Finance T3 & T4

Topic 3: Cost Management

Break-even analysis (425)

Planning and Budgets (558/568) - see topic guide for pros and cons

Cost-volume-profit equation (CVP)

Break-even

Costs (426)

Fixed costs (indirect costs)

Variable costs (direct costs)

Semi-variable, semi-fixed costs or stepped fixed costs

Cash break-even (excludes depreciation) (430)

Accounting break-even (includes depreciation) (426)

Sales revenue - variable costs - fixed costs = Profit

(Selling price x units) - (variable costs x units) - fixed costs = profit

Contribution margin = selling price - variable costs per unit (428)

Degree of operating leverage (DOL) (433)

Connects the relationship between the balance of fixed and variable costs, with the difference between % increase in rev compared with % increase in operating profit

DOL = % change in OP / % change in revenue

Therefore, DOL x % change in rev = % change in OP

Topic 4: Working Capital Management (Ch18)

Working capital cycle (586)

Managing current liabilities and calculating the cost of credit (592)

Working capital policy (583)

Managing current assets

Net working capital (580)

= current assets - current liabilities

Risk return trade-offs to consider when managing working capital

Working capital management should be a day-to-day activity

Short-term assets should be funded by short-term liabilities and long-term assets should be funded by long-term liabilities

Principle of self-liquidating debt, i.e. maturity matching

Assets

Temporary, CA except min level of AR/Inventory

Permanent, N-CA plus min level of AR/Inventory

Sources of financing

Spontaneous, i.e. AP / accrued expenses

Termporary, i.e. overdraft

Permanent, i.e. long-term loans

Operating cycle

Cash conversion cycle

= Inventory conversion period + Average AR collection period

Shorter = more efficient use of working capital

Is the period between purchasing inventories to receiving cash for goods sold

= Operating cycle - Average AP period

Will therefore be shorter than Operating cycle by the Ave AP period

Factors in AP period

See table that illustrates these concepts on p.586

Ave AP period = 365 / (COGS / AP)

Inventory conversion period = 365 / Inventory turnover ratio

Ave AR collection period = Ave AR / (Annual Credit Sale / 365)

Inventory turnover ration = Annual COGS / Ave inventory

Cash and marketable securities (594)

Managing AR (595)

Managing inventories (599)

Terms of sale (596)

Quality of customer (596)

Collection effort (598)