ACCOUNTING AND DECISION MAKING – IDENTIFYING THE PROBLEM SITUATION Learn accounting and finance basics so you can effectively analyze business data to make key management decisions. Business owners are faced with countless decisions every business day. Managerial accounting information provides data-driven input to these decisions, which can improve decision-making over the long term. Fig 1.1- ACCOUNTING INFORMATION FOR A SINGLE PRODUCT   The above illustration clearly depicts that there has been a loss of Rs.100 in one year’s time for this particular product. The reason can be attributed to the increase in the “cost of goods” whereas other expenses have remained the same in both the years. For a single product manufactured, the problem is identifiable and solvable. But when the organization is producing a range of products, you need to apply some accounting technique by which the product losing money is identified and suitable measures are taken to cut down the escalating cost. Fig 1.2- Accouning Information for a Product Range The above illustration compares and contrasts the relationship of three products a company manufactures. It is seen that products P1 and P2 are doing well. Though the cost of sales has gone up for P1 and P2, the sales volume has also increased thus increasing the gross profit over the period of time. Here the product that has to be dealt with is P3 whose sales volume has drastically gone down, yet with the same cost of sales. When there is an increase in cost of sales, two things have to be considered. Identifying the problem-product Either cut down the production cost or increase the selling-price if the product has a real demand in the market. Uses of Accounting Data: Accounting information helps the management to arrive at make or buy decisions, to outsource production of certain components to cut down or control costs, to expand the production, to increase the sales volume or to downsize their project capacity. Techniques like Break-Even Analysis, Costing and Budgeting aid in going for the right production-mix, marketing-mix and sales target plans for the respective financial years. Aggregate Planning: As we all know planning is the key to the future and financial planning has to be given utmost importance for a production process. Aggregate planning involves translating long-term forecasted demand into specific production rates and the corresponding labor requirements for the intermediate term. It takes into consideration a period of 6 to 18 months, breaking it into work modules weekly or monthly and planning for the specific period in terms of men, material and...

TURNOVER RATIO OR ACTIVITY RATIO  or  ASSET MANAGEMENT RATIO Turnover ratios are also known as activity ratios or efficiency ratios with which a firm manages its current assets.  The following turnover ratios can be calculated to judge the effectiveness of asset use. Inventory Turnover Ratio Debtor Turnover Ratio Creditor Turnover Ratio Assets Turnover Ratio  1.  INVENTORY TURNOVER RATIO This ratio indicates whether investment in stock is efficiently used or not, in other words, the number of times the inventory has been converted into sales during the period.  Thus it evaluates the efficiency of the firm in managing its inventory. It helps the financial manager to evaluate the inventory policy.  It is calculated by dividing the cost of goods sold by average inventory. Inventory Turnover Ratio = Cost of goods sold / Average Inventory (or) Net Sales / Average Stock  Cost of goods sold = Sales-Gross profit Average Stock =Opening stock + Closing stock/2  2.  DEBTOR TURNOVER RATIO Debtors play a vital role in current assets and to a great extent determines the liquidity of a firm. This indicates the number of times average debtors have been converted into cash during a year.  It is determined by dividing the net credit sales by average debtors. Debtor Turnover Ratio = Net Credit Sales / Average Trade Debtors (or) Net Credit Sales / Average Debtors – Average Bills Receivable Net credit sales = Total sales – (Cash sales + Sales return) Total debtors = [ Op.Dr. + Cl.Dr. / 2 + Op.B/R + Cl. B/R / 2]   When the information about credit sales, opening and closing balances of trade debtors is not available then the ratio can be calculated by dividing total sales by closing balances of trade debtor Debtor Turnover Ratio = Total Sales / Trade Debtors Note: Bad and doubtful doubts and their provisions are not deducted from the total debtors. The higher ratio indicates that debts are being collected promptly. 3.  CREDITOR TURNOVER RATIO This is also known as “Creditors Velocity”. It indicates the number of times sundry creditors have been paid during a year.  It is calculated to judge the requirements of cash for paying sundry creditors.  It is calculated by dividing the net credit purchases by average creditors. Creditor Turnover Ratio = Net Credit Purchases / Average Trade Creditor (or) Net Credit Purchases / Average Creditors + Average Bills Payable Net credit purchases = Total purchases – (Cash purchase + Purchase return) Total Creditors = [Op.Cr. + Cl.Cr. / 2 + Op. B/P + Cl. B/P / 2]   The higher ratio should indicate that the payments are made promptly. Net credit purchases consist of gross credit purchases minus purchase return.  When the information about credit purchases, opening and closing balances of trade creditors is not available then the ratio is calculated by dividing total purchases by the closing balance of trade creditors. Creditor Turnover Ratio = Total purchases / Total Trade Creditors  4.  ASSETS TURNOVER RATIO The relationship between assets and sales is known as assets turnover ratio.  Several assets turnover ratios can be calculated depending upon the groups of assets, which are related to sales. a)      Total asset turnover. b)      Net asset turnover c)      Fixed asset turnover d)      Current asset turnover e)      Net working capital turnover ratio a. TOTAL ASSET TURNOVER This ratio shows the firms ability to generate sales from all financial resources committed to total assets.  It is calculated by dividing sales by total assets. Total asset turnover = Total Sales /  Total Assets b. NET ASSET TURNOVER This is calculated by dividing sales by net assets. Net asset turnover =Total Sales / Net Assets Net assets represent total assets minus current liabilities. Intangible and fictitious assets like goodwill, patents, accumulated losses, deferred expenditure may be excluded for...

Understanding Net Present Value One method of deciding or not a firm should accept an investment project is to determine the net present value of the project. The net present value (NPV) of a project is equal to the present value of the expected stream of net cash flows from the project, discounted at the firm’s cost of capital, minus the initial cost of the project. The value of the firm will increase if the NPV of the project is positive and decline if the NPV is negative. Thus, the firm should undertake the project if the net present value is positive and reject proposals whose values are negative. This method is considered the best, as it takes into account, the initial investment, and cost of capital and cash inflow over a period. Estimation of Future Cash Flow: One of the most important and difficult aspects of capital budgeting is the estimation of the net cash flow from the project. It is the difference between cash receipts and cash payments over the life of a project. Projected cash flow statement is an important criterion for banks to decide on sanctioning medium and long-term loans to prospective clients. Since cash receipts and expenditures occur in the future, a great deal of uncertainty is involved in their estimation. Some general guidelines are to be followed while estimating cash flows. First; cash flows should be measured on an incremental basis. That is, measurement of the firm’s cash flows with and without the project must be ascertained. Any increase in expenditure or reduction in the receipts of other divisions of the firm resulting from the adoption of a given project must be considered. Effect of Depreciation: Second thing is that, net cash inflow must be estimated on an after-tax basis, using the firm’s marginal tax rate.Third, as a non-cash expense, depreciation affects the firm’s cash flow only through its effect on taxes. The initial investment to add a new product line may include the cost of purchasing and installing new equipment, reorganizing the firm’s production process, providing additional working capital for inventory and accounts receivable and so on. The monetary flows generated by this kind of investment include, the incremental sales revenue form the project, salvage value of the equipment at the end of its economic life, if any and recovery of working capital at the end of the project. The outflow will be in the form of taxes, fixed costs and incremental variable costs. Internal Rate of Return or IRR: Another method of determining the acceptance rate of a project proposal is internal rate of return method (IRR).This is nothing but the discount rate that equates the present value of the net cash flow from the project to the initial cost of the project. The firm should undertake a project if the IRR on the project exceeds or is equal to the marginal cost of capital. Capital Rationing and Pay Back Period: More techniques are available for evaluating the feasibility of investment proposals, like, capital rationing, profitability index, pay back period and others. It is always a good thing to analyze the rate of return on investment before the start of the project. If it happens to be satisfactory, then the firm can take a step forward to finalize the proposal. The cost of capital climbs up when the investment return declines, and the firm is subjected to undue pressures of mounting interest rates and capital depletions....

Costing is the technique and process of ascertaining cost whereas cost accounting is the application of costing and cost accounting principles, methods and techniques to the science, art and practice of cost control and ascertainment of profitability.