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Performance Operations (p1)

November 2011

Theory Revision Pack

Resource Person:
Sugeeth Patabendige
ACMA (UK), ACIM (UK), MEcon, BBA Sp (Hons),
PG Dip Finance, PG Dip M.
Lecturer
Wisdom Business Academy, CIMA quality partner
&
Department of Marketing Management,
University of Kelaniya,
Sri Lanka.
November 11

Sugeeth Patabendige @ Wisdom

Unit 01
Cost Accounting System

November 11

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Summary 01
Traditional OH Cost Accounting Systems
Old methods / the assumption of costs are volume driven
End Product/Service

Cost

DM/DL

Absorption Costing
Direct
Cost

Indirect
Cost

Cost
Centre

Allocation
&
Apportionment

Re-allocation

OAR

*OAR calculated using direct bases


*OAR=production & fixed
*Under or over absorbed
(budgeted Vs Actual: value or volume difference)

Marginal Costing
O/Hs divided in to Fixed and Variable

Only variable
O/H related

O/H = Production
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Sugeeth Patabendige @ Wisdom

Summary 02

Profit Calculation
Marginal Costing

Absorption Costing
DM/DL
1.
Production
/Stocks

2.
Under/Over
absorption Adj.

Variable
Production
O/H
Fixed
Production
O/H

1.
Production
/Stocks

2.
To calculate
contribution

Variable non
Production
3.
End period
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Fixed non
Production
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3.
End period
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Summary 03

Profit Reconciliation
Marginal Costing
Profit

Stock
x
OAR

Absorption Costing
Profit

Stock

Stock

No change in stock

(In Absorption)
More cost with closing stock
goes to next period

(In Absorption)
More cost comes to the
period via opening stock

stock value is
same

Absorption Profit
Marginal Profit

Absorption Profit
Marginal Profit

Profit = same

In Marginal FPOH is deducted from the relevant period


but
in Absorption the FPOH of unsold units are taken forward
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Sugeeth Patabendige @ Wisdom

Summary 04

Budgeted

Budgeted Gross x Budgeted - Budgeted


Profit per unit
Sales units non production
cost

Absorption costing
Profit
Sales

@Actual

Less- cost of sales


Actual

Op. Stock

@ Std (FPC)

Production

@ Actual (FPC)

Cl. Stock

@ Std (FPC)

Under/Over absorbed

N0

Non production cost


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@ Actual
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Summary 05

Budgeted

Budgeted Contribution x Budgeted - Budgeted fixed


per unit
Sales units
cost

Marginal costing
Profit
Sales

@Actual

Less- cost of sales


Actual

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Op. Stock

@ Std (VPC)

Production

@ Actual (VPC)

Cl. Stock

@ Std (VPC)

Variable non production cost

@Actual

Fixed cost

@ Actual

Sugeeth Patabendige @ Wisdom

Summary 06

O/H Cost
Accounting Systems

Most
Organizations
use

But two
new
problems

Not suited for modern


organizations

Absorption
Incorrect Valuation

Marginal

Actual Cost
Per unit

Absorption
Cost Per
unit

High Volume
Low Volume

Activities
End Products

Cost Pool
Cost Driver

O/H

Cost per Driver


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Sugeeth Patabendige @ Wisdom

So a new method is
developed
ABC
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Summary 07
Output forecasted

ABB

Budgets
prepared
based on

The required activities forecasted


&
the no. of drivers forecasted

resources allocated

ABC
ABM

To Manage the organization


Manage the activities
Reduce cost & improve customer value

Leads to:
1. Operational ABM (better operational planning and control)
2. Strategic ABM (better strategic planning)
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Sugeeth Patabendige @ Wisdom

Summary 08
Standard Costing
With any modern
organization no. of
problems:

-How to plan in a
dynamic Environment ?
-Need continues
improvement ?
-How to motivate
employees towards
stds?
-Analysis needed in
more detail?
-Std based on labour hrs
not appropriate?
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1. Developing Standards

Developing Standards depends on:

Manufacturing

Service

No. of problems when applying:


Cost unit? (can use composite cost units)
Each service different? (for similar parts can develop std)
More humans? (more machinery introduced)
But exceptional cases
McDonaldization

DRG

the success of STD


Costing in McDonalds &
similar organizations

Used in healthcare
industry to develop standards
(Patients grouped on diagnosis
and std developed for each
diagnosis)

No. Advantages:
Calculability
Control
Efficiency
Sugeeth
Patabendige @ Wisdom
Predictability

Used by: Health care funding


authorities & Insurance com.
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Summary 09

Standard Costing

2. Compare standards
with actual (Variances)
Operating
Statement

A document that
shows the
reconciliation of
planed outcome
to actual outcome
through variances
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Bud. Profit = use the formula


Profit Statement Sales volume profit variance
Both fixed o/h variances
(Absorption)
Actual profit = detail but stocks@std FPC

Bud. Profit = use the formula


Profit Statement Sales volume contribution variance
(Marginal)
Only fixed o/h exp. variances
Actual profit = detail but stocks@std VPC

Cont. Statement
(Marginal)

Bud. Cont. = use the formula


Sales volume contribution variance
No F o/h
Actual Cont. = detail but stocks@std VPC

Cost Statement

Starts with standard cost (BRxAQ)


Adv. add and Fav. deduct
Actual cost (add the given values)

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Summary 10
When, Std price > WAP = buying less is Fav
= buying more is Adv
When, Std price < WAP = buying more is Fav
= buying less is Adv

Standard Costing

2. Std price - WAP


2. Variances
Advance
Variances

(Std Mix Actual Mix) x


If there is
more than
one type of
Material or
Labour

1. Std price

Mix Variance
Production

Yield Variance
(Std yield Actual yield) Std cost per
unit of output

Adds up to:
Material Usage / Labour Efficiency
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Summary 11
Sales types separately taken
Sales Mix
(Std mix actual mix) std
profit/
cont.

Standard Costing

2. Variances
Advance
Variances

If there
is more
than
one
type of
sales

Production

Sales types together taken


Sales Yield/ Quantity profit
(Budgeted sales Actual sales) Std W.A.
profit/
cont

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Summary 12

Original
Std

Standard Costing

Planning
Variance

2. Variances
Advance
Variances

If the
standard is
wrong ?

Revised
Std

Point to Remember
T. Std Qty = S/B.R x A.U
T. Std Cost/Profit = S/B.R x A.U
T. Std Units = S/B.R x AU

Operating
Variance
Actual

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Summary 13

Based on
bottlenecks and
non bottlenecks

1. Indentify bottlenecks
and non bottlenecks
2. Plan for bottlenecks

TOC

How to maximize
operating profit

3. Plan for non bottlenecks

4. Remove the bottlenecks

Five steps of
Guidelines

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Manage &
Optimize in
the short
term

5. Repeat the steps

Sugeeth Patabendige @ Wisdom

Improve and
continuously
develop in
the long
term

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Summary 14
1. Indentify bottlenecks
and non bottlenecks

Accounting
Techniques

1. Recourse
Utilization rate
2. Maximum
production units

Resource required
Resource available
Total resource
per product time

TOC

2. Plan for bottlenecks

Accounting
Techniques

Throughput
Accounting

Throughput per time period


used to rank and identify the best product from
the bottleneck resource

Similar to
contribution per
limiting factor
But assumes;
only true variable
cost is DM

But as a secondary measure = TA ratio


to identify whether the product covers other costs needed in conversion
Throughput (value added/return) per time period
Conversion (factory) cost per time period
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Summary 15

Traditional/JIC

* No. of functional departments in production


* Specialized workers and high supervision
* High inventories

Goals:
Elimination of non value adding activities
Zero inventory/Breakdown/Defects
100% on time delivery
Batch size of one
Manufacturing

Modern/JIT

* Production @ one place = cell


and in U shape = cellular layout
* Multi-skilled workers and less supervision
* Less inventories

JIT: required items / quality / quantities / @ precise time


JIT Production: production = demand-pull basis
JIT Purchasing: usage of materials = delivery of materials
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Summary 16
Traditional/JIC

Sequential Tracking Accounting


Accounts prepared by tracking the production process
Inventory valuation is emphasized

Types of
Manufacturing
&
Relevant Accounting

Modern/JIT

Backflush Accounting

Accounting undertaken after the events & working back


Inventory valuation is not important
Points to remember:
* Entries made at trigger points
* M and CC recorded @ actual when incurred
* M and CC applied @ std
* Any difference in CC taken to COG a/c

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Summary 17

Traditional = Quality Control

Quality

Get it right first


Continues improvement
Competitive benchmarking
Employee empowerment and team work
Supplier quality

Modern = Quality Management


= TQM

November 11

Setting quality standards and compliance


Monitored through QC dept.

Everyone
Continual effort to improve
Customer satisfaction

Quality Cost Classifications:


Appraisal / Prevention = Compliance costs
Internal / External failure = Non compliance costs
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Summary 18
CAD & CAM = designing & production through computer technology
FMS = producing range of products / Integrated computer system
EDI = customers & suppliers electronically linked

AMT = CAD/CAM/FMS/EDI +
Normally undertaken with JIT & TQM = AMT environment
Modern Other
Techniques

MRP I = System..based on production schedule..materials needed


identified.. adequate amounts available when needed
MRP II = System..based on production schedule..planning undertaken for
finance, logistics, engineering, marketing..expansion of MRP i
OPT = System..Planning .. + optimize use of bottleneck..maximize
throughput (TOC and TA)
ERP = Accounting oriented system..enterprise wide resource planning..in
delivering orders

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Summary 19
Modern Mgt
Accounting

Benchmarking

Main Classification

Alternative Classifications

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Attempt in identifying outside best


organization can compare its performance
to improve its performance.

Internal = within the same ownership


External = with different ownership

Functional = same functions


Competitive = same industry
Strategic = for strategic purpose

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Summary 20
collection, analysis and assessment
What ? corrective management action
external reporting
Tangible (current costs)
Intangible/contingent (possible costs)

Environment
Accounting

Types of Cost ?
Internal failure
External failure

For pricing
For regulatory requirements
For reputation
Why ?
For cost savings
Absorption costing = a flat rate used.

How ?

ABC = more correct allocation through multiple rate use


based on multiple cost drivers of multiple activities.
LC costing = spreading cost based on LC (not only based on
the particular time period the cost was incurred). & allows
better anticipation of costs.

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Unit 02
Budgeting

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Summary 01

Why ?

Planning
Control & Performance Evaluation
Motivation
Communication and Coordination

Too many
purposes

Any conflicts ?
Budgeting
Mainly balancing the
challenging and
achievability
Top down / Imposed
How ?

Main approaches
Bottom up / Participatory

B. Committee
Oversees / Responsible for
budgeting
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B. Manual
Budget holder
Set of docs giving
Party responsible
info.
Sugeeth
Patabendige @ Wisdomfor achieving

Budget Slack
Overestimation or
underestimation
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Summary 02
Incremental / Traditional
Budgeting

Rolling

How ?
Alternative Methods
ZBB

Last period budget/actual ++

When a sub period is over (earliest


period) equal sub period added from next
year

Start all new = Zero based


Items taken are Justified & Prioritized
How to implement ?
Options identified (Decision packages)
Cost benefit analysis
Allocate resources

Method of budget preparation for non profit


makers.
PPBS
1. Identify long term objectives
2. Identify program
How to measure performance?
3. Cost benefit analysis of each and allocate
Use Value for Money
resources to the best
(Economical / Efficiency / Effectiveness)
4. @Reevaluation
November 11
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Wisdom
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Summary 03

Budgeting
How ?
The Actual Preparation

Getting the figures

Graphically =
Scatter diagram
method
Identifying the relationship How to
between two variables and identify the
extending the relationship relationship
to get the forecast
Mathematically
Least square
regression
Y = a+bx
Regression

Forecasting
Time Series

T
S
Identify reasons for
past information & Reasons?
the reasons are used
C
to forecast
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Additive = Y-T
Should add up to 0

Multiplicative = Y/T
Should add up to 4
Assumed as
negligible

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Summary 04

Functional Budgets
Budgeting

Mainly
Production
department
budgets

How ?
The Actual Preparation
Cash Budget

For other
departments
any appropriate
format

Getting the figures


Organizing the figures
Master Budgets
Starts with the key/principle
budgetary factor
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Sugeeth Patabendige @ Wisdom

Budgeted P&L
Budgeted
Balance sheet
Budgeted Cash
flow statement

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Summary 05
Keeping things under control through
What?
continues comparison
Leading to management by exception
Budgeting
By comparing actual to plan

Control
&
Performance Evaluation

How?

If the planning & actual activity levels are different


: a flexed budget prepared
Flex = BVR x AAL + BFC
* Use high-low

When?

Feedback:
end of the period (Actual results to Budget )

Feed forward:
beginning of the period (Forecasted actual results to Budget)

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Unit 03
Project Appraisal

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Summary 01
Project Appraisal / Analysis & Acceptance

1. Identify relevant Information

2. Analyze

3. Accept or reject

Modern / DCF methods

Basic / Traditional / Non


DCF methods

Pay back
Cash
taken

Time taken to cover the


initial investment from
operational cash flow
November 11

ARR
Main Difference
Only non cash
item assumed
is depreciation

Profit
taken
T. Cash - T. Dep.
No. of years
Average PBIT
Initial / Average investment

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Investment + Scrap value/2


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Summary 02

NPV

(Initial Investment) + PV of Future cash flows


Individual DCF
(Table 01)

Project Appraisal

Working Capital

Cumulative/Annuity DCF
(Table 02)

- Part of the Initial Investment


- Taken as an inflow in the last year

Modern / DCF methods


1. Actual rate the project is earning
(internal rate earned)
IRR

&
2. Rate @ which NPV = 0
(Initial Investment = PV of Future cash flows)
How to calculate = Graphically / Formula
A + (B-A * a/a-b)

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Summary 03
Gross PI =

PV of FCF
Initial Investment

Net PI =

NPV
Initial Investment

Project Appraisal
Profitability Index

Modern /
DCF methods

ratio of
PV / NPV to
Investment
Making NPV
a relative
measure

Discounted Payback
Method

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Sugeeth Patabendige @ Wisdom

Time taken to cover the


initial investment from
discounted cash flow

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Summary 04
Project Appraisal

Advance
with
NPV

Low Inflation

Inflation
Cash flows

Forecasting based on
now situation

High Inflation
DCF

Market determined

No
inflation

High inflation
component

Mismatch of information
Two options
1. Monetary/Nominal Concept
Cash flows x Inflation
DCF = (1+MR) = (1+RR)(1+IR)

2. Real Concept
Cash flows
DCF = (1+MR) = (1+RR)(1+IR)

With multiple inflation rates


November 11
Sugeeth Patabendige @ Wisdom
this is a better option

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Summary 05
Project Appraisal

Advance
with
NPV

Cash flow
Gets reduces

Tax

But how to
calculate tax

Excluding
Depreciation

Taxable profit
(Accounting profit
or NCF)
Less : Capital Allowance
Net Taxable profit x Tax%
= Tax

Excluding:
IC, WC, SV
Tax deduction =
Incentive given by
the Govt. to motivate
investors

Normally paid
this year next year

DCF

November 11

Pre Tax COC


Less: Tax Savings
Post Tax COC

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Summary 06

Project Appraisal

If no. options
are available

Which option is the best ?


But options are with unequal life periods

Advance
with
NPV

Bring options to same level through


Annual equivalent method

Asset
Replacement
Information
available is:
Cost or Cost
savings

If only one option


is available

How frequently to replace ?

Bring options to same level through


Annual equivalent method
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Summary 07
Project Appraisal

Advance
with
NPV

Capital
Rationing

Divisible Projects
(we can break down
projects)

Use PI to identify the best

Capital is a limiting factor


Trial and Error method
Indivisible Projects
(all or nothing projects)

November 11

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Identify possible
combinations
Identify the best fit to
capital available and
the best NPV giver
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Summary 08

Project
Appraisal

Long term decision making

Origination of proposal
Initial screening
Analysis & Acceptance

What ?

Monitoring & reviewing

objective independent assessment


success of a capital project in relation to plan
feedback to managers

Content ?
A summary of the plan, the actual outcomes,
the deviations (Financial and nonfinancial)
And the lessons learned
(Types/Classifications) Why?

Improve the long term decision making process


Improve the performance of future projects
For project control (if done after the initial investment)
November 11

Sugeeth Patabendige @ Wisdom

Post Completion Audit


PCA

Continue ?
what's the new NPV
Vs
Discontinue ?
What's the NRV
If there are overspendings:
Continue or discontinue ?
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Unit 04
Risk & Uncertainty

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Summary 1

Uncertainty
&
Risk

November 11

Why ?

In decision making the items taken in analysis is


uncertain so the conclusions are also uncertain and risky

What ?

Possibility that actual


outcome being different to
the expected

Uncertainty
No prior experience
No statistical evidence

In Theory

Risk
Prior experience
Statistical evidence

No. of options:
-Probabilities
-Probabilities / Decision Trees
How to tackle ?
-Data tables
-Alternative Criteria
Sugeeth Patabendige @ Wisdom
-Sensitivity analysis

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Summary 2

Uncertainty
&
Risk

How to tackle ?
01.
Assigning
Probabilities

How possible are


those outcomes
(probabilities)

Possible
Outcomes
(Variables)

AV
x i /n

X
=
=

Return
EV
pi x i

Which depends on the


decision makers characteristics
Risk Averse
Risk Seekers
Risk Neutral
Deviation between
actual outcomes
possible and
expected outcome is
the risk

November 11

SD = p (x ) 2

i
Sugeeth Patabendige @i Wisdom

Decision
making base on
Risk and Return
tradeoff

Risk

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Summary 3
No. of items uncertain
&
some based on others

Uncertainty
&
Risk

02. Decision Trees

How to tackle ?
Assigning
Probabilities

Need to identify
Decision points
&
Outcome points

Decision making is on EV
Two methods possible: Forward & Backward

What are possible


outcomes: when variables
are changing

03. Data tables

November 11

Possible outcome:
with one variable changing
= One way data table

Sugeeth Patabendige @ Wisdom

Possible outcome:
with two variable changing
= Two way data table

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Summary 4

Uncertainty
&
Risk

How to tackle ?

Types

04.
Alternative Criteria

Maximin

Maximax

Minimax
Regret

November 11

Assumption

Decision

Worst will

Select the

happen

best out of worst

Best will

Select the best

happen

out of best

I have made the

Select the minimum

incorrect decision &


what is my regret
(after the event)

out of maximum

Sugeeth Patabendige @ Wisdom

regret possible

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Summary 5
Uncertainty
&
Risk

How to tackle ?
No. of Options?

EV of the decision without info.


(Highest EV giving option)

But
can we bring a
consultant to
takeout the risk and
uncertainty

November 11

Value of Information

To make better decisions


what is the price of info. ?

Sugeeth Patabendige @ Wisdom

Vs.
EV of the decision with
consultants perfect info.

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Summary 6

Identify the item/items


Take the PV of those cash flows
NPV to go to zero what should happen?
The change needed as a percentage of the
current PV/COC of the item.

Uncertainty
&
Risk

How to tackle ?
05.
Sensitivity
Analysis

Normally sensitivity is:


What is the change to a net
outcome as for a change in a
variable ?

November 11

How?
As for
NPV

For the decision maker to change the decision


Extent to which each individual element change
To Identifies the most critical elements

How to interpret ?
Higher the % = unlikely to happen
Lower the % = more likely to happen
Control the more likely ones more

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Unit 05
Working Capital Management

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Summary 01
Internal view point = Capital needed for day to day operations
Working Capital
Management

External view point = Current Assets Current Liabilities


Making adequate resources available for day to day operations.

1. Investment Function

Identify the amounts needed:


No. of factors to be looked at

There are two main functions

2. Financing Function

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Getting the needed


working capital

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Summary 02
General Information:
Large/Small,
Manufacturing/Services,
Retailers/Wholesalers,
Stable/Growth
Normal/Seasonal Demand
Manufacturing technology (JIC or JIT)
Credit policies / Operating efficiency

Working Capital
Management

1. Investment Function

How to identify ?

Shows Overcapitalized
Liquidity Ratio
or
= CR & QR
(Undercapitalized) overtrading

Working Capital Cycle (WCC)


Time taken for cash to get to
cash through operations
+ Inventory time (RM/WIP/FG)
+ Receivable time
- Payable time
Working Capital
Ratios

commitments in excess of its available resources


& lengthy working capital cycle.
Too much too quickly with too little long term capital.
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Sugeeth Patabendige @ Wisdom

Activity /Efficiency Ratios


= ITD / RTD / PTD
Also used to calculate WCC

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Summary 03

Aggressive
Permanent capital = LTS + STS
Temporary capital = STS
Working Capital
Management

2. Financing Function

Three working capital policies


How to finance ?
Short term sources (STS)
or
Long term sources (LTS)

Moderate
Permanent capital = LTS
Temporary capital = STS

Conservative
Permanent capital = LTS
Temporary capital = LTS+STS

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Summary 04
Working Capital
Management
:Advance

Cash
Management

What is the amount of cash needed ?


1. Direct (from cash budget)
2. Indirect (from financial statements)

If there is a cash deficit ?

If there is a cash surplus?

Spontaneous (from: receivables/payables/cheque float)


OD
Loan (Short / Medium(Term or interest only) / long)
Factoring (Advance / Full factor /
Guaranteed settlement/ Confidential invoice discounting)
Arrangement..with a factoring company..advances a % of
receivables.. commission/interest to be paid
In Export Trade
Export Factoring
Bill of Exchange
Written acknowledgement..of debt..negotiable document
Document Credit/LC
Imp. gets its bank to issue..to Exp. bank..Advance possible
Forfaiting
Imp. gives upfront cash and promissory notes.. Exp. gets
the promissory notes discounted..No recourse

T Bills / Bonds
Bank deposits
Certificate of deposits
Numbered accounts

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Money Market A/C


Bank a/c..only to invest in
Money Mkt..higher minimum
balance needed
Local authority deposit/bond

Commercial Paper/Corporate
Bonds
Short/Long term borrowing..By
blue-chip companies
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Summary 05
Cash
Management
Deficit Mgt
= Borrower
Borrower
or Lender
@What Price?

@What Rate?

or

Surplus Mgt
= Lender

Short Term Security

Long Term Security

Price/Loan = Total Value Interest


Price/Loan for a given security

Interest
&
Redemption/Maturity value

FV (1 i t)
y

PV of Future cash flow

Interest Yield
Earnings
Current Mkt. value of the security

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Yield to Maturity
What the security really
earns in the long term = IRR
Before IRR a rough calculation
is done to identify suitable
DCFs to getter a more correct
50
IRR

Summary 06
Receivables Management
&
Payable Management

Cash Discount to be
given or Taken ?

Age analysis ?

Price of giving or taking


a cash discount

From now to old:


the credit
information identified

A = (FV/PV) y/t - 1
Considered as
A cost to the seller
A benefit to the buyer
&
Compared with alternative options
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Summary 07
How to Manage ?
Two bin system
Reorder level system
Periodic review system
Mix system
JIT purchasing
Inventory
Management

Optimum Inventory ?
The EOQ formula

Quantity discount to take or not to take?

Total cost of inventory


@ normal EOQ

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Vs.

Total cost of inventory


@ qty discount achievable qty

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