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Free Essays - Finance Essays

Financial Costing Measures.

MARGINAL COSTING:

Marginal costing or also called direct costing divides costs into fixed and variable elements. The variable costs are those that fluctuate with changes in volume, while the fixed costs are those that fluctuate with time. Variable or marginal costs comprise materials, labor and expenses, plus variable works, administration and selling expenses. These are deducted from the sales revenue to give the 'contribution' or margin, which indicates the amount contributed by sales to the fixed expenses of the organization and to the profit. The main point in marginal costing is that until the fixed expenses have been recovered, no profit has been earned.

Marginal pricing is less common in practice than full cost pricing but has the advantage that it is based on costs that will change in the future and does not attempt to spread fixed cost over a normal volume that may not represent actual or potential sales It helps management in determining minimum price to be charged and in particularly pricing additional sales units at some discounted rates when sales have been already made at normal selling prices. For example in events of extreme competition or for producing extra sale to make extra profit for company, marginal costing is helpful.

ABSORPTION COSTING:

A costing method that includes all manufacturing costs, direct materials, direct labor, and both variable and fixed manufacturing overhead in the cost of a unit of product. Absorption costing is also referred to as the full cost method.

Absorption costing has the following advantages which favor organizations to opt for this option:

Ease of implementation and maintenance - Since full-absorption costing only requires expense pools at the center or functional level as a numerator and volumes (cost drivers) as the denominator, an organization-wide costing implementation with this methodology can be put in place quite rapidly. In addition, many organizations have downsized their accounting/finance support staffs, and this methodology requires a relatively small staff for development and ongoing maintenance. Cost analysts do not have to visit the production sites in person, since a detailed understanding of these sites and the functions they perform is not required to create the expense pools and perform the necessary calculations.
Treats all expenses as relevant - Full-absorption costing directly recognizes that, in the long run, prices established for products and services must cover the institution's full expense structure and therefore, should be included in unit costs.

Provides results that are "directionally correct" - Since all expenses incurred in the production areas are included in the expense per unit calculation, they are indeed reflective of the expense structure of the financial institution. As such, the bottom line profitability measures are directionally correct.

Supports Organization, Product and Customer profitability measures - The cost drivers selected to create the expense per unit rates are generally aligned to organizational units, products and customers. As the actual volumes for these cost drivers, with their organizational unit, product and customer identities, are brought into a profitability process monthly and extended by their fully-absorbed unit rates, the resultant total cost can be matched with the revenues to create fully absorbed profitability measures

WORKING CAPITAL MANAGEMENT:

Working capital management is the management of current assets and current liabilities to maximize short-term liquidity. Adequate working capital is an indicator of financial health. Without working capital, arts organizations suffer from persistent cash crunches and have trouble meeting financial obligations. Working capital is the money used to make goods and attract sales.

Working capital is the life blood of any business and every manager’s primary task is to help keep it flowing and use to generate profits. Each component of working capital has 2 dimensions TIME AND MONEY and when it comes to managing working capital then TIME IS MONEY. If manager can get money to move faster around the cycle (e.g. collect monies due from debtors more quickly) or reduce the amount of money tied up (e.g. reduce inventory levels relative to sales), the business will generate more cash or it will need to borrow less money to fund working capital. As a consequence, he/she could reduce the cost of bank interest or have additional free money available to support additional sales growth or investment. Similarly, if he can negotiate improved terms with suppliers e.g get longer credit or an increased credit limit, he/she effectively create free finance to help fund future sales

CAPITAL INVESTMENT DECISIONS:

In business world, the objective of any business project is to identify the most effective investment opportunities and strategies to pursue well in advance of actually making an investment. The best for example engineering design does not necessarily ensure that a company will achieve the desired return on investment capital or achieve the targeted rate of return on invested capital. Capital budgeting is one of the techniques to check feasibility of the project to pursue. In capital budgeting first firms goals converted into specific objectives. Priorities get set and strategies identified. Thereafter investment opportunities identified. Business can get many proposal but are not evaluated due to time and money constraint. In capital budgeting process proposal get check against risks and return through it which is the most important part of any business entity. Capital budgeting helps manger in identifying right project which gives more output as compare to other projects. Capital budgeting has following advantages for management:

• Project would preserve an existing capital facility, avoiding greater expense in future years.

• Project would result in significant savings in operating costs.

• Project would result in the purchase of land for future projects at favorable prices.

• Project would generate sufficient revenue to be essentially self-supporting in its operations

• Project would significantly reduce current and future operating and maintenance costs.

• Project would link other existing or planned improvements that will mutually benefit from the linkage and will improve port efficiency and ability to deliver service to customers.

• Project is required as a result of lease terms.

• Project results in enhanced productivity at same or lower operating costs.

• Project timing is critical; if the project is not acted upon at once, the opportunity will be irrevocably lost, or other major alternative actions would have to be initiated.

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