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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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 • 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 Make Money Profit Return on Investment Cash Flow Investment Revenue Cost Men Machine Methods Material Put Money
Finance Function Capital Provider Firm’s Operations Overview of Finance function Deploys Invests Ploughs back Returns Generates
Treasury Controlling Finance Management Recording, monitoring & controlling of financial consequences of past & current operations Acquiring funds to meet current and future needs
Banking Relations Obtaining Finance Cash Management Treasury
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 When money changes hands there is a transaction “I” - The business “You” - the owner “They’- Others
Owners’ Equity Changes in Owners’ Equity • Payments to Owners • Business Losses • Owners’ Investments • Business Earnings
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 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 • Different Rates • Block of assets • WDV
These transactions impact the statement of Cash flows These transactions impact the Profit and Loss Account
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 Beginning of period End of period Time Balance Sheet Balance Sheet Profit and Loss Account Statement of Cash Flows
Business Entity Going Concern Money Measurement Cost Concept Revenue Realisation Accrual Materiality Consistency Prudence or Conservatism Account Period Basic Accounting Concepts
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
Share Capital & Reserves Fixed Assets Current Liabilities Long Term Liabilities Current Assets Understanding Balance Sheet Liabilities Assets Investment Deferred Rev.Exp.
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 • Auditor’s Report • Balance Sheet • Profit and Loss Account • Schedules, Accounting Policies and notes • Cash Flow Statement • Directors’ Report
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.
Share Capital & Reserves Fixed Assets Long Term Liabilities D E F I C I T Current Assets Current Liabilities Assets Liabilities
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 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 • 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 • Decision Making • Long Term Pricing/Strategy • Short Term Tactical • Control • Long Term Control • Short Term Control • FA/Statutory Requirements
Connection is not between Cost and Price but between cost and desirability to sell at the market place
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 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 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 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 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 • 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.
Rupees Volume of Sales Break Even Point BEP Fixed Cost Sales Total Cost
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)
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 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 • 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 • Control is ensuring that actual performanceconforms to plan H
Base - Standard, Target, Norm, Budget, Plan Feed Back of Actuals Comparison Variance Analysis Corrective Action Cost Control
Cost Reduction • Relentlessly question the purpose • Understand the behaviour • Address the cause than the effect
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 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
Cash Raw materials Debtors Finished Goods Work-in-process Operating Cycle (Working Capital Cycle)
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 • Short Life Span • Swift transformation from one form to another • Repetitive Decisions
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 • 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 • 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