Inventory is a current asset that is held by an entity either to be used in production or to be sold. Inventory that is held at the begining of the financial year is known as opening inventory. The inventory that remains unused or unsold at the end of financial year is known as closing inventory.
There are three forms of inventory.
1. Raw material
2. Work in progress (WIP)
3. Finished goods
Saturday, December 18, 2010
Ordering stock
The store manager will decide that an order needs to be placed and the number or the units to order. The amount to be ordered will be determined by the future plans for production and sales.
It is calculated as follow
Ordering stock = required for sales + closing stock – opening stock
Question:
Hussy Ltd makes a product which requires 2 kg of material X. Hussy Ltd always keep closing inventory of 200 kg of material X each month. As the production of last three months were 500 hundred units. Hussy Ltd is planning to increase its sale to 600 hundred units from the present month.
Required:
How many kg of material X should be ordered?
Solution:
Closing stock 200 kg
Opening stock 200 kg
Requirement for sale 600/2= 300 kg
Now put in formula:
Ordering stock = 300+200-200
Ordering stock = 300 kg of material required.
It is calculated as follow
Ordering stock = required for sales + closing stock – opening stock
Question:
Hussy Ltd makes a product which requires 2 kg of material X. Hussy Ltd always keep closing inventory of 200 kg of material X each month. As the production of last three months were 500 hundred units. Hussy Ltd is planning to increase its sale to 600 hundred units from the present month.
Required:
How many kg of material X should be ordered?
Solution:
Closing stock 200 kg
Opening stock 200 kg
Requirement for sale 600/2= 300 kg
Now put in formula:
Ordering stock = 300+200-200
Ordering stock = 300 kg of material required.
Friday, December 17, 2010
Cash and Cash Flows
Money in terms of notes, bills, currency and coins is called cash. Also includes current accounts, deposits etc.
Cash Flows: It is the money that is flowing into the business and out of the business. OR A term which shows the receipt and payments of cash.
It is a measure of a company’s financial health.
Deficit: When cash outflows exceed cash inflows it is called as negative cash flows or deficit.
Surplus: When cash inflows are greater than cash outflows.
Types of Cash flows:
1. Cash flows from operating activities: Amount of cash a company generates from the revenues and expenses e:g cash flows from sales and cash payments to suppliers.
2. Cash flows from investing activities: Is a measure of the total cash generated or lost by a company’s investments it includes buying and selling assets, lending money etc.
3. Cash flows from financing activities: Funds related to the financing of the company. This includes any dividend payments, borrowing money etc.
4. Capital receipts and payments: Related to issue of shares and acquisition of fixed assets.
5. Drawings & Dividends: Cash payments to shareholders as dividends
Sources of Cash: Cash can be obtain from finance activities i:e increase long term debt, equity etc and also from selling assets i:e decrease in current assets and fixed assets.
Uses of Cash: Uses of cash are vice versa of sources of cash. Paying payables that decrease in long term debt. equity. Buying assets that results increase in current assets, fixed assets.
Cash Accounting: A method in which receipts and expenses are recorded in the period in which they are actually receive and paid.
Cash Forecast: Cash forecasting is a method that forecasts cash position in future it ensures that sufficient funds will be available when they are needed. It provides an early warning of liquidity problems. Enables management to plan strategies to deficits and surpluses.
Objectives of Cash Budget: The main objectives of cash budget is:
To help management what to do with surpluses and deficits i:e where to invest the surpluses and for deficits where to get finance.
For working capital management.
To set borrowing limits and minimize cost of funds.
To compare actual cash flows with budgeted cash flows which allows business to decide whether it will have enough cash or new sources of borrowing will be necessary.
Types of Forecast:
1. Balance sheet base forecast
2. Financial statement base forecast
3. Receipt and payments base forecast
Cash Flows: It is the money that is flowing into the business and out of the business. OR A term which shows the receipt and payments of cash.
It is a measure of a company’s financial health.
Deficit: When cash outflows exceed cash inflows it is called as negative cash flows or deficit.
Surplus: When cash inflows are greater than cash outflows.
Types of Cash flows:
1. Cash flows from operating activities: Amount of cash a company generates from the revenues and expenses e:g cash flows from sales and cash payments to suppliers.
2. Cash flows from investing activities: Is a measure of the total cash generated or lost by a company’s investments it includes buying and selling assets, lending money etc.
3. Cash flows from financing activities: Funds related to the financing of the company. This includes any dividend payments, borrowing money etc.
4. Capital receipts and payments: Related to issue of shares and acquisition of fixed assets.
5. Drawings & Dividends: Cash payments to shareholders as dividends
Sources of Cash: Cash can be obtain from finance activities i:e increase long term debt, equity etc and also from selling assets i:e decrease in current assets and fixed assets.
Uses of Cash: Uses of cash are vice versa of sources of cash. Paying payables that decrease in long term debt. equity. Buying assets that results increase in current assets, fixed assets.
Cash Accounting: A method in which receipts and expenses are recorded in the period in which they are actually receive and paid.
Cash Forecast: Cash forecasting is a method that forecasts cash position in future it ensures that sufficient funds will be available when they are needed. It provides an early warning of liquidity problems. Enables management to plan strategies to deficits and surpluses.
Objectives of Cash Budget: The main objectives of cash budget is:
To help management what to do with surpluses and deficits i:e where to invest the surpluses and for deficits where to get finance.
For working capital management.
To set borrowing limits and minimize cost of funds.
To compare actual cash flows with budgeted cash flows which allows business to decide whether it will have enough cash or new sources of borrowing will be necessary.
Types of Forecast:
1. Balance sheet base forecast
2. Financial statement base forecast
3. Receipt and payments base forecast
Working Capital Management
Working capital is the capital available for day to day transactions/operations of an organization. It ensures that a company has sufficient cash flow in order to meet its short-term debt obligations and operating expenses. Working capital management involves management of cash, stock, amount receivables from debtors, amount payable to creditors.
Working capital= Current assets-Current liabilities
Current assets include cash, stock, debtors etc.
Current liabilities include creditors, loan payable, dividend payable etc.
Main objectives of working capital management is to:
minimize the investment in working capital
minimize cost of investment
minimize working capital cycle
Working capital= Current assets-Current liabilities
Current assets include cash, stock, debtors etc.
Current liabilities include creditors, loan payable, dividend payable etc.
Main objectives of working capital management is to:
minimize the investment in working capital
minimize cost of investment
minimize working capital cycle
Financial management:
Financial Management can be defined as the management of the finance of a business in order to achieve financial objectives.
The key point of financial management of a business are:
• Create wealth
• Generate cash
• Provide an adequate return on investment
There are 3 key elements in the process of financial managment
1) Financial Planning: Management need to ensure that enough resources are available at the right time to meet the needs of the business. In the short term, to invest in equipment and stocks etc. In the medium and long term, funding may be required for significant additions to the productive capacity of the business
2) Financial Control:Financial control is a important activity to help the business ensure that the business is meeting its objectives.
• Are assets being used efficiently?
• Are the businesses assets secure?
• Do management act in the best interest of shareholders and in accordance with business rules?
3) Financial Decision-making: The key aspects of financial decision-making relate to:
• Investments must be financed in some way there are always financing alternatives that can be considered. For example it is possible to raise finance from selling new shares, borrowing from banks.
• Financing and dividends decision is whether profits earned by the business should be retained after distributed dividends to shareholders. If dividends are too high, the business may be run out of funding to reinvest in growing revenues.
The key point of financial management of a business are:
• Create wealth
• Generate cash
• Provide an adequate return on investment
There are 3 key elements in the process of financial managment
1) Financial Planning: Management need to ensure that enough resources are available at the right time to meet the needs of the business. In the short term, to invest in equipment and stocks etc. In the medium and long term, funding may be required for significant additions to the productive capacity of the business
2) Financial Control:Financial control is a important activity to help the business ensure that the business is meeting its objectives.
• Are assets being used efficiently?
• Are the businesses assets secure?
• Do management act in the best interest of shareholders and in accordance with business rules?
3) Financial Decision-making: The key aspects of financial decision-making relate to:
• Investments must be financed in some way there are always financing alternatives that can be considered. For example it is possible to raise finance from selling new shares, borrowing from banks.
• Financing and dividends decision is whether profits earned by the business should be retained after distributed dividends to shareholders. If dividends are too high, the business may be run out of funding to reinvest in growing revenues.
Accruals & Prepayments
Accrual:
Accruals concept states that income and expenses must be recorded in the accounting records and reported in the financial statements of the period to which they relate.
Accruals are accrued expenses, they have not yet been paid for. Accruals are current liabilities.
Prepayment:
The payment of a debt in full before it is due. OR Payments which have been made in one accounting period, but should not be charged against profit until a later period because they relate to that later period.
If we pay for something that relates to next accounting period, we use a prepayment to transfer that charge forward to the next period. Prepayments are current assets.
KEY TERMS:
Accrued expenses:Expenses that has been incurred but not yet paid.
Accrued income:Income that is earned but not yet received.
Prepaid expense:Expenses that has not been incurred but has been paid in advance.
Pre-received income:Income that is not earned but received in advance.
Accruals concept states that income and expenses must be recorded in the accounting records and reported in the financial statements of the period to which they relate.
Accruals are accrued expenses, they have not yet been paid for. Accruals are current liabilities.
Prepayment:
The payment of a debt in full before it is due. OR Payments which have been made in one accounting period, but should not be charged against profit until a later period because they relate to that later period.
If we pay for something that relates to next accounting period, we use a prepayment to transfer that charge forward to the next period. Prepayments are current assets.
KEY TERMS:
Accrued expenses:Expenses that has been incurred but not yet paid.
Accrued income:Income that is earned but not yet received.
Prepaid expense:Expenses that has not been incurred but has been paid in advance.
Pre-received income:Income that is not earned but received in advance.
Safety/Buffer Stock
Minimum level of stock required to meet emergencies. Safety stock should be quite enough to cover problems i:e break in supply,shortage of material. In Justin in time(JIT) system the purpose is to eliminate the buffer stock.
Buffer stock=2 x average stock – reorder quantity
Buffer stock=2 x average stock – reorder quantity
Free Stock
Free stock represents what is really available for future use.
The free stock balances give better picture to the manager that how much stock needed for the current situation. So he can take decisions regarding the inventory.
Free stock is calculated as:-
Materials in stock X
Materials on order from suppliers X
Materials requisitioned, not yet issued (X)
Free stock balance X
Question: – Mick Ltd, a wholesaler has 8,500 units outstanding for material on existing customers orders; there are 4,000 units in stock. Order from supplier is 5,500.
Required:-
Calculate free stock for Mick Ltd?
Solution:-
Materials in stock 4000
Materials on order from suppliers 5500
Materials requisitioned, not yet issued (8500)
Free stock balance 1000
The free stock balances give better picture to the manager that how much stock needed for the current situation. So he can take decisions regarding the inventory.
Free stock is calculated as:-
Materials in stock X
Materials on order from suppliers X
Materials requisitioned, not yet issued (X)
Free stock balance X
Question: – Mick Ltd, a wholesaler has 8,500 units outstanding for material on existing customers orders; there are 4,000 units in stock. Order from supplier is 5,500.
Required:-
Calculate free stock for Mick Ltd?
Solution:-
Materials in stock 4000
Materials on order from suppliers 5500
Materials requisitioned, not yet issued (8500)
Free stock balance 1000
Overheads
Resources consumed or lost in completing a process and which cannot be traced directly to the cost of the product.
Overheads are indirect costs. Overheads are total of:
1) Indirect materials (e:g nails in a chair, gum used in table )
2) Indirect labour (e:g supervisor, storekeeper)
3) Indirect expenses (e:g rent, machine running expense)
Overheads can be categorized into:
Production Overheads
Non-production overheads
Production overheads are those, that are directly related to production e:g machine insurance, machine greases etc.
Non-production overheads are not directly related to production e:g selling and distribution cost, research cost etc.
The production and non-production overheads are further categorized into:
Variable overheads
Fixed overheads
Variable overheads are those indirect cost which varies with the level of output but constant for unit cost e:g salesman commission, electricity charges etc.
Fixed overheads are that cost which remain the same for a given level of output during the period e:g rent and rates, factory managers salary etc.
Overheads are indirect costs. Overheads are total of:
1) Indirect materials (e:g nails in a chair, gum used in table )
2) Indirect labour (e:g supervisor, storekeeper)
3) Indirect expenses (e:g rent, machine running expense)
Overheads can be categorized into:
Production Overheads
Non-production overheads
Production overheads are those, that are directly related to production e:g machine insurance, machine greases etc.
Non-production overheads are not directly related to production e:g selling and distribution cost, research cost etc.
The production and non-production overheads are further categorized into:
Variable overheads
Fixed overheads
Variable overheads are those indirect cost which varies with the level of output but constant for unit cost e:g salesman commission, electricity charges etc.
Fixed overheads are that cost which remain the same for a given level of output during the period e:g rent and rates, factory managers salary etc.
Cost Volume Profit (CVP) Analysis
It is a method to determine the relationship between change in activity level, total sales revenue, expenses and profit. OR a method that deals with how profits and costs change with a change in volume.
Objective of CVP analysis:
Establish the financial results when specified level of activity or volume changes. To establish this management need to know
Break-even point
Margin of safety
Break-even point: The level of activity where there is no profit or loss i:e the point at which cost or expenses and revenue are equal.
It can be calculated in units or in value, and can be calculated as follows:
Break-even point (in units) = Fixed cost ÷ Contribution per unit
Contribution per unit = Selling price per unit – Variable cost per unit
Break-even point (in value) = Fixed cost ÷ Contribution to sales ratio
Contribution to sales ratio = Total contribution ÷ Total Sales revenue
Margin of Safety: It is the difference between budgeted sales volume/revenue and break-even sales volume/revenue. It shows the amount by which actual sales can fall without a loss being incurred.
It can be calculated also in units or in value, and can be calculated as follows:
Margin of safety (in value/units) = Budgeted Sales revenue/unit – Break-even Sales revenue/unit
Margin of Safety (in % value) = Budgeted Sales revenue – Break-even Sales revenue × 100% ÷ Budgeted Sales revenue
Margin of Safety (in % units) = Budgeted Sales units – Break-even Sales units × 100% ÷ Budgeted Sales units
Objective of CVP analysis:
Establish the financial results when specified level of activity or volume changes. To establish this management need to know
Break-even point
Margin of safety
Break-even point: The level of activity where there is no profit or loss i:e the point at which cost or expenses and revenue are equal.
It can be calculated in units or in value, and can be calculated as follows:
Break-even point (in units) = Fixed cost ÷ Contribution per unit
Contribution per unit = Selling price per unit – Variable cost per unit
Break-even point (in value) = Fixed cost ÷ Contribution to sales ratio
Contribution to sales ratio = Total contribution ÷ Total Sales revenue
Margin of Safety: It is the difference between budgeted sales volume/revenue and break-even sales volume/revenue. It shows the amount by which actual sales can fall without a loss being incurred.
It can be calculated also in units or in value, and can be calculated as follows:
Margin of safety (in value/units) = Budgeted Sales revenue/unit – Break-even Sales revenue/unit
Margin of Safety (in % value) = Budgeted Sales revenue – Break-even Sales revenue × 100% ÷ Budgeted Sales revenue
Margin of Safety (in % units) = Budgeted Sales units – Break-even Sales units × 100% ÷ Budgeted Sales units
Surplus & Investment of Surplus
Surplus is, when a business have excess of cash inflows over cash outflows because of large amount of cash generated from operations or sale of fixed assets
Business have to invest surplus funds but it should be kept in mind that the surplus is temporary or permanent. Temporary surplus may be invested until it is ensure that it need not be used in current operations. Permanent surplus should be invested. It should be kept in mind that investment should be profitable and secure.
Objectives of investment of surplus:
As they are assets of company so need to be look after like any other assets.
In time of inflation, value of money effectively fall.
There are some factors that should be consider before investment of surplus
Risk
Liquidity
Maturity
Return
Risk: There is a strong link between risk and return the higher the risk the higher the return and vice versa. High risk can lead to permanent losses that can collapse the company. Shares traded in stock market are consider to be most high risk type of investment
Liquidity: It involves the ability to turn investment into cash immediately. There is also a close link between liquidity and return. A less liquid investment generally provide a higher return and a high liquid investment generally provide a lower return. It is important to consider investments liquidity before investing. If the amount and duration of cash surplus are to be change then highly liquid investment should be taken, if not then less liquid investment should be taken.
Maturity: The length and duration of investment. The longer the maturity the higher the return. A company’s investment should be mature so that surplus cash is available when business needs it.
Return: Income generated by an investment, expressed usually as percentage of amount invested. The whole purpose of investment is to receive a return the rate of return is also an important factor when investing cash surpluses.
Types of Investment:
Shares
Bonds
Debenture stocks
Certificates of deposit (CDS)
Gilt-edged securities
Bills of exchange etc…….
Business have to invest surplus funds but it should be kept in mind that the surplus is temporary or permanent. Temporary surplus may be invested until it is ensure that it need not be used in current operations. Permanent surplus should be invested. It should be kept in mind that investment should be profitable and secure.
Objectives of investment of surplus:
As they are assets of company so need to be look after like any other assets.
In time of inflation, value of money effectively fall.
There are some factors that should be consider before investment of surplus
Risk
Liquidity
Maturity
Return
Risk: There is a strong link between risk and return the higher the risk the higher the return and vice versa. High risk can lead to permanent losses that can collapse the company. Shares traded in stock market are consider to be most high risk type of investment
Liquidity: It involves the ability to turn investment into cash immediately. There is also a close link between liquidity and return. A less liquid investment generally provide a higher return and a high liquid investment generally provide a lower return. It is important to consider investments liquidity before investing. If the amount and duration of cash surplus are to be change then highly liquid investment should be taken, if not then less liquid investment should be taken.
Maturity: The length and duration of investment. The longer the maturity the higher the return. A company’s investment should be mature so that surplus cash is available when business needs it.
Return: Income generated by an investment, expressed usually as percentage of amount invested. The whole purpose of investment is to receive a return the rate of return is also an important factor when investing cash surpluses.
Types of Investment:
Shares
Bonds
Debenture stocks
Certificates of deposit (CDS)
Gilt-edged securities
Bills of exchange etc…….
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