UNIT 3

Working Capital
Working capital is a financial metric that represents the difference between a company's
current assets and current liabilities. It reflects the funds a company has available to manage
its daily operations and meet short-term obligations. Here’s a closer look:
Key Points:
1. Formula:
Working Capital=Current Assets−Current Liabilities
 2. Components:
 Current Assets: Cash, accounts receivable, inventory, and other assets that are
expected to be liquidated or used within a year.
 Current Liabilities: Accounts payable, short-term loans, accrued expenses, and other
obligations due within a year.
 3. Importance:
 Operational Stability: Sufficient working capital ensures that the company can meet
its short-term expenses without financial strain.
 Flexibility: Adequate working capital provides a buffer for unforeseen expenses and
opportunities.
 Creditworthiness: Lenders and suppliers often assess working capital as a measure of
the company’s ability to repay debts and maintain stability.

Fund Flow Operation

Fund flow operation, or fund flow analysis, tracks the movement of funds within a
company over a specific period. It highlights how funds are generated (sources) and
utilized (applications) and provides insight into the financial health and decision-making
of a business.
Key Points:
1. Definition: Fund flow analysis involves preparing a statement (often called a fund
flow statement) that shows the changes in a company’s financial position by
examining sources and applications of funds between two balance sheet dates.
2. Purpose:
o Analyze Financial Position: Helps identify where the company’s funds come
from and how they are used.
 o Decision-Making: Offers management insights into cash flow, enabling more
informed decisions regarding financing, investment, and operational
strategies.
o Track Financial Movement: Unlike the cash flow statement, fund flow
statements also account for changes in working capital and non-cash
transactions, giving a fuller picture of financial resources.
Importance:
 Improves Financial Planning: Helps management understand how funds are
allocated and prioritize needs.
 Analyzes Liquidity: Identifies sources of funds and expenditures, aiding in assessing
liquidity for long-term projects.
 Highlights Non-Operational Cash Flows: Unlike the cash flow statement, fund flow
analysis includes non-cash items like depreciation and non-operational financing
activities.

Increasing Working Capital

Increasing working capital involves boosting the available funds a company has to cover its short-
term obligations and sustain its daily operations.

Benefits of Increasing Working Capital:

 Liquidity: Ensures that the company can meet its short-term obligations without facing
financial strain.

 Operational Flexibility: Allows the business to take advantage of new opportunities and
invest in growth initiatives.

 Creditworthiness: Improving working capital enhances the company’s ability to obtain

financing and better terms from creditors.

 Business Continuity: Adequate working capital helps prevent cash flow crises, ensuring that
day-to-day operations run smoothly.

Applications of Funds: Shows where funds are used, including:

 Purchase of Fixed Assets: Investing in equipment, property, etc.

 Repayment of Long-Term Debt: Settling outstanding obligations.

 Increase in Working Capital: Investing in inventory, accounts receivable, or other current

assets.

 Payment of Dividends: Distributing earnings to shareholders.

 UNIT 4

CASH BUDGET

A cash budget is a financial plan that outlines the expected cash inflows and outflows over a
specific period, usually monthly, quarterly, or annually. It helps an organization manage its
liquidity and ensure that it has enough cash to meet its obligations, such as paying bills,
salaries, and other expenses.

Importance of a Cash Budget:

1. Ensures Liquidity

2. Helps in Planning

3. Prevents Cash Shortages

4. Aids in Decision Making

5. Improves Financial Control

6. Builds Investor Confidence

7. Supports Growth

FLEXIBLE BUDGET

A flexible budget is a budget that adjusts or flexes based on changes in the level of activity or
volume, such as sales or production. Unlike a static or fixed budget, which remains unchanged
regardless of actual activity, a flexible budget provides a more accurate representation of costs and
revenues by adjusting for variations in activity levels.

Importance of a Flexible Budget:

1. More Accurate Performance Evaluation

2. Better Planning and Forecasting

3. Cost Control

4. Improved Decision Making

5. Performance Management

SALES BUDGET

A sales budget is a financial plan that estimates the expected sales revenue for a business
over a specific period, typically a month, quarter, or year.
Importance of a Sales Budget:

1. Guides Operational Decisions

2. Cash Flow Management

3. Goal Setting

4. Cost Control

5. Helps with Pricing and Marketing Strategies

6. Benchmark for Performance

PRODUCTION BUDGET

A production budget is a financial plan that outlines the expected production levels for a
business during a specific period, such as a month, quarter, or year. It helps ensure that the company
produces enough goods to meet the expected sales demand while managing resources efficiently.

Importance of a Production Budget:

1. Resource Planning

2. Cost Control

3. Inventory Management

4. Operational Efficiency

5. Financial Planning

Zero-based budget (ZBB)

A zero-based budget (ZBB) is a budgeting method in which every expense must be justified and
approved for each new period, regardless of whether it is a recurring cost or not. In contrast to
traditional budgeting methods, where the budget is built upon the previous year's figures with
incremental adjustments, zero-based budgeting starts from "zero," meaning no prior budget
assumptions are carried forward. Each department or unit must justify its budget requests in detail,
starting from scratch.

Importance of Zero-Based Budgeting:

1. Cost Efficiency

2. Better Resource Allocation

3. Improved Financial Discipline

4. Alignment with Organizational Goals

5. Transparency

6. Flexibility
 DEFINE BUDGETRY CONTROL

Budgetary Control refers to the process of comparing actual financial performance

with the budgeted figures to ensure that the organization's financial goals and targets are
achieved.

Merits of Budgetary Control:

1. Financial Discipline

2. Resource Allocation

3. Performance Evaluation

4. Improved Decision Making

5. Cost Control

6. Goal Alignment

7. Forecasting and Planning

8. Motivational Tool

9. Risk Management

10. Better Communication

TYPES OF BUDGET

 Sales Budget: Estimates expected revenue from sales.

 Production Budget: Plans the number of units to be produced based on sales and inventory.

 Cash Budget: Forecasts cash inflows and outflows to manage liquidity.

 Master Budget: A comprehensive budget combining all departmental budgets.

 Flexible Budget: Adjusts according to changes in activity levels or production.

 Zero-Based Budget: Starts from zero, justifying every expense anew each period.

 Capital Budget: Plans for long-term investments in assets like machinery or buildings.

 Operating Budget: Covers day-to-day operational costs like salaries and rent.

 Cash Flow Budget: Focuses on the timing of cash inflows and outflows.

 Departmental Budget: A budget prepared for individual departments.

 Income Budget: Projects the expected income or profit for a period.

 Performance Budget: Focuses on results and performance rather than just expenses.

 Expense Budget: Estimates expected costs or expenses over a period.

 Government Budget: Plans government income (taxes) and expenditure (public services).

 Project Budget: Focuses on the cost of a specific project, including labor and materials.
Unit 5

Break even point

The break-even point (BEP) is the point at which total revenue equals total costs, meaning there is
no profit or loss. It’s an essential concept in finance and business, as it helps to determine how much
sales or production is needed to cover all costs. Beyond the break-even point, any additional sales
contribute to profit.

Formula

For a simple calculation, the break-even point in units can be determined using this formula:

Break-Even Point (units)=Fixed Costs/Selling Price per Unit−Variable Cost per Unit

Fixed Costs are costs that do not change with the level of production (e.g., rent, salaries).

 Variable Cost per Unit is the cost that varies with production (e.g., raw materials).

 Selling Price per Unit is the price at which each unit is sold.

Example

Suppose:

 Fixed Costs = $10,000

 Variable Cost per Unit = $5

 Selling Price per Unit = $15

Then,

Break-Even Point (units)=10,000/15−5=1,000 units

This means you would need to sell 1,000 units to cover all costs.

Understanding the break-even point helps in pricing, cost control, and making strategic business
decisions.

Variance Analysis

Variance analysis is a financial analysis tool used to evaluate the difference between planned
(budgeted) and actual financial performance. It helps businesses understand why actual results
deviate from budgeted or standard costs and revenues, aiding in decision-making and performance
improvement.

Types of Variances

Variance analysis usually looks at two main types of variances:

1. Cost Variance - Differences between the budgeted cost and actual cost.

2. Revenue Variance - Differences between budgeted revenue and actual revenue.

Importance of Variance Analysis

 Identifies areas of concern by highlighting deviations from the budget.

 Improves cost control by focusing on variances that negatively impact profitability.

 Assists in future planning by understanding patterns and reasons for variances.

Standard costing

Standard costing is a cost accounting method that assigns expected or "standard" costs to goods
and services, rather than actual costs.

Benefits of Standard Costing

1. Efficiency Measurement: Provides benchmarks to measure performance and operational

efficiency.

2. Cost Control: Allows management to identify and control costs by comparing actual costs to
standard costs.

3. Budgeting and Forecasting: Facilitates more accurate budgeting and financial planning by
establishing cost expectations.

4. Pricing Decisions: Helps in setting prices that can cover costs and achieve profitability.

5. Variance Analysis: Identifies areas of improvement through variance analysis, supporting

continuous improvement in operations.

Example of Standard Cost Calculation

For a product, suppose:

 Standard Direct Material Cost: $10 per unit

 Standard Direct Labor Cost: $15 per unit

 Standard Overhead Cost: $5 per unit

Then, the Total Standard Cost per Unit would be:

Standard Cost per Unit=10+15+5=$30

If the actual cost per unit is $32, the variance is $2 (unfavorable), indicating costs were higher than
expected.
Standard costing and Budgetry costing

Types of material, labour and sales

Marginal costing

Marginal costing (also known as variable costing or contribution costing) is an accounting approach
that focuses on variable costs associated with producing an additional unit of a product. This method
includes only variable production costs (like direct materials, direct labor, and variable manufacturing
overhead) in product costs, while treating fixed costs (like rent and salaries) as period costs, meaning
they are expensed in full in the period they occur.

Key Concepts in Marginal Costing

1. Contribution Margin: Marginal costing emphasizes the contribution margin, which is the
difference between sales revenue and variable costs. It represents the amount available to
cover fixed costs and generate profit.

Contribution Margin=Sales−Variable Costs

or, per unit,

Contribution Margin per Unit=Selling Price per Unit−Variable Cost per Unit

Break-Even Analysis: Marginal costing aids in determining the break-even point, where total revenue
equals total costs, indicating no profit or loss.

Break-Even Point (units)=Total Fixed Costs/Contribution Margin per Unit

Profit Calculation: Profit can be calculated by subtracting fixed costs from the total contribution
margin.

Profit=Total Contribution Margin−Fixed Costs

Marginal Cost: This is the cost of producing one additional unit, which includes only variable costs. In
marginal costing, fixed costs are not considered in product costing because they do not vary with
production level.

Example of Marginal Costing

Suppose a company produces a product with the following information:

 Selling Price per Unit: $50

 Variable Cost per Unit: $30

 Fixed Costs: $10,000

Contribution Margin per Unit

Contribution Margin per Unit=50−30=20

Break-Even Point

Break-Even Point (units)=10,000/20=500 units

This means the company needs to sell 500 units to cover all fixed and variable costs.

Benefits of Marginal Costing

1. Simplified Decision-Making: Helps management in decision-making by clearly showing how

changes in sales volume impact profitability.

2. Cost Control: Enables better control of variable costs and more accurate cost analysis for
production decisions.

3. Pricing and Sales Decisions: Assists in setting prices for special orders or additional units by
considering only incremental costs.

4. Flexible Budgeting: Useful in flexible budgeting, as it separates fixed and variable costs,
making it easier to adjust costs with changes in activity levels.

P/V ratio

The PV Ratio (or Profit-Volume Ratio), also known as the Contribution Margin Ratio, is a key metric
in cost-volume-profit (CVP) analysis. It represents the relationship between contribution margin and
sales and shows the portion of sales revenue that contributes to covering fixed costs and generating
profit. The PV ratio is a useful tool for analyzing profitability and helps in decision-making related to
pricing, cost control, and profit planning.

Formula

The PV Ratio can be calculated in several ways:

1. Using Contribution Margin and Sales:

PV Ratio=Contribution MarginSales×100

Using Contribution Margin per Unit and Selling Price per Unit:

PV Ratio=Contribution Margin per Unit/Selling Price per Unit×100

Using Change in Profit and Change in Sales (when comparing two periods):

PV Ratio=Change in Profit/Change in Sales×100

Where:

 Contribution Margin is the difference between sales and variable costs.

Example

Suppose:

 Sales = $100,000

 Variable Costs = $60,000

The Contribution Margin is:

Contribution Margin=Sales−Variable Costs=100,000−60,000=40,000

The PV Ratio is:

PV Ratio=Contribution MarginSales×100=40,000100,000×100=40

This means that 40% of each dollar of sales contributes to covering fixed costs and generating profit.

Importance of PV Ratio

1. Profitability Analysis: A higher PV ratio indicates that a larger percentage of sales contributes
to profit after covering variable costs.

2. Break-Even Analysis: Helps in calculating the break-even point and determining the level of
sales required to cover fixed costs.

3. Profit Planning: Assists in assessing the impact of changes in sales volume on profit.

4. Decision-Making: Supports decisions on pricing, product mix, and cost control by

highlighting the profitability of different sales levels.

Relationship with Break-Even Point

The PV Ratio is directly related to the break-even point. The higher the PV ratio, the lower the sales
volume needed to break even, since a larger portion of sales is contributing to covering fixed costs.

Break-Even Sales=Fixed Costs/PV Ratio