The entrepreneurs always confronted with questions whether to take a particular order or not ; whether to expand the business by further investment or not; whether to take up a particular project or not.
Break-even Analysis This concept helps us know at what quantity ofproduction/sales we incur no loss nor gain any profit. The formula for Break Even point= Fixed Cost/ Sales price per unit – Variable cost perunit. Illustration: Sales price= Rs. 100; Variable cost = Rs.60,Fixed Cost = 25,000/- Therefore Breakeven quantity = ????
Marginal Revenue Pricing This is extension of Break even analysis. Revenue earned by selling additional unit, after havingcovered the fixed expenses, is called MarginalRevenue. Illustration : Transport operator incurs Rs17,000/ asfixed operating expense per trip. Per passengervariable cost incurred is Rs.50. The ticket fare isRs.500.Total capacity is 35 seats. Current occupancy is34. What price you can offer under marginal revenuepricing concept???
Marginal Revenue Pricing Exercise : Price =20; Variable cost is Rs.10; fixed overhead permonth Rs.10,000/ You are producing 1000 units permonth. Break even is achieved. Now additional orderof 100 units are ordered by another party for Rs.15/-can we accept? What would be the net effect?
Capital Budgeting – Payback Method Payback Analysis :The investment which gives back quickly is generallyconsidered for investments, other things beingequal.How to calculate payback method :Illustration : Entrepreneur wants to invest Rs. 250,000 inone of the below 2 projects, which project should hechoose based on Pay Back method( Cont…..)
Capital Budgeting – Payback Method(Cont..)Projected Payback :Project A Project B Year 1 100,000 20,000 Year 2 80,000 40,000 Year 3 70,000 50,000 Year 4 30,000 60,000 Year 5 20,000 80,000
Capital Budgeting – Payback Method(Cont..) Project A takes about 3 years to pay back theinvestment while Project B takes about 5 years to payback. Applying Pay back method the entrepreneur shouldselect Project A as it has shorter pay back period.
Capital Budgeting – Net Present Value Net Present Value : By this method value of future cash flow is discountedby a chosen discounting factor, which is representedby interest rate / Inflation rate. The formula is :
Capital Budgeting – Net Present Value Initial Investment 50,000;Cash Flow 10% Discount factor Present valueY1 25,000 0.9091 22,728Y2 20,000 0.8264 16,528Y3 15,000 0.7513 11,270Y4 1,000 0.683 683Y5 550 0.6209 34161,550 Present Value of Cash flow 51,549
Capital Budgeting – Net Present Value Initial Investment 50,000 Net Present Value 1,549You select the project which offers higher NPV for thesame discounting factor.
Ratio Analysis Return on Investment (ROI)= Net IncomeOwner’s EquityWhy this ratio is calculated? Return on Assets = Net IncomeTotal assets
Ratio Analysis Net profit Margin : = Net IncomeSales Asset Turnover Ratio = Sale/Total Assets Average Collection period : Accounts Receivable X 365Annual Credit Sales
Ratio Analysis Average age payables = Average Accounts Payable x 365Purchase Inventory turnover = Cost of Goods SoldAverage Inventory
Ratio Analysis Current Ratio = Current AssetsCurrent liability Debt Servicing Ratio : Net IncomeInterest Expenses Cash Flow to Liabilities : Operating Cash FlowTotal Liabilities