financial reaction

Make Money

Profit

Return on Investment

Cash Flow

Investment

Revenue

Cost

Men

Machine

Methods

Material

Put Money

slide4

Finance

Function

Capital

Provider

Firm’s Operations

Overview of Finance function

Deploys

Invests

Ploughs

back

Returns

Generates

slide5

Treasury

Controlling

Finance Management

Recording, monitoring

& controlling of financial

consequences of past

& current operations

Acquiring funds to meet

current and future needs

slide6

Banking

Relations

Obtaining

Finance

Cash

Management

Treasury

slide7

Management Control

Statutory

MIS

Costing

Financial Public

Relations

Controlling Function

Score keeping

Admn. & Safeguarding

Assets

Performance Appraisal

Admn. Finance Function

Audit

Book keeping

Accounting &

A/c ing System

Taxation

Legal

a business transaction
A business transaction

When money changes hands there is a transaction

“I”

- The business

“You” - the owner

“They’- Others

owners equity
Owners’ Equity

Changes in Owners’ Equity

  • Payments to Owners
  • Business Losses
  • Owners’ Investments
  • Business Earnings
a business transaction1
A business transaction

or money’s worth

When money changes hands there is a transaction

“I”

- The business

“You” - the owner

“They’- Others

more on depreciation
More on depreciation

1. Matching Principle

Purchased now

Usable for 10 years - so match Revenue to Cost

1

2

3

4

5

6

7

8

9

10

2. Wear and Tear

3. Prudence

depreciation companies act and income tax
Depreciation - Companies Act and Income Tax
  • Different Rates
  • Block of assets
  • WDV
slide13

These transactions impact

the statement of

Cash flows

These transactions impact

the Profit and Loss

Account

introduction to financial statements
Introduction to Financial Statements

Revenues result in positive cash flow.

Expenses result in negative cash flow.

Either in the past, present, or future.

relationships among financial statements
Relationships Among Financial Statements

Beginning of period

End of period

Time

Balance Sheet

Balance Sheet

Profit and Loss Account

Statement of Cash Flows

basic accounting concepts
Business Entity

Going Concern

Money Measurement

Cost Concept

Revenue Realisation

Accrual

Materiality

Consistency

Prudence or Conservatism

Account Period

Basic Accounting Concepts
balance sheet p and l a c
Shows financial status of the firm as on a particular date

Snap shot – Still photograph

Where the money was invested and from where the money was sourced

What we owe and what we own

Both sides are always equal

Shows income earned and the expenses incurred to earn that income during a particular period

Flow statement – for a period

Not income received and expenses paid but accrued

Balance Sheet & P and L A/c
understanding balance sheet

Share Capital

& Reserves

Fixed

Assets

Current

Liabilities

Long Term

Liabilities

Current

Assets

Understanding Balance Sheet

Liabilities

Assets

Investment

Deferred Rev.Exp.

profit loss account blocks

Liabilities

Assets

Share Capital

& Reserves

Fixed

Assets

Long Term

Liabilities

Current

Assets - Current

liabilities

Profit & Loss Account Blocks

Income

Less: Cash Op. Expenses

= PBDIT

Less: Depreciation

= PBIT

Less: Interest

= PBT

Less:Taxation

= PAT

= Retained Earnings

Less: Statutory Appropriations and Dividend

parts of annual report
Parts of Annual Report
  • Auditor’s Report
  • Balance Sheet
  • Profit and Loss Account
  • Schedules, Accounting Policies and notes
  • Cash Flow Statement
  • Directors’ Report
cash flow statement1
Cash Flow Statement

Operating activities include the cash effects of revenue and expense transactions.

Investing activities include the cash effects of purchasing and selling assets.

Financing activities include the cash effects of transactions with the owners and lenders.

liabilities

Share Capital

& Reserves

Fixed

Assets

Long Term

Liabilities

D E F I C I T

Current

Assets

Current

Liabilities

Assets

Liabilities
slide24

Share Capital

& Reserves

Long Term

Liabilities

Margin

Net W Cap.

Bank Finance

for W Cap.

Current

Liabilities

Liabilities

Assets

Fixed

Assets

Current

Assets

can fa give the information
Can FA give the information…
  • Can you find out the cost of power generated in a particular location?
  • Do you know whether the customer is profitable or not?
  • Do you know whether you are better off using a specific fuel?
  • Is this “tool” FA useful at all?

Don’t try to drink the soup

with a fork and complain that

something is wrong with the fork!

the domain of financial accounting
The domain of Financial Accounting
  • Information needs of the investor
  • Statutory Reporting purposes
    • Tax authorities (Direct and indirect)
    • Company law requirements
    • Labour law requirements
  • Economic Analysis
requirements of a costing system
Requirements of a costing system
  • Decision Making
    • Long Term Pricing/Strategy
    • Short Term Tactical
  • Control
    • Long Term Control
    • Short Term Control
  • FA/Statutory Requirements
slide28

Connection is not between

Cost and Price

but between

cost and desirability to sell at the market place

slide29

There is no such thing as “THE COST” of any thing,

but only “A COST”

depending on a method of cost consumption and

the purpose for which is used

changing perspective of cost
Changing Perspective of Cost

C

+

P

=

S

Monetary Equivalent of Resources Sacrificed

S

-

C

=

p

Resources consumed With a Purpose

S

P

=

C

-

Allowable

Cost

Resources consumed that Adds Value to the Customer

----------

relevant information for decision making
Relevant Information for Decision Making

Relevant

for

Decision

Making

Does

it vary with

alter.?

Yes

Is it

Futuristic?

Yes

Relevant

information

is futuristic& varies

with alternative

No

No

Irrelevant for Decision Making

decision making
Decision Making

Decision-making is concerned with the future …

involves a choice between alternatives.

Many factors, both qualitative and quantitative, need to be considered.

For many decisions financial information is a critical factor.

contribution
Contribution
  • Contribution is the surplus available after the variable cost is covered by the sales. It contributes to the fixed cost; if any thing is left it contributes to the profit.
  • Contribution

= Sales - Variable Cost

= Fixed Cost + Profit

short run tactical decisions
Short run tactical decisions
  • These are those decisions, which seek to make the best use of the existing facilities.
  • Typically, in the short run, fixed costs remain unaffected by the changes, so that the variable cost, revenue and contribution of each alternative is relevant.
  • However, if any short run decisions may have any long-term strategic implications, they are to be weighed in the right perspective.
break even point

Rupees

Volume of Sales

Break Even Point

BEP

Fixed

Cost

Sales

Total Cost

break even point1
Break Even Point
  • Break Even Point is a point at which the contribution equals the Fixed Cost; it is a no profit-no loss point. It is measured as follows:

= Fixed Cost/ Contribution per unit (BEP in units)

margin of safety

B

A

Rupees

Volume of Sales

Margin of Safety

BEP

Fixed

Cost

Sales

Total Cost

At which point you are safer? A or B?

What is your margin of safety?

margin of safety1
Margin of Safety

Margin of Safety is the level of sales beyond the Break Even Sales. The higher the sales the greater the margin of safety. It is measured as follows:

= (Actual sales - BEP Sales)/ Actual Sales x 100

profit volume ratio bep
Profit/Volume Ratio & BEP
  • P/V Ratio measures the rate at which the profit changes with changes in sales levels. It is measured as follows:

= Contribution/Sales x 100

= Change in Profit/Change in Sales x 100

  • Break Even Point (in Value)

= Fixed Cost/P/V Ratio

cost control
Cost Control
  • Control is ensuring that actual performanceconforms to plan

H

cost control1

Base - Standard, Target, Norm, Budget, Plan

Feed Back of Actuals

Comparison

Variance Analysis

Corrective Action

Cost Control
cost reduction
Cost Reduction
  • Relentlessly question the purpose
  • Understand the behaviour
  • Address the cause than the effect
cost management
Cost Management
  • Philosophy
    • Find ways to make the right decisions to create more customer value at lower cost
  • Attitude
    • Realisation that for every action there is a financial reaction
  • Techniques
    • To be used individually or together to support the organisation’s overall management

H

tools of cost management
Tools of Cost Management

Manufac-

turing

Cycle

R & D and

Engineering

Cycle

Post-Sales

Utilisation by

Customer

Transactional

Costing

Inter Organisational Cost Management

Target

Costing

Kaizen

Costing

Customer

Account

Profit-

ability

A

B

C

Resource Consumption based Costing System

slide45

Cash

Raw

materials

Debtors

Finished Goods

Work-in-process

Operating Cycle

(Working Capital Cycle)

working capital management
Working Capital Management

Working Capital

= Current Assets

(Stocks, Debtors, Loans, Bank, Cash, etc.,)

minus

Current Liabilities

(Creditors, Trade Advances, Provisions, etc.,)

Management of Working Capital implies,

  • managing the various components of Working Capital,
  • managing their interactions and
  • sourcing the working capital gap
characteristics of current assets
Characteristics of Current Assets
  • Short Life Span
  • Swift transformation from one form to another
  • Repetitive Decisions
slide48
Risk
  • Types of Risk
    • Stand-alone risk
    • Corporate risk or Firm Risk
    • Systematic risk or market risk
  • Analysis and measurement of risk
    • Statistical tools
    • Sensitivity analysis
    • Scenario analysis
    • Decision Tree Analysis
principles of value creation
Principles of Value Creation
  • Discounted cash flow
    • Magnitude
    • Timing
    • Degree of uncertainty
  • NPV
    • Implies that value created is more than the cost of capital
  • IRR
    • The projects return
  • The goal is not to maximise IRR but to maximise NPV
the road covered
The Road covered
  • Language of Finance
    • Understanding Financial Statements
    • Balance Sheet and Profit and Loss Account
  • Understanding Cash Flows
    • Key for survival
    • Operational, Financial and Investment activities
  • Understanding Costs
    • Nothing called “THE” cost, there is only ‘A’ cost
    • Relevant Information for Decision Making
    • Cost control and Cost Reduction – an attitude
  • Understanding Investments
    • Investment in Working Capital
      • We tend to fill in the gap with money
    • Investment in Long Term Assets
      • Don’t get romantic with your proposals
points to ponder
Points to ponder…
  • Requirement Planning
  • Timing of Purchase
  • Linking with suppliers
supplier relationships
Supplier Relationships
  • We generate a lot of “savings” by purchasing
    • in bulk quantities; earning volume discounts;
    • from marginal suppliers whose quality, Reliability & delivery were less than outstanding
    • from (cheaper) distant domestic suppliers, especially if freight costs are not traced to individual supplies
    • suppliers with limited engineering and other resources
these savings lead to much higher costs of procurement due to activities
Receive materials

Inspect materials

Return materials

Move materials

Store materials

Scrap obsolete materials

Scrap and rework products due to undetected defective incoming materials

Order materials

Delay production due to late deliveries

Expedite materials to avoid shutdowns because of late-arriving materials

Design, engineer and determine materials specifications (using internal engineering resources, not suppliers’ engineers)

Pay for materials

These “Savings” lead to much higher costs of procurement, due to activities...
understanding supplier relationships
Understanding supplier relationships
  • Choosing low-cost; not low-price suppliers.
    • Ideal supplier minimizes the total cost of ownership.
      • Low Defects
      • No Inspection
      • Direct delivery to mfg. process
      • using supplier engineering resources.
      • No invoicing.
      • Electronic Funds Transfer.
understanding cost behaviour
Understanding cost behaviour
  • Better understanding of cost behaviour
    • Unit level (purchase price)
    • Batch level (ordering, receiving, inspecting, moving & paying)
    • Product Sustaining (Designing & maintaining specs.)
    • Vendor sustaining (ongoing discussions, file maintenance, periodic evaluation).
control of raw material inventory
Control of Raw Material Inventory
  • Ageing
  • Raw Material Turns
points to ponder1
Points to ponder…
  • Cycle time
  • “Keeping busy”
  • Constraint
constraint and inventory management
Constraint and Inventory Management
  • Inventory everywhere is dangerous, but not having inventory before the constraint is disastrous
the focus should be
The Focus Should Be ...

How Strong is the Chain?

Focus Any where?!

or

Focus on the Bottleneck

the 5 steps
The 5-Steps

1. INDENTIFY the system’s constraint(s).

2. Decide how to EXPLOIT the system’s

constraint(s).

3. SUBORDINATE everything else to the above

decision.

4. ELEVATE the system’s constraint(s).

5. If, in a previous step, a constraint has been broken

go back to step 1. But do not allow INERTIA to

become the system’s constraint.

control of wip inventory
Control of WIP inventory
  • Location wise analysis
  • WIP Turns (Item wise)
points to ponder2
Points to ponder..
  • “Giraffe is hungry; when will it get its food?”
  • Look within to manage the Finished goods
  • Look beyond to manage the Finished goods
control of fg inventory
Control of FG Inventory
  • Ageing
  • Location wise Stock
  • FG Turns
monitoring collection and billing
Monitoring Collection and Billing
  • Prompt Billing
  • Expediting Collection
  • Prompt Deposit of cheque
  • Control of Payables
  • Playing the float
receivable management
Receivable Management

Credit Evaluation

  • Character/Capacity/Collateral
  • Analysis of Financial Statement
  • Bank Reference
  • Other References
  • Firm’s Experience
  • Numerical Scoring
  • Risk Classification
receivable management1
Receivable Management

Steps to Sale and Collection

  • Establish Terms of Sale (Sales and Credit monitoring)
  • Decide on a form of contract (Tie up with an instrument)
  • Credit granting decision
  • Arm the Sales people with information
  • Collect (Along with order fill in the form detailing payment procedure)
  • Link performance to collection
receivable management2
Receivable Management

Credit Control

  • Debtors Velocity
  • Ageing
  • Payment Pattern
  • Analyse Root Cause of delay
    • Delay in collection
    • Delay in deposit
    • Cheque bouncing
  • Reconciliation
    • Lack of follow-up
    • Delay in reconciliation
slide68

Collection

Costs

Costs of

Financing

Costs of

maintaining

Debtors

Default

Costs

Delinquency

Costs

points to ponder3
Points to ponder…
  • “We have more cows than tigers”
  • Looking beyond
cash management
Cash Management

Motives of Cash Holding

  • Transaction
  • Uncertainty
  • Speculation
we tend to fill communication gap not with information but with cash time and other resources
We tend to fill“communication gap”not with informationbut withCash, Time and other Resources
tools of cash management
Tools of Cash Management
  • Cash Budget - Short Term & Long Term
  • Cash Report - Daily, Monthly
  • Treasury Report
  • Bank Reconciliation
drucker the guru
Drucker… The guru….

"Until a business returns a profit that is greater than its cost of capital, it operates at a loss. Never mind that it pays taxes as if it had a genuine profit. The enterprise still returns less to the economy than it devours in resources…Until then it does not create wealth; it destroys it."

some home truths about capex
Some “home truths” about Capex
  • Good investment projects do not simply emerge out of woodwork - they have to be identified, defined and revised
  • Non-quantifiable aspects frequently have a significant impact on the decision outcome
  • Estimates are rarely free from bias
  • “The child that cries loudest normally gets the chocolate”

November

slide75

Divisional

Level

Divisional

Level

Factory/Branch Level

Investment Proposals

Investment

Proposals

Investment

Proposals

Capex

Appraisal

Filter

Top Management

Level

Investments Selected

slide76
Generation of Proposals

Categorisation of proposals

Evaluation /Screening

Selection of Proposals

Compilation of Departmental Proposals

Compilation of preliminary Budget

Departmental Reviews/Feedback

Budget Proposal

Finance Review/Financing Plan

Budget Document for Approval

Board Review - comments

Approved Capital Budget Document

Incorporation in Business Plan

Origination of Capex Proposal

Appraisal of Capex Proposal

Approval of Capex Proposal

Process of Capex Budgeting

classification by needs
Classification by Needs
  • Cost Reduction
    • Modernisation
    • Upgradation
    • Process Improvements
  • Revenue Generation
    • Expansion
    • Diversification
  • Operational Necessity
    • Reconstruction
    • Replacement
    • Risk Reduction
  • Statutory/Societal compulsions
cost numbers for capex
Cost numbers for Capex
  • Relevant & Irrelevant Costs
  • Avoidable & Unavoidable Costs
  • Sunk Costs & Opportunity Costs
  • Apportioned Costs
  • Marginal & Incremental Costs
financial evaluation basics
Financial Evaluation - Basics
  • Cost numbers for Capex
  • Cash flows
  • Time Value of Money
  • Cost of Capital
  • Appraisal Criteria
  • Risk
cash flows
Cash Flows
  • Initial investment
    • Cost of capital assets
    • Installation costs
    • Working Capital Margin
    • Other startup expenses
cash flows1
Cash Flows
  • Operating Cash Flows
    • Profit after Tax + Depreciation + Other non-cash charges + Interest on long term debt(1-tax rate)
  • Terminal Cash flows
    • Post-Tax proceeds from the sale of capital assets + Net recovery of Working capital margin
biases in cash flow estimates
Biases in Cash Flow Estimates
  • Overstatement of Profitability
    • Intentional Overstatement
    • Lack of Experience
    • Myopic Euphoria
    • Capital Rationing
    • Splitting the Proposal
  • Understatement of Profitability
    • Salvage values are under-estimated
    • Intangible benefits are ignored
cost of capital
Cost of Capital

(Proportion Debt x Cost of Debt) + (Proportion of Equity x Cost of Equity)

( 60% x 9%) + (40% x 16%)

= 11.8%

appraisal criteria
Appraisal Criteria
  • Non-Discounting Criteria
    • Pay back period
    • Accounting Rate of Return
  • Discounting Criteria
    • Net Present Value
    • Benefit Cost Ratio
    • Internal Rate of Return
pay back period
Pay Back Period
  • Easy to use
  • Favours projects with higher initial cash inflows
  • Shorter PLC
  • Ignores Time Value of Money
  • Overlooks cash flows beyond pay back

3 Years

4 Years

net present value1
Net Present Value
  • Considers Time Value of Money
  • Considers entire Cash flow stream
benefits cost ratio profitability index
Benefits Cost Ratio (Profitability Index)
  • Present Value of Benefits / Initial Investment

From the Example given for NPV:

16717/10000 = 1.67

internal rate of return
Internal Rate of Return
  • The rate at which the NPV = 0 is IRR
  • Represents the rate of return on the un-recovered investment balance in the project
  • Rate of return on the initial investment made in the project
slide92
Risk
  • Types of Risk
    • Stand-alone risk
    • Corporate risk or Firm Risk
    • Systematic risk or market risk
  • Analysis and measurement of risk
    • Statistical tools
    • Sensitivity analysis
    • Scenario analysis
    • Decision Tree Analysis
principles of value creation1
Principles of Value Creation
  • Discounted cash flow
    • Magnitude
    • Timing
    • Degree of uncertainty
  • NPV
    • Implies that value created is more than the cost of capital
  • IRR
    • The projects return
  • The goal is not to maximise IRR but to maximise NPV
the road covered1
The Road covered
  • Language of Finance
    • Understanding Financial Statements
    • Balance Sheet and Profit and Loss Account
  • Understanding Cash Flows
    • Key for survival
    • Operational, Financial and Investment activities
  • Understanding Costs
    • Nothing called “THE” cost, there is only ‘A’ cost
    • Relevant Information for Decision Making
    • Cost control and Cost Reduction – an attitude
  • Understanding Investments
    • Investment in Working Capital
      • We tend to fill in the gap with money
    • Investment in Long Term Assets
      • Don’t get romantic with your proposals