Cost analysis for entrepreneurs


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Cost analysis for entrepreneurs

  1. 1. COST ANALYSIS FOR ENTREPRENEURS by : DR. T.K. JAIN AFTERSCHO ☺ OL centre for social entrepreneurship sivakamu veterinary hospital road bikaner 334001 rajasthan, india FOR – CSE & PGPSE STUDENTS (CSE & PGPSE are free online programmes open for all, free for all) mobile : 91+9414430763
  2. 2. My word..... My purpose here is to give a few ideas about cost analysis for entrepreneurs. These are introductory ideas. You can develop your own innovative methods for cost analysis. Be an entrepreneur, change the society, change the world. Go with positive spirit. Please pass this presentation to all those who might need it. Let us spread knowledge as widely as possible. I welcome your suggestions. I also request you to help me in spreading social entrepreneurship across the globe – for which I need support of you people – not of any VIP. With your help, I can spread the ideas – for which we stand....
  3. 3. What is a cost centre ? Cost centre means, a production or service location, function, activity or item of equipment whose costs may be attributed to cost units.
  4. 4. What is a cost unit ? It is a unit of product or service in relation to which costs are ascertained.
  5. 5. What is cost accounting ? It is the establishment of budgets, standard costs and actual costs of operations, processes, activities or products, and the analysis of variances, profitability or the social use of funds.
  6. 6. What is costing ? Cost is to ascertain the cost.
  7. 7. What are the principles of cost accounting ? Cost should be related to its cause Abnormal costs should be excluded Cost should be properly recorded
  8. 8. What is the difference between cost accounting and financial accounting ? Financial accounting is historic and based on actual data. It puts the total profit / loss of the company. It is based on transaction with the external firms. Cost accounting is based on partly actual and partly estimated values. It is based on data relating to internal working of the company. It focuses on individual product / service – rather than total profit / loss of the company.
  9. 9. What is marginal costing? In this system, only variable costs are accumulated and cost per unit is ascertained only on the basis of variable costs As against this in Absorption costing, we take into account both fixed costs and variable costs.
  10. 10. What is variable cost ? There are some costs which are directly dependent on production volume. If production volume will increase, these costs will also increase and vice versa. Fixed costs are those, which dont change with change in scale of production / level of activity. They will remain same whatever may be the scale of production. But the variable costs are moving in direct relation to volume of production.
  11. 11. What is contribution ? It is the difference between selling price and variable cost it can be expressed as per unit contribution or as total contribution example : selling price per unit = 10, variable cost per unit = 6, contribution per unit = 4
  12. 12. Is contribution same as profit ? NO profit is calculated only after considering all the costs – fixed and variable contribution takes into account only variable costs.
  13. 13. Which inventory will be more – marginal cost or full cost based Full cost based the reason is simple : in full cost (also called absorption cost or conventional cost) all manufacturing costs, both fixed and variable are charged to product cost.
  14. 14. WHAT IS DISCRIMINATING PRICE AND DIFFERENTIAL SELLING Discriminate = to charge different prices differential = to have differnt approach in selling In marginal costing, it is possible to charge different prices on different occasion. If you have surplus production capacity lying idle, you may go for lower contribution and thus charge lower price. Later if you get another offer – which is for higher price, you may go for that.
  15. 15. What is CVP chart / BEP chart ? CVP = cost volume profit (showing relation between cost, revenue and profit) BEP = break even point – the point where there is no profit – no loss CVP Chart is a graphic relationship between costs, volume and profits. It shows not only the BEP but also the effects of costs and revenue at varying levels of sales.
  16. 16. What is Margin of Safety? It shows the difference between the actual sales and sales at break-even point formula : sales – BEP level EXAMPLE : fixed cost =1000, contribution = 20%, Sales = Rs. 12000, what is margin of safety ? BEP = 1000/20% =5000 margin of safety=12000-5000 = 7000 answer
  17. 17. Calculate BEP if Sales are Rs. 1,50,000, producing a profit of Rs. 4,000 in period I. Sales are Rs.1,90,000, producing a profit of Rs. 12,000 in period II. Formula = %change in profit / % change in sales or change in profit / change in sales = 8000/40000 * 100 = 20% answer
  18. 18. What is composite BEP ? When you make different products, you can have composite BEP, which is calculated on the basis of combination of different products / services.
  19. 19. What are the approaches to calculate composite BEP? There are 2 approaches : 1. constant product mix 2. variable product mix
  20. 20. What is unit costing ? Unit costing refers to the costing procedure, which is ideally used in case of concerns producing a single article on large scale by continuous manufacture.
  21. 21. What is contract costing ? Contract costing is that form of specific order costing which applies where work is undertaken as per customers’ special requirements and each order is of long duration.
  22. 22. What is cost plus contract ? Cost plus contract is a contract where the contractee agrees to pay to the contractor the cost price for the work done on the contract plus an agreed percentage thereof by way of overhead cost and profit
  23. 23. What is escalation clause? It is usually provided in the contract as a safeguard against any likely changes in the price or utilisation of material and/labour. Example : after the allotment of contract, the prices go up by 10%. There is 10% escalation clause, thus the contract price will also goup by 10%
  24. 25. What is cost sheet ? It is a statement which shows different costs and classifies them in different heads as under : 1. prime cost= (direct material + direct labour + direct expenses) 2. works cost / factory cost= (prme cost + factory overhead) 3. cost of production =(works cost + administrative overhead) 4. cost of sales =(cost of production+sales cost)
  25. 26. What is the difference between cost sheet & production account ? Cost sheet is a statement, but production account is a type of account. Cost sheet classifies costs in different categories like prime cost etc. But production cost only puts them without classification cost sheet is based on both actual & estimated values, but production account is based on actual data.
  26. 27. Material management sytems There are many systems like : 1. ABC 2. two bins system 3. perpetual inventory control system 4. poka yok 5. kaizen
  27. 28. What is ABC ? ABC analysis is a tool to classify inventory into 3 categories : A = very costly items, these are in small numbers, but these require special attention – they have 90% of the total investment in inventory B=medium priced C = bulky but low priced items. In terms of volume, they occupy 90% of space, but in terms of value, they have only 2-5% of value. Last priority should be given to them.
  28. 29. What is Perpetual inventory management system? Perpetual inventory system is a method of recording stores balances after each receipt and issue to facilitate regular checking and obviate closing down for stock taking. Here we take physical verification of stock on every receipt and issue. It is advisable in the case of costly goods, precious items in inventory. Example : a jewellery making firm has to maintain perpetual inventory system
  29. 30. What are the components of perpetual inventory management system? There are 3 components : 1. bin record 2. stock ledger 3. continuous stock taking
  30. 31. What is bin record? Bin means the physical stock of goods. Bin refers to the box containing inventory item. On the bin, there is a record of goods. When goods arrive, the record is updated. When goods are issued, the quantity is reduced.
  31. 32. What is a stock ledger? It is maintained by store keeper. It is a record of the goods in godown. Stock ledger is like any ledger. Here we have proper record of entry and disposal of stock. Details like date of issue, etc. Are properly maintained. Proper vouchers (like good issue note) etc. Are also kept.
  32. 33. What is continuous stock taking? In perpetual inventory system, we regularly undertake stock taking. In this process, we compare inventory as per bin to the inventory as per stock ledger. Thus there is continuous comparison of the bin to stock ledger to identify discripancy if any.
  33. 34. What is Kaizen? It is continuous improvement of processes in manufacturing, engineering, supporting business processes, and management. It can be applied in any sector. Thus it can be applied in inventory management also. Here we try to innovate, humanise and improve the work processes through participation of workers and by introducing a reward system for those workers, who introduce some innovation.
  34. 35. What is Poka Yoke ? It is a Japanese technique for minimising errors. Yoke = production, Poka = mistake it is a mistake proof system. Here we try to introduce a system, which is fool-proof it is used in the case of lean manufacturing system (lean manufacturing is based on Just in time philosophy – means keep minimum inventory, manufacture when you really need).
  35. 36. What is Muda, Mura , Muri ? These are japanese management techniques. Muda means waste. Mura means unevenness and muri means to inconcistency. These three terms denote wastes – which should be avoided in production process or in inventories.
  36. 37. What is JIT? Just in Time - it is a system of Japanese management – where there is no inventory - raw material is procured when it is really required. Goods are made to order. If there is no order – dont make. It is also a part of lean manufacturing system – where you make as much as is required. It enables companies to be very flexible, agile (agile manufacturing) and quick to respond.
  37. 38. What is EOQ? Economic Ordering Quantity (EOQ) is that size of the order which gives maximum economy in purchasing any material and ultimately contributes towards maintaining the material at the optimum level and at minimum cost. It is calculated using a formula : =sqrt (2 * ordering cost * annual requiements / carrying cost).
  38. 39. What is FSN analysis ? F=FAST MOVING S=SLOW MOVING N=NOT MOVING it is an inventory management technique, where we classify inventory items into F / S / N items and try to give more attention to F items. We try to dispose off N items (not moving) so that we are able to manage inventory properly
  39. 40. What is Min-Max analysis ? It is a type of inventory management system here you fix up minimum and maximum levels.
  40. 41. What is two bin system? There are two bins here : 1. one bin contains materials to be used. 2. 2 nd bin contains material to be used after 1 st bin is empty. If the first bin is empty, inventory order is placed and by the time the goods arrive, the 2 nd bin is used.
  41. 42. Example of material costing 2,000 kgs. of material valued at Rs. 8,000 were issued for the manufacture of medium sized cartons. 2,400 Nos. medium sized cartons including 320 damaged cartons weighing 0.50 kg. each were manufactured. 480 kg. of offcuts were used for the manufacture of small sized carton. This would have amounted to Rs. 1,000. 320 medium sized cartons were damaged and rectification costs came up to Rs. 160. 120 kg. of offcuts were sold as scrap for Rs. 20. You are required to calculate the cost of one medium sized carton assuming that there are no opening or closing stocks.
  42. 43. Solution ... Cost of raw material = 8000 less material used for small cartons = 1000 add repairing charges = 160 less scrap = 20 final cost = 7140 items made = 2400 cartons cost per carton = 2.98 per carton. Answer
  43. 44. Calculate reorder level ? Monthly demand (units) 250 - Cost of placing an order (Rs.) 100 - Annual carrying cost (Rs. per unit) 15 - Normal usage (units per week) 50 - Minimum usage (units per week) 25 - Maximum usage (units per week) 75 - Re-order period (weeks) 4-6
  44. 45. solution Reorder level is the level when we will place an order for goods. When inventory reaches reorder level, we will place the order to the supplier. Formula = maximum consumption * max. Delivery time =75 * 6 = 450 iunits
  45. 46. What is maximum inventory in this example ? Maximum inventory = (reorder level + EOQ) – (minimum use * min. Time) so first calculate EOQ EOQ= sqrt((2 * 12*250*100) / 15) =200 Max. Inventory= (450+200)-(25*4) =550 answer
  46. 47. What is minimum inventory in this example ? Formula = reorder level – (normal usage * normal delivery time) = 450 – (50 * 5) =200
  47. 48. What is bill of material ? A bill of materials is a comprehensive list of materials with specifications, material codes and quantity of each material required for a particular job prepared by = production planning deparment sent to : 1. stores 2. cost dept. 3. accounts 4. purchase dept.
  48. 49. What is Material Requisition Note? It is a formal written demand or request usually from the production department to the stores for the supply of specified materials, stores etc. Prepared by = production dept. Issued to = stores department to issue stock it is prepared in triplicate 1 st copy – to stores, 2 nd copy – to cost dept. 3 rd copy = record copy
  49. 50. How to treat waste / spoilage ? These are of two types : 1 normal 2. abnormal normal loss is adjusted into the goods. (for example suppose 5 units are wasted, it is reduced from the finished goods. Abnormal loss is transferred to costing profit and loss department.
  50. 53. What is Kanban? It has evolved out of Toyota manufacturing system. It is a part of Just in time inventory management system. Here signals are passed for supply of goods. It is a signaling system to trigger action. As its name suggests, kanban historically uses cards to signal the need for an item. However, other devices such as plastic markers (kanban squares), balls (often golf balls), an empty part transport trolley, or simply a floor location can also be used to trigger the movement, production, or supply of a unit in a factory.
  51. 54. What is Jidoka ? It is also Japanese management work. It means to use automation.
  52. 56. What are different components of costs ? Material + labour + other costs or direct cost + indirect cost or direct material + direct labour + direct expenses + indirect material + indirect labour + indirect expenses
  53. 57. What constitute labour cost? Wages other benefits = like incentives workers can be paid on piece rate basis or daily wages basis or on performance basis
  54. 58. How to pay incentives ? There are 4 types of methods : Differential piece rate Premium bonus schemes Group bonus plans Bonus schemes for indirect workers.
  55. 59. What is differential piece rate ? F.D. Taylor was the promotor of this idea : here we use different piece rates for different workers depending on their performance.
  56. 60. Example of Taylor's plan Suppose the base rate is 10 per unit. Standard production is 10 per day If a worker is producing upto or more than the standard he will ge t 125% higher rate + 50% bonus payment if 10 units are made = 12.5*10+50% bonus=187.5 if a worker produces 9 units, he gets payment @ 83% rate, so 9 * 8.3 = 74.7 thus there is a difference of 117.5 with just 1 unit of more production.
  57. 61. What is Merrick's plan ? If a worker produces less than 83%, he gets normal payment if a worker produces between 83% to 100%, he gets 110% of normal payment if a worker produces more than 100% : he gets 120% of normal payment
  58. 62. Example of Merrick Plan : Suppose the base rate is 10 per unit. Standard production is 10 per day and worker A produces 7 units and worker B produces 10 units. A = 7*10 = 70 B = 10*11*120% =132 so worker B gets 62 more by producing just 4 units more.
  59. 63. Gantt's plan Give 20% bonus on time saved, and minimum time rate is assured. Higher piece rate may be given on higher production
  60. 64. Example of Gantt method A worker is paid Rs. 100 per day for standard production of 100 units. The worker produces 120 units. He gets 100 + 20% bonus = 120 per day.
  61. 65. What is Emerson's plan ? 66.66% efficiency = base rate 90% efficiency = base rate + 10% bonus 100% efficiency = base rate + 20% bonus above 100% efficiency = base rate + 20% bonus + 1% for every 1% increase in productivity efficiency = standard time / time taken * 100
  62. 66. Example of Emerson's plan A worker has to take 20 hours to do a work. He is paid Rs. 100 per hour. He actually takes 18 hours. How much should be paid ? Efficiency = 20/18*100 = 111% normal payment = 18*100 = 1800 bonus = 20% = 360 additional bonus = 198 total = 2358
  63. 67. What is Halsey plan ? Here 50% bonus is given for time saved .
  64. 68. Example of Halsey plan A worker has to take 20 hours to do a work. He is paid Rs. 100 per hour. He actually takes 18 hours. How much should be paid ? Solution : time saved = 2 18*100 = 1800 + bonus = (2 * 100 * 50/100) = 100 total payments = 1900 answer
  65. 69. What is Rowan plan Here payment for standard time is guaranteed, but if a worker is able to finish it faster, he has a possibility of getting bonus
  66. 70. Example of Rowan plan A worker has to take 20 hours to do a work. He is paid Rs. 100 per hour. He actually takes 18 hours. How much should be paid ? Solution : minimum guarantee = 20*100 = 2000 payment as per Rowan plan : 18*100 = 1800 bonus = 2/20*18*100 = 180 total payments = 1980 the worker would get 2000.
  67. 71. 2 nd example on Rowan plan A worker has to take 20 hours to do a work. He is paid Rs. 100 per hour. He actually takes 15 hours. How much should be paid ? Solution : minimum guarantee = 20*100 = 2000 payment as per Rowan plan : 15*100 = 1500 bonus = 5/20*15*100 = 375 total payments = 1875 the worker would get Rs. 2000
  68. 72. What is Bedaux Plan Here bedaux points are calculated. The worker gets bonus for Bedaux points saved. Thus if a worker is able to save 30 bedaux points, he gets incentives for 30 B points
  69. 73. WHAT ARE DIRECT EXPENSES ? costs, other than materials or wages, which are incurred for a specific product or salable service
  70. 74. WHAT ARE INDIRECT EXPENSES ? expenses which cannot be directly, conveniently and wholly allocated to cost centres or cost units
  72. 76. RENT OF THE OFFICE ? It is indirect expenses – as it cant be attibuted to any product (the company may be making many products).
  73. 77. What are overheads? cost of indirect material, indirect labour and such other expenses, including services, as cannot be conveniently charged direct to specific cost centres or cost units
  74. 78. Types of overheads? 1. Function wise classification (manufacturing, administrative and selling overheads) 2. behaviour based classification (fixed, variable and semi-variable). 3. Element based overheads (material, labour and expenses)
  75. 79. What is allocation? Allocation of overheads is the process of charging the full amount of overhead costs to a particular cost centre
  76. 80. What is absorption ? allotment of proportions of items of cost to cost centers or cost units on some logical basis
  77. 81. What is the difference between allocation and absorption of overhead ? Allocation refers to charging overhead to a particular head – because it belongs to that. Absorption = when we take up an equitable basis and try to divide overhead expenses to different departments on that basis, it is called absorption of overhead
  78. 82. Example of absorption ? The expenses of maintenance department can be absorbed by different production departments on the basis of amount of investments in plant and machinery (or any other logical basis)
  79. 83. What is machine hour rate? overhead cost for operating the machine for one hour
  80. 84. What is primary distribution of overhead? When overhead expenses are divided among all the departments, it is called primary distribution. Here distribution is also made to service department. Example : Factory building rent is distributed to 5 departments equally, so Rs. 1000 is distributed to A,B,C,D,E department and each department gets Rs. 200
  81. 85. What is secondary distribution of overhead? After primary distribution, the expenses of service department is distributed to production departments. In the previous slide, we have E department which is a service deparment and gets Rs. 200. this amount has to be again distributed between A,B,C,D. So now A,B,C,D get 50 each. This is called secondary distribution.
  82. 86. What is standing order number? Standing order number is a code number given to a factory overhead item
  83. 87. How to control overheads? There are two possibilities : 1. fix standards regarding fixed and variable expenses 2. fix standards regarding range of activities and accordingly prepare flexible budgets and give executives responsibilities to minimise these
  84. 88. What are the ways to make people responsible to reduce overheads? Adopt responsibility accounting, responsibility costing, cost centre approach and other tools of management, which can enable you to control expenses
  85. 89. What are selling and distribution overheads? These expenses help us in increasing sales. So they must be carried out but in proper manner. They include expenses on sales promotion, publicity, dealer awareness programmes, sales executive motivation programmes etc. They can be standardised as follows : 1. as % of works cost 2. as % of selling price 3. as fixed rate per unit sold etc.
  86. 90. What are administrative costs... Cost of office staff, office maintenance expenses, general administrative expenses like correspondence, etc. They are not directly related to manufacture or sale of a product, but they have to be incurred. Thus they have to be standardised.
  87. 91. How to standardise administrative expenses? Administrative overheads can be standardised as follows : as % to Works cost basis as Sales value/quantity basis as % to Gross profit on sales as a fixed rate to Units manufactured as a % of conversion cost etc.
  88. 92. Example : fix standard for office overheads Materials Consumed 400 Direct Labour 300 Factory Overheads 240 Office and Administrative Expenses 94 Sales =1240 You have to apply for a project. It is estimated that the project will require materials costing Rs. 300 and direct wages for it will be Rs. 450. What should be the quotation?
  89. 93. solution... Prime cost = (material+labour +direct expenses) = (400+300) = 700 add :factory overhead = 240 (34% of prime cost) works cost = 940 administrative overhead = 94 (10% of works cost) cost of production = 1034 sales = 1240 profit = 206 (20% of cost of production)
  90. 94. Quotation .... Material = 300 labour 450 prime cost = 750 add factory overhead = 34% =255 works cost = 1005 add : administrative overhead 10% = 100 =1105 add profit 20% = 220 price to quote = 1325 answer
  91. 95. Example ... In a certain department of a factory there are two shops. Total departmental overheads for a year are Rs. 1,20,000 and the estimated number of direct labour hour is 24,000 (10 men employed for 48 hours per week during 50 weeks in the year). From the particulars given below calculate the prime cost and works cost of a work order No. 54 which passes through both shops: (1) Material consumed Rs. 1,000. (2) Direct labour hours : Shop A  8 hours @ Rs. 6.00 per hr Shop B  5 hours @ Rs. 7.50 per hr. (3) Works overheads are to be levied by means of a direct hour rate.
  92. 96. solution... Overhead rate = 120000/24000 = 5 per hour. Direct cost : Material 1000 labour (8*6 + 5*7.5) = 85.5 prime cost = 1085.5 factory overhead (13*5) = 65 works cost = 1150.5 answer
  93. 97. Example ... Vivek & Gautam Ltd. manufactures four sizes of the product `Bikana Model’ called A, B, C, and D in the Department. The workers are paid the piece rate of Re. 1.00, Rs. 1.50, Rs. 2.00, Rs. 3.00 per unit of the product sizes A, B, C and D respectively. Dearness allowance paid to the workers is Rs. 4.00 per day. Miscellaneous payments are 20% of the basic wages. Calculate cost for product size A. Direct Labour (Days) 104 (total days 286) Production (Units) 320 Direct Material (Rs.)250 (total material cost for all units is 625) Overhead Expenses: Indirect Material 500 Indirect Labour 572 Indirect Expenses 429
  94. 98. solution... Direct material : =250 Direct labour (320 * 1)+ (104 *4)+(64) =800 other direct expenses = nil prime cost = 1050 / 320 = 3.28 per unit indirect material 500 *250/625 * 1/320 = .62 indirect labour and overhead can be approtioned on the basis of labour days : 1001*104/286 * 1/320 = 1.14 total works cost per unit : (3.28+.62+1.14) = 5.04
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