Importance of Cost Reduction and Control

Importance of Cost diminution and ControlAssignment on pecuniary principles and techniquesIntroductionSt arrangegic investing decision shew indicates the answer of identifying, evaluating, and selecting among stand outs which ar more likely to dumbfound signifi screwt effect on the shapings agonistical advantage. More clearly, the decision influences what the organization does (i.e., the set of overlap and t competent service attributes that be offerings of the organization), where it does it (i.e., the structural characteristics that determine the scope and geographical dispersion of organizations trading ope dimensionns), and how it does it (i.e., the set of ope rational surgical procedurees and work practice).The st yardgic investiture decision making put to work is arguably hotshot of senior management greatest ch bo henceges. It is signifi undersidetly needed to devil these decisions right. If the decision is successful, the firm can enjoy strategic as hale as operational advantage. But while the decision proves wrong, either a potential opportunity is lost or it has needlessly spoiled substantial resources ( d one(a) fruitless investment). well-nigh traditional approaches to strategic investment appraisals which overwhelm payback, score rate of income tax return, return on investment, residual income, and discount rateed hard property flow project been criticized on the flat coat of a number of grounds. Some main criticisms be their narrow perspective, exclusion of nonfinancial benefits, overemphasis on the improvident-term, faulty assumptions about the stipulation quo, inconsistent treatment of inflation, and promotion of non- survey adding behavior. parturiency 1Cost Reduction Techniques.Cost reduction means reducing personify associated with production or some(prenominal)(prenominal) other cost activities without affecting the quality of product or service as well as activities. Through cost reduction procedures or techniques managers reduce cost. For this they break diverse cost reduction techniques. The success of all organization largely depends on how strategically cost is managed comp atomic number 18d with that of competitors. It certainly provides private-enterprise(a) advantage which is inhering in this hyper competitive market or telephone line world. As the manager is the higher authority of any organization, they ar to develop different ca expends of policies and strategies to run the business successfully.Processes of Cost ReductionIdentify the parsimonyMake your prediction on savingMeasure the process prior(prenominal) to adjustmentMake the cost saving changeMeasure the process afterConfirm saving has been made and it hasnt impacted other areas to take form a loss.If YES move onto next stick out.If NO go back to the rise and start again.Appropriate Costing SystemCost that is allocated to units of production can be effective cost or banal cost. In an veridical or historical cost system, cost is allocated as they occur. Under standard cost system, product operations and process are costed by means of habituate standard for both activities and dollar follow. These standards are predetermined in pressurize of production. The actual cost system and standard cost system can be used with either transmission line army or process cost accumulation approaches. Job order costing is applied to job order work in factories, workshops and repair shops as well as to work by builders, construction engineers and printers. A variation of the job order cost method is that of costing orders by lots. In the shoe manufacturing companies for example, a contract is typically divided into lots which consists of 100 to 250 pairs of one sizing and style of shoe. The cost is then accumulated for each lot. On the other wad, the process cost system is applied to industries such as dredge mills, breweries, chemical purposets and textile factories. However there are many companies that use both job order and process costing according to their needs. The prefatorial difference amid job order costing and process costing is the breadth of the denominator. The denominator of job order costing system is small (e.g. one painting 100 advertising circulars, one special package railway car or one highway bridge). But in the case of process costing, the denominator is large (e.g. thousands of pounds, gallons or board feet.).Task 2The importance of underdeveloped cost reduction techniquesIt helps to enhance management performance or facultyIt helps to know the nature of costIt helps to reduce the cost of operations of the organizationIt helps to set competitive worth of product or serviceIt helps to add-on market share in the attentionIt helps to increase advance or returnIt helps to enjoy competitive advantage over competitorsProposed costing and price systemsBasis of Costing MethodsMaterial costLabor cost operating cost costOpportunity cost Structure of CostingCosting principles and methodologyFixed and variable costDirect cost (material and attention)In cipher cost (overhead and activity based costing) carrefour cost and periodic costProduct cost and gross revenue costActual CostingTo set actual costTo change to actual costTo analyze variance rating of ProjectBreakeven analysisMarginal contributionOpportunity cost requitalNPV,DCF, IRRROIROCProject Case PricingHow to cost project correctlyHow to fill project approveWhat cost to excludeEssential cost to includeA business case proposalPreparing a Master computeMaster reckon is a comprehensive planning document which incorporates several(prenominal) other individual figures.The operation budget consists of eight individual budgets which are as followsSales budget The gross revenue budget shows the expected gross sales in units at their expected selling price in a certain period of duration. A business firm generally prepares the sales budget for a habituated p eriod of time on the basis forecasted sales level, production capacity, as well as long and short term goals.Production cypher Production budget is a plan for obtaining the resources needed to carry out the manufacturing operations of the organization to meet up the expected sales and maintain the expected level of ending inventory. The flow production level depends on sales level, units of finished goods ending and commencement inventory.Direct Material Budget The prepareed material budget shows the submit materials business firm needs for its production and the budgeted cost. This budget is really more than related to production budget.Direct Labor Budget To prepare direct labor budget and the direct materials budget, production budget is needed. It helps personnel segment of the organization to plan for new hires and repositioning of employees. A good labor budget is very helpful for a business firm to obviate urgent hiring and help to prevent the shortage of labor.Facto ry Overhead Budget This budget includes all the production costs except for direct materials and direct labor budgets. Manufacturing cost is the cost that varies in direct proportion with the fabricate units and how the business firm carries out its operation.Selling and administrative spendings budget This type of budget indicates a plan for all non-manufacturing expenses. This budget provides you with a road map for selling and administrative activities for the period of your budget.Budgeted income Statement Budgeted income statement is the stick up fragmentize of operational of a police captain budget. It real estimates the expected operating income from budgeted operations in a certain period of time.The second part of master budget includes financial budget and financial budget is the combination of chase two individual budgetsCash Budget A cash budget shows the effect/impact of all the budgeted activities on cash. Through preparing a cash budget, the management of a bu siness firm is supposed to be able to make sure that they have sufficient cash on hand needed to carry out activities. It also helps them to have enough time to plan for any additional financing and plan for investment of supererogatory cash.Budgeted Balance Sheet Budgeted balance sheet is the persist part in preparing master budget. This budgeted balance sheet shows the expected financial position at the end of the fiscal socio-economic class (at a point of time) or budget period.It is very important to understand how to prepare a master budget since it helps a business to maximize its good/return and to have a good handle on their budget period.Potential for the Use of action mechanism Based CostingABC system provides highly accurate product or customer cost that a company can use for strategic decision.This system helps to understand the cause effects relationship between day to day activities and product or customer cost and hypothesis aids the operational control purpose of cost management system.Task 3Calculation of ratio symmetry analysis of Amber Lights ltd for two years is as followsLast Yeara) Return on seat of government employed = Net Profit/Total not bad(p)= 8000/109000= 7.34%b) Return on ordinary shareholders fund = Net profit/ ordinary shareholders fund=8000/16000=50%c) Gross profit margin = Gross profit/Net sales= 92000/350000=26.29%d) Net profit margin = Net profit/Net sales=8000/350000=2.29%e) Current ratio = Current asset/ period liabilities=110000/50000=2.21f) pane test ratio =C.A-Closing convey/ veritable liabilities=110-44/50=1.321g) mean(a) stock turnover period =Cost of sales/Average parentage=258000/44000=5.86 measurePeriod =360/5.86=61.43 daysThis Yeara) Return on capital employed = Net Profit/Total capital= 12000/117000= 10.26%b) Return on ordinary shareholders fund = Net profit/ ordinary shareholders fund= 12000/16000=75%c) Gross profit margin = Gross profit/Net sales=110000/420000=26.19%d) Net profit margin = Net pr ofit/Net sales=12000/420000=2.86%e) Current ratio = Current asset/current liabilities=136000/92000=1.481f) panelling test ratio =C.A-Closing stock/ current liabilities=136000-63000/92000=.791g) Average stock turnover period =Cost of sales/Average Inventory=310000/63000=4.92 timesPeriod =360/4.92Analysis of Operating Efficiency and ProfitabilityThe given ratio of Amber Lights ltd. indicates two types of ratio including operating efficiency and gainfulness. The operating profitability ratio indicates that return on capital employed ratio of last year is 10.26% and this year is 7.34%, return on ordinary shareholders fund ratio of last year is 50% and this year is 75%, gross profit margin of last year is 26.29% and this year is 26.19%, on the other hand, winnings profit margin ratio is 2.29% and this year is 2.86%.So we can say from the in a higher place discussion that operating profitability of two year is very pie-eyed except ordinary shareholder fund. So this year performance i s infract than last year. We also see from the operating efficiency ratio that current ratio of last year is 2.201 and current year is 1.481, acid test ratio of last year is 1.321 and current year is .791, and average stock turn over period of last year is 61.43 days and this year is 73.17 days. From the given data of last year and the current year of Amber Lights ltd we find that last year performance is smash than this year. So from the given data analysis we can say that last year operating efficiency was go bad than that of current year.Limitation of ratio AnalysisAlthough ratio analysis provides important implications, there are some limitations of ratio analysis. The main limitations of ratio analysis are given infraAccounting treatment varies between firmsFirms with different divisions operating in different industries make it difficult to find industry ratio analysisSome Results may be in consistentRatios which are outside an industry range might be cause of much concer n.Task 4Financial Appraisal MethodsThere are several different appraisal methods and each of those methods has its fussy applications, advantages and drawbacks.Simple PaybackThis is one of the simplest and widely recognize methods of cost/benefit analysis. Payback period is defined as the aloofness of time required to recover the original investment on the project, through cash flows. The cash flows include operating profit, less income tax payable, gain depreciation.Internal Rate of ReturnIt can be said that it is the mostly used method for the financial evaluation of a companys investment. The internal rate of return (IRR) can be defined as the rate of return required to make the testify pry of approaching cash flows positivistic the final market comfort of the investment, equal to the current market price for the investment. Actually it is a discount rate making the electronic network shew value equal to zero.Average Rate of ReturnThe average rate of return is calcula ted profit after tax divided by book value of investment. Under this method, the entire life of any project is considered.Net Present ValueNet subject value is one of the discounted cash flow techniques. This method considers time value of money. It is calculated as present value of future cash inflows over the life of the project less present value of cash outflows.Benefit Cost RatioBenefit cost ratio is another version of net present approach. Under this approach, the benefits from the project are reduced to their present value at a specified rate of discount and this figure is divided by the present value of the cost of the project.Discounted Cash FlowThis approach actually represents what a company is willing to pay at the present (today) to become anticipated cash flow in future years. So it is a process of converting future earnings into todays money. Future cash flows are discounted to constitute their present values and determine the value of the project.These are well r ealized and understood appraisal tools to financially evaluate projects. All appraisal methods are not supposed to provide the same result. Increasingly, with the creation of stakeholder value macrocosm determined by an organizations environmental and social policies and values, new criteria and perspectives will have to be factored into organizations decision-making process.Strategic Issues in Making Investment DecisionsThe prime target of every business organization is to make money for the owners now and in the future. Investment decision plays a significant role in making investment decisions.Both quantitative as well as qualitative issues must be considered in decision making.Short-term decisions are relatively easy on the quantitative sideWould you rather spend $10,000 or $15,000 given the same revenue?Would you rather sell something for $5.00 per unit or $7.00 per unit given the same costs?Would you rather have net income of $60,000 or $50,000?Long-term (investment) decisi on involves two additional dimensions as follows timeMagnitudeDiscounted Cash Flow Analysis addresses the timing issue.Discounted Cash Flows (DCF Analysis)A dollar today is worth more than a dollar in the future.A dollar in the future is worth less than a dollar today.Steps to DCFTo determine future cash flowsTo determine the take into account discount rateHigher discount rate = lower present valueLower discount rate = higher present valueHigh adventure generally requires greater returnHigher risk = higher discount rateDiscount the future cash flows by using the selected hurdle rateCompare the present value of the future cash flows to the investmentIf PV of inflows PV of outflows, project is acceptableIf PV of inflows PV of outflows, project is rejectedNPV = PV of all Inflows PV of all outflowsTools of DCFPV = to compute the present value of single future amount or a set rente using a given cross discount rateFV = to compute the future value of a single present amount or a se t annuity given a particular discount rateRate = to computes the particular discount rate needed to convert a present value to a future value or a future value to a present valueNPV = to computes the net present value of a series of dissimilar future cash flows given a particular discount (hurdle) rateIf NPV 0, the investment is acceptableIf NPV 0, the investment is rejectedIRR = computes the discount (hurdle) rate which makes net present value equal to zero.If IRR the hurdle rate, the investment is acceptableIf IRR the hurdle rate, the investment is rejectedExample Suppose, company XYZ wants to make investment decision of $ 200000 for a project. The company must justify the PV of cash inflows and compare it with the cash outflows. If the value of PV is greater than cash outflow then the company should accept the project.ConclusionCost concept is very essential for decision making process. As the manager is the higher authority of any organization, they are to develop different types of policies and strategy to run the business successfully. So development of cost reduction procedures is one of the most important strategies. It is very important to develop cost reduction procedures because it increases the profit of the firm through reducing cost of production. If the manager cannot control cost their operating expense will be higher and higher and therefore reducing the profit of the firm. A firm which can not control cost cannot throw in the competitive business world. So to make proper investment decisions financial managers should have clear knowledge about financial principles and techniques for better performance.