Finance and Cost Management!!!

Treasury management

noreply@blogger.com (NS) — Sun, 18 May 2008 15:34:00 +0000

Treasury management relates to

1. Efficient management of liquidity.
2.Management of financial risk.

Activities covered by treasury management are

1.Cash Management :- Efficient collection and repayment of cash.

2.Currency management :-
Deals with Foreign currency risk,exchange risk,currency to be used in billing foreign Turnover.

3.Funding management :-
Planning and sourcing of short ,medium and long term fund needs.Capital structure planning,Future interest forecast,Foreign currency rates decision -making process.

4.Banking :- Good relations with banks .Negotiating with them for fund requirements.

5.Corporate finance:-Capital structure ,merger and acquisition.

Types of Material losses & Method of controlling.

noreply@blogger.com (NS) — Sun, 11 May 2008 13:23:00 +0000

Waste :-
Def : - That portion of the basic raw material Lost in processing having no recovery value.
Nature :- 1.Sometimes not physically available.
2. May not have a recoverable value.
Effects : - 1.Reduces the output quantity.
Control :- 1. Allowance for normal wast should be made on the basis of past experience etc.
2. Resposibilities affixed for control of excess over normal waste.
3.Waste Report should be prepared periodically to compare the actual waste with the predetermined level.
Scrap :-
Def :- The incidental residue from certain types of manufacture usually of small amount and low value,revocerable without further processing.
Nature :- 1. Incidental to manufacturing process.
2. Usually of small value.
3. No further processing is required to sell it.
4.Phsically available.
5.Scrap cannot be used as a material for original purpose.
6. It could be sold for a nominal amount.
Control :- 1.Standard for scraps should be set.
2.Responsibility for scrap should be fixed .
3.Compute variance of scrap and suitable action taken.

Accounting :- 1.As other Income –Sale of scrap treated as other income when it is of small value
2.Credit to overhead –a.Net sale price of scrap may be credited to production overhead of department producing the scrap.
b. Credited to material cost.
3. Credit to Job or process – If the job or process could be identified the net selling price may be credited to job or process.

Spoilage :- When materials gets damaged in manufacturing operation in such a way that they could not be rectified and brought back to normal specification then spoilage results.
Nature :- 1. It has a realizable value and could be sold as seconds sometimes.
2. Spoilages can be avoided by checking the defects in material or manufacturing operations.

Control :- 1. Divided into Normal and abnormal spoilage.
2. Causes of abnormal spoilage investigated.

Accounting :- 1. Normal spoilage should be transferred to production cost by including the cost of spoilage in the production and dividing it among the good units.
2. Abnormal spoilage transferred to costing profit and loss account.

Defectives :-
Def :- That production which is below standard specifications or quality and can be rectified by incurring additional expenditure (of Material ,labour etc) know as rectification costs.
Nature :- 1.It can be rectified as good units by incurring additional costs and brought back to normal standards.
2. If it cannot be rectified it could be sold as seconds.

Control- It is divided into two parts
a. Control on the quantity of defectives .
b. Control on rectification cost.
c. Standards for quantities and cost should be kept.It should be compared with actual and corrective actions should be taken.

Accounting :- 1.Abnormal cost of rectification should be transferred to costing profit and loss account.
2. Normal cost should be charged to job concerned(if identifiable) or if not identifiable to job then charged to overhead costs.

For Problem Click here

For another problem Click here

Portfolio Theory-Risk Return Trade off!!!

noreply@blogger.com (Sudhakar) — Sun, 11 May 2008 08:16:00 +0000

Portfolio Theories :
One of the major factors that play a role in decision making regarding the purchase or sale of portfolio is Risk.The other factor is of course return.Hence an appropriate trade off between risk and return is the requisite factor in making the right decision .To manage the risk we need to measure the risk and return.
Measurement of Risk.
1. For future datas :-

Probabilities :-
Expected Return R(e) = Sigma (sum of) Pi X Ri

Where Pi = Probability of return (i)
Ri = Return (i)
Standard Deviation σ = Square root of (Sigma(sum of) Pi X ( Ri - R( e)) 2 )
2. For current and past datas.
Average Return R(e) = Sigma(sum of ) Ri/ n
Where Ri = Return (i)

Standard Deviation of the returns above is given by.

= Square root of (sigma(sum of)( Ri - R(e))2 / n )

Click here for the Problems .

Different methods of Stock Issue !!!

noreply@blogger.com (Sudhakar) — Thu, 01 May 2008 16:23:00 +0000

One of the problems that arise in costing is the pricing of the issues. This is due to the fact that generally the goods are purchased at different lots at different points of time. When issues are made it is difficult to keep track of the issue lot and link with the purchases. Hence a method of pricing the issue has to be selected.
Let us now examine different methods of pricing the issues and see one problem in this regard.

A..FIFO-First –in – First- Out Method

1. It is based on the assumption that the materials which are purchased first are issued first.
2. Accordingly the Stock will be valued at the latest purchases.

Advantages:
1. Closing stock is valued at the latest price.
2. Materials are priced at actual cost and hence no unrealized profit arises.
3. Charge to production is at the oldest price of materials.
4. Easy and Simple.

Disadvantages:
1. Since the materials issued are valued at old prices the cost of production may not reflect the latest prices.
2. Comparisons become tough.
3. Complex calculation.
4. In period of rising prices the FIFO produces higher profit and increases tax liability.

B.LIFO-Last in First out Method.

1. It is based on the assumption that the materials which are purchased last are issued first.
2. Accordingly the Stock will be valued at the oldest purchases unissued.

Advantages:
1. Materials charged to production are at latest cost. Hence in times of rising prices the company’s product quotation will be competitive.
2. This method does not result in unrealized profit or loss like FIFO
3. Simple to operate at the time of steady prices.
4. In period of rising prices the profit and tax liability under LIFO will be lower than under FIFO as the cost of production will be valued at the lower cost (old cost).

Disadvantages:
1. The physical flow is different from logical flow.
2. Closing stock will not represent the current economic value and be valued at old prices.
3. Comparison of different jobs becomes difficult.
4. Complex to operate.
.
C .Average cost Method:
It is based on the assumption that the materials kept together lose their identity and has to be valued at average price.

C1. Simple Average Method.
Simple average represents the average of prices. The average prices of all the materials in stock is calculated .It does not take into account the quantities.For example if there are three different rate of products in stock say 21 , 23 , 25 then the simple average is (21+23+25)/3 =23
The simple average method operated with FIFO method. The prices of stocks issued fully as per FIFO method is not taken into account for computation.

Advantages.
1. Simple

Disadvantages:
1. Unscientific.
2. Results in unrealized profit and loss.

D. Weighted average Method.
This method takes into account the quantities. The price is calculated by dividing the total cost of material in stock calculated at actual purchase price for each lot (present in stock) by the total quantity of materials in stock.

Advantages:
1. Smoothens out the effect of fluctuations and hence useful at the time of fluctuating prices.
2. The work load is reduced as it does not necessitate the calculation of issue price at the time of each issue.
3. No unrealized profit or loss arises in this method.

Disadvantages :
1. Issue price may not be at the current market price.
2. When there are several lots of purchases the work load increases.
3. Excessive high or low prices are reflected in the average even after their total consumption.

E.Replacement Price Method.
The issues are valued at the price at which the materials would be replaced.

Advantages:
1. Simple to operate
2. Production reflects the current market price.
3. When the company has bought the goods at a cheap prices earlier in a large stock and the benefit need not be passed on to the customer ,then this method will reflect profit as the production will reflect the current prices .

Disadvantages:
1. The stock valuation is not at the current prices.
2. Unrealised profit or loss will arise.
3. It involves finding the replacement price at each issue and hence a little difficult to operate.

F.Standard Price Method.
Under this method the prices are issued at standard prices. Standard prices are fixed for a definite period. In the time of fluctuating prices the standard prices has to be fixed for short term period and changed constantly. Receipts will be at actual cost of purchase only. The difference between the standard and actual prices is transferred to Material Price variance account.
Standard price is a notional price and not actual price .It is fixed taking into several factors liked Market condition, fluctuation in prices, trends, discounts etc.
This method can be used in connection with standard costing system or without standard costing system.
Advantages:
1 .No cumbersome calculations at the time of each issue.
2. When standards are fixed correctly it makes the task simple.

Disadvantages.
1. It results variance in profit.
2. If not fixed correctly it can affect the valuation of stock and cost of production.

G.Highest –in –First _Out (HIFO) Method.
The materials are issued at the highest price of material in stores. Once the highest price material in stock is exhausted the next highest price will be used.

Advantages :
1. Production is at the high cost of production and during fluctuating prices the highest cost is recovered first .
2. Inventory value is kept low and results in secret reserve.
3. Used in cost plus contracts.
Disadvantage
1. Results in secret reserve.
2. Unrealised profit or loss arises.
3. Production is not valued at current prices.

H.Next –in-First-out (NIFO) method.

This is more similar to replacement price method except that the issues are priced at the price at which an order (purchase order) has been placed and will be received next in store.
Advantages :
1. Production reflects the current market trend.

Disadvantages :
1. It results in unrealized profit or loss.

I .Specific price or Identifiable cost method.
When materials are purchased and set aside for a specific job order then issue of that material should be at the price at which (the specific price) it has been purchased. Other issues can be at FIFO, LIFO or other methods.

Advantages :
1. The job is costed at the actual material puchase cost.
2. Useful for Job costing .

Disadvantages :
1. The material should be carried separately till it is issued fully.

J. Base Stock Method.
This method assumes that a minimum base stock is always held in stock and is not issued. This is considered as a fixed cost and carried at original cost. The quantities in excess of base stock are valued by using FIFO or LIFO etc.

Advantages
1. Simplification of valuation of inventory as the base stock values is fixed.
2. Merits of other methods (FIFO, LIFO Etc) of valuation which is used along with this will be reflected here.
Disadvantages
1. It is not an independent method.
2. This is rarely used.
3. Demerits of other valuing methods that is used along with this method will be reflected here.

So for Problems Click Here

All about purchase procedure and EOQ

noreply@blogger.com (NS) — Sun, 20 Apr 2008 04:06:00 +0000

First about the purchase procedure

Click here

So here is the details about EOQ

Privacy Policy

noreply@blogger.com (NS) — Fri, 18 Apr 2008 14:32:00 +0000

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Marginal Costing and Absorption Costing(continued)

noreply@blogger.com (Sudhakar) — Mon, 14 Apr 2008 11:42:00 +0000

In the previous post we saw that the profit under both marginal costing and absorption costing are same when there is no opening and closing stocks
Now let us see a situation when the Profit changes due to the presence of opening and closing stock.
We will also Understand that if Production is more than sales Absorption profit gives more profit and vice versa.To understand these two concepts let us now look at at problem.
Click here.

Marginal costing and absorption costing.

noreply@blogger.com (Sudhakar) — Sun, 30 Mar 2008 08:40:00 +0000

1.Absorption costing.
a.This is a total costing technique under which total cost (fixed and variable ) are charged to product ,Process,operations.
b.In this method fixed factory overhead are absorbed on the basis of predetermined factory overhead rate.
c.Under or over absorption are absorbed before computing the profit for a particular period.
d.Closing stock is valued at total cost which includes fixed factory overheads.
This method is also know as conventional costing,full costing.

2. Marginal costing.
a. Here only the marginal costs (variable costs ) are charged to product ,process and operations.
b. Fixed factory overheads are not not absorbed but treated as period costs in determining the profit or loss .
c. Under or over absorption of overheads does not arise as the fixed overheads are not absorbed.
d . Closing stock is valued at marginal cost which does not include fixed factory overheads.

Note : Under both Marginal costing and absorption costing the administration,selling and distribution overhead are treated period cost and are not inventoriable cost
Here is a concept problem .

Consolidation (Part 3)

noreply@blogger.com (Sudhakar) — Tue, 25 Mar 2008 14:56:00 +0000

So continue with the consolidation of accounts.

Let the situation in the previous problem(previous post) be the same except that there is Pre acquisition profit at the time of investment in B Ltd.

So the conditions become as follows.

1.B Ltd is a 100% subsidary of A Ltd.

2.There is Preacquisition profit.

3.The value of investment made by holding company and Share (along with preacqusition profit ) of subsidary company is not equal.

4. There are no other inter company transactions.

So in this case just add all the assets and liabilities .Cancel the Investment of Holding company with the sum of Share capital and pre acquisition profit of subsidary company.Difference is Goodwill ( Investment > Equity)or capital reserve.

Note preacquisition profit is added to the share capital for the purpose of computing Goodwill or capital reserve.

For Problem click here.

Consolidation Part 2

noreply@blogger.com (Sudhakar) — Mon, 24 Mar 2008 16:21:00 +0000

Let us now look into the same situation given in Part 1 of consolidation (Previous post).Except for 1 change.The investment value of holding company is not equal to share capital value .So the fresh conditions are

1.The holding company holds 100% shares in subsidary .

2.There is no preacquisition profit.

3.The investment value not = Share capital value.

4.and No inter company transactions.

This is a case where we tend to get goodwill or capital reserve.The process is as follows.

Find Investment value of holding company(A)- Share capital of subsidary(B)

a.If A > B Put the difference in Good will

b.If B>A Put the difference in capital reserve.

c.Cancel A and B (DO not show them separately as the net is shown )

d.Add all assets and liabilities line by line .

Click the link below to see the example.

click here

We will see next level in next problem.

Concept of consolidation of accounts.

noreply@blogger.com (Sudhakar) — Sun, 23 Mar 2008 17:04:00 +0000

1.Consolidation of accounts of a holding company and subsidiary company is considered here.
2.This does not specify any Accounting standard of any body, but considers only the basic concept involved in consolidation.
3.So to first understand consolidation let us now consider a simple consolidation of two companies.
4.Let us assume that A Ltd holds 100 % shares in B Ltd(At the time of formation of B Ltd itself-No Pre acquisition profit.) .The investment made by A Ltd is at par with the share capital of B ltd ,and there are no inter company transactions.
5.In this case the consolidation becomes simple.
6.All you need to do is to add the assets and liabilities and then cancel the investment of A ltd and share capital of B ltd. As there will be no good will or capital reserve. See the example given in the link .Click here

We will go step by step to next stage. Next in next post.

Concept of Semi variable,step variable and step fixed costs.

noreply@blogger.com (Sudhakar) — Sun, 23 Mar 2008 06:16:00 +0000

These costs are often confused .So here is clarification for each of them.

Semi-variable:- Costs that have both a variable and fixed component. Eg -Commercial leases.They often have a fixed rent per month plus an additional rent based on the amount of production or sales. For example, rent is Rs 6,000 plus Rs0.50 for each product that is made. The base rent of Rs 6,000 is a fixed cost and the Rs 0.50 per product is a variable cost.

Step variable or step fixed:-Costs that are constant over a range of production. If one employee can make 5000 units, then the employee’s wage is constant over a production range of one to 5000 units. If you produce 5001 units, you will need another employee. So your cost doubles. If you make 14,000 units your cost triples because you need three employees.
It can be defined as
Fixed costs that increases to a new level in steps with significant change in activity or usage.

Instruments of International Finance.

noreply@blogger.com (Sudhakar) — Sun, 23 Mar 2008 05:07:00 +0000

1. Euro Bonds : Euro Bonds are debt instruments denominated in a currency issued outside the country of that currency.Eg:-Yen bond issued in France.

2. Foreign Bonds :These are Debt instruments.These are denominated in a currency which is foreign to the borrower.It is sold in a country of that currency.A British firm placing $ denominated bonds in USA is said to be selling Foreign bonds.

3.Fully Hedged bonds: Foreign bonds has the risk of currency fluctuations.Fully hedged bonds eliminate the risk by selling in Forward markets the entire stream of interest and principal payment.

4.Floating rate Notes: These are issued upto 7 years maturity. Interest rates are adjusted to reflect the prevailing exchange rates.They provide cheaper money than foreign loans.

5.Euro commercial Papers : These are short term money market instruments.They are for maturities for less than a year. They are usually designated in US dollars.

6.Foreign currency options : It provides a right to buy or sell ,spot ,future or forward a specified foreign currency .It provides a hedge against financial and economic risks.

7.Foreign currency futures : Foreign currency futures are obligations to buy or sell a specified currency in the present for settlement at a future date.The most common period for a future contract is a week , a month or two months.

Job costing,Batch costing & Process costing.

noreply@blogger.com (Sudhakar) — Sat, 22 Mar 2008 10:44:00 +0000

Job costing
1.It is used when work is undertaken as per customer’s special requirement.
2.Cost expected to be incurred on the job are estimated and on the basis of estimate a price is quoted to the customer.
3.Actual costs of material , labour ,overhead are accumulated and on the completion of the job these are compared with the quoted price and thus the profit or loss on it is determined.
4.Applications :-Printing press, hardware, ship building ,heavy machinery ,foundry ,general engineering works, machine tools, interior decoration ,repairs etc.

Here is a problem on Job costing. Click here .

Batch costing
1. It is a refinement of job costing.
2. Here the unit of measurement is batch comprising of lots of similar units.
3. Separate cost sheet are maintained for each batch of products by assigning a unique batch number.
4. Cost per unit in a batch =Total cost of batch/No of units in the batch.
5. Applications :-Pharmaceuticals , drug industry, readymade garments ,manufacture of electronic parts of TV etc.

Here is a problem on Batch costing. Click here .

Process costing.
1. The process of producing the product has a continuous flow and products are homogenous
2. Costs are compiled on time basis –for process or department.
3. Product lose their individual identity as they are manufactured in a continuous flow.
4. Unit cost of process is the average cost for the period.
5. Costs are calculated at the end of the cost period.
6. Unit cost of process =Total cost for the period /Output during the period
7. Process of production is standardized and quite stable.
8. Control is comparatively easier.

Here is a problem on Process costing. Click here

Operating costing.

noreply@blogger.com (Sudhakar) — Fri, 21 Mar 2008 17:50:00 +0000

Costing applied to service rather than production of commodies.
Operating costing is a form of operation costing.
The emphasis is on ascertaining the cost of rendering service rather than on the cost of manufacturing a product.
It may be applied separately to service department in a company.(Power house department,maintenance department)
Examples of companies using this are Transport companies,gas and water works,electricity supply company etc.

Here is a Small problem involving operating costing to gain better understanding.

Click here

Project report for bank loan

noreply@blogger.com (Sudhakar) — Fri, 21 Mar 2008 13:19:00 +0000

Here is a project report for bank loan purposes.The calculations have been kept simple.For actual purposes the basic report can be expanded as necessary. This statment shows minimum requirement only.

Click here for the report

Activity based costing.

noreply@blogger.com (Sudhakar) — Fri, 21 Mar 2008 11:32:00 +0000

Under activity based costing the overhead expenses will be absorbed on the basis of activities involved rather than the machine hour or labour hour.

The different stages in activity based costing are.

1 . Identification of different activities within the organization.

2. Relating the overhead cost to the identifies activities.

3. Spread the support activities across the primary activities.

4. Determine the activity cost drivers

5. Calculate the activity cost driver rates.

6. Compute the overhead cost to be charged over the product by using cost driver rates.

Here is a activity costing based problem for your understanding.

http://spreadsheets.google.com/pub?key=pEv2ZQmyGV-BkXFPDtGW7Og

Treasury management

noreply@blogger.com (Sudhakar) — Fri, 21 Mar 2008 11:09:00 +0000

Treasury management is concerned about –Efficient management of liquidity and financial risk in business.

The activities involved in treasury management.

1.Cash management –Efficient collection and repayment of cash to insiders an third parties.

2.Currency management-Managing foreign currency risk,exchange rate risk.Advise on the currency to be used when invoicing overseas sales.

3.Funding management –Planning and sourcing firm’s short ,medium and long term needs.Capital structure planning,forecasting of future interest and foreign currency rates decision making process.

4.Banking-Maintain good relationship with bankers and negotiating with them for short term loans.

5.Corporate finance.-Advises on the aspects of corporate finance.Participates in capital structure,mergers and acquisitions.

Lets look at some new Financial instruments(Part 2)

noreply@blogger.com (Sudhakar) — Sun, 16 Mar 2008 17:25:00 +0000

1.Partly convertible debentures with buy back arrangement.
a.Part of the debentures money will be converted into equity (with premium) after a stipulated period.
b.Balance portion which is the non convertible is redeemed at par in some annual instalment at the end of few years from the date of allotment of debentures.

2.Non convertible debentures with equity warrant.
a. The debentures are redeemed at full at a usual premium of about 5%.
b. The redemption is at an annual instalment for two to three years.
c.One detachable equity warrant will be attached with the debentures.
d.The holder will have the option to exchange the warrant for one equity share at its face value at the end of 12 months from the date of allotment of debentures ,on surrender of the warrant alongwith the payment for the equity share ,at face value.

3.Secured Premium notes.
a. SPN is issued at a Nominal value
b.It is repaid in some annual instalments along with an equal instalment to cover the interest and premium on redemption.
c.The holder can seek allotment of one equity share using the warrant attached to the SPN.
d.This right (given in c) is however exercisable after about a year or two as the SPN will be fully paid by then.

4.Index linked Gilts .
a. The index linked gilts are inflation proof over their term of maturity.
b.The base for index linking can be Consumer Price Index(CPI)
c.The base date for index linking can be CPI value.
d. Each intervening coupon payment and maturity proceeds are to be increased in the ratio of the CPI value.

Concepts in cost accounting related to materials.

noreply@blogger.com (Sudhakar) — Sun, 16 Mar 2008 16:27:00 +0000

1.Replacement Price(materials).
The price at which it is possible to purchase an item identical to that which is being replaced or revalued. Materials issued are valued at replacement costs.It presupposes the determination of the replacement cost of materials.Product is at the current market price.This method is particularly useful in increasing prices periods as the production would include the increased cost for replacement of materials.This is further useful to find the true cost of production.

2. Standard Price(materials).
1. Predetermined price fixed for specific period.
2. It is fixed on the basis of all factors which may affect future price.
3.Fixation of standard price takes into consideration quantity of materials purchased ,possibility of price fluctuations. Etc.
4.The standard price is used for comparison with actual prices.It helps in calculation of efficiency in the purchase of materials.
5.For controls ,standard costing system is a tool to the management particularly when the fluctions in prices are not violent.

3.FIFO
1.It is a method for accounting the issue of materials.
2.According to this method the quantities purchased first or manufactured first which come in first are issued first .
3.As a result the stock of materials will consist of the latest purchases only.
4.Sometimes the profit can rise as a result of use of this method in the periods of increasing prices.

4.LIFO
1.It is another method of accounting for the issue of materials.
2.According to this method the quantities purchased last issued first .
3.As a result the stock of materials will consist of the latest purchases only.
4.It is particularly useful in the time of price rise.

Some financial Instruments(Part I).

noreply@blogger.com (Sudhakar) — Sun, 09 Mar 2008 17:27:00 +0000

Lets look at some new Financial instruments.

A.Commercial Paper.
1. It is a short term fund raising instrument.
2. It is a usance promissory note negotiable by endorsement and delivery
3. It is effected at a discount.

B.Zero Interest convertible debentures bonds.
1.Debentures bonds are convertible into equity shares.
2.No interest is payable till conversion.
3.When the project bears income the company would be in a better position to service the equity as no interest is payable.
4.The gain here is in the form of long term capital gains on sale of shares.
5.Interest is in the form of premium on conversion of shares.
6.No tax is payable for interest which is notional.
7.Long term capital gain is usually exempt from tax.

C.Deep discount bonds.
1.These are sold at a large discount from nominal value.
2.There is no interest element.
3.These are issued ,sometimes for a long years ,say 25 years with a option to withdraw at each term of 3 to 5 years from the date of allotment.

D.Option bonds
1.This could be cumulative,non cumulative interest payment type payable at the end of the term or for a period of 1year.
2.Sometimes redemption premium is also offered.

E.Cumulative convertible Preference shares(CCP’s)
1.The entire issue of CCP would be convertible into equity shares between 3 to 5 years according to company.
2.The conversion would be deemed as being resulting from the process of redemption of preference shares out of the proceeds of fresh shares made for the purpose.
3.Preference shares will have voting rights as applicable to preference shares under companies act 1956(India)
4.Face value of shares will ordinarily be Rs 100 each.

Working Capital.

noreply@blogger.com (Sudhakar) — Sat, 15 Dec 2007 09:08:00 +0000

Working capital refers to the gap between the current assets and current liabilities. It shows the fund that the organization requires to smoothly carry out the production process or the regular activities. To understand the working capital further let us try to understand the working capital cycle. In a production process the raw material gets converted to finished product and which is sold to become debtor and finally the cash is realized. It can be shown in the form of the diagram shown in figure 1.

Thus the cash which goes into the production process gets locked up in the process until it is realized as cash on realization from debtors. Thus the company realizes the cash only after 20 days. If credit of 5 days is allowed by the creditor then the net period becomes 20-5=15. The funds that gets locked up here is the working capital. The company needs this level of funds at any time , to sustain the production process. This cycle is called the working capital cycle. This working capital needs to be financed.

Now let us see the modes of financing the working capital.

1. Loan : The entire working capital is granted as a loan which is withdrawn by the customer at his convenience. When he repays in instalment his account is credited. The interest is paid at the balance amount in the account.

2. Overdraft : Under this facility the borrower is allowed a limit in his current account over his balance in the account. The withdrawl is allowed upto that limit. The interest is calculated on the amount utilized. The borrower is allowed repayment at his convenience. The whole limit is secured by a security provided by the borrower.

3. Cash credit: Under this method a limit is fixed .The limit varies with the availability of security in the form of stock ,debtors etc.The customer is allowed withdrawl any number of times subject to limit. He can repay at his convenience.

4. Bill Finance : In this method the bills for collection ( Debtors-Bills ) are discounted in the bank by the seller. The bank provides the finance on the bill even before paid by the debtors.The debtor settles the amount to the bank. For this the bank charges a small amount of the bill called discount charges.

5. Term loans : Bank also provide loans repayable over a long period of time say 3-6 years. The instalments are repayable half yearly or yearly by the borrower.

6. Commercial paper : When the company resorts to borrowing directly from the public than through banks, the commercial paper comes into existence. Commercial paper is an Usance promissory note issued by the company with the approval of RBI(In India) negotiable by endorsement and delvery. It is an easy method of borrowing by the company.

Project Finance.

noreply@blogger.com (Sudhakar) — Sun, 02 Dec 2007 10:21:00 +0000

A project has a start and end period . It is carried out to meet a goal. There will be definite cost , financing option quality options etc.Eg:- of project will be Development of a site .The project financing refers to financing of a project.Generally the project involves the following stages of development.

1. Developing an idea of the project:-In this stage idea required for the project is put in.

2. Feasibility study :-A feasibility study is carried out to check whether the
project could be undertaken or not. This takes the shape of a project report. The project report focuses on the Industry atmosphere , the cost of project, means of finance, the promoters ,the profitability, the tax angle, the cash flow ,the repayment capacity ,technical feasibility, economic feasibility ,managerial performance and ability.

3.Financing the project :- The project could be financed from Equity or loan funds. In fact appropriate mix of funds reduces the cost of capital to the company and optimise the risk to the company. Equity (owner’s )contributions involves either equity shares or promoter’s contribution in other forms.The promoter’s contribution can be in the form of asset contributions, debentures ,unsecured loans to company and in the case of non company as capital introduced. The shares can be either listed or unlisted shares, original shares or rights shares in the company. The loan capital is in the form of bank loan, debentures, bonds and other debt instruments etc. Let us see an example of project report for loan purpose in the next post.

Stock levels

noreply@blogger.com (Sudhakar) — Fri, 16 Nov 2007 17:36:00 +0000

Stock levels are required to maintain the appropriate level of stocks required for the production department .If the stock accumulation is more ,then the organisation will loose interest on the excess investment in the stock.Also the carrying cost of stocks will increase.If the stock level is low then there is a danger of productions getting affected.Hence appropriate stock levels are necessary to control the stock. Hence let us see the formulae for computing stock levels.

Minimum stock level=Reorder level -(Average rate of consumption x Average time required to obtain fresh delivery)

Maximum stock level=Reorder level + reorder quantity-(minimum consumption x minimum reorder period )

Reorder level = Minimum stock + (Average rate of consumption x Average time required to obtain fresh delivery)

or
Reorder level = Maximum reorder period x maximum usage

Average stock level =(Minimum stock + Maximum stock )/2 or
= Minimum stock level +1/2 Reorder quantity

Payback period.

noreply@blogger.com (Sudhakar) — Sat, 10 Nov 2007 05:19:00 +0000

Pay back period.
Payback period represents the period by which the initial investment will be realised.
To tell a small example if the initial investment is Rs 200000 and yearly return is Rs 10000 then payback period (PBP) will be given by the formula

PBP = Initial investment
Return.
= 200000/ 10000
= 20 years.

Payback period is a useful method of determining the feasibility of a project though not without disadvantages.The project with a lower pay back period will be preferred.

Here we have to substantiate what is return.Return means Net profit after tax and before depreciation.The adding back of depreciation is because it is a non cash item and does not affect the cash inflow.
Thus if Profit before tax is Rs100000 (after depreciation) and tax is Rs50000 and depreciation is Rs20000 then

Return is given by Rs100000-50000+20000=Rs 70000

Pay back reciprocal:-
Payback reciprocal is the opposite of pay back period and is given by the formula

(Average annual cash inflows /Initial Investment ) x 100

In the above example the payback reciprocal will be =10000x100/200000
= 5%

It is argued that when the life of project is 2 times the pay back period and the project generates equal amount of returns then the pay back reciprocal will be approximate to Internal rate of return.