Finance and Accounts By: K. Venkat Swamy M.B.A., B.Ed., (ICWAI) Accounting and Business Studies Faculty Ph

FIXED COSTS VARIABLE COSTS SEMI-FIXED COSTS

FIXED COSTS Fixed costs are any costs that do not vary directly with the level of output. Fixed costs remain the same, no matter how much the business produces. Fixed costs exist even if a business is not producing any goods or services.

FIXED COSTS e.g., insurance costs, administration, rent, some types of labour costs (salaries), some types of energy costs, equipment and machinery, buildings, advertising and promotion costs etc.,

In the long term, fixed costs can alter. The manufacturer referred to earlier may decide to increase output significantly; this may require renting additional factory space and negotiating loans for additional capital equipment. Thus rent will rise as may interest payments.

Variable costs Variable costs are those costs that change in proportion to the amount of output produced. e.g., raw material costs, some direct labour costs, some direct energy costs

Semi-fixed costs Semi-fixed costs are costs which only change when there is a large change in output. For example, costs associated with buying a new machine to cope with increased production.

COSTS Costs are the expenses incurred by a firm producing and selling its products, this is likely to include expenditure on wages and raw materials etc., Total costs (TC) = Fixed costs + Variable costs Average costs (AC) = Marginal costs(MC) = TC n – TC n-1 the cost of producing one extra or one fewer units of production.

REVENUE Total Revenue is the value of total sales made by a business within a period (usually one year). Sales revenue (TR) = Quantity of goods sold (Q) X selling price (P) TR=Q x P

PROFITS Profit is the difference that arises when a firm’s sales revenue exceeds its total costs. (TR >TC) Profit = Total revenue – Total costs P = TR-TC Normal Profit–the minimum amount required to keep a business in a particular line of production Abnormal/Supernormal Profit–the amount over and above the amount needed to keep a business in its current line of production

CONTRIBUTION The difference between the selling price and the variable costs. Contribution = Sales – Variable Cost Or Contribution = Fixed costs + Profit

BREAK EVEN Occurs where Total Costs = Total Revenue Start-up costs –fixed costs Running costs –variable costs Revenue stream depends on price charged ‘Low’ price –need to sell more to break-even ‘High’ price –lower level of sales required before breaking even

Purpose of Accounts Provide information for stakeholders –customers, shareholders, suppliers, etc. Provides the opportunity for the business to monitor its own activities Provides transparency to enable the firm to attract investment Reduces the chance for fraud –not 100% successful!!

Accounting and Finance Types of Information: Profit and Loss Account –the revenue and costs of a business over a time period Balance Sheet –the assets and liabilities of a business at a specific point in time Use these sources to give ratios –the relationship between different aspects of the business

Profit and Loss Account Shows the flow of sales and costs over a period Shows the level of profit or loss made Shows what has been done with the profit or loss

Balance Sheet * A snapshot of the firm’s position at a point in time. * Shows what a company owns (assets) and what it owes (liabilities). * Balance Sheet shows what assets a company has (use of funds) and where the money came from to acquire those assets (source of funds)

Balance Sheet A guide to the structure of the assets of a company. A guide to the level of gearing–the ratio of loan to share capital Gives a guide as to the degree of working capital–the amount the company has to be able to pay its everyday debts (current assets –current liabilities) Shows the total value of a firm at that moment in time

Accounting and Finance Assets: the resources a business owns - Fixed Assets–those lasting more than one year and not used up in production –equipment, machinery, buildings, etc. Freehold assets–where the business has full ownership of the assets Leasehold assets–agreement permitting the leaseholder the right to use the asset for a fixed period in exchange for a regular payment Goodwill–the difference between the audited value and the market value of a business –the image, brand name, the existence of patents or trademarks, etc. Current Assets–assets used up during production and which will realise cash within a year –debtors, raw materials, stock, etc.

Accounting and Finance Liabilities: The financial obligations of a business –what a business owes * Loans, shareholders funds, creditors, tax liability, interest owing Current liabilities–those obligations the business has to meet within a year

The Purpose of Accounts: To provide information for stakeholders Shareholdersprogress of their investment Governmenttax liability Supplierscredit worthiness Customerslong term future of the business Prospective Investorsdecision making Potential biddersin acquisition activity Trade Unionsnegotiations with the company Managementmonitor performance of the business Employeestheir position in the business (they may well also be shareholders!)

Ratio Analysis Key types: 1. Profitability ratios- a measure of how much profit its activities generate 2. Liquidity ratios– ability of a business to meet its debts 3. Investment ratios– a measure of the performance of the business

Advantages of ratios Comparisons are relative to other figures Compare businesses of different size Gives picture of company strategy Financial and trading performance Compare with industry averages Simple summary of complex information

Reasons for using ratios Gives summary statistics Helps identify industry benchmarks Input to formal decision model Standardise for size

Applications of analysis Predictions of corporate earnings Construct projected financial statements Predict corporate failure Indicators of financial distress e.g. Altman’s models, combination of ratios

Problems with ratio analysis No agreement on definitions or specific set of ratios Accounting estimation Data not available Timing of data does not match Differing accounting policies Negative numbers and small divisors

Limitations of ratio analysis Diverts attention from the underlying information May not give sufficient attention to the notes to the accounts Accounting policies may affect comparison Industry differences

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