Marginal Costing Formulas

Marginal Costing Equation: We know that profit is difference between sales & total cost. Total can bifurcated in to Fixed & Variable costs. Thus,

Profit = Sales – Total Cost. (Variable + Fixed Cost).

Fixed Cost + Profit = Sales – Variable Cost.

The above equation termed as Marginal Costing equation.

Fixed Cost: F.C ,as the name suggests, remain fixed in amount. The amount spent towards such an expensive remains the same irrespective of the Volume of production. They may have to be incurred even if there is no production. For ex: rent of factory building has to be paid irrespective of whether or not production is taking place. Ex: Salaries, Audit fees, go down rent etc.,

Variable Cost: Variable cost varies in direct proportion to the volume of production. No variable costs are included if production is stopped. As production increases, variable costs increase. However, Variable cost P.U will not change. For Ex: if it is estimated that 2 units are required to produce 1 unit of finished product, then material cost will continue to increase as the number of units finished stock desired increases. All direct costs are Variable cost. Commission to sales persons, Certain taxes., etc.

Semi -Variable Cost: S.V.C change with the changes in out put of production, but the change not proportionate. For the purpose of analysis, S.V.C are split in to Fixed Cost and Variable Cost. S.V.C normally has a fixed cost component, which needs to be incurred irrespective of no. of units produced. Telephone expenses are a example of S.V.C. Telephone exp. Can be split in to a fixed component of a rent, that needs to be paid whether or not the telephone is used. The charge for every call made constitutes the variable component.

Two point Method: Under this method, the out put at two different levels is compared with corresponding amount of semi variable expenses. Since fixed costs, the change in amount of expenses is on account of variable costs, divided by the change in out put, gives the variable costs per unit. If the number of units at a given level of output are multiplied with variable cost per unit, we get the variable proportion in the total amount of expenses at the given level. The difference between the two amounts gives us the ‘Fixed Cost’ component in the semi – variable cost.

Contribution: Contribution is the difference between sales and Variable Costs. Since sales & Variable Cost can be both be expressed in P.U. terms, contribution is usually expressed in P.U. terms.

Contribution = Sales –Variable Cost

Contribution P.U. = Selling Price P.U.= Selling Price P.U. – Variable Cost P.U.

Total contribution = Contribution P.U. X No. of Units.

“ “ Total Sales – Total Variable Cost.

P/v Ratio: P/v Ratio stands for Profit /Volume Ratio. However, it is ratio of contribution to sales. (The term Profit is used as fixed costs are not considered in Marginal Costing technique & profit is same as Contribution).

= P/v Ratio = Contribution / Sales; Sales-Variable Costs/ Sales;

1-V.C/Sales; Change in Profit(Contribution)/Change in Sales;

BEP ( Break – Even Point ):

BEP= Fixed Cost / P/V Ratio;

In Units : Fixed Cost / Contribution P.U;

Fixed costs / Selling Price P.U. – Variable Cost P.U;

BEP (Sales in Volume) BEP in Units X Selling Price P.U

= Fixed Cost X Total Sales / Total Sales – Total Variable Cost.

Units for Desired Profit = Fixed Cost + Desired Profit/ Contribution P.U.

Sales for Desired Profit = Fixed Cost / Desired Profit / P/v Ratio.

Margin of Safety (MOS) = Total Sales – BEP Sales

Example:

Sales Rs.50, 000; Fixed Cost Rs.1, 00,000; Profit Rs.1, 50,000;

Find out the following (i) P/V Ratio (iii) BEP (iv) MOS

Sol: P/V Ratio = Contribution / Sales

Contribution = Sales – Variable Cost; Fixed Cost + Profit / Sales

Sales = Rs.50, 000, Profit = Rs.1, 50, 000

1, 00, 000 + 1, 50, 000 / 5, 00, 000

= 0.5 or 50%.

I.e. P/v Ratio = 0.5 or 50%;

BEP = Fixed Cost / P/V Ratio

Fixed Cost = Rs.1, 00, 000; P/V Ratio = 0.5 or 50%;

BEP = 1, 00, 000 / 50%

= 2, 00, 000

Margin of Safety (MOS) = Total Sales – Break – Even Sales

.5, 00, 000 – 2, 00, 000 = 3, 00, 000.

Balance Sheet Ratios

Balance Sheet Ratios

1. Current or Working Capital Ratio: (Test of Liquidity)

*C.R = Current Assets/ Current Liabilities

Since C.A are expected to be converted in to cash with in the normal period and since C.L are satisfied by use of C.A. The C.A generally considered being an indicator of the ability of the business to pay its current debts promptly.

C.R is also a measure of the liquidity of the business. And also to determine the solvency of the business enterprise, that is the probable ability of the business to meet its debts promptly & with out loss.

Satisfactory Current Ratio

The ultimate results of all factors is that the financial analysts usually accept that an organization have its C.L covered at least twice by C.A. Thus a minimum 2 to 1 (2:1) C.R is often referred as a ‘rule of thumb’. Standard of liquidity of business, especially from the point of view of short term creditors such as bankers.

Factors affecting Current Ratio

1. The ability of the business to convert debtors, Bills Receivables & stock in to cash determines the extent of C.R. 1 to 1 (1:1) C.R is sufficient in business enterprise in which there is quick stock turnover & collection of debtors because in that case the requirement of working capital would be low. On the other hand a business engaged in the prolonged manufacturing process requires more working capital & hence a high C.R.
2. Seasonal fluctuations also have considerable impact on the C.R. A larger amount of working capital is needed in the peak season when there are heavy purchases of raw materials &production is in full swing. The liabilities may be assumed. As goods are sold, the stock of goods is replaced debtors & B. Receivables. While cash is diminished by the expenses of operation. The cycle is completed when the repayment of Liabilities.

Window Dressing:

For keeping C.R. at a satisfactory level the enterprises uses manipulation or malpractice. It is commonly known as Window Dressing. One of the most common devices used to enhance C.R. is to avoid purchase of goods just before the closing of the books of accounts. The Balance sheet also window Dressed by sale of Fixed Assets, Sale of Debentures.

3. Liquid, Quick or Acid Test Ratio:

= *Quick Assets-(stock +prepaid Exp.) / C.L–(Bank over Draft)

Satisfactory Level:

It indicates a satisfactory liquidity position for the simple reason that the ratio is more than the required yardstick of 1 to 1 (1:1). It may be emphasized that sometimes the investors are more liquid than the debtors & B. Receivables, especially under condition of scarcity.

Balance sheet Ratios Regarding Long Term Position:

1. Proprietary Ratio (Equity – Asset Ratio/ Net worth – Total Asset Ratio (Test of Solvency)

= *Total Shareholders Equity / Total Assets

The ratio should probably be expressed in percentage which can never exceed 100% & it would at the most equal to 100 when there are out side liabilities.

The ratio is of particularly importance of the investors because the presence of a high performance of shareholders fund indicates that there is relatively little danger of winding up or forced reorganization in the event of default in payments to outside liabilities.

Satisfactory Level:

A low proprietary ratio indicates that in the event of financial difficulties the sharejolders may receive little if any of their original investment.

Then the higher proprietary ratio des not it self show that the business is sound. An equity ratio of say 80% or 100% would not necessarily good because sometimes funds from outsiders can be used to the long run advantage of the business enterprises.

2. Asset Proprietorship Ratio:

i. Fixed Asset to Proprietors Fund

ii. C.A to Proprietors fund

F.A to P.F : It expresses the relation of the F.A with funds contributed by the owners or shareholders. In this there are no fictitious assets.

F.A/P.F*100

If the ratio is unduly high the enterprise may be handicapped as 100 much capital is not circulating but it is locked up in F.A.

C.A to P.F: This ratio designed to express the percentage of the amount invested in the C.A to the total funds of the Proprietors.

Total C.A / Total P.F *100

Funds Flow Analysis

The Funds flow analysis explains the various sources from which funds are raised and uses to which funds are put. It shows the change in assets and liabilities from the end of one period of time to the end of another period of time (i.e. between two Balance sheet dates). An analysis of statement helps us in answering question such as what is the amount of funds generated from Operations. How were the Fixed Assets of Organisation Financed? Whether the liquidity position of the organization increased? Etc.

Concept of Funds

The term fund has been defined and interpreted differently by different experts. Broadly the term fund refers to all the financial resources of the company. On the other extreme, fund has been understood as Cash only. However, the most acceptable meaning if funds is working capital. Working capital is the excess of current assets over current liabilities.

Concept of Flow

The flow of funds refers to transfer of economic values from one asset or equity to another. When funds mean working capital, flow of funds refers to changes in assets and liabilities, which cause a change in working capital of the organisaton. To identify a flow of funds, we have to understand the difference between current and Non – current Accounts.

Current Accounts and Non – Current Accounts.

Any account which is either current asset or a current liability is a current account. An account which is neither current asset nor current liability is Non – Current Account.

The concept of current accounts is important as fund implies working capital, which is the difference between current assets and current liabilities. If there is a change in a current account, there is a Possibility of Flow of funds If there is no change in any of the current accounts, there is cannot be any flow of funds.

General Rule

1. Transactions that involve only current Accounts do not result in a flow. In other words, if both the accounts getting impacted on account of a transaction are Current accounts there is no change in position of funds.
2. Similarly, transactions that involve only Non – Current Accounts also do not result in a flow.
3. Transactions that involve one current account and one non – current account results in a flow of funds.

Examples:

1. Cash Purchases Rs.10,000/-

In this transactions two current accounts are affected i.e. Cash & Stock. Firstly there is a decrease in cash. Therefore, C. Assets will fall by Rs10,000/-. However there is increase in Stock Therefore, C .Assets will rise by Rs.10,000/-. There is no effect in Current Assets and Working Capital. So, there is no flow of Funds.

2. Bills Payable accepted Rs.5,000/-

In this transaction two Current Liabilities are affected. Creditors are reduced by Rs.5,000/-. However, Bills Payable increase by Rs.5,000/-. No net change in Current Liabilities and Working Capital. So, there is no flow of funds.

3. Cash Paid to Creditors Rs.2,000/-

In this transaction, cash gets reduced by Rs.2,000/-. Thus, C.A decreased by Rs.2,000/-. However, creditors are also reduced by Rs.2,000/-. Consequently, C.L decrease by Rs.2,000/-. Since Working Capital is the difference in C.A and C.L, it remains same as the change in C.A is equal to the change in C.L There is no flow of funds.

4. Issue of Bonus shares to equity share holders out of General Reserve in the ratio 1:1

The effect of this transaction is the Equity share capital of the company gets doubled. However, the reserves of the company come down. Both accounts are non-current accounts. The current accounts are not affected. There is no flow of funds.

5. Land Purchased for Rs.3,00,000/-, payment made by cheque.

In this account cash at Bank, a current account gets reduced. Consequently, there is a fall in working capital to the extent of Rs.3,00,000/-. A new asset, land is acquired. However, it being a non-current account, it does not affect the working capital. Therefore the net affect is a fall in working capital to the extent of Rs.3,00,000/-. There is an outflow of funds.

6. Sale of Building for Rs.10,00,000/-

In this transaction, the amount received on sale is current asset. The current asset increased by Rs.10,00,000/-. Consequently, working capital increased by Rs.10,00,000/-. The business has to part with an asset worth Rs.10,00,000/-, but building being a non-current account, it does not affect working capital. There is an inflow of funds.

Preparation of Funds Flow Statement

The funds flow statement is prepared to reflect the changes in the financial position of an organization during a particular period. As such, Balance sheets of the organization at the beginning and end of the particular period are the basic documents that are needed for preparation of funds flow statement

The fund flow statement can also be presented in a vertical form. In such a case, all sources are listed down, totaled and then all Applications are listed at one place and totaled. The totals should be the Increase and decrease in Working capital.

Statement of changes in Working Capital

This statement follows the statement of Sources and Application of Funds. The primary purpose of the statement is to explain the net change in Working Capital, as arrived in the Funds Flow Statement. In this statement, all current Assets and Current Liabilities are individually listed. Against each account, the figure pertaining to that account at the beginning and at the end of accounting period shown. The net change in its position also shown. The changes taking place with respect to each account should and up to equal the net change in working capital, as shown by the Funds Flow statement.

While entering the effect of change in a current account on working capital, the following rules must be followed.

1. An increase in Current Assets means an increase in Working Capital;
2. An decrease in Current Assets means an decrease in Working Capital;
3. An increase in Current Liabilities means an decrease in Working Capital;
4. An decrease in Current Liabilities means an increase in Working Capital;

Time Value of Money

The time value of money is the basis of the mathematics of finance determination of the time value of money in financial decision making is extremely important. The objective of wealth maximization much of the subject matter of financial management is future oriented. The financial decision taken day has implications for a number of years i.e. if spreads into the future

Ex Firms have to acquire fixed assets for which they have to pay a certain sum of money to the vendors (cash outflows). The benefits arising out of the acquisition of such assets will be spread over a number of years. In the future till the waking life of the assets.

On the other hand funds have to be procured from different sources such as rising of capital through new issues. Bank borrowings, term loams from financial institutions, sale of debentures & so on. These as well as an obligation to pay interest/Dividend & return the principle in future.

It is on the basis of comparison pf the cash out flows & the benefits (cash inflows) that financial decisions are made for a meaningful comparison. One basic requirement of compatibility is the incorporation of time element in the calculations.

In other words in order to have a logical and meaningful comparison between cash flows and that accrue in different time period. It is necessary to convert the sums of money to a common point of time.

Definition: “Time value of money means that the value of a unit of money of different in different time periods”.

The value of sum of money receive today is more than its value received after some time. The sum of money received in future is valuable than it is today. The present worth of rupee receive after sometime will be less than a rupee receive today.

The main reason for the time preference for money is to be found in the reinvestment opportunities for funds which are received early. The funds so invested will earn a rate of return. This would not be possible if the funds are received at a later time.

The capital budgeting decision s generally involves the current cash outflows in terns of the amount required for purchasing a new machine or lunching a new project and the execution of the scheme generates future cash inflows during its useful life.

Ex: Assume that the project cost (current cash outflows) as Rs.10lakhs. Assume it has a life of only one year in which it is estimated to have cash inflows Rs.10.80lakhs (at the end of first year). This project is acceptable as it adds Rs.80,000 as profit. However when we take into account a rate of interest. Say 10% the earlier conclusion has to be realized as without the project the sum could have amounted to Rs.11lakhs.

If the decision us made to raise at loan of Rs.10lakhs from a financial institution or by issuing debentures for a period of 10 years. The firm is not only under obligation to make interest payment as and when it becomes due on debt of fixed intervals, but also must make a provisions. So that it can we pay Rs.10lakhs when the loan or debenture becomes due. Thus time value of money is of critical significance. This requires the development of processors and techniques for evaluating future incomes in terms of the present.

Financial Management

Introduction:

Financial Management is that managerial activity which is concerned with the planning & controlling of firms financial recovers.

Firms creating manufacturing capacities for production of goods and services to their customers and sell it to earn Profit. Funds are acquiring manufacturing and other facilities.

A firm secure whatever capital it needs and employs it in activities (Finance activity) which generate returns a invested capital. (Production & marketing Service)

The function of raising fund interesting them in asset and distributing returns earned from asset to share holders are respectively known as financing investment and dividend decisions.

Real Assets:

1.Tangible Assets:

Plant & Machinery

Building

Furniture

2. In Tangible Assets:

Goodwill

Patents & Copy Rights

3. Financial Assets:

Shares

Debentures

Lease obligation

Borrowings

Finance may be defined as the Art and Science of managing money. The major areas of financing are

(i) Financial Services:

It is concerned with the designed and delivery of advice and financial products to the individuals, business and Govt. with the areas of banking and related institutions, personals financial planning, investments, real estate, insurance and so on.

(ii) Financial Management:

It is concerned with the duties of financial managers in the business firm. Financial managers actively manage the financial affairs of any type of business. Namely financial and non-financial, private & public, large & small, Profit Seeking & not for profit. They performs varied tasks as budgeting, financial forecasting. cash management, credit administration, investment analysis find management and so on.

Managing financial management:

The term F.M has been defined differently by different authors. According to Solomon “Financial management is concerned with the efficient use of an important economic resource, namely Capital funds”

There are two basic aspects of F.M

(i) Procurement of Funds

(ii) Effective use of these funds.

(i) Procurement of Funds: Since funds can be obtained from different sources therefore their procurement always considered as a complex problem by business concerns. Funds procured from different sources have different characteristics in terms of risk control & cost.

The funds raised by the issue of equity shares are the best from the risk point of view for the company. Since these are no question of repayment of equity capital except when the company is under liquidation from the cost point of view. However, equity capital is usually the most expensive source of funds. This is because the dividend expectations of share holders are normally higher than prevalent interest rate and also because dividend is an appropriation of profits not allowed as an expense under the income tax act. Also the issue of new shares to public may dilate the control of the existing share holders.

(ii) Effective of Utilisation of funds:

The financial manager is also responsible for effective utilization of funds he has to point out situation where the funds are being kept idle or where proper use of funds is not being made.

All the funds are procured at a certain cost and after entailing a certain amount of risk. If these funds are not utilized in the manner so that they generate an income higher than the cost of procure them. There is no point in running the business. This is also an important consideration on dividend decision.

Analysis of Variance - Sales Variance

Sales variance.

The analysis of variances will be complete only when the difference between the actual profit and standard profit is fully analyzed.

Profit method of calculating sales variances:

The sales variances according to this method can be analyzed as:

1. Total sales margin variance (TSMV).

Actual Profit – Budgeted Profit Or Actual Quantity Of Sales X Actual Profit Per Unit – Budgeted Quantity Of Sales X Budgeted Profit Per Unit.

2. Sales margin variance (SMV) due to volume:

It is that portion of total sales margin variance which arises due to the number of articles sold being more or less than the budgeted quantity of sales.

Standard Profit Per Unit (Actual Quantity Of Sales – Budget Quantity Of Sales)

3. Sales Margin variance (SMV) due to selling price:

It is that portion of total sales margin variance which is due to the difference between the actual price of quantity of sales affected and the standard price of those sales. It is calculated as:

(actual selling price per unit – standard selling price per unit)

Value method of calculating sales variance:

Sales variances calculated according to value method show the effect on sales value and enable the sales manager to know the effect of the various sales efforts on his overall sales value figures. Sales variances according to this method may be as follows:

1. Sales value variance (SVV):

It is the difference between the standard value and the actual value of sales affected during a period.

It is calculated as:

Sales value variance = actual value of sales – budgeted value of sales.

2. Sales price variance:

It is that portion of sales value variance which arises due to the difference between actual price and standard price specified.

The formula is:

SPV = actual quantity sold (actual price – standard price)

3. Sales volume variance (S.Vol.V):

It is that portion of the sales value variance which arises due to the difference between actual quantity of sales and standard quantity of sales.

Formula:

Sales volume variance = standard price (actual quantity of sales – budgeted quantity of sales.

Analysis of Variance - Labour Variance

Labour variance

Labour variances can be analyzed as follows:

a) Labour cost variance:

It is the difference between the standard cost of labour allowed (as per standard laid down) for the actual output achieved and the actual cost of labour employed. It is also known as wages variance.

Labour cost variance= standard cost of labour – actual cost of labour.

b) Labour rate variance:

It is that portion of the labour cost variance which arises due to the difference between the standard rate specified and the actual rate paid.

It is calculated as follows:

Rate of pay variance = actual time taken (standard rate – actual rate)

c) Total labour efficiency variance:

It is that part of labour cost variance which arises due to the difference between standard labour cost of standard time for actual output and standard cost of actual time paid for.

It is calculated as follows:

Total labour efficiency variance = standard rate (standard time for actual output – actual time paid for)

d) Labour efficiency variance:

It is that portion of labour cost variance which arises due to the difference between standard labour hours specified for the output achieved and the actual labour hours spent.

Labour efficiency variance = standard rate (standard time for actual output – actual time worked)

e) Labour idle time variance:

It is calculated only when there is abnormal idle time. It is the portion of labour cost variance which is due to the abnormal idle time of workers. While calculating labour efficiency variance abnormal idle time is deducted from actual time expended to ascertain the real efficiency of the workers.

Labour idle time variance is expressed as:

Idle time variance = abnormal idle time x standard rate.

Total labour cost variance = labour rate of pay variance + total labour efficiency variance

f) Labour Mix variance or Gang composition variance:

It is like materials mix variance and is a part of labour efficiency variance. This variance shows to the management as to how much of the labour cost variance is due to the change in the composition of labour force.

It is calculated as follows:

i) If there is no change in the standard composition labour force and total time expended is equal to the total standard time, the formula is:

Labour mix variance = standard cost of standard composition (for actual time taken) – standard cost of actual composition (for actual time worked).

ii) If the standard composition of labour force is revised due to shortage of a particular type of labour and total time expended is equal to the total standard time, the formula is:

Labour Mix variance = standard cost of revised standard composition (for actual time taken) – standard cost of actual composition (for actual time worked).

iii) If the total actual time of labour differs from the total standard time of labour, the formula is:

Total time of actual labour composition (standard cost of standard

-------------------------------------------------- x composition) – (standard cost of

Total time of standard labour composition actual composition)

iv) If the standard is revised and the total actual time of labour differs from the total standard time of labour, the formula for the calculation of labour mix is:

Labour mix variance =

Total time of actual labour composition (standard cost of revised standard ------------------------------------------------- x composition) – (standard cost of

Total time of revised standard labour actual composition)

composition

g) Labour yield variance:

It is like material yield variance and arises due to the difference between yield that should have been obtained by actual time utilized on production and actual yield obtained. It can be calculated as follows:

Standard labour cost per unit (actual yield in units – standard yield in units expected from the actual time worked on production)

h) Substitution variance:

This is a variance in labour cost which arises due to the substitution of labour when one grade of labour is substituted by another. This is denoted by difference between the actual hours at standard rate of standard worker and the actual hours at standard rate of actual worker.

Substitution variance = (actual hours x standard rate for standard worker) – (actual hours x standard rate for actual worker)