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Managing Financial Principles and Techniques

By wahabessani Aug 24, 2012 1030 Words
MANAGING FINANCIAL PRINCIPLES AND TECHNIQUES

TABLE OF CONTENTS
INTRODUCTION………………………………………………………………………………………….. COST CONCEPTS TO THE DECISION MAKING PROCESS………………………………………. FORECASTING TECHNIQUES TO OBTAIN INFORMATION FOR DECISION MAKING……….. BUDGETARY PROCESS………………………………………………………………………………… COST REDUCTION AND MANAGEMENT PROCESS…………………………………………….. FINANCIAL APPRAISAL TECHNIQUES TO MAKE STRATEGIC INVESTMENT DECISIONS… INTERPRETING FINANCIAL STATEMENTS FOR PLANNING AND DECISION MAKING……… BIBLIOGRAPHY…………………………………………………………………………………………… APPENDICES………………………………………………………………………………………………

INTORDUCTION
As the business environment changes, the organizations are also expected to change their business processes. There are several business processes in an organization that needs to manage effectively, so that the organizations may survive in the foreseeable future, meanwhile achieving their short term objectives as well. The most important business process of an organization is its Finance Function. Finance function is being managed through a set of financial principles and techniques. Various financial experts have developed different financial theories and techniques that allow organizations to manage their finance function in the most effective way by following those principles and applying different techniques. In this report we will analyze and interpret different financial principles and techniques with the context of predetermined set of criteria.

LEARNING OUTCOME 1: COST CONCEPTS TO THE DECISION-MAKING PROCESS IMPORTANCE OF COSTS IN THE PRICING STRATEGY
Once a business has decided its strategy for the next five years, in terms of, for example, market share, revenue and profit growths, diversification into new areas, development of new products etc, it then has to set about planning the achievement of the strategy. At this point, it will need to recognize any “key factors” that may limit the extent to which targets can be achieved, at least in the short term. One most important key factor that can impact the achievement of those targets to a great extent is the costing system and pricing strategy of the organization. It is the cost can decide the profit margin which is added up to form the price of the product. In case of Great Deals it is very important for the organization to have a solid costing system and a sound pricing strategy to survive and remain in the competition. Since the sales are decreasing due to increased competition, it is very important the Great Deals has a strong control system that can identify the costs associated with the production and sales of its Product P. Thus, in order to improve sales Great deals will have to design an appropriate pricing strategy that can be sustainable in the longer term and profitable in the short- term as well. Consequently, all the costs should be known to the entity so that I can design an appropriate pricing strategy for its product P.

COSTING SYSTEM
Firms have the choice of two basic costing methods – marginal costing and absorption costing. Under absorption costing it is necessary to absorb overheads into units of production using a suitable basis. OAR = Budgeted overheads / budgeted level of activity

To enable this, all overheads must first be allocated / apportioned into production departments, again using a suitable basis (e.g. rent on the basis of floor area) Step 1: Overheads allocated or apportioned to cost centres using suitable basis. Cost Centres (Usually departments)

Step 2: Service centre costs reapportioned to production centres. Step 3: Overheads absorbed into units of production using an OAR (Usually on the basis of direct labour hours). Overheads

A B C
(Prod n) (Prod n ) (Service)

AB

Production Output

We can use the above discussed costing methods to Great Deals in order to devise an appropriate pricing strategy You may notice the OAR rate for fixed factory overhead is £30.00 per unit i.e. (£30,000/1000) and OAR rate for fixed selling overhead is £1.00 per unit i.e. (£1,000/1000). Having determined the OAR (Overhead absorption rate) we can now determine the cost of the product to determine the margin on each unit product P produced and sold. By summing up all the costs you may notice that the cost of each Product P is £70.00 and gross profit on each unit of Product P Produced and sold is £50.00 (Please see the Appendix “A” for the detailed cost schedule.) ASSUMPTIONS

The assumption underlying the traditional method of costing is that overhead expenditure is connected to the volume of production activity. This assumption was probably valid many years ago, when production system were based on labour-intensive or machine-intensive mass production of fairly standard items. Overhead costs were also fairly small relative to direct materials and direct labour costs; therefore any inaccuracy in the charging of overheads to products costs was not significant.

The assumption is not valid in a complex manufacturing environment, where production is based on smaller customized batches of product, indirect costs are high in relation to direct costs and a high proportion of overhead activities – such as production scheduling, order handling and quality control – are not related to production volume. PROPOSED IMPROVEMENTS

As you have noticed that the above method of absorption costing system provides a profit £50.00 on each unit of product P i.e. (£120.00-£70.00) that is almost 71.5% markup on cost. In my opinion, if Great Deals has to survive in the competition it will need to reduce its selling price of Product P. Although it will reduce the gross margin earned by the product but it will attract more sales and ultimately increase the overall profitability of the entity. In order to reduce the selling price Great Deals will have to improve its costing method. The current method of absorption costing is not valid in the modern business environment. The entity should adopt Activity Based Costing method to know exactly how much does it cost to make a unit of Product P and then add a desired percentage markup to cost so that a competitive selling price may be set. Although Activity based costing method is seems more appropriate in the modern business environment but it also has its own assumptions e.g. Products incur overhead costs because of the activities that go into providing the products, and these activities are not necessarily related to the volumes of the product that are manufactured.

LEARNING OUTCOME 2: FORECASTING TECHNIQUES TO OBTAIN INFORMATION FOR DECISION MAKING

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