CIMA P1 Slides 2011

Performance Operations

CIMA Paper 1

Format of the Paper

Section A: 20 marks• Compulsory objective test questions

Section B: 30 marks• 6 compulsory short answer questions

Section C: 50 marks• 1/2 compulsory questions

Core Areas of Syllabus

• Cost accounting systems 30%

• Forecasting and budgeting techniques 10%

• Project appraisal25%

• Dealing with uncertainty in analysis15%

• Managing short term finance20%

11ChapterChapterVerb hierarchy

• Explain• Illustrate• Apply• Calculate• Discuss• Analyse• Evaluate

Typical verbs used in questions

22ChapterChapterTraditional Costing

Session Content

Absorption CostingAbsorption Costing

Traditional CostingTraditional Costing

Marginal CostingMarginal Costing

Contribution AnalysisContribution Analysis

Absorption costing

• Absorption costing is a method of costing in which the cost of a product is built up as the sum of direct costs and a fair share of production overhead cost

• A fully absorbed cost is used to value inventory and as a basis for pricing

Standard cost card

• Full production cost

• Direct materials x• Direct labour x• Variable overheads x• Fixed production overheads x• Full production cost per unit x

– Fixed non-production overheads are treated as period costs.

– Gross profit is highlighted.

OAR

Proforma of Income Statement Using Absorption Costing Approach

Sales x Less full production cost of goods sold (x) Opening inventory x + Production x - closing inventory (x)

Gross profit x

Over absorption x Under absorption (x)

Less

Variable sales and distribution [sales commission etc]

(x)

Fixed non production (x)

Profit/(loss) x/(x)

Marginal Costing

– Inventories and production are valued at the variable production costs per unit.

• Direct materials x• Direct labour x• Variable overheads x

x– Fixed overheads [both production and non

production ] are treated as period costs and are therefore written off in the income statement for the time period.

– Contribution is highlighted/emphasised.

Contribution

Contribution = Sales Less Variable Costs

Direct MaterialsDirect Materials Direct LabourDirect Labour Variable Overheads

Variable Overheads

Proforma of Income Statement Using Absorption Costing Approach

Sales x Less variable production cost of goods (x) Opening inventory x + Production x - closing inventory (x)

Gross contribution x

Less non production variable cost [sales commission etc]

(x)

Contribution x Less fixed cost

Production x Non-production x (x)

Profit/(loss) x/(x)

Reconciliation of profits

The only difference between the two approaches is the value of inventories.

• Under absorption costing inventory values include fixed production overhead (FPOH).

– increased inventory increases current period’s profit compared with marginal costing.

– decreased inventory decreases current period’s profit compared with marginal costing.

Differences in profit

1. If Opening Stock > Closing Stock

then MC Profit > TAC Profit

2. If Opening Stock < Closing Stock

then MC Profit < TAC Profit

3. If Opening Stock = Closing Stock

then MC Profit = TAC Profit

• Break even point = Total fixed costs Contribution per unit

• Margin of safety = Budg. Sales – B/E Sales

• Target units = Total fixed costs + Target profit Contribution per unit

Break even analysis

33ChapterChapterTechniques for ModernEnvironments

Session Content

MRPMRP

Techniques for Modern

Environments

Techniques for Modern

Environments

ERPERPMRP IIMRP II

JITJIT TQMTQMBack flush Accounting

Back flush Accounting

Overview

‘To compete successfully in today's highly competitive global environment companies are making customer satisfaction an overriding priority, adopting new management approaches, changing their manufacturing systems and investing in new technologies. These changes are having a significant influence on management accounting systems’

Colin Drury' Management and Cost Accounting'

Aims of modern systems

• Improve efficiency

• Improve effectiveness

• Improve quality

• Reduce waste

MRP

MRP1• A computer system for production, planning,

purchasing and inventory control• Not integrated with other related systemsMRP II• Extension of MRP 1 • Links production/materials planning to other

systems with the accounting system• Budgets can be prepared from a common

database

JIT

• ‘Pull through’ system (Kanban)• Ideal inventory of raw materials, WIP and

finished goods is zero• Work cells• Multi-skilled labour• Contracts with single suppliers for high

quality raw materials

Suitable conditions for JIT

• Local supplier with short lead times • Even demand• Fast throughput• Cost savings from lower inventory and

improved quality exceed cost increases from higher skilled staff and higher quality materials

Total Quality Management (TQM)

• Get things right first time• Continuous improvement

Costs affected• Prevention costs• Appraisal costs• Internal failure costs• External failure costs

Backflush accounting

• An approach to cost accounting which can be used if– throughput is high and – inventories are low

• Actual material purchases are recorded in raw materials account

• Actual conversion costs are recorded in the cost of goods sold account

• At the end of the period values for closing inventory are estimated

• This results in a figure for the actual production cost

44ChapterChapterThroughput Accounting

Session Content

Calculating Throughput

Calculating Throughput

ThroughputAccounting

ThroughputAccounting

Theory of Constraints


Throughput Accounting Measures

Throughput Accounting Measures

Throughput

Sales Revenues – Direct Material Cost=

Throughput


• Bottlenecks prevent throughput from being maximised

• Throughput accounting is concerned with identifying and removing bottlenecks

• Goldratt’s five steps- identify- exploit- subordinate- elevate- return to step 1

Throughput Formulae

Return Per Factory HourThroughput

Time on Bottleneck Resources=

Cost Per Factory Hour Total Factory Cost

=

Throughput Accounting Ratio Cost Per Factory Hour

=

Total Time on Bottleneck Resources

Return Per Factory Hour

55ChapterChapterActivity Based and EnvironmentalCosting

Session Content

Activity Based Costing (ABC)


ABC PrinciplesCost Drivers

Pro’s and Con’s

ABC PrinciplesCost Drivers

Pro’s and Con’s

Absorption Costing

(Revision)

Absorption Costing

(Revision)


• Absorption costing– Charges overheads to products based on

a hourly absorption rate

• ABC– Charges overheads to products on a

causal basis using cost drivers

Absorption Costing

Service Departments

Production Departments

Product Lines

Stage 1 Stage 2

Assigning Costs Using Measures of

Service Usage

Allocating Costs Using a Measure of

Volume

Elements of ABC

Activity cost pool:– An activity that incurs cost. – Costs are linked to the activity accurately

and from the activity to the cost unit. – Knowledge of the activity is key to the

application of ABC.

Elements of ABC

Cost driver:

• This is the causal link between the activity and the cost unit. • Cost drivers describe exactly how the production of units incur

costs within the activity. • The overhead is linked to the cost unit using a cost driver rate.

Cost driver rate = Cost poolLevel of cost drivers

Activity Based Costing

Service Departments and Factory Overhead

Activity CostPools

Assigning Costs of Individual Activities

Allocation of Costs Driver Rates

Stage 1 Stage 2

Product Lines

Why are traditional OARs less reliable?

• Increased complexity of operation

• Increased percentage of overhead costs

• Reduced significance of labour

• Less volume related costs

Favourable Conditions For ABC

Production overheads are high relative to direct costs.

Diversity in the product range. Diversity of overhead resource input to

products. Consumption of overhead resources is not

driven primarily by volume.

Benefits of ABC

• More accurate product line costs.

• More flexible the approach can analyse costs by processes, areas of managerial responsibility and customers.

• ABC avoids the problem of cost absorption on an inappropriate basis.

• Provides a reliable indication of long-run variable product cost.

• Provides meaningful financial (periodic cost driver rates) and non-financial (periodic cost driver volumes) measures.

• Improves cost estimation by accurate identification and understanding of cost behaviour.

Limitations

• Little evidence to date that ABC improves corporate profitability.

• ABC information is historic and internally orientated and therefore lacks direct relevance for future strategic decisions.

• Practical problems such as cost driver selection.• It can be viewed as simply a rigorous application of

conventional costing procedures.• More expensive than traditional absorption costing

as it requires more detailed information and analysis.

• Environmental costs should be removed from general overheads

• They will have their own cost pool and cost drivers

• They should be charged to products in a similar way to all other activity based costs

• This should ensure that product costs fully reflect the true cost of production

Environmental costing

66ChapterChapterVariance Analysis:Calculations

Session Content

Variances AnalysisVariances Analysis

MaterialVariances

MaterialVariances

LabourVariances

LabourVariances

VariableOverheadVariances

VariableOverheadVariances

FixedOverheadVariances

FixedOverheadVariances

SalesVariances

SalesVariances

BudgetedProfit

Actual Profit

Difference

Total Material Variance

Total Material Variance

Usage Variance

Usage VariancePrice VariancePrice Variance

Material Variances

Rate Variance

Rate Variance

Idle Time Variance

Idle Time Variance

Efficiency Variance

Efficiency Variance

Total Labour Variance

Total Labour Variance

Labour Variances

Total V/O/HVariance

Total V/O/HVariance

Efficiency Variance

Efficiency Variance

Expenditure (Rate)

Variance

Expenditure (Rate)

Variance

Variable Overhead (V/O/H) Variances

Total F/O/H Variance

Total F/O/H Variance

Volume Variance

Volume Variance

Expenditure Variance

Expenditure Variance

Fixed Overhead (F/O/H) Variances

Total Sales Variance

Total Sales Variance

Volume Variance

Volume VariancePrice VariancePrice Variance

Sales Variances

77ChapterChapterVariance analysis:discussion elements

Session Content

Interpretation of Variances

Interpretation of Variances InterrelationshipsInterrelationships BenchmarkingBenchmarking

Variance Reporting and Benchmarking

Variance Reporting and Benchmarking

Causes of variances

• Be prepared to explain possible causes of variances

• Be aware of any interdependencies. For example, a favourable materials price variance may indicate that lower quality material was purchased. This in turn could cause:– An adverse sales price or volume variance– An adverse labour efficiency variance

When to investigate variances

• Significant

• Controllable

• Benefit exceeds cost

• May use control charts to monitor variances and investigate if variance exceeds control limits

McDonaldisation

PredictabilityPredictability CalculabilityCalculability

EfficiencyEfficiency

McDonaldisationMcDonaldisation

ControlControl

Benchmarking Types

• Internal

• Competitive

• Functional

• Strategic

• Within same organisation

• Direct competitors

• Similar function, not competitors

• Aimed at action & change

88ChapterChapterAdvanced Variances

Session Content

Labour Mix Variance

Labour Mix Variance

Advanced variancesAdvanced variances

Material Yield Variance


Material Mix Variance


Labour Yield Variance


Planning &Operating Variances

Planning &Operating Variances

Valuation Methods

Valuation Methods

Material UsageVariance

Material UsageVariance





Material Mix and Yield

Mix Variance: Individual Units Method

xxXxXx Std Price4.

XXXMix variance5.

XXDifference in quantity3.

XXXX

Actual inputs

2.

XXXX

Actual inputs in std proportions

1.

Total

Kg

Material

B

Kg

Material

A

Kg

Yield Variance

xXx Std cost per Kg of output4.

XYield Variance5.

X3.

XActual yield2.

XStandard yield of actual input1.

Kg

Mix Variance: Weighted Average Method

XXDifference in quantity3.

XXXX

Actual inputs

2.

XXXX

Actual inputs in std

proportions

1.

Total

Kg

Material

B

Kg

Material

A

Kg


xXx(X – X)

x(X)x(X – X)

x Difference in Price (Weight Average std price – Individual material Std Price)

4.

XXXMix variance5.

Total

Kg

Material

B

Kg

Material

A

Kg

Labour Mix and Yield

Labour Mix Variance

Labour Mix Variance



Labour Efficiency Variance

Labour Efficiency Variance

Mix Variance: Individual Units Method

5.

4.

3.

2.

1.

XXXMix variance

xXxXx std rate

XXDifference in quantity

XXXXActual hours in std proportions

XXXXActual hours

Total hrsUnskilled labour

Hrs

Skilled labour

Hrs

Yield Variance

XYield Variance5.

xXX std cost per kg of output 4.

X3.

XActual yield 2.

XStandard yield of actual hours 1.

Kg


4.

3.

2.

1.

xXxXx difference in rate

(weighted average std rate individual labour std rate)

XXDifference in quantity

XXXXActual hours in std proportions

XXXXActual hours


Hrs

Skilled labour

Hrs


5. XXXMix variance

x (X – X)

x (X – X)

xX

x (X)


Hrs

Skilled labour

Hrs

• The sales volume variance can be analysed into

– sales mix, and – sales quantity

• components using the same logic encountered in regard to materials usage and labour efficiency variances.

Sales mix and quantity

Planning variances

Original Standard

Original Standard ActualActualRevised

Standard

Revised Standard

Traditional Variance

OperationalVariance

PlanningVariance

99ChapterChapterThe Budgeting Framework

Session Content

Purposes of Budgets

– Planning– Control– Communication – Co-ordination– Evaluation– Motivation

Principal budgetary factor

• A factor which places a limit on the activities of an organisation. For most companies this will be the level of sales that they can generate.

• Budget preparation should always start with a budget for the principal budgetary factor.

Budget Preparation

Sales BudgetSales Budget

Production BudgetProduction Budget

Raw MaterialRaw Material LabourLabour Factory OverheadFactory Overhead

Cost of Goods Sold BudgetCost of Goods Sold Budget

Selling and DistributionExpenses Budget

Selling and DistributionExpenses Budget

General and AdministrationExpenses Budget

General and AdministrationExpenses Budget

Budgeted Income StatementBudgeted Income Statement

Cash BudgetCash Budget

Budgeted Balance SheetBudgeted Balance Sheet

Master Budget

Capital Expenditure BudgetCapital Expenditure Budget

Step 1

Step 2

Step 3

Step 4

Step 5

Step 6

Step 7

Materials budgets

Material usage budget =

Production budget x standard material usage per unit

Material purchases budget =

Material usage budget + closing inventory of raw material – opening inventory of raw material

Steps in preparation of a budget

– Budget aims – Identify the principal budget factor – Prepare the sales budget – Prepare all other functional budgets – Consolidate master budgets– Negotiation – Review – Acceptance

– This is the most common method of budgeting.

– It involves adjusting the figures for the last period to reflect the anticipated figures for next period.

– Start with either the previous period’s budget or actual results and add (or subtract) an incremental amount to cover inflation and other known changes.

Incremental Budgeting

– This involves starting the preparation of the budget from zero each time.

– Every element of cost and benefit has to be justified as if it were the first time of preparing a budget.

– The principal behind this technique is to prepare for current future needs, rather than reflect past actions.

– ZBB is normally found in service industries where costs are more likely to be discretionary.

Zero Based Budgeting (ZBB)

• A method of budgeting which uses cost driver information to analyse data

• May involve preparing an activity matrixExample Activity 1 Activity 2 TotalLabourMaterialsOverheadTotal

Activity Based Budgeting (ABB)

1010ChapterChapterForecasting Techniques

Session Content

The High Low Method

The High Low Method RegressionRegression Time Series

Analysis

Time Series Analysis

Forecasting Techniques

Forecasting Techniques

• Choose highest and lowest output• Calculate the variable cost per unit

= Increase in cost / increase in activity

• Deduct total variable costs from total costs to get fixed costs

• We can now use this data to forecast total costs at any output

High Low Method

Least Squares Regression Analysis

y = a +bxDependent variable

Intercept (on y-axis)

Gradient

Independent variable

Equation of a straight line

Least Squares Regression Analysis

a = y – bx

n∑x2 – (∑x)2=b

n∑xy – ∑x∑y

– A time series is a series of figures relating to the changing value of a variable over time.

– The data often conforms to a certain pattern over time.

– This pattern can be extrapolated into the future and hence forecasts are possible.

– The actual data can be broken down into four components that are said to affect the results.

Time Series Analysis

1. The Trend; describes the long term general movement of the data.

2. Cyclical Variations; economic cycle of booms and slumps. This element can be ignored for numerical examples in the exam.

3. Seasonal Variations; a regular variation around the trend over a fixed time period, usually one year.

4. Residual Variations; irregular, random fluctuations in the data usually caused by factors specific to the time series. We try to remove this element in the averaging process.

Components of a time series

There are two different time series models because the seasonal variations may be expressed in absolute terms or proportional

terms.

– The Additive Model looks at the seasonal variation in absolute terms.

»Actual (A) = T + S + R

– The Multiplicative Model looks at the seasonal variation in proportional terms.

»Actual (A) = T x S x R

The seasonal variation

An equation or relationship for the trend may be given in the exam with seasonal variations. These must be used to forecast future values. The trend may be forecast by extrapolating the trend line on the time series graph.

–Additive Model:• Forecast of the Actual = Forecast of Trend + SV

–Multiplicative Model:• Forecast of the Actual = Forecast of Trend x SV

proportion

Forecasting with time series

1111ChapterChapterThe Treatment of Uncertainty and Risk in Decision Making

Session Content

Dealing withRisk and

Uncertainty

Dealing withRisk and

Uncertainty

Managers’ Attitudes

DecisionCriteria

Decision Trees Value of Information

MeasuringRisk

Introduction

RiskRisk UncertaintyUncertainty

• Past experience – Probabilities

• No experience – No probabilities

Several Possible Outcomes

Expected Values

EV = ∑px

Long run weighted average

Probability of the outcome occurring

Future outcomeSum of

Decision Making Criteria and Risk Attitudes

Maximax

• Best possible outcome

• Choose the best of the best

Risk Seeker

Maximin

• Worst possible outcome

• Choose the best of the worst

Risk Averse

Expected Value

• Weighted average profit

• Choose the highest expected value

Risk Neutral

Perfect and Imperfect Information

• Always 100% accurate

Perfect Information

• Usually correct

Imperfect Information

Both have a value!

Value of information =

expected profit WITH information

– expected profit WITHOUT information

Decision Trees and Multi-Stage Decision Problems

1. Draw tree from left to right, showing decision and outcomes: – Label tree– Show cash inflows/outflows– Probabilities

2. Evaluate tree from right to left:– Outcome point – calculate EV– Decision point – choose best option

3. Recommend a course of action

1212ChapterChapterBasic Investment Appraisal Techniques

Session Content

Capital InvestmentAppraisal

Capital InvestmentAppraisal

Revision ofCompounding

and Discounting

Revision ofCompounding

and DiscountingThe Appraisal

Process

The AppraisalProcess

DiscountedCash FlowTechniques

DiscountedCash FlowTechniques

TraditionalTechniques

TraditionalTechniques

PostCompletion

Audit

PostCompletion

Audit

NetPresentValue

NetPresentValue

InternalRate ofReturn

InternalRate ofReturn

PayBack

Period

PayBack

Period

AccountingRate ofReturn

AccountingRate ofReturn

Compounding and Discounting Revision

=

Compounding

V = X(1+r)n

Future value

Discounting

Present Value

FutureValue

Discount Factor

Present value

x

Net Present Value

• The net benefit or loss in present value terms of an investment opportunity

• Basic decision rule:

Positive = accept, negative = reject

Internal Rate of Return (IRR)

• The rate of return at which the NPV of a project is zero.

• Decision rule:

IRR > cost of capital = accept

Internal Rate of Return - Formula

IRR =NL

NL - NHL + (L – H)

• L = lower discount rate

• H = higher discount rate

• NL = NPV at the lower discount rate

• NH = NPV at the higher discount rate

Payback

• This is the time which elapses until the initial investment is recovered

• Decision rule:

payback within company’s required time = accept

Accounting Rate of Return

• The impact on accounting profit of investing in an asset over the life of that asset

• Decision rule:

ARR > company’s target = accept

Accounting Rate of Return - Calculations

ARR =Average Annual Profit

Average Investmentx 100

Average annual profit is after depreciation

Average Investment =Initial Inv + Residual Value

2

Capital Investment Process

1. Identify Objectives 1. Identify Objectives

2. Search for Investment Opportunities 2. Search for Investment Opportunities

3. Identify States of Nature 3. Identify States of Nature

4. List Possible Outcomes 4. List Possible Outcomes

5. Measure Payoffs 5. Measure Payoffs

6. Select Investment Projects 6. Select Investment Projects

7. Obtain Authorisation and Implement Projects7. Obtain Authorisation and Implement Projects

8. Review Capital Investment Decisions 8. Review Capital Investment Decisions

CreationPhase

CreationPhase

DecisionPhase

DecisionPhase

ImplementationPhase

ImplementationPhase

1313ChapterChapterFurther Aspects of Investment Appraisal

Session Content

AdvancedAreas

AdvancedAreas

Relevant Cash Flows

Risk SensitivityAnalysis

Capital Rationing

Inflation

Taxation

Replacement Decisions

Uncertainty and Risk

• Add premium for risk• Payback period• Sensitivity charts• Probability distribution

Sensitivity Analysis

Sensitivity Margin =NPV

PV of Flow Under Consideration

Considerations in NPV Questions

TaxationTaxation InflationInflationWorkingCapital

WorkingCapital

Relevant Cash Flows

Relevant Cash Flows

Taxation

Two WorkingsTwo Workings

Capital AllowancesCapital AllowancesCorporation TaxCorporation Tax

• Net cashflows are taxable

• Timings given• CT rate given

• WDA and balancing allowance

• Timings given• Use separate working

NPV with Tax Proforma

XXXTax saved (cap all)

XScrap value(X)Investment

(X)(X)(X)Tax on net cash flow

XXNet cash flow

(X)(X)Costs

XXRevenue

Time 3

$

Time 2

$

Time 1

$

Time 0

$

X(X)Working capital

NPV with Tax Proforma

PVPVPVPVPresent value

xxx1.00Discount factor

XXX(X)Net cash flows

Time 3

$

Time 2

$

Time 1

$

Time 0

$

Inflation

• Real cashflows; without inflation

• Money, or actual, cashflows; including inflation

• Use real rate

• Use money, or nominal, rate

(1 + r)(1 + i) = (1 + m)

Must be Consistent !

PrashantS

Other NPV Based Questions

Capital RationingCapital RationingAsset ReplacementAsset Replacement

• Mutually exclusive options with unequal lives

• Optimum replacement cycle

• Single period• Divisible or not• Multiple period

1414ChapterChapterWorking capitalmanagement

Session content

The balancing actThe balancing act

Working CapitalManagement

Working CapitalManagement

MeasuresMeasures

Operating cycleOperating cycle

The balancing act

Typical indicators

• A rapid increase in turnover • A rapid increase in the volume of current

assets • Most of the increase in assets being financed

by credit • A dramatic drop in the liquidity ratios

Overtrading

Current ratio

= Current assets Current liabilities

Quick ratio (acid test)

= Current assets – inventoriesCurrent liabilities

Liquidity ratios

• the balance sheet values at a particular time may not be typical

• balances used for a seasonal business may not represent average levels

• ratios can be subject to window dressing/manipulation

• ratios concern the past (historic) not the future

• figures may be distorted by inflation and/or rapid growth.

Limitations of ratios

Creditor Period

Operating Cycle Diagram

Issue toProduction

Completionof Production

Sale of unitsProduced

Receiptfrom Sale

RM Stock WIP Stock FG Stock Debtor Period

Payment forMaterials

Operating Cycle(in Days)

Time Line (Days)

Purchases

1515ChapterChapterInventory control

Session content

CostsCosts

Inventory controlInventory control

BenefitsBenefits

EOQEOQ

• purchase costs (money tied up)• holding costs

– storage stores – administration – risk of theft/damage/obsolescence.

Costs of high inventory levels

• stockouts: – lost contribution– production stoppages– emergency orders

• high re-order/setup costs • lost quantity discounts

Costs of low inventory levels

Economic Order Quantity

2Co.DQ =

Ch

Economic Order Quantity (EOQ) Theory

Cost

EOQ

Total CostHolding Costs

Ordering Costs

Reorder Quantity

Step 1: Calculate EOQ, ignoring discounts.

Step 2: If the EOQ is below the quantity qualifying for a discount, calculate the total annual inventory cost arising from using the EOQ.

Step 3: Recalculate total annual inventory costs using the order size required to just obtain each discount.

Step 4: Compare the cost of Steps 2 and 3 with the saving from the discount, and select the minimum cost alternative.

Step 5: Repeat for all discount levels.

Dealing with quantity discounts

1616ChapterChapterCash control

Session content

ReasonsReasons

Cash controlCash control

Dealing with deficitsDealing with deficits

Failure to carry sufficient cash levels can lead to:

•loss of settlement discounts•loss of supplier goodwill•poor industrial relations•potential liquidation.

Reasons for holding cash

• additional short-term borrowing • negotiating a higher overdraft limit with the

bank • the sale of short-term investments, if the

company has any • using different forms of financing to reduce

cash flows in the short term, such as leasing instead of buying outright

• changing the amount of discretionary cash flows, deferring expenditures or bringing forward revenues.

Measures to improve a forecast deficit

1717ChapterChapterAccounts receivableand payable

Session Content

Receivables and payables

Receivables and payables

Settlement discounts

Managing receivables

Factoring

Recoveringoverdue debts

Invoice discounting

Managingpayables

Costs of granting credit to customers

• Exposure to bad debts• Lost interest• Staff costs for credit control department• Discounts

Benefits of granting credit

• Extra sales• Maintains customer goodwill• Money collected more securely

Managing receivables

Costs of taking credit from suppliers

• Loss of settlement discounts• Loss of credit status / supplier goodwill• Staff costs

Benefits of taking credit

• Convenient and informal cheap short term finance

Managing payables

Annual cost of discount =

Settlement Discounts

1.Reminder letter

2.Telephone call

3.Withhold supplies

4.Use debt collectors

5.Take legal action

Stages in recovering overdue debts

• Get paid a % upfront• Can remove admin function

But

• Expensive in the long run• Customers can become concerned

Factoring

• Get paid a % upfront• Customer is unaware

But

• Expensive in the long run• Extra administration costs

Invoice discounting

1818ChapterChapterShort term financeand investments

Session content

FinanceFinance

Short term financeand investments

Short term financeand investments

InvestmentsInvestments

Yield to maturityYield to maturity

• Overdrafts• Trade payables• Factoring• Bills of exchange• Documentary credits• Forfaiting

Short term sources of finance

• Interest-bearing bank accounts

• Negotiable instruments

• Investing in short-dated government bonds

• Corporate bonds

Short term investments

Calc the IRR of the following:

T0 (MV)

T1 to Tn Coupon interest

Tn Redemption receipt

Annual yield to maturity

CIMA P1 Slides 2011

Documents

Transcript of CIMA P1 Slides 2011