Working Capital, Pricing &

Performance Management

AFZAL AHMED, FCA

FINANCE CONTROLLER
NAGAD
 Exam Question 1 : Cash Operating Cycle & Liquidity

Following are the items from Standard Ltd's opening and

closing balance sheet and income statements for the year 2015:
1 January 31 Decmber
Receivables 800,000 900,000
Inventory 600,000 700,000
Payables 200,000 250,000
Credit sales 10,000,000
Cost of Goods sold 6,000,000

Requirements:
What is the approximate length of Cash operating Cycle?
 Exam Question 2 : Cash Operating Cycle & Liquidity

A retailing company earns a gross profit margin of 37.5% on its monthly

sales of Tk. 20,000. In order to generate additional cash, the following
changes are proposed:

Present Proposed
Inventory Holding Period 1.5 months 1.0 month
Payable Payment Period 1.0 month 1.3 months

Requirements:
How much additional cash will be generated at the end of the month if the
above proposal is materialized?
 Pricing &
Performance Management
 Full cost-plus pricing

In full cost-plus pricing the sales price is determined by calculating the

full cost of the product or service and then adding a percentage mark-up
for profit.

The full cost may be a fully absorbed production cost only, or it may
include some absorbed selling, distribution and administration
overheads. In the former case the mark-up on costs must be greater in
order to recover the other costs.

The most important criticism of full cost-plus pricing is that it fails to

recognise that, since sales demand may be determined by the sales price,
there will be a profit-maximising combination of price and demand.
 Full cost-plus pricing

Option 1:
Unit sales price = Total production cost per unit + Percentage mark-up

Option 2:
Unit sales price = Total production cost per unit + Other costs* per unit +
Percentage mark-up
*Other costs include selling, distribution and administration costs

Clearly, to achieve the same sales price, the mark-up on cost must be greater under
Option 1 than under Option 2 in order to recover the other costs.
 Sample example

XY Ltd has begun to produce product S, for which the following cost estimates have
been prepared.
CU per unit
Variable materials 14.00
Variable labour at CU12 per hour 54.00
Variable production overheads at CU3 per hour 13.50
Variable production cost per unit 81.50

Fixed production overheads are budgeted to be CU69,000 each period. The overhead
absorption rate will be based on 17,250 budgeted direct labour hours each period.
The company wishes to add 20 per cent to the full production cost in order to
determine the selling price per unit for product S.
 Sample example
Step 1:
Calculate the fixed production overhead absorption rate.
Overhead absorption rate = CU 69,000/17,250
= CU4 per direct labour hour
Step 2:
Calculate the full production cost per unit.
Direct labour hours per unit = CU54/CU12 = 4.5 hours
CU per unit
Variable production cost per unit 81.50
Fixed production overhead absorbed (4.5 hours X CU4) 18.00
Full production cost per unit 99.50

Step 3:
CU per unit
Full production cost per unit 99.50
Mark-up 20% 19.90
Full cost-plus selling price 119.40
 Sample example

The full cost of providing a service is CU40 per hour and its
selling price is currently determined as full cost plus 60%. In each
of the following separate situations, calculate the required profit
mark-up percentage.

1. A competitor launches a similar service for CU60 per hour. In order to sell
the service at the same price as the competitor the percentage mark-up must
be reduced to:

2. The full cost of providing the service increases to CU50 per hour. The
required mark-up percentage to achieve the same absolute value of mark-up
per hour of service provided is:
 Sample example

ZZ Ltd requires an annual return of 30% on the investment in all

of its products. In the forthcoming year CU800,000 will be
invested in non-current assets and working capital to produce
and sell 50,000 units of product Z. The full cost per unit of
product Z is CU100.

Determine the Pricing to generate required return on investment.

 Marginal cost-plus pricing

Marginal cost-plus pricing involves adding a profit mark-up to the

marginal or variable cost of production or sales.

The chief advantage of marginal cost-plus pricing is that it avoids the

arbitrary apportionment and absorption of fixed costs.
 Sample Example

Product Y incurs direct variable production costs of CU7 per unit. Fixed production
costs amount to CU17,900 each period.

Variable selling and distribution costs are CU3.80 per unit and fixed selling,
distribution and administration costs amount to CU24,800 each period.

Selling prices are determined on a marginal cost-plus basis, using a mark-up of 30%
of the marginal cost of sales.

Calculate the selling price per unit of product Y and the profit that will
result from sales of 26,800 units each period.
 Exam Question 3

Alfath & Co. is an industrial components manufacturer. One of their products that is
used as a sub-component in coffee maker manufacturing is CFM392.

This component has the following financial structure per unit:

Selling price 300
Direct Materials 40
Direct Labor 30
Variable Manufacturing overhead 24
Fixed Manufacturing overhead 60
Shipping and handling 6
Fixed Selling and Administrative overhead 20
Total cost 180
During the next year, CFM392 sales are expected to be 10,000 units. All of
the costs will remain the same except for material which will increase by 10% and
labor by 15%.The selling price per unit for next year will be Tk.320.

Required: Based on the above data, what will be the contribution

margin from CFM392 for next year? 6
 Exam Question 4

A retailing company is preparing its annual budget. It plans to make a profit of 25%
on the cost of sales. Inventories will be maintained at the end of each month at 30%
of the following month’s sales requirements.

Details of budgeted sales are as follows:

Credit Sales Cash Sales
(Tk ‘ooo) (Tk ‘ooo)
December 1,900 400
January 1,500 250
February 1,700 250
March 1,600 300

Calculate the budgeted inventory level at the end of December and budgeted
inventory purchases for January?
 Exam Question 5

ABC Limited manufactures and sells a single product, P. Since the P is highly
perishable, no inventories are held at any time. ABC Limited’s management uses a
flexible budgeting system to control costs.
Extracts from the flexible budget are as follows
Output & Sales (units) 4,000 5,500
Budget cost allowances: TK TK
Direct material 16,000 22,000
Direct labor 20,000 24,500
Variable production overhead 8,000 11,000
Fixed production overhead 11,000 11,000
Selling & distribution overhead 8,000 9,500
Administrative overhead 7,000 7,000
Total expenditure 70,000 85,000
 Exam Question 5 cont…

Production and sales of product P amounted to 5,100 units.

Calculate the following:

(i)Direct material.
(ii)Direct labor.
(iii)Variable production overhead.
(iv)Fixed production overhead.
(v)Selling & distribution overhead
 Transfer Pricing

A transfer price is the amount charged by one part of an

organisation for the provision of goods or services to another
part of the same organization.

In a perfectly competitive market the optimum

transfer price is the market price. This should be reduced for
savings in costs that are not incurred on internal transfers,
such as distribution costs, advertising and marketing costs,
and bad debts.
 Aim of Transfer Pricing System

 To enable the realistic measurement of divisional

profit.
 To provide the supplier with a realistic profit and the receiver
with a realistic cost.
 To give autonomy to managers.
 To encourage goal congruence, whereby individual
managers' own goals are the same as the goals of the
company as a whole.
 To ensure profit maximisation for the company as a
whole.
 Transfer Pricing

TP
Methods

Market Cost + Two Part Dual

Price Price TP Pricing
 Transfer Pricing

A company has two divisions, S and R. Both divisions

manufacture multiple products.
Division S transfers its output of component C to division R at full cost plus
10%. Division R then incurs further costs to convert component C into
finished product P for sale on the external market at CU40 per unit. Costs
incurred are as follows.
Div S Div R
(CU per unit) (CU per unit)
Variable Cost 20 15
Fixed Cost 10
Full Cost 30

Requirements: Would the transfers be recommended from the

point of view of: (a) The company as a whole? (b) The manager
of division R?
 Exam Question 6

a)What is transfer price? Briefly explain the aims of transfer pricing systems? 4

b)Division M manufactures product R incurring a total cost of Tk. 30 per unit. Fixed
costs represent 40% of the total unit cost.

Product R is sold to external customers in a perfectly competitive market at a price of

Tk. 50 per unit.

Division M also transfers product R to division N.

If transfers are made internally then Division M does not incur variable distribution
costs, which amount to 10% of the variable costs incurred on external sales.

Total demand for product R exceeds the capacity of Division M.

Calculate the optimum price per unit at which Division M should transfer product R
to Division N? 10
 Performance measurement tools

Return on Investment:
ROI = (Controllable divisional profit / Divisional capital employed) * 100%

ROI ties in directly with the accounting system and is identifiable from the income
statement and balance sheet.

ROI tends to focus attention on short-term performance, whereas investment

decisions should be evaluated over their full life

Example:
Target ROI (cost of capital)…………………………… 20%
Divisional Profit……………………………………………CU 300,000
Capital Employed………………………………………….CU 1,000,000

Requirement:
Would the division manager accept a project requiring capital of CU100,000 and
generating profits of CU25,000, if the manager were paid a bonus based on ROI?
 Performance measurement tools

Residual Income (RI):

RI is a measure of the centre's profits after deducting a notional or imputed interest
cost of the capital invested in the centre.

RI can avoid some of the behavioral problems of dysfunctionality that arise with the
use of ROI.

Using RI to compare divisions of different sizes is misleading.

Example:

Returning to the data in the previous example, would the division manager accept
the proposed project if the manager's bonus was based on RI?
 Performance measurement tools

Using ROI and RI to measure comparative performance

A company has a target ROI of 20% for each of its investment centers. Which of the
two divisions is performing better, using the following performance measures?
(a) Residual income
(b) Return on investment

Division 1 Division 2
Capital employed CU 1,000,000 CU 100,000
Controllable profits:
Year 1 CU 200,000 CU 20,000
Year 2 CU 220,000 CU 40,000
 Performance measurement tools

Sample Problem
An investment centre with capital employed of CU 570,000 is budgeted to earn a
profit of CU119,700 next year.

A proposed non-current asset investment of CU50,000, not included in the budget at

present, will earn a profit next year of CU8,500 after depreciation.

The company's cost of capital is 15%.

Complete the boxes to show the budgeted ROI and RI for next year, both with and
without the investment.
ROI RI

Without Investment

With Investment
Thank you