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Building Economics and

Cost Control

Dr. Sarbesh Mishra


Finance Area, NICMAR
Hyderabad – 500 084.
About Myself
Name : Dr Sarbesh Mishra

Qualifications 1. B.Com (Hons) 2. Post-graduate in Commerce


3. M.Phil in Commerce
4. Ph.D. (Commerce)

Experience : Joined University of Delhi, as a Lecturer in


Commerce in 2001 and continued till 2005 and then joined
Army Institute of Management, NOIDA as Senior Faculty,
Finance prior to current appointment at NICMAR.

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Related to Cost (Thoughts)
 The most successful man in the life is the
man who has the best information.
Benjamin Disraeli, 19th. Century PM of England
 Even if you’re on right track, you’ll get run
over if you just sit there.
Will Rogers, Certified Cost Analyst
 He who controls the past controls future.
George Orwell, Certified Public Accountant

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Contd….
 You can’t get caught up in things that
you can’t control…….we can’t control
our selling price. We can control our
cost of manufacturing. We can control
our efficiencies. We can control our
waste.
Steven Appleton, CEO of Micro Technology
 If you don’t know where you’re going, it
doesn’t matter how you get there.
Prof. Sarbesh Mishra, NICMAR, Hyderabad

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Capital Expenditure (CAPEX)
Expenditure expended for the purpose of
obtaining long term advantage for the
business.
Examples
 Expenditure incurred in increasing the quality

fixed assets e.g. Purchase of additional


furniture, Plant, Building for permanent use
in Business.

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Revenue Expenditure
“An expenditure that arises out of and in
the course of regular business of a
concern is termed as revenue
expenditure”.
Example
Expenditure incurred in the normal course
of running the business e.g. expenses of
administration, maintaining of facilities viz.
Electricity, Telephone etc. cost incurred in
manufacturing & selling the products,
repairs, Depreciation, Interest on loan.

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Importance of Investment Decision
 Influence the firm’s growth in long-
term
 They affect the risk of the firm
 They involve commitment of large
volume of funds
 They are irreversible, or reversible at
substantial loss
 They are among most difficult
decisions to make.

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Investment Evaluation Criteria
 Estimation of Cash flows.

 Estimation of required rate of


return (Opportunity cost of capital)

 Application of decision rule for


making the choice

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Cash Flows
 Cash inflows or outflows occur at three
stages of capital investment project
1. Project Initiation (For beginning operations,
Working Capital needs, Replacement of asset)
2. Project Operation (Operating Expenditure,
Addl. Working capital need, inflow of cash generated by
the investment)
3. Final Project Disposal (Cash inflows or
outflows related to investment’s disposal, Cash inflows
from the release of working capital no longer committed
to the investment)

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Investment appraisal Techniques
Traditional Techniques
 Payback Period Method

 Accounting Rate of return Method

Discounted Cash flow Technique


1. Net Present Value method (NPV)

2. Internal Rate of Return Method (IRR)

3. Profitability Index Method (PI)

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Traditional Techniques
Payback Period Method
 Payback is the number of years required to
recover the original cash outlay invested in a
project.

 Payback = Initial Investment


Annual Average Cash Flows

Project would be accepted if its payback period is


less than the maximum or standard payback
period set by management.

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Accounting Rate of Return (ARR)
 This measures the profitability of an
investment.

ARR = Average Income


Average Investment

Projects with higher ARR over the minimum rate


established by the management will be accepted.

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DCF Techniques
 It explicitly recognizes the time value of
money.

 Cash flows arising at different time periods


differ in their value and are comparable when
their present values are found out.

 The compound interest rate is used for


discounting cash flows is also called as the
discount rate.

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Net Present Value Method (NPV)
 Cash flows of the invested projects should be
forecasted based on realistic assumptions.
 Appropriate discount rate should identified to
discount the forecasted cash flows.
 Present value of cash flows should be calculated
using the opportunity cost of capital as the
discount rate.
 Net Present Value is found out by subtracting
present value of cash inflows.

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NPV Formula

n
Ct
NPV = Ʃ - C0
t=1 (1+k)t
C1, C2 ….. Represent cash inflow in year 1,2 ….,
k is the opportunity cost of capital
C0 is the initial cost of investment
n is the expected life of the investment
* k is assumed to be known and is constant

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Acceptance Rule
1. Accept the project when NPV is positive

2. Reject the project when NPV is negative

3. May accept the project when NPV is zero.

Higher the NPV, the better it is.

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Meaning of Budget
 A budget is a detailed plan of operations for
some specific future period.
 According to CIMA, London “a financial
statement, prepared prior to a defined
period of time”.
 Essentials budget includes:
1. It is prepared in advance & is based on
future plan of actions.

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Contd….
2. It relates to future period & is based on objectives
to be attained.
3. It is a statement expressed in monetary and/or
physical units prepared for the implementation of
policy formulated by management.
 Different types of budgets are prepared for
different types of purposes e.g. sales budget,
Manufacturing Cost budget & at the end Master
Budget is prepared.

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Classification & Types of Budget
Classification According to Time
 Long-term budgets.

 Short-term budgets.

 Current budgets.

Classification on the Basis of Flexibility


 Fixed budget.

 Flexible budget

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Budget, Budgeting & Budgetary Control
 Budget – Individual objectives of a
department etc.
 Budgeting – The process/act of
building budgets.
 Budgetary Control – “It embraces all
the above & includes the science of
planning the budgets themselves & the
utilization of such budgets to effect an
overall management tool for the
business planning & Control”
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Activity Based Budgeting
 Activities that incur costs in every
functional area of an organization are
recorded and their relationships are
defined and analyzed.
 Activities are then tied to strategic
goals, after which the costs of the
activities needed are used to create
the budget.

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Eliminate Muda
Japanese Waste Management
 MUDA means waste, but the word carries a

deeper connotation. Any non-value activity or


obstruction to smooth flow of an activity is
Muda.
 Muda exists in many forms and is to be

eliminated.
Less Muda = More happy clients (as it
impacts quality, cost and delivery of products and
services)

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Example
 Overproduction and Inventory, items not
immediately needed
 Defective products requesting repair or
scraping
 Motion; unnecessary movement and
energy used to perform tasks
 Process imposing inefficient and/or
unnecessary tasks, fail to synchronize
systems

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Contd….
 Idling; by excessive set-up or
equipment breakdowns
 Transport, poor timing; too frequent
or infrequent movement of goods and
deliveries.
Turning loss into profit by muda
elimination is one of the easiest ways
for a company to improve its
operations

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THANK
YOU

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