Today and tomorrow is free seeding. You can see it anywhere you want. You don't
have to be with your group. Please settle down quickly and start the recap of
yesterday. All other discussions after 11, 30? Please do the recap. All other
discussions after 11, 30. How many children to how they will do schooling?
Everything you can discuss after 11, 30. This is a recap time. This is not a time
for rejoicing.
Recap. Yesterday's discussion. Future planning, family planning, everything after
11, 30.
Now only recap. Our ears.
And your gum every day you take off one day. Like that, generally will come. Maybe
I didn't see you as sturdy. Recap.
Recap a serious discussion. Very quickly. What are you mixing? Mixing Water is the
most intoxicating drink. You mix it with anything, you will go high. We recap.
How do we do budgeting? What is the budgeting process? Why do we need budgets? What
are the different approaches to budget? What is zero-based budgeting? What is
kaizen budgeting? What is activity-based budgeting? Why do we need different
approaches to budgeting? What the sensitivity analysis. How do we do sensitivity
analysis? Check your emails and WhatsApp messages after 11, 30. Activity-based much
In same as activity-based budgeting, but we do it wherever there is a time-bound
project. Suppose you are executing a time-bound project where if you don't finish
it, you have penalties, then the budgeting will also include time that is required
for each of the activities. It could be It could be. Okay.
Time up. Thank you so much. Let's go back to the subject. So yesterday we were
talking about goal congruence. What happens with gold congruence is each department
sets their own goals and each department thinks that they are the most crucial
department in the company. So they don't have empathy for the other departments. If
the sales department says I can't sell more, IT will say no, no v-out upgrade the
system. If the sales is going to be less than, your revenue is going to be less.
Urea earnings are going to be less. Why should I ET go ahead and spend more? Why
can't they understand the business? Why can't they understand the external world
and say, Okay, if you're a sales is going to be less next year, let me see where I
can curtail my IT budget. This is why I said yesterday when we were closing that in
Harvard Business School, there is a case study, very interesting case study which
says actors in the corporate world. It says every single manager in the corporate
world, He's an actor. They pose a facade in front of everybody in the meeting room.
And the real self is never seen when they come out of the meeting room. That, that
is when you will see the real face. For everything they will agree in the meeting
room. But after the meeting, they will not do anything towards implementing those
ideas. It's not that they want to sabotage the plans of the company. It is just
that they have a different behavior, which is their real self. That is way goal
congruence is a problem. So first problem is the cushion that people are building
in the budget by providing more if it is expenditure and providing less seafood is
revenue. And second is the goal congruence. And of course at the end of it, when we
are doing the consolidation of everything, the operating unit will suddenly say,
Hey, why am I paying so much for the support? Support will say, no, no. You said
all these deliverables for me. If I were to meet with these deliverables, I need
this amount of people. That back-and-forth will always happen in organizations.
That is way I said, minimum three to five iterations is what you will see budgeting
process.
what you will see budgeting process. Going through. There are some companies where
the number of iterations could be more for multiple reasons. Right?
Right? So this is what we discussed yesterday. And now I'm going to talk about D
variances. What happens with the variances? I have a budgeted figure. Against that
budgeted figure, I'm plotting the actuals. And then I see that there is a
difference between the the plan will never be matching with the reality. The plan,
so many things. Reality will always be different from what we planned. But what we
should do is we should take a step back and say, I planned for this, but the
reality seems to be different. What is the difference between the two? Is revenue.
g.
E. if the budgeted revenue is 1 million, revenue happens to be 1.2 million. The
variance will be 200,000. Variants where your actual achievement is more than the
budgeted revenue. We call it favorable. In terms of expenditure. If you are
budgeted expenditure is 800,000, but your actual expenditure is 820,000. We call
this 20,000. As diverse or unfavorable. Some textbooks will prescribe adverse. Some
textbooks will call it favorable and unfavorable. Whenever the variances are
unfavorable, whether it is in revenue or in expenditure. We show it in parenthesis.
Within brackets. These are all the management accountants style of working.
Universally.
This has been accepted. Now what we are going to do, we are going to look at the
variance. What is our job? Routing variants and the TPM can do it. It's a silly
job. Flooding variables is not the job. Some media will do it for you, but what are
you going to do as a business owner or a business manager, you are going to see
whether any corrective action is required. Whenever you will find in the
unfavorable or adverse variances, you will need to take immediate action away. They
don't provide proper offends. You need to take immediate action. If it is a
favorable variance, what do we do for action? No action.
No action. We will have an action. What is that action? Next time when you do your
budgeting process, you should say, Oh, last year I budgeted one but I did 1.2. That
means I underestimated my market potential. So this time when I do the budgeting, I
love to be a bit more careful. I should not be conservative in understanding how
much I am capable of selling in the market, right? Sometimes we, our sins
underestimate ourselves, right? We don't know what our true potential is unless
somebody comes and tells us that, look, you are actually good. You're **** good in
this and you should further your knowledge in this area. Until someone comes and
tells me, keep thinking, no, I'm not so great, I'm not so good. Right now. We are
only doing the comparison of the budget, which is taken for comparison purposes.
When you prepare the budget, you prepare an optimistic budget, you prepare the
pessimistic budget, you prepare the realistic budget. We are now doing a comparison
against to one of the three. Each company will decide which one they are going to
take. Assume that we are taking the realistic budget. And then in that case, we are
only going to look at what are the variances. You've read this a favorable
variance, it is worth noting for the future budgeting exercises. Are we clear?
Now, budget is prepared in the month of September 2022 for the year 2023. New thing
you can predict everything that happened in Jan to December 2023 accurately. What
if the market moves by June? And then by June you realize that the market is
shrinking by 20 per cent. Are you not being stupid to compare the original budget
with the actual performance and keeps saying, yeah, I didn't do well, I didn't do
well. You didn't do well because the entire market has shrunk by 20 per cent. So
what do you do in such cases? Each company has a different way of doing. Many of
the companies what they do, they prepare a flexible budget. In some very large
companies I've seen citizen budget is approved by the board. The budget will stay
as it is. But against the budget, they will have what is known as forecast. The
forecast will be done based on the reality, based on the market situation, and the
actual performance will be compared only with the forecast. Start with the flexible
budget, not with the original budget because of original budget when it was
prepared. The conditions that were prevailing very different. Now that we're in
year 2023, we know what the reality is. Hence, we are going to flex it. How do you
flex it? Flex it to suit the reality, the flexible budget. You then go on and check
with your actuals and then take your corrective action. Are we aligned?
Are we aligned? I'm going to show you a real-life example. The budget was 1,000
units sale, okay. This is the number of units and 1,000 units. And we found that
the actual sale is 780 units. So if we compare the budget and the actual the sales
department has done a terrible job. So we think we should fire the sales
department, right? Useless fellows. But then you are told that the entire industry
is facing at 22 per cent reduction in the sales. There is a market which has
shrunk, wait 22 per cent. So then what we are doing, if they enter a market has
shrunk. Wait 22 per cent. We make a flexible budget for 780 units. Original budget
was 4,000 units at $800. Eat my flexible budget is for 780 units at $800 each.
Accordingly, I flex my contribution and variable cost, but fixed cost to what was
originally budgeted, keep the same fixed cost. Now what I realize is my add jewel
sale is 6139600. But according to the flexible budget, it should be 624,000. That
means my budgeted sales realization per unit net realization is $800. My real
realization actually is $820. In a market that is shrinking. My sales team instead
of going and selling at eight and bread managed to sell every unit at 08:20. Are
you going to fire the sales team? You should actually appreciate them for doing a
good job in a shrinking market because though the original budget was 800,000, but
that was on the basis of thousand units. But the flexible budget shows that they
should or really is the 624,000 they are realizing 639,000. They've actually
brought $15,000 additional revenue. If I were the manager, I will give away 10% of
that $15,000 as incentive to all the salespeople and encourage them to do well and
further well in the next year, I would rather encourage them and not tell them, Hey
guys, you didn't do a good job. They actually did a very good job. So what happens
when the market scenario changes during the year? You will be taking wrong
decisions if you are going to compare your actual performance with the original
budget because the original budget was prepared at nine months ago when we were not
aware of the market reality until March 2020, how many people knew about COVID-19?
I came from us on the 7th of March. On the 8th of March. 10th of March. I don't
remember it. Just within 23 days. I go for a walk every day in the morning around
Seville park. So I was going for my work and the way police car pulled in on my
side and said, would you please go home? I said, What happened? He said No, there
is going to be alone. Don't just go home. I said no problem. My car is on this
side. I'll finish their own. Take my car and he said, No, I saw you parking the
car. It is easier for you to go this way and faster. You better go this way, take
your car and go home immediately. So everything changed in a matter of few days.
And then they airports got closed and there was so much of chaos. And then Dubai
police said you cannot step out of your house unless you take a permission. So
nobody knew what was happening. Right.
So when when such things unfold in front of you, whether it is COVID-19 or a
business scenario, or a change in the environment or change in technology or the
change in comparative traction, or changing customer preferences. Whatever be the
change when dramatic changes happen, you will be stupid to compare your original
budget with the actual and take action. Why do you should do? Ideally, you should
prepare a flexible budget in line with the changed circumstances are gains to the
flexible budget. You compare the actual and then go line by line and see where
corrective action is required. g.
E. my sales figure is favorable, my variable cost is favorable. Hence contribution
margin is also favorable. But guess what has happened to my fixed cost? My fixed
cost has gone up. Julie, one-fifteenth self is on the higher side because iron
50,000 fixed cost is projected for 1,000 unit activity. Your activity is at 22 per
cent less, which means this fixed cost in itself is on the higher side. According
to me, we should have scaled it down. But anyway, we kept it at the same level.
Display that you will find that you are actual fixed cost is 160,006 50. That means
this is the only one which is unfavorable. So no corrective action is required on
the sales team. No corrective action is required on the variable cost. But
corrective action definitely is required in the fixed costs because you seem to be
incurring far too high fixed cost for the level of activity that you are
performing. Maybe there are some deadweight who are there, like marriage boils,
wife and brother-in-law. So you should first remove them from the company so the
fixed cost will come down.
Are we clear? So if you are given certain parameters, you should be in a position
to first create a flexible budget. If you are given certain parameters, you should
be in a position to plot the actual performance. Then you should be able to make a
comparison between the flexible budget and the actual performance. And then against
each line item, you should say whether the variances are favorable or unfavorable.
And then in the next two column, you can open one more column. Since your
examination you are going to do in Excel, you can open one more column and write
your comments as to what action you recommend to the manager of this unit, or if
you are managing this unit or you are the winner of this unit, what actions you
would prefer to take. Corrective actions you are going to take.
Are we clear? So if you are asked to comment on something like this, I would not
give weightage of more than 25 per cent for the computations. I would rather give
75% weightage on your commentary. Because to me, managerial decisions are far more
important than the accounting as they keep repeating, the accounting task will be
done by somebody. Our system will do it for you, right? There are so many systems
that are available to do the matching and creation of table. You can construct it
32-30, that is what you are dreaming about. So those, those systems will do all the
number crunching and data can be presented in whichever way you want. Then comes
the crucial part, which is taking managerial action. What are those actions? What
are the characteristics that can be taken? There are situations where the
corrective measures that you take cannot be a staggered measure. What is a
staggered measure? Slowly reducing it. To talk to smokers, they will say, I'm
smoking 20 sticks, but I will bring it down to 15 and then ten and then five. And
then I'm going to smoke only two per day. This will never happen. We will never
give up smoking. Reducing number of cigarettes will not help. That's where, you
know, people are buying that whip. Just put a few drops of some liquid. I had a
year MBA students working with two waves into my class. I asked her why you are
carrying too. She said no, this one whale coming to the class, I bought it. The MBA
classes are at 01:30. She said tonight I'm going for a party and I'm wearing a
purple dress. To match with the purple dress. I had to be a purple whip. Now web is
matching the recited only the shoe will match the decimal web is magic. Then as
rent also should be wearing matching. Bristol car should be matching. Drivers
chapel should also match. Okay.
Well, we're going as a flock of birds for the party, right? We are not as wind and
wave for individual, we are a whole flock. That dog also has to be, the dogs should
be purple color.
the dogs should be purple color. Scheme is there. When they invade, they are
ascending the invitation by saying that dress code, the color code, you should be.
Monday, I saw the Executive MBA students were coming in traditional attire. I said,
What does that mean? They said We have decided today is a traditional day. We
thought of informing you. Then we said you are somebody who cannot be redeemed or
change it. Useless guy. That's why we didn't tell you. I said even if you had told
me, I would not have changed my attire because I have a monthly contract with the
laundry in Karameh. I don't want any of these things somebody is giving me on a
daily basis with a monthly contract. I love a problem with the laundry. Be clear on
this project at work we have already discussed. Now we will move to the next the
next lake is going to be. Really challenging, but extremely intelligent, extremely
interesting. So what we're going to talk about today is today we are going to focus
only on performance management. How do we manage the performance through management
accounting, through recommendations made by the management accountant. And the
first thing that I wanted to talk about is there are financial statements that are
produced, right? What are these financial statements? Do we know?
Do we know? Balance sheet? Balance sheet income statement or a P and L.
Equity changes in equity cashflows. That is income statement P and L. And then load
some accounts where you explain all these files together as per IFRS are all the
files together is called financial statements. Unfortunately, what happens when
business performance is reviewed? We have a tendency to look at the P and L and see
how much income is generated by this company, which is revenue minus expenses. And
then we say, this company is a good company. Fight.
But what about the cashflow? Where are we now looking at the cashflow? How
important is the cashflow? Cashflow is as important as the income statement. If I
don't tell breakfast today, I'll still be okay. If I had not had my dinner last
night, I'm still okay. Couple of years ago we had Ramadan during the peak summer.
And people in this country I will fostered for 15 h, 14 h, right? So there is one
set of people in Roger Stan, they don t need for one month. One whole month. They
don't eat Sorry.
Something. I don't know. So there is there is one Jane community where they don't
need for one whole month. Nothing happens to those people. So profit and loss
account or profitability, I always equated to food. If you don't have food, nothing
will happen to you don't worry. I always eat great cash-flow to oxygen. If the
oxygen supply in this room is cut off, I can probably be comfortable for 30 to 60
s.
I can probably be comfortable for 30 to 60 s. After that, I will start wobbling
exactly after 90 s. I will go like this and then you all to call the ambulance and
I'll be in the rush to the hospital. Either in the emergency ward or in the
mortuary. Right?
Right? Gardens are way more than 60 to
cache is not flowing into the company,
your salary is let's say you don't pay
employees will remain in your company?
90 s without oxygen. In a company, if the
what will happen? You will be unable to pay
monthly salaries for three months. How many
All of them will be there.
All of them will be there. Man will be there. Except your wife or husband or
brother-in-law. Everybody else would have left the company. If you don't pay your
suppliers, Do you think your suppliers will continue to supply you the goods or
services? There's no supplier who's going to continue. If you incur losses, do you
think you love to close down your company?
your company? No need. Because the two-year losses can be recouped in the third
year where you make super profits and the profits are so good that you are able to
wipe clean the losses incurred in the past two years. So if you are not profitable
for a while, nothing will happen to your company. But if you don't have cash
rotation, everything will come to a grinding halt. We saw a major opportunity in
the mobile phone business in my group around 200056. So we had a meeting of all the
senior managers. And the chairman said, I see there is a huge opportunity in mobile
phone trading. Can we hire somebody who can look up for the trading desk? I raised
my hand and I said, No, I will look up for the trading desk. I will do the trading
myself. So I appointed somebody as the CFO of the group and I became a trader. So
it's a natural tendency, right? We add six businesses in the group. So all the six
general managers were very keen to know what this trading business is all about and
why ATP was the CFO suddenly moved into trading. So they used to come and ask me,
Hey, I was trading doing. I used to tell them, yeah, I'm very comfortable. My
margin was 0.75 per cent to one-and-a-half percent. On an average, I had a margin
of, let's say, 1% I'm looking for so many of my peers used to laugh at me and say,
What is this TPU grow comfortably sat there as the CFO of the group. And now you're
running around all the time when you are having two phones. I used to be busy for
18 h a day because I had customers in Miami, I had customers in Hong Kong, I had
customers in Europe. And I was extremely busy. I alone as a single person, I was
doing close to $9 million per month. On an average. There are months when I've done
30 million, 14 million Also, I used to do on an average $9,000,000 business at a
gross margin of 1%. And people used to laugh at me. And they used to say, you are
really stupid. But none of them really understood the business that I was running.
I was getting 90 days credit from Motorola. And every time I sold my goods, I
always sold for cash or on chip on hold basis for the ship on hold. I will ship it
to the destination, but tell me freight forwarder to hold the goods so that you
save time. As the goods arrive at the destination, the buyer will go and inspect
the goods. If he's API will wire the money. The moment I see in my account the wire
transfer appearing in the queue. If it appears in the queue, that means nobody can
pull it out. Okay, so if it appears in the queue, I tell the freight forwarder,
please release the goods instead of the customer paying and then use shipping. E.g.
there was a time when there was a cooling period of 24 h 40, any shipment going to
Hong Kong, whatever reason. Which means once you hand over the Garver to the
airline, they airline will quarantined the cargo and leave it there for 24 h.
It's called the cooling period. And then they will load the cargo into the
aircraft. Maybe there is a bomb or something else inside the cargo. They will be
able to detect it or what I don t.
So you had all of these difficulties. So what I was doing, I was really using my
cash on an average age. In seven days. When I started the trading activity,
Motorola gave me a credit of 1 million. I increase it to 3 million, then I increase
it to 5 million, then I increase it to ten. And then I reached a level where my
credit with Motorola was $100 million. So who's funding my trading activity? My
company is funding. No.
Somebody who's funding it, right? Every seven days, I sell and realize my cache. So
when 90 days credit is given to me, within that 90 days, how many rotations am I
making with their money? Rotations.
Each time I rotate their money, how much am I making? So that means within that 90
days, man, I'm making bold per cent margin with their money. There are four such 90
days in a year, because in a year you have 360 days, four times 12.
four times 12. We lose money. Are you making 48 per cent per annum your money? So
all the general managers who are laughing called for a meeting after the first six
months and then they were exposed to the figures and they were all saying, Wow, how
come this is possible? So this is why a chartered accountant will do well in a
trading environment where the pricing is varying between dollars and euros. And
your customers are in different parts of the world and they are willing to pay you
in different currencies. A chartered accountant brain will work better. You should
be as in the model ID. So the deadly, deadly combination, deadly, that's why I said
this level at level is the elsewhere. They said Neil Armstrong landed in moon. And
he was **** tired after walking in the moon. So he was looking around for some
refresher, you know. So somebody approached him and said, Would you like to have a
cup of chai? That is Momoko t from Kerala. There is Momoko D from Kerala who is
serving Chai Bu, somebody who's lending in moon. So this used to be the popular
joke in all the parties 30 years ago here in Dubai. And then they said, No, we're
not happy with this joke reshoot either. An extension to the joke. They extension
to the joke is my Omega t given gum, came and gave you the Chae. But who gave the
Visa or Momoko De Bu, which asynchrony, Who's the cindy businessman. He set up his
gun in moon and he gave the result. If he doesn't give the visa home or moody will
go there and make a child who can write here what is happening. If you see, in
terms of profitability, you look very silly because you are making 1% profit. We
add a division supplying air conditioning equipment within our group, which always
operate it at 40% margin, where it is 40% margin and varies 1% margin. But they
always had a lead time of 180 to 270 days to realize their money, which used to get
extended to 300 days. And then eventually they will lose the retention money. They
will have to compromise on certain things, giveaway, some discount or face some
penalties. So their realization always was hovering around 25 to 30 per cent in the
air conditioning business, where the margins are supposed to be fat here the
margins looking crazy really low. But I had a minimum return of 48 person coming my
way, the two without having any money being invested with somebody else's money I
was operating the business. Are we clear?
Are we clear? So performance evaluation of a business should not be done in
isolation by looking only at the income statement. You all to look at the income
statement, you how to look at the cashflow. I'll give you a classic example. What
really happened there is this company was a client of mine in Sharjah, was doing
very well.
Trading company. God only knows how they manage a credit of 60 days with their
supplier in China. The Chinese supplier was giving them 60 days credit and they
were selling for cash. So basically, you are like a car for what happens in car for
everything is sold for cash, right? Can you buy something in car for and tell them
I'll pay you in 30 days time. There's no one who can do that. Car for sells
everything for cash. But do you know when they pay for their suppliers? After 60
days? That means for 60 days the supplier money is sitting with God for what is car
for doing. R4 is doing the banking for all the Alpha TIM group companies because
they have a lot of money. So other group companies take money from card four. So
four is a bank for the rest of the alphabet in business. You understand, because
you are asserting with craters, money, suppliers, money. So this guy in charge or
youngster, 28, 29. So he was doing exceedingly well for almost two years. And when
you are doing well, you will find these angels called friends who will suddenly
descended on new right from nowhere they will come and they are not in touch with
you, they are not in contact with you. But when you are doing well, suddenly they
will come like angels and fly in and then land next to you. And one of those angels
came. And over a beer, gave a brilliant idea. Much are you are sitting with
supplier money. We're crazy idea, right? With the suppliers money, buy a Ferrari,
driver only surgeon. You will not get this kind of opportunity with your own money
unless you run the business for ten years. So what do you do with these suppliers,
money gone, buy a Ferrari, driver on the variety for one-and-a-half months, sell
the variety, and then pay the supplier. Anything wrong with the idea? Good idea,
right? Or she was laughing leasing. Why I didn't think of this man. I grow and so
burgdorferi, while I'm doing the GMV, a bloody ****, I'm here for one year and I
didn't think of this.
Good idea. 10% is gone the moment you drive out of the dealers outlet or the
showroom? Right? If you've ever driven for one-and-a-half months, that means its
value is down by 15% or 20 per cent. Now, who's willing to pay for that loss in
value of a depreciable asset that you bought, you had the pleasure of driving it.
Is that the one-and-a-half months pleasure of driving the Ferrari equal to the 15
per cent of the value of a random question to be answered. That's for the
individual to answer. We don't know how each person will view. Their own labor in,
their own pleasures in life, right? So this is the problem, particularly with small
and medium enterprises. They have no clue about their cash management. I started
working when I was 16 years of age. 16 was my age when I started working. Now I'm
60 years old. And my father told me you're asserting your foot on your own. Just
make sure that when you yearn money, you will first save and then sprint.
Unfortunately, what people are doing, their first spend and then see what is left
behind for saving. That's a wrong approach.
That's a wrong approach. First fuel to save. Why America is going to be in
recession for the whole of next two years. And I was serious problem because the
disposable surplus of an American is 00. Why India will not face a problem? Same as
America in the next two years. Because in India, every single person has this
mentality of saving some money. They buy gold or they buy land, or they just simply
put it aside, hide it under the salary under the lintel box, inside the race box or
whatever, you know, my mother had a unique way of saving money and it used to come
from multiple places. Sometimes used to forget where she kept the money. I used to
ask her do you remember do you remember them? If I remember, I'll quietly take it
and go and spend it because she doesn't remember go. So you can call it stealing or
whatever, but this is what I was doing in my childhood. This. So how do you measure
the performance? You measure the performance against the plants and look at the
variances and then decide whether action is required. I'm going to give you a
problem, okay? Before I give you a problem, I want to talk about a concept which
has gained popularity in the last ten years. It is called the strategic business
unit. What is a strategic business unit? A strategic business unit is a unit which
requires we call it SBU. Strategic business unit is a business unit which requires
a strategic focus and attention. Should it be a profit center? Not necessary. It
can be a cost center. A strategic business unit can be a revenue center. A
strategic business unit can be a cost center. Invariably at strategic business unit
will be either a profit center or an investment center that is, without any doubt.
But it can also be a cost center. Nothing wrong, right? There are companies which
are treating their procurement department as a profit center. Do you know that?
Procurement department is treated as a profit center? Why procurement department
generates revenue? How do they generate revenue? Every time a procurement
department disabled to identify an alternate material, they will charge the user
department $15,000. Every time the procurement department identifies a new
supplier, they will charge the user department $10,000. Why? Procurement department
is doing research in the market to look for alternate material, alternate source of
supply, alternate supplier. What does the research? Researchers and nothing but
repeated. Such, you keep repeating. You are a search on a daily basis are repeated
searches called the research. What is procurement department doing? They are
repeatedly searching again and again, again and again to see if there could be a
better supplier. There could be a better material, there could be a better method.
Hence, what the procurement department is doing, they are charging every time they
bring something new to the organization. And the user department, which is a SBU,
will pay money to the procurement department. We are talking about one single
company within the same company this is happening. And there is a BPO or CAPD or
whatever it is called in Bangalore with 400 employees and what they do, they do
procurement for companies in the West. What is their job?
The 400 employees are searching all over the world for that particular material
supplier. Then they are finding out who's the best. Not always in terms of money,
there are multiple criteria, right? It could be money, it could be something else,
something else, something else all put together. Their job is to identify the
Western companies are paying for it. If that k p or is not in Bangalore, but if
that KP all where to operate from inside the company as I insource do procurement
department, you would still end up being for it. Do you understand?
So this is where the whole world is moving. We are moving in a direction where
everything has to be managed in a strategic manner. My granddaughter was only six
years old, was taken to the science lab because she didn't want to go for swimming.
She had a cold. So they said if you are not going to assuming you should come to
the science lab. So she spend maybe half an hour or 1 h in the science lab. And
then she came home and told me that are due day, I learned something about
transparent, translucent and opaque. Instead, what does this transparent? Do you
know or you don't know? I said I don't know. They never taught me at school. She's
only six years old. And Lynch, he made me suit. We live next to the wireframe. So
across the balcony we can see the debate frame. So she said, Are you able to see
the debate frame? I said yes. But isn't there a glass in-between in the balcony? I
said this there is a glass. She said This is a transparent glass. She explained
what this transparent or translucent and what is the peak, how they are different.
Right? So what is the school doing? The school is actually repairing them
strategically. I bought something and to get home. The first question she asked me
is, is this a healthy food or not? I said I don't know. I bought it didn't for this
disorder is pizza restaurant in Karameh, bags of food. So she is asking, is this a
healthy food or not? First explained to me. I didn't have an answer, so I looked at
my wife, I looked at my daughter-in-law. Then they started explaining to her. Then
she has always made She's keen to know how we prepare it. What are the ingredients
at six years of age? So strategic focus is all about what you are aiming for and
where you are going. What do you want to do, where you are heading? So I'm not
going to bore you with this. Now. I want to open a case study. This is what I
wanted to open. No, you are seeing the bank consumer loan department of a bank.
Okay. These are real numbers, so don't ask me any additional information I cannot
give you. Don't ask me which meant I cannot tell you. Okay. That's all. Now. This
is a consumer loan. You know what consumer loan is, right? You give a loan, that
guy will go and buy some item and then you will pay in 12 months time or six months
time or whatever, right? So that direct labor is $23,000, supervision is $15,000.
Non controllable costs are these three? We discussed yesterday a controllable costs
and uncontrollable costs and uncontrollable costs are thrust upon you by the
headquarters or by the corporate office. It is non negotiable. Are we going to look
at the non controllable costs? We're simply going to ignore it. Then our focus will
be on the controllable fixed cost. And our focus is on the direct labor. How do we
focus on this? I'm giving you some pointers. You have to carefully understand the
pointers I'm giving you, which are called non-financial metrics, right? And then
you, our task is to link and non-financial metrics to financial metric and make
sense. And then tell me whether you are happy or not. E.g. I'm telling you, number
of accounts at the end of the month is 133 for number of new or cones is 54, number
of clauses, the accounts is 22. What does it mean? 22 people finish to their six
months installment or three months installment and paid the loan in full. This is
going to be a regular phenomenon. So are we to worry about the 22. We should not,
because it's a regular phenomena. It will keep happening every month. Ten people,
20 people, 30 people will close their accounts. And what because they finished
paying the installments. Number of transactions processed, 1009, 94, number of yen
queries that they received is 334. If you wanted to discuss with your neighbors who
are sitting next to you, you can do so. I'll give you 3 min because I'm going to go
for a 10 min break. First ask yourself, do we have a problem or not? Is this
department well-run, then we don't have a problem. You have a problem. If you have
a problem, where is the problem? Is if you not gone maintenance, new customer
acquisition, where is the problem? If you say there is no problem, you have to just
keep way where you say there is no problem. I see there is a problem. At the stroke
of 1025, we will take a break and we will come back at 10:35. According to that,
watch. Others is all fallen off. Anything which is not really significant, maybe it
is made up of ten different things. Yeah, there is nothing you can do on others,
but you love to see where else is the problem. These others is not a problem. So
this 33 is not a problem. You are not controlling. These others is not a problem.
Then you ought to look at only this, this, this, this, and this, and link it from
here to see, are we paying the right amount of money to maintain the accounts? Are
we paying the right amount of money to acquire new customers? Customer acquisition
is their manager. So I am the Assistant time getting paid 23,000. My son buys me,
manager is getting paid 15,000. Like me, there are a few Assistant don't think I'm
getting more salary than ten times my salary. So let's say me and the six jokers
are sitting. But sometimes super easy. So we're paying the six jokers, 23,000 and
we are paying the supervisor 15 those of you who can't have okay, guys, 10 min
break, come back in 10 min after the break. I'll give you again another 5 min. Then
you tell me your views. How do you reading for me?
Doug. Doug while I do my office but his work was okay and comfortable with what is
available. Thanks for joining. Let's start the discussion. What do you think?
You understood the braced time, date and TB and we'll never wait for anybody. I can
also use some dialogues electrogenic on my thing wrong, right? That tell me where
is the problem? 6,500 and cost of advertising 334 inquiries and 334 enquiries
converted into. So you are linking 6,500 to 33334. You are linking to before.
They're not happy. You're not happy with the conversion rate or you are not happy
with the cost of enquiries being generated?
being generated? Nadh, I agree with both. Okay.
So you are not happy with the cost of conversion? The conversion, cost of inquiries
and the conversion. Okay.
Anything else? Yes. The direct labor is generating and queries or they're
processing transaction, what are they doing? A clerk in your bank or D will do.
Yeah. So then what does what does is connected to 6,400 advertising cost because
the fees and services are paid for processing the new loan, external agencies are
there, right? So the fees and services should be linked to the number of new
accounts because water maintaining you don't need a piece. Late. Fees and services
affordable chosen to 26 is connected to the number of new accounts. Okay.
What else? We'll give it a dance. Number of transactions. Okay. So hungry if you
are if you are looking at 1009 94 transactions, I would like you to look at the one
Towson Main 94 transactions basis of direct labor of great P3 for 46, plus the
supervision cost of 1539. That's a link that you have to look at. Those online 94
transactions are processed. How do you process the transaction with the direct
labor? If you want, you can even add this applies for the transactions processed.
So you can add the 3836 here. Then you can say whether you are happy or not. Any
other dimension, Yes. Excellent.
Okay. So now she is linking the 23,000 for $46 is link the 215003 or nine? This is
a question I was asking during the break with their supervisor. I told him that
supervisor is Watson. Who are the stuff I said me and for more jokers. So he said,
either we allowed to fire was Center, we load to fire all the five jokers who are
doing the processing. That is the first point.
You are still having coffee. We already discussed. That is our first point,
advertising cost. This is the first point. And then for two to six, we linked it
fees and services to the number of new accounts. Then we link the cost of
processing the transactions with the number of transactions. And then somebody said
on a burner said, the cost of labor link it to cost of supervision. And if this
figure is from a bank in Dubai, and if these figures are of recent times, do you
think this bank will be having a manual system or will they be having a fully
automated system? There were fully automated system. Because all the banks are
fully automated. Right? And I say fully automated you all systems for everything
not that you have dispensed with the people. And then you walk into the branch and
you are dealing with a robust night in a, in a computerized environment where
everything is through the system and where the controls are built well within the
system. The first two question, when we did the performance that we raise duos, why
the supervision cost is so high? That was the first question that we raised.
Unfortunately in the banking industry in UAE, there is a amortization which is a
requirement of 70%. That means 70 per cent of their employees should be a monarchy.
There are some tribal people who Lou on goldman support. They don't work because
they are school dropouts. So the government said because I know because I work with
the Ministry of HR. So the government said we will not support these tribal people
in there to do some work. So in places like debulk or a phone call and all these
people who are told go and work in a petrol pump.
We can support you. What do you mean the petrol pump where this person is working,
an Indian expiratory eight or a Pakistani or a Filipino is being paid. Put those on
their own salary. The salary is 6,000 drums in a petrol pump. Three times the
salary of unexpected. So you can imagine what will happen in a bank. The salary
differential between an expiatory it and then MRR. So one of the constraints the
bank had was because of the amortization. Another constraint the bank had was this
a very old bank and they've been operating in a certain manner for the last 30
years. So in a world organization, what happens? Old practices continue, nobody
questions. So the conclusion is, this is a very, very poorly managed department.
What DO two fixes the management of the department. Once you fix the management of
the department, then all the efficiencies will start flowing one way. One.
Are we clear? But all these points that people raised are all very good points. And
this is what you are expected to do as a manager. Of course, more information is
required. If I give you more information, then your decision will get the enhanced
and we'll get properly justified, right? Okay, so let's move on. When we talk about
performance. Problem is, this is what happens in reality. This is the marketing
plan for a luxury yet. But the marketing budget is for. Panasonic or Inbox? Why do
you say I inbox that is minus Sonic. And where does it return that is expected.
Returns that you normally get from a luxury cruise. This is 0 performance Ceasar.
When we hire people also, this is the same problem. We want to hire a person. What
do we say? Should have minimum seven years of experience of which 40 years should
be in a managerial position. Preferably Gulf experience should be an engineering
graduate. Preferably with MBA. Okay? So we keep on adding preferable, preferable,
preferable, preferable. And we add so many qualifications when you sit back and
analyze it. This person actually should have started off 16 years before he was
concealed in his mother's womb. Other ways, it is impossible for him to meet all
those requirements of the job specification. Right? So this is the problem in the
world in which we are living. And another problem in the world in which we are
living is when the organization is a location. What happens if the organization is
multi-location? I'll give you an example. I saw Glenn has got a factory in
Bangalore where they make vehicles. I saw Glenn land also has a factory in Russell
K-map where they make mini buses and many trucks. Mostly these mini buses, the mini
buses that are made by Layland in self-schema are being sold in the other Middle
East countries and their main market is Africa. So what is the Russell game or
factory getting the Russell gameified three escaping from Bangalore, a kid called
CKD. We have two types of kids in the manufacturing process. Ckd and SKD. Skd means
semi knocked down. Ckd means complete knockdown. Semi-log don't is a knockdown
which you knew at a higher level, complete lockdown is an unknown you'll do at the
component level. So complete. Now, don't get this come into the cell Kmart end. In
every country today when you set up a manufacturing business or any other business,
there is a requirement called I see. I see V stands for in-country value. What is
the value that you are adding in the country? Which means you can't do paper
transaction. Who can sit here and say, I did $1,000,000 business out of that
million dollar. What is the value that is added locally in-country value y in
country values specified. If the in-country value is not specified, then many, they
knew you cannot put made in UAE. This is called certificate of origin. You can
bring something here and put a sticker made in UAE and send it unless you
demonstrate that there is an in-country value of minimum 20 per cent. How do you
get the dean country value? It can be through labor, it can be through some local
material or whatever. So what does show Cleland is doing? I saw Glenn lenders
buying paint from Joe Newton paints and merge your pains. And do they do painting
of certain parts of the vehicle? They also employ 400 people in Brazil came out who
are doing the assembly of the CKD into a mini bus. So they are able to achieve the
in-country value. Let me clear what happened when there was a trade war between US
and China. We know goods, we're still going from China, but how they were going to
us when there was a trade war, they were routed. Where they were routed to the
answer, the woodland routed. Where were they routed through? The routing was done
through. And the Vietnam government being a very, very smart government, they swung
into action. They saw this as a huge opportunity and they passed a new rule in
Vietnam. If the ISEV is 1%, you can put made in Vietnam.
So what happened? Goods were made in China. Those goods came to Vietnam. In
Vietnam, they did some bare minimum repackaging or whatever that costed 1% of the
value of the goods. Halloween spent 1% of the value of goods locally in Vietnam.
That company in Vietnam. Hi to the liberty to put a sticker made in. In reality,
where are these goods made? If you have the sticker made in China, it will not be
allowed at the port of destination anywhere in the US. But if it had a sticker of
made in Vietnam, It will be allowed to how to get them made in Vietnam. The Vietnam
government itself said, one person didn't country value is enough. They passed a
new rule. So all the Chinese manufacturers, they routed their entire shipments via
Vietnam. So China to Vietnam, you can reach it by road, so you bring it. There are
some small value addition is done for 1% of the value of the goods. Then you put
the sticker made in Vietnam or maybe the sticker made in Vietnam also is put in
China. I don t know. Quite possible. The one-percent addition and then you ship it.
But if you are dealing within the same company, Azure, Glen Island and national
glial. And then what happens? The performance of Bangalore will get the impacted by
the units produced if our Russell came up because Bangalore and Russell K map units
are part of the same company or show Glen Island owned by the Hindu Zhao group,
which is sitting in London. So everything is belonging to that London Company in
Hindu job group. So if the Mangalore unit produced the hundred they sold in the
local markets, seven time units. They ship, put it 30 units to Russell, came up on
this 73 units. They make a profit of 30%. On these 30 units. They don't make
anything because it is made for us sister concern. Are we aligned? Why did they
make on 100? Uop evaluate the performance of the Bengaluru unit. What did they make
on 100? They made on hundred. Only 21.
Only 21. Are they making 20, 1% in reality? No. If you gave them the liberty to
deal with the rest of the world, they would make 30 per cent. You restricted them
and said No, no deal with the rest of the world for 70% of your production and
yield 30 per cent here. Then what happens?
Then what happens? Are we evaluating the performance of the bank lower unit
perfectly. Know what happens to their cell gamma unit. They got inputs at cost. And
then they added the ICB of painting something and buying some local components and
fitting into a bus. And they sold that bus at a huge profit. Where is that profit
sitting? That profit is sitting in Russell came up. This whole mechanism of
transferring the output of one unit to another unit and the other unit reading that
output as their input. And then they're coming up with an output at a much higher
profit is many times done for shifting the tax base. Why? In India, if I ensure tax
profit, I'll pay 30 per cent tax in UAE for a show profit. I'm paying nothing now,
but from phosphoric June 23, I will start paying maybe nine per cent. So should I
show all my province in India are so only some profits in India and show the entire
province in Brazil gamma, which is better for me. So transfer pricing is a huge
subject. I'm not going to get into that subject now. I'm only going to highlight to
you that transfer pricing is nothing but the price at which goods are transferred
from one unit to the other unit, where the performance of each of those units which
are involved in the transport routes, both of them is not correct. If you don't
follow certain logical steps. Unit which is giving at cost, performance is not
correct. The unit which is guarded at cost and sold at market, that performance is
also not correct because they are showing a bloated profit. These people are
showing a lesser profit. This less profit is wrong. This should go to 30%. Higher
probability is wrong. It should be brought down or normalized to the ground level.
So this is a problem. What is the best way to do transfer pricing so that it is
unquestionable. Even though we see the guidelines. The first one that he says is
the answer IT market price. So that nobody can question you whether you sold 70 per
cent to the outside world or 30 per cent to your own sister concern? Yeah, anything
you sell, you sell at 30% margin. That is a marketplace. We have a very popular
case in Howard Business School of P&G. P&g in Japan developed a product called SKA
to escape too is a makeup kit. And the makeup has to be a played in three stages.
And it takes one-and-a-half hours to apply the makeup. Because they escaped to was
developed from her BS in Japan, Japanese herbal product. Very, very successful in
Japan. The European country.
He'd said, I want to sell this product in Europe. The Japanese country hates it. I
cannot allow you to sell this product in Europe. So the countries of Europe wants
to take this K2 to Europe. The Japanese country head is not willing to give aid. So
they had a fight. When to country heads are fighting, what does the resolution,
what is the next step? Keep waiting.
Warm, start to walk. Agreed to disagree. They both went to the president of P and G
are sitting in America. And the President heard both of them and said, What's your
problem idea, Japanese friend. The Japanese friends said, I took painstaking
efforts of seven years to develop the escape to. If I give it to this fellow. Here,
we'll take it to Europe. And in Europe, our brand is known as Max Factor. He will
change it as Max Factor and D will go and sell it as Max factor. Then what happens
to all my efforts of seven years? I don't want them to sell it as Max factor. So
the president asked the European C, are you willing to sell at yes, K2, he said,
Yeah, no problem. I will call it the SKA to their original name. Then came the next
objection. The Japanese guy said, every kid, I produce, these are just illustrative
numbers. Okay, not real numbers. He said it is costing me 300. I sell it to the
fashion retail at foreign bread. They sell it to the customer for 500. So this is
my dealer price. If I produce at 300 and go to Europe because the European CEO is
also part of P&G. You being the president, you'll tell me, give me that cost. I'm
not willing to give it cost. So what is the price you want to give it? He said,
I'll give only at 400. Right now I am producing thousand kids.
Right now I am producing thousand kids. Fall Europe. I know they need another 300
kids. So the thousand kids, I will sell it for hundred, $300. So I will sell it for
Android. If the European guy agrees, I'm game for it, otherwise, I'm not interested
in giving this product. So the European CBO agreed to Europe, launched it at a
selling price of thousand dollars. Because he spent a lot of money on marketing it.
This is a Harvard Business School case, P&G Escape, Escape, who is now selling
everywhere in the world, even in Dubai, you can find this k2. So now my question to
you is, do you think it was successful in Europe are not really. In fact, the case
study says the European women feel that the Japanese women are not good-looking. So
if it is a Japanese product, then the European women may not accept it also. Any
other abuse. Was it successful in Europe?
Yes. Function the businessman in the night. Why do you think he's a daytime student
at nighttime businessman? Know Glenda stain activities ease into normally is
immediately looking at you in a suspicious manner? Yeah. You don't think it would
have succeeded any other abuse? Their globally at that time when they launched in
Europe needed click or not. We can say now Coca-Cola is selling well in the first
year they sold only 23 bottles. You know that the whole first year they sold only
28 bottles. Coming from a brand like PNG should be a success. Then why Fire Phone
failed in Amazon? Why oxygen's failed in Amazon? Coming from Jeff Bezos, like
Kindle and AWS secret, I've been a success. Why did it fail? Sorry, in UK, know in
Europe it is called the Max factor. Next factor is the P&G product. That's a brand
name. Because he is scared too, is connected with Japan. So people will not see it
in Europe. Yes. So since it's a luxury product and to apply the makeup, it takes
one-and-a-half hours. So my wife and daughter-in-law will not buy this. It
shouldn't be a different breed of people, probably from the royal family in UK
because they have all the plundered wealth of the whole world. Because two teams in
the world, or the royal family of UK. So he says maybe in Milan and Amsterdam it
sold well not elsewhere. Looks like you are experiencing stalking known slowly.
Mono made in Japan. They can't brand it as made in Europe. That is this condition.
You should sell it as yes, K2. You should promote data has made out of Japanese
hubs in Japan. Okay, you got the point because I said it was promoted that thousand
dollars with the heavy marketing campaign. Guess what happened when they escape was
taken into Europe. There was a hue you will sweeping through Europe called organic.
This whale or nasally use that to wave and say how bold and organic makeup kit,
where there are no chemicals made in Japan, painstakingly developed du over seven
years in our laboratory in Japan. Right? So created a huge hype around it. It was a
mass su, success. Now, who is going to be laughing? European seawater Japanese CEO.
Who's happy because Japanese, he was selling additional units at the same price.
That is a link to his dealers, right? So he's making more profit. European z was no
God. Another brand apart from Max Factor which is selling well, we don't know is
advertising costs, but he is making money. So which one of the two is going to be
very happy? It is a president who will be the happiest of the lot. Because guess
what happened to P&G? P&g developed a product in Japan which was selling well in
Japan. Now that product has been received well in your, which means that this
product is today. A global product can be sold all over the world and continued to
be produced in Japan with the same hubs. Production can still continue in Japan,
but it can be shipped all over the world, right? So please understand that when you
do the transfer pricing mechanism in your organization, the two units within the
same organization will be sticky about how it has to be done. You think the
Japanese to see what was wrong?
wrong? He had a point. He said, Look, I'm making are 300 selling at 400. If I make
it for another PNG is historic concern. I will still make it at 300 and sell it for
400. For all you know, with the global presence of SQL to this Japanese, he was
making more money. Because the 300 with scale must have come to maybe to 72 to ten
per cent reduction. That 10% reduction is still helping him. Why Japanese C was
incentive bonuses depending on the profit generated in Japan. What about the
European CEO or the European C was salary is Mona's, everything is dependent on the
profit Z is generating in Europe. Really get paid anything for what the Japanese
guy is doing. Nothing at all varies is the effort. This is why they transfer
pricing has become a huge problem in multinational companies. Because I said this
yesterday. Each department Warner EEG, SBU one, is running his own fiefdom and he's
sitting like a hand on top of weird with the totally exit or hatching. So they are
very, very possessive about what they do. So what are the different mechanisms in
transfer pricing? You should know that the first and the foremost, which is
unquestionable is the price at market price. Now second methodology that is
followed by many companies is cost plus. The third methodology that is followed by
certain companies, particularly in the Western world is market price less? The
market price is 100 to my sister concern, I will give it less routine per cent. g.
Market price, less cost plus e. in Motorola. When I worked in Motorola, any
internal sales we used to charge a cost plus four. So as an employee, I always got
mobile phones at a much, much cheaper price. So every time I traveled to India,
used to travel with 1015 phones because everybody will ask me to bring the forms
and there is no limit on how many phones you can buy. Used to make ten phones, 12
phones, take it to India and give it to all my people because I used to get it at
cost plus four. And there is a big differential between the market price and what
the stock price will be, right? So it is either a cost-plus our market price, less
our market price. And then there is a fourth one also which is called predetermined
price. Where do you have this pre determined the price? The predetermined price
normally is there wherever a company has an annual contract and wherever the
company has an annual fixation on what they are doing, e.g. my client is supplying
shrimps to Emirates Airlines every day. He has to go and deliver 800 kilos in the
morning before 09:00. So 800 kilos of shrimp and eat the shrimp should be of this
size. It's called the thing brown or whatever brand it is. And it should come only
from Thailand or from certain other waters. If there is a famine in Ireland, then
it has to come from a distance place like Columbia and elsewhere in South America.
These are all specified. But if the stop procuring the shrimp changes, Emirates
will not pay anything more. The contract with the hemorrhage says, if it is 60 g
per kilo for 800 kilos, that contract designed for the whole year. That means that
contract is applicable from 1st of January too, 31st of December in-between if
there is a famine in the waters in Thailand and you're not getting the shrimps. So
you are going and sourcing it from South America, which is costing you more. And
when it's just not going to pay you more, they'll pay you the same rate. So in
businesses where you are tied down on certain contractual obligations, then you
might have, but eat, determine the rate at which transfer happens between two units
within the same organization. Are we clear? Now how do we review the performance of
these units if they are also doing internal supplies? This is where we discussed
briefly, and I said you will do what is known as normalization. You will not have
malaise the reserved me saying had this internal sale wasn't not there, then what
would be the performance? Odd? If we read the internal sale on par with the rest of
the world sale, then how do we treat this performance? Because he will get
deprived? There are units in an organization where 60 to 80 per cent of their
output. This for internal consumption, that means in the external world is only
selling 20 per cent. Are you going to evaluate the performance of that manager
based on the 20% that he sells for their own world. What a mood is the effort in
producing the remaining 80% economically. He's doing something on the 80 per cent
as well to maintain the cost, to maintain the quality, to maintain that it is on
par with the international standards. Then what are you doing for that performance?
You are not giving any credit for that performance. You are giving credit only for
the 20% that is sold to the rest of the world. That's not correct.
That's not correct. That's why we do the normalization. None Nevada is fog is there
in your financial statements? Why?
Why? In the financial statement? If a student concern is being given the goods,
there is no financial transaction. Right? I removed my phone from my browser. Now I
have shifted to my shirt. Is my trousers selling the phone to the shirt or what?
Please understand in accounting, as long as the goods are remaining within the
system, that is no transaction when there is a transaction, when there is an
involvement of an external company. Within the same organization, I show glial and
Bangalore supplying goods to show glial and Russell came out probably, yes. You can
treat it as an external transaction. Why? Soap Layland dry cell K-map probably is
wounded by a different set of people and is registered as an organization. And
that's okay, my economic zone. So this is a separate entity. That is a separate
entity. They are legal entity, so it is okay. Here's what Barbara is doing. There's
a big company in India called Daubert. They make a very popular product called the
Chavan brush. For your kind information. Feel cold or problem. You can buy the
javelin brush for that product. Does automata, which one is the person who will
come in the advertisement because he is promoting school term, jacket, slipper,
everything. I want brushes coming from India to Java lolly in bulk. In Java, there
is a plant of the harbor where the brush is now getting pegged into maybe small,
small bottles of hundred grams, 200 g or whatever. And then from here, it is going
to Europe, it is going to Africa, it is going to various countries from here. What
are they doing? They are trying to economize on the cost of shipping the product
all the way from India to Africa. So they are sending the product in bulk to jab
allele. Allele it is getting repackaged into smaller containers or bottles, and
then it is shipped to Africa. So the unit in India probably is producing, let's
say, 100 kilos. But only 60 kilos is being sold in India, the 40 kilos are being
shipped to job allele. So when you check the performance of the factory that is
running in India, which is producing 100 kilos. The 60 kilos is making a profit,
but the 40 kilos is not making a profit. If they are transferring at cost, then
what you should do, you should normalize that transaction through a management
accounting report, which is done in Excel so that the Albert factory head who is
sitting in India is not being assessed do far as performance based on the 60 kilos
that is selling to the external world. You assess its performance on the basis of
the 100 kilos that he produced.
Does that make sense? Yes, no or not applicable. Then comes the question of return
on investment. I will briefly touch upon this because this is a slightly tricky
issue because some textbooks are showing a different formula. That is why people
get confused. Your investment in the business is $1,000,000. Say $1 million. The
profit you yearned is 260,000. How do you calculate the return on investment? Very
simple.
Profit divided by the investment in 200, you will see what is the return on
investment. But what standard textbooks or mood authors like hunger and will
suggest is big the profit, the way they buy? The age investment? Why average
investment? The capital I deployed in the beginning of the year and the capital I
deployed at the end of the year might be different. But the profit is yearn to war
over the year. So what you are doing, profit divided by the capital at the end of
the year. That is not correct. Then what you should do, take the profit earned over
the year, which is 260,000, divided by the capital at the beginning of the year
plus the capital at the end of the year, divided by two, which is average capital
deployed in the business. So profit for the year divided by average investment that
was made during the year times 100, you will get what is the return on investment?
Leave the capital that was deployed and the beginning of the year, while 600,000
and the capital at the end of the year was 1 million. We will take 600,000 plus
1,000,001 point 6000000/2800000 to 60/800 K.
60/800 K. If you take 260 divided by the closing, you are arriving at 26 per cent.
So that's why I said, seasoned developers like hunger and will tell you, no, that
is wrong because profit is yarn over a period of time. Over a period of time when
money is required more for the business, you are pumping more money into the
business. So it is better to take opening, closing, the weighted by two. I've seen
companies where they even take at monthly intervals. Because on a monthly basis you
are computing your profitability on a monthly basis you are passing all your
entries, like depreciation and also they do even at monthly intervals each month.
And what is the capital deployed? And then on a month, on month basis, what is the
profit here? And then they will average it out and say, for the year I actually
earned 28 per cent or not 26 per cent. Are we clear?
Are we clear? Does it make sense? So if you're asked what is written on investment,
don't say profit divided by investment. Always it is better to say profit divided
by average investment. While you profit divided by average investment. Profit is
not the earned on the balance sheet date. Profit is yearned over a period of time.
We call it profit and loss account for the year ended 31st. Whereas balance sheet
is a snapshot balance sheet. We don't call it for the year-end balance sheet. We
say as on it is as on 31st of December. Profit and loss account is for the year
ended. Since the profit is yearn to over a period of time. We divide the profit by
taking the average investment. What is average investment? Investment at the
beginning of the year plus investment at the end of the year divided by the L.
Elaine. Same page. Okay. Then comes residual value. This is another concept which
is used by many, many companies around the world to measure the performance of the
company. How do we measure the performance of the company? I take the residual
income. What is a residual income? Income earned by the business unit after paying
for the charge on the funds invested. There is a community in India, garden Marbury
community, what they do. At the end, we every Monday we'll knock off 1% as interest
on investment. That's so fast expenditure to be paid. Why? If you are sitting in
the aircraft, the pilot is saying when the pressure is low, the oxygen mask will
come down. Help yourself first. If you are not fit, are you Leo? Help other people?
So you'll have to help yourself first. The logic is if I run a business and if I
have invested $1 million in my business, first, I allowed to be paid for the
investment I made. What is the return that you are expecting? This community in
India fields? A reasonable return is 12 per cent per annum. That's why they take
out 1% every month. Everybody Monday take out 1%. So profit is 260,000, but that is
not the true profit of the organization. Why you're not feed the interest on the
investment made by the owner? Fast, you pay interest on the investment that he has
made. Why? This logic of paying interest on the investment? Suppose when you
started the business, you didn't tell them money and you went and borrowed from a
bank. The bank say why she's is a very nice guy. Let's view the money to him
without interest, which bank is going to give. So if you don't invest your own
money, you are going to end up by borrowing. When you borrow you all to pay
interest. So the same logic is applied here. When I was CFO of a local group, I
used to charge interest at ten per cent on the retained earnings of my units. And
they used to come and tell me, no, this is atrocious, nobody is doing you are the
only crazy guy who was doing. I used to tell them, Look, you earned a profit. I
have every right to pull that profit out from your unit rate, but I'm not pulling
that profit out. I'm taking only a small portion of it as dividends. What happens
to the remaining profit it is laying with you as retained earnings. If I pull the
empire for offering it and if you want to grow your business from where the money
will come, you'll go and borrow it. If you borrow, you are going to pay 10% to the
bank. Now since you are not borrowing in that, I provided the money to you, you pay
10% to me. Unquestionable, non negotiable. So some of the GMs in our group never
liked this argument. They used to say, this is the only company in Dubai doing all
this nonsense, right? The logic is you have to value the money if you don't know
the value of money and if you think money is coming to you free and the investment
is coming to you free. You will not be concerned about the return on investment.
You should know the value of the money or will you know the value of money? You
will know the value of money when Lee, when you are paying a certain charge on the
investment that is made by the owners of the company. If there is no charge on the
investment made by the owners, the new thing money has come for free. What is your
primary responsibility? You are primary responsibility is to protect the capital
invested by the owners. Then second, grow the capital invested by the owners of the
capital is not growing, then what the **** you're doing with that money? Another
argument is I have $1 million with me. On first of January 2023. I set aside this
$1 million and I kept it in a safe box, and then comes 311-22-0203. Nothing has
changed with that $1,000,000 rate, it is laying in the safe box. So do I have my 1
million in safe box? Yes.
No or not applicable? No way. The inflation in this country is four-and-a-half per
cent. So the 1 million I kept in the safe box on 1st of January 2023. If I pull it
out of the safe box on the 31st of December, it is already lost its value by fourand-a-half percent, which is the inflation in this economy, which is the quotient
by which my buying power has dropped. Do you understand? So what should I do if I
have $1,000,000 at the beginning of the year, by the end of the year, I should
first meet the inflation. Let's make this task. How to meet the inflation, get a
return or minimum four-and-a-half percent, and then go over that four-and-a-half
percent. Making sense.
That's what this residual value is, a very, very important metric that is being
used in many, many companies. Then comes economic value added, EVA. We call it as
EVA, which is nothing but net operating profit after tax minus the total cost of
capital, including notional cost on reserves. You build reserves in your business.
It could be specific resolve, it could be a general reserve, but you always build
results. Why do you build? You build reserves in order to meet certain
eventualities in the future, some unforeseen circumstances. So EVA is calculated by
even ascertaining what is the cost of the capital. Cost of capital is not easy
because, why? I'm not going to do a deep dive into this concept I will explain at a
higher level. Because intention is not to do a deep dive. What is capital? Capital
is the money invested in the business? How do you invest money in the business? Do
you always put all your own money? Not necessarily. So you put your money, which is
called equity. You put money by borrowing rate. The model, the funds is called the
own funds. What you have is called equity. Equity is your one firm's borrowed funds
is called debt. When you borrow money from somebody, that somebody will expect a
certain return. And that is interest on the borrowings.
Very simple. But waterboarded equity. How do you ascertain the cost of equity then
the cost of equity as to be ascertained on the basis of what is the cost of the
money that the investor is thinking because he has other opportunities, e.g. today,
instead of investing in a business $1 million, if I go and put the money in India
in a public provident fund account, the government is giving seven per cent. It's a
fantastic written. I don't know how to do anything. Just put the money with
government of India and I get seven per cent return. I don't have to do anything if
I invest out to be worried about my investment. Whereas in the deposit there is no
worry at all. Money is growing and the accretion is coming or 7% each year. So what
is the opportunity that I have? I have an opportunity to go and investigate demand,
government savings. How much will I get? I will get seven per cent. If we put it in
a business, then my list is there. So I have to add a risk premium to the seven per
cent, which means depending on the industry, depending on the size of investment, I
will have a certain expectation which is calculated through a methodology called
the cap M method. You will study a bolted in another subject, which is capital
asset pricing model. So the date is 50 per cent equities would be present if the
equity is costing me ten per cent and disgusting me six per cent. We calculate the
weighted average cost of capital. g.
E. DHL, DHL, 95% of the capital is borrowed. Viper uncertainties, own funds.
Viper uncertainties, own funds. I don't mix. 99% is owned firms, only 1% is data.
I'll explain why you tomorrow, okay. If you wanted to leave, you can leave now. If
you have any questions, I'll wait here to answer your questions. Most ulama, today
will be the last day of our session on management accounting. We will wrap up all
the discussions by tomorrow or today. Tomorrow. Tomorrow is the last day. We will
wrap up everything by tomorrow. Right? Hello.