Business Arithmetic will help the entrepreneur to do a careful analysis of various options available to him or her for business strategy.
Managerial accounting methods provide techniques for evaluating the viability and ability to grow or "scale" a business. These techniques are called cost-volume-profit analysis (CVP).
In today's complex business world, bringing a balance amongst variables like revenue, cost, profit, etc. is a tedious task. Managerial economists use various tools to analyze these variables.
Break-Even sales in value or Rupees
Break-Even Sales in units
The margin of safety in value (₹) = Actual Sales (₹) - BES (₹))
Margin of safety in units = Actual Sales (units) - BES (units)
Example 1: The following information is extracted from the records of ABC Ltd.
You are required to determine
(i) P/V Ratio
(ii) Break-Even Point in terms of value (₹)
(iii) Break-Even Point in terms of units
(iv) Margin of safety when Actual Sales are 15,000 units.
(v) Prepare a Break-Even Chart.
Contribution Ratio or P / V Ratio
(ii) Break even Point in terms of(iii) Break Even Point in terms of units
(iv) Margin of safety
= Actual Sales - Break Even Sales
= 15000 - 12,500 = ₹ 2,500 units
or
(v) Break Even Chart
In the above diagram, fixed cost is indicated by horizontal line FC parallel to x-axis. Total Revenue curve is shown by 45° line from the origin. Total cost curve is drawn by Joining Total Revenue at 12,500 units (point L) and point P at Y-axis.
Example 2: From the following information of ABC Plastics Ltd., calculate Break-Even Sales terms of value and volume.
Contribution Ratio or P / V Ratio
Formulae to Remember for Break Even Analysis
- Contribution = Sales - Variable Cost
Contribution = Fixed Cost + Profit- Margin of Safety = Actual Sales - BES
Example 3: Calculate P/V Ratio, BES, and Margin of Safety from the following information:
Assumptions: Underlying Break-Even Analysis
(i) The analysis is applicable to short-term decision-making.
(ii) In the short run the costs can be classified into fixed and variable,
(iii) There is no change in sales per unit and variable cost per unit.
(iv) All the goods produced are sold.
Cash flow projection indicates the cash inflow and outflow estimates for a particular period.
The following are the importance of cash flow projection:
Another important exercise for an entrepreneur is to prepare a budget for future years and managing the company finances accordingly.
The process of preparing budgets is as follows:
Budgeting involves the preparation of a budget and analysis of variances with the actual performance of the business. An entrepreneur should also arrange the funds for the future period to ensure that the finances are available when the requirement arises. We can see the format of the budget as below:
Working capital is the difference between current assets and current liabilities. It measures the liquidity or cash availability for day to day business operations.
Inventory control is an important aspect of the production planning process. The key decision to inventory control is how much stock one should hold to bring a balance between the demand and investment cost in such stock levels. In other words, inventory control is concerned with minimizing the total cost of inventory. There are three factors that affect the inventory control decision:
There are different levels of stock that can be maintained depending on the size of the business and the level of demand of the product in the market. Broadly there are three levels of inventory.
The reorder level is the inventory level at which an entity should issue a purchase order to replenish the quantity on hand. When calculated correctly, the reorder level should result in replenishment inventory arriving just as the existing inventory quantity has declined to zero.
The formula for reorder level is Maximum Consumption x Maximum Reorder Period For example, maximum consumption 1,000 units per week, Delivery time 8-10 weeks.
Reorder level = 1,000 x 10 = 10,000 units.
Economic Order Quantity (EOQ) is a simple inventory management model to determine the point at which the combination of inventory order costs and inventory carrying costs are the least. In other words, EOQ represents the balance between the inventory ordering cost and inventory carrying cost. It indicates the most cost-effective quantity to order. EOQ is beneficial when you have repetitive purchasing of an item.
Where U stands for annual consumption
P stands for cost of placing an order
C S stands for the cost of storing one unit for one year.
This means that if the sales do not fluctuate then one should order 400 units every quarter to keep the ordering and carrying cost at a minimum level.
Q.1. What is a budgeting process?
- Budgeting is a collective process for preparing and estimating budgets.
- The operating units estimate their budgets as per the projected sales, costs and expenses.
- The budget of each operating unit is provided to the upper management for reviewing
- Keeping in mind the overall goals, upper management makes necessary changes in the budgets
- Finally, the approved budget is the road map for the following year or for specific time
- After the implementation of budget, the performance is measured and then compared with actual standards to find out deviations and take corrective action, if necessary.
Q.2. What is a budget? What are the essentials of a budget?
- A budget is a financial and/or quantitative statements, prepared prior to a defined period of time of the policy to be pursued during the period for the purpose of attaining a given objective.
- It is prepared in advance and is future based. Information is expressed in monetary terms and it also states the physical units.
- Essential of budget are:
To know and control the resources of the enterprise.
To communicate plans to various stakeholders
Give the managers a target to achieve
Evaluate the performance of the company and managers and fix responsibility and accountability of people
Q.3. What is financial management? What is the main objective of financial management?
- Financial management is concerned with optimal procurement as well as the usage of finance.
- Financial Management involves the following activities:
Identification of sources of finance
Comparison of the sources vis-à-vis cost & associated risks
Investment of the finance procured in most profitable avenues- Objectives of financial management:
The primary objective of Financial Management is Maximisation of Shareholder’s Wealth
This can be done by keeping a regular and adequate supply of funds to the concerned.- Assuring adequate returns to shareholders in the form of dividends.
- Optimum utilization of funds.
- Forming a capital structure to maintain debt and equity.
Q.4. There is a Budget to suit every business and its need. Elucidate.
There are the following types of budget:
a. Sales budget: It provides an estimate of sales in the future. It reflects both units and rupees and is used to create target sales to be achieved during a specific period.
b. Production budget: It gives a projection of the number of units that should be manufactured for the target sales. This also estimates different costs involved in the manufacturing of these units.
c. Capital budget: It evaluates whether a long-term investment in the new machinery, research and development projects, and other long-term assets are worth or not.
d. Cash budget: It estimates cash receipts and expenditures for a particular time period and analyses whether income will be sufficient to cover expenses. it also determines the quantum of finance that will be required from other sources.
e. Marketing budget: It provides an estimate of the funds required for promotion, advertisement, and public relations for increasing the market share
f. Project budget: It is the task-wise budget of a project that incorporates the costs related to and accruing to a specific project. Different task budgets are consolidated to prepare the project budget.
g. Operational budget: It is a budget that is used to forecast annual revenues and expenses for a business.
19 videos|60 docs|12 tests
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1. What is the importance of business arithmetic? |
2. How does cost-volume-profit (CVP) analysis help businesses? |
3. What is the significance of cash flow projections in financial management? |
4. How does budgeting help in managing finances? |
5. What is the significance of inventory control and economic order quantity (EOQ) in business operations? |
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