Management Accounting
Relevance [timeliness]
Detailed and extensive
Basic Management Functions
 PLANNING – road mapping, goal setting
 ORGANIZING – Directing, motivating; staffing, subordinating
 CONTROLLING – monitoring, feedback mechanism
Controller
 Financial reporting, cost and management accounting, AIS,
financial analysis, special studies, etc.
 Primarily staff function, has line authority to subordinates
over his own department
Line Function
Authority to give orders
(VP Ops → Ops Manager)
Direct downward authority
over line departments
Directly involved in
achieving company
objectives
Staff Function
Authority to advice but not
to command
Commonly exercise
laterally or upward
Staff managers supports
other managers thru advice
or assistance
COST BEHAVIOR
 Make or Buy
↳ includes opportunity cost for Maximum Purchase Price
 Accept or Reject
↳ Full Capacity: Minimum selling price = Regular SP + FC
↳ Excess Capacity: Minimum selling price = VC + FC
 Continue or Shutdown
↳ Segment margin is the basis
↳ Product elimination
► Shutdown point = (FC – SD Cost) ÷ Unit CM
► Deduct SD Cost only if it is unavoidable, what remains is
the avoidable/relevant cost
 Sell or Process Further
↳ SELL
= Sales value at Split-off
↳ PROCESS
= Final sales value – FPC [also called NRV]
↳ Joint cost is irrelevant
 Scrap or Rework
↳ Joint cost is a sunk cost, irrelevant
 Best Product Combination
↳ Ranking is based on CM per Activity (ex. CM per hour)
 Change in Profit
es
Financial Accounting
Emphasis on reliability
Aggregated and simplified
RELEVANT COSTING
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BASIC CONCEPTS
► Fixed costs are irrelevant unless it became avoidable
► Variable costs are relevant (includes DM, DL, VFOH)
► Opportunity costs are relevant (sacrificed, not realized)
Linear Programing – quantitative technique
↳ Used to achieve the best outcome [maximum profits or
lowest costs] in linear representations
↳ Handles multiple constraint, as opposed to relevant costing
↳ Objective function: Maximize Z = UCM1A + UCM2B
↳ Non-negativity Constraint: A, B ≥ 0
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Cost Estimation
 High Low Method
Cost YH – YL
VC =
Activity XH – XL
 Graphic/Scatter Graph/Scatter Diagram
↳ Draws straight line through plotted points
 Least-Square Regression
↳ “Line of best fit” most accurate
↳ ∑Y = Na + b∑X; ∑xy = ∑xa + b∑x2
BUDGETING
Correlation Analysis
 Measure strength of linear relationships of variables
 Can be seen through scatter graph
 Does not establish cause-effect relationship
 Coefficient of Determination (r2)
↳ Degree which the behavior of IV predicts DV
↳ The closer r2 is to 1.0, the better; more confidence
 Coefficient of Correlation (r)
r
+1.0
0
-1.0
Linear Relationship
Direct/Positive
none
Inverse/Negative
Scatter Diagram
Upward sloping line to the right (/)
No pattern. Random points
Downward sloping line to the right
COST-VOLUME-PROFIT ANALYSIS
Limitations and Assumptions
 Sales and costs are linear
 Constants
↳ Selling price
↳ Variable cost per unit
↳ Fixed Costs
↳ Sales mix
 No changes in inventory levels (Sales = Production)
 Volume affects sales, VC, and profit
 Time value of money, ignored
Break-Even
With Target
BEP Units =
Fixed Cost
Unit CM
Sales Units
(W/ target profit)
FC + TP
Unit CM
BEP Peso =
Fixed Cost
CM Ratio
Sales Peso
(W/ target profit)
FC + TP
CM Ratio
BEP Ratio =
BEP
Sales
With target profit
ratio
Fixed Cost
CMR - PR
Margin of Safety
 Sales – BEP Sales
 Profit ÷ CM Ratio
Indifference Point
Profit based:
FC + (VCu x X)
Cost based:
(CMu x X) - FC
Sales Mix
Overall BEP Units =
Fixed Cost
WACM
Fixed Cost
.
CMu x % + CMu x %
Overall BEP Peso =
Fixed Cost
WACM Ratio
 Operating Budget – revenues and expenses
 Financial Budget – assets, liabilities, equity (usually: cash)
 Capital Expenditure Budget – long-term goals
 Authoritative (top-down) – prepared by top management
↳ Long-range planning
 Participatory (bottom-up) – top management and
personnel; promotes better management support
 Fixed (Static) Budget – single activity
 Flexible (Variable/Dynamic) – series of budgets
↳ Uses standard cost (comparison of actual vs budget)
↳ Facilitates better cost control
 Zero-based – encourage periodic re-examination of costs
 Kaizen – continuous improvement
 Budgetary slack – underestimating revenues, over
estimating costs to make targets easily achievable
Master Budget [in order]
I. Sales Forecast (FAQ: starting point)
II. Sales Budget (FAQ: most difficult)
III. Production Budget
IV. Inventory Budget
i. Raw Materials
ii. Direct Labor
iii. Overhead
V. Cost of Sales
VI. Marketing and Admin Expense
VII. Cash Budget
VIII. Working Capital Budget
IX. Projected (Pro-forma) FS
i. Income statement
ii. Financial Position
iii. Cash Flow (FAQ: last prepared)
Operating Budget
Financial Budget
GROSS PROFIT VARIANCE ANALYSIS
Actual (Current) GP
↑F GP Variance
vs.
Budget (Previous) GP
↑UF GP Variance
Price Factor
 Sales Price Variance = AQ (Actual SP – Budget SP)
 Sales Price Variance = Actual Sales – AQ @ Budget SP
Cost Factor
 Cost Price Variance = AQ (Actual CP – Budget CP)
 Cost Price Variance = Actual CGS – AQ @ Budget CP
Volume Factor
 Sales Volume Variance = (AQ – BQ) x Budgeted SP
 Cost Volume Variance = (AQ – BQ) x Budgeted CP
Alt: AQ @ Budgeted SP or CP - Budgeted Sales or CGS
1MPV*: a.k.a.
DM Variance
 Spending variance
 Rate variance
 Money variance
Actual Quantity
2MQV: a.k.a.
Actual Price
 Usage variance
Standard Quantity
 Efficiency variance
Standard Price
*Use the actual quantity purchased in case of doubt.
Direct Labor
AH ✖ AR
LRV1
AH ✖ SR
LEV2
SH ✖ SR
1LRV: a.k.a.
DL Variance
 Price variance
 Spending variance
 Money variance
Actual Hours
2LEV*: a.k.a.
Actual Rate
 Usage variance
Standard Hours
 Quantity variance
Standard Rate
*not including IDLE TIME – an unfavorable cost
Controllable
Non-controllable
Non-controllable
Direct Costs
Indirect Costs
Return on Investment
ROI
↓
Income
Assets
↓
=
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Mix and Yield Variance:
AQ ✖ AP
Material Price Variance
AQ ✖ SP
Material Mix Variance*
DM Variance
TAQ ✖ ASP
Material Yield Variance*
SQ ✖ SP
Total Actual Quantity ✖ Average Standard Price
*MMV + MYV = Materials Quantity Variance [MQV]
Segmented Income Statement
Sales
Less:
Variable Manufacturing Cost
Manufacturing Contribution Margin
Less:
Variable Non-Manufacturing Cost
CONTRIBUTION MARGIN
Less:
Controllable Direct Fixed Cost
Controllable or Performance Margin1
Less:
Non-controllable Direct Fixed Cost2
Segment Margin3
Less:
Allocated Common Cost
Profit
1
Used to evaluate the performance of the manager.
2
Committed cost, or controlled by higher authority.
3
Used to evaluate the performance of the segment.
es
Direct Materials
AQ ✖ AP
MPV1
AQ ✖ SP
MQV2
SQ ✖ SP
 Profit center – cost and revenues
↳ Uses variance analysis and segmented income statement
↳ Parts department, college department, etc.
 Investment center – cost, revenue, investments
↳ Uses variance, segmented IS, ROI, RI and EVA
↳ Branches, product divisions, etc.
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STANDARD COSTING
Sample Illustration: Material Mix Variance
SQ: 500, 400, 100
AQ ✖ SP
Material A:
60,000
3
Material B:
30,000
4
350,000
Material C:
10,000
5
10,000 F
TAQASP
100,000 3.6 = 360,000
*
3(50%) 4(40%) 5(10%) = 3.6
Factory Overhead:
1-way: AFOH – SFOH
2-way: [Con-Vol]
AFOH – Actual FOH
BASH – Budget Adjusted for Std Hrs
SHSR - Standard FOH [SFOH]
Controllable
Volume
*BASH = Budgeted FFOH + (SH x VFOH Rate)
3-way: [S-E-Vol]
AFOH – Actual FOH
BAAH – Budget Adjusted for Act Hrs.
BASH – Budget Adjusted for Std Hrs
SHSR - Standard FOH [SFOH]
Spending
Efficiency
Volume
*BAAH = Budgeted FFOH + (AH x VFOH Rate)
4-way: [S-S-E-Vol]
AFOH – Actual FOH
BAAH – Budget Adjusted for Act Hrs.
BASH – Budget Adjusted for Std Hrs
SHSR - Standard FOH [SFOH]
Spending
Volume (f)
Notes
 SFOH = Applied OH so, AFOH > SFOH = under-applied
 Volume variance is also capacity variance
 Volume variance is only fixed, no such thing is variable
 VFOH Efficiency alternative = (AH – SH) x VR
There is no such fixed efficiency and variable volume
RESPONSIBILITY ACCOUNTING
 Decentralization – must avoid sub-optimization
(managers decide in favor of their own unit at the
expense of the entire organization)
↓
Income
Sales
↓
×
Turnover
×
↓
Sales
Assets
↓
=
RoS
×
“Du Pont Technique”
ATo
Residual Income = Income – Required Income
↳ Required Income = Assets x Minimum ROI
EVA = Income after tax – Required Income
↳ Required Income = (TA – CL) x WACC
ROI vs RI
 ROI: Accepts investments that exceed ROI
 RI: Accepts investments as long as it earns in excess of
minimum rate of return (minimum ROI)
↳ PROS: better measure than ROI;
encourages investments that ROI will reject
↳ CONS: cannot be used to compare divisions with different
sizes; favors larger divisions (larger amounts)
ABSORPTION VS. VARIABLE COSTING
Comparison
Direct Materials (a variable cost)
Direct Labor (a variable cost)
Variable
Absorption
Variable Factory Overhead
Costing
Costing
Fixed Factory Overhead*
Total Manufacturing Cost
*their difference is the Fixed FOH
Efficiency (v)
*Variable Spending: BAAH = Actual Hours x VFOH Rate
*Fixed Spending: BAAH = Budgeted FFOH
Responsibility Centers
 Cost Center
↳ Uses variance analysis
↳ assembly department, accounting dept, etc.
 Revenue Center
↳ Uses variance analysis
↳ ticket outlets, convenience store, etc.
ROA
=
Margin
Also known as
Fixed Factory Overhead
↳ how is it considered?
Inventory cost
Matching principle
Purpose
ABSORPTION COSTING
Full costing; GAAP Costing
Product/Inventoriable cost
Part of COGS when sold
HIGHER [includes FFOH]
Compliant
External-Financial Reporting
VARIABLE COSTING
Direct/Marginal costing
Period cost
Fully expensed
LOWER
Non-compliant
Internal–Decision making
Key: P S ; A𝑦 V𝑦 ; EI BI [P.S. Ay ♡you pero AmBaho]
 If the Produced goods are greater than Sold, the
Absorption profit (𝑦) is also greater, as well as the
Ending Inventory. [Also applies if less than or equal]
 FAQ: Net income of AC or VC:
Step 1: Determine the FFOH rate
Total FFOH
!!! Use the key
÷ Produced units
to know which
FFOH %
income is higher
Step 2: Determine the difference (FFOH)
FFOH %
× Ending/Unsold units [Production – Sales]
Difference in income
Four Perspectives
FINANCIAL
CUSTOMER
 ROI
 Level of
 Operating
returns
Margin
 Complaints
Non-controllable Factors
Lagging
indicator
 MCE
LEARNING
AND
GROWTH
 Employee
training
 EE satisfaction
Controllable Factors
Leading Indicators
Start of
Production
Shipment
of Goods
INVERSE
DIRECT
INVERSE
DIRECT
DIRECT
DIRECT
DIRECT
INVERSE
Cost ⬆ ⬇ Supply
Producers ⬆ ⬆ Supply
Returns ⬆ ⬆ Other products
Complement ⬆ ⬆ Curve: Rightward
Future price ⬆ ⬆ Production
Advancement increases supplies
Reduces production costs
Increases production costs
Equilibrium – demand and supply are in balance [like BEP]
D
S
Market Surplus
8
Equilibrium
4
Market Shortage
6
2
2
4
6
8
Quantity
Market Surplus – QS exceeds QD
↳ PRICE FLOOR set above equilibrium price
Market Shortage – QD exceeds QS
↳ PRICE CEILING set below equilibrium price
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Receipt
of order
INTERNAL
BUSINESS
PROCESS
Effects on Supply
Production cost
Number of producers
Price of Substitute
Price of Complementary
Expected future prices
Technology
Government subsidies
Tax and Tariffs
es
BALANCED SCORECARD
Demand – relationship between price and quantity supplied
 Quantity Demanded – plan to sell at a particular price
 HIGHER PRICE, greater quantity supplied:
 Supply Curve – Positive relationship of P and QS
↳ Positively sloped [/]
↳ Increase in supply = shift rightwards
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Goal Congruence – (to prevent sub-optimization) division
managers = consistent with goals and objectives of the
organization as a whole
 Market Price – best transfer price if:
↳ Competitive market exist
↳ Divisions are independent of each other
 Cost-based Price – easy to understand, convenient to use
↳ Based on selling division’s variable or full cost, or cost-plus
 Negotiated Price – no market exist, or subject to fluctuation
↳ Max (buying): market price
↳ Min (selling): outlay [VC] + opp cost [CM of external sales]
 Arbitrary Price – imposed by higher authorities [no basis]
MPC + MPS = 100%
MPC = △ Consumption ÷ △ Disposable Income
MPS = △ Savings
÷ △ Disposable Income
Price
TRANSFER PRICING
MCE
=
Wait
Process + Inspection + Move + Queue
VA
MC
Manufacturing Cycle
Factors of Production
↳ LAND (natural) – land, water, mineral, timber
↳ LABOR (human) – skills, works, efforts
↳ CAPITAL (financial and man-made) –savings, equipment, etc.
(Throughput Time)
Delivery Cycle
(Lead Time)
*Value-Added
Productivity =
Output
Input
→ Finished Goods or Sales
→ DM, DL, FOH
ECONOMICS
(Filtered)
Demand – relationship between price and quantity demanded
 Quantity Demanded – plan to buy at a particular price
 HIGHER PRICE, lower quantity demanded:
↳ Substitution effect – raises opportunity cost, people buy
less, other goods have lower price
↳ Income effect – reduces amount of goods people can afford
 Demand Curve – Inverse relationship of P and QD
↳ Negatively sloped [\]
↳ Increase in demand = shift rightwards
Effects on Demand
Price of Substitute
DIRECT ex. Price of pork ⬆ Demand for beef ⬆
Price of Complementary
INVERSE ex. Price of gas ⬆ Demand of cars ⬇
Demand now ⬆
Expected future prices
DIRECT Future price ⬆
DIRECT Normal goods: Income ⬆ Demand ⬆
Consumer wealth or
income
INVERSE Inferior goods: Income ⬇ Demand ⬆
Population growth
DIRECT Increase of potential buyers
Market size
DIRECT Market size expands, Demand ⬆
Consumer preference/taste
Indeterminate
Substitute – In place of another (ex. pencil and pen)
Complementary – cannot function without the other
Inferior goods – ex. instant noodles, sardines
Gross Domestic Product – MV of all final goods and services
produced by a country, not including intermediate goods.
Expenditure Approach: C + I + G + (X - M) = GDP
Household Consumption; Business Investments; Government
Spending; Exports, Imports
Income Approach: WIRIPIT DAF = GDP
Wages; Self-employment Income; Rent; Interest; Profits;
Indirect Business; Taxes (ex. VAT); Depreciation and
Amortization; Income from Foreigners
Nominal GDP – value of final goods at current MV
Real GDP - value of final goods at a certain year, valued at
constant price (adjustment that eliminates inflation effects)
Recession – decline in REAL GDP
Economic Growth – increase in REAL GDP
Inflation
Demand Pull – too much demand: not met by supply increase
Cost Push – increase in production cost (wage/material price)
Consumer Price Index
Inflation Rate = (CPIcurrent – CPIlast year) ÷ CPIlast year
GDP Deflator
GDP Deflator = Nominal GDP ÷ Real GDP
Elasticity of Demand (ED)
△% in Quantity Demanded ➝ QD ÷ Average Quantity
△% in Price
➝ Price ÷ Average Price
Unemployment – inverse with inflation
 Cyclical – changes in business cycle; increases in recession
 Frictional – normal workings; new graduates, resignation
 Structural – mismatch between kind and job skills
Effect of Price Increase to QD and Total Revenue
ED
Elasticity
Quantity Demanded
Total Revenue
>1
Elastic
Reacts MORE
Decrease
=1
Unitary
Proportionate
<1
Inelastic
Reacts LESS
Increase
0 Perfectly Inelastic
No reaction
Increase
*Luxury goods: more ELASTIC vs. basic/staple goods
*Badly needed goods: PERFECTLY INELASTIC
Fiscal/Monetary Policy – counters recession or inflation
Fiscal Policies – action by government [⬆GDP - Expansion]
↳ Reduction of taxes – increases disposable income
↳ Increased spending – ex. subsidies
*Otherwise is Contraction
Disposable Income – amount after paying taxes
 Marginal Propensity to Consume – how much will be spent
↳ Marginal Propensity to Save – how much will be saved
Difficult to reverse
Uncertainties (risk)
Large fund
Long-term
↳ ex. PPE, expansion
It is an investing activity
rather than financing.
Decisions:
 INDEPENDENT PROJECT
 Unrelated projects
 Accept or Reject
 MUTUALLY EXCLUSIVE
 Acceptance of one
rejects the other:
↳ Lease or own
↳ Repair or replace
Evaluation Methods
NON-DISCOUNTED
DISCOUNTED
Payback Period
Net Present Value
Payback Reciprocal
Profitability Index
Bail-out Payback
Discounted Payback
Accounting Rate of Return
Internal Rate of Return
Year 1
500
1,400
(900)
800
(100)
Year 2
1,200
1,400
(200)
600
400
Year 3
×bailedout×
(Unrecovered portionY1 – Salvage valueY2) ÷ CFATY2 = 1.43 years
 ACCOUNTING RATE OF RETURN:
o aka. book rate of return; unadjusted rate of return
o Accept if ARR is HIGHER ✓ than cost of capital
Advantages
Disadvantages
👍 Easy to use
👎 IGNORES:
👍 IFRS Compliant
- time value of money
👍 Emphasis on profitability
- cash flows after payback
Annual Net Income After Tax1
Average/Original Investment2
1before adding back the depreciation (ACFAT + depre)
2use average if silent: (Cost + Salvage Value) ÷ 2
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Important Considerations (Cornerstones)
 Net Investment: TOWA-RAT [Start; Year 0]
Tax on gain*
Other incidental costs
Resale/trade-in value of (old)
Working capital1
Avoidable costs (after tax)
Acquisition cost
.
Tax on loss
.
Cash outflow
Cash inflow
= Net investment
Cash flows (cumulative)
Investment
.
Unrecovered investment
Salvage value
.
Recovery
es
Characteristics:
 PAYBACK BAIL-OUT:
o Length of time to recover investment
o Cash recoveries include salvage value
Sample Problem: Bailout Period [Investment: 1,400]
Cash inflows
SV
 Cash flows are cumulative
Year 1: 500
800
Year 2: 700
600
 Salvage value is current
Year 3: 850
400
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CAPITAL BUDGETING
*Resale value ↑ – CA of old = Gain↑ × Tax = Tax on G/L
Gain – tax = Proceeds of sale of old asset
 Net Returns: Cost savings/Increased Revenues [During useful life]
Cash cost (old)↑
L: Cash cost (new)
Cash savings↑
× (100%-Tax) xx
L: Depreciation .
× (Tax)
+ xx
[tax shield]
Net Income Before Tax
ACFAT*
L: Tax
.
Net Income After Tax
A: Depreciation (non-cash expense is added back)
Annual Cash Flow After Tax*
DISCOUNTED TECHNIQUES
 NET PRESENT VALUE:
o Measures true income using discounted cash flows
o Accept if NPV is POSITIVE ✓ [MORE THAN 0]
o Cost of capital as reinvestment rate [disc rate]
PV of ACFAT [Net cash inflow]
Less: PV of TCFAT [Net cash outflow]
 PROFITABILITY INDEX: [NPV Index]
o Makes NPV comparable
o Peso earned per peso invested
o Accept if PI is MORE THAN 1 ✓
PV of ACFAT [Net cash inflow]
PV of TCFAT [Net cash outflow]
 Termination Cash Flow After Tax : CWTS [End of Life]
→ an OUTFLOW
Cost to remove, net
→ an INFLOW
Working capital1
→ CA – Salvage Val(new) × Tax
Tax on Loss (Gain)
Salvage value (new)
→ an INFLOW
TCFAT
1Additional working capital will reverse at end of life
Relationship of NPV and PI
PV of ACFAT [IN]
PI
= PF of CFAT
L: PV of TCFAT [OUT]
Net investment
PV of CFAT
PI
L: Net Investment
NPVI =
NPV
.
NPVI
Net Present Value
Net investment
NON-DISCOUNTED TECHNIQUES
 PAYBACK PERIOD:
o Length of time to recover investment
o Accept if payback period is SHORTER ✓
Advantages
Disadvantages
👍 Easy to use, less risky
👎 IGNORES:
👍 Measures liquidity:
- time value of money
PB < UL = Liquid
- profitability
PB > UL = not recover
- cash flows after payback
Payback Period; Useful Life
- salvage value
 INTERNAL RATE OF RETURN: [Reinvestment rate]
o aka. time-adjusted rate of return
o Use interpolation to find IRR.
o Conditions:
 That PV of CFAT is = to Net Investment
 NPV is 0; and PI is 1
Advantages
Disadvantages
👍 Reveals true return
👎 Reinvestment rate is not
👍 Emphasis on cash flows
realistic if the project has
👍 Considers time-value
negative earnings.
Formula: Even cash flows
Net Investment
Net Cash Inflows [or ACFAT]
Sample Problem: Uneven cash flows [Payback schedule]
Investment: 90,000 NInvt: 90,000
Cash flows:
Year 1: (40,000)1year
Y1: 40,000
50,000
Y2: 35,000
Year 2: (35,000)1year
2.5 years
Y3: 30,000
15,000
Y4: 20,000
Year 3: (15,000)0.5 year
 PAYBACK RECIPROCAL:
o Good estimate of IRR
o Cash flows are even [uniform throughout the life]
o Useful life is atleast twice the payback
 DISCOUNTED PAYBACK PERIOD: [use cost of capital]
o Same as payback period, but discounted.
INVESTMENT RISKS AND RETURNS
 The standard deviation [risk] is compared with the
expected return [return], and the relationship is the
coefficient of variation.
Standard Deviation
Coefficient of Var =
Expected Return
Other formulas:
 Variance = ER – Cash flow × (Probability %)
 SD = √Variance
 The higher the CV, the riskier the investment.
COST OF CAPITAL
Cost of Capital Formula
Long-Term Debt: Yield rate – Tax
Preferred shares: Yield rate (fixed, no growth)
Common shares: Yield rate + Growth rate
Retained Earnings: Yield rate + Growth rate
KD: Cost of Debt
 Use the effective interest rate as yield rate:
(Annual Interest ÷ Current Market Price)
 Other way is the use of Yield-to-Maturity:
YTM [Simple Average]
YTM [Weighted Ave (60:40 Method)]
Interest +/- Amortization of Disc.(Prem)
(Net proceeds + Face Value) ÷ 2
Interest +/- Amortization of Disc.(Prem)
Net proceeds (60%) + Face Value (40%)
KP: Cost of Preferred Shares
 Use the dividend yield as yield rate, computed as:
Dividend Per Share
Market Value Per Share*
Current Ratio
Quick Ratio
Quick Assets
Current Liabilities
*excluding inventories
 SOLVENCY RATIOS: Leverage ratio [long-term]
Total Liabilities
Debt Ratio
Total Assets
(Acid Test Ratio)
Equity Ratio
Total Equity
Total Assets
Debt-to-Equity Ratio
Total Liabilities
Total Equity
1
Equity Ratio
*aka: Equity Ratio Reciprocal [Assets ÷ Equity]
Equity Multiplier*
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includes growth rate → expected dividend [Gordon Growth Model]
2
floatation costs are ignored
 Other way is the use of Capital Asset Pricing Model
KE = KRF + β (KM – KRF)
KRF: Risk free rate (ex. T-Bills, gov’t issued, no risk)
KM : Market return (KM – KRF = Market risk premium)
β : Beta-coefficient (volatility/sensitivity/systematic risk)
;
Stock market (a)
Stock price (A)
Stock price (a)
;
;
Stock price (A)
Stock price (A)
Stock Price ; Market Price
NON-DIVERSIFIABLE RISKS (deals with CAPM)
 non-controllable, systematic, market-related
 risks-caused by “outside world” (market, interest
rates, purchasing power)
Sales
L: VC .
CM
L: FC .
EBIT
L: FFC .
Profit
DOL
DTL
DFL
2or:
∆ % in EPS
∆ % in Sales
Net Profit
Sales
Return on Sales
Income
Sales
Return on Assets
Income
Average Assets
Income
Average Equity
*alternative:
RoA ÷ Equity Ratio
 ACTIVITY/EFFICIENCY RATIOS: Asset Utilization Ratio
TURNOVER
AGE
CCC
ITo
COGS
Ave. Inv
Conversion
Period
360
ITo
= Age of Inv
RTo
Cr. Sales
Ave. AR
Collection
Period
360
RTo
= Age of Recv
PTo
Cr. Purch
Ave. AP
Payable
Period
360
PTo
= Age of Pybl
Normal
Operating
Cycle
(Age of Pybl)
Cash Conversion Cycle
Asset Turnover
Sales
Average Total Assets
Fixed Asset Turnover
Sales
Average Fixed Assets
 PROFITABILITY RATIOS: Performance ratio
Net Income – PS Dividends
Earnings Per Share
Weighted Ave Number of OS Outs
Degree of
Operating
Leverage
Degree of
Financial
Leverage
 risk of not covering
 risk of not covering
Price-Earnings Ratio
Market Price per Share
EPS
EBIT
EBIT
EBIT – FFC1
Dividend Yield
Dividend Per Share
Market Price per Share
Dividend Payout
Dividend Per Share
EPS
Retention Ratio
100% - Dividend Payout
operating costs (fixed
costs)
CM1
financial costs (returns
to ordinary sh’s)
EBIT = CM - fixed
operating costs
FFC = Interests +
Preferred Dividends
(before tax)
or
or
∆ % in EBIT
∆ % in Sales2
∆ % in EPS2
∆ % in EBIT
DTL = DOL × DFL
1or: CM÷(EBIT – FFC)
Net Profit Margin
Return on Equity*
DIVERSIFIABLE RISKS
 controllable, unsystematic, company-related
 risks-caused by internal matters (business risk,
liquidity risk, borrowers’ defaults)
LEVERAGE
EBIT
Sales
Operating Profit Margin
1
Stock price (A)
.
 PROFITABILITY RATIOS: Performance ratio
Gross Profit
Gross Profit Margin
Sales
KE: Cost of Equity (Common stock and RE)
 Also use the dividend yield [DPS + ÷ MVPS]
Dividend Per Share + Growth Rate1
Market Value Per Share2
SP is more volatile than MP
SP is as volatile as MP
SP is less volatile than MP
EBIT
Interest Payments
Time Interest Earned
(Interest Coverage Ratio)
*should be net of floatation or issue cost (spread, expenses, etc.)
β>1
β=1
β<1
Current Assets
Current Liabilities
(Working Capital Ratio)
es
Used for decision in:
 Capital budgeting
 Long-term financing
 Capital structure
maintenance [optimal]
rc
ul
Also known as:
 Minimum required
rate of return
 Hurdle rate
 Desired rate
 LIQUIDITY RATIOS: to meet short-term obligations
Net Working Capital Current Assets – Current Liabilities
FS ANALYSIS
Horizontal Analysis
 TREND ANALYSIS [△%]
Current Value – Base Value
Base Value
Vertical Analysis
 COMMON SIZE [single pd]
 Total assets for BS items
 Total sales for IS items
(Plowback Ratio)
 ADDITIONAL FUNDS NEEDED: [AFN]
o aka. External Funds Needed
Variable Assets
∆ in Variable Assets =
Old Sales
Less: ∆ in Variable Liab =
Less:
Retained Profit
Variable Liabs
Old Sales
× ∆ Sales
× ∆ Sales
(Earnings – Dividends)
Additional Funds Needed
 Transaction [liquidity motive] – normal transactions
 Precautionary [contingent motive] – buffer against
contingencies, cash held beyond normal cycle
 Speculative – profit-making opportunities (sudden price drop)
 Contractual – held as required (compensating balance)
Cash Management
Helps shorten Cash Conversion Cycle
 Accelerating collections: Lockbox system [early collection]
 Reducing precautionary cash: Line of credit
 Slowing disbursements: Zero-balance accounts (use checks)
Short-term Financing
 Increases liquidity risk [technical insolvency]
 Factors to consider for short term funds [AIR C]
↳ Availability, Influence, Requirement, Cost
 Cost of trade credit: caused by foregoing discounts (opp cost)
Discount %
360
x
100%-Discount %
Cr Pd – Disc Pd
OTHER TOPICS
Learning Curve: Sample Problem
80% learning curve. First unit requires 20 hours to complete
Units
Cumulative ave. time per unit
Total Hrs
Hours used
1
20
201
20
2
16
32
122
4
12.8
51.2
19.23
1
Hours used to produce the first unit
2
Hours used to produce the second unit
3
Hours used to produce the third and fourth unit
Labor efficiency – directly affected by learning curve
La
N st
O M
T
i
FO nu
R te
SA by
LE H
e
Optimal Cash Balance/Economic Cash Quantity [Baumol]
*ECQ ÷ 2 = Average cash balance
*D ÷ ECQ = No. of transactions
2DT
O
Annual Demand for Cash
*(ECQ ÷ 2) x O = Opport. Costs
Cost per Transaction [FC]
*(D ÷ ECQ) x T = Trans. Costs
Opportunity cost
Usage Based
↳ Without safety [LD QTY]: Nor. Usage x Lead Time
↳ With safety [Reorder Pt]: Max Usage x Lead Time
es
 Policies
↳ Conservative – “relaxed policy”
► Minimize liquidity risk → high working capital
► Less profitable → reliance on long-term financing
↳ Aggressive – “restricted policy”
► Risky → reliance on short-term financing
► Enhances profitability → minimum working capital
↳ Moderate – “balanced” not too high. not too low
↳ Matching – “self-liquidating/hedging”
► Maturity is matched with asset’s useful life
► Current assets → Current liabilities
Delivery Based
↳ Without safety [LD QTY]: Ave. Usage x Normal Lead Time
↳ With safety [Reorder Pt]: Ave. Usage x Max
Lead Time
rc
ul
WORKING CAPITAL MANAGEMENT
Other Techniques: BEP, NOC, CCC [CVP, FS Analysis]
Float: helps shorten Cash Conversion Cycle
 Positive/Disbursement Float: Bank balance > Book
↳ Outstanding checks are not yet cleared
 Negative/Collection Float: Book balance > Bank
↳ Mail Float: Customer – mailed ; Seller – not yet received
↳ Processing Float: Seller – received, but not deposited
↳ Clearing Float: Deposited, but not yet cleared
*negative float: Opportunity cost if exceeds 30 days
Good cash management:
↳ Positive/Payment float: MAXIMIZED [Lengthen]
↳ Negative/Collection float: MINIMIZED [or eliminated]
Receivable Management
 Normally non-interest bearing
 Risk of non-collection
 Short average collection period = low opportunity cost and
risk of delinquency and default
 5C’s
↳ Character – willingness to pay
↳ Capacity – ability to generate cash flows
↳ Capital – financial resources
↳ Conditions – current economy/business condition
↳ Collateral – pledge to secure debt
Cost of Forgoing Discount
Discount Rate
360
.
x
100% - Discount
Payment Pd – Disc Pd
Basically: P x R x T
Inventory Management
*EOQ ÷ 2 = Average inventory
*D ÷ EOQ = No. orders per year
2DO
C
Annual Demand or usage
*(EOQ ÷ 2) x C = Carrying costs
Cost of placing one Order
*(D ÷ EOQ) x O = Ordering Costs
Cost of Carrying one unit
When used for production: D = Production; O = Setup cost
Assumptions:
 Demand occurs evenly throughout the year
 Lead time is constant [sales/demand, CC, OC]
 Unit costs are constant
 Inventories are received one at a time
 Inventory size is unlimited
Stock-out Costs: lost sales (opportunity cost)
Reorder Point = *Lead quantity + Safety stock
*
also called as Delivery Time Stock
Financial Markets
 Money Markets
↳ Short-term debt securities
↳ Dealer-driven markets
↳ Low default risk
↳ Usually considered as substitute to cash
 Capital Markets
↳ Long-term debt and equity securities
↳ Primary markets – new securities; larger investors (IPO)
► Normally can be sold only once
► Investor deals directly with the issuing entity
↳ Secondary – existing (exchange); small investors (PSE)
► No limit to number of times can be traded
► Traded entities after entities
~Nothing follows~
“Hasten, O God, to save me;
O LORD, come quickly to help me”
Certified Public Accountant 2023