FINANCE FOR NON-

FINANCE IN
MATERIALS
MANAGEMENT
DATE : FRIDAY, 11th
MARCH 2011
 Ground Rules

• Request not to take calls during the session / put the cell phone on
silent mode

• We all would adhere to the time frames in terms of breaks etc

• No talks in Groups , please speak up loudly trainer would make all

possible efforts to solve your query

• This is a exhaustive program and your attention is required all the time

• This being a participative style program get involved actively to get

maximum value out of it.
 AGENDA FOR THE DAY
Why Business Manager should
be finance savvy….
 Accounting Concepts
 Balance Sheet interpretation
and preparation
 Example of P&L and Balance
Sheet, cash flow
 Ratio Analysis and
interpretation
 Working capital
 Capital Budgeting
 Important Terms
 Costing
Financial Capability of
Business Manager
Need of understanding Financial Indicators

Technical
Expertise

Need of Finance –
To translate the actions
into Number

Business
Good Good
Manager
Manager Leader
Why Financial capabilities ?

Balancing Manage
Orders, business
Revenue, successfully
Earnings &
Cash Early
warning to
the

Need of subordinates
Foresee risk
and mitigate Financial
knowledge

Achieve
Achieve organizational
quantifiable objectives
targets Clean books
of accounts
How to attain Financial capability ?

 Understand the key financial parameters

 Spend time with controller in understanding the
commonly used financial terms
 Involve controller in business meetings
 Visit finance portals frequently
 Update on economy
 Attend training on Finance for non finance
 Often use financial indicators
Financial Parameters
 Profit & Loss account
• Done to calculate the
Direct & accounting periods profit
Indirect or loss
Material cost • Starts from Revenues
• Subtracts the costs of
Revenue creating the revenues
Direct & Indirect
+ Other • Costs and Revenues are
Overheads

Personnel costs
income Volume based expense to be matched
Establishment expenses
Other expenses
• Should only have costs
Contribution
Allocations belonging to the specific
Depreciation period
Interest costs• Ends in Net Profit
EBIT Taxes and duties
PAT
 P&L in business or privately
Company Household
+ Payroll
+ Revenues - Cost of food, clothing, gasoline, rent,
- Cost of Sales (material, production related healthcare, dentist, car service
overhead costs incl. depreciation)
------------------------------------------------------------------
------------------------------------------------------------------
= Gross Profit
= Gross Profit
- Sales General & Admin expenses (SG&A) - phone, TV-license, newspaper, insurance,
(remaining overhead costs incl. hobbies, the decrease of the value of the TV
depreciation) as it is getting old
- Unusual Items
+/- Other Income/expense +/- Other Income/expense
------------------------------------------------------------------ ------------------------------------------------------------------
= Earnings Before Interest and Tax (EBIT) = Earnings Before Interest and Tax (EBIT)
+/- Interest
+/- Interest on car loan, interests on deposits
------------------------------------------------------------------
------------------------------------------------------------------
= Income Before Tax (IBT)
- Tax = Income Before Tax (IBT)
= Net Income - Tax
= Net Income =
The remaining money, that you can deposit
on the bank account, buy a motorbike, flat…
….. or pay off loans….
 Balance Sheet
 Describes company assets and liabilities and sources of financing
 States where the assets are located now
 States the source of funds (liabilities and equity) from which the
assets have been financed
 Snapshot of the situation at the moment of the closing of the books
 Assets and Liabilities must be EQUAL and in BALANCE
 By deducting debt from assets we get the liquidation value
 Liquidation value not necessarily = company value

Assets Liabilities
 Balance Sheet
 Cash & Bank Deposits  Trade Payables
 Trade Receivables  Accrued expenses
 Accrued income  Provisions
 Material  Short Term Loans
 Work in Progress  Long Term Loans
 Finished Goods  Other Liabilities
 ---------------------------------------  ---------------------------------------
 Total Current Assets  Total Liabilities
 Shares  Share Capital
 Intangible assets  Retained Earnings
 (incl. Capitalised software)
 Net Income
 Machinery and equipment
 ----------------------------------------
 Land and Buildings
 Total Stockholders Equity
 ----------------------------------------
 ----------------------------------------
 Total Fixed Assets
 Total Stockholders Equity
 ----------------------------------------
 and Liabilities
 Total Assets

=
Balance Sheet

Capital employed
Share holders equity

Liabilities
Assets

Fixed assets
Inventory
Receivables Long term borrowings Net working capital
Loans & advances Short term borrowings
Other current assets Payables
Current assts Cash & Bank balances Current laibilities Other current liabilities

Long term - Sources and application of funds

Short term - Sources and application of funds

EBIT – Earnings Before Interest & Tax
 It Includes “Profits from Operations” & Excludes “
Cost of Capital”.
 EBIT Workings
Revenues

Less: Material Cost

Less: Personnel Expenses

Less: Expenses ( a + b + c)
a) Volume Based Exp.,
b) Establishment Exp.,
c) Other Exp & Allocations.,
EBIT
+/ - : Interest
ICO - Income from continuing
operations
Cash flow "Where Did The Money Come From?" "Where Did It Go?"

Workings :
Cash Flow Matrix
EBIT
( + / - ) Change in Current
Assets / Liabilties. OCF Current Assets Current Liabilities

OCF - Operating cash flow

- CAPEX - Capital
expense Increase OCF OCF

FCF - Free Cash Flow

Decrease OCF OCF

EXAMPLE
M/s Smart Company Ltd
Profit & Loss Account for the year ended 2007-08

Particulars Amount %
Revenue 10,000,000 100

Material Cost (RMC) 5,500,000 55

Employee Cost 1,000,000 10
Power / Fuel , Maintenance etc 300,000 3
Other Admin Exp. 1,000,000 10
Depreciation 500,000 5

EBIT 1,700,000 17

Calculation of OCF (Operating Cash Flow)

EBIT 1,700,000

Add : Depreciation 500,000

Add : Increase / Decrease Inventory (3,500,000)
Add : Increase / Decrease Creditors 1,000,000
Add : Increase / Decrease Debtors (3,500,000)

TOTAL OCF (3,800,000)

EXAMPLE SUPPORTING OF SMART COMPANY LTD.
Raw Material Consumption Amount (Rs) Amount (Rs)
A Opening Stock
RM 275,000
WIP 150,000
FG 75,000 500,000
B Purdchases 9,000,000
C Closing stock
RM 2,500,000
WIP 1,200,000
FG 300,000 4,000,000
RM Consumption (A + B - C) 5,500,000

D Impact on OCF of Inventory

RM (2,225,000)
WIP (1,050,000)
FG (225,000) (3,500,000)
Increase in Stock (A - C)
Purchases (Creditors)
Total Purchases 9,000,000
Less Paid 8,000,000
Creditors 1,000,000
Debtors (Receivables)
Opening Drs 2,000,000
Total Revenue 10,000,000
Total Receivable 12,000,000
Collection 6,500,000
Closing Debtors 5,500,000
Impact on OCF (3,500,000)
Increase in Debtors
EXAMPLE
M/s Good Company Ltd
Profit & Loss Account for the year ended 2007-08

Particulars Amount %
Revenue 10,000,000 100

Material Cost (RMC) 5,500,000 55

Employee Cost 1,000,000 10
Power / Fuel , Maintenance etc 300,000 3
Other Admin Exp. 1,000,000 10
Depreciation 500,000 5

EBIT 1,700,000 17

Calculation of OCF (Operating Cash Flow)

EBIT 1,700,000

Add : Depreciation 500,000

Add : Increase / Decrease Inventory (1,500,000)
Add : Increase / Decrease Creditors 4,000,000
Add : Increase / Decrease Debtors (2,500,000)

TOTAL OCF 2,200,000

EXAMPLE SUPPORTING OF GOOD COMPANY LTD.
Raw Material Consumption Amount (Rs) Amount (Rs)
A Opening Stock
RM 275,000
WIP 150,000
FG 75,000 500,000
B Purdchases 7,000,000
C Closing stock
RM 1,250,000
WIP 600,000
FG 150,000 2,000,000
RM Consumption (A + B - C) 5,500,000

D Impact on OCF of Inventory

RM (975,000)
WIP (450,000)
FG (75,000) (1,500,000)
Increase in Stock (A - C)
Purchases (Creditors)
Total Purchases 7,000,000
Less Paid 3,000,000
Creditors 4,000,000
Debtors (Receivables)
Opening Drs 2,000,000
Total Revenue 10,000,000
Total Receivable 12,000,000
Collection 7,500,000
Closing Debtors 4,500,000
Impact on OCF (2,500,000)
Increase in Debtors
 Basic Concepts in
Accounting
 Business Entity Concept
 Money Measurement Concept
 Matching concept
 Going Concern concept
 Conservatism Concept
 Accounting Period Concept
 Types of Accounts

Personal Real Nominal

Debit the receiver Debit what comes in Debit all loses and expenses
Credit the giver Credit what goes out Credit all profit and gains

Ram, Shyam, Cash, Building, Rent, Electricity

Mahesh Machinery Bill
Following is the given transactions of ABC Co. Ltd, you are required to prepare the Profit
& Loss A/c and Balance Sheet

ILLUSTRATION :-

Sr.No Transactions during the year Amount

1 Money Borrowed from Bank working capital 1,000,000
2 Purchases of Raw Material 750,000
3 Paid Salaries 50,000
4 Admin Expenses 25,000
5 Marketing Exp 20,000
6 Revenue 900,000
7 Printer Purchased 10,000

Additional information
1 Out of total revenue 500,000 is Outstanding
2 30 % of Purchases are on credit and not paid as on 31.03.2008
3 Charge Depreciation on printer Rs. 2,000 per year
4 A Customer has gone bankrupt and Rs. 20,000 is no more receivable
6 Interest on Bank borrowing @ 13 % p.a.
7 RM Consumption is 45% of Revenue
8 Bank Charges 15,000
SOLUTION
Dr. Cr.
Profit & Loss A/c

Raw Material cons. 405,000 Sales 900,000

Salaries & Wages 50,000
Admin. expenses 25,000
Marketing expenses 20,000
Depreciation 2,000
Bad Debts 20,000
Bank Interest 145,000

667,000 900,000

233,000

Dr. Cr.
Balance Sheet

Creditors 225,000 Inventory 345,000

Working Capital Loan 1,000,000 Capital Assets 8,000
Sundry Debtors 480,000
Profit For the year 233,000 Bank A/c 625,000

1,458,000 1,458,000
 CAPITAL BUDGETING
Capital budgeting decisions have long term implications on the
operation of the business. Wrong decision may affect the long
term survival of the company. These decision involve large
amount of the funds as such, it necessary to take the decision
very carefully and to make the arrangement of the funds for
the procurement of these assets, Further these are irreversible
due to the fact that it is difficult to find the market for such
capital goods. The only alternative is to scrap these assets
which involve huge losses.
Capital budgeting decisions are difficult to make because it
involves the assessment of future events which are difficult to
ascertain. The investments are required to be made
immediately but the returns are expected over a number of
years
 CAPITAL BUDGETING
Internal Rate of return

EXAMPLE:
"Electronics Industries Ltd." is considering to purchase a new machine. Two
alternative models are under consideration.Following information is available.

PARTICULARS MODEL A MODEL B

Cost of Machine Rs.3,00,000 Rs.5,00,000

Estimated Life 10 Years 12 Years
Estimated Saving in Scrap per year Rs.20,000 Rs.30,000
Additional Cost of Supervision per year Rs.24,000 Rs.32,000
Additional Cost of Maintenance per year Rs.14,000 Rs.22,000
Additional Cost of indirect material per year Rs.12,000 Rs.16,000
Estimated Saving in wages per year Rs.1,80,000 Rs.2,40,000
Rate of taxation may be Regarding as 50 % of Profits.
 CAPITAL BUDGETING
Internal Rate of return
Solution:
Statement of Profitability

MODEL A MODEL B
Rs. Rs. Rs. Rs.
(A)Estimated Saving
Scrap 20,000 30,000
Wages 180,000 240,000
200,000 270,000
(B) Estimated Additional costs
Supervision 24,000 32,000
Maintanence 14,000 22,000
Indirect Materials 12,000 16,000
50,000 70,000

(C) Saving before deprecation (A-B) 150,000 200,000

(D) * Depreciation 30,000 41,667

(E) Saving after Depreciation (C-D) 120,000 158,333

(F) Tax on Savings @ 50% 60,000 79,167

(G) Net savings per year 60,000 79,166

(H) Annual Cash inflow (G-D) 90,000 120,833

 CAPITAL BUDGETING
Internal Rate of return

Calculation of back Period

Model A: Cost of Machine Rs.3,00,000

=
Annual Cash Inflow Rs.90,000

= 3 Years 4 Months

Model B: Cost of Machine Rs.5,00,000

=
Annual Cash Inflow Rs.1,20,833

= 4 Years 2 Months (Approximately)

Hence,model A is More Profitable.

Cost of Machine
* Depreciation is computed as =
Estimated life in Years
 Working capital cycle
Operation process
Money blocked Financed by
Material: Conversion Material:
Stores,
WIP, FG,
Advance to Payables
CTC
Suppliers
25 days 15 days 82 days

Collections Others Customers

Other Assets
Receivables Advances
& Liabilities

118 days -9 days 27 days

Total 149 days 109 days

No. of days for which Capital is blocked 40 days

 Factors affecting Working Capital

• Nature of Business
• Nature of Raw Material Used
• Process Technology Used
• Nature of Finished Goods
• Growth and Expansion
• Degree of Competition in the Market
EXAMPLE FOR CALCULATION OF
WORKING CAPITAL
INFORMATION AVAILABLE

COST STRUCTURE OF THE PRODUCT

AMOUNT
ELEMENT OF COST
PER UNIT
RAW MATERIAL 80
DIRECT LABOUR 30
OVERHEADS 60
TOTAL COST 170

PROFIT 30

SELLING PRICE 200

 INFORMATION FOR CALCULATION OF
WORKING CAPITAL
SR.
WORKING CAPITAL ELEMENT CRITERIA
NO.

1 RM 1 MONTH STOCK
2 CREDIT ALLOWED BY SUPPLIER 1 MONTH
3 CREDIT ALLOWED TO CUSTOMER 2 MONTH
4 WAGES 1.5 WEEKS (LAG IN PAYMENT)
5 OVERHEADS 1 MONTH (LAG IN PAYMENT)
6 WIP AVERAGE HALF MONTH IN PROCESS
7 FG AVERAGE ONE MONTH IN STOCK
8 CASH SALES 25 % OF OUTPUT SOLD IN CASH
9 CASH IN HAND AND BANK MINIMUM RS.25,000 IS EXPECTED TO BE MAINTAINED

Assumptions :-
I. You are requested to prepare a Statement showing the WORKING CAPITAL needed
to finance a Level of activity of 1,04,000 Units of product.
II. You may assume that production is carried on evenly throughout the year. wages
and overheads accrue similarly and a period of 4 weeks is equivalent to a month.
 SOLUTION OF WORKING CAPITAL
CALCULATION
Estimate of Working Capital Amount
(A) CURRENT ASSETS (Rs.)
1 Raw Material 2000 Units X Rs.80 X 4 Weeks 640,000
2 WIP 2000 Units X Rs.170 X 2 Weeks 680,000
3 FG 2000 Units X Rs.170 X 4 Weeks 1,360,000
4 Debtors 1500 Units X Rs.170 X 8 Weeks 2,040,000
(Cost Equivalent)
5 Cash Balance 25,000
TOTAL (A) :- 4,745,000

(B) CURRENT LIABILITIES

1 Creditors 2000 Units X Rs.80 X 4 Weeks 640,000
2 Outstanding Wages 2000 Units X Rs.30 X 1.5 Weeks 90,000
3 Outstanding Overheads 2000 Units X Rs.60 X 4 Weeks 480,000
TOTAL (B) :- 1,210,000
(C) NET WORKING CAPITAL REQUIRED (A - B) 3,535,000
 BREAK EVEN POINT (BEP)

The simple meaning of a break-even point is the volume of sales

needed for a business to generate zero profit. A break-even
analysis shows, you when you have started to make a profit. Break
even analysis is useful tool in tracking your business cash flow.

Utility of the Break-even Analysis

 It serves as the most useful and important tool to study cost
output-profit relationship at varying level of output.
 It is useful in reviewing pricing polices.
 It aids in planning capitalization of the enterprise.
 It provides the entrepreneurs decide whether to acquire or not
assets involving additional fixed costs.
 Types of Cost

• Fixed Cost
It is a cost which remains constant at all
levels of activities/output. For ex. Rent, etc

• Variable Cost
It is a cost which varies according to
change in activities/output. For ex. Fuel, Raw
material, etc
 BREAK EVEN POINT (BEP)

Formulae for calculation of BEP :-

1) Profit Volume Ratio = Contribution

Sales

2) Break Even Point (Rs) = Fixed Cost

PVR

3) BEP (Sales in units) Fixed Cost

(Selling price per unit -
Variable cost per unit)
 Contd…

• Semi-variable cost
Cost which remain constant upto specific
level of output and it shows rise beyond this
specific point along with increase in activities.
For ex. Telephone bill
 BREAK EVEN POINT (BEP)
COST SHEET
Rupees
A Selling Price Per Unit 200.00
Variable Costs :-
RM Cost 110.00
Consumable& Repairs 4.00 These costs are dependent
Power cost 0.50 on level of activity and pure
Direct Labor 5.50
variable in nature and
B Variable Cost / Unit 120.00 incurred for every unit
manufactured
A - B Contribution / Unit 80.00
Fixed Costs :-
Fixed Overhead
Salaries 200,000 These are the costs which
Power (Other than Variable) 350,000 are generally are Fixed and
Depreciation 150,000 are incurred irrespective of
Rent 25,000
level of activity
Prperty Taxes 10,000
Stationary 5,000
Total Fixed Overheads 740,000

Profit Volume Ratio (PVR) 40.00%

( PVR) = Contribution / Sales
 BREAK EVEN POINT (BEP)
1) Break Even Point (Rs) = Fixed Cost
PVR

= 740,000
40%

= 1,850,000

2) BEP (Sales in units) Fixed Cost

(Selling price per unit -
Variable cost per unit)

= 740000
80

= 9250
DSO & DPO
 How DPO & DSO is worked out, higher or lower DPO/DSO & indicates what ?

• DPO - Days of payables outstanding • DSO - Days of receivables outstanding

• = Average Payables X 365 • = Average Receivables X 365

Cost of purchase (for last 12 Sales (for last 12 months)
months)

Higher the DSO means –

Higher DPO means - Money in the hands of the customer
Profitable credit terms
Lower the DSO –
Lower DPO means - Consistent liquidation of receivables
Un-favorable credit terms
Inventory
Inventory refers to
 Raw materials
 Work In process
 Finished goods

 Focus on non-moving and obsolete inventory

 Lower the level of inventory higher the cash flow
ROCE – Return on Capital employed
EBIT
ROCE = ------------------------------ X 100
Avg. Capital employed

Capital employed = Fixed assets + Net working capital or

Share holders equity + Reserves & surplus
+ Long term borrowing

Average Capital employed = (Op. Capital employed + Cl. Capital

employed)
2
Financial / Controlling
Function

Role of Business
Managers in
enhancing efficiency
of finance function
Expectation from each other (Manager & Controller)
Business Controller Business Manager

Business Reporting & Analysis– Analysis of Reporting & Take

Timely & Correct Business actions - Based on Analysis, initiate
Information to help in various various action to improve the
business decision business efficiency
Involvement in Business - Involvement in Business -
Ability to involve in various Review of various function involving
business matter which help him in controller
taking various decision

Risk Analysis & Early Warning – Risk Analysis & Action on Early
Ability to anticipate & predict the Warning – Involve controller in Risk
risk and plan the mitigation, on Analysis & Initiate the process to
time mitigate in various Risk

Cost Control & Profit Check on Cost & Focus Profit

Improvement – Persistent thrust Improvement Areas – Support
on cost saving method and look Controller in cost saving ideas
for improvement in profits

Never Give UP Approach – Organization & Resource

Keep Trying till Success Planning – Ensure right
organization & resource planning
Expectation from each other (Manager)
Business Controller Business Manager

Awareness of Policies & Adherences to Process &

Procedures – Updated knowledge Procedures - Encourage the
of Company’s policies&procedures people to adhere the processes..
help in various business decisions standardisation of Processes !
System Support - Good Review by System - Encourage
understanding of system & Initiate the reviews based on system &
the system change for smoothening suggest the system change for
the operation smoothening the operation
Awareness of Market & General Awareness of Market & General
Economy – Information on Market Economy – Get all Forecast &
& Economy will help controller in Budget updated on market /
Forecasting & Budgeting economy trend
Co-ordination & Follow-ups– Co-ordination & Follow-ups–
With various functions to get the Continuously keep track on various
thing done in correct way commitment to management
 Finance function - Combination
Subject Manager Controller
CASE A Finance 5 5
Rare Combination
Business 5 5
10 10

Subject Manager Controller

CASE B Finance 0 5
Not Smooth Business Functioning
Business 5 0
5 5

Subject Manager Controller

CASE C Finance 3 5
Ideal Combination for Business
Business 5 3
8 8

Subject Manager Controller

CASE D Finance 0 0
Dangereous for Business
Business 5 3
5 3

5 = Excellent knowledge , 3 = Average Knowledge, 0 = No Knowledge