Financial management involves planning, directing, monitoring, and organizing the monetary resources of an organization. It helps managers understand profitability ratios like profit/volume ratios and return on assets. An operating budget is a detailed projection of estimated income and expenses over a given period, usually one year. Preparing an operating budget involves forecasting materials, labor, staffing, expenses, and revenues to calculate the total budgeted expenditure and projected profit. The budget helps monitor and control activities but may not be 100% accurate. Depreciation is the gradual conversion of a capital asset's cost into an expense over its useful life. Straight-line and reducing balance are methods to calculate depreciation annually. Financial concepts like future value,

1. Financial Management

2. Financial Management
Planning, directing, monitoring, organizing the monetary
resources of an organization
Importance: helps P/O managers in understanding P/V ratios &
ROAs (profitability ratio).
Why Financial Management?

3. Operating Budget –Preparation and Advantages
Operating budget: a detailed projection of all estimated income and expenses
based on forecasted sales revenue during a given period (usually one year).
Preparation of operational budget:
 Forecast helps in estimation of:
a) Materials required
b) Direct human resources
 Direct human resources helps in estimating:
a) Direct labor required for each department
b) Supervisory resources required to monitor/control human resource in each department.
c) Ancillary resources required to support the work of each department.

4.  Required budget estimated for staff and control ( maintenance, quality, wages,
technical, design & development etc.) required to achieve forecast.
 From long range forecast and objectives of organization, indirect staff (training,
development) required are estimated.
 General expanses calculations (rent, tax, insurance, lighting, heating, etc.)
 For financial period under consideration: all above estimations are made to form total
expenditure.
 Difference between total expenditure and revenue (profit) is calculated.
 Profit added to estimated expenditure is called the operating budget.
No budget 100% correct, an acceptable budget (what is required)
Operating Budget –Preparation and Advantages

5. Features of an Operating Budget
1. An agreed document with consensus of all to whom it may concern directly.
2. Not order giving but a situation displaying document.
3. Considers the staff and organizational structure.
4. Helps in decision making.
5. Shows the effect of extra expenditures on year’s trading
6. Helps in deciding whether the expenditure justifies the benefits to be gained.
7. Helps in policy making.
8. Simple and accurate tool to monitor and control activities.
At beginning stage of an organization difficult to prepare an appropriate budget.

6. Break-Even Chart
 Categorizes variable cost and fixed cost
 Fixed Cost: all those costs, not affected by the level of
activity over a feasible range of operations. Includes cost of
administration, lease and rent costs, taxes, etc.
 Variable Cost: Includes all the costs, vary in direct proportion
with the level of activity. Materials and direct labor cost.
 OA: variation of income with output
 BC: variation of cost with output
 P (break-even): cost = income
 Loss: budget figure less than Q
 Profit: budget figure greater than Q
 BE analysis refers to study of determination of that level of activity where total sale is equal to total
cost and also the study of determination of profit at any level of activity.

7. Break-Even Chart
𝑇𝑅 = 𝑇𝐶 Or 𝑃𝑥 = 𝐹 + 𝑉𝑥
Solving for x
𝐵𝐸𝑃𝑥 =
𝐹
𝑃 − 𝑉
𝐵𝐸𝑃$ =
𝐹
𝑃 − 𝑉
𝑃 =
𝐹
(𝑃 − 𝑉)
𝑃
=
𝐹
1 − 𝑉
𝑃
𝑷𝒓𝒐𝒇𝒊𝒕 = 𝑻𝑹 − 𝑻𝑪
𝑃𝑥 − 𝐹 + 𝑉𝑥 = 𝑃𝑥 − 𝐹 − 𝑉𝑥 = 𝑃 − 𝑉 𝑥 − 𝐹
BEPx = break even point
in units
BEP$= break even point
in dollars
P= price per unit
x= number of units
produced
TR=Total revenue = Px
F= Fixed costs
V= Variable costs
TC= total costs = F+Vx
Stephens, Inc. wants to determine the minimum
dollar volume and unit volume needed as its new
facility to break even.
Approach: The firm first determines that it has fixed
a cost of $10,000 this period. Direct labor is $1.50
per unit and material is $0.75 per unit. The selling
price is $4.00 per unit
Solution:
Break even point in $
𝐵𝐸𝑃$ =
𝐹
1 − 𝑉
𝑃
=
$10,000
1 − (1.50 + 0.75)
4.00
=
$10,000
0.4375
= $22,875.14
Break even Point in no. of units
𝐵𝐸𝑃𝑥 =
𝐹
𝑃 − 𝑉
=
$10,000
4.00 − (1.50 + 0.75)
= 5,714
At BE point

8. The Margin of Safety
The ratio by which budgeted income exceeds B/E income to budgeted income itself.
It is actually a measure of risk.
𝑚𝑎𝑟𝑔𝑖𝑛 𝑜𝑓 𝑠𝑎𝑓𝑒𝑡𝑦 =
𝑏𝑢𝑑𝑔𝑒𝑡𝑒𝑑 𝑖𝑛𝑐𝑜𝑚𝑒 − 𝐵
𝐸 𝑖𝑛𝑐𝑜𝑚𝑒
𝑏𝑢𝑑𝑔𝑒𝑡𝑒𝑑 𝑖𝑛𝑐𝑜𝑚𝑒
Calculate % risk based on following data:
Budgeted income = $5000
Break-even income = $2500, $3000, $3500
Predicted
income
statement for
future period of
time

9. The Profit/Volume ratio
 Relates profit earned to output. It is the slope of profit graph.
P/V ratio =
𝐾𝑀
𝐹𝑀
=
𝐾𝐿+𝐿𝑀
𝐹𝑀
𝑃
𝑉 𝑟𝑎𝑡𝑖𝑜 =
𝑝𝑟𝑜𝑓𝑖𝑡 + 𝑓𝑖𝑥𝑒𝑑 𝑐𝑜𝑠𝑡
𝑜𝑢𝑡𝑝𝑢𝑡
 100
OR
𝑃
𝑉 𝑟𝑎𝑡𝑖𝑜 =
𝑝𝑟𝑜𝑓𝑖𝑡
𝑚𝑎𝑟𝑔𝑖𝑛 𝑜𝑓 𝑠𝑎𝑓𝑒𝑡𝑦
=
𝐾𝐿
𝑃𝐿
FM = budgeted output
KL = profit generated at
budgeted output level
LM = fixed cost (loss at
zero output)
 At outputs below B/E, negative profit (loss) is
generated.
 At B/E, no profit or loss is created.
 P/V ratio is increase in profit per unit increase
in output
 P/V also tells marginal cost which is increase
in variable cost per unit increase in output.

10. Value Added
 A part of income, available to the organization after paying for the materials and
utilities.
 All other expenses like rent, insurance, capital costs, depreciation, design cost
administration costs and taxes are paid from the value added leaving the rest of value
added as profit.
 VA can be increased by:
1. Increasing income: by increasing selling price
2. Reducing expenditures on purchased materials and services
Value added = Income – Cost of materials and utilities

11. Product Value and its Types
Exchange Value:
The price at which a customer accepts the product. A company earns profit if the
exchange value of its product is higher than cost value.
Profit = Exchange Value – Cost Value
Exchange value is the sum of use value and esteem value.
Use Value:
It is determined by the economic utility of a product

12. Esteem Value:
The part of price, which a customer offers to possess it, in excess of use value.
A product with low demand and large supply will have low esteem value and a product with high
demand and low supply will have a high esteem value.
Book Value:
 The worth of an equipment or asset as shown on the accounting record of a company.
 It equals to the original value of the equipment minus the amounts charged as depreciation.
 It is of interest for the purpose of balance sheet of assets and liabilities.
 The market value or actual worth of the equipment or asset may be quite different from book
value.
Product Value and its Types

13. Product Value and its Types
Salvage Value:
A residual value or price of the equipment or asset obtained after it has been used.
Salvage value may be positive or negative.
A negative salvage value implies the cost of removal of the equipment or structure when its use
value is zero.
Market Value:
The price obtained for an asset if it were sold on the open. It may be quite different from the book
value and clearly is important for determining the true asset value of the company.
Current Value:
The value of an asset in its condition at the time of valuation

14. Capital
Wealth in the form of money or property that can be used to produce more wealth
The types of Capital
 Equity capital: owned by individuals who have invested their money or
property in a business project or venture in the hope of receiving a profit.
 Debt capital: often called borrowed capital, is obtained from lenders for
investment.

15. Depreciation
 The gradual conversion of cost of a capital asset or a fixed asset into operational
expense (depreciation expense) over asset’s estimated useful life.
 Useful life: period during which an asset is projected to generate revenue or provide
other valuable services.
Types of Depreciation:
Physical Depreciation
Functional Depreciation

16. Types of Depreciation
Physical Depreciation
 The physical facilities deteriorate and decline in usefulness with time; thus,
the value of a facility decreases.
 Physical depreciation: the measure of the decrease in value of a facility due
to the changes in the physical aspects of a property.
 Wear and tear, corrosion, accidents, and deterioration due to the age or the
elements are all causes of physical depreciation.
 The serviceability of a property is reduced because of the physical changes.

17. Types of Depreciation
Functional Depreciation
 Depreciation due to all other causes is known as functional depreciation.
 Obsolescence (common type of functional depreciation) caused by
technological advances which make an existing property obsolete.
 Other causes of functional depreciation:
1. Decrease in demand for the product/service rendered by the property
2. Shifts in population
3. Changes in requirements of public authority
4. Inadequacy or insufficient capacity
5. Abandonment of the enterprise.

18. Depreciable Investments
 All property with a limited useful life of more than 1 year that is used in a trade
or business, held for the production of income, is depreciable.
 Physical facilities, including such costs as design and engineering, shipping, and
field erection, are depreciable.
 Land, working capital and start-up costs are not depreciable.
 Maintenance is necessary for keeping a property in good condition - mending or
replacing of broken or worn parts of property.
 The costs of maintenance and repairs are direct operating expenses and thus are
not depreciable.

19. Methods of Calculating Depreciation
Straight-line or Linear Depreciation
 Absolute value is deducted each year w.r.t time (100, 80, 60, 40, 20)
 No book value after 5th year
𝒗𝒂𝒍𝒖𝒆 = 𝑷 −
𝑷(𝒏 − 𝟏)
𝑵
P= Initial price
N= number of years in which it is being depreciated
n= number of years at which value is being calculated

20. Methods of Calculating Depreciation
Reducing Balance Method of Depreciation
 Constant percentage of book value is deducted each year from book value
 Example: 50% depreciation each year on book value, then value each year
would be 100; 50; 25; 12.5; 6.25
 Value never becomes 0.
 At negligible value (1%), the asset is ‘written off’
𝒗𝒂𝒍𝒖𝒆 = 𝑷 𝟏 − 𝑹 n-1
P= initial price
R= depreciation rate
n= number of years at which
value is being calculated

21. Costing
An ascertainment of the amount of expenditure incurred on a single
item or service or a group of items or a group of service
Two types of costings:
Historical costing: costs are collected and analyzed after the expenditure.
Standard costing: costs are compared as they occur, with predetermined
cost prepared in advance usually known as standard cost. – useful in
repetitive manufacturing operations.
Same features as that of other managerial control systems.
Reading assignment
Diff. Historical and
Standard costing
www.accountingnotes.net/co
st-accounting/standard-
costing/difference-between-
standard-cost-and-historical-
cost/4735

22. Location of Cost
Data collected should be group around cost center
Cost center: a defined area, machine, or a person to whom direct & indirect costs are allocated
Cost center is the division, a part or a function of a whole enterprise wherein a responsibility can be
meaningfully located. – size & complexity of CC can vary from organization to organization.
Example: a subsidiary company, a division, a team, a person, a project, a machine
A cost center may itself have various cost units within it.
A cost unit is a unit of product or a service to which cost can be traced.
Example:
To a computer manufacturing company, a laptop will be a cost unit
To a bus company, a cost unit can be a bus journey

23. Recovery of Overheads
Following types of expenditures are considered in any budget
 Direct human resource cost
 Direct material cost
 Other costs that cannot be allocated to any specific job
(indirect cost)
Overhead: resource consumed or list in completing a process
that does not contribute directly to the end product. (e. g. rent,
insurance and taxes etc.)
An aggregate cost of indirect material, indirect people &
indirect expenses.
Recovered by spreading this over all jobs/unit by adding on
the fixed percentage to the labor cost.

24. Cash Flow & Growth
1
1.1
1.21
1.33
1.46
1.61
Let us invest $1 today for a period of 5 years at a rate of 10% return.
Tenure Principal
($)
Growth
($)
Total
($)
Now, beginning
of year
1 - -
End of year 1 1 0.1 1.1
End of year 2 1.1 0.11 1.21
End of year 3 1.21 0.121 1.331
End of year 4 1.331 0.1331 1.464
End of Year 5 1.464 0.1464 1.610
0
0.5
1
1.5
YEAR 1 YEAR 2 YEAR 3 YEAR 4 YEAR 5
$
GROWTH OF $1
Growth ($) Principal ($1)
Principal= $1; R = 10%; t = 4 years

25. Future Value
Future value (FV) refers to a method of calculating how much the present value
(PV) of an asset or cash will be worth at a specific time in the future.
𝐹𝑉 = 𝑃𝑉 𝑥 (1 + 𝑅)𝑛
FV = Future Value
PV = Present Value
R = Rate of Interest/return on asset
n = No. of years
𝑃𝑉 =
𝐹𝑉
(1 + 𝑅)𝑛
What will be the Future value of an investment of $100 at a rate of
15% ROA for a period of a) 5 years b) 10 years?
For 5 years
𝐹𝑉 = 100 𝑥 (1 + 0.15)5
= $ 201.135
For 10 years
𝐹𝑉 = 100 𝑥 (1 + 0.15)10
= $ 404.555
Calculate FV of $1 at ROI=10% for a period of 1 year
𝐹𝑉 = 1 𝑥 (1 + 0.10)1= $ 𝟐. 𝟏

26. Discounted Cash Flow (DCF) & Discounting
DCF = Value of anticipated revenue stream from an investment as at today or any given
date
 Valuing a project, company, or asset using the concepts of the time value of money
 A dollar received today is less valuable than a dollar received in future – when placed in
an interest earning account.
 Taking sum in future and calculating its present value (at some particular rate of return)
 Discounting: the act of determining the present value of future cash flows/future amount
What will happen if we are given a future value and asked to
calculate how much do we need to invest today to make sure we will
arrive at the future value
?

27. 1
1.1
1.21
1.33
1.46
1.61
Discounted Cash Flow (DCF) & Discounting
Present value of $1.61 @ R = 10%; t= 5 yrs.
@ year 5
𝑷𝑽 =
𝟏. 𝟔𝟏
(𝟏 + 𝟎. 𝟏𝟎)𝟏
= $ 𝟏. 𝟒𝟔
@ year 4
𝑷𝑽 =
𝟏. 𝟒𝟔
(𝟏 + 𝟎. 𝟏𝟎)𝟏
= $ 𝟏. 𝟑𝟑
@ year 3
𝑷𝑽 =
𝟏. 𝟑𝟑
(𝟏 + 𝟎. 𝟏𝟎)𝟏
= $ 𝟏. 𝟐𝟏
@ year 2
𝑷𝑽 =
𝟏. 𝟐𝟏
(𝟏 + 𝟎. 𝟏𝟎)𝟏
= $ 𝟏. 𝟏𝟏
@year 1
𝑷𝑽 =
𝟏. 𝟐𝟏
(𝟏 + 𝟎. 𝟏𝟎)𝟏
= $ 𝟏
1
1.11
1.21
1.33
1.46
1
1.05
1.1
1.15
1.2
1.25
1.3
1.35
1.4
1.45
1.5
Year 1 Year 2 Year 3 Year 4 Year 5
$
PV ($)
Present Value → Discounting

28. Use of Present Value
There are two opportunities for
investment, the details are as
follows
Option Principal Rate Time
1 $3 10% 5 yrs.
2 $2.5 12% 5 yrs.
Which one of these options would
be better suited for you to invest in
terms of getting maximum benefit
at the end of 5 yrs.?
Discounting (or calculating present value)
Option 1
𝐷1 =
3
(1 + 0.10)5
= $1.86
Option 2
𝐷2 =
2.5
(1 + 0.12)5
= $1.41
Clearly, Option 1 will give more ROA (has a greater PV) than
Option 2, although Principal in Option 1 is greater than that of
Option 2

29. Net Present Value
 NPV is the difference between present value of future cash
flows from an amount of investment
𝑵𝑷𝑽 = 𝑷𝑽 − 𝑷𝒓𝒊𝒏𝒄𝒊𝒑𝒂𝒍 (𝒐𝒓 𝒊𝒏𝒗𝒆𝒔𝒕𝒎𝒆𝒏𝒕)
 Let us spend $1000 today at a return rate of 10%. This means
by the end of first year we will get $1100.
 Thus the present value of $1100 at 10% rate is $1000
𝑁𝑃𝑉 = $1000 − $1000 = $0
NPV = 0
The project repays the
original investment
NPV = +ve
The project returns
investment + profit
NPV = -ve
The project returns a
loss
The project repays original investment plus the required rate of return

30. What will you choose?
You are required to buy a machine to carry out a certain process in your
production chain. You have two options to choose from. These options along
with financial particulars is as below
Machine Principal ROI FV Time
1 PKR 50,000 8%
PKR
250,000
10 yrs.
2 PKR 70,000 12%
PKR
300,000
10 yrs.
Based on above data, it is clear that Machine 2 gives higher ROA than Machine 1.
However, Machine 2 has a higher Future Value than Machine 1. In this case, what
machine would you choose, the decision being based on calculation of Present Value
(discounting)?

31. 1. The ratio of profit and volume of a company is 50% while its margin of safety is 4/1.
The sales volume is Rs. 50,00,000. Find Breakeven point & net profit.
2. A television was bought at a price of $25 in 2002. It is expected to be depreciated in 6
years. Calculate the depreciated value and total value of the television at the end of each
year from 2002 onwards using Straight line or linear depreciation
3. Find depreciated value of a car @ 7% with a book value of $3000 at following years 1st
year, 2nd year, 3rd year, 4th year, 5th year using reducing balance method.