Discuss about margin of safety, Zero Based Budgeting (ZBB), Pay Back Period, Cost-volume-profit analysis, budgetary control system, Industrial sickness and its causes & Financial Statement Analysis

Q. Describes the margin of safety,  Zero Based Budgeting (ZBB), Pay Back Period, Cost-volume-profit analysis, budgetary control system, Industrial sickness and its causes, Financial Statement Analysis (June'14).

Margin of Safety: Margin of safety represents the strength of the business. It enables a business to know what the exact amount it has gained or lost is and whether they are over or below the break-even point. Margin of safety= (Current output-BEP)

That's where the margin of safety comes in. It’s a calculation of how much 'sales revenue' can drop before the manager will incur a loss. It can be calculated in sales units, or when a company has more than one product, in sales revenue dollars. Margin of safety is calculated as the difference between expected sales and the break-even point:

1.    Margin of safety in sales dollars = Expected sales revenue - BE sales revenue
2.    Margin of safety in units = Expected sales in units - BE sales in units

Note that a company's current sales level can be used instead of expected sales level if you need to determine the margin of safety the company has achieved. More often, managers want to know what the expected margin is before sales have occurred instead of after the fact so they can do something to prevent a loss.

Zero Based Budgeting (ZBB): Zero-based budgeting is a budgeting approach that is considered to be more cost-effective than traditional budgeting. It requires that all budgeted amounts be justified from the ground up for each budgeting period, even if such items existed in previous budgets. It is employed by the majority of government agencies, but is effective in corporate companies as well.

Pay Back Period: The length of time required to recover the cost of an investment. The payback period of a given investment or project is an important determinant of whether to undertake the position or project.

Payback period is calculated as:
PBP = A+ (NCO-C)/A

Here,
A=the year at which the cumulative cash flow to net cash flow
NCO= Nest cash flow
C= Cumulative cash flow at the year A.

Cost-volume-profit analysis/Break-Even Analysis: Breakeven analysis is the study of the relationship between selling prices, sales volumes, fixed costs, variable costs and profits at various levels of activity. It is also known as cost-volume-profit analysis.

Breakeven analysis is simply a technique for determining whether what you sell will make any money or not. It is often requested in business plans. Its form is quite simple. If you assume that you can price your product at P, the fixed costs are FC, and the variable costs to produce the product is VC, then you can calculate the quantity of the product you need to sell just to breakeven (that means you just cover your costs and don't make any more money) as:

Breakeven number of units = FC/ (P-VC)

So, if the price of the product is $5, the variable costs to produce it is $3 and the fixed costs are $1000, then the breakeven number of units is = 1000/(5-3)=500 units.

Budgetary control system: Budgetary control system are helpful in controlling performance.

Industrial sickness and its causes: Industrial sickness is defined as "an industrial company which has, at the end of any financial year, accumulated losses equal to, or exceeding, its entire net worth and has also suffered cash losses in such financial year and the financial year immediately preceding such financial year".

Internal causes for sickness:

1) Lack of finance;
2) Bad production policies;
3) Marketing and Sickness;
4) Inappropriate personnel management;
5) Ineffective Corporate management

External causes for sickness:

1) Personnel Constraint;
 2) Marketing Constraint;
3) Production Constraint;
4) Finance Constraint;
 

Financial Statement Analysis: Analysis of the statement of financial position referred to as a balance sheet analysis, reports on a company’s assets, liabilities, and ownership equity at a given point in time.

1. A financial statement analysis provides information on the operation of the enterprise. These include sale and the various expenses incurred during the processing state.

2. Financial statement analysis gives information about the changes in equity which helps to explain the changes of the company’s equity throughout the reporting period.

3. Financial statement analysis provides information about cash flows which helps to prepare report on company’s cash flow activities, particularly its operating, investing and financial activities.