Conceptual Framework of Financial

Performance
Financial performance depends on revenue and cost.
Revenue is provided from sales of merchandise by retailers, sales of
products and sale of services.
Companies generate three types of costs including discretionary,
engineered and committed costs.
Various costs fall into one of these three categories based on the
cause and effect relationships involved.
These three cost concepts are summarized in next slides.

Discretionary Cost
Many activities are viewed as beneficial to an organization, even
though the benefits obtained or value added by performing the
activities cannot be defined precisely , either before or after the
activity is completed.
The costs of the inputs, or resources required to perform such
activities are referred to as discretionary costs.
These costs are discretionary in the sense that management must
choose the desired level of the activity based on intuition or
experience .
Examples include employee training, advertising, sales promotion,
legal advice
Engineered costs
Engineered costs result from activities with reasonably well defined
cause and effect relationships between inputs and outputs and costs
and benefits.
Direct material costs provide a good example.
Engineers can specify precisely how many parts (inputs) are required
to generate a specific output such as a microcomputer, a coffee
maker, an automobile, or a television set.
Value addition by the activity is easy to measure.
Committed costs
Committed costs refers to the costs associated with establishing and
maintaining the readiness to conduct business.
The benefits obtained from these expenditures are represented by
the company's infrastructure.
For example, the costs associated with the purchase of a franchise, a
patent, drilling rights.


Marketing ROI
It is different from Corporate ROI.
It is basically a relationship between Net Marketing Margin (NMM)
and Investment in Marketing Operation.
Here manufacturing and marketing department are two different
profit center so performance measurement will be separate.
So amount of total costs and revenue have to be earmarked
differently.
For manufacturing organization non marketing allocations will be
more that of trading organization.

COSTVOLUME PROFIT
ANALYSIS
CVP ANALYSIS
Shows the relationships between cost sales and net profit.
It helps to ascertain the financial performance at a given level of
sales.
It helps to know the break even level for an organization where total
revenue equalize the total cost.
Assumptions;
Fixed cost remain static & marginal costs are completely variable at all
levels of output.
Selling prices are constant at all sales volume.
Factor prices are constant at all sales volume .
Efficiency and productivity remain unchanged. In a multi product
situation ,there is constant sales mix at all level of sales.
Turnover level is only relevant factor affecting cost & revenue.
Value of production is equal to volume of sales.
ELEMENTS-
MARGINAL COST EQUATION
CONTRIBUTION MARGIN .
PROFIT /VOLUME RATIO .
BREAK EVEN POINT .
MARGIN OF SAFETY.
MARGINAL COST EQUATION
SALES=VARIABLE COSTS +FIXED
EXPENSES+P/L
OR
S-V=F+P/L
CONTRIBUTION MARGIN-
CONTRIBUTION =SELLING PRICE MARGINAL COST
OR
C=F+P/L
OR
C-F=P/L

PROFIT /VOLUME RATIO;
P/V=CONTRIBUTION /SALES
OR
F+P/L/V.C+F.C+P/L=[F+P/S]
OR
S-V/S=CHANGE IN PROFITS OR CONTRIBUTION/CHANGE IN SALES
BREAK EVEN POINT;
B.E.P=FC/P/V
OR
TOTAL FIXED EXPENSES/S.P PER UNIT-MC PER UNIT
OR
TOTAL FIXED EXPENSES/CONTRIBUTION PER UNIT
VALUE OF SALES TO EARN DESIRED
AMOUNT OF PROFIT ;
SALES=F.C+D.P/P/V RATIO
MARGIN OF SAFETY ;
MOS=PROFIT/P/V RATIO
Assignment 1
ABC Ltd has provided the following information
Sales @ Rs. 5 per unit.- 20000 units
Variable cost p.u.-Rs.3
Fixed Cost Rs.8000
Calculate PV Ratio and Break even sales.
Assignment 2
Following data is given by XYZ Ltd.
Sales @ Rs 10 pu -100000
Variable cost per unit Rs.6
Fixed cost 300000
Calculate Margin of safety.
Assignment 3
A company producing a single product sells it at Rs.50pu . Unit variable cost
is Rs.35 and fixed cost is Rs.1200000.
Find out Break Even Sales and P/V ratio.
New break even sales if variable cost increase by Rs.3 pu without increase
in selling price.
Increase in sales required if profits are to be increased by Rs.2.4 lakh
Percentage increase or decrease in sales volume units to set off
An increase of Rs.3 in the variable cost per unit
A 10% increase in selling price without affecting existing profit profits
quantum
Quantum of advertisement expenditure permissible to increase sell by 1.2
lakhs without affecting existing profit quantum.
Assignment 4
Material cost 120 Labour Cost 30 Overhead is 12
Selling price 270
Fixed cost 14 lakhs
Sales 40.5 lakhs.
During forthcoming year direct workers will be entitled a rise in 10%
Material cost will rise by 7.5% and overhead by 5%
Fixed cost will rise by 3%
Find New sales price in the forthcoming year if current P/V ratio is tobe maintained.
Number of units that would require to be sold during the forthcoming year to have
the same amount of profit in the current year without increasing the selling price.
Concept of Return on Investment
ROI = Net Profit/Capital Employed
Further Decomposed it is the multiplication of Net Profit Ratio and
Capital turnover Ratio
NPR is NP/Sales
CTR is Sales/Capital Employed
Assignment 1

Fixed asset 100
Working Capital 100
Sales 400 Variable cost of sales 300
Fixed Cost Operation 40
Fixed cost Finance Charges 20
Calculate ROI, CS Ratio and Capital Turnover Ratio, Margin of safety
Assignment 2
From the following details and with the help of previous data find out
Marketing ROI.
10% of operational fixed asset represents automobile ware house and
office equipment used for marketing division.
60% represents finished inventory and net receivables
Finance charges is calculated at the rate of 10% on Capital employed.
Rs320 is the transfer prices of goods from manufacturing to marketing.
Marginal cost for marketing dept is 350 includes 320 from transfer price
and 30 additional variable marketing expenses.
Operation fixed cost allocated to non marketing departments as 18
Calculate the Marketing NOI for the said department.
Assignment 3
A company has a margin of safety at 20% and a profit of Rs.4 lakhs. If
its contribution to sales is 0.4 calculate its current sales and fixed cost.
Multi Product Sales Mix
A manufacturer may have more than one product and also their sales.
The relative proportion of each product sold in the aggregate sales is
termed as sales mix
A change in the mix of products sold usually affects the weighted
average P/V Ratio and hence the BEP
So when the product have different P/V Ratios changes in the sales
mix will affect the BEP.
Assignment
Three products X Y and Z have their sales at 100000, 60000, 40000
respectively. Their variable costs are 80000, 42000, 24000
respectively. Fixed cost for the firm is 27000 find out the break even
sales for the firm.
If Rs.40000 sales of the product X could be shifted equally to product
Y and Z then what will be the new profit and new BEP sales for the
firm.
Impact of selling price, Fixed Cost and
Variable cost on BEP.
An increase in selling price increases the amount of contribution
resulting in improvement in P/V Ratio and vice versa.
The increase or decrease in fixed cost does not affect the P/V ratio
even though it may increase or decrease the total profit.
Increase in variable cost per unit will reduce the contribution and
result to decrease in P/V Ratio and vice versa.
The increase in P/V Ratio means lower break-even point and higher
margin of safety and vice versa.
Make an analysis of the below mentioned
assignment.
Selling price per unit Present Rs.50 Proposed Rs.40
Variable Cost per unit Present Rs.30 and Proposed Rs.30
Fixed Cost p.a. Rs.60000 in both arrangements.
Production units 10000 units in both the cases.
Calculate P/V Ratio Break Even Point and Margin of safety and
comment on the situations of lowering selling price per unit in the
light of previous slides discussion.
Assignment
A company wants to buy a new machine to replace one which is having a
frequent break down. It received offers for two models M1 and M2.Further
details of these two models are given below.
Installed capacity in units for M1 10000 and for M2 10000
Fixed overhead p.a. for M1 Rs. 240000 and for M2 Rs. 100000
Estimated profit at the above capacity M1 Rs 160000 and M2 Rs.100000.
The product manufactured using this type of machine M1 or M2 is sold at
Rs.100 per unit.
You are required to find out the Break Even level of sales for each model.
The level of sales at which both the models will earn the same profit.
Assignment
The following figures relate to a company manufacturing a varied
range of product.

Total Sales Total Cost
Year ended 31
st
March 2005 22,23,000 19,83,600
Year ended 31
st
March 2006 24,51,000 21,43,200
Assuming stability in price with variable cost carefully controlled to reflect predetermined relationship and
an unvarying figure cost calculate the following
P/V Ratio, Fixed Cost,Fixed Cost % to Sales, Break even point and margin of safety for the year ended 2005
and 2006.
Assignment
XYZ Ltd has to decide between launching one or two similar new
products. It does not have the production capacity to launch both the
product. Fixed Cost for the company is Rs.20000 p.a. Product A can be
sold at Rs.400 per item and product B at Rs.350 per item. The variable
unit cost are Rs.240 for Product A and Rs.200 for product B. The likely
demand for both the products are given by the following probability
distribution. Calculate the Break-even point for both the product and
estimate the profitability of these two products.
Likely Demand Probability of A Probability of B
100 0.1 0.3
200 0.3 0.4
300 0.4 0.2
500 0.2 0.1
Total 1.0 1.0
Practical application of Linear
Programming technique
Allocation of scares resources : Limited resources to be allocated to
various products.
Product mix problems Capacity utilization optimization so that
profit can be maximized.
Determinations in joint product profitability In case of product
involving joint cost where one or more of the joint products may be
processed further. LP may help determine the profitability of further
processing.
Cost volume profit analysis for Multi product cost volume profit
analysis.

To formulate the LPP
Objective Functions : The objective functions of each problem is a
mathematical representation of the objective in terms of a
measurable quantity such as profit, cost, revenue etc.
It should be an optimization function either to maximize or to
minimize.
Constraint functions : There are always certain limitations on the use
of limited resources like labour, machine, raw material etc.
Such constraints must be expressed as linear equalities or inequalities
in terms of decision variables.
The solution of an LP model must satisfy these constraints.
Guidelines for formulations
Express objective function in words.
Define the objective function whether to maximize or minimize.
Express them in mathematical terms.
Express it as a linear function of decision variables multiplied by their
profit or cost considerations.
Define decision Variables: Express each constraints in words
Formulate the constraints imposed by the resource availability and
express them in linear equality or inequality in terms of decision
variables defined.
.
Assignment
A firm is engaged in producing two products. A and B. Each unit
of product A requires 2 kg of raw material and 4 labour hours for
processing, where as each unit of B requires 3kg of raw materials
and 3 labour hours for the same type. Every week, the firm has
an availability of 60 kg of raw material and 96 labour hours. One
unit of product A sold yields Rs.40 and one unit of product B sold
gives Rs.35 as profit. Formulate this as an Linear Programming
Problem to determine as to how many units of each of the
products should be produced per week so that the firm can earn
maximum profit.
Assignment
A firm can produce 3 types of cloth, A , B and C.3 kinds of
wool are required Red, Green and Blue.1 unit of length of
type A cloth needs 2 meters of red wool and 3 meters of blue
wool.1 unit of length of type B cloth needs 3 meters of red
wool, 2 meters of green wool and 2 meters of blue wool.1
unit type of C cloth needs 5 meters of green wool and 4
meters of blue wool. The firm has a stock of 8 meters of red,
10 meters of green and 15 meters of blue. It is assumed that
the income obtained from 1 unit of type A is Rs.3, from B is
Rs.5 and from C is Rs.4.Formulate this as an LPP
Example for Formulation
A company can produce three products A,B and C. Products use a machine
which has 400 hours capacity in the next processing period.
Each unit of product uses 2, 3 and 1 hour respectively of the machines
capacity.
There are only 150 units available in the period of a special component
which is used singly in product A and C.
Only 200 kgs of special alloy is available in the product . Product A uses
2kgs per unit and product C uses 4 kgs per unit.
There is an agreement with a trade association to produce not more than
50 units of product B in the period.
The company wishes to have the production plan which maximizes
contribution where contribution per unit for A, B and C are Rs.8, Rs.5 and
Rs.10 respectively