Management Account- Fund flow-Cash flow.pptx

Fund flow statement and cash flow statement

1. VISION GROUP OF INSTITUTION B BA – 3 rd SEMESTER Management Accounting Unit 3 – Fund Flow and Cash Flow Analysis Unit 4 – Marginal Costing and Cost Volume Profit Analysis Ashish Singh

2. Fund Flow Statement MEANING A fund flow statement is a statement prepared to analyse the reasons for changes in the financial position of a company between two balance sheets. It portrays the inflow and outflow of funds i.e. sources of funds and applications of funds for a particular period. According to Foulke: “A statement of sources and application of funds is a technical device, designed to analyze the changes in the financial conditions of a business enterprise between two balance sheet dates.” Funds Flow Fund being working capital, Funds flow indicates the flow of working capital between two points of time. It involves information relating to the various transformations undergone by working capital (i.e. the changes that have taken place in working capital) during the period involved between the two points of time. Every change in working capital is associated with (or is on account of) a flow either an inflow or an outflow. Thus, funds flow involves information relating to the inflows and outflows that resulted in a change in working capital between the two points of time. Ashish Singh

3. Movement of Funds Ashish Singh

4. MANAGERIAL USES OF FUND FLOW STATEMENT The foremost use of the fund flow statement is to explain the reasons for changes in the assets and liabilities between two balance sheet dates. Fund flow statement gives details about the funds obtained and used in past. Based upon this detail; manager can take correct actions at appropriate times. Fund flow statement acts as a control device when compared with budgeted figures. It also gives guidance to the finance manager for taking remedial action if there is any deviation. It helps the management to formulate various financial policies-viz dividend, bonus etc. It gives guidance to the management with regard to working capital. Through fund flow statement, management can take proper steps for effective utilization of surplus working capital or in case of inadequacy, suitable arrangement can be made for improving the working capital position. It identifies the strong and weak financial areas of the firm. Effective utilization of available resources and scarce resources should be allocated according to the preferential needs. With the help of the fund flow statement, financial and lending institutions can easily evaluate the credit worthiness and repaying capacity of the borrowing company. It enables the management to reformulate the firm’s financial activity on the basis of the statement. Ashish Singh

5. LIMITATIONS OF FUND FLOW STATEMENT In the real sense, the fund flow statement lacks originality because it is only a rearrangement of data given in financial statements. It indicates only the past year’s performance and is not for the future. Even to prepare projected fund flow statement, it cannot show much accuracy. It cannot reveal continuous changes. Because only any particular two years are taken into account for analysis purpose. Fund flow statement is not a substitute for a financial statement. It gives only some information about changes in working capital alone. Ashish Singh

6. DIFFERENCE BETWEEN FUND FLOW ANALYSIS AND CASH FLOW ANALYSIS Cash flow statement starts with the opening cash balance and ends with the closing cash balance by processing through various sources and uses. But there is no opening and closing balances in fund flow statement. Cash from operation can be found out under the cash flow statement. But fund from operation can be found out under the fund flow statement. Separate statements are prepared for the purpose of finding out increase or decrease in working capital under the fund flow statement. But no separate statements for increase or decrease in working capital are prepared in cash flow analysis. A cash flow statement explains the causes for the changes in cash and bank balances i.e., cash receipts and cash payments alone. But fund flow statement indicates the causes for the changes in net working capital. Cash flow statement is suitable for short term financial planning and decision, while fund flow statement is appropriate for long term financial planning and decisions. Cash flow analysis deals with the movement of actual or notional cash. But fund flow statement deals with not only cash but also the items constituting working capital. Cash is one of the components of working capital. Whenever, wherever there is inflow of cash there will definitely be inflow of funds. But sound fund position need not be a sound cash position. Ashish Singh

7. STEPS IN PREPARATION OF FUND FLOW STATEMENT Preparation of fund flow statement Preparation of statement of changes in working capital. Preparation of adjusted profits and loss account (to find out fund from operation or fund lost in operation) Adjustment and their treatment Preparation of separate ledger Treatment about the provision for taxation and proposed divider NOTE: Fund flow statement alone is a major part of the solution; remaining other things are supported to work the fund flow statement. Ashish Singh

8. 1. Fund Flow Statement (Specimen form) Sources of Funds Amount Rs. Application of Funds Amount Rs. Issue of Equity Shares -- - - Purchase of Fixed Assets -- - - Issue of Preference shares -- - - Purchase of Investments -- - - Issue of Debentures -- - - Redemption of shares -- - - Loan borrowed -- - - Redemption of debenture -- - - Sale of Fixed Assets -- - - Payment of loan -- - - Sale of Investments -- - - Payment of Tax -- - - Non- trading incomes -- - - Payment of Dividend -- - - Fund from Operation (profit) -- - - Non- trading losses -- - - Decrease of working capital -- - - Increase of working capital -- - - Fund from operation (loss) -- - - -- - --- - - - ---- - Ashish Singh

9. TAC - TCL = WC After the computation of working capital, we have to find out the increase or decrease in working capital. Particulars Previous Year Current Year Effect on Working Capital Increase Decrease Current Assets: Cash on Hand ------ - ------ - Cash at Bank ------ - ------ - Sundry Debtors ------ - ------ - Bills Receivable ------ - ------ - Stock/ Inventory ------ - ------ - Prepaid Expenses ------ - ------ - Short-term Investments ------ - ------ - Outstanding Incomes ------ - ------ - Total Current Assets (A) ------ - ------ - Current Liabilities: Sundry Creditors ------ - ------ - Bills Payable ------ - ------ - Bank Overdraft ------ - ------ - Outstanding Expenses ------ - ------ - Short-term Loan ------ - ------ - Prepaid Incomes ------ - ------ - Provision of Taxation * ------ - ------ - Total Current Liabilities (B) ------ - ------ - Net Working Capital (A - B) ------ - ------ - Net Increase / Decrease in Working Cap. ------ - ------ - TOTAL ------ - ------ - Proforma - Working Capital Statement Ashish Singh

10. Effect of working Capital Increase in the current year current assets than pre V ious year - Increase in Working Capital Decrease in the current year current assets than previous year - Decrease in Working Capital Increase in the current year current liabilities than previous year - Decrease in Working Capital Decrease in the current year current liabilities than previous year - Increase in Working Capital Current Assets Working Capital Working Capital Working Capital Working Capital Current Assets Current Liability Current Liability Ashish Singh

11. Adjusted Profits and Loss account for the year ended Particulars Amount Particulars Amount To Non- Fund items (non- cash) By Balance b/d (opening balance) Depreciation / Depletion By Non- Fund items (non- cash) Loss on sale of fixed assets Interest received Premium on redemption debentures and preference shares Dividend received Discount on issue of shares and debentures Refund on taxes Write off intangible assets (goodwill, patent, trade- mark) Profit on sale of fixed assets Write off fictitious assets (preliminary exp., advertisement,) Change in stock (current assets) To Appropriation / Provision General reserve By Adjusted Profit (funds from operations) Debenture sinking fund Proposed dividend (equity and Preference shares) Interim dividend Taxation provision To balance C/f (Closing Balance) Ashish Singh

12. Important adjustments and their treatment All the adjustments appear in two places : Adjustment Treatment 1. Depreciation 2. Dividend paid 3. Income tax paid 4. Income tax provision 5. Loss on sale of fixed Assets 6. Interim dividend paid P.L. A/c debit side Respective asset A/c credit side P.L. A/c debit side Fund flow statement- Application side Income tax A/c debit side Fund Flow Statement- Application side P.L. A/c debit side Income tax A/c credit side P.L . A/c debit side. Respective asset A/c credit side. P.L. A/c debit side Fund flow statement- Application side. Ashish Singh

13. Preparation of separate ledger A/c, if necessary i.e., about the non-current (either Assets or Liability) items related information given in the adjustment means we have to prepare separate ledger. Balances from this ledger can be transferred to fund flow statement means we have to prepare a separate ledger. Balances from this ledger can be transferred to fund flow statement. Treatment about the provision for taxation and proposed dividend Provision for taxation and proposed dividend taken as current liability means it should appear under working capital statement. Some times, regarding the provision for taxation, information is given in the adjustment. So, it should be treated as non current liability. Provision for taxation taken as non-current liability means proposed dividend is also taken as a non-current liability. (a) Treatment of provision for taxation (i) Income Tax provided given in the adjustment, we have to find the tax paid- P. L. A/c debit side Income Tax A/c credit (Balancing figure of taxation Ale is called tax paid and then it is transferred to Applications side Ashish Singh

14. Liabilities 2002 Rs. 2003 Rs. Assets 2002 Rs. 2003 Rs. Share capital 3,00,000 4,00,000 Buildings 1,20,000 2,50,000 Debentures 2,00,000 2,50,000 Machinery 3,00,000 2,60,000 Profit & Loss A/c 40,000 60,000 Stock 90,000 80,000 Creditors 70,000 80,000 Debtors 1,40,000 2,40,000 Bank overdraft 25,000 25,000 Prepaid expenses 15,000 25,000 Provision for Taxation 30,000 40,000 6,65,000 8,55,000 6,65,000 8,55,000 Problem – I: The following are the summaries of the balance sheets of the Bharat Vijay Ltd. as on 31-12- 02 and 31-12- 03. The following additional information is obtained: The net profit for the year was Rs. 40,000 after charging depreciation. During the year depreciation charged was Rs. 30,000 on building and Rs. 40,000 on machinery. The company purchased during the year buildings worth Rs. 1, 60,000. Dividend paid during the year amounted to Rs. 20,000. From the above information, prepare a statement of changes in working capital and statement of sources and application of funds for the year 2003. Ashish Singh

15. STATEMENT OF CHANGES IN WORKING CAPITAL PARTICULAR 2002 2003 INCREASE in W.C. DECREASE in W.C. Current Assets: Stock 90,000 80,000 - 10,000 Debtors 1,40,000 2,40,000 1,00,000 - Prepaid Expenses. 15,000 25,000 10,000 - Total (A) 2,45,000 3,45,000 Current Liabilities: Creditors 70,000 80,000 10,000 B.O.D. 25,000 25,000 - - Provision for Taxation 30,000 40,000 - 10,000 Total (B) 1,25,000 1,45,000 Working Capital (A- B) 1,20,000 2,00,000 Increase in Working Capital 80,000 80,000 2,00,000 2,00,000 1,10,000 1,10,000 Fund Flow Statement Sources of Funds Amount ₹ Applications/ Uses of Funds Amount ₹ Issue of Equity share capital 1,00,000 Purchase building 1,60,000 Debenture 50,000 Dividend Paid 20,000 Funds from operation 1,10,000 Increase in working capital 80,000 2,60,000 2,60,000 Ashish Singh

16. Building A/c Particular Amount ₹ Particular Amount ₹ Opening Bal 1,20,000 By Depreciation 30,000 To bank A/C- Purchase 1,60,000 By closing balance 2,50,000 2,80,000 2,80,000 Machinery A/c Particular Amount ₹ Particular Amount ₹ To opening bal. 3,00,000 By Depreciation 40,000 By closing bal. 2,60,000 3,00,000 3,00,000 Adjusted Profit and Loss A/c Particular Amount ₹ Particular Amount ₹ To Depreciation By opening bal 40,000 Building 30,000 Machinery 40,000 70,000 To Dividend Paid 20,000 To closing bal. 60,000 By Funds from Operation 1,10,000 1,50,000 1,50,000 Ashish Singh

17. Liabilities Rs. Rs. Assets Rs. Rs. Creditors 39,520 41,135 Cash at bank 2,520 4,820 Bills payable 33,780 12,645 Debtors 85,175 72,625 Bank-overdraft 59,510 - Sundry Advances 2,315 735 Provision for taxation 40,000 50,000 Stock 1,11,040 97,370 Reserve 50,000 55,000 Land- building 1,48,500 1,44,250 P & L A/c 39,690 36,220 Plant 1,12,950 1,16,200 Equity shares capital 2,00,000 2,60,000 Goodwill - 19,000 4,62,500 4,55,000 4,62,500 4,55,000 Problem – 2: From the following balance sheets of Bhairav Ltd. prepare: A statement showing changes in working capital A statement of source and application of funds. Additional information: During the year taxes and interim dividend paid were Rs. 35,000 and Rs. 39,000 respectively. The assets of another company were purchased for Rs. 60,000 payable in fully paid equity shares of the company. The assets consisted of stock Rs. 21,640, plant Rs. 18,360 and remaining amount was for goodwill. During the year the purchase price is Rs. 5,650 for a plant. Ashish Singh

18. STATEMENT OF CHANGES IN WORKING CAPITAL PARTICULAR 2010 2011 INCREASE in W.C. DECREASE in W.C. Current Assets Stock 1,11,040 97,370 Less: Asset Purchase ( 2nd effect in Eq. share A/c.) 21,640 Correct Stock 1,11,040 75,730 35,310 Cash at bank 2,520 4,820 2,300 Sundry Advances 2,315 735 1,580 Debtors 85,175 72,625 12,550 Total(A) 201,050 1,53,910 Current Liabilities Bills Payable 33,780 12,645 21,135 - Creditors 39,520 41,135 1,615 B.O.D. 59,510 - 59,510 - Total(B) 1,32,810 53,780 Working Capital(A- B) 68,240 1,00,130 Increase in Working Capital 31,890 82945 82945 Ashish Singh

19. Fund Flow Statement Sources of Funds Amount Application of Funds Amount Purchase of machinery 5,650 Tax paid 35,000 Interim Dividend 39,000 Funds from Operation 1,11,540 Increase in working capital 31,890 1,11,540 1,11,540 Adjusted Profit & Loss Account Particular Amount Particular Amount To Provision for reverse 5,000 By bal b/d. 39,690 To goodwill written off 1,000 To provision for taxation 45,000 By Adjusted profit 1,11,540 TO interim Dividend 39,000 To dep. On land- building 4,250 To dep. On machinery 20,760 To bal c/f 36,220 1,51,230 1,51,230 Ashish Singh

20. Equity share Capital Account Particular Amount Particular Amount By bal b/d. 2,00,000 By machinery 18,300 By Stock 21,640 By bal c/d 2,60,000 By G/W A/c. 20,060 2,60,000 2,60,000 Machinery Account Particular Amount Particular Amount To opening bal. 1,12,950 By profit & loss (Dep.) 20,760 To Machinery(business) 18,360 To bank (purchase) 5,650 By closing bal. 1,16,200 1,36,960 1,36,960 Provision for Taxation Account Particular Amount Particular Amount To tax paid 35,000 By Bal b/d 40,000 To bal. c/f 50,000 By profit & loss (provision) 45,000 85,000 85,000 Ashish Singh

21. Cash Flow Statement Cash flow statement is a statement which is prepared from the historical data showing the inflow and outflow of cash. It shows the sources and uses of cash between the two balance sheet dates. It clearly explains the causes for changes in cash position between two periods. Simply, it is a receipts and payments account in a summary form. Cash flow statement which classifies cash flows during the period from operating, investing and financing activities. This statement provides relevant information in assessing a company’s liquidity, quality of earnings and solvency. Benefits: Cash flow statement provides information about the changes in cash and cash equivalents of an enterprise. Identifies cash generated from trading operations. The operating cash surplus which can be applied for investment in fixed assets. Portion of cash from operations is used to pay dividend and tax and the other portion is ploughed back. Very useful tool of planning. Purpose: Cash flow statements are prepared to explain the cash movements between two points of time. Ashish Singh

22. Cash and relevant terms as per AS- 3 (revised) As per AS- 3 (revised) issued by the Accounting Standards Board 1.(a) Cash fund : Cash Fund includes (i) Cash in hand (ii) Demand deposits with banks, and (iii) cash equivalents. (b) Cash equivalents are short- term, highly liquid investments, readily convertible into cash and which are subject to insignificant risk of changes in values. Cash Flows are inflows and outflows of cash and cash equivalents. The statement of cash flow shows three main categories of cash inflows and cash outflows, namely : operating, investing and financing activities. Operating activities are the principal revenue generating activities of the enterprise. Investing activities include the acquisition and disposal of long- term assets and other investments not included in cash equivalents. Financing activities are activities that result in change in the size and composition of the owner’s capital (including Preference share capital in the case of a company) and borrowings of the enterprise. Ashish Singh

23. Classification of Cash in-flows and outflows From sales of goods and services to customers From receipt of customer advances From receipt of interest revenue or dividends or rent revenue or similar revenue items Operating Activities To wages salary payments To suppliers for purchases of inventories To other operating expenses To interest payments To tax payments To advance payments to suppliers From sale of Fixed and other long-term assets From collection of loans Investing Activities To purchase Fixed and other long-term assets To make loans and to collect such loans From sale of common or preferred stock From issuance of short or long term debt Financing Activities To repay debt To pay dividends Ashish Singh

24. 1. Cash Flow Statement (Specimen form) Indirect Method Inflow of Cash Amount Rs. Outflow/Uses Amount Rs. Opening Cash Balance -- - - - Cash from operation (loss) Issue of Equity Shares -- - - Purchase of Fixed Assets -- - - Issue of Preference shares -- - - Purchase of Investments -- - - Issue of Debentures -- - - Redemption of shares -- - - Loan borrowed -- - - Redemption of debenture -- - - Sale of Fixed Assets -- - - Payment of loan -- - - Sale of Investments -- - - Payment of Tax -- - - Non- trading incomes -- - - Payment of Dividend -- - - Cash from Operation (profit) -- - - Non- trading losses -- - - Closing Cash Balance -- - - -- - - -- - --- - - ---- - - Ashish Singh

25. Preparation of Separate Ledger If information of any particular assets or liabilities are given in the adjustment, we have to prepare separate asset or liabilities account. Balances from this ledger can be transferred to cash flow statement. Treatment of adjustments The additional information which are given apart from the balance sheet are, simply called as adjustment. All the adjustments will appear in two places. The following are the important adjustments and their treatment. (a) Dividend paid Depreciation Loss on sale of Assets (d) Income Tax Provision Cash flow statement – outflow side – Profit & loss A/C – Debit side P.L.A/c- Debit side P.L.A/c – Debit side Respective asset A/c – credit side – P.L.A/c – Debit side Income Tax – Credit side. NOTE : The adjustments applicable for fund flow statements will also be applicable for cash flow statements. Ashish Singh

26. Liabilities 1- 1- 05 31- 12-05 Assets 1-1- 05 31- 12-05 Creditors 36,000 41,000 Cash 4,000 3,600 Loan from Partner - 20,000 Debtor 35,000 38,400 Loan from Bank 30,000 25,000 Stock 25,000 22,000 Capital 1,48,000 1,49,000 Land 20,000 30,000 Building 50,000 55,000 Machinery 80,000 86,000 2,14,000 2,35,000 2,14,000 2,35,000 PROB: 1 Following are the balance sheets of a Vijay & son: Prepare a cash flow statement. During the year Rs. 26,000 paid as dividend. The provision made for depreciation against machinery as on 1.1.05 was Rs. 27,000 and on 31.12.05 Rs 36,000. Ashish Singh

27. Cash From Operation Particular Rs. Rs. Net profit before tax 27,000 36,000 Add: Adjustment for dep. 9,000 Funds from Operation Add: Inc. in current liabilities 5,000 Add: Decrease in stock 3,000 Less: Inc. in debtor 3,400 4600 Cash From Operation: 40,600 Cash Flow Statement for the year ended 31.12.2005 Sources of Cash Amount Applications/Uses Amount Opening Cash balance 4,000 Purchase of land 10,000 Loan 20,000 Purchase of building. 5,000 Purchase of machinery 15,000 Repayment of bank loan 5,000 Payment of Dividends 26,000 Cash from Operation 40,600 Closing cash balance 3,600 64,600 64,600 Ashish Singh

28. Machinery Account Particulars Rs Particulars Rs To Balance b/d 80,000 By Depreciation 9,000 To Bank (purchase) 15,000 By Balance c/d 86,000 95,000 95,000 Workings: Net profit before tax. Capital (1.1.05) Capital (31.12.05) Diff. Add. Dividends Net Profit 1,48,000 1,49,00 1,000 26,000 27,000 Provision for Depreciation A/c Particulars Rs Particulars Rs To Balance c/d 36000 By Balance b/d 27,000 By Adjusted P & L A/c (Depreciation) 9,000 36000 36000 Ashish Singh

29. Liabilities 2005 2006 Assets 2005 2006 Share capital 4,50,000 4,50,000 Fixed asset 4,00,000 3,20,000 General Reserve 3,00,000 3,10,000 Investment 50,000 60,000 P & l a/c 56,000 68,000 Stock 2,40,000 2,10,000 Creditors 1,68,000 1,34,000 Debtor 2,10,000 4,55,000 Tax provision 75,000 10,000 Bank 1,49,000 1,97,000 Mortgage loan - 2,70,000 10,49,000 12,42,000 10,49,000 12,42,000 PROB: 2 The summarized balance sheet of Bhadresh Ltd. as on 31.12.05 and 31.12.2006 are as follows: Additional Details: Investment costing Rs. 8,000 were sold for Rs. 8,500 Tax provision made during the year was Rs. 9,000 During the year part of fixed assets costing Rs 10,000 was sold for Rs 12,000 and the profit was included in P & L A/c. You are required to prepare cash flow statement for 2006. Ashish Singh

30. Cash Flow Statement Sources of Cash Amount Applications/Uses Amount Opening Cash balance 1,49,000 Cash Lost in Operation 1,50,500 Sale of investment 8,500 Purchase of Investment 18,000 Sale of Fixed assets 12,000 Loan 2,70,000 Payment of Tax 74,000 Closing cash balance 1,97,000 4,39,500 4,39,500 Ashish Singh

31. Adjusted Profit & Loss A/c Particulars Rs Particulars Rs To Provision for tax To Provision for G.R. To Depreciation To Balance c/d 9,000 10,000 70,000 68,000 By Balance b/d By Profit on sale of Inv. By Profit on sale of F.A. By Adjusted Profit (Funds from Operation) 56,000 500 2,000 98,500 1,57,000 1,57,000 Cash From Operation Particular Rs. Rs. Funds from Operation 98,500 Add: Dec. in stock 30,000 Less: Dec. in creditor 34,000 Less: Inc. in debtor 2,45,000 2,49,000 Cash Lost in Operation: 1,50,500 Ashish Singh

32. Provision for tax A/c Particulars Rs Particulars Rs 74,000 75,000 To Bank (tax paid ) 10,000 By Balance b/d 9,000 To Balance c/d By P & L A/c (provision) 84,000 84,000 Ashish Singh

33. Fixed Assets A/C Particular Rs Particulars Rs To Balance b/d 4,00,000 By Bank a/c 12,000 To Profit and Loss a/c 2,000 By Dep. 70,000 By Balance c/d 3,20,000 4,02,000 4,02,000 Investment A/c Particulars Rs Particulars Rs To Balance b/d To P & L A/c To Bank (purchase) 50,000 500 18,000 By Bank(sale) By Balance c/d 8,500 60,000 68,500 68,500 Ashish Singh

34. Unit 4 – Marginal Costing and Cost Volume Profit Analysis Ashish Singh

35. Marginal Costing Marginal costing is the ascertainment of marginal cost and of the effect on profit of changes in volume or type of output by differentiating between fixed costs and variable costs. Marginal cost : The amount at any given volume of output by which aggregate variable costs are changed if the volume of output is increased by one unit. In practice this is measured by the total variable cost attributable to one unit. Marginal cost can precisely be the sum of prime cost and variable overhead. Marginal Cost = Variable Cost = Direct Labour + Direct Material + Direct Expenses + Variable Overheads Contribution: Contribution is the difference between sales value and the marginal cost [Contribution (C) = Sales (S) – Variable Cost]. Ashish Singh

36. DETERMINATIONOF COST AND PROFIT UNDER MARGINAL COSTING For the determination of cost of a product or service under marginal costing, costs are classified into variable and fixed. All the variable costs are part of product and services while fixed costs are charged against contribution margin . Cost and Profit Statement under Marginal Costing Amount ( ` ) Amount ( ` ) Revenue (A) xxx Product Cost: - Direct Materials xxx - Direct employee (labour) xxx - Direct expenses xxx - Variable manufacturing overheads Product (Inventoriable) Costs (B) xxx xxx xxx Product Contribution Margin {A – B} xxx - Variable Administration overheads xxx - Variable Selling & Distribution overheads xxx xxx Contribution Margin (C) xxx Period Cost: (D) Fixed Manufacturing expenses xxx Fixed non-manufacturing expenses xxx xxx Profit/ (loss) {C – D} xxx Ashish Singh

37. COST-VOLUME- PROFIT (CVP) ANALYSIS Meaning: It is a managerial tool showing the relationship between various ingredients of profit planning viz., cost, selling price and volume of activity. As the name suggests, cost volume profit (CVP) analysis is the analysis of three variables cost, volume and profit. Such an analysis explores the relationship between costs, revenue, activity levels and the resulting profit. It aims at measuring variations in cost and volume. Impact of various changes on profit : An understanding of CVP analysis is extremely useful to management in budgeting and profit planning. It elucidates the impact of the following on the net profit: (i) (ii) (iii) Changes in selling prices, Changes in volume of sales, Changes in variable cost, Changes in fixed cost. Marginal Cost Equation The contribution theory explains the relationship between the variable cost and selling price. It tells us that selling price minus variable cost of the units sold is the contribution towards fixed expenses and profit. If the contribution is equal to fixed expenses, there will be no profit or loss and if it is less than fixed expenses, loss is incurred. Since the variable cost varies in direct proportion to output, therefore if the firm does not produce any unit, the loss will be there to the extent of fixed expenses. These points can be described with the help of following marginal cost equation: Marginal Cost Equation = S- V = C = F±P/L S= Selling Price per unit, V = Variable cost per unit, C= Contribution, F = Fixed Cost P = Profit/Loss Ashish Singh

38. Marginal Cost Statement Sales xxxx Less: Variable Cost xxxx Contribution xxxx Less: Fixed Cost xxxx Profit xxxx 2. Contribution to Sales Ratio ( Profit Volume Ratio or P/V ratio): This ratio shows the proportion of sales available to cover fixed costs and profit. Contribution represent the sales revenue after deducting variable costs. This ratio is usually expressed in percentage. A higher contribution to sales ratio implies that the rate of growth of contribution is faster than that of sales. This is because, once the breakeven point is reached, profits shall grow at a faster rate when compared to a product with a lesser contribution to sales ratio. Break-Even Analysis: Break-even analysis is a generally used method to study the CVP analysis. This technique can be explained in two ways: In narrow sense it is concerned with computing the break-even point. At this point of production level and sales there will be no profit and loss i.e. total cost is equal to total sales revenue. In broad sense this technique is used to determine the possible profit/loss at any given level of production or sales. Ashish Singh

39. Breakeven Point This is the point where neither profits nor losses have been made is known as a break-even point. This implies that in order to break even the amount of contribution generated should be exactly equal to the fixed costs incurred. Hence, if we know how much contribution is generated from each unit sold we shall have sufficient information for computing the number of units to be sold in order to break even. Prob.1: Pepsi Company produces a single article. Following cost data is given about its product:- Selling price per unit Marginal cost per unit Fixed cost per annum Rs.40 Rs.24 Rs. 16000 Calculate: (a) P/V ratio (b) break even sales (c) sales to earn a profit of Rs. 2,000 (d) Profit at sales of Rs. 60,000 (e) New break even sales, if price is reduced by 10%. Solution: We know that (S-v) /S= F + P OR S x P/V Ratio = Contribution So, = 40% P/V Ratio = Contribution/sales x 100 = (40-24)/40 x 100 = 16/40 x 100 Break even sales Fixed Cost ÷ P/V Ratio or Fixed cost /contribution per unit contribution per unit = sales - variable cost 40-24 = Rs.16 Fixed cost = 16,000 P/V ratio = 40% BES = 16,000 / 40% = Rs. 40,000 OR 16,000/16 = BES in units = 1000 units Ashish Singh

40. The sales to earn a profit of Rs. 2,000 Fixed Cost + Expected Profit ÷ P/V Ratio (16,000+ 2000 )÷ 40% = Rs. 45,000) Rs. 45,000/40 = 1,125 units Profit at sales of 60,000 S x P/V Ratio = contribution - F = P Putting this values: Rs. 60,000 x 40/100 = 16000 - Fixed cost 24,000 – 16,000 = P P = 8,000 New break even sales, if sale price is reduced by 10% New sales price = 40- 10% = 40- 4 = 36 Sales = 36 Marginal cost = Rs. 24 36- 24 = Contribution = Rs. 12 P/V Ratio = Contribution/Sales New P/V ratio = 12/36 x100 OR 33.33% Now, s x P/V Ratio = F = Rs.16000 (at B.E.P. contribution is equal to fixed cost) S x 100/300 S = 16000 x 33.33% = Rs.48,000. Ashish Singh

41. B.E.P. = Prob.2: From the following information find out: P/V Ratio Sales Margin of Safety Fixed Cost = Rs.40, 000 Profit = Rs. 20,000 Rs. 80,000 Solution: a. P/V Ratio. We know that S – V = F + P OR S(S – V)/S = F + P Fixed cost / PV ratio = 80,000 BES = Fixed cost/ P/V Ratio P/V Ratio = 40,000/PV = 80,000 P/V ratio = B.E.S. x P/V Ratio = F (Value of P is zero at BE Sales) OR F/BES Putting the value, P/V Ratio = 40,000/80,000 = 50/100 OR 50% Sales x P/V Ratio = Contribution OR Sales = Sales. We know that Sales x P/V Ratio = F+ P OR Contribution/P/V Ratio So, = (40,000 + 20,000)/50/100 = (60,000 x 100)/50 =Rs.1, 20,000 Margin of Safety. Margin of Safety = Sales – B.E.P Sales So, MOS = 1, 20,000 – 80,000 Ashish Singh

42. Prob.3: You are given the following data : Sales Profit Year 2010 1,20,000 8,000 Year 2011 1,40,000 13,000 Find out – P/V ratio, B.E. Point, Profit when sales are `1,80,000, Sales required earn a profit of `12,000, Margin of safety in year 2011. Year Sales Profit 2010 1,20,000 8,000 2011 1,40,000 13,000 Difference 20,000 5,000 (i) P/V Ratio = Change in Profit /Change in Sales* 100 13,000- 8000 /140,000-120,000 = 5,000/20,000 * 100 = 25% (ii) BE Point = Fixed cost / P/V ratio Fixed cost = Contribution – Profit Contribution = Sales * P/V ratio = 1,20,000*25% = 30,000 (you may take any year sales) 30,000 – 8000 = 22,000 Fixed cost BES = 22,000/25% = Rs. 88,000 (iii) Profit when sales are Rs. 1,80,000 Contribution (`1,80,000 X 25%) Less: Fixed cost Profit Rs. 45,000 22,000 23,000 Sales to earn a profit of 12,000 Fixed Cost+ Expected Profit /P/V ratio 22,000 + 12,000/25% = 1,36,000 Margin of safety in 2011 Margin of safety = Actual sales – Break- even sales = 1,40,000 – 88,000 = 52,000 . Ashish Singh

43. APPLICATION OF CVP ANALYSIS IN DECISION MAKING Management uses marginal costing and CVP concepts for making various decisions. Profit Planning: Profit planning is the planning of future operations to attain maximum profit. Pricing of Products Selection of Product Mix Problem of Key/Limiting Factor Make- or-Buy Decision Accepting Additional Orders and Exploring Foreign Market Shut Down/Suspending Activities Prob.4: A company has a machine No. 9 which can produce either product A or B. The cost data relating to machine A and B are as follows: Particulars Product A Product B Selling price Rs. 20.00 Rs. 30.00 Variable expenses Rs. 14.00 Rs. 18.00 Contribution Additional Information: Rs. 6.00 Rs. 12.00 Capacity of machine No. 9 is 1, 000 hrs. In one hrs machine No. 9 can produce 3 units of A and 1 unit of B. Which product should machine No. 9 produced? Ashish Singh

44. Particulars Product A Product B Sales 20.00 30.00 Variable expenses 14.00 18.00 Contribution per unit 6 12 Contribution per hour Rs. 6 X 3 units 18.00 12.00 Contribution for 1,000 hrs 18,000 12,000 Solution: Statement showing contribution per hour for machine No. 9 Divisions A B C Rs. Rs. Rs. Sales 1, 12, 000 56, 000 84, 000 Direct material 14, 000 7, 000 14, 000 Direct labor 5, 600 7, 000 22, 400 Variable overhead 14, 000 7, 000 28, 000 Fixed cost 28, 000 14, 000 28, 000 Total cost 61, 600 35, 000 92, 400 From the above table we can see that company should produce product A with the help of machine No. 9. Prob.5: Meet & company Ltd. has three divisions each of which makes a different product. The budgeted data for the next year is as follows: The management is considering closing down division C. There is no possibility of reducing variable costs. Advice whether or not division C should be closed down. Solution: Marginal Costs Statement Division A B C Rs. Rs, Rs. Sales 1, 12, 000 56, 000 84, 000 Marginal cost (Direct Material + Direct Cost + Variable overheads) 33, 600 21, 000 64, 400 Contribution 78, 400 35, 000 19, 600 Fixed cost 28, 000 14, 000 28, 000 Profit 50, 400 21, 000 (8, 400) Advice: Division C’s Contribution is Rs.19,600, if the company can raise sales in division C, there is a possibility of earning profit, if not the company may go for shut down the division of C Ashish Singh

45. Prob.6: The following budget has been prepared at 70% level of home market: Units - 4, 200 Rs. Wages - 12, 600 Materials - 21, 000 Fixed cost - 7, 000 Variables cost - 2, 100 Total - 42, 700 The selling price in India is Rs. 15. In Sri Lanka about 800 units may be sold only at Rs. 10 and in addition 25 paise per unit will be expenses as freight etc., Do you advise trying for the market in the Sri Lanka? Solution: Marginal Cost Statement Particulars India (4200 units) Sri Lanka (800 units) Total (5000 units) Rs. Rs. Rs. Sales (units x price) (A) 63, 000 8, 000 71, 000 Materials (Rs. 5 per unit) 21, 000 4, 000 25, 000 Wages (Rs. 3 per unit) 12, 600 2, 400 15, 000 Variables(Rs. 0.50 per unit) 2, 100 400 2, 500 Freight (Only for Sri Lanka Rs. 0.25 per unit) ----- - ---- - 200 200 Marginal cost (B) 35, 700 7, 000 42, 700 Contribution (A – B ) 27, 300 1, 000 28, 300 Less: Fixed cost 7, 000 -------- - 7, 000 20, 300 1, 000 21, 300 Suggestion: It is advisable to try for the Sri Lankan market at Rs. 10 per unit as by doing so there is an increase of Rs. 1000. Ashish Singh

46. Prob.7: The cost analysis of two products A and B is given below: Particulars Product A Product B Rs. Rs. Material Rs. 2.50 per unit 25 45 Labor @ Rs. 1 per hour 12 -- - Labor @ Rs. 1.50 per hour - - - 15 Variable overheads 2 5 Selling price 70 80 factor? Statement showing marginal cost and contribution Particulars Product A Product B Rs. Rs. Selling price(A) 70 80 Material 25 45 Labor 12 15 Overheads 2 5 Marginal cost (B) 39 65 Contribution (A – B) 31 15 Contribution per unit of Material 31/10 units = 3.10 (25 units/ 2.50 = 10 units) 15/18 units = 0.83 (45 units/ 2.50 = 18 units) Contribution per labor Hour 0.258 (31/12 hrs) 1.50 (15/10 hrs) Advise: If labor is key factor then product B and if material is key factor then product A should be produced On the basis of above information, which product would you recommend to be manufactured if labor is key factor and if material is key Solution: Here first of all we have to find out contribution on the basis of both, material as a key factor and labor as a key factor. Ashish Singh