Costing and Finance

P R UPADHYAY

Outline

• Business & Accounting terminology
• Cost classification & analysis
• Cost-benefit analysis
• Interest & time value of money
• Investment decision

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• Risk analysis
• Demand analysis and sales forecasting
• Engineering Economy

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Business & Accounting terminology

• Covered in General Accounting Principles

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Cost

• Cost is the amount of expenditure, actual or notional, relating to a specific thing or activity.
• The special thing or activity may be a product, job, service, process or any other activity.
• Cost is expressed in monetary terms.

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Cost classification

• It is the process of grouping costs according to their common characteristics.
• Cost classification serves the following objectives:
• Determining product cost
• Planning
• Decision making
• Control

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Different Cost classifications

• On the basis of nature of cost:
• Direct material
• Direct labour
• Direct expenses
• Factory/ works overhead
• Administrative overhead
• Selling & distribution overhead
• On the basis of behavior of cost:
• Fixed
• Variable
• Mixed (Semi-variable or semi-fixed)

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Different Cost classifications

• On the basis of degree of traceability to the product:
• Direct cost
• Indirect cost
• On the basis of association with the product:
• Product cost
• Period cost
• On the basis of function:
• Manufacturing cost
• Administrative cost
• Selling & distribution cost

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Different Cost classifications

• On the basis of relationship with the accounting period:
• Capital cost
• Revenue cost
• On the basis of decision making and planning:
• Opportunity cost
• Sunk cost
• Relevant cost
• On the basis of controllability:
• Controllable and uncontrollable cost
• Standard cost

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Cost analysis

• Cost analysis is the identification of the costs, as per their required classification, for the purpose of planning, decision making and controlling.

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Cost-benefit analysis

• It analyses the cost and expected benefit there from.
• Helps in decision making relating to level of production.
• Following techniques are used:
• Break-even analysis
• Cost-volume-profit analysis

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Interest and time value of money

• Interest is the amount of return of investment in money market.
• Money has time value therefore specific cash inflow and outflow are analysed for decision making.
• To determine the time value of money, following techniques are used:
• Discounting
• Compounding
• Equivalence

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Investment decision

• It is fully based on time value of money.
• It analyses the feasibility of an investment project from financial aspects.
• Following methods are used:
• Pay back period (PBP)
• Discounted pay back period
• Net present value (NPV)
• Internal rate of return (IRR)
• Profitability Index (PI)

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Risk analysis

• It focuses on:
• identification of risk relating to project or business operation,
• assessment of the impact of such risk,
• prioritization of risk on the basis of their impact on business and project; and
• using the methods of mitigation or avoidance.

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Demand analysis and sales forecasting

• Demand analysis and sales forecasting try to identify the expected demand of the product or services to be produced or delivered and the expected volume of sales to be made
• Helps in determining the level of production required, expenditures to be made and resources to be used.
• Takes the help of various environmental factors, production capacity and customers behaviors.

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What is Engineering Economy?

• Economic decision making for engineering systems is called engineering economy.

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• Engineers are the people who are familiar with all the technicalities of machinery and production therefore they are the best judges of the useful lives of an asset and they also have the technical knowledge to calculate the number of units a proposed plant would produce when operational.

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• In today’s competitive world of business it has become essential that engineers should practice financial project analysis for engineering projects and make rational decisions.

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• Engineering economy also includes the study of accounting practices for manufacturing concerns. Unique features of accounting for manufacturing concerns are process costing, batch costing, cost allocation.
• Engineering economy deals with justification and selection of projects.

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What is Engineering Economy?

• Engineering economy

systematic evaluation of the economic merits of proposed solutions to engineering problems

• Principles:

– Develop the alternatives

• Alternatives need to be identified and defined.

– Focus on the difference

• Only the differences in expected future outcomes among the alternatives will effect the decision.

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What is Engineering Economy?

– Use a consistent viewpoint

• Prospective outcomes should be developed from a consistent, defined viewpoint.

– Consider all relevant criteria

– (try to) Use a common unit of measure

– Make uncertainty explicit

• Uncertainty is inevitable. Identify and explore it in analyses.

– Revisit your decisions

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Engineering Economic Analysis - Seven Steps

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1. Recognition and formulation of the problem.

2. Development of the feasible alternatives.

3. Development of the net cash flows (and other prospective outcomes) for each alternative.

4. Selection of a criterion (or criteria) for determining the preferred alternative.

5. Analysis and comparison of the alternatives.

6. Selection of the preferred alternative.

7. Performance monitoring and post-evaluation.

Engineering Economy

• Objective – Evaluation

– How to compare the economic value of alternative design options?

• Basis – Cash Flow Analysis

– One is indifferent between investments with equivalent cash flows

• Key issues

– Time value of money

– Cash flows occurring at different times

– “Designs” with different durations

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Thank You

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