Importance of Cost Reduction and Control

Importance of Cost Reduction and ControlAssignment on financial principles and techniquesIntroductionSt localisegic investment ending making indicates the military service of identifying, evaluating, and selecting among projects which atomic number 18 more likely to draw signifi bathroomt effect on the organizations competitive advantage. More clearly, the ratiocination influences what the organization does (i.e., the set of crop and service attributes that argon offerings of the organization), where it does it (i.e., the structural characteristics that de borderine the scope and geographical dispersion of organizations ope balancens), and how it does it (i.e., the set of operating accomplishes and work practice).The st rategic investment decision making process is arguably wiz of senior management greatest challenges. It is signifi mountaintly needed to get these decisions right. If the decision is successful, the squ ar can enjoy strategic as thoroughly as ope symmetryn al advantage. that while the decision proves wrong, either a potential opportunity is lost or it has needlessly spoiled substantial resources (through sleeveless investment). Some traditional approaches to strategic investment appraisals which include payback, accounting rate of return, return on investment, residual income, and dissolveed hard currency flow have been criticized on the undercoat of a number of grounds. Some main criticisms atomic number 18 their narrow perspective, exclusion of nonfinancial benefits, overemphasis on the short-term, faulty assumptions about the status quo, inconsistent treatment of inflation, and procession of non- take account adding behavior.Task 1Cost Reduction Techniques.Cost decrease means reducing greet associated with intersection pointion or other make up activities without affecting the prime(a) of product or service as closely as activities. Through embody reduction procedures or techniques managers reduce cost. For this the y develop antithetic cost reduction techniques. The success of any organization largely depends on how strategically cost is managed compared with that of competitors. It certainly provides competitive advantage which is essential in this hyper competitive merchandise or business world. As the manager is the higher authority of any organization, they are to develop different types of policies and strategies to run the business successfully.Processes of Cost ReductionIdentify the prudenceMake your prediction on savingMeasure the process prior to adjustmentMake the cost saving changeMeasure the process after(prenominal)Confirm saving has been made and it hasnt impacted other areas to make a loss.If YES move onto next project.If NO go back to the beginning and start again. prehend Costing SystemCost that is allocated to units of production can be actual cost or standard cost. In an actual or historical cost system, cost is allocated as they occur. Under standard costing system, pr oduct operations and process are costed through using standard for both activities and dollar sign amount. These standards are predetermined in advance of production. The actual cost system and standard cost system can be used with either communication channel distinguish of magnitude or process cost accumulation approaches. Job order costing is applied to job order work in factories, workshops and repair shops as well as to work by builders, construction engineers and printers. A variation of the job order cost method is that of costing orders by lots. In the shoe manufacturing companies for example, a contract is typically divided into lots which consists of 100 to 250 pairs of one size and style of shoe. The cost is then accumulated for each lot. On the other hand, the process cost system is applied to industries such as flour mills, breweries, chemical plants and textile factories. However there are many companies that use both job order and process costing according to thei r needs. The basic difference between job order costing and process costing is the breadth of the denominator. The denominator of job order costing system is small (e.g. one painting 100 advertising circulars, one special package machine or one highway bridge). But in the case of process costing, the denominator is large (e.g. thousands of pounds, gallons or board feet.).Task 2The importance of developing cost reduction techniquesIt helps to enhance management execution or efficiencyIt helps to know the nature of costIt helps to reduce the cost of operations of the organizationIt helps to set competitive price of product or serviceIt helps to increase market share in the industryIt helps to increase profit or returnIt helps to enjoy competitive advantage over competitorsProposed costing and set systemsBasis of Costing MethodsMaterial cost fag out cost knock costOpportunity costStructure of CostingCosting principles and methodology doctor and variable costDirect cost (material and labor)Indirect cost (overhead and activity based costing)Product cost and periodic costProduct cost and gross gross revenue costActual CostingTo set actual costTo change to actual costTo analyze varianceEvaluation of ProjectBreakeven analysis peripheral contributionOpportunity costPaybackNPV,DCF, IRRROIROCProject Case PricingHow to cost project correctlyHow to get project approveWhat cost to drawEssential cost to includeA business case proposalPreparing a Master calculateMaster work out is a comprehensive proviso document which incorporates several other individual budgets.The operation budget consists of eight individual budgets which are as followsSales budget The sales budget shows the expect sales in units at their expected interchange price in a certain period of time. A business firm generally prepares the sales budget for a given period of time on the basis forecasted sales level, production capacity, as well as long and short term goals.Production Budget Production b udget is a plan for obtaining the resources needed to carry out the manufacturing operations of the organization to meet up the expected sales and maintain the expected level of ending inventory. The accredited production level depends on sales level, units of finished replete(p)s ending and beginning inventory.Direct Material Budget The directed material budget shows the direct materials business firm needs for its production and the budgeted cost. This budget is very much related to production budget.Direct Labor Budget To prepare direct labor budget and the direct materials budget, production budget is needed. It helps personnel de realmment of the organization to plan for new hires and repositioning of employees. A good labor budget is very helpful for a business firm to avoid urgent hiring and help to prevent the shortage of labor.Factory Overhead Budget This budget includes all the production costs except for direct materials and direct labor budgets. Manufacturing cost is t he cost that varies in direct proportion with the fabricate units and how the business firm carries out its operation.Selling and administrative expenses budget This type of budget indicates a plan for all non-manufacturing expenses. This budget provides you with a guideline for selling and administrative activities for the period of your budget.Budgeted income Statement Budgeted income statement is the finishing part of operational of a master budget. It actually estimates the expected operating income from budgeted operations in a certain period of time.The second part of master budget includes financial budget and financial budget is the combination of following two individual budgets bullion Budget A cash budget shows the effect/impact of all the budgeted activities on cash. Through preparing a cash budget, the management of a business firm is supposed to be able to make sure that they have sufficient cash on hand needed to carry out activities. It likewise helps them to have enough time to plan for any extra financing and plan for investment of surplus cash.Budgeted Balance Sheet Budgeted balance sheet is the last part in preparing master budget. This budgeted balance sheet shows the expected financial position at the end of the fiscal year (at a point of time) or budget period.It is very important to understand how to prepare a master budget since it helps a business to maximize its profit/return and to have a good handle on their budget period.Potential for the Use of Activity Based CostingABC system provides highly accurate product or customer cost that a company can use for strategic decision.This system helps to understand the cause effects relationship between day to day activities and product or customer cost and theory aids the operational control purpose of cost management system.Task 3Calculation of ratio symmetry analysis of Amber Lights ltd for two years is as followsLast Yeara) Return on detonator employed = crystalise Profit/Total cap ital= 8000/109000= 7.34%b) Return on ordinary shareholders dependr memory = concluding profit/ ordinary shareholders fund=8000/16000=50%c) Gross profit margin = Gross profit/Net sales= 92000/350000=26.29%d) Net profit margin = Net profit/Net sales=8000/350000=2.29%e) Current ratio = Current asset/current liabilities=110000/50000=2.21f) venomous test ratio =C.A-Closing stock/ current liabilities=110-44/50=1.321g) Average stock turnover period =Cost of sales/Average Inventory=258000/44000=5.86 measurePeriod =360/5.86=61.43 daysThis Yeara) Return on capital employed = Net Profit/Total capital= 12000/117000= 10.26%b) Return on ordinary shareholders fund = Net profit/ ordinary shareholders fund= 12000/16000=75%c) Gross profit margin = Gross profit/Net sales=110000/420000=26.19%d) Net profit margin = Net profit/Net sales=12000/420000=2.86%e) Current ratio = Current asset/current liabilities=136000/92000=1.481f) Acid test ratio =C.A-Closing stock/ current liabilities=136000-63000/9200 0=.791g) Average stock turnover period =Cost of sales/Average Inventory=310000/63000=4.92 timesPeriod =360/4.92Analysis of Operating Efficiency and profitabilityThe given ratio of Amber Lights ltd. indicates two types of ratio including operating efficiency and profitability. The operating profitability ratio indicates that return on capital employed ratio of last year is 10.26% and this year is 7.34%, return on ordinary shareholders fund ratio of last year is 50% and this year is 75%, gross profit margin of last year is 26.29% and this year is 26.19%, on the other hand, net profit margin ratio is 2.29% and this year is 2.86%.So we can say from the above raillery that operating profitability of two year is very close except ordinary shareholder fund. So this year performance is disclose than last year. We also see from the operating efficiency ratio that current ratio of last year is 2.201 and current year is 1.481, acid test ratio of last year is 1.321 and current year is .791, and average stock turn over period of last year is 61.43 days and this year is 73.17 days. From the given selective information of last year and the current year of Amber Lights ltd we find that last year performance is better than this year. So from the given data analysis we can say that last year operating efficiency was better than that of current year.Limitation of Ratio AnalysisAlthough ratio analysis provides important implications, there are some limitations of ratio analysis. The main limitations of ratio analysis are given belowAccounting treatment varies between firmsFirms with different divisions operating in different industries make it difficult to find industry ratio analysisSome Results may be in consistentRatios which are outside an industry grade might be cause of much concern.Task 4Financial Appraisal MethodsThere are several different appraisal methods and each of those methods has its peculiar(a) applications, advantages and drawbacks.Simple PaybackThis is one of the simplest and widely recognized methods of cost/benefit analysis. Payback period is defined as the length of time required to convalesce the original investment on the project, through cash flows. The cash flows include operating profit, less income tax payable, plus depreciation.Internal Rate of ReturnIt can be said that it is the mostly used method for the financial evaluation of a companys investment. The internal rate of return (IRR) can be defined as the rate of return required to make the vex value of in store(predicate) cash flows plus the final market value of the investment, equal to the current market price for the investment. Actually it is a discount rate making the net present value equal to zero.Average Rate of ReturnThe average rate of return is calculated profit after tax divided by book value of investment. Under this method, the entire life of any project is considered.Net Present ValueNet present value is one of the discounted cash flow techniques. This method considers time value of money. It is calculated as present value of future cash inflows over the life of the project less present value of cash outflows.Benefit Cost RatioBenefit cost ratio is another version of net present approach. Under this approach, the benefits from the project are reduced to their present value at a specified rate of discount and this figure is divided by the present value of the cost of the project.Discounted Cash FlowThis approach actually represents what a company is willing to pay at the present (today) to receive anticipated cash flow in future years. So it is a process of converting future earnings into todays money. Future cash flows are discounted to demonstrate their present values and determine the value of the project.These are well established and understood appraisal tools to financially evaluate projects. All appraisal methods are not supposed to provide the same result. Increasingly, with the creation of stakeholder value being determine d by an organizations environmental and social policies and values, new criteria and perspectives will have to be factored into organizations decision-making process.Strategic Issues in Making Investment DecisionsThe prime objective of every business organization is to make money for the owners now and in the future. Investment decision plays a significant role in making investment decisions.Both quantitative as well as qualitative issues must be considered in decision making.Short-term decisions are relatively easy on the quantitative sideWould you preferably spend $10,000 or $15,000 given the same revenue?Would you rather sell something for $5.00 per unit or $7.00 per unit given the same costs?Would you rather have net income of $60,000 or $50,000?Long-term (investment) decision involves two additional dimensions as followsTimingMagnitudeDiscounted Cash Flow Analysis addresses the timing issue.Discounted Cash Flows (DCF Analysis)A dollar today is worth more than a dollar in the f uture.A dollar in the future is worth less than a dollar today.Steps to DCFTo determine future cash flowsTo determine the appropriate discount rate taller discount rate = lower present valueLower discount rate = higher present valueHigh risk generally requires greater returnHigher risk = higher discount rateDiscount the future cash flows by using the selected overleap rateCompare the present value of the future cash flows to the investmentIf PV of inflows PV of outflows, project is satisfactoryIf PV of inflows PV of outflows, project is rejectedNPV = PV of all Inflows PV of all outflowsTools of DCFPV = to compute the present value of single future amount or a set annuity using a given token discount rateFV = to compute the future value of a single present amount or a set annuity given a particular discount rateRate = to computes the particular discount rate needed to convert a present value to a future value or a future value to a present valueNPV = to computes the net present value of a series of dissimilar future cash flows given a particular discount (hurdle) rateIf NPV 0, the investment is acceptableIf NPV 0, the investment is rejectedIRR = computes the discount (hurdle) rate which makes net present value equal to zero.If IRR the hurdle rate, the investment is acceptableIf IRR the hurdle rate, the investment is rejectedExample Suppose, company XYZ wants to make investment decision of $ 200000 for a project. The company must justify the PV of cash inflows and compare it with the cash outflows. If the value of PV is greater than cash outflow then the company should accept the project.ConclusionCost concept is very essential for decision making process. As the manager is the higher authority of any organization, they are to develop different types of policies and strategy to run the business successfully. So development of cost reduction procedures is one of the most important strategies. It is very important to develop cost reduction procedures beca use it increases the profit of the firm through reducing cost of production. If the manager cannot control cost their operating expense will be higher and higher and therefore reducing the profit of the firm. A firm which can not control cost cannot sustain in the competitive business world. So to make proper investment decisions financial managers should have clear knowledge about financial principles and techniques for better performance.