MANAGEMENT Consultant

-Outsource professional –not an employee

MANAGEMENT CONSULTANCY -Catalyst of change (agent)
-Primary purpose: to improve clients’ use of its capabilities & resources to -Professional attributes:
achieve the objectives of the organization.
 Technical skills
NATURE of management consultancy: (SIR HEBIE)  Interpersonal skills
 Consultancy skills
Services are rendered in behalf of management
Involves problem solving
Relates to the future MANAGEMENT ACCOUNTING
-is the process of planning, organizing, and controlling tasks to achieve or meet the
Human relations play a vital role
goals of organizing.
Engagement requires highly qualified staff

Broad in scope  Planning
-It is the basic function of management.
Involves various assignments -chalking out a future course of action
-deciding in advance the most appropriate course of actions for
Engagements is non-recurring (non repetitive in nature)
achievement of pre-determined goals
 Organizing/Directing
1. Consultation
-physical, financial and human resources
2. Engagements -developing productive relationship amongst them for
(Services)
CONSULTANT MNGT achievement of organizational goals.
(Fees) -actuates the organizational methods to work efficiently
  Supervision 
 Motivation
 Leadership
 Communication
 LINE (downward authority)
 Controlling –performance evaluation -directly involved in the daily operations of a business
-Actual vs Expectation (standard) -production, operations, sales & marketing.
-correction of deviation  STAFF(upward/lateral authority)
 Decision Making- inherent in all management functions. -Primary purpose: is to provide assistance and specialized advice and
expertise to colleagues in line position.



FINANCIAL ACCTG MANAGEMENT ACCTG
1. REPORTING STD PFRS/PAS/GAAP None TREASURER CONTROLLER
2. USERS OF INFO Internal & External Internal (Exclusively) Provision of capital Protection of Assets
3. TYPE OF INFO Financial/Monetary Only Monetary/Non- Collection & Credit Prep of FS
Monetary
4. EMPHASIS OF Reliability (Precision) Relevance(Timeliness)
Investment TAX administration
REPORTS -objective and verifiable Sourcing of capital(short-term Gov’t reporting
5. SOURCE OF INFO Internal info Internal/External financing)
6. FOCUS OF Business as a whole Segments & Divisions Investor relations Audit (Reporting &
REPORTING (Aggregated/Summarized) (Detailed) Interpreting)
7. FREQUENCY OF Periodical (at least Whenever needed Insurance Economic appraisal
REPORTING annually) - mandatory
Banking and Custody Planning and Control
8. TIME Past /Historical Future
ORIGINATION
9. REFERRED AS PROCESS END PRODUCT
 C. ENHANCING THE VALUE OF MNGT ACCTING SYSTEM BY
GUIDING MANAGERS TO FOCUS ON CHALLENGES.
a. Customer Focus
I. STRATEGIC DECISIONS
-Key to a company’s success in creating value for customers while b. Value-Chain and Supply chain thru
differentiating itself from its competitors. It is a set of activities that an org
carries out to create value for its It pertains to the movement of
customers. goods from raw materials to
II. IDENTIFYING AND BUILDING RESOURCES AND CAPABILITIES WIP to FG and eventually to the
-Building resources and capabilities requires efficient logistics to customer or end-user.
become successful.
-Logistics pertain to the movement of goods or services when needed
and to whom it is needed. i. Companies add value thru (sequenced)
1. R&D
III. ROLE IN IMPLEMENTING STRATEGY planning 2. Design
To help the collective
A. IMPLEMENTING STRATEGY control decision of an organization 3. Production
*Feedback – linking planning and controlling a. Implementation 4. Marketing
to help future decision making. b. Performance evaluation
5. Distribution
6. Customer Services
ii. Managers in all bus. Functions are customers
B. SUPPORTING MANAGERS of mngt acctng info.
-Involves choosing between two alternatives as possible
Problem solving
solution to a problem. ---Strategy Decision.
ROLES OF MNGT c. Key success Factors
Scorekeeping -Gathering of actual information. ---Control Decision
ACCTANT FOR -Directly affects the economic viability of an org.
SUCCESS Attention-directing -Involves helping management focus on what matters..
---Control Decision
-It includes, cost and efficiency, innovation, quality,
and efficient time management.
 d. Continuous improvement and benchmarking

Benchmarking – process of measuring the performance of a

company’s products, services, or processes against those of another
business considered to be the best in the industry “best in class”.

 Competence – fit to do the job

 Integrity - straightforward
 Confidentiality
 Objectivity (Credibility) – report everything w/o bias.
 K.G. ABIGATO
COST BEHAVIOR - refers to how a cost will react to changes in the level of activity.
DEFINITION COST DRIVER -has
-has a adirect
directrelationship
relationship with
withthe
thecost.
cost.

COST OBJECT -anything that cost can be computed.

COST BEHAVIOR COST POOL -grouping of similar pool.

RELEVANT RANGE -refers to the band of activity within which the identified cost behavior patterns are valid.
-grouping of similar pool.

COST CLASSIFICATION ACTIVITY LEVEL

COST BEHAVIOR PATTERNS VARIABLE COST:
PER TOTAL (DIRECT)
METHODS OF SEGREGATION COSTS PER UNIT K(constant) K
FIXED COST:
CORRELATION ANALYSIS
PER TOTAL K K
PER UNIT (INVERSE)
Y = a + bX MIXED COST:
PER TOTAL (DIRECT)
PER UNIT (INVERSE)

TOTAL COST (MIXED TOTAL FXD COST VC/UNIT COST DRIVER

COST)

Y-intercept SLOPE INDEPENDENT

DEPENDENT VARIABLE VARIABLE
INHERENT ASSUMPTIONS 8. In case of multiple product companies, the selling prices, costs, and
proportion of units (sales mix) sold will not change.
9. Technology as well as productive efficiency is constant.
1. All costs are classifiable as either fixed or variable.
10. TVM is ignored.
2. Fixed costs remain constant within the relevant range.
3. The behavior of total revenues and total costs will be linear over the relevant
range.

TOTAL COST

PRICE

REVENUE
TOTAL COST
BEP

UNTIS

4. Total VC varies directly with units while VC/UNIT is constant

5. Total FC is constant while FC/UNIT varies inversely with units.
6. There is no significant change in the inventory level during the period under
review.
7. SP is constant
 COST VOLUME PROFIT VARIABLE COST

-it is a cost that varies, in total, in direct proportion to changes in the level of
activity. (Table A)
Cost classification for predicting Cost Behavior
-is a constant per unit. (Table B)
COST BEHAVIOR

-refers to how a cost will react to changes in the level of activity.

Variable Cost
Table A Table B
CLASSIFICATION: Fixed Cost
Unit Variable Cost
Total Variable Cost
Mixed Cost

Quantity Quantity
FACTORS AFFECTING PROFIT:

1. Selling price per unit 4. Fixed Cost

2. Variable cost per unit 5. Sales Mix VARIABLE COST IN TOTAL VARIABLE COST IN UNIT
3. Volume or number of units
*upward slope, positive slope,
CLASSIFICATION OF COSTS: positively correlated w/ quantity.

1. Functional
 Manufacturing, selling and administrative.
2. Behavioral
 Variable, Fixed and Mixed.
3. Nature of Expense
 TFC
FIXED COST STEP FIXED COST
-Fixed cost that is constant at a given level or period but significantly
-It is a cost which is constant within the relevant rang increases beyond that level or period.

Q TFC

IN TOTAL

-Fixed Cost per unit changes inversely with the units

Q
produced. 1000 2000

o Downward slope or negative slope,

TFC
or negatively correlated with quantity.

BREAK-EVEN ANALYSIS
Q
IN UNITS I. METHOD OF COMPUTING BREAK-EVEN POINT

1. EQUATION METHODS OR ALGEBRAIC APPROACH

TOTAL COST Let:
X = sales units at BEP
PRICE SPU = Selling price per unit
TOTAL COST VCU = Variable cost per unit
FC = Total Fixed cost
VARIABLE COST Where
TR = SPU . X
TC = FC+ VCU . X
FIXED COST
Therefore BEP

UNTIS TR = TC
2. CONTRIBUTION MARGIN METHOD OR FORMULA APPROACH D. CONTRIBUTION MARGIN RATIO (CMR)

TOTAL FIXED COST CMU 1 - VCR

A. BEP in PESOS SPU
CMR
NPR
TOTAL SALES PESOS – MOS PESOS TCM MSR
TOTAL SALES PESOS
B. BEP in UNITS
TOTAL FIXED COST
CM/unit FIXED COST
BEP PESOS
TOTAL SALES UNITS – MOS UNITS

PROFIT
C. CONTRIBUTION MARGIN PER UNIT (CMU) MOS PESOS

SP / unit - VC / unit
CHANGE IN FC
CHANGE IN BEP PESOS
TCM
TOTAL SALES UNITS
E. FIXED COST
FIXED COST
BEP UNITS TCM - PROFIT BEP UNITS X CMU

PROFIT
TOTAL COST - TVC BEP PSOS X CMR
MOS units

CHANGE IN FC
CHANGE IN BEP UNITS
F. VARIABLE COST RATIO ( VCR)
VC / unit SENSITIVITY ANALYSIS
SP / unit -is very important in determining factors that will significantly affect profits.

% CHANGE IN OUTPUT
TVC
% CHANGE IN INPUT
TOTAL SALES

1-CMR
SALES MIX IN MULTI-PRODUCT COMPANIES
G. TOTAL SALES PESOS OR AMOUNT OF SALES TO EARN A DESIRED -The proportion of two or more products sold.
PROFIT
ASSUMPTIONS:

TOTAL FIXED COSTS + DESIRED PROFIT AFTER TAX (1-TAX RATE) 1. The proportion of sales mix must be predetermined.
2. The sales mix must not change within the relevant time period.
CMR

BEP PESOS + MOS SALES A. MIX BEP PESOS TOTAL FIXED COST
COMPOSITE CMR
H. TOTAL SALES UNITS OR NUMBER OF UNITS TO BE SOLD TO EARN A
DESIRED PROFIT B. MIX BEP UNITS
TOTAL FIXED COST
COMPOSITE CMU
TOTAL FIXED COSTS + DESIRED PROFIT AFTER TAX (1-TAX RATE)
C. COMPOSITE CMR
CMU (CMR a X Mix Ratio a) + (CMR b X Mix Ratio b) + (CMR nth X Mix Ration nth)

BEP units + MOS units D. COMPOSITE CMU

(CMU a X Mix Ratio a) + (CMR U X Mix Ratio b) + (CMU nth X Mix Ration
nth)
MARGIN OF SAFETY E. NET PROFIT RATION (NPR) OR ROS
-it indicates the amount by which actual or planned sales may be reduced
EBIT or OI
without incurring a loss.
TOTAL SALES PESOS
-the LOWER the MOS, the riskier the business is.

A. MARGIN OF SAFETY PESOS (MSP) MSR x CMR

TOTAL SALES PESOS – BEP PESOS

PROFIT / CMR

B. MSU DEGREE OF OPERATING LEVERAGE (DOL)

-is a financial ratio that measures the sensitivity of a company’s operating
TOTAL SALES UNITS – BEP UNITS
Income to its sales.
-it shows how a change in the company’s sales will affect its operating
PROFIT / CMU
income.
C. MSR -CONSTANT
MSP/ TOTAL SALES PESOS TCM
MSU/ TOTAL SALES UNTIS OPERATING PROFIT, if 1yr of operations is
presented
NPR / CMR
% CHANGE IN PROFIT
D. PROFIT % CHANGE IN SALES, if 2yrs
TOTAL REVENUES-TOTAL COST
CM
TCM- FC OI

MSUxCMU

MSPxCMR

TOTAL REVENUES x NPR

POINT OF INDIFFERENCE
- is the point at which total cost (fixed and variable) of two alternatives under
consideration is the same.

COST OF INDIFFERENCE POINT

DIFFERENTIAL FIXED COST

DIFFERENTIAL VC/unit

POI units CHANGE IN FC

CHANGE IN CMU

POI PESOS CHANGE IN FC

CHANGE IN CMR

SCENARIO ANALYSIS/ MULTIPLE DRIVERS

-assesses the effect of changing all of the variables at the same time.
-The difference from sensitivity analysis examines, is that sensitive only
assesses the effect of changing a single variable at a time.

BENEFITS:

 More proactive risk management

 Better decision-making
 A methodical approach to analyze the future may help companies to
find:
o Opportunities
o Risks they may have otherwise overlooked.
VARIABLE AND ABSORPTION COSTING SEVERAL STEPS TO REDUCE THE UNDESIRABLE EFFECTS BY TOP MANAGEMENT

 focus on careful budgeting and inventory planning

COST CLASSIFICATION  incorporate a “carrying charge” for inventory in the internal accounting system

PRODUCT COST PERIOD COST  change the period to evaluate performance

INVENTORIABLE YES NO  include nonfinancial as well as financial variables in the measures of performance evaluation
COST FLOW INCURRENCE--INVENTORIES-- INCURRENCE -- P/L
P/L
ACCOUNTING TREATMENT CAPITALIZED FIRST EXPENSE OUTRIGHT VARIABLE COSTING INTERNAL REPORTING
P/L ITEM COGS OPEX
-Marginal ONLY VARIABLE MANUFACTURING COST
PRINCIPLE(by matching principle) COST AND EFFECT IMMEDIATE
RECOGNITION -Non-GAAP

ABSORPTION COSTING REQUIRED BY PFRS -Direct

-Full costing EXTERNAL REPORTING -segregates costs according to behavior

-Conventional ALL MANUFACTURING COST - uses the Contribution Margin Income approach

-GGAP/PFRS

-Traditional THROUGHPUT COSTING ONLY DIRECT MATERIALS COST

-segregates costs according to function -Super variable cost

-uses the Conventional Income Statement
OPERATING COSTS VARIABLE ABSORPTION THROUGHPUT SUPER
PERFORMANCE ISSUES OF ABSORPTION COSTING: COSTING COSTING COSTING ABSORPTION
 manipulation of income-producing too many units a. Direct materials product product product product
b. Direct Labor - Variable product product period product
 manufacture product with highest amount of fixed cost c. Factory ovrhd
-variable product product period product
 accepting an order of another department to increase production
-fixed period product period product
 Deferring maintenance d. Selling and admin
-variable period period period product, if
-fixed period period period value adding
FOUR DIFFERENT CAPACITY LEVEL used to compute the budgeted fixed COMPUTATION:
manufacturing rate: SALES xxx
LESS:
1. THEORITICAL CAPACITY – based on producing at full efficiency all the time. VARIABLE MANUFACTURING OVERHEAD COST (xxx)
VARIABLE SELLING AND ADMIN EXPENSE (xxx)
2. PRACTICAL CAPACITY – reduces theoretical by considering unavoidable. CONTBUTION MARGIN xxx
3. NORMAL CAPACITY – satisfies average customer demand over a period of time. LESS:
FIXED MANUFACTURING OVERHEAD COST (xxx)
4. MASTER-BUDGET CAPACITY UTILIZATION – managers expect for the current period. FIXED SELLING AND ADMIN EXPENSE (xxx)
NET OPERATING INCOME(LOSS)-VARIABLE COSTING xxx(xxx)

Net income- variable costing xxx

ALTERNATIVE COST METHODS in allocation of overhead to the units produced.
Add: Fixed cost in ending inventory xxx

Less: Fixed cost in beginning inventory (xxx)

1. ACTUAL COST SYSTEM – uses actual cost or actual rates, and actual quantities or
Net income- absorption costing xxx
hours used in production.
2. NORMAL COST SYSTEM – a company measures the actual costs of direct materials
and direct labor, but uses predetermined factory overhead rates. *If the company is using normal cost systems and the variance is significant, reconciliation
of net income will be:
3. EXTENDED NORMAL COST SYSTEM OR FLEXIBLE BUDGET – used to track
Net income- variable costing xxx
production costs. It uses budgeted costs of the inputs used in production multiplied
by the actual quantity of the inputs that were used in production. Add: Fixed cost in ending inventory xxx

4. STANDARD COST SYSTEM OR STATIC BUDGET – is a tool for planning budgets, Less: Fixed cost in beginning inventory (xxx)
managing and controlling costs, and evaluating cost management performance. Add/deduct any Over (Under) applied OH xxx(xxx)

Net income- absorption costing xxx

Relationship between
Production and Sales NET INCOME INVENTORIES
a. P = S AC = VC BE = BB
b. P > S AC > VC BE > BB
c. P < S AC < VC BE < BB
STANDARD COSTING & VARIANCES
USES OF VARIANCE ANALYSIS

 MANAGEMENT BY EXCEPTION
-is the concept that supports variance analysis
STANDARD COSTING -only the most important variances from the planned direction or results of
-practice of substituting an expected cost for an actual cost in the accounting the business matters to managers
records
-the creation of estimated costs for some or all activities within a company  PERFORMANCE EVALUATION

VARIANCES  FEEDBACK TO PLANNING AND CONTROL

-recorded to show difference between the expected and actual costs

 Rate variance – also known as price variance

 Volume variance
IF:
SC = AC Variance

ADVANTAGES/USES OF STANDARD COSTING Unfavorable

SC<AC variance
 Budgeting Debt/adverse
 Inventory costing
 Overhead application Added to COGS
 Price formulation
SC>AC F variance

Credit variance
DISADVANTAGES/PROBLEMS OF STANDARD COSTING Deducted -
COGS
 Cost-plus contracts
 Drives inappropriate activities
 Fast-paced environment
 Slow feedback
 Unit-level information
VARIANCES
FACTORY OVERHEAD
 Variabe Fixed
Actual AVR x AH + AFR x AH Spending/Budget
BAAH SVR x AH + BFC Efficiency
DIRECT MATERIALS
BASH SVR x SH + BFC Volume
AP(P) = AQ(U)
Standard SVR x SH + SFC x SH
AQ x AP = xx
PRICE VARIANCE
AQ x SP = xx
QTY VARIANCE 2 way
SQ x SP = xx
CONTROLLABLE VARIANCE
Actual xxxx
less: BASH xxxx xxxx
AP(P) ≠ AQ(U) UNCONTROLLABLE/VOLUME VARIANCE
BASH xxxx
AQ(P) x AP = xx less: Standard xxxx xxxx
MATERIAL PRICE VARIANCE TOTAL VARIANCE XXXX
AQ(P) x SP = xx

AQ(U) x SP = xx
MATERIAL QTY VARIANCE
SQ x SP = xx
3 way
SPENDING VARIANCE
 Actual xxxx
less: BAAH xxxx xxxx
EFFICIENCY VARIANCE
DIRECT LABOR BAAH xxxx
less: BASH xxxx xxxx
AH x AR = xx
VOLUME VARIANCE
LABOR RATE VARIANCE BASH xxxx
AH x SR = xx
LABOR EFFICIENCY VARIANCE less: Standard xxxx xxxx
SH x SR = xx TOTAL VARIANCE XXXX
 4 way
Variable spending variance xxxx
Fixed spending variance xxxx
Efficiency variance xxxx
Volume variance xxxx
TOTAL VARIANCE XXXX
STANDARD COSTING & VARIANCES
USES OF VARIANCE ANALYSIS

STANDARD COSTING  MANAGEMENT BY EXCEPTION

-practice of substituting an expected cost for an actual cost in the accounting -is the concept that supports variance analysis
records -only the most important variances from the planned direction or results of
-the creation of estimated costs for some or all activities within a company the business matters to managers

VARIANCES  PERFORMANCE EVALUATION

-recorded to show difference between the expected and actual costs
 FEEDBACK TO PLANNING AND CONTROL
 Rate variance – also known as price variance
 Volume variance

IF:
ADVANTAGES/USES OF STANDARD COSTING SC = AC Variance
 Budgeting Unfavorable
SC<AC
 Inventory costing variance
 Overhead application Debt/adverse
 Price formulation
Added to COGS

SC>AC F variance
DISADVANTAGES/PROBLEMS OF STANDARD COSTING
Credit variance
 Cost-plus contracts
Deducted -
 Drives inappropriate activities
COGS
 Fast-paced environment
 Slow feedback
 Unit-level information
VARIANCES 3. Closing Entry
F-Materials Price Variance xxxx
DIRECT MATERIALS UF-Materials qty Variances xxxxx
CGSs xxxxx
AP(P) = AQ(U)
*assuming price variance is favorable and Qty variance is unfavorable*
AQ x AP = xx
PRICE VARIANCE DIRECT LABOR
AQ x SP = xx
QTY VARIANCE AH x AR = xx
SQ x SP = xx
LABOR RATE VARIANCE
AH x SR = xx
LABOR EFFICIENCY VARIANCE
SH x SR = xx
AP(P) ≠ AQ(U)

AQ(P) x AP = xx ENTRY:
MATERIAL PRICE VARIANCE LABOR IS APPLIED TO WIP
AQ(P) x SP = xx WIP (SR x SH) xxxxx
AQ(U) x SP = xx UF-Labor rate variances (AR – SR)xAH xxxxx
UF-Labor efficiency variance (AH – SH) x SR xxxxx
MATERIAL QTY VARIANCE
SQ x SP = xx Wages Payable (AR x AH) xxxxx
F-Labor rate variances xxxxx
F-Labor efficiency variance (AH – SH) x SR xxxxx

ENTRY: CLOSING ENTRY

1. Purchase of Raw Materials CGS
Raw Materials (SP x AQ) xxxxx F-Labor rate variances xxxxx
UF-Materials price variances (AP – SP)xAQ xxxxx F-Labor efficiency variance (AH – SH) x SR xxxxx
Accounts Payable (AP x AQ) xxxxx UF-Labor rate variances (AR – SR)xAH xxxxx
F-Materials Price Variances xxxxx UF-Labor efficiency variance (AH – SH) x SR xxxxx
2. RM applied to WIP
WIP (SP x SQ) xxxxx
UF-Materials qty variances (AQ – SQ)xSP xxxxx
Raw Materials xxxxx
F-Materials qty Variances xxxxx

*debit: Unfavorable; credit: Favorable*

 FACTORY OVERHEAD 4 way
Variabe Fixed Variable spending variance xxxx
Actual AVR x AH + AFR x AH Spending/Budget Fixed spending variance xxxx
BAAH SVR x AH + BFC Efficiency Efficiency variance xxxx
BASH SVR x SH + BFC Volume Volume variance xxxx
Standard SVR x SH + SFC x SH TOTAL VARIANCE XXXX

2 way ENTRY:
CONTROLLABLE VARIANCE ACTUAL FO INCURRED DURING THE PERIOD
FO control (all actual FO) xxxxx
Actual xxxx
Cash or any appropriate account xxxxx
less: BASH xxxx xxxx
UNCONTROLLABLE/VOLUME VARIANCE
BASH xxxx FO IS APPLIED TO WIP
less: Standard xxxx xxxx WIP (Std FO allowed) xxxxx
TOTAL VARIANCE XXXX Applied FO xxxxx

3 way CLOSING ENTRIES(entry under cost acctg)

SPENDING VARIANCE Applied FO xxxxx
Actual xxxx CGS xxxxx
less: BAAH xxxx xxxx FO xxxxx
EFFICIENCY VARIANCE
BAAH xxxx
If there’s variances (optional)
less: BASH xxxx xxxx
CLOSING ENTRIES
VOLUME VARIANCE
Applied FO xxxx
BASH xxxx
UF-Variable spending variance xxxx
less: Standard xxxx xxxx UF-Volume variance xxxx
TOTAL VARIANCE XXXX UF-Fixed spending variance xxxx
FO control xxxxx
F-Fixed Spending Variance xxxxx
F-Variable spending variance xxxxx
F-Variable Efficiency variance xxxxx
VARIANCES ARE CLOSED TO COGS
COGS xxxxx
UF-Fixed spending variance xxxxx
UF-Variable spending variance xxxxx
F-Variable spending variance xxxxx
F-Volume variance xxxxx

MIX AND YIELD VARIANCE

MIX – is a deviation from the standard combination of raw materials or labor.

MIX
Actual Mix % - Std Mix % %
X Total Actual Consumption xxxx
X Std Rate xxxx
XXXX

YIELD – is a deviation from expected output of input components, (materials and labor).

YIELD
Total Actual Consumption xxxx
Less: Total Std Consumption xxxx
xxxx
X Std Mix % %
X Std Rate xxxx
XXXX
 BUDGETING
-is a forecasting tool to determine future sources and uses of resources.
-expressed in quantitative information
-are fuure-oriented.
-It is also a tool used for strategic and tactical planning intended to control costs
to attain customer satisfaction and become successful against.

PLANNING
-It is a quantitative expression of what management wants to attain.
-It also serves as a guideline on what to do to attain desired outcomes or objectives.

Budget Cycle

setting the overall

goals and
objectives.

Planning after performance

corrective actions evaluation.
are created.

Investigation of
deviations.

BUDGET PROCESS

TOP-DOWN
-Authoritarian approach
COMMUNICATION PREPARATION
-essential aspect of -imposed budgeting
budgeting process. BOTTOM-UP
-where succcess -Participative
-individual budgetingwill
department
depends on. create budget and will
communicate it upward.
APPROVAL
IMPLEMENTATION (BUDGET
COMMITTEE)

MONITORING

ADVANTAGES AND USES OF BUDGETS

1 Compels periodic planning;
2 Basis of performance evaluation;
3 Motivational tool;
4 Promotes coordination within the company; &
5 Enhances communication within the company.
SOURCE OF INFORMATION
1 Past company records
2 Benchmark Attainable (Practical)
3 Standards developed by company
-standards allow allowance for down-time & rest periods.

Theoretical (Ideal)
-standards assume 100% efficiency.

BUDGETING METHODOLOGIES
1 ROLLING BUDGET (CONTINUOUS BUDGET)
-extending budget continuously

2 INCREMENTAL BUDGET
-create estimation in terms of percentages

3 Activity-based budgesting
-this is the budget that supports Activity Based Management.
-is a planning system under which costs are associated with activities, and expenditures are then
budgeted based on the expected activity level.

4 LIFE CYCLE
-to budget everything from the start to the end.

5 ZERO BASED BUDGETING

6 Kaizen budgeting
-this is the budget that supports Total Quality Management.
-budgeting technique focusing on continuous imrovement from a service or product perspective.
-management to set goals based on future plans for process and operational improvements, rather than
creating budgets based on the existing cost structure.

TYPES OF BUDGET
1 Static(Fixed) Budget
-budget that is prepared for a single level of output.

2 Flexible Budget
-this is the only budget that is adjusted to actual level of output.

OPERATING BUDGET

MASTER BUDGET FINANCIAL BUDGET

CAPITAL BUDGET

OPEX

SALES PRODUCTION
CASH BUDGET
BUDGET BUDGET

DM
COGS BUDGET
DL BUDGET B/S
BUDGET I/S
FOH
 RELEVANT COSTING

RELEVANT COSTING
-SHORT TERM non-routine decision making.
-expected fututre cash costs w/c differs between decision alternatives.
-it changes between two alternatives.

TWO TYPES: marginal costs -increase in cost as a result of producing more units
1 FUTURE DIFFERENTIAL CASH COST avoidable costs -the company will not incur if not performed.
2 OPPORTUNITY COST-benefit forgone

examples:
n Variable cost
n Avoidable cost
n Imputed Costs
n Opportunity costs
n Savings `
*not all savings and avoidable costs are relevant

IRRELEVANT COSTING
1 PAST COST/ SUNK COST joint cost
2 NON-DIFFERENTIAL allocated cost
common cost
NON CASH COST- related to the past cost
GR: irrelevant
exception: if to be incurred in the future

TYPES OF DECISIONS.
1 MAKE OR BUY
2 ACCEPT OR REJECT SPECIAL ORDER
3 CONTINUE OR DROP/SHUTDOWN
4 SELL OR PROCESS FURTHER, BEST PRODUCT COMBINATION

MAKE OR BUY
-basically an analysis of avoidable costs.
-cost decisions.
-outsourcing (buy) decision.
-Alternative - LOWER TOTAL COST

MAKE BUY
Variable mftg costs Purchase price
+Avoidable Fxd factory OH +Freight costs
+Avoidable non-mftg costs rental income +Variable Handling costs
free space
+Opportunity costs CM of new product
+Variable Handling costs
Savings if the part were bought
ACCEPT OR REJECT
Characteristics os Specialorder:
1 Non-recurring
2 Customer - NOT regular (irregular one time order)
3 Market is distinguishable - does not affect regular sales
4 Price is usually lower than regular sales

*IF THERE IS INCREMENTAL PROFIT - ACCEPT

*ONLY COST INCURRED ARE RELEVANT. HENCE, AVOIDABLE COST ARE IRRELEVANT (EXCEPTION TO GR)

Incremental Sales
(SP of special order x # orders) xxxx
LESS: Incremental costs
Variable costs (mftg & non) (xxxx)
Incremental FC (xxxx)
Opportunity costs (CM of RS) (xxxx) -if there's a need to sacrifice. idle capacity = NO OC
full capacity = there's OC
Incremental Profit/Loss xxxxxx

KEEP OF DROP
GR If Segment Margin is POSITIVE = DO NOT DROP
*because it would reduce the overall profit
*but also consider COMPLIMENTARY EFFECTS

Sales xxxx
VC (xxxx)
CM xxxx
Direct/Avoidable/Traceable FC (xxxx)
Segment Margin xxxx
Allocated/indirect FC (xxxx)
Operating income xxxx

Minimum SP:
w/ excess capacity VC/unit + FC/unit
w/o excess capacity VC + FC/unit + OC/unit

SELL OR PROCESS FURTHER

Incremental revenue > further processing cost = PROCESS FURTHER

OPTIMIZING SCARCE RESOURCES

-prioritize the product with the highest contribution margin per limited resource.

*If there's IDLE CAPACITY = prioritize the HIGHEST CM/unit

 PRICING
FOUR MARKET STRUCTURES:
1 MONOPOLY -one seller and many buyer.
2 PERFECT COMPETITION -multiple buyers and sellers.
3 MONOPOLISTIC COMPETITION -sells differerntiated products.
4 OLIGOPOLY -few sellers and many buyers.

CONSIDER DEGREE OF COMPETITION

MARKET LEADER AND CHALLENGER

-often engage in price wars.
-they engage in various competitions to outo the other.

FOLLOWER
-does not engage in price wars. Its selling price is lower compared to ML & C.
-usually caters to target market other than the one captured by ML & C.

NICHE
-cater to the special few.

TIME HORIZON AND PRICING DECISIONS

1 Short-run pricing decisions
a. Time horizon less than a year.
b. More opprtunistic-prices decreased when demand weak and increases when stong.
c. Types include adjusting product mix and output volume in a competitive market.

2 Long-run pricing decisions

a. Time horizon of one year or longer
b. Price of product in major market with some leeway in setting price. Basis of stable priceng or external prices.
c. More costs relevant because can alter in a long run.
d. Earn reasonable rate of return on investment through setting profit margins.

SHORT-RUN PRICING
-objective is to determine the minimun selling price.
Minimum SP
=VC + OPPORTUNITY COST
dependent on the idle capacity.
the greater idle, the lower the OC
-e.g setting price on SPECIAL ORDER.

1 COST: only cost incurred are RELEVANT. If AVOIDABLE - IGNORED.

a. FMC - irrelevant bc NO CHANGE
b. All direct and indirect VMC related to SO-relevant.
c. All material procurement and process-changever costs related to SO-relevant.
d. All nonmanufacturing costs unaffected by accepting SO - irrelevant
e. note that unit costs can mislead.

2 COMPETITIOON
a. Data on capacity conditions-idle
-If there's an idle capacity, there is NO opportunity cost.
b. Minimum price identified.
 3 CUSTOMERS
a. Price must cover incremental costs.
b. Price may also need to cover revenues lost on existing sales if price lowered.
c. Price may be set at what market will bear if strong customer demand and limited capacity.

MARKET-BASED VS. COST-BASED PRICING

Market-based approach
-customers dictate the SP.
Prices are determined by teo market methods:
1. Demand-based priceng
2. Competition-based pricing

Cost-based approach
-the producer or seller dictate the selling price.
-FULL COST - includes ALL cost compnents across all bus functions whether variable or fixed.
-mark up cost-based pricing is typrically expressed as a percentage of the full cost.

COST-BASED PRICING
FULL COST /UNIT XX
+MARK UP (COST BASED*%) XX
SP XX

LIFE CYCLE BUDGETING

INFANCY STAGE -introduction stage
GROWTH STAGE -expansion stage
MATURITY STAGE -climax stage
DECLINE STAGE -pull-out stage

ANOTHER METHOD
Minimum Required Rate of Return (Return on Investment)
-also known as Cost-plus target rate of return on investment

Desired profit per unit

=
Full cost

Alternative Cost-Plus Method

-mostly used for ony Special Order or Opportunistic pricing.

Desired Profit + Cost not included in the base

=
Aletrnative Cost Base

TARGET PRICING
-this is the long-run pricing strategy that lets the market determine the selling price
-all costs are RELEVANT
-is the estimated price for product or service that potential customers will pay.
-highest price that can be charged for a product or services.
-it is an estimate of how much potential customers are willing to pay based on their value perceptions.

To determine the target price, consider the fellowing:

a. Understanding what customers value, identify products that are needed by the potential customers.
b. Understanding how competitiors will price competing products.
RELATED PRICING STRATEGY
l Peak-Load Pricing
l Market penetration pricing
l Price Skimming
l Competitive pricing
l Predatory pricing
l Psychological pricing
l Bundled pricing/ Price bundling
l Geographical pricing
l Premium pricing
prices.
 CAPITAL BUDGETING
-long term decision making.
-it is the process of identifying, evaluating, planning, and financing capital investment
projects of an organization.
-evaluaiton of acceptable potential investment alternatives.

Identification Estimation of
of Potential costs and Evaluation
Projects benefits
PROCESS

Development
Re-evaluation/
of the capital
Post-audit
budgets

CAPITAL INVESTMENT DECISION

Characteristics: Other characteristics:
1 requires large commitments of resources 1 substantial funds
2 long term commitments 2  uncertainty =  risk
3 more difficult to reverse than short-term decisions 3 difficulty to reverse
4 future/multiple periods
Net investment for decision making 5 significant
Factors: Cost of Capital
Cash and accrual net returns

Essential Information:
A RELEVANT CASH FLOWS DURING THE PROJECT'S LIFE

1) NET INVESTMENT - initial net cash outflow at the start of the project.

COST OR CASH OUTFLOWS xxxx

LESS: CASH INFLOWS OR SAVINGS 7]
NET INVESTMENT xxxx

Initial cash outlay Trade-in value of old asset

Cash outflows: Working capital req. Cash inflows: Proceeds from sale of old asset (net
MV of current idle asset of tax)
Add'l investment Avoidable cost (net of tax)
*any gains &losses are subject to tax.

2) NET CASH INFLOWS FROM OPERATION - annual cash inflows generated from operating activities
during the project's life

Earning Before Interest but After Tax (EBIAT) xxxx

Add: Depreciation expense xxxx
Cash inflows from operation or CIAT xxxx
OR
Cash inflows before Tax (CIBT) xxxx
Less: Tax (xxxx)
Add: Depreciation tax shield xxxx
Cash inflows after tax (CIAT) xxxx
 3) TERMINAL VALUE or END OF LIFE RECOVERY VALUE - net cash proceeds expected to be
realized at the end of the project's economic life.

PV of freed-up working capital xxxx

CIAT from the last-year of operations xxxx
Proceeds of sale of investment net of tax of gain/loss xxxx
Terminal Value xxxx

B ACCOUNTING NET INCOME OR EARNINGS BEF INTEREST BUT AFTER TAX

-measures the profitability of an investment project.
-it is simply the EBIAT

C COST F CAPITAL
D TIME VALUE OF MONEY
E INCOME TAX
1) AFTER-TAX BENEFIT OR CASH INFLOW
2) AFTER-TAX COST
3) DEPRECIATION TAX SHIELD (DTS)

NON-DISCOUNTED CAPITAL BUDGETING TECHNIQUES

A PAYBACK PERIOD
-the length of time required by the project to recover the initial cost of investment.
-the LOWER the payback period the BETTER
-A project is acceptable provided that the payback period is less than a company's acceptable payback
period.

IF C is EVEN: IF C is NOT EVEN:

Initial Investment -accumulate CFAT up until it
Annual Net cash inflows equals net investment

Advantages: Disadvantages
l Easy to compute l no time value
l serves as a screening tool l doesn't consider all CF after payback period
l help companies compete when l tends to be misleading
products become obsolete l no SV
l measure liquidity NOT profitability

B BAIL-OUT PAYBACK PERIOD

-it incorporates the salvage value of the asset into the calculation
-considers salvage value
-the SHORTER the payback period, the MORE attractive a company is.

Cummulative CFAT PY + SV CY
net investment -
CFAT CY

C ACCOUTNING RATE OF RETURN

-a test of project's profitability.
-it determines of net income is suffcient to settle cost associated with the project.
-A project is acceptable if ARR is equal or greater than WACC.

on intial investment: on Ave. investment:

Ave. Annual Net Income Ave. Annual Net Income
ARR = ARR =
Investment Investment + SV/2
 Advantages: Disadvantages:
1 investors easily understand return 1. no time value
2 Rough screening 2. no CF timing-focus on acctg net OI
3. Diffirent averaging tech & Acctng policies
4. The same project may appear desirable in some
years and undesirable in other years.
5. measures PROFITABILY not liquidity

D PAYBACK RECIPROCAL
-it is a rough estimate of IRR if the two simplifying assumptions are met:
1) The economic life of the project is at least twice the payback period.
2)The net cash inflows are constant thruout the life of the project.

Net cash inflows 1

OR
Investment Payback period

DISCOUNTED CAPITAL BUDGETING TECHNIQUES

Advantages Disadvantages
1 More Reliable 1. Complex
2 Over entire life 2. Difficult
3 More objective & relevant 3. Detailed forecast of CF
4. Cost capital / Discount rate

A NET PRESENT VALUE

-is the difference between PV of CI and the initial cost of investment.
-used when dealing with independent projects
-analyzes profitability and liquidity

Pros: Con
>The discount rate can be adjusted during the >Does not provide the true rate of return of the project
life of the project to reflect the degree of risk

>More relistic than the IRR

assumptions:
1) all CF other than the initial investment occur at the end of periods.
2) all CF are reinvested immediately at a rate equal to the discount rate used in NPV calculations.

computed as:
1) PV of C  - Cost of Investment
2) PV of C  - PV of the cost of investment
3) PV of C  - PV of Cash outflows

B INTERNAL RATE OF RETURN

PV of C.I = PV of C.O.
simply NPV = 0
IF:
IRR > Cost of capital ACCEPT
IRR < Cost of capital REJECT

C PROFITABILITY INDEX
-value investment ratio (VIR) or Profit investment ratio (PIR)
-is an index that represents the relationship between the initial cost of investment and the PV of its future
cash flows.
 computed as IF:
1) Total PV of CI PI > 1 ACCEPT
Cost of investment PI < 1 REJECT

2) Total PV of CI
Total PV of Cash outflows

D EQUIVALENT ANNUAL ANNUITY

E FISHER RATE/NPV POINT OF DIFFERENCE
 RELEVANT COSTING

RELEVANT COSTING
-SHORT TERM non-routine decision making.
-expected fututre cash costs w/c differs between decision alternatives.
-it changes between two alternatives.

TWO TYPES: marginal costs -increase in cost as a result of producing more units
1 FUTURE DIFFERENTIAL CASH COST avoidable costs -the company will not incur if not performed.
2 OPPORTUNITY COST-benefit forgone

examples:
n Variable cost
n Avoidable cost
n Imputed Costs
n Opportunity costs
n Savings `
*not all savings and avoidable costs are relevant

IRRELEVANT COSTING
1 PAST COST/ SUNK COST joint cost
2 NON-DIFFERENTIAL allocated cost
common cost
NON CASH COST- related to the past cost
GR: irrelevant
exception: if to be incurred in the future

TYPES OF DECISIONS.
1 MAKE OR BUY
2 ACCEPT OR REJECT SPECIAL ORDER
3 CONTINUE OR DROP/SHUTDOWN
4 SELL OR PROCESS FURTHER, BEST PRODUCT COMBINATION

MAKE OR BUY
-basically an analysis of avoidable costs.
-cost decisions.
-outsourcing (buy) decision.
-Alternative - LOWER TOTAL COST

MAKE BUY
Variable mftg costs Purchase price
+Avoidable Fxd factory OH +Freight costs
+Avoidable non-mftg costs rental income free space +Variable Handling costs
+Opportunity costs CM of new product
+Variable Handling costs Savings if the part were bought
ACCEPT OR REJECT
Characteristics os Specialorder:
1 Non-recurring
2 Customer - NOT regular (irregular one time order)
3 Market is distinguishable - does not affect regular sales
4 Price is usually lower than regular sales

*IF THERE IS INCREMENTAL PROFIT - ACCEPT

*ONLY COST INCURRED ARE RELEVANT. HENCE, AVOIDABLE COST ARE IRRELEVANT (EXCEPTION TO GR)

Incremental Sales
(SP of special order x # orders) xxxx
LESS: Incremental costs
Variable costs (mftg & non) (xxxx)
Incremental FC (xxxx)
Opportunity costs (CM of RS) (xxxx) -if there's a need to sacrifice. idle capacity = NO OC
full capacity = there's OC
Incremental Profit/Loss xxxxxx

KEEP OF DROP
GR If Segment Margin is POSITIVE = DO NOT DROP
*because it would reduce the overall profit
*but also consider COMPLIMENTARY EFFECTS

Sales xxxx
VC (xxxx)
CM xxxx
Direct/Avoidable/Traceable FC (xxxx)
Segment Margin xxxx
Allocated/indirect FC (xxxx)
Operating income xxxx

Minimum SP:
w/ excess capacity VC/unit + FC/unit
w/o excess capacity VC + FC/unit + OC/unit

SELL OR PROCESS FURTHER

Incremental revenue > further processing cost = PROCESS FURTHER

CONTINUE OR SHUTDOWN
should the company continue to operate at a loss or temporary shutdown.

alt1: continue vs. shutdown

-minimize loss

alt2: continue demand if it is > SP

 shutdown demand if it is < SP

SHUTDOWN SAVINGS
SHUTDOWN POINT =
CM/u

FC - [FC shutdown + start-up cost]

SHUTDOWN SAVINGS =
CM/u

OPTIMIZING SCARCE RESOURCES / PRODUCT- MIX DECISION

-prioritize the product with the highest contribution margin per limited resource.

*If there's IDLE CAPACITY = prioritize the HIGHEST CM/unit

LINEAR PROGRAMMING
-used when there's multiple product and multiple limited resources issue.
-Quantitative technique used to determine the optimal mix of lmited resources for maximazing profits or
minimizing costs. It is very useful in analyzing complex problems.
 FINANCIAL STATEMENT ANALYSIS
past performance
-involves the assessment and evaluaion of the firm's: present condition
future business potentials

Provide informations about:

1 Profitability of the business firm.
2 The firm's ability to meet its obligations
3 Safety of the investment in the business.
4 Effectiveness of management in running the firm.
5 Over-all company marketability.

VERTICAL ANALYSIS
--FS technique in w/c each line item is listed as a percentage of a base figure in the statement.
--makes comparing FS from one company to another and across industries much easier.

Converted FS - Common size FS. it comprehends or visualizes the changes in individual items
it compares statements of 2 or more companies.

HORIZONTAL ANALYSIS
--enables investors and analysits to see what has been driving a company's financial performance over time, as
well as identify trends and growth patterns.
--statements for 2 or more periods are used.
--study of percentage changes in comparative statements.

CASH FLOW ANALYSIS

-also know as statement of cash flow.
-it summarizes the amount of cash and cash equivalent entering and leaving a company.

Main components:
1 CF from operating activities
2 CF from investing activities
3 CF from financing activities
4 Disclosure of noncash activities

FREE CASH FLOW

-it is the cash generated after acctg for cash outflows to suport operations and maintain assets.
-is a measure of porfitability that excludes non-cash expenses from the statement and includes spending on
equipment and assets as well as balance-sheet changes in working capital.

COMPUTATION:
1 Operating Activities to FCF 3 NI TO FCF
CF from OA xxxx NI xxxx
add: Interest Expenses xxxx add:
less: Interest expense xxxx
Tax shield on Interest expenses (xxxx) NC expenses (dep, amort, etc) xxxx
Capital Expenditures(CAPEX) (xxxx) less:
=FREE CASH FLOW xxxx Tax-shield on Interest xpenses (xxxx)
Changes in WC (xxxx)
2 EBIT to FCF CAPEX (xxxx)
EBIT (1-Tax rate) xxxx =FREE CASH FLOW xxxx
add:NC Expenses (dep, amort) xxxx
less: FCF reasons:
Changes in WC (CA-CL) (xxxx) Revenue growth share buybacks
CAPEX (xxxx) Effeciency improvement Dividend distributions
=FREE CASH FLOW xxxx Cost reductions Debt Eliminations.
 GROSS PROFIT ANALYSIS
-used to determine why GPM changes from period to period.

∞ Sales price variance (SPV)/ Sales Factor

= (Selling price per unit this year – Selling price per unit last year) x Sales units this year
= Total sales this year – Sales this year at last year’s price

∞ Cost price variance (CPV)/ Cost Factor

= (Unit cost this year – Unit cost last year) x Sales units this year
= Cost of sales this year – Cost of sales this year at last year’s price

∞ Sales Quantity Variance (SQV)

= (Sales Qty this year – Sales Qty last year) x Selling price last year

∞ Cost Quantity Variance (CQV)

= (Sales Qty this year – Sales Qty last year) x Unit cost last year

∞ Sales Volume Variance/ Quantity Factor

= (Sales Qty this year – Sales Qty last year) x Gross Profit per unit last year

TESTS OF LIQUIDITY
Liquidity Ratio - measure a company's ability to pay off its short-term debts as they become due.

1 Current ratio (or banker's ratio or WC ratio)

Current Assests
= measures the number of times that the
Current Liabilities
CL could be paid with the available CA.
Working Capital = Current Assets – Current Liabilities

2 Acid Test Ratio

Quick Assets*
= measures the number of times that the
Current Liabilities
CL could be paid with the available
cash and near cash assets.
*CA - INVENTORY
*Cash + marketable securities + receivables.

3 Cash Ratio
Cash and Marketable securities
=
Current Liabilities

4 Working capital activity ratios (turnovers):

A. Receivable Turnover The time required to complete one

Net Credit Sales* collection cycle-from the time
= receivables are recorded, then
Ave. Receivables collected, to the time new receivables
are recorded again.
Average age of receivables
(or days’ sales in receivables or average collection period)
No. of working days in yr.
=
Receivables turnover
indicates the average number of days
during which the company must wait
Average receivables before receivables are collected.
=
Average daily credit sales
 B. Inventory Turnover:
Cost of goods sold
= Measures the number of times that
Ave. Mdse. Inventory inventory is replaced during the period.

Average Age of Inventory

Number of Working Days
=
Inventory Turnover Indicates the ave. number of days
during which the company must wait
Ave. Inventory before inventories are sold
=
Ave. daily cost of goods sold

 Operating Cycle
= Ave. age of Rec + Ave. age of Inv.

C. Trade Payables Turnover

Net Credit Purchases
=
Ave. Trade Payables

Ave. age of trade payables Indicates the length of time during

No. of working days which payables remain unpaid
=
Payables Turnover

 Cash Flow Cycle

= Operating Cycle - Ave. age of Trade payables

D. Current Assets Turnover

Cost of Sales + Operating Expenses Measures the movement and utilization
= (excluding dep and amort) of current assets to meet operating
requirements.
Average Current Assets

5 Working capital to total assets

Working Capital Indicates relative liquidity of total assets
=
Total Assets and distribution of resources employed.

6 Working Capital Turnover

Net Sales
= Indicates adequacy and activity of WC.
Average Working Capital

TESTS OF SOLVENCY
-also called financial leverage ratios.
-compare a company's debt level with its assets, equity, earnings, to evaluate the likelihood of a company
staying afloat over the long haul, by paying off its long-term debt as the interest on its debt.

1 Times Interest Earned

Income before tax + Interest expense determines the extent to w/c operations
= cover interest expense
Interest Expense

2 Debt-Equity Ratio
Total Liabilities Proportion of assets provided by
= creditors compared to that provided by
Total Owners' or Stockholders' equity
owners.
3 Debt Ratio
Total liabilities
= Proportion of total assets provided by
Total Assets creditors.
4 Equity Ratio
Total Owner's or Stockholders' Equity Proportion of total assets provided by
=
Total Assets owners.

5 Fixed Assets to Long-term Liabilities

Fixed Assets Reflects extent of the utilization of
= resources from long-term debt.
Long-term liabilities
Indicative of sources of additional funds.
6 Fixed Assets to Total Equity
Fixed Assets
= Indicative of over or under investment by
Total Equity owners; also weakness in "trading on the

7 Fixed Assets to Total Assets

Fixed Assets
= Indicates possible over expansion of plant
Total Assets
and equipment.
8 Sales to fixed assets (plant turnover)
Net Sales
= Test roughly the efficiency of mngt in
Fixed Assets (Net) keeping plant properties employed.

9 Book value per share on common stock

Common stock equity
= Measures recoverable amount in the
# of outstanding common stock event of liquidation if assets are realized
at their book values.
10 Times Preferred Dividend
Net income After Taxes
=
Preferred Dividend Indicates ability to provide dividends to
preferred stockholders.
11 Times Fixed Charges Earned
Net income before taxes and fixed charges
=
Fixed charges (rent + interest + Sinking fund payment before taxes)

12 Sinking fund payments bef. Tax Measures ability to meet fixed charges.
Sinking fund payment after taxes
=
1 - Tax Rate

TESTS OF PROFITABILITY
-how well a company can generate profits from its operations.

1 Return on Sales
Determines the amount of income
Earnings After Tax
= earned on each peso sales.
Net Sales

2 Return of Total Assets (ROA)

Income before Interest but after taxes Efficiency with w/c managers use total
=
Average total assets assets to operate the business.

3 Return on Owners' equity

Earnings After Tax Measures the amount earned on the
=
Ave. Owners' Equity owners' or stockholders' investment.

4 Earnings Per Share

Earnings After Tax - Preferred Dividends Measures the amount of NI
=
Weighted Ave. Number of Common Shares earned by each CS.

5 Rate of Return on Current Assets

Earnings After Tax Measures the profitability of current
= assets invested.
Average Current Assets
6 Rate of Return Per turnover of current Assets
Rate of Return on Ave. Current Assets Shows profitability of each turnover of
= current assets.
Current Assets Turnover

MARKET TESTS
-These are the most commonly used ratios in fundamental analysis.
-refers to how financial instruments can be quickly converted into cash at a reasonable price.

1 Price/Earnings Ratio (P/E)

Price Per Share Indicates the number of pesos required
=
Earnings Per Share to buy P1 of earnings

2 Dividend Yield
Ordinary Dividend Per Share Measures the rate of return in the
=
Price Per Share investor's common stock investments

3 Dividend Pay-out
Ordinary Dividend Per Share Indicates the proportion of earnings
=
Earnings Per Share distributed as dividends.

4 Plow-back ratio
= 1- Payout Ratio determines the portion of earnings used
for internal financing
5 Earnings Yield
Earnings Per Share
= determines how much will be earned for
Price Per Share
every P1 invested.

DU PONT EQUATION
-is a useful technique used to decompose the different drivers of return on equity (ROE).

ROE = NPM x ASSET TURNOVER x EQUITY MULTIPLIER

OI x TOTAL SALES x TOTAL ASSETS

=
SALES TOTAL ASSETS SHAREHOLDER'S EQUITY

Financial forecasting using additional funds needed (AFN)

-is a way of calculating how much new funding will be required

AFN = Projected increase in assets – spontaneous increase in liabilities – any increase in RE.

= (A*/S0)ΔS – (L*/S0)ΔS – MS1(RR)

A- Assets tied directly to sales

L-spontaneous liabilities that are affected by sales
S0=the previous year’s sales
S1=total projected sales for next year
ΔS=the change in sales between S0 and S1
M=profit margin
MS1=projected net income
RR=the retention ratio from net income (equal to 1 minus the dividend payout ratio; disregard if
dividends are not declared).
 RESPONSIBILITY ACCOUNTING
-is the basis of a management control system.
-should be done in respect of all responsibility centers to ascertain their level of performance.

RESPONSIBILITY ACCOUNTING
-is an internal reporting system that supports decentralization of decision making and generation of
information specific to the center.

A. Decentralization vs. Centralization

Decentralization -is the delegation of authoirty and responsibility to supervisors or mid-level mngt.
-creation of divisions or segments to become more manageable sub-units in the org.

ADVANTAGES DISADVANTAGES
1 It serves as a motivational tool It may lead to too much decentralization resulting to lack of
coordination among division managers.
2 Top level mngt can focus on strategic issues and It can also lead to sub-optimization.
overall concerns
3 It allows quicker response to operational Too much leeway granted to lower-level manager in
problems. resolving issues will result to losing sight on the "big picture".

4 It is a training ground for lower-level This may result to "in-breading".

managers.

Centralization -leaves decision making to few top-level mngt.

-decision is cascaded to lower-level mngt for implementation.

B. Segment Reporting
-provides an accurate picture of a public company's performance to its shareholders
-mngt uses business segment reporting to evluate the income, expenses, assets, and liabilities of each business
division to assess its general health-- including profitability and potential pitfalls.

C. Goal Congruence and Motivation

-is a situation in wc people in multiple levels of an organization share the same goal.
-the situation when the goals of different interest groups coincide.
-In contrast an org that lacks goal congruence often results in substantial losses, or draining off of assets.

Controllable & Non-controllable costs, Direct and Common costs

Controllable cost
-these are costs w/c may be directly regulated at a given level of managerial authority and time-frame.

Non-Controllable cost
-this is a cost that cannot be altered based on personal business decision or need.

*While controllable costs can be altered in the short run, uncontrollabel costs can be altered in the long run.

Direct/Traceable
-is a fixed cost that is avoidable if a segment or division is discontinued.

Common Fixed cost (Unavoidable fixed, Allocated fixed)

-is a FC necessary to sustain operations of multiple segments.
RESPONSIBILITY CENTERS

TYPE OF CENTER
COST PROFIT REVENUE INVESTMENT
ACCOUNTABILITY Cost & Expenses Revenues; Cost & Revenues Investment; Revenues; Cost &
Expenses Expenses
EVALUATION Standard Cost CM; Segment Revenue Variances ROI; Residual income;
Variances Income Economic Value Added
Analysis( EVA)
EXAMPLE Product Marketing Each sales division Investment in Branch;
Department Department in a dep't store Investment in Subsidiary

A) Operating income
Return on Investment (ROI) =
Ave. Investment or Assets

or Operating income Sales

ROI = X
Sales Ave. Investment or Assets

B) Residual income (RI) = Operating Income - (Minimum ROR x Ave Investment Income or Assets)

C) Economic Vale Added (EVA)

-is a measure of a compay's financial performance based on the residual wealth calculated by
deducting its cost of capital from its Earnings before Interest but after Tax (EBIAT) or (NOPAT)
-it can also be referred to as economic profit, as it attempts to capture the economic profit of a co.

EVA = EBIAT - (WACC x Total Long-term Sources of Financing)

= NOPAT - (Total Assets - Current Liablities) x WACC

Rational and need for transfer price

Transfer price (TP)
-is the price charged by one segment org for a product or service that it supplies to another segment of an
org.
-only intended for performance evaluation.

The highest/maximum TP of the buying division

-the highest price the buying division would be willing to pay is the external price it pays from an outside
supplier.

The lowest/minimum acceptable transfer price for the selling division.

-it is the variable cost per unit of his division.
 BALANCED SCORECARD
-consists of an integrated set of performance measures that are derived from and support the company's
strategy throughout the organization.
-it is a strategic management system that translates the vision and strategy of an organzation into
operational objectives and performance measures.

STRATEGY -specifies how an organization matches its own capabilities with the opportunities in the
marketplace to accomplish its objectives.
-describes how an organization can create value for its customers while diffirentiating itself
from its competitiors.

MICHAEL PORTER'S FIVE FORCES:

1 Competitors
2 Potential entrants into the market
3 Power of supplies
4 Bargaining power of customers
5 Threat of substitutes

TWO BASIC STRATEGY

1 Product Diffirentiation
is an org's ability to offer products or services perceived by its customers to be superior & unique relatve
to which of its competitors.

2 Cost Leadership
is an org's ability to achieve lower costs relative to competitors thru productivity and efficiency
improvements, elimination of waste, and tight cost control.

THE FOUR PERSPECTIVE OF BALANCED SCORECARD

A. The Financial Perspective C. The internal business process perspective
Three strategic themes: Process value chain:
1 Revenue growth 1 Innovation
2 Cost reduction 2 Operation
3 Asset utilization 3 Post-sales services

B. The Customer Perspective D. The Learning and Growth Perspective

Five key core objectives: Three perspectives' objectives:
1 Increase market share 1 Increase employee capabilities
2 Increase customer retention 2 Increase motivation, empowerment &
3 Increase customer acquisition alignment
4 Increase customer satisfaction 3 Increase information systems capabilities
5 Increase customer profitability

FINANCIAL
"How should we appear to our
shareholders"

INTERNAL PROCESS CUSTOMER

"What business process must we STRATEGY "How should we appear to our
excel at?" customers"

LEARNING & GROWTH

"How will we sustain our ability
to change & improve"
NON-FINANCIAL PERFORMANCE MEASURES
Productivity
is concerned with the efficient production of output

output
=
input

Partial Productivity
-measures th relationship between output and a single input.
-closey related to the manufacturing efficiency variances.

output units
operational productivity =
input units

peso output
Financial productivity =
peso input

Total Productivity
Measuring productivity for allinputs at once.

Unit or sales value of output

=
Total cost of all input resources

Internal business performance measures

A. Delivery Cycle Time process time VALUE-ADDING
B. Throughput (Manufaturing Cycle) Time inspection time
C. Manufacturing Cycle Efficiency (MCE) move time NON-VALUE-ADDED TIME
value-added time queue time
=
Throughput time

If the MCE is less than 1, th productio process contains "non-value-added" time.

D. Velocity

FINANCIAL PERFORMANCE MEASURES

-highlights the analysis of the financial perspective.

Growth component

-measures the change in operating income attributable solely to the change in the quantity of output sold

Price-recovery component
measures the change in OI attributable solely to changes in between 2 years.

Product component
measures the change in costs attributable to a change in the quantity of inputs used in 20X1 relative to the
quantity of inputs that would have been used in 20X0 to produce the 20X1 output.
 FINANCIAL MARKETS

PRIMARY (new issuances)

Treasury Bills
MONEY MARKETS Commercial papers
(Debt Securities; 1 yrs or less) CODs
FM Banker's Acceptances VALUATION:
T-Notes & Bonds
Debt Securities (Long Term) FMV (PV of FCFs)
(More than 1 yr) Bonds
CAPITAL MARKETS
Equity Securities Common Stock DGM/GGM
(No Maturity) Market price CAPM
Preferred stock
SECONDARY
(Trading) FORWARDS Forward Future
1) CFs @ end of contract Initial + Net Settlement
2) Standardized X 
FUTURES 3)Default risk  X

DERIVATIVES MARKETS EP/SP < MP IN the money

CALL (BUY)
EP/SP > MP OUT of the money
OPTIONS
EP/SP < MP OUT of the money
PUT (SELL)
EP/SP > MP IN the money
SWAPS

CURRENCY MARKETS
(Forex)
DGM -Dividends grow constantly CAPM
PREFERRED DIV (FIXED)
-N.I = R.E
Required rate of return = Rf + (Rm - Rf)
ORDINARY DV. ()
-Applies only to ordinary share
(Rm-Rf) =Risk Premium

D1
Required rate of return = + GR
Po - Floation cost

D1 =Future/ Expected Dividends

GR =Growth rate
Po =Current Market price
FC =Floatation Cost/Issuance Cost

Do =Current/Past Dividend
Do D1

D1 = Do x (1+GR)

MP
TRAILING PER =
CURRENT EPS
PER
LEADING PER MP
(FORWARD) = FUTURE/ EXPECTED EPS
RATIO USED BY INVESTORS

MP
PSR =
SALES/SHARE
 WORKING CAPITAL MANAGEMENT

OBJECTIVE To achieve BALANCE between Profitability & Risk

(RISK & RETURN Trade-off) (DEFAULT RISK)
RISK ; RETURN LIQUIDITY ; PROFITABLITY

OC & CCC
OC CCC CCC = OC - days AP
Objective:
BASUC CONCEPT The funds are tied-up in WC
Puchase of Sale of Collection Payment of Collection (Basis "HOW MUCH TO INVEST?")
inventory Inventory of sale purchase of Sale

days inv days AR days AP

WC POLICY WC Investment Policy

("where to invest?")
CASH & MS MNGT ConServative vs. Aggressive
AR MNGT 1) Profitability  
INV MNGT 2) Liquidity  
3) Investment CA NCA
4) A.K.A. Relaxed Strict

WC Financing Policy Hedging (Maturity Matching)

("How to Finance?") Consevative
Aggressive
MM C A
STF
STF
CA TEMPORARY
STF
LTF
PERMANENT STF
LTF LTF
NCA PERMANENT LTF
 WORKING CAPITAL MANAGEMENT (PART II)
CASH & MS MNGT BY: MA'AM SEANNE
 OPTIMAL CASH BALANCE
-Steady supply of cash that will maintain liquidity without sacrificing profitability from idle funds

2 (D) (T)
OCB =
O

D = Annual cash Demand

T = Transaction cost or Conversion Cost
O = Opportunity cost or Cost of borrowing or holding cash

Total Cost = Conversion Cost + Opportunity cost

(# transactions x Consversion Cost) (Average Cash x Opportunity Cost)

 CASH CONVERSION CYCLE  FLOAT Collection Float

Disbursement Float
AIP + ACP - APP Sources of Float:
1. Mail Float
 Collection Period  Disbursement Period 2. Processing Float
l Concentration banking l Controlled Disbursing 3. Clearing Float
l Lockbox system l Playing the float
l Direct send l Staggered Funding Net Float = CF - DF
l Pre-authorized Check or post-dated checks l Payable-through Draft
l Depositary Check l Overdraft System Bank > Book = Positive / Disbursement
l Wire transfers l Zero-balance Account Bank < Book = Negative / Collection
l Automated Clearing House

Idle Cash
l Line of credit
AR MNGT INV MNGT
-ensuring that cutomers pay their invoices  When to restock inventory?
5 Cs of credit  How much to buy or produce?
l Charcter  How much to pay?
l Capacity  When to sell?
l Condition  What price to charge?
l Collateral
l Capital
Factors Affecting Inventory Decisions:
Extend credit if: Incremental revenue > incremental cost 1. Acquisition Cost
Extend Credit sales if: Marginal Cost = Marginal Revenue 2. Order Cost
3. Holding Cost
Effect of relaxing credit terms: 4. Stock out cost
 Credit Sale 5. Cost of Capital
 AR
 BDE 2 (D) (O)
EOQ =
 Collection Cost CC
 Opportunity cost on incremental investment in AR
 Sales Discount D = Annual Demand Usage
O = Ordering Cost/unit
Discount Period CC = Carrying Cost/unit
Major factors of Credit Terms Cash Discount
Credit Period  REORDER POINT

ROP W/O safety stock = Normal Lead time x Ave. Daily usage
ROP w/ safety stock = Normal Lead time usage + Safety Stock

(Daily usage x NLT) (MAX LT - Min LT = SS LT)

SS LT x Daily usage
SS in units
 SHORT TERM FINANCING
 financing source for a period of less than one year.
refers: online loans
 generates cash for working line of credit
through
capital & operating expenses invoice financing

SOURCE OF STF
a) Trade Credit or Spontaneous financing Accounts Receivables
Accruals
% Discount 360 or 365
x
100% - % Discount Credit period - Disc Period

b) Commercial Bank Loan

 Cost of Term Loans
Interest (FC) 360/365
x
P-Interest-CB Days loan is outstanding

 Unsecured Sources  Principal

Amount needed Net proceeds in P
or
(1 - CB% - interest &) Net proceeds in %

 Revolving Credit Agreement vs Credit line

Borrowed funds x interest
total / borrowed funds
Unborrowed funds x commitment fee

 Cost of Installment Loans

2 x # of installments x interests
(1 + # of installments) x principal

maturity of 1 - 270 days

sold at a discount
c) Commercial Paper no developed secondary market
par value - redeemable value = return
may be sold directly to buyers of
indirectly thru delears

Disc + Floatation cost 365 days

x
Issue price Credit period

a) Receivable Financing Pledging Account Receivable

Factoring Accounts Receivable
Financing cost 365 days
x
 Secured Sources Net Proceeds Credit period

b) Inventory Financing

Used funds x interest + Add'l cost

Used funds
 LONG TERM FINANCING
 CAPITAL STRUCTURE
-combi of debt and equity used by a company to finance its overall operations and growth.

Long Term Debt

-must be after tax interest rate
-Yield to Maturity
LTF Issue price
(FC x PV factor) + (Annual int payments x PV annuity)

Estimate of Yeild to Maturity on Bonds

Annual int. payments Face Value-Bond Price
+
Yrs to Maturity
[60% (Bond price) + 40% ( Face Value)]

 COST OF CAPITAL Preferred Stock

Preferred dividend per share
Market prce per share - Flotation cost*

Common Equity
Common Stock
Cost of New Common Stock
Dividend per share
+ growth rate
Price per share - Floatation cost*

CAPM
Risk free return (rr) + β (Market rr + Risk free rr)

Retained Earnings
Current Dividend
+ growth rate
Market Share
*ignore Floatation cost in computing cost of RE !!!

 WACC COC x Weighted average

LTD x % = %
PS x % = %
CS x % = %
WACC

 MARGINAL COC
-considering NEW WACC because of add'l source of capital
-new capital structure considering the RE breakpoint.

RE BALANCE
RE BREAKPOINT =
Weighted RE

COC x Weighted average

LTD x % = %
PS x % = %
CS x = %
new %
RE x = %
WACC