Sandeep Vilas Shirsekar Batch 13 B Roll No 93

1. Sandeep Vilas Shirsekar Batch 13 B Roll No 93

2. Budgeting * INTRODUCTION * TYPES * METHODS Capital Budgeting Working Capital Management

4. WHAT IS A BUDGET? “ A plan expressed in money. It is prepared and approved prior to the budget period and may show income, expenditure and the capital to be employed. May be drawn up showing incremental effects on former budgeted or actual figures, or be compiled by Zero-based budgeting.”

9. 5. PERSONNEL BUDGET: This budget gives an estimate of the requirements of direct labour essential to meet the production target. This budget may be classified into – a. Labour requirement budget b. Labour recruitment budget 6. RESEARCH AND DEVELOPMENT BUDGET: This budget provides an estimate of expenditure to be incurred on R & D during the budget period. A R&D budget is prepared taking into consideration the research projects in hand and new R & D projects to be taken up.

10. 7. CAPITAL EXPENDITURE BUDGET: T his is an important budget providing for acquisition of assets necessitated by the following factors: a. Replacement of existing assets. b. Purchase of additional assets to meet increased production c. Installation of improved type of machinery to reduce costs. 8. CASH BUDGET: This budget gives an estimate of the anticipated receipts and payments of cash during the budget period. Cash budget makes the provision for minimum cash balance to be maintained at all times.

11. 9. MASTER BUDGET: CIMA defines this budget as “ The summary budget incorporating its component functional budget and which is finally approved, adopted and employed”. Thus master budget is a summary of all functional budgets in capsule form available in one report. 10. FIXED BUDGET: This is defined as a budget which is designed to remain unchanged irrespective of the volume of output or turnover attained. This budget will, therefore, be useful only when the actual level of activity corresponds to the budgeted level of activity.

12. 11. FLEXIBLE BUDGET: CIMA defines this budget as one “ which, by recognising the difference in behaviour between fixed and variable costs in relation to fluctuations in output, turnover or other variable factors such as number of employees, is designed to change appropriately with such fluctuations”. 12. PERFORMANCE BUDGETING: These days budgets are established in such a way so that each item of expenditure is related to specific responsibility centre and is closely linked with the performance of that standard.

14. 14. RESPONSIBILITY ACCOUNTING: Responsibility accounting fixes responsibility for cost control purposes by establishing responsibility centres namely – a. Cost centre b. Profit centre c. Investment centre Principles of responsibility accounting are as follows: 1. Fixation of targets for each responsibility centre 2. Actual performance is compared with the target 3. The variances therein are analyzed so as to fix the responsibility of centres. 4. Taking corrective action.

16. CAPITAL BUDGETING

17. CAPITAL BUDGETING Capital budgeting is a decision situation where large funds are committed (invested) in the initial stages of the project and the returns are expected over a long period of time. These decisions are related to allocation of investible funds to different long-term assets. Capital budgeting is a continuous process and it is carried out by different functional areas of management such as production, marketing, engineering, financial management etc.

20. 1. ESTIMATION OF CASH FLOWS The costs and benefits for a capital budgeting decision situation are measured in terms of cash flows. An important point is that all cash flows are considered on after tax basis. The rule is that all financial decisions are subservient to tax laws. The cash flow from the project are compared with the cost of acquiring the project.

22. Calculation of different cash flows may be summarized as follows: INITIAL CASH OUTFLOW: Cost of new plant + Installation expenses + Other Capital expenditure + Additional working capital – Tax benefit on account of capital loss on sale of old plant (if any) – Salvage value of old plant + Tax liability on account of capital gain on sale of old plant (if any).

23. SUBSEQUENT ANNUAL INFLOWS: Profit after tax + Depreciation + Financial charge ( 1-t) – Repairs (if any) – Capital Expenditure (if any). TERMINAL CASH FLOW: Annual cash inflow + Working capital released + Scrap value of the plant (if any).

24. 2. DECISION CRITERIA TECHNIQUES OF EVALUATION Traditional or Time-adjusted or Non-discounting Discounted cash flows 1. Payback period 1. Net Present Value 2. Accounting Rate of 2. Profitability Index Return 3. Internal Rate of Return

25. TRADITIONAL OR NON-DISCOUNTING TECHNIQUES I . PAYBACK PERIOD: # The payback period is defined as “the number of years required for the proposal’s cumulative cash inflows to be equal to its cash outflows.” # The payback period is the length of time required to recover the initial cost of the project. # The payback period may be suitable if the firm has limited funds available and has no ability or willingness to raise additional funds.

27. DISCOUNTED CASH FLOWS OR TIME ADJUSTED TECHNIQUES These are based upon the fact that the cash flows occurring at different point of time are not having same economic worth. I . NET PRESENT VALUE (NPV) METHOD : The NPV of an investment proposal may be defined as the sum of the present values of all the cash inflows less the sum of present values of all the cash outflows associated with the proposal. The decision rule is “ Accept the proposal if its NPV is positive and reject the proposal if the NPV is negative”.

28. II . PROFITABILITY INDEX METHOD : This technique is a variant of the NPV technique and is also known as BENEFIT - COST RATIO or PRESENT VALUE INDEX . Total present value of cash inflows PI = Total present value of cash outflows. Accept the project if its PI is more than 1 and reject the proposal if the PI is less than 1.

31. WORKING CAPITAL MANAGEMENT

32. WORKING CAPITAL MANAGEMENT Working capital management is concerned with the problems that arise in managing the current assets, current liabilities and the interrelationships between them. GOAL : To manage the firm’s current assets and liabilities in such a way that a satisfactory level of working capital is maintained.

33. CONCEPTS : GROSS WORKING CAPITAL – The current assets which represent the proportion of investment that circulates from one form to another in the ordinary conduct of business. NET WORKING CAPITAL – The portion of current assets financed with long term funds or current assets – current liabilities

34. PURPOSE : The NWC is necessary because the cash outflows and inflows do not coincide. The purpose of NWC is to measure the liquidity of the firm. DETERMINING FINANCING MIX : Financing mix is the choice of sources of financing of current assets. SOURCES OF ASSET FINANCE : 1. Short term sources (Current liabilities) 2. Long term sources (Share capital, long term borrowings).

36. APPROACHES TO DETERMINE FINANCING MIX 1. Hedging approach 2. Conservative approach 3. Trade off between the above mentioned two approaches.

37. HEDGING APPROACH (MATCHING APPROACH) This is the process of matching maturities of debt with the maturities of financial needs. According to Hedging approach, the permanent portion of funds required should be financed with long term funds and the seasonal portion with short term funds . Under this approach working capital = 0 since CA are not financed by long term funds (CA = CL).

38. CONSERVATIVE FINANCING APPROACH : This is a strategy by which the firm finances all funds requirement, with long term funds and uses short term funds for emergencies or unexpected outflows. TRADE OFF BETWEEN HEDGING AND CONSERVATIVE APPROACHES : One possible trade off could be equal to the average of the minimum and maximum monthly requirements of funds during the given period of time. This level of requirement of funds may be financed through long run sources and for any additional financing need, short term funds may be used.

39. FACTORS DETERMINING AMOUNT OF WORKING CAPITAL Purchase Payment for Sell product Receive resources resource purchase on credit cash Inventory Receivable conversion conversion period period Payables Cash period Conversion period Operating cycle

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