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 rc ul 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 La N st O M T i FO nu R te SA by LE H e 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 ↓ = La N st O M T i FO nu R te SA by LE H e 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. rc ul 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 La N st O M T i FO nu R te SA by LE H e 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 rc ul 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 La N st O M T i FO nu R te SA by LE H e 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 rc ul 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* La N st O M T i FO nu R te SA by LE H e 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