Management Accounting - PDF

Management Accounting – Help managers make decitions. Financial Management – to maximize shareholder’s wealth  Management Accounting – Help managers make decitions Decision-Making Planning Organizing Cont...

Management Accounting – Help managers make decitions. Financial Management – to maximize shareholder’s wealth  Management Accounting – Help managers make decitions Decision-Making Planning Organizing Controlling Staffing Directing Sales VP - Operations Downward Production Authority LINE Operations Manager Directly involved Delivery VP - Finance Upward Lateral Advice STAFF Advice Provide support via Controller Treasurer assistance and advice Controller Treasurer OBJECTIVE Recording Function Custody Function FUNCTIONS: Planning and controlling Provision of capital Economic Appraisal Investor Relation Recording and Interpretation Collection Protection of asset Credit management Evaluating Banking and custody Consulting Investment Tax administration Insurance GOVERNMENT Reporting SHort term Insurance  SOURCES OF COMPETITIVE ADVANTAGE Michael Porter’s three Generic Strategies Cost Leadership Strategy  Increase profits by educing costs Differentiation Strategy  Unique products or services and more attractive Focus Strategy  Financial Accounting Management Accounting By function By behaviour Sales Sales - CGS - VC GP CM - Exp - FC Net Income Profit  COST-VOLUME-PROFIT AND BREAK-EVEN ANALYSIS Behavior Vol. TVC Vol. FC/u Direct Relationsip Inverse Relationsip Mixed Cost = TFC + TVC Y = a + bx Total Cost = TFC + VC/u × Units ESTIMATES: 1. High-Low Method (X ang masusunod) Y = a + b (x) 2. Scattergraph 3. Least Square regression ∑ 𝒚 = 𝒏𝒂 + 𝒃 ∑ 𝒙 ∑ 𝒙𝒚 = 𝒂 ∑ 𝒙 + 𝒃 ∑ 𝒙𝟐  CVP Analysis – a profit planning tool Examines: Cost  Cost driver (x)  Profit Contribution Margin Segment Sales SP × Unist Sold Elements Effect in Profit SP Less: Variable Cost VC/u × Unit Sold Sale – Direct Contribution Margin CM/u × Unit Sold Unit sold P VC/u Less: Fixed Cost. Total Fixed Cost P Cost – Inverse FC PROFIT Assumptions and Limitations P/u P/T % QTY Sales xx xx 100% Classifiable Vriable and Fixed -VC (xx) (xx) (xx) VC ratio CM ratio Unchange Condition (Constant) CM xx xx xx -FC (xx) (xx) (xx) Internal  Technology, Effective production (100% of Tx %) ROS b4 Tx OI xx xx xx External  Market Competitive, Stable Selling Price -TAX % xx xx xx ROS after Tx NI xx xx xx Time Value Money Required Constant Equal (Production = Sales) GENERAL RULE: BEP = (CM=FC) Constant (TFC,VC/u,SP,CMR) TRY THIS SIR KARIM METHOD WEEK 2 LIVE LECTURE Predictable and linear relation to Cost and Sales Break-Even Point – ang tuldok kung saan nag tatagpo ang total cost at total sales (always ZERO profit sales) Contribution Margin = FC + P (kasi CM is to cover FC and is to contribute in Profit) FC BEP CM,CMR  Required Sales This is bout the Break-even Point plus its target profit FC + TP RS CM Sales Mix – 2 poduct having 1 fixed cost and finding its break even point/required sales Weighted Average Contribution Margin – used to get the BEP of 2 products BEP/RS of Sales FC + TP Mix RS WACM WACM/u WACMR Peso Sales Mix Composit Unit Unit Sales Mix CM/u CM/u CM/u × Composite Ratio × Unit Sales Mix × Peso Sales Mix Composite/unit WACM/u WACMR 𝐹𝐶 𝐶𝑜𝑛𝑠𝑡𝑎𝑛𝑡 BEP = ; = ; = 𝑊𝐴𝐶𝑀 𝐶𝑜𝑛𝑠𝑡𝑎𝑛𝑡 A B C WACMR CMR 30% 40% 60% Example: × Peso Sales Mix 20% 60% 20% WACMR 6% 24% 12% 42% Margin of safety – eto yung amount na affod mo mawala sa sales mo nang hndi ka pa din nag nenegative profit Margin of safety = Sales – BEP Exp: Sales 200 – BEP 150 = 50 pesos lang afforrd mo mawala sa sales mo para di ka mag negative profit MoSR = RISK P MoSR S Degree of Operating Leverage - measures how much a company's operating income changes in response to a change in sales. CM %Sales × DOL = %Profit DOL P 𝟏 Or 𝑴𝑺𝑹 Fixed Cost = DOL = Sensitivity in Income = Risk = MOSR High DOL - High Fixed Cost, Lower Variable Cost, High Contribution Margin Low DOL - Low Fixed Cost, Higher Variable Cost, Low Contribution Margin Sa sales, the higher the DOL, the more na sensitive ang operating income sa changes sa sales  ABSORPTION AND VARIABLE COSTING EI > BI ; P > S ; Ay > Vy ; FFOH AC < FFOH VC Manufacturing Cost TRY THIS SIR KARIM METHOD WEEK 2 LIVE LECTURE DM Beg + DM Purch - DM End DM Usage + DL + FOH TMC + WIP Beg - WIP End CGM + FGI Beg - FGI End CGS  FINANCIAL ANALYSIS PAST  EVALUATE PRESENT  CONDITION OF BUSINESS OPERATION/PERFORMANCE FUTURE  POTENTIAL OBJECTIVE PRIMARY: Evaluate and Forecast Financial Statement OTHERS: 1. Profitability Effectiveness of operation 2. Ability to pay obligation  Short-term /Long-term 3. Safety of Investment  Returns on Investment 4. Efectiveness of Management  Effectiveness of Assets 5. Marketability  Salability I. Vertical Analysis and Horizontal Analysis VERTICAL ANALYSIS HORIZONTAL ANALYSIS  Point In Time 100% SFP – Net Assets  Several Period (more years)  With Common Base SCI – Net SAles  Base must be determined (PRIOR PERIOD)  Common Size FS  all are presented in Amount of Change  (CY -PY) percetage 𝐴𝑚𝑜𝑢𝑛𝑡 𝑜𝑓 𝐿𝑖𝑛𝑒 𝐼𝑡𝑒𝑚  2-way calculation % of Change/ Growth rate  (𝐶𝑌−𝑃𝑌) 𝑃𝑌 %= 𝐴𝑚𝑜𝑢𝑛𝑡 𝑜𝑓 𝑏𝑎𝑠𝑒 II. Financial Ratio Ability to convert Non-Cash Asset to Cash CA & CL Ability to pay LIQUIDITY and ACTIVITY Current Liability RATIO SOLVENCY PROFITABILITY Includes:  Convertion of Inventory to sale ACTIVITIES  Convertion of Net Credit sales/AR to Cash  Payment of AP and other CL 𝑾𝒐𝒓𝒌𝒊𝒏𝒈 𝑪𝒂𝒑𝒊𝒕𝒂𝒍 = 𝑪𝑨 − 𝑪𝑳 Positive Amount  Kaya makapag bayad ng CL gamit ang CA Negative amount  hindi enough ang CA pang bayad sa CL 𝐶𝐴 𝑪𝒖𝒓𝒓𝒆𝒏𝒕 𝑹𝒂𝒕𝒊𝒐 = = 𝑥: 1 𝐶𝐿 > 1 is better; sa bawat piso na utang mo may X kang kakayahan makapag bayad gamit ang iyong CA 𝐶𝑎𝑠ℎ + 𝑀𝑎𝑟𝑘𝑒𝑡𝑎𝑏𝑙𝑒 𝑆𝑒𝑐𝑢𝑟𝑖𝑡𝑦 + 𝐴𝑅 𝐶𝐴 − 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 𝑸𝒖𝒊𝒄𝒌 𝑹𝒂𝒕𝒊𝒐 = 𝑜𝑟 = 𝑥: 1 𝐶𝐿 𝐶𝐿 > 1 is better; sa bawat piso na utang mo may X kang kakayahan makapag bayad gamit ang iyong Cash, Marketable Security, at AR 𝐶𝑎𝑠ℎ + 𝑀𝑎𝑟𝑘𝑒𝑡𝑎𝑏𝑙𝑒 𝑆𝑒𝑐𝑢𝑟𝑖𝑡𝑦 𝑪𝒂𝒔𝒉 𝑹𝒂𝒕𝒊𝒐 = 𝐶𝐿 > 1 is better; sa bawat piso na utang mo may X kang kakayahan makapag bayad gamit ang iyong Cash at Marketable Security >1= = Ratio = 1 = = 1 Ratio < 1 = = Ratio  𝐼𝑆 𝑪𝒐𝒏𝒗𝒆𝒓𝒕𝒊𝒐𝒏 𝒐𝒇 𝑰𝒏𝒗𝒆𝒏𝒕𝒐𝒓𝒚 𝒕𝒐 𝑺𝒂𝒍𝒆𝒔 = 𝐵𝑆 𝐶𝑂𝐺𝑆 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 𝑇𝑢𝑟𝑛𝑂𝑣𝑒𝑟 = = 𝑡𝑖𝑚𝑒𝑠 𝐴𝑣𝑒. 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 365 𝑑𝑎𝑦𝑠 𝐴𝑣𝑒. 𝐴𝑔𝑒 𝑜𝑓 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦/𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 𝐶𝑜𝑛𝑣𝑒𝑟𝑡𝑖𝑜𝑛 𝑃𝑒𝑟𝑖𝑜𝑑 = = 𝑑𝑎𝑦𝑠 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 𝑇𝑢𝑟𝑛𝑂𝑣𝑒𝑟 𝐼𝑆 𝑪𝒐𝒏𝒗𝒆𝒓𝒕𝒊𝒐𝒏 𝒐𝒇 𝑵𝒆𝒕 𝑪𝒓𝒆𝒅𝒊𝒕 𝑺𝒂𝒍𝒆𝒔/𝑨𝑹 𝒕𝒐 𝑪𝒂𝒔𝒉 = 𝐵𝑆 𝑁𝑒𝑡 𝐶𝑟𝑒𝑑𝑖𝑡 𝑆𝑎𝑙𝑒𝑠 𝐴𝑅 𝑇𝑢𝑟𝑛𝑂𝑣𝑒𝑟 = = 𝑡𝑖𝑚𝑒𝑠 𝐴𝑣𝑒. 𝐴𝑅 365 𝑑𝑎𝑦𝑠 𝐴𝑣𝑒. 𝐴𝑔𝑒 𝑜𝑓 𝐴𝑅/ 𝐴𝑅 𝐶𝑜𝑙𝑙𝑒𝑐𝑡𝑖𝑜𝑛 𝑃𝑒𝑟𝑖𝑜𝑑/ 𝐷𝑆𝑂 = = 𝑑𝑎𝑦𝑠 𝐴𝑅 𝑇𝑢𝑟𝑛𝑂𝑣𝑒𝑟 𝐼𝑆 𝑷𝒂𝒚𝒎𝒆𝒏𝒕 𝒐𝒇 𝑨𝑷 = 𝐵𝑆 𝑁𝑒𝑡 𝐶𝑟𝑒𝑑𝑖𝑡 𝑃𝑢𝑟𝑐ℎ𝑎𝑠𝑒 𝐴𝑃 𝑇𝑢𝑟𝑛𝑂𝑣𝑒𝑟 = = 𝑡𝑖𝑚𝑒𝑠 𝐴𝑣𝑒. 𝐴𝑃 365 𝑑𝑎𝑦𝑠 𝐴𝑣𝑒. 𝐴𝑔𝑒 𝑜𝑓 𝐴𝑃/ 𝑃𝑎𝑦𝑚𝑒𝑛𝑡 𝐷𝑒𝑓𝑓𝑒𝑟𝑎𝑙 𝑃𝑒𝑟𝑖𝑜𝑑 = = 𝑑𝑎𝑦𝑠 𝐴𝑃 𝑇𝑢𝑟𝑛𝑂𝑣𝑒𝑟  Ability to convert Non-Cash Asset to Cash CA & CL Ability to pay LIQUIDITY and ACTIVITY Current Liability RATIO SOLVENCY PROFITABILITY SOLVENCY RATIO  Ability of the company to survive 𝑇𝐿 𝐷𝑒𝑏𝑡 𝑅𝑎𝑡𝑖𝑜/𝐷𝑒𝑏𝑡 𝑡𝑜 𝐴𝑠𝑠𝑒𝑡 𝑅𝑎𝑡𝑖𝑜 = =% 𝑇𝐴 𝑇𝑆𝐻𝐸 𝐸𝑞𝑢𝑖𝑡𝑦 𝑅𝑎𝑡𝑖𝑜/𝐸𝑞𝑢𝑖𝑡𝑦 𝑡𝑜 𝐴𝑠𝑠𝑒𝑡 𝑅𝑎𝑡𝑖𝑜 = =% 𝑇𝐴 𝑇𝐿 𝐷𝑒𝑏𝑡 𝑡𝑜 𝐸𝑞𝑢𝑖𝑡𝑦 𝑅𝑎𝑡𝑖𝑜 = =% 𝑇𝑆𝐻𝐸 𝐸𝐵𝐼𝑇 𝑇𝑖𝑚𝑒 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝐸𝑎𝑟𝑛𝑖𝑛𝑔 𝑅𝑎𝑡𝑖𝑜 (𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝐶𝑜𝑣𝑒𝑟𝑎𝑔𝑒 𝑅𝑎𝑡𝑖𝑜 ) = 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝐸𝑥𝑝𝑒𝑛𝑠𝑒 = 𝑡𝑖𝑚𝑒𝑠 ∗ *The higher the times it has the better PROFITABILITY RATIO  Ability of the company to make profit MARGIN RATIO 𝐺𝑃 𝐺𝑃 𝑀𝑎𝑟𝑔𝑖𝑛 = =% 𝑆𝑎𝑙𝑒𝑠 𝐸𝐵𝐼𝑇 𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑜𝑛 𝑀𝑎𝑟𝑔𝑖𝑛 = =% 𝑆𝑎𝑙𝑒𝑠 𝑁𝑒𝑡 𝐼𝑛𝑐𝑜𝑚𝑒 𝑃𝑟𝑜𝑓𝑖𝑡 𝑀𝑎𝑟𝑔𝑖𝑛 = =% 𝑆𝑎𝑙𝑒𝑠 RETURNS RATIO 𝑬𝑩𝑰𝑨𝑻 𝑹𝑶𝑨 & 𝑹𝑶𝑰 = =% 𝑨𝒗𝒆. 𝑻. 𝑨. 𝑵𝑰 𝑹𝑶𝑬 = =% 𝑨𝒗𝒆. 𝑻𝑺𝑯𝑬 Financial Leverage  III. Cash Flow Analysis Operating Activity L Current Asset Current Liab A E Non-Current Asset Non-Current Liab Financing Activity Investing Activity 𝑭𝒓𝒆𝒆 𝑪𝒂𝒔𝒉 𝑭𝒍𝒐𝒘 = 𝑶𝒑𝒆𝒓𝒂𝒕𝒊𝒏𝒈 𝑪𝒂𝒔𝒉 𝑭𝒍𝒐𝒘 − 𝑰𝒏𝒗𝒆𝒔𝒕𝒊𝒏𝒈 𝑨𝒄𝒕𝒊𝒗𝒊𝒕𝒊𝒆𝒔 To pay Creditors and Type equation here. Capital Expenditures Investors (Financing Direct Indirect Activities) (+) Interest Expense; (-) Tax Shield IV. Gross Profit Variance (Standard Costing and Variance Analysis HO6)  BUDGETING  Planning for future and controls cost Capital Long Term Strategic Short Term Operating Corrective Project Investment Operating Objectives Plan Plan Actions Spending Operating Budget Production Sales Budget Budget Build Evaluate Standard S&A Expense Budget DM DL OH Budget Income Statement Cost Sheet Proforma Cost/unit = COGS Balance Sheet Statement of Cash Sources of Information Cash/Capital Proforma flow Proforma Budget 1. Past Records Financial Budget 2. Benchmark MASTER BUDGET 3. Static Budget Static Flexible Zero-based Continuous Short term/ Long Planning Period Short term Long term Short term term YES NO NO Adjustment ∆ of After or during YES Do before operation Justifiable Amount activity level Operation Regularly Updated (Fixed) (No basis) (Actual) Flexible Budget  CM Statement Format Selling Price Unit Sold VC/u Fixed Cost Actual Actual Actual Actual Actual Flexible Standard Actual Standard Standard Standard Standard Standard Standard Standard Rolling/ Continuous Budget  Regularly updated Collection Summary Table Cash Cash Budget Sales Credit JAN FEB MAR APR … Credit Sales Accounts receivables Cash Sales JAN AR FEB AR Accounts Receivable Balance MAR AR AR. Beg. APR AR Add: Credit Sales Less: Collection from Credit Sales … AR AR Ending Balance Total Collection BUDGET ANALYSIS USING COST PROFORMA Sales FGI, beg. WIP, beg DM DM, beg. Less: COGS Add: CGM Add: TMC DL Add: Mat. Puch Gross Profit Less: FGI, end Less: WIP, end FOH Less: DM, end Less: Expense COGS CGM TMC DM used Net Profit  measure of acceptable preferrence What Estimated by management Benchmark Why Decision making Planning Standards Where Control Evaluate When Before Operation Ideal Standard How Practical Standard Ideal Standard Practical Standard COMPONENTS Performance Optimum Level Efficient Level Standard Price Production Perfect Expected Apply: Standard Qty (Input) Standard Cost Budgeting TOP-DOWN (Authoritative) BOTTOM-UP (Participative) VARIANCE ANALYSIS  Variance Signals  Investigtion if Favorable or Unfavorable Variance  Material  Efficiency Static Budget Variance ACTUAL FLEXIBLE STANDARD Flexible Budget Variance Volume Variance Yield Variance Mix Variance Total Actual Quantity/Hour of all Product ×: Sales mix (product a/total sales) ×: Standard Rate/Price TAQSP Direct Material Direct Labor Over head Inventoriable Cost Current Wage Rate + Allowance for Normal Losses + Adjustments 𝐸𝑥𝑝𝑒𝑐𝑡𝑒𝑑 𝑂𝑣𝑒𝑟ℎ𝑒𝑎𝑑 = Estimated Required Quantity Required Poduction Time 𝐸𝑥𝑝𝑒𝑐𝑡𝑒𝑑 𝐴𝑐𝑡𝑖𝑣𝑖𝑡𝑦 + Allowance for Normal Losses + Allowance for Normal Losses Direct Material Variance = Actual Cost – Standard Cost = (AQ × AP) – (SQ × SP) Material Quantity Variance (MQV) = (AQ – SQ) SP Material Price Variance (MPV) = AQ (AP – SP) AQ × AP Alternative MPV Direct Solution AQ × SP Material MQV Variance SQ × SP Material Mix Variance (MMV) = ∑ 𝑀𝑄𝑉 Material Yield Variance (MYV) = Ave. Selling Price Direct Labor Variance = Actual Cost – Standard Cost = (AH × AR) – (SH × SR) Labor Efficiency Variance (LEV) = (AH – SH) SR Labor Rate Variance (LRV) = AH (AR – SR) AH × AR Alternative LRV Direct Solution AH × SR Labor LEV Variance SH × SR Idle Time = Idle Time x Standard Labor Rate Factory Overhead Cost = FC + VC/u (x) # of hours  Standard 1-way analysis: FOH Variance  Budgeted Production AFOH  Budgeted Hours  Divisor FOH Variance SHSR Numerator 2-way analysis: Con-Vol FFOH FR AFOH Controllable VFOH VR BASH BFOH SR Volume SHSR BAAH = FC + VC/u (AH) 3-way analysis: SEVOL BASH = FC + VC/u (SH) FAFOH + VAFOH Spending F&V FBAAH + VBAAH Efficiency V BASH + VBASH Volume SHSH + SHSR  PERFORMANCE EVALUATION RESPONSIBILITY ACCOUNTING  Managerial Level.  Cost and Revenue are accumulated and reported by levels of responsibilities TYPES: Cost Revenue Asset Investment Cost Center √ × × Management Own Goal Revenue Center × √ × 1. Participation Own Standard Profit Center √ √ × Controllable Traceable/Direct Cost Investment Center √ √ √ 2. Substantial Control Non-controllable Indirect Cost  Allocated to common cost DECENTRALIZATION Benefits of Decentralization  Division of organization into manageable units  Enhance Competetion Authority  Awareness of Needs Manager  Timely Decision – Focus Management Accountability  Motivates Employees Organizational Goal = Managers Interest  Faster Development of Managers Goal Congruence  Management by Objective Organizational Goal > Managers Interest Subopimization Performance Report  Actual Performance vs Standard Sales Less: Variable Manufacturing Cost Sales Product Contribution Margin Less: Total Variable Cost Less: Variable Non-manufacturing Cost Contribution Magin Contribution Margin Less: Traceable Fix Cost Less: Controllable Fix Cost Segment Margin Short-term Performance Margin Less: Allocated Cost Less: Non-controllable Fix Cost Net Income Segment Margin Evaluated Less: Allocated Cost Pag negative ang segment margin ELIMINATE IT pag positive padin ang segment margin then GO pursue it Net Income Death Spiral  Kapag paulit ulit mong pinapatay ang mga segments kahit profitable naman ito. CENTERS  Cost Evaluated by  Revenue Performance Report  Profit  Investment  Performance Report + others 1. Return on Investment (ROI)  How well assets were utilized to generate income Asset Efficiency Operating Effectiveness Total Asset Turnover × Profit Margin = ROI 𝑆𝑎𝑙𝑒𝑠 𝑁𝑒𝑡 𝑖𝑛𝑐𝑜𝑚𝑒 𝑁𝑒𝑡 𝑖𝑛𝑐𝑜𝑚𝑒 𝐴𝑣𝑒. 𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡 × 𝑆𝑎𝑙𝑒𝑠 = 𝐴𝑣𝑒. 𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡 2. Residual Income Actual Income  Net Income Less: Desired Income  Minimum Rate of return × Operating Asset Residual Income NCL  Interest Rate Financing Equity  Dividends 2. Economic Value Added  Specific Return Investment Earnings Before Income After Tax Less: Desired Income  WACC × (Total Asset – Non-Interest-Bearing CL) Economic Value Added 𝑇𝐿 Interest % × Weighted Ave. 𝑇𝐴 Cost of Capital Dividends % × 𝑇𝑆𝐻𝐸 𝑇𝐴 TRANSFER PRICING/INTERSEGMENT PRICING  Amount charged by one segment to another  System that aligns cost center and revenue center with organization focus GENERAL RULE:  Ensure Goal Congruence 𝑻𝒓𝒂𝒏𝒔𝒇𝒆𝒓 𝑷𝒓𝒊𝒄𝒆 = 𝑨𝒅𝒅′ 𝒍𝑶𝒖𝒕𝒍𝒂𝒚 𝑪𝒐𝒔𝒕/𝒖𝒏𝒊𝒕 + 𝑶𝒑𝒑𝒖𝒓𝒕𝒖𝒏𝒊𝒕𝒚 𝑪𝒐𝒔𝒕/𝒖𝒏𝒊𝒕 Variable cost/unit Contri. Mar. Forgone TYPES OF TRANSFER PRICING 1. Cost Base and Cost + Markup Base COST + MARKUP Variable Costing Full Absorption Costing Full Costing DM DL VOH FOH VS&A FS&A 2. Market Base  Fair Value a. Market Price  Regular selling price to outside customer b. Modifired Price  Regular selling price LESS allowances and discounts 3. Negotiated Price  Maximum and Minimum Transfer Price  Must be st to minimize effect of sub optimization a. UPPER LIMIT  Ceiling Price i. Purchase Cost from outside supplier HIGHER ii. Regular selling price of selling division b. LOWER LIMIT  Floor Price Regular selling Price YES  TP = VC/u + Opp Cost + Incidental Fix Cost Operating @ Supply = Demand full capaciy NO  S>D TP = VC/u + Incidental Fix Cost 4. Arbitrary Price  Walang basehan DECISION NO Negotiate Based on Cost Is there an outside Minimum TP = VC/u + Incidental Fix Cost supplier? NO Maximum TP = Market Price YES - Is selling division @ full capacity? Minimum TP = VC/u + Opp Cost/u + YES Incidental Fix Cost Is this TP > SP from Outside Supplier? YES NO 1. Negotiate 2. Buy From outside CONTINUE supplier BALANCE SCORECARD  A strategic system that defines a strategic based responsive accounting  Involves Financial (value-based management) and non financial measures Financial Perspective Top Level Middle Level How do we look to our ↑ 𝑅𝑒𝑣; ↓ 𝐶𝑜𝑠𝑡; ↑ 𝑁𝐼 Management Managemnet stockholders 3 Process Internal Perspective 1. R&D (innovation) What business process we must excel? 2. Prod. and Dev. 3. Post-service/ Support sale Strategic Objective what to chieve? 3 Areas Learning and Growth 1. Employee perspective HOw do we sustain change and 2. System Strategic Initiative Progress? 3. Structure How to achive Mission Customer Perspective and Vission What do our customer value? Base-line Performance Actual Performance Performance Measure How to measure performance Targets Level of Performance Non-Financial Peformance Measure RECEIVE Wait time START OF Process time + Move time + Oueue time + OF ORDER PRODUCTION DELIVERY Inspection time Manufacturing Cycle time or Through Put Time Delivery Cycle Time 𝑉𝑎𝑙𝑢𝑒 𝑎𝑑𝑑𝑖𝑛𝑔 𝑡𝑖𝑚𝑒 → 𝑃𝑟𝑜𝑐𝑒𝑠𝑠 𝑡𝑖𝑚𝑒 𝑴𝒂𝒏𝒖𝒇𝒂𝒄𝒕𝒖𝒓𝒊𝒏𝒈 𝑪𝒚𝒄𝒍𝒆 𝑬𝒇𝒇𝒊𝒄𝒊𝒆𝒏𝒄𝒚 = 𝑇ℎ𝑟𝑜𝑢𝑔ℎ𝑝𝑢𝑡 𝑇𝑖𝑚𝑒 𝑂𝑢𝑡𝑝𝑢𝑡 Productivity Efficiency  𝐼𝑛𝑝𝑢𝑡 PRODUCT LIFE CYCLE 𝑂𝑢𝑡𝑝𝑢𝑡 Financial Production = 𝐼𝑛𝑝𝑢𝑡 = (𝑃𝐸𝑆𝑂) R & D (Innovation) Partial Productivity  Output in a given single Input 𝑂𝑢𝑡𝑝𝑢𝑡 Design Upstream Cost Operational Production = 𝐼𝑛𝑝𝑢𝑡 = (𝑈𝑁𝐼𝑇𝑆) 𝐺𝑜𝑜𝑑𝑠 𝑈𝑛𝑖𝑡 𝑃𝑟𝑜𝑑𝑢𝑐𝑒𝑑 𝐏𝐫𝐨𝐜𝐞𝐬𝐬 𝐐𝐮𝐚𝐥𝐢𝐭𝐲 𝐘𝐞𝐢𝐥𝐝 = =% Production 𝑈𝑛𝑖𝑡 𝑆𝑡𝑎𝑟𝑡𝑒𝑑 𝑖𝑛 𝑃𝑟𝑜𝑑 ↑ 𝑸𝑷𝒀 = 𝐵𝑒𝑡𝑡𝑒𝑟 ↓ 𝑸𝑷𝒀 = 𝑖𝑠𝑠𝑢𝑒𝑠 𝑤/ 𝑞𝑢𝑎𝑙𝑖𝑡𝑦 𝑐𝑜𝑛𝑡𝑟𝑜𝑙 𝑈𝑛𝑖𝑡𝑠 𝑆𝑡𝑎𝑟𝑡𝑒𝑑 𝑖𝑛 𝑃𝑟𝑜𝑑 Delivery Downstream Cost 𝐏𝐫𝐨𝐜𝐞𝐬𝐬 𝐏𝐫𝐨𝐝𝐮𝐜𝐭𝐢𝐯𝐢𝐭𝐲 = = 𝑼𝒏𝒊𝒕𝒔 𝑉𝑎𝑙𝑢𝑒 𝑎𝑑𝑑𝑒𝑑 𝑃𝑟𝑜𝑐𝑒𝑠𝑠𝑖𝑛𝑔 𝑡𝑖𝑚𝑒 Post-sale Support Disposal Relevant Costing Make or buy: Choose the lowest Cost Relevant Cost to make vs Cost to buy Relevant Cost to Make Cost to Buy Avoidable variable manufacturing cost + Purchase price Material Handling Cost Avoidable fix Cost Material Handling Cost Opportunity cost Accept or Reject: Is it wort accepting? Incremental Revenue > Incremental Cost = Accept Incremental Revenue Incremental Cost (Special price × Demanded) Total Variable Cost Opportunity Cost: Full capacity (CM/u) Additional Fix Cost Continue or Shutdown Avoidable Revenue > Avoidable Cost = Revenue Linear Pogramming Max. CM = CM of A/u (Units Can produced) + CM of B/u (Units can produced) Mat 1: Required material 1 of A (Units can produced) + Required material 1 of B (Units can produced) ≤ Material 1 Limit Mat 2: Required material 2 of A (Units can produced) + Required material 2 of B (Units can produced) ≤ Material 2 Limit  QUANTITATIVE TECHNIQUES  Process of collecting and evaluating measurable (Quantify) and verifiable data (Past data) GOAL: Create a mathematical model that stimulates real world process and systems so optimal solutions can be found USE: 1. Planning and Control a. Cost Estimation i. High-Low ii. Scatter Graph iii. Least-Square Method b. Prediction i. Correlation ii. Learning Curve 2. Decision Making a. Probability Analysis b. Decision Tree c. Linear Programming PLANNING AND CONTROL a. COST ESTIMATE i. High-Low Method ii. Scatter Graph iii. Least-Square Method All points All points 1. Data 2 points Visual Fit Visual Ft 𝐶𝑜𝑠𝑡 (𝑌 𝐻 − 𝑌 𝐿 ) Plot the graph to get the 𝑏= Elimination method 𝑄𝑡𝑦 (𝑋𝐻 − 𝑋𝐿 ) value of a 2. Computation 𝑦−𝑎 ∑𝑦 = 𝑛𝑎 + 𝑏∑𝑥 Note: X prevail over Y ∑𝑥𝑦 = 𝑎∑𝑥 + 𝑏∑𝑥 2 𝑏= 𝑎 = 𝑦 − 𝑏𝑥 𝑥 3. Costly 3rd 2 nd 1st 4. Accurate 2nd 3rd 1st b. PREDICTION Regression  Provides quantitative measure of precision and reliability   Accuracy Reflects actual relationship  > Coefficient of correlation Standard Error (SE) Strength and direction of relationship SE =  Confident and accurate > T Value and P Value T Value = Malayo sa reality T Value = Malapit sa reality i. Correlation  Strength and Direction of Relationship DIRECTION: STRENGTH: General rule on correlation of data Y-intercept = Total fixed cost (a) Coefficient of Independent Variable = Variable cost per unit (b) Coefficient of correlation = Degree of relationship Standard Error of Estimate = (a) ± Standard Error of Estimate Standard Error of Regression Coefficient = (b) ± Standard Error of Regression Coefficient Mean of Independent Variable = MV of Independent Variable – Central tendency Coefficient of determination = Goodness of Fit Degree of freedom =n–2 ii. Learning Curve/ Experience Curve  As the quality of product DOUBLES, the recurring cost per unit DECREASE at fix rate/ constant percentage Non-linear cost behavior influenced by learning  Repetitive Work = Experience;  Hours need to finish task;  Cost  Habang nagkakaroon ng experience ang laborer, bumababa naman ang cost ng produkto 𝑁𝑒𝑤 ℎ𝑜𝑢𝑟𝑠 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡 𝐿𝑒𝑎𝑟𝑛𝑖𝑛𝑔 𝑅𝑎𝑡𝑒 = =% 𝑂𝑙𝑑 ℎ𝑜𝑢𝑟𝑠 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡 Limitations: 1. Labor Intensive 2. Learning Rate is constant 3. Changes in Productivity  Learning rate becomes UNRELIABLE DECISION MAKING a. PROBABILITY ANALYSIS  Likelihood of event to happen/ occur Used to: 1. Help Identity Risk 2. Quantify Risk 3. Assess Decision making under condition of: 1. Risk  Probability distribution is known 2. Uncertainty  Probability distribution is unknown and Subjectly determine (Expert opinion, Dast data, assumption) Types of Uncertainty 1. Most Likely 2. Expected Value = Outcome × Probability Information needed: a. Possible Outcome b. How likely for each outcome to occur Example of Expected Value Bonus Performance × Possibility = Expected Value 1 week done 100 × 30% = 30 2 weeks done 20 × 20% = 4 3 weeks done 10 × 10% = 1 Expected Value = 35 3. Expected Value with perfect Information (EV w/ PI) EV w/ PI = Outcome × Maximum Probability 4. Expected Value of Perfect Information (EV of PI) EV of PI = EV w/ PI – EV(uncertainty)  b. DECISION TREE Stages: 1. Construction Stage 2. Evaluation and Feedback c. LINEAR PROGRAMMING - Mathematical Model - Theory of Constraint Objective: Maximize Profit with limited resources Step 1: Identifying Decision Variables Limits Product A Product B Machine 1 24 2 3 Machine 2 16 2 1 Profit P6 P7 Step 2: Determine Objective and constrain function OBJECTIVE: Profit = 6A + 7B CONSTRAIN: Machine 1: 2A + 3B ≤ 24 Machine 2: 2A + 1B ≤ 16 Step 3: Elimination/ Substitution Method Eliminate A, Substitute B Eliminate B, Substitute A Machine 1: 2A + 3B = 24 Machine 1: 2A + 3B = 24 Substitute 3B using Machine 2 2A + 1B = 16  B= 16 – 2A 𝟏𝟔 – 𝟏𝐁 Substitute 2A using Machine 2 2A + 1B = 16  𝑨 = 𝟐 Machine 1: 2A + 3(16 – 2A) = 24 𝟏𝟔 – 𝟏𝐁 Machine 1: 2A + 48 – 6A = 24 Machine 1: 2( 𝟐 ) + 3B = 24 Machine 1: 48 – 4A = 24 Machine 1: 6 – 1B + 3B = 24 Machine 1: – 4A = 24 – 48 Machine 1: 24 – 16 = 2B −4𝐴 −24 8 2𝐵 Machine 1: = Machine 1: 2 = 2 −4 −4 Machine 1: A= 6 Machine 1: B = 4 Substitute: Profit = 6(6) + 7(4) = 64  FINANCIAL MARKET FINANCIAL SYSTEM Financial Intermediaries INDIRECT TRANSACTION DIRECT TRANSACTION Savers/Investors Financial Markets Financial Intermediaries  Institution that are between the saver(investor) and the borrower(Business) Financial Markets  A platform or system where buyers and sellers come together to trade financial assets  Facilitates the flow of money KINDS OF FINANCIAL MARKET CAPITAL MARKET MONEY MARKET Long-term Investment Short-term Investment Definition > 12 months ≤ 12 months No stipulated time frame Higher Risk Lower Risk Risk Longer Maturity Shorter Maturity Less Liquidity More Liquidity Return Higher return Lower return Purpose Raising Capital Growth Day to day operation capital needs 1. Bills 1. Bonds 2. COD 2. Stocks 3. Commercial papers Type a. Capital Share 4. Repurchase Agreement b. Premium Share 5. Call Money 6. Bankers acceptance OTHER TERMS 1. Marketability – easiness of the conversion 2. Liquidity – ability to convert non-cash asset to cash w/out loss in value 3. Broker 4. Dealer CAPITAL MARKET 1. Bonds Long-term debt financing Issuer Promise to Government  Treasury Bonds Pay: Corporation  Corporate Bonds 1. Principal 2. Interest Terms: 1. Indenture – agreement of issuer and issued a. Maturity date b. Interest payment c. Callable  early payment d. Convertible 2. Covenant a. Negative –CB b. Affirmative – Specific requirement 3. Collateral  asset forfeited if failed to repay debt 4. Sinking Fund  money set aside for riskiness of bonds 5. Bond Rating  helps investor asses riskiness of bonds AAA – Lower risk Investment Grade Bond – Lower return C – Higher risk Junk Bond – Higher return Bond Valuation Elements: 1. Principal 2. Nominal Rate 3. Effective Rate Single  PV of 1 Pay Principal Interest Series  Equal and Regular Interval NO NPV of DCF YES When is the first payment? End of period Start of period PV of OA PV of AD General Rule: Principal  Single Interest  Annual @ end period 2. Stocks a. Preferred Stock Valuation  Same as bonds as it has a fixed cash flow (dividend) 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑 𝑃𝑟𝑖𝑐𝑒 = 𝐷𝑖𝑠𝑐𝑜𝑢𝑛𝑡 𝑟𝑎𝑡𝑒 Discount rate = require rate of return b. Common Stock Valuation More Complex: 1. Dividends are less certain in size and timing 2. No Maturity date 3. Discount rate used in discounted cashflow of common share is not directly observable Valuation: 1. Dividend Discount Model a. Stock price b. Current Dividend c. Growth Rate Zero-Growth Dividend Model Constant Growth Dividend Model Variable Growth Dividend Model 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑 𝑁𝑒𝑥𝑡 𝑦𝑒𝑎𝑟 𝐷𝑖𝑠𝑐𝑜𝑢𝑛𝑡 𝑅𝑎𝑡𝑒 − 𝐺𝑟𝑜𝑤𝑡ℎ 𝑅𝑎𝑡𝑒 PV of Dividend 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑 𝑃𝑟𝑖𝑐𝑒 = + PV of CG Div. Model 𝐷𝑖𝑠𝑐𝑜𝑢𝑛𝑡 𝑅𝑎𝑡𝑒 Dividend next year Price = Current Dividend × (1 + Growth Rate) Relative Models 𝑀𝑎𝑟𝑘𝑒𝑡 𝑃𝑟𝑖𝑐𝑒 1. Profit/ Earnings Ratio = 𝐸𝑎𝑟𝑛𝑖𝑛𝑔 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒 𝑀𝑉 𝑜𝑓 𝐸𝑞𝑢𝑖𝑡𝑦 2. Market Value to Book Value Ratio = 𝐵𝑉 𝑜𝑓 𝐸𝑞𝑢𝑖𝑡𝑦 MV of Equity = MP × Outstanding share 𝑀𝑉 𝑜𝑓 𝐸𝑞𝑢𝑖𝑡𝑦 3. Price to Sales Ratio = 𝑆𝑎𝑙𝑒𝑠 MONEY MARKET Short term Instruments Factors to Consider: 1. Risk – Additional Exposure to Risk 2. Liquidity – Ability to convert without loss in value 3. Maturity – Match maturity to timing of need cash SECURITIES Issuer Risk Liquidity Maturity TREASURY BILLS Highly Liquidity than Government Low Risk or No Risk ≤ 12 months COD/ Time Deposit CERTIFICATE OF DEPOSIT Common Banks Low Risk, PDIC Highly Liquid 1 to 3 months (Time Deposit) COMMERCIAL PAPER Corporation w/ Depends of Credit Relatively Liquid 1 to 270 days (Unsecured Promissory Note) high credit rating Worthiness BANKER’S ACCEPTANCE Depends – Credit Corporation – (Time Drafts) Worthiness of Less Liquidity than Guaranteed by Varies corporation Treasury Bills & CODs bank Estimated by Bank REPURCHASE AGREEMENT Low Risk  High Corporation Highly Liquidity Overnight – Varies (Short-term Collateralized Loan) Quality Collateral EURODOLLAR DEPOSIT Depends – Credit International/ Bank Generally Liquid Varies (us Dollar deposit not in US bank) Worthiness of Bank CALL MONEY Common Banks Lower Risk Highly Liquid Overnight - Varies (Repayable on demand) DERIVATIVES Financial contract whose value is derived from the performance of underlying asset 1. Exchange Traded Organized Exchanges a. Future – Agreement to buy/sell asset at predetermined price @ future date b. Option i. Call – holder has right not obliged to buy Underlying asset @ specified ii. Put – holder has right not obliged to sell price w/in a specified time 2. Over the Counter  Private agreement a. Forward – same as future but no standard contract Black Sholes Binomial Assumption b. Swaps – exchange of financial obligations Model Pricing Model i. Interest Rate One Time Discrete – only Computation time frame ii. FOREX Dividends x x OPTIONS Exercise Transaction European Expiration x x Cost American Anytime Risk Free Rate CONSTANT 5 Inputs: and volatility 1. Strike Price Normal Return N/A Distribution 2. Current Stock Price Risk N/A Neutral 3. Expiration Date European and Options European 4. Risk Free Rate American 5. Volatility Efficient, No Market Random Arbitrage  WORKING CAPITAL MANAGEMENT ULTIMATE GOAL OF FIRM: Maximize its market value  Financial Managers must decide on the following: Working Capital  1. Operating  CA & CL 2. Investing  NCA Short-term Financing Capital Budgeting  Debt 3. Financing Long-term Financing Equity WORKING CAPITAL MANAGEMENT  Administration & Control of Current Asset and Current Liability  Maximize Value by achieving a balance between profitability and risk of liquidity Working Capital = Current Asset – Current Liability Liquidity Profit  =  –    GOAL:  =  –    The goal is to decrease working capital to increase profit NOTE: Increase of Sale = Increase of Current Asset WAYS OF MINIMIZING WORKING CAPITAL 1. Seeking favorable terms w/ supplier and creditors 2. Having efficient management of Cash, AR, Inventory, and operation 3. Effective collection & Credit management 4. Time log reduce  Completion of Finished goods  Delivery WORKING CAPITAL POLICIES 1. Temporary Current Asset  Seasonal CA 2. Permanent Current Asset  Maintained level of asset to keep operations going NCA 3. Fixed Asset 4. Temporary Short-term Financing ST Loans; Promissory Notes CL 5. Spontaneous Debt  AP, Accruals (permanent) NCL 6. Long Term Debt Long Term Financing 7. Equity 1. CONSERVATIVE/RELAXED/FLEXIBLE Temporary Current Asset Permanent Current Long Term Financing Asset Short Term Financing Fixed Asset 0 5 10 15 Maintain CA  Long Term Financing  Liquidity and Profit 2. AGGRESSIVE/RESTRICTED Temporary Current Asset Permanent Current Long Term Financing Asset Short Term Financing Fixed Asset 0 5 10 15 CL Liquidity and  Profit 3. MODERATE/SELF LIQUIDATED Temporary Current Asset Permanent Current Long Term Financing Asset Short Term Financing Fixed Asset 0 5 10 15 CASH AND MARKET SECURITY MANAGEMENT Maintain appropriate level of cash and market security to meet cash requirements and maximize income from idle funds REASONS FOR HOLDING CASH TRANSACTIONS 1. Transaction purposes – Operation 2. Compensating balance 3. Precautionary Reserves – Emergency Funds 4. Potential Investment Opportunity 5. Speculation REASONS FOR HOLDING MARKET SECURITY (Short-term Investment) 1. Substitute for cash 2. Yield returns while funds are idle MAJOR CONCEPT OF MARKET SECURITY 1. FLOAT  delay  Disbursement float  Collection float CUSTOMER BUSINESS BANK MAIL FLOAT PROCESSING CLEARING FLOAT FLOAT COLLECTION FLOAT DISBURSEMENT FLOAT COLLECTION FLOAT Difference Check issued by company Check received by company Effects to Book Cash Cash CIB > Book Balance CIB < Book Balance Maximize the float Minimize the float  2. CASH CONVERSION CYCLE  Inventory  sales = Inventory Turnover  Average Age of Inentory  AR Cash = AR turnover Average age of AR  Cash  AP = AP turnover  Average age of AP 3. ECONOMIC CONVERSION QUANTITY (ECQ)  Optimum Transaction Size Amount of Market Security to be converted to cash considering total costs (conversion cost and opportunity cost) 𝟐 × 𝑪𝒐𝒏𝒗𝒆𝒓𝒔𝒊𝒐𝒏 𝒄𝒐𝒔𝒕 𝒐𝒓 𝒕𝒓𝒂𝒏𝒔𝒂𝒄𝒕𝒊𝒐𝒏 𝒄𝒐𝒔𝒕 × 𝑨𝒏𝒏𝒖𝒂𝒍 𝒅𝒆𝒎𝒂𝒏𝒅 𝒇𝒐𝒓 𝒄𝒂𝒔𝒉 𝐸𝐶𝑄 = √ 𝑶𝒑𝒑𝒐𝒓𝒕𝒖𝒏𝒊𝒕𝒚 𝑪𝒐𝒔𝒕 𝒐𝒓 𝑰𝒏𝒕𝒆𝒓𝒆𝒔𝒕 𝑹𝒂𝒕𝒆 RECEIVABLE MANAGEMENT Formulate and implement policies related to sales and AR that ensures maintenance of receivable @ a predetermined level and collectability as planned WAYS TO ACCELERATE COLLECTION OF AR EFFECTIVE AR MANAGEMENT 1. Shortening Credit Terms 1. Prevention late or non-payment 2. Offer discount for prompt payment 2. Effective Credit management 3. Speed up mailing time  Lock box Credit Policy for Credit Management System 1. Credit Period – Length of time customer have 4. Minimize Float 2. Discount – Price reduction for prompt payment a. Discount Rate b. Discount Period 3. Credit Standard – Financial Strength of Cost 4. Collection Policy – Degree of toughness in enforcing credit terms Lax RESTRICTIVE Sales   AR   BDE   Profit Depends Depends WAYS OF ANALYZING AR 1. Average age of AR  Average Balance of AR 2. AR Turnover 3. Aging of AR a. Ratio of AR to sales b. Ratio of BDE to sales 4. Annualized Opportunity Cost a. Forgone benefit of client for not taking the discount b. Saving/other income of computation List Price  Gross (Discount)  Other income True Price  Net Nominal Rate of Interest  Annualized Opportunity Cost 𝑫% # 𝒐𝒇 𝑫𝒂𝒚𝒔 𝒊𝒏 𝒂 𝒚𝒆𝒂𝒓 × 𝟏−𝑫% 𝑪𝑷−𝑪𝑫 Example: 3/10; 3 is the D% (discount Rate) and 10 is the DP (Discount Period) n/30; 30 is the CP(Credit Period) INVENTORY MANAGEMENT Formulate and administer policy to efficiently and satisfactorily meet production & merchandising requirement and minimize cost INVENTORY MODEL 1. How many units should be ordered? ECONOMIC ORDER QUANTITY (EOQ) ECONOMIC ORDER QUANTITY If EOQ is Available it is used to compute Average Inventory Quantity to be ordered which minimize cost 𝐸𝑂𝑄 = + 𝑆𝑎𝑓𝑒𝑡𝑦 𝑆𝑡𝑜𝑐𝑘 2 Elements: Holding Cost  Carrying Cost per unit Ordering Cost  Cost incurred each order Assumptions: Order Quantity (EOQ)  # of units Ordered 1. Constant Demand  Annual Demand in unit a. Demand b. Cost 2. Independent Order 𝟐 × 𝑫𝒆𝒎𝒂𝒏𝒅 × 𝑶𝒓𝒅𝒆𝒓𝒊𝒏𝒈 𝑪𝒐𝒔𝒕 3. Instant Delivery 𝐸𝑂𝑄 = √ 4. No limitation on size of inventory 𝑯𝒐𝒍𝒅𝒊𝒏𝒈 𝑪𝒐𝒔𝒕  2. When should the units be ordered? REORDER POINT REORDER POINT: Level of inventory that signals reorder which is: o Not Too Late  Stock out o Not Too Early  Excess Inventory o Lead Time  Period of days between order is placed and delivered 𝑁𝑜𝑟𝑚𝑎𝑙 𝑇𝑖𝑚𝑒 𝑈𝑠𝑎𝑔𝑒 = 𝑁𝑜𝑟𝑚𝑎𝑙 𝐿𝑒𝑎𝑑 𝑇𝑖𝑚𝑒 × 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐷𝑎𝑖𝑙𝑦 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 𝑈𝑠𝑎𝑔𝑒 𝑆𝑎𝑓𝑒𝑡𝑦 𝑠𝑡𝑜𝑐𝑘 = ( 𝑀𝑎𝑥. 𝐿𝑒𝑎𝑑 𝑇𝑖𝑚𝑒 − 𝑁𝑜𝑟𝑚𝑎𝑙 𝐿𝑒𝑎𝑑 𝑇𝑖𝑚𝑒) × 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐷𝑎𝑖𝑙𝑦 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 𝑈𝑠𝑎𝑔𝑒 REORDER POINT COMPUTATION: Is there Safety Stock? YES NO Normal Lead Time + Safety Stock Normal Time Usage Or Max. Lead Time + Ave. Daily Inventory Usage Ave. Inventory Bal Holding Cost Order Cost        SHORT-TERM FINANCING SPONTANEOUS 1. AP Discount Loss UNSECURED 2. Accruals N/A SHORT-TERM FINANCING 3. Deferred Income N/A NEGOTIATED 1. Bank Loans UNSECURED d. Line of Credit a. Simple Interest e. Revolving Credit b. Discount Interest Agreement c. Effective Rate 2. Commercial Papers 3. AR Financing SECURED Effective Rate 4. Inventory Finance AP MANAGEMENT (TRADE CREDIT) List Price  Gross Value of Liability (Discount)  Finance Cost True Price  Net Value of Liability Trade Credit  Ave. True Price of AP, if discount is not taken  (Ave. Daily AP × Credit Period) +Free Trade Credit  Ave. True Price of AP, if discount is taken  (Ave. Daily AP × Discount Period) Costly Trade Credit  Excess AP Bal. because of not taking the discount  Ave. Daily AP × (CP-DP) Ave. Daily AP × (CP-DP) Financing (CP-DP) Cost of giving the discount (loss) Nominal Interest Rate Effective Rate (Compound) Annualized Opportunity Cost 𝐷% # 𝑜𝑓 𝐷𝑎𝑦𝑠 𝑖𝑛 𝑦𝑒𝑎𝑟 (1 + 𝑃𝑒𝑟𝑖𝑜𝑑𝑖𝑐 𝐼𝑛𝑡. 𝑅𝑎𝑡𝑒)𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑝𝑒𝑟𝑖𝑜𝑑 − 1 × 1 − 𝐷% 𝐶𝑃 − 𝐷𝑃 (Periodic Int. Rate × Int. Period) BANK LOANS  Short-term credit provided by the bank issue promissory note to the bank Line of Credit Revolving Credit Agreement Nature Maximum Limit Maximum Limit One-Time Guaranteed Line of Credit Terms & Requirement Informal Formal More Flexible Specific Terms and Conditions Borrowed Amount Insert Interest Unborrowed Portion N/A Commitment Fee If only interest 𝐹𝑖𝑛𝑎𝑛𝑐𝑒 𝐶𝑜𝑠𝑡 is paid = 𝐴𝑚𝑜𝑢𝑛𝑡 𝑅𝑒𝑐𝑒𝑖𝑣𝑒𝑑 Bank Loans If interest and 𝑬𝒇𝒇𝒆𝒄𝒕𝒊𝒗𝒆 𝑹𝒂𝒕𝒆 principal rate are paid 2 × # 𝑜𝑓 𝐼𝑛𝑠𝑡𝑎𝑙𝑙𝑚𝑒𝑛𝑡 × 𝑇𝑜𝑡𝑎𝑙 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 = (Installment Terms) (1 + # 𝑜𝑓 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡) × 𝑃𝑟𝑖𝑛𝑐𝑖𝑝𝑎𝑙 COMMERCIAL PAPERS o Issue Promissory notes to investor/ other corporation o Issued by firm w/high credit rating (interest rate lower than prime rate) o Sold @ Discount – non-interest bearing Cost  1 to 270 days 𝐹𝑖𝑛𝑎𝑛𝑐𝑒 𝐶𝑜𝑠𝑡 360 = × 𝐴𝑚𝑢𝑛𝑡 𝑅𝑒𝑐𝑒𝑖𝑣𝑒𝑑 𝐶𝑃 AR FINANCING o Pledging – AR Collateral retain ownership o Factoring – Sold AR at discount to 3rd Party (FACTOR) Cost 𝐹𝑖𝑛𝑎𝑛𝑐𝑒 𝐶𝑜𝑠𝑡 # 𝑜𝑓 𝐷𝑎𝑦𝑠 𝑖𝑛 𝑎 𝑦𝑒𝑎𝑟 𝐴𝐹𝐶 𝑜𝑟 𝐸𝑓𝑓𝑒𝑟𝑐𝑡𝑖𝑣𝑒 𝑅𝑎𝑡𝑒 = × 𝐴𝑚𝑜𝑢𝑛𝑡 𝑅𝑒𝑐𝑒𝑖𝑣𝑒𝑑 𝐶𝑟𝑒𝑑𝑖𝑡 𝑃𝑒𝑟𝑖𝑜𝑑 Amount Received: 1. Average Loan Balance or; 2. Net Proceeds INVENTORY FINANCING Inventory issued as collateral Classifications  Inventory as Collateral 1. Floating Lien  General Claim 2. Trust Receipt  Specific unit written in document 3. Warehouse Receipt  Specific unit store in public warehouse Cost 𝐹𝑖𝑛𝑎𝑛𝑐𝑒 𝐶𝑜𝑠𝑡 = 𝐴𝑚𝑜𝑢𝑛𝑡 𝑅𝑒𝑐𝑒𝑖𝑣𝑒𝑑 Amount Received: 1. Average Loan Balance or; 2. Net Proceeds SUMMARY: a. FINANCE COST Bank Loans Commercial Inventory AR Finance LOC RCA Paper Finance Interest Payment / / / / / Transaction Cost / / / / / Interest Income/ Savings / / X / / Commitment Fee X / X X X Issuance Cost / Floatation Cost X X X X X Advance Interest Expense / X Incidental Warehouse Cost / b. AMOUNT RECEIVED Amount Discount Compensating Floatation Factors Transaction = Principal - - - - - Received Interest Balance Cost Holdback Cost Interest / X / Bearing Non-Interest / / / Bearing Commercial / / X / Paper (Face Value) AR Financing / X / X / / Inventory / x / X / / Financing  LONG-TERM FINANCING Cost of Capital – these are long term funds and new funds coming from liability’s interests and equity’s dividends Capital – This are economic resources capable of being invested so that in the long run it will have something in return 1. WEIGHTED AVERAGE COST OF CAPITAL (WACC) NOTES: Weight (%): Market Value is preferred over Book Value (Pro-rata over total capital) Interest (%): Effective Rate is preferred over Nominal Rate Dividends (%): Dividends per share ÷ Market Price per share = Dividend Yield (%) Example: Cost × Weight = WACC Interest 20% × 70% = 14% Dividends 10% × 30% = 3% 17% Sources: Debt: Equity, Loans, etc  EIR % FUNDS Equity: Preferred Stocks, (Asset) Common Stocks, Retained Earnings  Dividend Yield (%) Debt Capital Equity Capital (Liability) (Equity) EBIT or Operating Income xxx Less: Interest xxx Earnings before Tax xxx Less: Tax xxx Profit after Tax xxx Less: Preferred Dividends xxx Income Available to common share xxx Sources Weight of Market Values Cost Bonds Liab ÷ Total Capital EIR % (1-tax) xx Preferred Stock PS ÷ Total Capital PS % × Par ÷Market Price xx Common Stocks & RE CS + RE ÷ Total Capital Expected Common xx Dividend per share ÷ Common share per share + Dividend growth rate WACC xx Cost of Capital vs. Rate of Return  Assume a cost of capital 8%  Is 15% Rate of return acceptable? YES Note:  Is 5% Rate of return acceptable? NO 𝐶𝑎𝑠ℎ 𝐼𝑛 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑌𝑖𝑒𝑙𝑑, 𝐸𝐼𝑅, 𝑀𝑎𝑟𝑘𝑒𝑡 𝑅𝑎𝑡𝑒 =  Alternative names for cost of capital 𝐶𝑎𝑠ℎ 𝑂𝑢𝑡  Minimum acceptable rate of return  Minimum desired rate of return  Required rate of return  Hurdle rate/overcome  Standard Rate  Cut-off rate 2. COST OF DEBT  After Tax (remove tax)  Cost of Long-term Debt (“KD”) 𝐶𝑎𝑠ℎ 𝑜𝑢𝑡 (𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡) 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑌𝑖𝑒𝑙𝑑 𝑜𝑟 𝐸𝐼𝑅 = 𝐶𝑎𝑠ℎ 𝐼𝑛 (𝑆𝑒𝑙𝑙𝑖𝑛𝑔 𝑃𝑟𝑖𝑐𝑒) 3. COST OF PREFERRED STOCK (“KP”) 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑 𝑝𝑒𝑟 𝑆ℎ𝑎𝑟𝑒 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑 𝑌𝑖𝑒𝑙𝑑 = 𝑀𝑎𝑟𝑘𝑒𝑡 𝑃𝑟𝑖𝑐𝑒 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒 Dividend Per share = Preferred Dividend Rate × Par value per share Market Price = Net of cost or floatation cost/ issue cost 4. COST OF COMON EQUITY: GORDON GROWTH MODEL (GGM)  Cost of Common Stock and Retained Earnings (“KE”) a. Common Stock Dividend  Shall be net of Floatation Cost  IF NOT YET PAID: 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑 𝑝𝑒𝑟 𝑆ℎ𝑎𝑟𝑒 𝐃𝐢𝐯𝐢𝐝𝐞𝐧𝐝 𝐘𝐢𝐞𝐥𝐝 = 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑 𝑀𝑎𝑟𝑘𝑒𝑡 𝑃𝑟𝑖𝑐𝑒 𝑛𝑒𝑡 𝑜𝑓 𝐹𝑙𝑜𝑎𝑡𝑎𝑡𝑖𝑜𝑛 𝐶𝑜𝑠𝑡 Cost of Common Stock = Dividend Yield + Growth Rate  IF RECENTLY PAID: 𝐄𝐱𝐩𝐞𝐜𝐭𝐞𝐝 𝐃𝐢𝐯𝐢𝐝𝐞𝐧𝐝 𝐏𝐞𝐫 𝐒𝐡𝐚𝐫𝐞 = 𝑃𝑎𝑠𝑡, 𝑝𝑟𝑒𝑠𝑒𝑛𝑡 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑 𝑝𝑒𝑟 𝑆𝐻𝑎𝑟𝑒 × (1. 𝑔𝑟𝑜𝑤𝑡ℎ 𝑟𝑎𝑡𝑒) 𝐸𝑥𝑝𝑒𝑐𝑡𝑒𝑑 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑 𝑝𝑒𝑟 𝑆ℎ𝑎𝑟𝑒 𝐃𝐢𝐯𝐢𝐝𝐞𝐧𝐝 𝐘𝐢𝐞𝐥𝐝 = 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑 𝑀𝑎𝑟𝑘𝑒𝑡 𝑃𝑟𝑖𝑐𝑒 𝑛𝑒𝑡 𝑜𝑓 𝐹𝑙𝑜𝑎𝑡𝑎𝑡𝑖𝑜𝑛 𝐶𝑜𝑠𝑡 Cost of Common Stock = Dividend Yield + Growth Rate b. Retained Earnings  Ignore Floatation Cost  IF NOT YET PAID: 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑 𝑝𝑒𝑟 𝑆ℎ𝑎𝑟𝑒 × 1. 𝑔𝑟𝑜𝑤𝑡ℎ 𝑟𝑎𝑡𝑒 𝐃𝐢𝐯𝐢𝐝𝐞𝐧𝐝 𝐘𝐢𝐞𝐥𝐝 = 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑 𝑀𝑎𝑟𝑘𝑒𝑡 𝑃𝑟𝑖𝑐𝑒 Cost of Retained Earnings = Dividend Yield + Growth Rate  IF RECENTLY PAID: 𝐄𝐱𝐩𝐞𝐜𝐭𝐞𝐝 𝐃𝐢𝐯𝐢𝐝𝐞𝐧𝐝 𝐏𝐞𝐫 𝐒𝐡𝐚𝐫𝐞 = 𝑃𝑎𝑠𝑡, 𝑝𝑟𝑒𝑠𝑒𝑛𝑡 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑 𝑝𝑒𝑟 𝑆𝐻𝑎𝑟𝑒 × (1. 𝑔𝑟𝑜𝑤𝑡ℎ 𝑟𝑎𝑡𝑒) 𝐸𝑥𝑝𝑒𝑐𝑡𝑒𝑑 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑 𝑝𝑒𝑟 𝑆ℎ𝑎𝑟𝑒 𝐃𝐢𝐯𝐢𝐝𝐞𝐧𝐝 𝐘𝐢𝐞𝐥𝐝 = 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑 𝑀𝑎𝑟𝑘𝑒𝑡 𝑃𝑟𝑖𝑐𝑒 Cost of Retained Earnings = Dividend Yield + Growth Rate CAPITAL ASSET PRICING MODEL 𝑲𝑬 = 𝑲𝑹𝑭 + 𝜷 (𝑲𝑴 − 𝑲𝑹𝑭 ) KE = Expected or required rate of return KRF = Risk-free rate based of treasury bill 𝛽 = Beta Coefficient KM = Market Return (KM – KRF) = Market Risk Premium 𝛽(KM – KRF) = Risk Premium SECURITY RISK 1. Diversifiable Risk/Controllable Risk/Unsystematic Risk/Company specific Risk  Security Risk that can be controlled through: a. Business Risk b. Liquidity Risk c. Default Risk 2. Non-diversifiable risk/ non-controllable risk/ systematic risk/ market-related risk  Results from forces outside of the firms control a. Market Risk b. Interest Rate Risk c. Purchasing Power Risk LEVERAGE Leverage  Portion of fix cost which represent a risk to the firm 1. OPERATING LEVERAGE  risk to the firm of being unable to cover operating costs 𝐶𝑀 ∆% 𝑖𝑛 𝐸𝐵𝐼𝑇 𝐷𝑂𝐿 = 𝑜𝑟 = "n" 𝑡𝑖𝑚𝑒𝑠 𝐸𝐵𝐼𝑇 ∆% 𝑖𝑛 𝑠𝑎𝑙𝑒𝑠 CM= Sales – Variable Cost EBIT = CM – Fixed operation cost 2. FINANCIAL LEVERAGE  The risk to the firm of being unable to cover financial obligation 𝐸𝐵𝐼𝑇 ∆% 𝑖𝑛 𝐸𝑃𝑆 𝐷𝐹𝐿 = 𝑜𝑟 = "n" 𝑡𝑖𝑚𝑒𝑠 𝐸𝐵𝐼𝑇 − 𝐹𝐹𝐶 ∆% 𝑖𝑛 𝐸𝐵𝐼𝑇 Net income-Preferred dividends EPS= # of common shares outstanding Fix Financing Charges (FFC) = Interest Charges + Pre tax preferred Dividends 3. TOTAL LEVERAGES  measures the total risk 𝐶𝑀 ∆% 𝑖𝑛 𝐸𝑃𝑆 𝐷𝑇𝐿 = 𝑜𝑟 = "n" 𝑡𝑖𝑚𝑒𝑠 𝐸𝐵𝐼𝑇 − 𝐹𝐹𝐶 ∆% 𝑖𝑛 𝑆𝑎𝑙𝑒𝑠 DTL = DOL × DFL  CAPITAL BUDGETING Operation  Working Capital Management FINANCIAL MANAGERS Investment Capital Budget Financing Capital Budgeting  Process of: a. Identifying Decisions:  Financing  How to raise b. Evaluating capital Capital Investment of c. Planning  Investing  Which asset will the Organization: be acquired d. Financing 1. Replacement 2. Improvement 3. Expansions Characteristics of Capital Budgeting 1. Large Resources 2. Long Commitments 3. Difficult to reverse 4. Risky and Uncertain Characteristics of Capital Budgeting 1. Cash Flow Stages: a. Initial Investment – Net Investment b. Operating Cash Flow c. Final Disposal 2. Cost of Capital  Hurdle rate (the minimum rate of return that a project or investment must achieve before it is considered acceptable) 3. Net Return after Tax a. Net Income b. Net Cash Flow Sales xx Less: Variable Cost (xx) Contribution Margin xx Less: Fixed Cost (Cash) (xx) Depreciation Expense (xx) Earnings Before Tax xx Less: Tax (xx) Net Income xx Add: Depreciation Expense xx NET CASH FLOW xx  NET INVESTMENT = CASH OUTFLOW/COST – CASH INFLOW/SAVINGS NO TAX WITH TAX 1. Initial Outlay Cost 1. Trade In Value old asset (replacement) a. Purchase Price 2. Cash proceeds from sale of old asset b. Increase Cost Gain – Less Tax 2. Working Capital Requirement Loss – Add Tax Savings 3. Market Value of unused asset that 3. Avoidable Cost, cost of repair will be used METHODS OF EVALUATING CAPITAL INVESTMENT BASIS Payback Period NCF NO Bail Out Period NCF Accounting Rat NI of Return Consider Time Value of Money? Net Present NCF Value Profitability NCF Index YES Discounted NCF Payback Period Discounted Rate NCF