Finance For Non-Finance Managers
Finance for Non-Finance ManagersHindol Datta
Module I Non-financial manager’s concern with finance Scope and Role of Finance Importance of Finance Responsibilities of Financial Managers Distinguish between Accounting And Finance Characterize and Identify the Financial and OperationalEnvironments Compliance vs.vs Operations
Non financial Manager’s ConcernsNon-financial What to look out for and keep in mind! Planning, Problem-Solving and Decision Making What do businesses look for? Know what the numbers mean in compliance and operational contextH doHowd you PlanPl withith fifinanciali l ttoolset?l t?Appropriate Data Points and Backups as necessaryStrategic ProposalsProposals: How finance plays a roleCapital Investment: How finance plays a role
Scope and Role of Finance Finance uses accounting information Financial accounting vs. Managerial Accounting Fund management and performance monitoring Look at current problems and manage prospective issues Fundamental is the return-risk or reward-risk tradeoff Who would benefit? Marketing and SalesProductionIInternall OperationsOiHuman ResourcesInvestment Analystsy
What do Financial Managers do? Financial Analysis and Planning Investment Decisions Financing and Capital Structure Decisions Manager Financial ResourcesFinancial Managersg attemptp to maximize shareholder wealth Present and future earnings (EPS) Timing and risk of earnings assessment Dividend policy Manner of financing
Relationship between Accounting andFinanceFi Accounting is input and sub-function to Finance Financial responsibilities carried out by the Controller,Treasurer, CFO TheTh responsibilitiesblare fairlyf l ddistinctive ddependingd on thehsize of the organization Management works with finance in 2 ways Record-keeping, tracking and controlling financial data Obtain and manageg funds to supportpp managementgobjectivesj Ensure that data is standardized for external reviews andanalysis
Key Personnel Responsibilities Controller Financial ReportingControlsPayrollGovt. ReportingRecordsTaxesInterpretationAnalysis of DataBanking RelationshipInsuring AssetsDividend PoliciesCredit AppraisalInvestment of fundRelationship mgmtPension MgmtMatchingTreasurer AccountingBudgetingInternal AuditAsset ProtectionObtain FinancingInvestor RelationsFinancing MixCash ManagementChiefh f Financiall Officerff Support Short –Term Corporate ObjectivesSupport Long-Term Corporate ObjectivesExternal facing to stakeholders – Creditors, Investors, Internal EmployeesAAssessingi RiRisk-RewardkRd ttradeoffsd ffDesigning Interfaces across multiple departmentsPartnerships and Business Development SupportTax Strategies , Financing Strategies, Operation Strategies
The Financial Environment Financial Intermediaries Efficient transfer of funds from savers to individualsindividuals, businesses andgovernments Financial Markets are composed of Moneyy Markets Short –Term ( less than one year) debt securities. US Treasury Bills, Commercial Paper, Negotiable Certificate of Deposits Capital Markets LongLong-TermTerm Debt and Stocks NYSE, AMEX and OTC ( over-the-counter ) Financial Assets vs. Real Assets Financial Assets: IntangiblegInvestments Equity Ownership in Company, Debt, Rights and Obligations to Exchange Real Assets: Tangible Investments Real Estate, Machinery and Equipment, Metals, Oil
Business Organizations Sole Proprietorship Multiple OwnersInformal ArrangementEach partner is an agentBetter credit reachMinimal Organizational CostsRights are definedDissolves upon Withdrawal or DeathLimited Liability & Unlimited LiabilityCorporation Organization Cost is MinimalUnlimited LiabilityLacks fund-raising abilityFull ConfidentialityPartnership One OwnerIncome is PersonalLife is limited100% Profits and ControlSeparate EntityMore Organization NeededTransfer of OwnershipD bl TDoubleTaxationtiLimited LiabilityUnlimited LifeRaise Capital easierB k t doesBankruptcyd nott dischargedi httax obligationsbli tiHybrid Structures Limited Partnership Shell CorporationsS-CorporationSpecial Purpose Entities
Module 2 Importance of Cost Data Describe the Types of Costs Cost Concepts for planning, control and decision-making Cost Behavior Segregate fixed and variable costs Cost Allocations Factors in Cost Analysis
Why Cost Data? Costs may drive Selling Price Costs must be comprehensive Costs are meaningful if all factors considered Full Cycle Costing is the Key Parameter Costs sets the tone for decision making Cost is useful for Planning and Budgetary Cycles Costs enable decision making around Capacity
Types of Costs Direct MaterialDirect LaborOverheadOpportunity CostOperating Costs Selling Expenses Research and Development General and Administrative Government CostsPrime Costs:DM DLConversion Costs: DL OverheadPeriod Costs: Cost incurred during a period. Charged to revenue immediately within the yearProduct Costs: Costs are charged to products upon sale of the productFixed Costs: Costs remain constant regardless of product activityVariable Costs: Costs change with respect to the activity being supportedSemivariable costs: Mixed Costs like a fixed costs a variable component
Other Cost Concepts Controllable vs. Uncontrollable Costs Standard Costs Incremental Costs Sunk Costs Relevant Costs Opportunity Costs Joint Costs DiscretionaryDCCosts or SSwag CCosts
How do Costs Behave Some Costs are variable Some Costs are fixed Time drives the fixed and variable componentsSales of ComputersVolumes50,000 75,000 125,000 Standard Cost ofMaterials ( 1)50,000 75,000 125,000 Standard Cost ofDirect Labor (1.50)FactoryRent ( 50,000)75,000 112,500 187,500 ** Variable Cost is 2.50** Fixed Cost per Unit goes down over increase in Volume*** Capacity Decisions can be made, assuming behavior is the same**** Learning Curve Imputation in advanced planning25000 Units75000 UnitsChange in Total Cost 187,500 62,500Change in Volume75,00025,000ChChangeffor Incr.IProductionP d ti2 502.502 502.5050,000 50,000 50,000 Unit Cost3.50 3.17 2.90 Total Cost175,000237,500362,500
Overhead Allocation Overhead Allocation is based on Standards ActivityA ti it BBasedd OverheadO h d AllocationsAll ti Overhead Allocation maybe subject to change Overhead Allocation needs to be revisited depending on the company Overhead Allocation is crucial for capacity planning Refer to previous example Case I: Advertising Costs What to keep in mind: Period vs. Product Costs What is the best allocation procedure What is the objective of the allocation procedure Is it a science or an art? Warning: This is a Dangerous Cost that is the MOST CONTENTIOUS INCOMPANIES
Module 3: Contribution Analysis What is Contribution Analysis? Why do it? Pricing Strategy ProductP d DDecisionsii Product Mix Decisions Performance Assessment Non-Recurrent Costs Factoring
Target AnalysisWidget Costs Per UnitUnits110200300333.33500Selling Price Total Sales252525252525 252505,0007,5008,33312 50012,500Variable Costs Total Variable Costs101010101010 101002,0003,0003,3335 0005,000 Contribution Margin151503,0004,5005,0007 5007,500Contribution Margin Selling Price ‐ Variable CostsContribution Margin in 15Contribution Margin Ratio 60% ( 15 CM / 25 Selling Price)Breakeven Sales in Fixed Costs/ Contribution Margin RatioBreakeven Sales in 8333.333333 ( 5000/60% Contribution Margin Ratio)Breakeven Sales in Units 333.3333333 (BE Sales in / Selling Price per Unit)Target Profit (Breakeven Sales in Target Profit) / Contribution Margin RatioTarget Profit 2,500Target Coverage 7,500 (Fixed Costs Target Profit)Target Salesl in 12,500 (Target(Coverage// ContributionbMargin Ratio))Target Sales in Units500 Fixed Costs5,0005,0005,0005,0005,0005 0005,000 Profit(4,985)(4,850)(2,000)(500)(0)2 5002,500
You have Idle Capacity! Idle Capacity Take the previous example: These are strategic decisionsChannel Conflicts may emergeType of industry organization and information disseminationLong-Term view is importantContribution Marging Analysisy is ggood for Market Penetration Decisions 50% Idle Capacity: Can produce up to 1000 units with no increase in fixed costsAn order comes in and buyer wants to pay 5, 10, 15What would you take and why?Importantpto note the following:g Presence of unused capacity together with insufficient raw materials or skilled labor. When idle capacity exists, a firm can take on anincremental order without increasingg the fixed costs.Absorb the fixed cost by producing to full capacityLower the Pricing to meet a total profit objectiveThe experience curve or learning curve impact kicks in!Full Capacity Utilization ( 100%) Produce up to the quantity that will not change Fixed Costs --- 1000 unitsFixed Cost per Unit 5.00Variable Cost per Unit 10.00Pricing can be 15.00 to BE or 18.00 for 20% Margins.Difference in Pricing is 7.00 ( 25 vs. 18 ).Get greater market shareH h MarketHighM k ShareSh willll increase theh experience andd llearning curve thush impacting andd llowering VVariablebl CCosts
Experience Curve Impact!WidgetidCostsCPer Uniti at 80% Learningi CurveCUnits10204080160Selling Price Total Sales2525252525 2505001,0002,0004,000Variable Costs (no learningcurve) 10 10 10 10 10 Variable Costs ( learningcurve)108654Management will know at what stepped up volumes will experience curve kick inFor various scales, experience curve could be different** As cumulative outputp doubles,, the experiencepcurve kicks in!Experience Curve simply put means that as you build more and morewidgets, you build then faster so that the average time spent perwidget becomes lower,lower and thus average variable costs become lower.lowerThus an 80% experience curve means that you are becoming efficientby 20% as you double your production.
Module 4: Relevant Costs Are not all costs relevant? Why are relevant costs relevant? Make or Buy Decisions Optimize Resources And there are the sunk costs! The Cost Paradox
What are Relevant Costs? Costs that are relevant for you to make a decision! They are the future costs between alternatives Sunk Costs are not relevant.You cannot go back and change it SunkS k CostsC t relevantlt forf examiningi i ththe efficiencyffi iandd effectivenessff tiof past decision-making, hence relevant in that context Incremental or Differential Costs are keyy relevant costs Prospective Opportunity Costs are relevant costs Thus the key funnel analysis is Take all Costs less the Sunk Costs less Costs that do not differ toexamine alternatives and then select the best decision based on theincremental costs measured againstgthe opportunityppy cost
Example of Relevant CostsEquipment AEquipment B Sales50,00075,000Variable Cost 30,000 45,000Insurance 5,000 8,500Setup Cost 3,000 9,500Other Fixed Cost 7,000 7,000Profits QQuestionsito AAskk to determinedi whath to bbuy:1.2.3.4.If we are to close business today, what decision would you make?Would it be different if we run the business for 4 years?yWhat other considerations would you throw in?How would your analysis change if sales changes for Equipment A and/or B?5,0005,000
J i tCJointCostst andd IncrementalIt l AnalysisA l i Joint Costs are costs incurred until split-off point These are costs that are pprettyy much unavoidable to gget to at least ONE commerciallyy viable productOnce one product is produced, one can make additional investments to monetizeresidual value(s)In order to assess the economic value,value costs and revenues have to be analyzed at theincrementThe initial joint costs for the purposes of additional products in not relevant or sunkProduction based until at least a break-even is reachedNon‐Refined OilR fi d OilRefinedPetroleumOther UsesJoint Cost 150,000 RevenueIncremental Cost250,000150 000 150,00075 00075,000100,000 90,00020,000 25,000 Profits100,00075 00075,00010,000(5,000)
Product Abandonment Decisions Companies want to reduce their product lines to focus on profitable productsAssume that there is no change in fixed costs in the shortshort-runrunDecision to drop the product will be based on ranking the contribution marginProducts with the highest contribution margin should be kept in playProduct AProduct BProduct C 35,000 50,000 45,000 25,000 40,000 35,000 10,000 10,000 10,000 29%20%22%SalesLess: Variable CostsContribution Margin (CM)CM RatioLess:Fixed Costs Allocated Allocation based on Product Lines8,000 33%8,000 33%8,000 33%Total Profit after Allocation2,0002,0002,000 Total Fixed Costs do not change!It is all about the Margins!Keep in mind experience curve for forecasting purposes!Keep in mind idle capacity or full utilization for product abandonment decisions130,000100,00030,00023%24,000100%6,000
Module 5: The Budget The Budgeting Process or The Operating Plan The Budgeting Workflow The Cash Budget Forecast and the Internal Reviews Forecast and the External Commitments Revisiting Forecasts or Re-forecasts Plan and the Forecasting Cycle
The Planning Cycle
The Plan Cycle You have ONE OPERATING PLAN or THE PLAN for a fiscal period ( could cover one or more fiscal periods)The operating plan sets the toneTh is theThish planl thath is establishedbl h d internallyllThere could be two plans – a management plan and plan foreveryone elsePlans are linked to corporate objectivesObjectives are established internally by management basedupon discussions and feedback internally and externallyThe Plan is built uponp a set of assumptionspand objectivesj
Corporate Objectives Sales Objectives To get 10% of the target market in 1 year. To become the #1 or #2 in the category Production Objectives To reduce the costs of existing products by 30%To retool existing capacity for greater productivityTo develop a strategic platform to create new high quality products fasterTo reduce inventoryResearch and Development To differentiate products by embedding new technologies and processes that can be patented To have quicker and effective commercial release of new technologies Financial Objective To maximize cash flow by managing vendor floatTo buyback shares to increase share priceTo increase dividend for long-term enhanced valueTo reduce cash tied in inventory and fixed costsTo raise financing at the maximum valuation based on EBIT ( Earnings before Income Taxes)To ensure that company meets the covenant rulings
ProcessAssumptions are clarified and agreed uponWhat if scenarios are played out at the highest levelWhat-ifContingencies are articulatedTop-Down Operating Plan Parameters are establishedObj ti are definedObjectivesd fi d – preferablyf bl withith metricstiObjectives are passed down to Business Unit or Functional HeadsNumbers are crafted bottoms upReserves established bottoms up for contingencies.( Sandbagging )Negotiations, Buy-ins, renegotiations occur. Process may take a monthup to several months. Top-downT dparameters andd bbottom-up numbersb are stress tested.d Formalization and rollout occurs There could be multiple budgets : Executive and Operational
Objective 1:AssumptionAssumptionCost of DL Time per UnitMaterials Per UnitWidget AWidget BWidget CObjectiveTo increase market share to 15%Target Market is 1M UnitsIncrease Market Spend to 8% of Sales2 Hours Qty81510Objective 2:AssumptionPercentage of Sales CommitmentG&A AssumptionTo develop new technologiesNew engineers and capex for new technologies5%2%50.00Costs2.5251.354XternalTop Down Plan1,000,000150 000150,000Target MarketUnit Sales Anticipated250.0050.0080.25119.75Total Costs per Unit2020.2540InternalVariable1,000,000100 000100,000Average Price Per SaleDirect Labor per SaleDirect Materials per SalegGross Margin Total Sales in Total Cost of SalesGross MarginGross Margin % Marketing and AdvertisingResearch and DevelopmentGeneral and Administrative 3,000,000.001,875,000.00750,000.00 2,000,000.001,250,000.00500,000.00Operatin ProfitOperating 12 337 500 0012,337,500.00 8 225 000 008,225,000.00Taxes at 34% average 4,194,750.00 2,796,500.00Net Income 8,142,750.00 5,428,500.0037,500,000 19,537,500.00 17,962,500.00 011,975,000.0048%
M d l 6:Module6 CCostt CControlt l andd VariancesV i What is a standard? Why variance analysis? Flexible Budgets List the various cost variances The Theory of Constraints Activity Based Costing Pros and Cons of Standard vs. Activity Based Costing
Define a Standard Standard costing is applying a predetermined cost to aproductd t forf futuref t periodsi d Standard costs generally include Direct Material Costs Direct Labor Costs Allocated Overhead Costs PrimeP i CostsC t andd CConversioni CCostst Costs applied to the product only. These are not operatingexpenses Operating expenses are normalized against Sales andexpressed as percentage of Sales
Standard Costs Standard costs are the expected costs of manufacturing the product Standard Direct Labor Costs Expected Wage rate X Expected Number ofHours Standard Direct Material Costs Expected Cost of raw materials X Expectednumber of Units of raw materials Standard Overhead Costs Expected Fixed OH Expected Variable OverheadX Expected Number of Units to be producedStandard Cost System Method of setting cost targets and evaluating performance Costs set based on various criteria, and pperformance vs. expectationspmeasured Material differences between performance vs. expectations investigated Helps management in decision making and control
Wh haveWhyhtheth StandardSt d d CostC t System?S t ? Decision Making HHow we produced our productd t Howe we price our product Contract Billing Monitor Manufacturing Large variances may be indicative of problems in production Performance Measurement Deviations are used to monitor performance Standard Setting processes based on historical, value pricing,benchmarks Also based on underlying assumptions of optimum, normal operatingconditions, capacity, stretch goals
Variances Raw Material Price Variance Raw Material Quantity Variance Direct Labor Wage Variance Direct Labor Quantity Variance Overhead Variances
COST EFFICIENCY VARIANCESStandard CostsStandard QtyRaw MaterialsWheatHopsBarleyStandard PriceTotal(in pounds)100 200 200 Direct Labor50 50 50 500 TOTAL COSTS20 5,00010,00010,00010,00035,000Raw Materials PriceVarianceWheatHopsBarleyActual Price 55 50 40RRaw MMaterialsi l QQtyVarianceWheatHopsBarleySStandardd dQty UsedQtyVariance Standard Price1001000 50150200‐50 5025020050 50Labor Wage VarianceStandardActual Price PriceVariance Actual HoursTotal Variance 22 20 2550 1,100Std. Price 50 50 50Variance Qty Purchased Total Variance 5100 500 ‐150 ‐ (10)250 (2,500) (2,000)Actual ResultsActual QtyRaw MaterialsActual PriceTotal(in pounds)Wheat100 55 5,500Hops150 50 7,500Barley250 40 10,000Direct Labor550 TOTAL COSTS22 12,10035,100Actual HrsLabor Qty ( EfficiencyVariance)550Std HrsVariance Std Rate500 50 TOTALTotal Variance ‐ (2,500) 2,500 ‐Total Variance20 1,000 100
Overhead Efficiency Variance Measure of the effect of the difference in the amount of an activitybase incurred compared to the expected amount of the activitybase. Overhead is allocated based upon pre-determined standard If additional labor or direct materials are used compared to thestandard, then that variable overhead rate is applied against thevariance in the activity base Overhead volume variance measures the costss or benefits of usingless or more than expected capacity Volume Variance Fixed Overhead * ( Budgeted Vol – ActualVolume)/Budgeted)gVolume If budgeted volume Actual Volume, no biggie; nothing changes. When budgeted volu
Relationship between Accounting and Finance Accounting is input and sub-function to Finance Financial responsibilities carried out by the Controller, Treasurer, CFO Th b l f l d d d h The responsibilities are fairly distinctive depending on the size of the organization Management works with finance in 2 way
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The non-financial manager who is responsible for resources or budgets should be familiar with the language of finance. b. Business decisions made by non-financial managers do affect the financial performance of the organization. c. All non-financial managers are really financial managers because their actions ultimately affect the financial .
The Finance for Non-Finance Manager course empowers managers to more effectively communicate with accounts and finance people and to understand the financial aspects of business decisions. Many operating managers have h
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