Describe the limitations of financial statements analysis.

Posted by Ripon Abu Hasnat on Saturday, February 6, 2016 | 0 comments | Leave a comment...

Limitations of financial statements analysis are-

1. The use of estimates in allocating costs to each period. The ratios will be as accurate as the estimates.

2. The cost principle is used to prepare financial statements. Financial data is not adjusted for price changes or inflation/deflation.

3. Companies have a choice of accounting methods i.e. inventory LIFO vs. FIFO and depreciation methods. These differences impact ratios and make it difficult to compare companies using different methods.

4. Companies may have different fiscal year ends making comparison difficult if the industry is cyclical.

5. Diversified companies are difficult to classify for comparison purposes.

6. It does not provide answers to all the users' questions. In fact, it usually generates more questions!

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Describe the uses of financial statements analysis. Or, Objectives Of Financial Statement Analysis

Posted by Ripon Abu Hasnat on Tuesday, February 2, 2016 | 0 comments | Leave a comment...

The uses/ objectives of financial statement analysis are as follows

1. Assessment of Past Performance: Financial statement analysis judging management's past performance and opportunities of future performance like operating expenses, net income, cash flows, return on investment, etc.

2. Assessment of current position: Financial statement analysis shows the current position of the assets liabilities.

3. Prediction of profitability and growth prospects: It helps in assessing and predicting the earning prospects and growth rates of earning and judging earning potential of business enterprise.

4. Prediction of bankruptcy and failure: It is an important tool in assessing and predicting bankruptcy and probability of business failure.

5. Assessment of the operational efficiency: It helps to assess the operational efficiency and deviation between standards and actual performance.

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Management Account is helpful in decision making. Explain. Or, Why Management Accounting Is Important in Decision-Making

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Managerial accounting information provides data-driven input, which can improve decision-making over the long term that helps to make their business more successful in business decision contexts.

1. Relevant Cost Analysis: Managerial accounting information is used by company management to determine what should be sold and how to sell it.

2. Activity-based Costing Techniques: By using activity-based costing techniques, management can determine the activities required to produce and service a product line.

3. Make or Buy Analysis: By completing a make or buy analysis, management can determine which choice is more profitable. While this technique is certainly useful, the decision makers should only use these analyses as a factor in the decision.

4. Utilizing the Data: It provides a data-driven look at how to grow. By focusing on this data, decision makers can make decisions that aim for continuous improvement and are justifiable based on intelligent analysis.

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Management Accounting is beneficial for banking operation. Comments with example.

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The management accounting function of a bank in conjunction, need to apply competitive bank management skills in order to remain competitive in their industry and maximize profits that may enhance competitiveness to adapting to analyzing bank performance and establishing profitability and risks; managing interest rate risks; managing the cost of funds, bank capital and liquidity; managing credit given to customers and managing the investment portfolio.

Banks are benefited by using the management accounting information to improve towards achieving the organizational goal and objectives; and to control over its expenditure. It is effective in minimizing cost, enhancing profitability, curtails overhead cost and recovers non-performing loans, and beef-up shareholders fund.

Banks can enjoy several advantages that usually coincide with the ability to improve operations and overall profitability. Some are-

1. Reduce expenses: Management accounting can help lower the operational expenses that conduct to analysis on cost of capital.

2. Managing cash flow: It can analyze and measures the effective liquidity requirement as well as careful analysis of necessary and unnecessary cash expenditures.

3. Management decisions: It usually provides a quantitative analysis for various decision opportunities.

4. Increase financial returns: Management accounting increase financial returns by analyzing financial forecasts on cost of capital and pricing of their assets and liabilities.

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Roles of management accounting in bank

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The management accounting function of a bank in conjunction, need to apply competitive bank management skills in order to remain competitive in their industry and maximize profits that may enhance competitiveness to adapting to analyzing bank performance and establishing profitability and risks; managing interest rate risks; managing the cost of funds, bank capital and liquidity; managing credit given to customers and managing the investment portfolio.
Banks uses the management accounting information to improve towards achieving the organizational goal and objectives; and to control over its expenditure. It is effective in minimizing cost, enhancing profitability, curtails overhead cost and recovers non-performing loans, and beef-up shareholders fund.

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Limitations of Break Even Analysis

Posted by Ripon Abu Hasnat on Tuesday, December 1, 2015 | 0 comments | Leave a comment...

While breakeven analysis is a useful marketing analytical tool, it does have limitations. This are-

1.    Constant Price: The straight line TR curve assumes that every level of output can be sold at the same price. This is unrealistic for the reason that product prices do not remain constant as output hikes. In fact, they change frequently.

2.    Constant Cost: It is also assumed that whatever the level of output, AVC remains the same. This suggests that there is no limit to output which the firm can produce. This is again highly unrealistic.

3.    Limitless Profits: This analysis assumes that profits are a function of output. This suggests that profits increase without limit as the level of output rises. In fact this never happens for the reason profits are influenced by technological changes, improved management, higher productivity, changes in the scale of fixed factors etc.

4.    Ignores Selling Costs: It is based only on production costs and neglects selling costs.

5.    Data Limitations: As the BE analysis is based on accounting data, it suffers from such limitations of data as neglect of imputed costs, arbitrary depreciation estimates, inappropriate allocation of overhead costs etc.

6.    Limited Products: This analysis is based on a limited range of products and area. The present day firm produces many products and has many departments or plants which cannot be lumped together and presented on a single BE chart. So the scope of this analysis is limited to a single product of a particular business firm.

7.    Short run Analysis: The BEA can be used only during the short run. As such it is not an effective tool for the long run.

8.    Ignores Elasticity of Demand: It ignores the concept of elasticity of demand and the possibility that different prices may lead to different levels of demand. It also ignores the principle of diminishing returns which every firm has to keep in view for breaking even.

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Usefulness/Importance of Break-Even analysis

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1. Fair knowledge about break even analysis can help bankers/banking to examine loan proposal of a firm.

2. Break even analysis helps the bankers in assessing working capital requirement of a unit.

3. This analysis helps in revealing clear projections of profit planning of an enterprise at different production level vis-à-vis the financial needs.

4. It also helps to find rate of return on investment of capital at varying levels of production.

5. Break-even lies can be quite useful to management in determining the need for action.

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Assumptions of BEP Analysis

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1.    Relevance range — it is assumed that a company is operating within a relevant range. The relevant range is the range of an activity over which the fixed cost will remain fixed in total and the variable cost per unit will remain constant.

2.    Fixed costs — Total fixed costs are assumed to be constant in total. Fixed costs per unit will decrease with the increasing number of units produced.

3.    Variable costs — Variable costs per unit are assumed to be constant.

4.    Total variable costs will increase with the increasing number of units produced. Sales revenue ---Sales revenue per unit is assumed to be constant and the total revenue will increase with the increasing number of units produced.

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What is Break-even Analysis?

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Breakeven analysis is the study of the relationship between selling prices, sales volumes, fixed costs, variable costs and profits at various levels of activity. It is also known as cost-volume-profit analysis. Breakeven analysis is simply a technique for determining whether what you sell will make any money or not. It is often requested in business plans. Its form is quite simple. 

If you assume that you can price your product at P, the fixed costs are FC, and the variable costs to produce the product is VC, then you can calculate the quantity of the product you need to sell just to breakeven (that means you just cover your costs and don't make any more money) as:

Breakeven number of units = FC/ (P-VC)

So, if the price of the product is $5, the variable costs to produce it is $3 and the fixed costs are $1000, then the breakeven number of units is = 1000/(5-3)=500 units.

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Management Accounting Short Note-'Cost-Volume-Profit relationships'

Posted by Ripon Abu Hasnat on Sunday, November 29, 2015 | 0 comments | Leave a comment...

Cost volume profit analysis is one of the most powerful tools that managers have at their command. It helps them understand the interrelationship between cost, volume and profit in an organization by focusing on interactions among the following five elements:
1. Prices of products; 
2. Volume or level of activity; 
3. Per unit variable cost; 
4. Total fixed cost; and
5. Mix of product sold.
Because cost-volume-profit (CVP) analysis helps managers understand the interrelationships among cost, volume, and profit it is a vital tool in many business decisions. These decisions include, for example, what products to manufacture or sell, what pricing policy to follow, what marketing strategy to employ, and what type of productive facilities to acquire.

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Management Accounting Short Note-'Hire Purchase finance'

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A hire purchase, also known as a lease purchase, closed-end lease, lease-to-own or rent-to-own, is a business arrangement between a seller and a customer where the customer gets possession and use of the goods in return for a fixed number of specified monthly payments, but the seller retains ownership title rights until the customer has made the final payment. At that point, ownership title passes to the customer.

A hire purchase resembles an installment purchase, but with the crucial difference that title to the property stays with the seller during the hire term. The customer enjoys the economic benefits of ownership but also assumes the risks of damage or loss. The seller is able to account for the hire purchase as the equivalent of a sale. Normally, title to the property passes to the customer at the end of the agreement's term, but a hire purchase also can be structured so the customer takes ownership after a final balloon payment.

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Management Accounting Math Solution (Capital Budgeting-2)

Posted by Ripon Abu Hasnat on Sunday, November 8, 2015 | 0 comments | Leave a comment...

Problem:
A large size company is considering to invest in a new project that costs Tk.4,00,000. 
The estimated salvage value is zero; tax rate is 35%. 
The company uses straight line depreciation and the proposed project has cash flows before tax (CBFT) as below: 
 
 
 
Year
Profit before Tax and Depreciation
1st year
1,00,000
2nd year
1,00,000
3rd year
1,50,000
4th year
1,50,000
5th year
2,50,000
Required: Determine the following: (i) Payback period; (ii) ARR; (iii) NPV at 15%; (iv) Profitability Index.
(The PV at 15% are 0.870; 0.756; 0.658; 0.572; 0.497)
Solution:
Depreciation = Cost – Salvage value/No. of year in lifetime = 4,00,000-0/5 = 80,000.
Statement of cash inflow:
Particulars
1st year
2nd year
3rd year
4th year
5th year
Profit before Tax & Depreciation
Less Depreciation
1,00,000
80,000
1,00,000
80,000
1,50,000
80,000
1,50,000
80,000
2,50,000
80,000
Profit before Tax
Less Tax @35%
20,000
7,000
20,000
7,000
70,000
24,500
70,000
24,500
1,70,000
59,500
Profit after Tax
Add depreciation
13,000
80,000
13,000
80,000
45,500
80,000
45,500
80,000
1,10,500
80,000
Cash inflow
93,000
93,000
1,25,500
1,25,500
1,90,500
Required 1: (Pay Back Period (PBP)):
Year
Cash inflow
Cumulative cash inflow
1
93,000
93,000
2
93,000
1,86,000
3
1,25,500
3,11,500
4
1,25,500
4,37,000
5
1,90,500
6,27,500
PBP = 3 + (Total investment – 3rd year cumulative cash inflow)/4th year cash inflow
        = 4 + (4,00,000 – 3,11,500)/1,25,500 = 3.71 years
Required 2: Average rate of return:
ARR= (Average annual profit / Average investment)*100
        =[{(13,000+13,000+45,500+45,500+1,10,500)/5}/(4,00,000)/2]*100=(45,500/2,00,000)*100
        = 22.75%
Required 3: Net Present Value (NPV) calculation:
Year
Cash flow
Discount factor@10%
Present value
1
93,000
0.870
80,910
2
93,000
0.756
70,308
3
1,25,500
0.658
82,579
4
1,25,500
0.572
71,786
5
1,90,500
0.497
94,679
Present Value of cash
Less, investment
=4,00,262
=(4,00,000)
Net Present Value (NPV)
262
Required 4: Calculation of Profitability Index (PI)
PI = PV of cash inflow/PV of investment cost
     = 4,00,262/4,00,000 = 1.000655
Ans:
i)                   Pay Back Period 3.71 years
ii)                ARR = 22.75%
iii)              NPV = 262
iv)              PI = 1.000655
Comments: Out of 5 years project life, the investment will return within 3.71 years, ARR is 22.75% which is higher than cost of capital, PI is greater than 1 and NPV value negative, So the project is viable.

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Management Accounting Math Solution (Capital Budgeting-1)

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Problem:
The Azad Int Ltd. is contemplating to invest in a new project that would require procurement of a machine costing Tk.25,50,000; and a working capital of Tk.1,00,000. The project is expected provide benefits for five years. The expected profit before depreciation and tax from the project is as below:
Year
Profit before Tax and Depreciation
1st year
8,50,000
2nd year
7,00,000
3rd year
6,50,000
4th year
6,00,000
5th year
4,50,000
 (The policy of the company is to depreciate fixed assets on straight line basis over the period of the asset. Salvage value of the machine is expected to be Tk.50,000. Assume a 40% tax rate and cost of capital of 10%)
Required: Determine the acceptability of the project on the basis of (i) Payback period; (ii) ARR; (iii) NPV; (iv) IRR; (v) Profitability Index.
(The present values of Tk1 for five years at 10% are 0.9091; 0.8264; 0.7513; 0.6830; 0.6209)
Solution:
Depreciation = Cost – Salvage value/No. of year in lifetime = 25,50,000 – (50,000/5) = 5,00,000.
Total Investment = 25,50,000 (Machine price) + 1,00,000 (Working capital) = 26,50,000.
Statement of cash inflow:
Particulars
1st year
2nd year
3rd year
4th year
5th year
Profit before Tax & Depreciation
Less Depreciation
8,50,000
5,00,000
7,00,000
5,00,000
6,50,000
5,00,000
6,00,000
5,00,000
4,50,000
5,00,000
Profit before Tax
Less Tax @40%
3,50,000
1,40,000
2,00,000
80,000
1,50,000
60,000
1,00,000
40,000
(50,000)
-
Profit after Tax
Add depreciation
2,10,000
5,00,000
1,20,000
5,00,000
90,000
5,00,000
60,000
5,00,000
(50,000)
5,00,000
Cash before Terminal cash inflow
Add Salvage value at 5th year
Add working Capital
7,10,000
-
-
6,20,000
-
-
5,90,000
-
-
5,60,000
-
-
4,50,000
50,000
1,00,000
7,10,000
6,20,000
5,90,000
5,60,000
6,00,000
Required 1: (Pay Back Period (PBP)):
Year
Cash inflow
Cumulative cash inflow
1
7,10,000
7,10,000
2
6,20,000
13,30,000
3
5,90,000
19,20,000
4
5,60,000
24,80,000
5
6,00,000
30,80,000
PBP = 4 + (Total investment – 4th year cumulative cash inflow)/5th year cash inflow
        = 4 + (26,50,000 – 24,80,000)/6,00,000 = 4.28 years

Required 2: Average rate of return:
ARR= (Average annual profit / Average investment)*100
        =[{(2,10,000+1,20,000+90,000+60,000-50,000)/5}/(26,50,000+50,000)/2]*100=(86,000/13,50,000)*100
        = 6.37%
Required 3: Net Present Value (NPV) calculation:
Year
Cash flow
Discount factor@10%
Present value
1
7,10,000
0.9091
6,45,467
2
6,20,000
0.8264
5,12,368
3
5,90,000
0.7513
4,43,267
4
5,60,000
0.6830
3,82,480
5
6,00,000
0.6209
3,72,540
Present Value of cash
Less, investment
=23,56,116
=(26,50,000)
Net Present Value (NPV)
(293884)
Required 4: Internal Rate of Return (IRR):
Since the NPV at 10% discounting rate is negative; Let us take lower discounting rate 5%
Therefore,
Present Value = {7,10,000/(1+0.05)+(620000)/(1+0.05) +5,90,000/(1+0.05)
+5,60,000/(1+0.05) +6,00,000/(1+0.05) } – 26,50,000 (total investment)
= (6,76,190.48 + 5,62,358.28 + 5,09,664.18 + 4,60,713.39 + 4,70,115.70) - 26,50,000 (total investment)
= 26,77,488 – 26,50,000 (total investment)
= 27,488.
IRR= A+C/C-D(B-A)
=5% +27,488/27,488-(-2,93,884)*(10%-5%)
=5% + 27,488/321372 * 5%
=5% +0.0855*5%
=0.05+0.0042 = 0.0542 = 5.42%
Here,
A= Lower discounting rate
B= Higher discounting rate
C=NPV of lower discounting rate
D= NPV of higher discounting rate
Required 5: Calculation of Profitability Index (PI)
PI = PV of cash inflow/PV of investment cost
     = 23,56,116/26,50,000 = 0.889 = 0.89 (Approximated)
Ans:
i)                   Pay Back Period 4.28 years
ii)                ARR = 6.37%
iii)              NPV = (-2,93,884)
iv)              PI = 0.89
 
Comments: 
Out of 5 years project life, the investment will return within 4.28 years, ARR is 6.37% which is lower than cost of capital, PI is less than 1 and NPV value negative, So the project is not acceptable.

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