Finance and AccountsBy: K. Venkat Swamy
M.B.A., B.Ed., (ICWAI)Accounting and Business Studies Faculty
[email protected]. 009609973472
009186869932272013
IntroductionA business has many different costs, from paying for raw materials through to paying the rent or the heating bill.
By careful classification of these costs a business can analyse its performance and make better informed decisions.
The main ways in which a business needs to manage its costs are as follows:
Classification of costs
FIXED COSTS
VARIABLE COSTS
SEMI-FIXED COSTS
FIXED COSTS
Fixed costs are any costs that do not vary
directly with the level of output. Fixed
costs remain the same, no matter how
much the business produces. Fixed costs
exist even if a business is not producing
any goods or services.
FIXED COSTS
e.g., insurance costs, administration, rent, some types of labour costs (salaries), some types of energy costs, equipment and machinery, buildings, advertising and promotion costs etc.,
In the long term, fixed costs can alter. The
manufacturer referred to earlier may decide to increase
output significantly; this may require renting additional
factory space and negotiating loans for additional
capital equipment. Thus rent will rise as may interest
payments.
Variable costs Variable costs are those costs that change in proportion to the amount of output produced.
e.g., raw material costs, some direct labour costs, some direct energy costs
Semi-fixed costs
Semi-fixed costs are costs which only change when there is a large change in output.
For example, costs associated with buying a new machine to cope with increased production.
COSTS
Costs are the expenses incurred by a firm producing and selling its products, this is likely to include expenditure on wages and raw materials etc.,
Total costs (TC) = Fixed costs + Variable costs
Average costs (AC) =
Marginal costs(MC) = TC n – TC n-1 the cost of producing one extra or one fewer units of production.
REVENUETotal Revenue is the value of total sales made by a business within a period (usually one year).
Sales revenue (TR) = Quantity of goods sold (Q) X selling price (P)
TR=Q x P
PROFITS
Profit is the difference that arises when a firm’s sales revenue exceeds its total costs. (TR >TC)
Profit = Total revenue – Total costs
P = TR-TC
Normal Profit–the minimum amount required to keep a business in a particular line of production
Abnormal/Supernormal Profit–the amount over and above the amount needed to keep a business in its current line of production
CONTRIBUTION
The difference between the selling price and the variable costs.
Contribution = Sales – Variable Cost
Or
Contribution = Fixed costs + Profit
BREAK EVENOccurs where Total Costs = Total Revenue Start-up costs –fixed costs
Running costs –variable costsRevenue stream depends on price charged‘Low’ price –need to sell more to break-even‘High’ price –lower level of sales required before breaking even
Purpose of AccountsProvide information for stakeholders –customers, shareholders, suppliers, etc.
Provides the opportunity for the business to monitor its own activities
Provides transparency to enable the firm to attract investment
Reduces the chance for fraud –not 100% successful!!
Accounting and FinanceTypes of Information:
Profit and Loss Account –the revenue and costs of a business over a time period
Balance Sheet–the assets and liabilities of a business at a specific point in time
Use these sources to give ratios –the relationship between different aspects of the business
Profit and Loss Account
Shows the flow of sales and costs over a period
Shows the level of profit or loss made
Shows what has been done with the profit or loss
Balance Sheet* A snapshot of the firm’s position at a point in time.
* Shows what a company owns (assets) and what it owes (liabilities).
* Balance Sheet shows what assets a company has (use of funds) and where the money came from to acquire those assets (source of funds)
Balance Sheet
A guide to the structure of the assets of a company.
A guide to the level of gearing–the ratio of loan to share capital
Gives a guide as to the degree of working capital–the amount the company has to be able to pay its everyday debts (current assets –current liabilities)
Shows the total value of a firm at that moment in time
Accounti ng and F inanceAssets: the resources a business owns -Fixed Assets–those lasting more than one year and not used up in
production –equipment, machinery, buildings, etc.
Freehold assets–where the business has full ownership of the assets
Leasehold assets–agreement permitting the leaseholder the right to use the asset for a fixed period in exchange for a regular payment
Goodwill–the difference between the audited value and the market value of a business –the image, brand name, the existence of patents or trademarks, etc.
Current Assets–assets used up during production and which will realise cash within a year –debtors, raw materials, stock, etc.
Accounti ng and Finance
Liabilities:The financial obligations of a business –what a business owes * Loans, shareholders funds, creditors, tax liability, interest owing
Current liabilities–those obligations the business has to meet within a year
The Purpose of Accounts:To provide information for stakeholders
Shareholders progress of their investmentGovernment tax liabilitySuppliers credit worthinessCustomers long term future of the businessProspective Investors decision makingPotential bidders in acquisition activityTrade Unions negotiations with the companyManagement monitor performance of the businessEmployees their position in the business (they may
well also be shareholders!)
Rati o AnalysisKey types:
1. Profitability ratios- a measure of how much profit its activities generate
2. Liquidity ratios– ability of a business to meet its debts
3. Investment ratios– a measure of the performance of the business
Advantages of ratios
• Comparisons are relative to other figures• Compare businesses of different size• Gives picture of company strategy• Financial and trading performance• Compare with industry averages• Simple summary of complex information
Reasons for using ratios
• Gives summary statistics• Helps identify industry benchmarks• Input to formal decision model• Standardise for size
Applications of analysis
• Predictions of corporate earnings• Construct projected financial statements• Predict corporate failure• Indicators of financial distresse.g. Altman’s models, combination of ratios
Problems with ratio analysis
• No agreement on definitions or specific set of ratios
• Accounting estimation• Data not available• Timing of data does not match• Differing accounting policies• Negative numbers and small divisors
Limitations of ratio analysis
• Diverts attention from the underlying information• May not give sufficient attention to the notes to
the accounts• Accounting policies may affect comparison• Industry differences
THANK YOU