MS

MANAGEMENT
As a group of people: Responsible for decision-making
As a function/ process: Process of planning, organizing, & controlling

FUNCTION
* Planning - setting of goals
* Directing/ Organizing - tackling activities
- instructs, guides, and inspire employees
- taps the resources for better use in accordance to plan
- oversees the day-to-day operations

* Controlling - performance evaluation

- Actual vs Planned Results (take actions if it didn't go as planned)

* Decision Making - inherent in all management function

Management Accounting
FINANCIAL ACCOUNTING MANAGEMENT ACCOUNTING
User of Primarily for Exclusively for
information EXTERNAL users INTERNAL users
Information
Internal data Internal data & external sources
source
Purpose/ Financial reporting &
Management decision-making
End result compliance
Guiding
Accounting standards (PFRS) Management wants and needs
principles
Type of
Primarily monetary in nature Monetary and non-monetary
information
Time
Historical Future-oriented using past data
orientation
Emphasis of Reliability
Relevance/Flexibility/Timeliness
reports (precision, verifiability)
Amount of
Aggregated and simplified Detailed and extensive
details
Focus of
Business as a whole Various segments (sub-units)
information
Frequency of
Periodic (annually, quarterly) Whenever needed
reports
Optional vs.
Mandatory (public entities) Discretionary or optional
Mandatory
Unifying model Assets = Liabilities + Equity No unifying model or equation
Financial statements Internal reports restricted by
Type of report restricted by GAAP cost-benefit analysis
(General-purpose report) (Special-purpose report)
Audit Audited Not Audited

MA vs. CA
COST ACCOUNTING MANAGEMENT ACCOUNTING
Revolves around cost
Inherent Helps management make effective
computation, cost control
meaning decisions about the business
and cost reduction
Prevents the business
Offers a big picture of how
Application from incurring costs
management should strategize
beyond the budget
Measuring Grid Quantitative Quantitative and qualitative
One of the many subsets
Subset of management Vast in itself
accounting
Basis of Decision Historic and predictive
Historic information
making information
Statutory Statutory audit is required Audit has no statutory
Requirement for big businesses requirement
Not dependent on
Dependent on both cost &
management accounting
Dependence financial accounting for successful
to be successfully
implementation
implemented
Users External & Internal Internal
 LINE STAFF
To give orders To advise but not to command others
Direct downward authority Exercised laterally or upward in an
over line departments organization
Directly involved in Provide support via advice and assistance
achieving company objectives. to other managers.
Directly Involved in provision of G/S NOT Directly Involved in provision of G/S

CONTROLLER (Recording function)

Chief management accounting -Planning and control -Gov’t reporting
executive who is mainly -Financial Reporting- FS -Protection of assets
responsible for the accounting -Interpreting -Economic appraisal
aspects of management planning -Evaluating/ consulting
& control -Tax administration
TREASURER (Custody function)
• Protector of company's value & -Provision of capital -Credit & collections
finances from financial risks that -Investor relations -Investments
arise from business activities. -Short-term financing -Insurance
• Deals with money, cash, or -Banking and custody -Safeguarding asset
wealth of an organization.
• He knows the sources of money
Role & Activities:
and exercises prudence in using
1. Cash flow management:
the money of an organization. 2. Risk management – insurance

Planning ➢ Deciding on company goals & objectives and

Management figures out how to achieve them.
Functions Organizing ➢ Deciding on how to use company resources to
put plans into action.
Controlling ➢ Deciding on what corrective actions to do
should there be any difference between actual
results and planned results.

✓ To establish Management Accounting as a recognized

profession in the field of business
✓ To encourage stricter and high quality educational
standards in Management Accounting
Objectives of CMA
✓ To provide objective means for measuring the
Management Accountant's knowledge and competence
✓ To encourage continued professional growth
Current Focus of Management Accounting:
1. Continuous reduction in cost Efficiency
2. Linked set of value-creating activities Industrial value chain
3. Using cost data to identify superior strategies Strategic cost management
4. Selling over the Internet E-business
5. Product’s total tangible and intangible benefits Total product
6. Suppliers and customers External linkages
7. Flow of materials from upstream to downstream Supply chain management
8. Internal value chain Internal linkages
9. Zero defects Total quality management
10. Realization of less sacrifice Customer value
11. Activity-based costing & process value analysis Activity-based management
Cost Concepts
COST BEHAVIOR
PER UNIT TOTAL
Variable Constant Varies- Directly
Fixed Varies- Inversely Constant
Mixed ↑ (Less Proportionately vs. VC) ↑ (Less Proportionately vs. VC)
(Semi-V) as production ↑ as production ↑

COST FUNCTION (LINE FUNCTION)

Y = Total Mixed Cost ➢ Dependent Variable
a = FC ➢ Y – Intercept/Vertical Axis
Y = a + b (x)
b = Unit VC
ΔY
➢ Slope = Δ x ; coefficient of independent variable
x = # of units ➢ Independent variable/Horizontal Axis

HIGH LOW METHOD:

H&L Based on Activity (Cost Driver)

Shortcut:
Highest Cost-Lowest Cost FC = HC – (HA x VCu)
VC/u =
Highest Activity-Lowest Activity FC = LC – (LA x VCu)
VC = H/L Activity x VCu
Ignore Outliers (Too high/low)
FC = H/L Cost – VC at H/L Relevant range Only- Cost Driver

LEAST SQUARE REGRESSION:

Y = Total cost Shortcut:
a = Total Fixed Cost NΣxy - (Σx )(Σy)
ΣY = Na + bΣx b=
b = Unit VC NΣx2 - (Σx)2
Σxy= aΣx+ bΣx 2
x = Total Activity levels Σy - bΣx
N = # of observations a=
N
1) Compute summation of Y, x , xy , x2
Y = a + bx
2) Substitute (1) in equation (a & b remain)
Multiply Σ → ΣY = Na + bΣx
Multiply Σx → Σxy = aΣx + bΣx2 3) Eliminate either a or b using the equation
4) Substitute the value of either a/b in equation

Regression Dependent Independent

Example:
Analysis Variable Variable
Simple Y = a + bx 1 1
Multiple Y = a + bx + cz 1 2 or more

+1 Direct Upward Strong; (+) Correlation

Coefficient of
0 None No pattern Weak; No Correlation
Correlation (r)
-1 Inverse Downward Strong; (-) Correlation
Coefficient of Closer r2
Squaring Better (↑ confidence)
Determination (r2) is to 100
value of r IV predicts the behavior of DV
(> =80%)

Straight line → High correlation

Scatter diagram
Random pattern → low or no correlation at all.
Product Costing
AC VC TC
DM Product Cost (COGS)
DL Period Cost (OPEX)
VOH
FOH FOH AC= Product Inventory COGS
V- S&A VC= Period OPEX
F- S&A
AC ➢ Units Sold
EXPENSED:
VC ➢ Units Produced

Produce Sold
Inventory -A>V>T
End Inventory > Beg Inventory
Gross Profit - A < V < T
AC- NI VC- NI

AC VC NI INV
P (10) = S (10) 10 - COGS 10 - OPEX A=V Same
8 - COGS
P (10) > S (8) 10 - OPEX A>V ↑
2 - EI
P (10) < S (14) 4 - OPEX last yr
14 - COGS A<V ↓
4 = From BI 10 - OPEX this yr

Δ PROFIT = Δ INVENTORY x UNIT FFOH

NI- VC
• Δ Profit = AC Profit – VC Profit
± Δ PROFIT
• ∆ Inventory = (End. Inv. – Beg. Inv.) = (Production – Sales)
NI- AC
• Unit FFOH = Total FFOH ÷ Units Produced

PROFIT FLUCTUATES TO EFFECT IN Δ IN PRODUCTION

AC Production ✔
VC Sales ✘
ABSORPTION COSTING
Sales Units Sold x SP Pxx
(-) COGS Units Sold x DM/unit
Units Sold x DL/unit
Units Sold x VOH/unit
Units Sold x ( Total FOH ÷ Units Produced) (xx)
GP Pxx
(-) OPEX Units Sold x Variable S&A/unit
Total Fixed S&A (xx)
NI Pxx
VARIABLE COSTING
Sales Units Sold x SP Pxx
(-) Variable Costs
V-COGS Units Sold x DM/unit
Units Sold x DL/unit
Units Sold x VOH/unit
V- S&A Units Sold x Variable S&A/unit (xx)
Contribution Margin Pxx
(-) Fixed Costs Total FOH (Based on Units Produced)
Total Fixed S&A (-)
NI Pxx
OPEX → Based on Units sold
CVP Analysis
CVP TEMPLATE
Qty (same) Unit Total % Ratio
Sales xx Pxx 100% Base
Direct relationship
VC (xx) (xx) xx% VC Ratio
to Quantity
CM xx Pxx xx% CM Ratio
FC (xx) (xx%)
Orange font= Constant OI Pxx xx% ROS before Tax
Tax (xx)
NI Pxx
Sales 400 Sales – Total Cost = 0 MOS= Sales – BES
VC -300 NI = 0 ; Sales = TC Sales = MOS + BES
CM 100 CM = FC Sales 100% = MOSr + BEPr
FC -100 Sales = VC + FC
Profit 0

CONTRIBUTION MARGIN BREAK-EVEN POINT DEGREE OF LEVERAGE

P = FC ÷ CMr ; VC + FC = CM ÷ PBT
= % Δ PBT ÷ % Δ Sales
U = FC ÷ CMu
=Sales-VC = 1 ÷ MOSr %
=FC + Profit = (FC ÷ PBT ) + 1
P = BES ÷ Sales;
=Units Sold x (SPu-VCu) = BEPu ÷ Sold Units
R % ↑ Profit= % ↑ Sales x DOL
=Sales x CMr = 100% - MOS Ratio ↑ CM =↑ Profit (If no Δ in FC)
DOL x MOSr= 1
= SPu-VCu MARGIN OF SAFETY SALES
= CM ÷ Units Sold = Sales - BEP FC
U P =
=SPu x CMr = Profit ÷ CMr P CMr - PM before Tax
= Δ CM ÷ Δ Units U = Sales units - BEP units = MOS + BEP
= CM ÷ Sales = MOS ÷ Sales R = MOSr + BEPr
= Δ CM ÷ Δ Sales = Profit Ratio ÷ CMr
= CMu ÷ SPu = 100% - BES Ratio PROFIT
R R = CM – FC
= 100% - VCr = 1 ÷ DOL
= PM ÷ MOS Ratio = MOS peso x CMr
= Δ Profit ÷ Δ Sales = Sales x PR

Inverse Relationship: DOL & MOS Profit Ratio (PR) :

Profit
At BEP = ↓ Favorable ; ↑ Unfavorable = or = CMr x MOSr
Sales

CM FC CM MOS Profit

BEPu CMu
CMr Sales BEP CMr DOL Profit MOSr SALES MOS CMr

SALES DOL SHOULD BE TO

Increasing Higher Maximize the % Δ in EBIT
Decreasing Lower Minimize the % Δ in EBIT
 DESIRED SALES Before tax profit
➢ Must be before tax
PAT FC + PBT FC+ PBT
After-tax to before tax= ( ) U = P =
1-Tax % CMu CMr
Additional FC = Add to Numerator

FC FC
P = CMr - PRBT PBT as % of CMr P = CMr-(1-PRBT)
PBT
% of sales FC FC
U = CMu - PMu PAT as % of CMr P = PRAT
CMr-[1-( )]
1-tax rate

PAT FC
P = PRAT PBT as per unit U
FC
= CMu-PMu
% of sales CMr-[(1
-Tax Rate)
]

As ROS or FC FC
P = CMr-ROS PAT as per unit U = PMu
PM ratio CMu-(
1-tax rate
)

PRBT = PRAT/(100%-Tax rate) ; PMu= SPu x % of sales (Profit Margin per unit)

Peso answer
Per unit shortcut = ; Per peso shortcut = Units answer x SP
Units Sold

MULTIPLE PRODUCTS:

SP-VC CM SMR Total Composite BEP = FC ÷ WACMu

A 1,200 – 480= 720 x 3/8 = 270 BEP per product = Composite BEP x SMR
B 240 – 160= 80 x 5/8 = 50 SMR → Sales mix ratio
WACMu = 320 Composite BEP → Total BEP
Standard Costing
DIRECT MATERIAL & DIRECT LABOR

Actual Costs Favorable/Unfavorable: AC - SC = (+) Unfavorable; (-) Favorable

DM: AQ x AP Debit: Unfavorable; Credit Favorable
DL: AH x AR
DM: MPV= AQ (AP-SP)
DL: LRV = AH (AR-SR) Actual Cost – STD. Cost
DM: AQ x SP DM: Total MV= (AQ x AP)-(SQ x SP)
DL: AH x SR DL : Total LV = (AH x AR)-(SH x SR)
DM: MQV= (AQ-SQ) SP
STD. Costs DL: LEV = (AH-SH) SR MPV: QTY Purchase if silent
DM: SQ x SP MQV: QTY Used always
DL: SH x SR

MIX & YIELD VARIANCE:

ACTUAL COST FLEXIBLE COST ASS STD COST
Materials AQ x AP AQ x SP TAQ x SM x SP APD x SQ/u x SP/u

Labor AH x AR AH x SR TAH x SM x SR APD x SH/u x SR/u

MPV/LRV Mix Variance Yield Variance

MQV/LEV
TAQ/H- Total actual Qty/Hrs ;
SM -Std Mix ; APD – Actual Production;
APD x SQ/u = STD QTY Allowed

OVERHEAD VARIANCE:
Variable Fixed (SFR x NC) → Budgeted FC
Spending Spending Above Higher Unfavorable
V F
ACTUAL AVR x AH + AFR x AH Spending
BAAH SVR x AH + SFR x NC Controllable-Budget Total
Efficiency -V OH
BASH SVR x SH + SFR x NC
Volume- F Non-Controllable
STD SVR x SH + SFR x SH

Budgeted Hours or Qty Total Budgeted hours/Qty or NC

per unit =
Budgeted Production in units
Budgeted Fixed OH = SFR x NC
Total Payroll = AH x AR
STD Hours/Qty allowed
= Actual Production x STD Quantity/hour per unit
for Actual production
Standard Fixed OH rate Budgeted Fixed Cost
= Budgeted Hours/Qty
VFOH = V. Spending Variance + Efficiency Variance
FOH VARIANCES
FFOH = F. Spending Variance + Volume Variance
1-WAY
Actual OH (AH x AR) xx
Total OH variance
Standard OH (SH x SR) xx

2- WAY
Actual OH (AH x AR) xx
BASH (Budgeted Allowed based on SH)
Budgeted Fixed OH (NC x FOH Rate) xx Controllable Variance
Variable OH (SH x VOH Rate) xx xx
Volume Variance
Standard OH (SH x SR) xx

3-WAY
Actual OH (AH x AR) xx
BAAH (Budgeted Allowed based on AH)
Budgeted Fixed OH (NC x FOH Rate) xx Spending Variance
Variable OH (AH x VOH Rate) xx xx

BASH (Budgeted Allowed based on SH)

Budgeted Fixed OH (NC x FOH Rate) xx Efficiency Variance
Variable OH (SH x VOH Rate) xx xx
Standard OH (SH x SR) xx Volume Variance

4-WAY
Variable OH
Actual OH (AH x AR) xx
Spending Variance
Adjusted OH (AH x SR) xx
Standard OH (SH x SR) xx Efficiency Variance

Fixed OH
Actual OH (AH x AR) xx
Spending Variance
Budgeted OH (NC x SR) xx
Standard OH (SH x SR) xx Volume Variance

2-WAY 3-WAY 4-WAY

SPENDING V- SPENDING
CONTROLLABLE F- SPENDING
EFFICIENCY EFFICIENCY
VOLUME VOLUME VOLUME
GROSS PROFIT VARIANCE ANALYSIS:

Overall GP variance = GP (Actual/Current) – GP (Budget/Previous)

2023- 2024-
Variance STD ACT Diff Δ%
STD Actual
Sales 20,000 22,500 2,500 F SPu 8 7.5 .5 ↓ 6.25%
COGS -15,000 -19,500 4,500 U CPu 6 6.5 .5 ↑ 8.33%
GP 5,000 3,000 2,000 U Units 2.5 3 500↑ 20%
Units 2,500 3,000
US – Unit Sold; SP – Selling Price ; CP – Cost Price

Actual Sales 22,500

SPV = 2,500 U
SALES AQ x BSP (3,000 x 8) 24,000 2,500 F
SVV = 4,000 F
Budgeted Sales 20,000
Actual COGS 19,500 CPV = 1,500 U
COGS AQ x BCP (3,000 x 6) 18,000 4,500 U
CVV = 3,000 U
Budgeted COGS 15,000

PRICE Factor SPV = AQ (ASP – BSP)

COST Factor CPV = AQ (ACP – BCP)
SVV = (AQ – BQ) x BSP
VOLUME Factor = (AQ – BQ) x BGP
CVV = (AQ – BQ) x BCP

AQ x ASP SVV Base → Last year

SPV P: Δ% =
AQ x BSP Base Budgeted → Last year
SVV
SVV V: Δ% = Actual → Current year
BQ x BSP Base
“Units” in S & C - same
AQ x ACP CPV Same
CPV P: Δ% =
Base
AQ x BCP
CVV V: Δ% =
CVV
BQ x BCP Base
Economics
ELASTICITY OF DEMAND (ED) Where:
∆ in QD
∆% in QD =
∆% in Quantity Demanded Ave. Quantity
ED =
∆% in Price ∆ in Price
∆% in Price =
Ave. Price

Quantity Demanded
ED ELASTICITY EFFECT OF PRICE ↑
(Degree of Reaction)
>1 Elastic Reacts MORE proportionately to Δ in price ↓ Total Revenue
=1 Unitary Reacts proportionately to Δ in price NO effect
<1 Inelastic Reacts LESS proportionately to Δ in price ↑ Total Revenue
Perfectly
=0 Does NOT react to Δ in price ↑ Total Revenue
inelastic
∆ in Consumption
Marginal Propensity to Consume =
∆ in Disposable Income
MPC+MPS = 100%
∆ in Savings
Marginal Propensity to Save =
∆ in Disposable Income

NOTE: Marginal → Additional ; Average → Total

PRODUCTION COST:
COST FORMULA LEGEND
TC FC + VC (= ATC x Q) TC = Total Cost ; ATC = Average TC
VC TC – FC (= AVC x Q) FC = Fixed Cost ; AVC = Average VC
FC TC – VC (= AFC x Q) VC = Variable Cost ; AFC = Average FC
MC ∆TC ÷ ∆Q (= ∆ TVC ÷ ∆Q) MC = Marginal Cost; Q = Quantity
ATC TC ÷ Q (= AFC + AVC) ∆TC = Change in Total Cost
AVC VC ÷ Q (= ATC – AFC) ∆Q = Change in Quantity
AFC FC ÷ Q (= ATC – AVC) ∆TVC = Change in Total VC
AVC is initially constant until inefficiencies in fixed-size facility would cause VC to rise.
MC initially decreases but begins to increase due to inefficiencies.
2 PRINCIPAL METHODS OF CALCULATING GDP
EXPENDITURE/AGGREGATE
INCOME APPROACH
DEMAND APPROACH
GDP = C + I + G + (X-M) Wages
Where: C – Household Consumptions + Self-employment Income
I – Business Investments + Rent
G – Government Spending + Interest
X – Exports + Profits
M – Imports + Indirect Business Taxes (VAT)
(X – M) – Net Exports + Depreciation & Amortization
+ Income of Foreigners
GDP
MEASURE INFLATION:
Inflation (CPI this year) – (CPI last year) Money 1
= x 100 CPI = Reserve Requirement
Rate CPI last year Multiplier
GDP Nominal GDP REAL Nominal GDP
DEFLATOR
= x 100 GDP
=
Real GDP GDP Deflator
Unemploym No. of people unemployed LABOR = Employed +
ent Rate
= x 100 FORCE Unemployed workers
Labor Force
Budgeting COGS(6)
DM (RM/unit*Cost/Unit) (3) Pxx
SALES (1) DL (DLH/unit*Rate/Unit) (4) xx
Sales Units VOH (5) xx
x SP FOH xx
Sales Revenue Manufacturing Cost PU Pxx
PURCHASING (2.1)- Merchandising Y1 Y2
Y1 Y2 Sales Units (1) xx xx
Sales Units (1) xx xx x Manufacturing Cost PU Pxx Pxx
+ Ending Inv. xx xx COGS Pxx Pxx
Units Required xx xx S&A EXPENSE (7)
(-) Beginning Inv. (xx) (xx) Yr 1 Yr 2

Units to be Purchased xx xx Sales Units (1) xx xx

x Purchase Price Pxx Pxx x VSAE Per Unit Pxx Pxx
Purchases Pxx Pxx Variable SAE Pxx Pxx
+ Fixed SAE xx xx
PRODUCTION (2.2) -Manufacturing S&A Expense Pxx Pxx
Y1 Y2
INCOME STATEMENT (8)
Sales Units (1) Must be at Cost xx xx Yr 1 Yr 2
+ Ending Finished Inv. xx xx Sales Revenue (1) Pxx Pxx
Units Required xx xx (-) COGS (6) (xx) (xx)
(-) Beginning Finished Inv. xx xx Gross Profit Pxx Pxx
Production Pxx Pxx (-) S&A Expense (7) (xx) (xx)
Operating Income Pxx Pxx
RM PURHASES BUDGET (3)
Y1 Y2 CASH RECEIPTS (9)
Production (2.2) xx xx Collections during sale xx xx
x RM needed PU produced xx xx + Collections after sale xx xx
RM needed - production xx xx Collections- credit sales Pxx Pxx
+ Ending RM xx xx + Budget Cash Sales (1) xx xx
Total RM needed xx xx Total Cash Collections Pxx Pxx
(-) Beginning RM (xx) (xx) Check for any uncollectible accounts
RM to be purchased xx xx CASH DISBURSEMENT (10)
x Purchase price Pxx Pxx + Paid during Purchase xx xx
Cost of RM purchased Pxx Pxx + Paid after purchase xx xx
Total Payment of RM Pxx Pxx
DIRECT LABOR (4) + DL Cost (4) xx xx
Y1 Y2 + MOH* (5) xx xx
Production (2.2) xx xx + OPEX** (7) xx xx
x DLH needed per unit xx xx
Total Cash Disbursement Pxx Pxx
DLH needed xx xx *DE: (-) MOH; BDE: (-) OPEX
x Cost Per DLH (Rate) Pxx Pxx
CASH BUDGET
Direct labor Cost Pxx Pxx
Beginning Cash balance
MOH (5) (+) Receipts
Y1 Y2
(-) Disbursements
Production (2.2) or Base xx xx
x VOH rate per unit Pxx Pxx (-) Minimum Cash requirement
Total Variable OH Pxx Pxx Excess (Deficiency) of Cash
Total Fixed OH xx xx + Financing (if deficient)
Total Overhead Pxx Pxx Ending Cash balance
 INVENTORY / FINISHED GOODS RAW MATERIALS
Beginning Sold units Beginning Used in Production*
Units Produced Purchased
Ending Inv. Ending Inventory
*Units Produced x Required RMper unit

TYPES OF BUDGETS:
• Involves employees at all levels in budgeting process.
PARTICIPATIVE
(Allows to have input)

TOP-DOWN
• Budgets are prepared by top management with little or no inputs from
APPROACH
operating personnel (imposed budgeting)
(AUTHORITATIVE)

BOTTOM-UP • Budgets are developed through joint decisions by top management and
APPROACH. operating personnel
(PARTICIPATORY) • It permits participation in the budget process.

BUDGETARY • Making budget look good by either understating expected sales or

SLACK overstating budgeted expenses.
• Starting over each budget and justifying each budgeted item as if the
programs involved were being proposed for the first time every period.
ZERO-BASED
• To encourage re-examination of all costs in the hope that some can be
reduced or eliminated.
CONTINUOUS • Incremental budget that adds current period and drops older period to
(ROLLING) maintain constant budget period of usually 12 mts.
FLEXIBLE • Presents plan for a range of activity so that plan can be adjusted for changes
(VARIABLE) in activity levels
STATIC (FIXED)
• Prepared for single level of activity; not adjusted for different levels of actual
sales activity.
INCREMENTAL • Setting budget allowances based on prior-year expenditures.
LIFE-CYCLE
• Product’s revenues & expenses are budgeted over its entire life cycle from
R&D to production to marketing to customer service.
KAIZEN • Assumes continuous improvement of products and/or processes so that
budgets are based not on existing system but on changes to be made.
ACTIVITY BASED • Applies mostly ABC principles/procedures to come up with budgets
STRATEGIC • Long-term budget based on identifications of action plans to achieve
BUDGET company goals/mission.
Responsibility Accounting
SEGMENTED INCOME STATEMENT
Sales Direct Costs- Traceable/Separable
(-) Variable Manufacturing Cost Indirect Costs- Common/Allocated
Manufacturing Contribution Margin Controllable Costs- Discretionary Costs
Noncontrollable Costs- Committed Costs
(-) Variable Non-Manufacturing Cost
Contribution Margin
(-) Controllable Direct Fixed Cost Used to Evaluate Manager
Controllable or Performance Margin (Only CONTROLLABLE)
(-) Non- Controllable Direct Fixed Cost
Segment margin or Profit Margin Used to Evaluate Segment
(-) Indirect Fixed Cost (Common Cost) (All DIRECT report)
Operating Income

RETURN ON INVESTMENT (ROI)

ROI = PROFIT MARGIN x INVESTMENT TURNOVER

Operating Income Operating Income Sales

= x
Ave. Operating Asset Sales Ave. Operating Assets

ROA ROS ATO

DU PONT TECHNIQUE: ROA= ROS x ATO
RESIDUAL INCOME (RI)

Operating Income
(-) Required Income = Ave. Operating Assets x Minimum ROI
Residual Income (RI) = (ROI % - Minimum ROI %) x Assets

ECONOMIC-VALUE ADDED (EVA):

Operating Income AFTER Tax EBIT x (100% - tax rate)

(-) Required Income (Total Assets–Current Liabilities) x WACC
Economic-Value Added = After tax profits – (Capital Invested x Cost of Capital %)

Operating Income – earnings before interest and taxes

Operating Asset – all assets acquired to generate operating income
Balanced Scorecard
Manufacturing Processing Time VAT
= VAT & NVAT
Cycle Efficiency Manufacturing Cycle Time

Delivery Cycle Processing Time

Efficiency =
Delivery Cycle Time
Units
Velocity =
Total Time
Manufacturing Total Time
=
Cycle Time Units

Order Production Goods

Received Started Shipped

Process Time + Inspection Time

Wait Time
+ Move Time + Queue Time
Throughput Time
Delivery Cycle Time

VALUE- ADDED TIME: NON-VALUE ADDED TIME:

- Processing Time - Wait time
- Inspection Time
- Move Time
- Queue Time

TOTAL QUALITY MANAGEMENT:

Prevention Costs – Training, Dev’t, Evaluation, Eng/Design
Conformance
Costs Appraisal Costs - Inspection, Testing, Depreciation

Internal Failure Costs – Scrap, Rework, Defects

Non-Conformance
Costs (Failure Cost) External Failure Costs – Complaints, Product Liability, Warranty
 NATURE OF
DECISION PROBLEM DECISION GUIDELINES
ALTERNATIVE
CHOOSE: Least costly option. (Lower relevant cost)
Should a part or product be
Fixed costs are Irrelevant.
MAKE OR BUY manufactured or bought from
Consider opportunity costs, if any. (Income
outside supplier?
Sacrificed)
ACCEPT: Add’l revenue > Add’l cost,
Should special order that requires Provided the regular market will not be affected
ACCEPT OR REJECT price lower than regular selling price Fixed costs are irrelevant.
be accepted or rejected? Opportunity cost if regular sales sacrificed in
order to meet the special order. (No excess)
Should a business segment/division RETAIN: Avoidable revenue > Avoidable costs
DROP or RETAIN
(product line, department, branch) Allocated FC to segment → unavoidable ,
(Permanent)
be continued or discontinued? irrelevant.
CONTINUE or
CONTINUE: Demand> Shutdown Point
SHUTDOWN (Temporary)
Should a product, after undergoing
SELL or PROCESS
joint process, be sold at split-off PROCESS: Add’l revenue > Further processing costs
FURTHER
point, or be processed further?
Which product/s should be ➢ Identify & measure the constraint on the limited
PRODUCT produced and sold when there are resource/s.
COMBINATION limited resources or bottleneck ➢ Rank product/s according to highest
operations? contribution margin per unit of limited resource.
➢ Identify factor to change and amount of
CHANGE IN PROFIT Should any of profit factors (Unit
contemplated change.
FACTORS sales, SP, VC, FC and sales mix) be
➢ Change profit factor if it will cause an improvement
(CVP relationships) manipulated to increase profit?
on the company’s overall profit
Relevant Costing
Relevant Cost: ➔ Future & different among alternatives (Differential/Avoidable Cost)
▪ All VC are RELEVANT (DM, DL, VOH, V S&A)
GR:
▪ FC are relevant ONLY if AVOIDABLE, otherwise, irrelevant
1. TOTAL – Total R & C are determined for each alternative, and results
Approaches: are compared to serve as basis for making decisions.
2. DIFFERENTIAL - only differences or changes in R & C are considered.
MAKE OR BUY
COST TO MAKE COST TO BUY
•
Avoidable VC: • Purchase Price
✓ DM, DL, VOH • Materials Handling
✓ Materials Handling
• Avoidable FC
• Opportunity cost
V S&A → Not avoidable because either make or buy, will still sell the product.
ACCEPT OR REJECT A SPECIAL ORDER

Incremental revenue Minimum SP:

(-) Incremental costs: Full Capacity = VC+(SP-VC)
VC (DM + DL + VOH) ▪ Equal to SP
Variable Selling expenses ▪ With OC = SP-VC
OC (CM lost on regular orders) Excess Capacity → VC
Additional FC
Incremental Profit
DROP OR RETAIN BUSINESS SEGMENT (Permanent)
Loss CM (Sales – VC) Alternative:
(-) FC Avoidable/Direct Profit OLD
Decrease (Increase) in Profit (-) SM of Dropped segment
Profit New
+ - Retain ; (-) - Drop
Allocated Cost → unavoidable , irrelevant
Traceable Cost → Generally Avoidable
Depreciation → Irrelevant
SHUTDOWN or CONTINUE OPERATION (Temporary)
Loss CM (Demand units, during SD x CMu)
+ Start-up cost
(-) Avoidable FC
Disadvantage (Advantage) of shutdown
CONTINUE SHUTDOWN
CM Demand, during suppose SD x CMu 0
(-) FC (-) Normal FC if continued (-) Unavoidable FC
(-) SU - (-) Startup cost
P/L Pxx Pxx

Demand = SP → Indifference point

SHUTDOWN FC Avoidable - Start-up Costs
= Demand > SP → Continue
POINT CMu
Demand < SP → Shutdown
 REPLACE or RETAIN EQUIPMENT

RETAIN (OLD) REPLACE (NEW)

Operating costs Acquisition cost
(-) SV Operating costs
(-) SV
(-) Proceeds of old or market value of old today

Whichever is LOWER

SELL AS IS OR PROCESS FURTHER

SP after processing further Joint Cost - Irrelevant (Sunk cost)

(-) SP at split-off.
Additional revenue
(-) Cost of processing further
Incremental revenue

PROFIT MAXIMIZATION (Utilizing limited/scarce resources)

A B
SP Pxx Pxx
(-) VC xx xx
CM xx xx
÷ CR per unit* xx xx or Multiply: Units produced per CR
CM per CR Pxx Pxx Highest = Priority
CR – Constrained resource

CHANGE IN PROFIT FACTORS

1. Unit sales
2. SP
Profit
3. VC
factors
4. FC
5. Sales mix
Transfer Pricing
LIMITATIONS OF TRANSFER PRICE: DECISION MUST BE: Minimum > Maximum
LOWER Selling Profit Maximiz MINIMUM
TP= SP outside
LIMIT Division Center e Profit TP

UPPER Buying Cost Minimiz MAXIMUM Full: TP = S

LIMIT Division Center e Cost TP Excess: TP = VC

= Outlay Cost + Opportunity Cost

MINIMUM Transfer Price (TP)
= VC* + Lost CM
(FC – irrelevant)
= VC* + (SP-VC)

Costs when the transfer take place Original Cost to

(Adjusted for cost savings/add’l costs) outside customer

SP=20; VC=8 ; Buying Division need 25,000

EXCESS (+)
TP= VC* + (SP-VC) = 8 TP= VC
-No OC
NO EXCESS (0)
TP= VC* + (SP-VC) = 8 + (20-8) = 20 TP= SP
-w/ OC
Units with OC 15,000
TP= VC* + [ (SP-VC) x ] = 8 + [ (20-8) ] = 15.2
INSUFFICIENT Total units need 25,000
EXCESS (-) or
No OC (TP=VC): 10,000 x 8 = 80,000
- Some OC
W/ OC (TP=SP): 15,000 x 20= 300,000 380,000
Excess/Idle Capacity= Capacity – Operations
Additional Cost or Cost Savings → Just adjust the original TP computed
WCM
WC = CURRENT ASSET – CURRENT LIABILITY

WC FINANCING POLICIES

Relaxed Policy
▪ High Level of WC.
Conservative ▪ Reliance on Long-Term Financing-
Relaxed Policy
↑ CA; ↓ CL ↑ Financing Costs.
▪ Increase in Ratio of CA & CL
↓ Liquidity Risk = ↓ Profitability
Restricted Policy
▪ Minimum WC
Aggressive ▪ Reliance on Short-Term Debts
Restricted Policy
↓ CA; ↑ CL - ↑ Short-Term Insolvency.
↑ Liquidity Risk = ↑ Profitability

Balanced or ▪ WC not Too High (Conservative)

Moderate nor Too Low (Aggressive).
Semi Policy
▪ Matching maturity of Financing Source w/
Self-Liquidating Asset’s useful life
Matching Hedging Policy ▪ ST Assets - Financed With ST Liabilities
▪ LT Assets - Funded By LT Financing Sources.

EFFECTS TO PROFIT & RISK IF 2 RATIOS BELOW WILL CHANGE:

EFFECT ON EFFECT
RATIO CHANGE
PROFIT ON RISK
Current Assets Increase Decrease Decrease
Total Assets Decrease Increase Increase
Current Liabilities Increase Increase Increase
Total Assets Decrease Decrease Decrease
 INVENTORY MANAGEMENT:
ECONOMIC ORDER QUANTITY:

2DO D → Annual Demand or usage in units

EOQ = √
C O → Order cost per order placed or set up cost
D C → Carrying cost annually of one unit
=
# of Orders
EOQ
CC = Ave. Inv x C Ave. Inventory = + Safety stock, if any
2
D
# orders =
EOQ
OC = # orders x O 360 days
Frequency of orders =
No. of orders per year
Total Annual Cost = CC +OC
EOQ WHEN USED FOR PRODUCTION: Becomes ECONOMIC LOT SIZE
P → Annual Production in units
2PS
ELS = √ S → Set-up cost per batch
C C → Carrying cost annually of one unit

Storage, handling, insurance, spoilage,

CC Order size ↑ ; Total CC ↑ security, record keeping, interest foregone
Delivery, inspection, handling, purchasing,
OC Order size ↑; Total OC ↓
processing, receiving, discount lost
REORDER POINT:

REORDER = (Normal LT x Daily demand ) + Safety Stock

POINT = Maximum LT x Daily demand
(Maximum LT – Normal LT) x Daily demand
SAFETY STOCK =
(Maximum Usage – Normal Usage) x Normal LT
No delay, no safety stock (Unless usage is given, use the other formula)
Normal Usage → Average Usage

Annual Usage
Daily demand (Average Usage) =
360

Normal LT Usage = Normal LT x Average Usage

Maximum Stock-out Cost = Stock out cost per occurrence x # of orders
Savings in Expenses
Maximum Interest Rate =
Additional Inventory

Stock-Out ➔ Opportunity costs & other costs incurred when inventory run out-of-
Costs stock (Lost CM on sales)
➔ Period from time an order is placed until received.
Lead Time ❖ Normal/Average LT – usual delay in receipt of ordered goods
❖ Max LT- adds to normal LT reasonable allow for further delay.
Safety ➔ Extra units to protect against SOC during periods of uncertain LT &
Stock demand
CASH MANAGEMENT:

Economic Cash Quantity or Conversion Size

OPTIMAL CASH BALANCE (OCB)
(BAUMOL model)

D → Annual Demand or Requirement for cash

2DT T → Transaction cost (Conversion Cost)
OCB = √
O O → Opportunity cost of holding cash Return foregone

D
T = No. of Transactions x T No. of transactions or Conversions =
OCB

OCB
O = Ave. cash balance x O Ave. cash balance =
2

Total Cost of maintaining cash balances= (OC + TC)  EQUAL

CASH BREAK-EVEN BEP in Unit Sales = Fixed Payments ÷ Unit CM

POINT (BEP) BEP in Peso Sales = Fixed Payments ÷ CM Ratio

CASH CONVERSION CYCLE (CCC) - CASH FLOW CYCLE

➔ GOAL: Shorten CCC = ↓ spending in operating cycle investment
360 360 360
= INV. TO + AR TO - AP TO
Inventory Receivables Payables
= COGS per day + Sales per day - Purchases per day
CCC

= Ave. Age of Inv + Ave. Age of AR - Ave. Age of AP

Inventory Receivable Payable
= + -
Conversion Period Collection Period Deferral Period

NOC
CCC = NOC – Payable Deferral Period DM TO = DM used ÷ Ave. DM INV
FG TO = COGS or Sales ÷ Ave. FG INV
Inventory → Both FG & RM AR TO = Sales ÷ Ave. AR
AP TO = Purchases ÷ Ave. AP
Sales & Purchases → On Account

Resource need to support firm’s CCC = Investment in Operating Cycle x CCC

Amount of WC must finance = Daily WC required x CCC

Collection Float = Mail Flot + Processing Float + Clearing Float

Reduction in collection float = Days reduced x daily cash receipt
 Cycle Turnover = 365 days/Operating Cycle
Investment in = (COGS/365)
Inventory x (Ave. Production Process Time + FG kept hand Ave. time)
Investment In AR = (Net sales/365) x Ave. time AR outstanding
Investment In AP = (COGS/365) X (Credit on Purchases from Suppliers.)
Net Financing = (Investment in Inventory + Investment in AR - AP)
Cash Tied-Up = Ave. cash receipts per day x Number of days tied-up
Net Float =Disbursement Flost + Collection Float

Cash balance
x Daily Interest Rate
Total interest earned
(-) Transaction cost of Investing
Opportunity Cost of Keeping Cash

Amount of cash freed/collect per day

x Days cash is freed (Reduction in cash float)
Cash freed-up or Reduction in AR
x % Rate of return
Expected return (benefit)
(-) Cost of lockbox system
NET ADVANTAGE (DIS) OF LOCKBOX

Amount of cash collection per day

x Number of days freed on the collection
Amount of cash free
(-) Increase in compensating balance
Increase in cash flow
x % Rate of return.
INCREMENTAL INCOME (LOSS)

Float before lockbox

(-) Float after lockbox
Benefit of lockbox
x Daily collection
INCREASE IN AVE. CASH BALANCE

Cost of Short-Term Financing (ST Funds %) x (Ave. Seasonal Fund Req.)

+ Cost of Long-Term Financing (LT funds %) x (Permanent funding Req.)
+ Earnings on Surplus Bal. (Interest on Earnings) x Surplus
TOTAL COST OF AGGRESSIVE STRATEGY

Cost of Short-Term Financing (ST Funds %) x (LR)

+ Cost of Long-Term Financing (LT funds %) x (UR+ Permanent fund req.)
- Earnings on Surplus Bal. (Int. on Earnings) x (UR- Ave. Seasonal Fund Req.)
TOTAL COST OF CONSERVATIVE STRATEGY
RECEIVABLE MANAGEMENT:

Age of AR or DSO AR
Average AR = (Credit Sales x ) or = AR TO
360
x VC Ratio
AVE. INVESTMENT IN AR
x % Cost of Capital
CARRYING COST on AR

Days Sales Outstanding (DSO) = % of customers x Days collection period

Additional Sales
x CM ratio
Additional CM ↑ Sales x CM Ratio
(-) Additional Carrying Cots (↑ Average AR x VC Ratio) x % Cost of Capital
(-) Additional bad debts (New AR x New % BD) – (Old AR x Old %BD)
(-) Additional Discounts
PROFIT PROPOSED PLAN

= Sales - VC
PROFIT = Unit sales x CM per unit
CONTRIBUTION =Sales x CM Ratio
= Variable Cost x (100% - VC ratio %)
CHANGE IN = Additional Sales x Contribution Margin Ratio
PROFIT

Old sales per day

x Change in day sales in Receivables
x Contribution margin
x Cost of Funds invested in receivables
Opportunity Costs
OPPORTUNITY
COSTS
Ave. Investment in AR, old
(-) Ave. Investment in AR, new
Increase in funds required for investment in AR
x Rate of Return
OPPORTUNITY COSTS
 Cost of Missed Discount from Discount % 360 days
Supplier
= x
100% - Discount % Payment Period - Discount Period
Interest 360 days
=( )x( )
Net Proceeds Loan Term

Lumpsum If one year, ignore

NP = Principal – Interest – CB Interest Expense deducted
= 100% - % Rate – % CB only when loan is DISCOUNTED
Principal
Annual Interest Principal + ( )
SHORT TERM MANAGEMENT:

No. of Payments
Effective Rate = [ ]
Average principal 2
(Bank Loans) Installment
2 x No. of payments x Annual Interest
=
(1 + No. of payments) x Principal

Annual Expense - Incremental Interest Income

Initial CB =
Principal - Incremental CB
has Interest
Incremental CB = (Required CB – CB before loan)
income
Incremental Int. Inc = Incremental CB x % Int.
Interest + Issue Costs 360 days
COMMERCIAL PAPERS COST= x
Face value - Interest - Issue Costs Paper Term
Interest + Factor's Fee 360 days
FACTORING RECEIVABLES = x
Face value - Interest - Factor's Fee - Factor's Holdback Remain. Maturity
SHORT-TERM FUNDS (Assume a 360-day year)
Fees & other cost → Deducted only if deducted in advance by the bank
Compensating Balance = Loan Amount x % Line Credit Cost Used portion x % Interest
Payment term
Interest = Loan Amount x Rate % x Unused portion x % Fee
360
Interest income → deducted in Interest expense Compounding i= Nominal monthly/quarterly rate
=(1+i)n - 1
Interest Rate n= # of compounding periods
Cost of Capital
✓ Minimum Acceptable/Required rate of return
➔ Rate of return necessary to
✓ Opportunity cost of capital
maintain MV or stock price
✓ Standard/Hurdle/Cut-off rate
1) LT Debt
1. Capital budgeting decisions Computed as WEIGHTED
USED 2) PS
2. Long-term financing decisions AVERAGE of various long-
FOR: 3) CS
3. Establish optimal capital structure. term capital sources:
4) RE

Weight (%): Market Value is preferred over BV

Interest (%): Effective Rate (YTM) is preferred over Nominal
Dividend per share If PS: % PS Div x Par value per share
Dividend Yield %* =
Market price per share

SOURCES COSTS
DEBT: Bonds, Loans = Yield Rate (1-Tax rate)
PS = Yield Rate*
EQUITY:
OS = Yield Rate* + Growth rate

LT
▪ After-tax since interest charges tax-deductible expenses.
DEBT
▪ Unlike cost of OS, growth rate is not added to PD yield since PD are
relatively fixed every year.
PS
▪ Tax is not considered since dividends paid are not deductible for tax
purposes (no tax shield).
GORDON’s GROWTH MODEL “KE = YR + GR” ; Return base
o Under GGM, GR of dividends is assumed to be constant
throughout perpetuity.
o Tax is not considered since dividends paid are not deductible for
tax purposes (no tax shield).
CAPM KE = KRF + β (KM - KRF) ; Risk base
o Deals with the relationship between
1. Non-diversifiable/systematic risk
2. Expected return for assets, particularly stocks
OS
o CAPM is graphically represented by drawing the Security Market
Line, which shows amount of returns an investor can expect from
market about the different levels of systematic risk (β).
o Fundamental idea behind CAPM is that investors expect a reward
for both waiting and worrying:
✓ Waiting: If you invest in risk-free T-bill, you just receive
rate of interest.
✓ Worrying: When you invest in risky stocks, you can
expect an extra return or risk premium for worrying.
Sources COSTS
Simple Interest ± Discount (Premium) Amortization
YTM = If semi-annual:
Ave. (Net Proceeds + Face Value) ÷ 2 o % Interest = ÷2
LT YIELD: o Term = x2
Weighted Interest ± Discount (Premium) Amortization
DEBT YTM = o YTM = x2
=Yield % x (1-Tax %) Ave. (Net Proceeds x 60%) + (Face Value x 40%)
‘KD’ Amortization = (Discount or Premium) ÷ Term
CURRENT Interest in 1st yr Net Proceeds = SP – Issuance Cost
= Discount Net Proceeds > Face value +
YIELD (CY) Net proceeds
Premium Net Proceeds > Face value (-)
PS D = % PD x par value per share
= Yield % Yield =
‘KP’ MP, net of FC
Next div = Present dividend per share x (100% + GR)
Next D If n years = Multiply: 100% + GR → by n+1 times
CS ‘KC’ = Yield % + GR Yield = Paid Present Div not yet paid Next
& RE‘KE’ (Gordon’s Growth Model) MP, net of FC Currently pays div Will/Expected to pay div

RE → Gross of FC, not considered

FC (FLOTATION COST) → Stock issuance cost D → Dividend per share ; MP → Market Price per share
CAPITAL ASSET PRICING MODEL (CAPM): KE = KRF + β (KM - KRF)
“KE” ➔ EXPECTED/REQUIRED RATE OF RETURN
“KRF” ➔ RISK-FREE RATE - based on treasury bill (T-bond) rate
“β” ➔ BETA COEFFICIENT, volatility (sensitivity) or systematic risk of security compared to SM as a whole.
β > 1 SP is more volatile than SM If SM rises by 10%, SP rises above 10% SP -Stock Price
β = 1 SP is as volatile as SM If SM rises by 10%, SP rises also by 10% SM- Stock Market
Β <1 SP is less
o volatile than SM If SM rises by 10%, SP rises below 10% Negative β- SP opposite direction with SM

“KM” ➔ MARKET RETURN

“(KM - KRF)” ➔ MARKET RISK PREMIUM (RPM)
“β (KM - KRF)” ➔ RISK PREMIUM, which is additional return required to compensate for assumed risks.
Capital Budgeting
CAPITAL INVESTMENT FACTORS
1) NET INVESTMENT – INITIAL COSTS - For decision making; not for recording.
COSTS or CASH OUTFLOWS
Purchase Price, net of discount taken or not Pxx
Freight, insurance, handling, installation xx
Additional WC xx
MV of existing idle assets to use in project. xx
Training cost, net of tax xx Pxx
(-) SAVINGS or CASH INFLOWS
Proceeds sale of old asset Pxx
Tax increase due to gain = Gain x % Tax Rate (xx)
Tax savings due to loss = Loss x % Tax Rate xx Pxx
Trade-in value of old asset (if replaced) xx
SV of old machine NOW xx
Avoidable repair cost on old asset replaced, net of tax xx xx
NET COST OF INVESTMENT Pxx
SV → ✘ -Not an initial cost
SV of old machine NOW → Added in Savings
Savings in Operating costs → ✘ -Not an initial cost
G/L on disposal → NO direct effect in Net Cost of Investment
Tax effects on such G/L on disposal → Affects Net Cost of Investment
Salvage value
TERMINAL CASH FLOW:
(-) Tax on Gain ( SV-CV)
(End of life)
+ WC from initial investment

2) NET RETURNS - Investment Recovery

Direct = Operating cash inflows - Tax
1) ACCOUNTING NI
Indirect = NI + noncash expenses
2) NET CASH INFLOWS = Cash Ope. inflows after tax + tax savings from DE

INDIRECT DIRECT
Contribution margin Pxx
(-) Cash fixed Costs (xx)
Operating cash inflows before tax Pxx Pxx
(-) Depreciation expense (xx)
Profit before Tax Pxx
(-) Income tax (xx) (xx)
Profit after Tax Pxx
Add back: Depreciation expense xx
ANNUAL CASH INFLOWS Pxx Pxx
Cash inflows AFTER TAX but BEFORE DE = Cash inflow x (100% - Tax %)
+ Tax savings from DE = Incremental Depreciation x Tax %
ANNUAL CASH INFLOWS = DE New- DE old
(-) Depreciation expense
PROFIT AFTER TAX/ NET INCOME

3) COST OF CAPITAL
▪ WA rate company must pay to long-term creditors for use of their funds.
▪ Used as discount rate in discounted techniques like NPV & IRR.
p

PROJECT INVESTMENT IS 1. LIQUIDITY ➔ Annual Cash Inflow

EVALUATED BASED ON: 2. PROFITABILITY ➔ Profit
NET DECISION
METHOD FOCUS FORMULA
RETURN CRITERION
Net Investment
NON-DISCOUNTED
UL
Payback Period ACF Liquidity = Net Annual Cash Flows PP ≤ 2

Net present value 1

Payback Reciprocal ACF Liquidity = or ↑; Better
Net Investment PP
Payback bailout ACF Liquidity = [(Cash to Date + RV) - Inv.] ↓ ; Better
Net Income
Accounting Rate of Return NI Profitability = ARR ≥ COC
Average Investment
NPV ≥ O
= PV, Cash In - PV, Cash Out
PROJECT EVALUATION TECHNIQUES:

Net Present Value ACF Liquidity

(Positive)

Profitability index ACF Liquidity = PV, Cash In ÷ PV, Cash Out PI ≥ 1

DISCOUNTED

➔ PV, Cash In = PV, Cash Out

Internal Rate of Return ACF Liquidity Cost of investment IRR ≥ COC
= Annual cash inflow
Net Investment
Discounted payback method ACF Liquidity = ↓ ; Better
Discounted Annual Cash Flows
Annualized NPV (EAA) - - = NPV ÷ PVF ↑; Better
CROSS OVER RATE = NPV point of indifference, Fisher Rate PROJECT SCREENING ➔ NPV
Discount rate at which NPV of two capital investment projects are equal PROJECT RANKING ➔ PI
METHOD PURPOSE ADVANTAGES DISADVANTAGES
✓ Not consider TVM
✓ Simple and easy
✓ More emphasis on liquidity rather than profitability
Length of time required by ✓ Information about project's
(More emphasis on Return OF Inv. vs. Return ON Inv.)
PP/PBP project to recover the initial liquidity.
✓ Not consider salvage value (payback period only)
cost of investment. ✓ Good surrogate for risk. A quick PP
✓ Ignores cash flows that may occur after payback
indicates less risky project.
period. (Subsequent benefits & costs)
✓ Can be incorporated to accounting
✓ Not consider TVM
concepts of income measurement
✓ Inflation is ignored since computation of income and
Tells managers how much net & investment return
BV is based on historical accounting data.
income a potential project is ✓ Facilitates re-evaluation of projects
LIMITATION:
ARR expected to generate as a due to ready availability of data
✓ Uses accrual, calculation is subject to judgements as
relative percentage of from accounting records.
how quickly to depreciate capitalized asset
investment required. ✓ Considers income over life of
✓ An average of all of capital projects; reveals nothing
project.
about performance of individual investment choices.
✓ Indicates the project's profitability.
Used to calculate current value
✓ Measures absolute increase in
of future stream of payments ✓ Requires accurate estimation of dr
NPV value to firm
from company, project, or ✓ Complex to calculate
✓ Considers all CF over project's life
investment
Expresses PV of cash benefits
as to an amount per peso of ✓ Useful for ranking projects when
investment in capital project capital is rationed ✓ May not be useful for mutually exclusive projects
PI
✓ Provides relative measure of ✓ Requires accurate CFs forecasts and discount rates
Measure of ranking projects in profitability
descending order desirability.
Compares PV of project’s future
✓ Emphasizes on cash flows.
cash inflows to PV of cash
✓ Recognizes time value of money. ✓ Requires predetermination of COC or discount rate.
outflows.
IRR ✓ Assumes discount rate as ✓ Incomparable if projects have different
reinvestment rate. magnitudes/sizes.
Determines cash inflows &
✓ Easy to apply
outflows at SAME time period/
UNDISCOUNTED:

PAYBACK PERIOD AND PAYBACK BAILOUT PERIOD

Net Initial Investment
Even = ➔ Equal to PV factor of IRR
Payback Annual Cash Inflow
Period Unrecovered Bal.
Uneven = Yr-by-yr basis ➔ Exact time =
Net Cash inflow

Net PV 1 • Represents percentage of annual cash

Payback = or returns provided by investment.
Reciprocal
Net Investment PP
Reasonable estimate 1. Net cash inflows are uniform
of IRR, provided: 2. Payback period is HALF of life of project

• Cash recoveries include not only operating net cash inflows but also
SV or proceeds from sale @ end of each year of life of project.
= Total Cash – Cost of Investment
Yr-by-yr analysis:
= (Cash to Date + RV) - Cost of Inv.
Unrecovered Balance - SV
Exact time in a year =
Net Cash inflow
Bail-Out
Period Bal. to Net cash Total cash PBBO
YR SV BAL
recover inflows inflows years
1 120K 40K 20K 60K 60K 1
2 120 – 40 = 80K 40K 20K 60K 20K 1
3 80 – 40 = 40K 40K 10K 50K - 0.75
➔ RV not deducted because you didn’t really sell the asset. 2.75
40-10
= .75
40

Discounted • Accumulating each year's discounted net cash flows until initial
PP investment is recovered.
ACCOUNTING RATE OF RETURN (ARR)
(Annual/Simple/Unadjusted/Average/FS/BV)
Initial Net Income
=
investment Original Investment

Net Income
Even = =
Initial Investment + RV
Ave. Investment 2

Net Annual Cash - DE Ave Net Income

Ave. = or =
Ave. Investment Ave Investment
investment Uneven
Total Cash flows through the years
= # years

ARR on Ave. is twice as much the Initial if RV is zero

 DISCOUNTED:
NET PRESENT VALUE (NPV)
ACCEPT = NPV ≥ 0
NPV = (PV of Cash Inflows - PV of Cash Outflows)
REJECT = NPV < 0

✓ Annual NET cash inflows ✓ Net Cost of investment

✓ SV ➢ PV of now (year 0) = PVF = 1
✓ Return of WC

PV = FV x PVF i=Desired Rate of Return / Cost of Capital

PROFITABILITY INDEX (PI)
- Benefit-cost ratio, desirability index, PV index
=PI > 1:
ACCEPT
PV of cash inflows = PV of future CF > Initial inv.
PI = =PI < 1
PV of cash outflows REJECT
= PV of future CF < Initial inv.
INTERNAL RATE OF RETURN (IRR)
- Discounted CF/Time-Adjusted/Sophisticated/Break-even CF rate of return
PV of Cash inflows = PV of Cash outflows (Cost)
It is discount Net Present Value = Zero
rate where: Profitability Index = 1
IRR = Cost of Capital
Cost of investment
PV factor of IRR = PV Cash inflows = PV Cash outflows
Annual cash inflow
Pxx (PVF) = Pxx
Then determine rate
Interpolate. ↑ Rate = ↓ PVF
If even CF → Search for the rate that match the PVF
If uneven CF → Search for the rate Compute the total PV of Cash inflows
If even CF → Search rate that match PVF If uneven CF → Pick rate, compute PV of
each ar. Match total inflows to given outflow

▪ ↑ IRR, ↓ PVF, ↓ PV of cash inflows

▪ Since at IRR: PV of cash inflows = Cost of investment
▪ Then cost of investment also goes lower.
▪ ↓ Cost of investment is favorable in the part of the business.
Alternatively, you may say that:
▪ If ↓ discount rate, ↑ PVF , ↑ PV of cash inflows, and ↑ NPV.
▪ Since at IRR: NPV is zero, then, you decrease NPV by decreasing PV of cash
inflows which is to be done by using higher discount rate.
Higher discount rate serves the objective of IRR

Indifference Point: NPV = 0 PI = 1 IRR = COC

Acceptable Scenario: NPV > 0 PI > 1 IRR > COC
Unacceptable Scenario: NPV < 0 PI < 1 IRR < COC
NPV= PV, Cash IN - PV, Cash OUT
PI= PV, Cash IN ÷ PV, Cash OUT
IRR: PV, Cash IN = PV, Cash OUT
Financial Statement Analysis
Most Recent Value – Base Period Value
Δ %=
HORIZONTAL Base Period Value
ANALYSIS ▪ Base - Earlier period
▪ If Base is Zero or negative → Δ % cannot computed

VERTICAL 100% Income Statement: ➔ Net sales

ANALYSIS Balance Sheet: ➔ Total assets

BASIC RULES IN RATIOS:

x Related amount
1) x-y ratio = 1) ‘x’ turnover =
y Average x
Income 360
2) Return on ‘x’ = 2) Age of ‘x’ =
x x turnover
x
3) ‘x’ margin =
Sales

Income
1. If IS & BS account are used in ratio → BS amount should be “average”: ROA=Ave. Assets
2. If Beg bal. of BS account is not available → End bal. is used to represent Ave. bal.
3. Operating year → Assumed 360 days

➢ If denominator is constant, Δ Numerator = Directly related to ratio

CHANGES
➢ If numerator is constant, Δ Denominator = Inversely related to ratio
IN RATIOS:
➢ Δ in Both, follow the lower amount of Δ

LIQUIDITY RATIOS
NET WC = CA - CL QUICK RATIO = QA ÷CL
CA RATIO = CA ÷ CL CASH RATIO = (Cash + MS) ÷ CL
QA: Cash; MS; AR; Short-term notes
ASSET MANAGEMENT/ACTIVITY/ EFFICIENCY RATIOS
Net Credit Sales INV TO COGS
AR TO = =
Ave. AR (Merch) Ave. Inv
Net Credit Purchase COGS
AP TO = FG TO =
Ave. AP Ave. FG
Sales CGM
ATO = WIP TO =
Ave. TA Ave. WIP
Sales RM used
FA TO = RM TO =
Ave. Net FA Ave. RM
Total Sales INV TO
WC TO = = FG TO + WIP TO + RM TO
Ave. WC (Manuf)
 SOLVENCY/DEBT MANAGEMENT/FINANCIAL LEVERAGE RATIOS
TL FC Coverage (EBIT + FC)
Debt Ratio = or 1- ER =
TA Ratio (Interest Charges + FC)
TE
Equity Ratio = or 1- DR
TA Time Interest EBIT
=
Debt-Equity TL DR Earned Ratio Interest
= or
Ratio TE ER
Equity 1 Ave. Assets
= or =
Multiplier Equity Ratio Ave. Equity
Cash Flow (EBIT + Fixed charges + Depreciation)
Coverage = PS Dividends Debt repayment
[Int. Charges + Fixed Chargers + ( )+( )]
Ratio 1-tax rate 1-tax rate

ER + DR = 1
MS – Marketable Securities TE – Total Equity
INV - Inventory FA – Fixed Asset
TA – Total Asset DR- Debt Ratio
TL – Total Liabilities ER- Equity ratio
EBIT – Earnings before interest & Tax FC- Finance Charge
Time Interest Earned Ratio – Interest Coverage Ratio
PROFITABILITY / PERFORMANCE RATIOS
GP ROS Income
GP Margin = =
Net Sales (PM) Sales
Operating
EBIT Income
Profit = ROA =
Margin Net Sales Ave. Assets
(Net) Profit Profit
= Income
Margin Net Sales = or ROA x FLR
ROE Ave. Equity
Cash flow Operating CF = ROS x ATO x Equity Multiplier
=
Margin Net Sales
FLR – Financial Leverage Ratio

DUPONT ANALYSIS
ROI = PM x INVESTMENT TO
ROA = ROS x ASSET TO
Income Income Sales
= x
Ave. Asset Sales Ave. Asset
ROA = ROE x EQUITY RATIO
Income Income Equity
= x
Ave. Asset Equity Ave. Asset
DPR = DYR x PER
Div per share Div Per Share MP Per Share
= x
EPS MP Per Share EPS
DU PONT Technique = NI is after Interest, taxes and PS Dividends
 MARKET VALUE / MARKET PROSPECT RATIO
BV per share Net Assets Price Earnings MP per share
= =
OF PS # PS Outs Ratio Diluted EPS
Net Assets*
BV per share = Market to Book MP per share
OF OS # OS Outs Ratio
=
BV per share

BV per Bond Net Assets Dividend Yield Div per share

= =
/Note Bond Outs Ratio MP Per Share
BV of Value of each Dividend Payout Div per share
= =
Securities # shares Outs Ratio Diluted EPS

Earnings per NI - PS Profit Retention

= = 100% - DPR
share WANOSO (Plowback) Ratio
* NAA= OS + APIC+ RE – PSD - Liquidation value of PS
Dividend Dividend Price Earnings
= x
Payout Ratio Yield Ratio Ratio
Div per share Div per share MP per share
= x
Diluted EPS MP per share Diluted EPS

OTHER FINANCIAL RATIOS

Interest EBIT Defensive QA
= =
Coverage Interest Exp. Interval Ave. Cap Exp.
Basic
PS NI after Interest & tax EBIT
= Earning =
Coverage Stated PS Dividends Ave. TA
Power
EBITDA EBITDA Dividends Div to OS
= =
Coverage Interest per share # OS Outs
Free Cash
= Operating CF + After-Tax Interest – Capital Expenditures
Flow
NI-PSD → NI available to OS = NI – PS Dividends
EBIT → Operating Profit; MP → Market Price

FINANCIAL FORECASTS:
Capital Intensity Assets Variable Liab Liabilities CL exc NP
= =
Ratio (CIR) Sales Ratio (VLR) Sales
= Total Δ Equity – Internal Financing
Additional = ↑ Assets - ↑ Liabilities – Profit Retained
Funds Needed
(AFN) = (CIR x ΔS) – (VLR x ΔS) – (New Sales x ROS x PRR)
= (Asset – Liab) x (%ΔS) – (New Sales x ROS x PRR)

Required ↑ Asset = ΔS x (Asset ÷ Sales)

(-) Spontaneous ↑ Liabilities = ΔS x (Liabilities ÷ Sales)
(-) ↑ RE = Earnings after tax – Dividend Payment
Additional Funds Needed from external source (creditor, investor)