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Q: Fixed costs are really variable, the more you produce the less they become.

Do you agree? Explain?


A: Thanks for your questions Ujala.
I agree and disagree.
As production increases, ones variable costs definitely increase. When production
increases even more, one's fixed costs can also increase.
For example, you run a small factory and make tables. It costs $10 for wood for one
table. In the small factory you make 1,000 tables per month. Your rent, water, electricity,
salaries, etc. (fixed costs) are $6,000 per month. You sell the tables for $30 a table.
Assume for this example that all workers are paid fixed wages or salaries, so wages and
salaries forms part of fixed costs.
Your income statement currently looks like this:
Sales $30,000
Variable costs (wood) $10,000
Fixed costs $6,000
Profit $14,000
Let's say the demand for your tables increases to 1,100 tables per month. You can still
produce this quantity of tables with the current staff and facilities (fixed costs remain the
same).
Your income statement now looks like this:
Sales $33,000
Variable costs (wood) 11,000
Fixed costs $6,000
Profit $16,000
Now let's say a short while later the tables start selling really well. Your customers
demand 1,500 tables each month. You cannot produce 1,500 in the same factory and
with the same number of workers. So you hire more people and move to a bigger
factory.
Here's the latest income statement:
Sales $45,000
Variable costs (wood) $15,000
Fixed costs $12,000
Profit $18,000
So, as you can see from this example, your variable costs always change according to
production. But when the production increased to a certain point, both your variable and
fixed costs would increase. Your fixed costs increase to a new higher level and stay at
that level until the next point of expansion.

To give a final answer to your questions above: Yes, fixed costs can vary, but no, when
production increases fixed costs would not usually decrease.
Because variable costs depend upon production qty where as fixed costs are fixed
irrespective of production. So fixed cost is not variable at any angle. Ya that sure that by
high production cost reduces

The given statement "Fixed costs are really variable, the more you produce the
less they become" is true. Fixed costs are the costs which are incurred
irrespective of the number of units produced. Thus, when number of units
produced are larger, fixed costs become less. For example, say the total annual
fixed cost for producing water bottles is $50,000. Now if only 20,000 units of
water bottles are produced, the fixed cost per unit will be $2.5 ($50,000 /
20,000). However, if 40,000 units of water bottles are produced, the fixed cost
per unit will be $1.25 ($50,000 / 40,000). From this example, we can see that
fixed costs become less with the increase in production

What Is A Cash Flow


Statement?
Complementing the balance sheet and income statement, the cash flow
statement (CFS), a mandatory part of a company's financial reports since
1987, records the amounts of cash and cash equivalents entering and leaving
a company. The CFS allows investors to understand how a company's
operations are running, where its money is coming from, and how it is being
spent. Here you will learn how the CFS is structured and how to use it as part
of your analysis of a company.
The Structure of the CFS
The cash flow statement is distinct from the income statement and balance
sheet because it does not include the amount of future incoming and outgoing
cash that has been recorded on credit. Therefore, cash is not the same as net
income, which, on the income statement and balance sheet, includes cash
salesand sales made on credit. (For background reading, see Analyze Cash
Flow The Easy Way.)
Cash flow is determined by looking at three components by which cash enters
and leaves a company: core operations, investing and financing,

Operations
Measuring the cash inflows and outflows caused by core business operations,
the operations component of cash flow reflects how much cash is generated
from a company's products or services. Generally, changes made in
cash, accounts receivable, depreciation,inventory and accounts payable are
reflected in cash from operations.
Cash flow is calculated by making certain adjustments to net income by
adding or subtracting differences in revenue, expenses and credit transactions
(appearing on the balance sheet and income statement) resulting from
transactions that occur from one period to the next. These adjustments are
made because non-cash items are calculated into net income (income
statement) and total assets and liabilities(balance sheet). So, because not all
transactions involve actual cash items, many items have to be re-evaluated
when calculating cash flow from operations.
For example, depreciation is not really a cash expense; it is an amount that is
deducted from the total value of an asset that has previously been accounted
for. That is why it is added back into net sales for calculating cash flow. The
only time income from an asset is accounted for in CFS calculations is when
the asset is sold.
Changes in accounts receivable on the balance sheet from one accounting
period to the next must also be reflected in cash flow. If accounts receivable
decreases, this implies that more cash has entered the company from
customers paying off their credit accounts - the amount by which AR has
decreased is then added to net sales. If accounts receivable increase from
one accounting period to the next, the amount of the increase must be
deducted from net sales because, although the amounts represented in AR
are revenue, they are not cash.
An increase in inventory, on the other hand, signals that a company has spent
more money to purchase more raw materials. If the inventory was paid with
cash, the increase in the value of inventory is deducted from net sales. A
decrease in inventory would be added to net sales. If inventory was purchased
on credit, an increase in accounts payable would occur on the balance sheet,
and the amount of the increase from one year to the other would be added to
net sales.

The same logic holds true for taxes payable, salaries payable and prepaid
insurance. If something has been paid off, then the difference in the value
owed from one year to the next has to be subtracted from net income. If there
is an amount that is still owed, then any differences will have to be added to
net earnings.
Investing
Changes in equipment, assets or investments relate to cash from investing.
Usually cash changes from investing are a "cash out" item, because cash is
used to buy new equipment, buildings or short-term assets such as
marketable securities. However, when a company divests of an asset, the
transaction is considered "cash in" for calculating cash from investing.
Financing
Changes in debt, loans or dividends are accounted for in cash from financing.
Changes in cash from financing are "cash in" when capital is raised, and
they're "cash out" when dividends are paid. Thus, if a company issues a bond
to the public, the company receives cash financing; however, when interest is
paid to bondholders, the company is reducing its cash.
Analyzing an Example of a CFS
Let's take a look at this CFS sample:

From this CFS, we can see that the cash flow for FY 2003 was $1,522,000.
The bulk of the positive cash flow stems from cash earned from operations,
which is a good sign for investors. It means that core operations are
generating business and that there is enough money to buy new inventory.
The purchasing of new equipment shows that the company has cash to invest
in inventory for growth. Finally, the amount of cash available to the company
should ease investors' minds regarding the notes payable, as cash is plentiful
to cover that future loan expense.
Of course, not all cash flow statements look this healthy, or exhibit a positive
cash flow. But a negative cash flow should not automatically raise a red flag
without some further analysis. Sometimes, a negative cash flow is a result of a
company's decision to expand its business at a certain point in time, which
would be a good thing for the future. This is why analyzing changes in cash
flow from one period to the next gives the investor a better idea of how the
company is performing, and whether or not a company may be on the brink of
bankruptcy or success. (For information on cash flow accounting, see Cash
Flow On Steroids: Why Companies Cheat.)
Tying the CFS with the Balance Sheet and Income Statement
As we have already discussed, the cash flow statement is derived from the
income statement and the balance sheet. Net earnings from the income
statement is the figure from which the information on the CFS is deduced. As
for the balance sheet, the net cash flow in the CFS from one year to the next
should equal the increase or decrease of cash between the two consecutive
balance sheets that apply to the period that the cash flow statement covers.
(For example, if you are calculating a cash flow for the year 2000, the balance
sheets from the years 1999 and 2000 should be used.)
Conclusion
A company can use a cash flow statement to predict future cash flow, which
helps with matters in budgeting. For investors, the cash flow reflects a
company's financial health: basically, the more cash available for business
operations, the better. However, this is not a hard and fast rule. Sometimes a
negative cash flow results from a company's growth strategy in the form of
expanding its operations.

By adjusting earnings, revenues, assets and liabilities, the investor can get a
very clear picture of what some people consider the most important aspect of
a company: how much cash it generates and, particularly, how much of that
cash stems from core operations.

Difference Advantage Disadvantage and Uses of


Cash Flow Statement & Funds Flow Statement
There are 3 basic financial statements that exist in the area of Financial Management.
1. Balance Sheet.
2. Income Statement.
3. Cash Flow Statement.
4. Fund Flow Statement
The first two statements measure one aspect of performance of the business over a period of
time. Cash flow statements signify the changes in the cash and cash equivalents of the business due
to the business operations in one time period. Funds flow statements report changes in a business's
working capital from its operations in a single time period, but have largely been superseded by cash
flow statements.
A Cash Flow Statement is a statement showing changes in cash position of the firm from one period
to another. It explains the inflows (receipts) and outflows (disbursements) of cash over a period of
time. The inflows of cash may occur from sale of goods, sale of assets, receipts from debtors,
interest, dividend, rent, issue of new shares and debentures, raising of loans, short-term borrowing,
etc. The cash outflows may occur on account of purchase of goods, purchase of assets, payment of
loans loss on operations, payment of tax and dividend, etc.
A cash flow statement is different from a cash budget. A cash flow statement shows the cash inflows
and outflows which have already taken place during a past time period. On the other hand a cash
budget shows cash inflows and outflows which are expected to take place during a future time period.
In other words, a cash budget is a projected cash flow statement.
Funds Flow Statement states the changes in the working capital of the business in relation to the
operations in one time period.
The main components of Working Capital are:
Current Assets

1. Cash
2. Receivables
3. Inventory
Current Liabilities

1. Payables
Net working capital is the total change in the business's working capital, calculated as total
change in current assets minus total change in current liabilities.

FOR EXAMPLE: If the inventory of the business increased from Rs 1,40,000 to Rs 1,60,000, then this
increase of Rs 20,000 is the increase in the working capital for the corresponding period and will be
mentioned on the funds flow statement. But the same would not be reflected in the cash flow
statement as it does not involve cash.
So the Fund Flow Statement uses all the above four components and shows the change in them.
While a cash flow statement only shows the change in cash position of the business.

Cash flow statements have largely superseded funds flow statements as measurements of a
business's liquidity because cash and cash equivalents are more liquid than all other current assets
included in working capital's calculation.

What is Included in a Cash Flow Statement?


The statement of cash flows uses information from the other two statements (Income Statement and
Balance Sheet) to indicate cash inflows and outflows.

A Cash Flow Statement comprises information on following 3 activities:


1. Operating Activities
2. Investing Activities
3. Financing Activities
1. Operating Activities: Operating activities include cash flows from all standard business
operations. Cash receipts from selling goods and services represent the inflows. The revenues
from interest and dividends are also included here. The operational expenditures are considered
as outflows for this section. Although interest expenses fall under this section but the dividends
are not included .Dividends are considered as a part of financing activity in financial accounting
terms.
2. Investing Activities: Investing activities include transactions with assets, marketable securities
and credit instruments. The sale of property, plant and equipment or marketable securities is a
cash inflow. Purchasing property, plant and equipment or marketable securities are considered as
cash outflows. Loans made to borrowers for long-term use is another cash outflow. Collections
from these loans, however, are cash inflows.
3. Financing Activities: Financing activities on the statement of cash flows are much more defined
in nature. The receipts come from borrowing money or issuing stock. The outflows occur when a
company repays loans, purchases treasury stock or pays dividends to stockholders. As the case
with other activities on the statement of cash flows depend on activities rather than actual general
ledger accounts.

Table of Difference between Funds Flow Statement and Cash Flow Statement
Basis of
Difference

Funds Flow Statement

Cash Flow Statement

1. Basis
of Funds flow statement is based on Cash flow statement is based on narrow
Analysis
broader concept i.e. working capital. concept i.e. cash, which is only one of the
elements of working capital.
2. Source

Funds flow statement tells about the


various sources from where the
funds generated with various uses to
which they are put.

Cash flow statement stars with the


opening balance of cash and reaches to
the closing balance of cash by proceeding
through sources and uses.

3. Usage

Funds flow statement is more useful Cash flow statement is useful in


in assessing the long-range financial understanding the short-term phenomena
strategy.
affecting the liquidity of the business.

4. Schedule of In funds flow statement changes in In cash flow statement changes in current
Changes in current assets and current liabilities assets and current liabilities are shown in
Working
are shown through the schedule of the cash flow statement itself.
Capital
changes in working capital.
5. End Result

Funds flow statement shows the Cash flow statement shows the causes
causes of changes in net working the changes in cash.
capital.

6. Principal of Funds flow statement is in alignment In cash flow statement data obtained on
Accounting with the accrual basis of accounting. accrual basis are converted into cash
basis.

Advantages of Cash Flow Statement


1. It shows the actual cash position available with the company between the two balance sheet dates
which funds flow and profit and loss account are unable to show. So it is important to make a cash
flow report if one wants to know about the liquidity position of the company.
2. It helps the company in accurately projecting the future liquidity position of the company enabling
it arrange for any shortfall in money by arranging finance in advance and if there is excess than
it can help the company in earning extra return by deploying excess funds.
3. It acts like a filter and is used by many analyst and investors to judge whether company has
prepared the financial statements properly or not because if there is any discrepancy in the cash
position as shown by balance sheet and the cash flow statement, it means that statements are
incorrect.

Disadvantages of Cash Flow Statement


1. Since it shows only cash position, it is not possible to deduce actual profit and loss of the
company by just looking at this statement.
2. In isolation this is of no use and it requires other financial statements like balance sheet, profit and
loss etc, and therefore limiting its use.

Advantages of Fund Flow Statements


A Funds flow statement is prepared to show changes in the assets, liabilities and equity between two
balance sheet dates, it is also called statement of sources and uses of funds. The advantages of such
a financial statement are many fold.

Some of these are:


1. Funds flow statement reveals the net result of Business operations done by the company during
the year.
2. In addition to the balance sheet, it serves as an additional reference for many interested parties
like analysts, creditors, suppliers, government to look into financial position of the company.
3. The Fund Flow Statement shows how the funds were raised from various sources and also how
those funds were deployed by a company, therefore it is a great tool for management when it
wants to know about where and from what sources funds were raised and also how those funds
got utilized into the business.
4. It reveals the causes for the changes in liabilities and assets between the two balance sheet dates
therefore providing a detailed analysis of the balance sheet of the company.
5. Funds flow statement helps the management in deciding its future course of plans and also it acts
as a control tool for the management.
6. Funds flow statement should not be looked alone rather it should be used along with balance
sheet in order judge the financial position of the company in a better way.

Disadvantages of Fund Flow Statements


Funds flow statement has many advantages; however it has some disadvantages or limitations also.

Lets look at some of the limitations of funds flow statement.


1. Funds Flow statement has to be used along with balance sheet and profit and loss account for
inference of financial strengths and weakness of a company it cannot be used alone.
2. Fund Flow Statement does not reveal the cash position of the company, and that is why company
has to prepare cash flow statement in addition to funds flow statement.
3. Funds flow statement only rearranges the data which is there in the books of account and
therefore it lacks originality. In simple words it presents the data in the financial statements in
systematic way and therefore many companies tend to avoid preparing funds flow statements.
4. Funds flow statement is basically historic in nature, that is it indicates what happened in the past
and it does not communicate anything about the future, only estimates can be made based on the
past data and therefore it cannot be used the management for taking decision related to future.

importance Of Cash Flow Statement


The cash flow statement provides information regarding inflows and outflows of cash of a firm for
a period of one year. Therefore cash flow statement is important on the following grounds.
1.Cash flow statement helps to identify the sources from where cash inflows have arisen within a
particular period and also shows the various activities where in the cash was utilized.
2. Cash flow statement is significant to management for proper cash planning and maintaining a
proper matching between

cash

inflows

and

outflows.

3. Cash flow statement shows efficiency of a firm in generating cash inflows from
its regularoperations.

4.Cash flow statement reports the amount of cash used during the period in various long-term
investing activities, such as purchase of fixed assets.

5. Cash flow statement reports the amount of cash received during the period through various
financing activities, such as issue of shares, debentures and raising long-term loan.

6. Cash flow statement helps for appraisal of various capital investment programmes to
determine their profitability and viability.

Zero-based budgeting is an approach to planning and decision-making that reverses the


working process of traditional budgeting. In traditional incremental budgeting (Historic
Budgeting), departmental managers justify only variances versus past years, based on the
assumption that the "baseline" is automatically approved. By contrast, in zero-based budgeting,
every line item of the budget must be approved, rather than only changes. [1] Zero-based
budgeting requires the budget request be re-evaluated thoroughly, starting from the zero-base.
This process is independent of whether the total budget or specific line items are increasing or
decreasing.
The term is sometimes used in personal finance to describe "zero-sum budgeting", the practice
of budgeting every unit of income received, and then adjusting some part of the budget
downward for every other part that needs to be adjusted upward.
Zero based budgeting also refers to the identification of a task or tasks and then funding
resources to complete the task independent of current resourcing.

Advantages
1. Efficient allocation of resources, as it is based on needs and benefits rather than history.
2. Drives managers to find cost effective ways to improve operations.
3. Detects inflated budgets.
4. Increases staff motivation by providing greater initiative and responsibility in decisionmaking.
5. Increases communication and coordination within the organization.
6. Identifies and eliminates wasteful and obsolete operations.
7. Identifies opportunities for outsourcing.
8. Forces cost centers to identify their mission and their relationship to overall goals.
Zero based Helps in identifying areas of wasteful expenditure, and if desired, can also be used
for suggesting alternative courses of action.

Disadvantages
1. More time-consuming than incremental budgeting.
2. Justifying every line item can be problematic for departments with intangible outputs.
3. Requires specific training, due to increased complexity vs. incremental budgeting.
4. In a large organization, the amount of information backing up the budgeting process may
be overwhelming.

Zero-Base Budgeting
Overview of Zero-Base Budgeting
A zero-base budget requires managers to justify all of their budgeted expenditures, rather than
the more common approach of only requiring justification for incremental changes to the budget or
the actual results from the preceding year. Thus, a manager is theoretically assumed to have an
expenditure base line of zero (hence the name of the budgeting method).
In reality, a manager is assumed to have a minimum amount of funding for basic departmental
operations, above which additional funding must be justified. The intent of the process is to

continually refocus funding on key business objectives, and terminate or scale back any activities
no longer related to those objectives.
The basic process flow under zero-base budgeting is:
1.

Identify business objectives

2.

Create and evaluate alternative methods for accomplishing each objective

3.

Evaluate alternative funding levels, depending on planned performance levels

4.

Set priorities

The concept of paring back expenses in layers can also be used in reverse, where you delineate
the specific costs and capital investment that will be incurred if you add an additional service or
function. Thus, management can make discrete determinations of the exact combination of
incremental cost and service for their business. This process will typically result in at least a
minimum service level, which establishes a cost baseline below which it is impossible for a
business to go, along with various gradations of service above the minimum.

Advantages of Zero-Base Budgeting


There are a number of advantages to zero-base budgeting, which include:

Alternatives analysis. Zero-base budgeting requires that managers identify alternative


ways to perform each activity (such as keeping it in-house or outsourcing it), as well as the effects
of different levels of spending. By forcing the development of these alternatives, the process
makes managers consider other ways to run the business.

Budget inflation. Since managers must tie expenditures to activities, it becomes less likely
that they can artificially inflate their budgets the change is too easy to spot.

Communication. The zero-base budget should spark a significant debate among the
management team about the corporate mission and how it is to be achieved.

Eliminate non-key activities. A zero-base budget review forces managers to decide which
activities are most critical to the company. By doing so, they can target non-key activities for
elimination or outsourcing.

Mission focus. Since the zero-base budgeting concept requires managers to link
expenditures to activities, they are forced to define the various missions of their departments
which might otherwise be poorly defined.

Redundancy identification. The review may reveal that the same activities are being
conducted by multiple departments, leading to the elimination of the activity outside of the area
where management wants it to be centered.

Required review. Using zero-base budgeting on a regular basis makes it more likely that all
aspects of a company will be examined periodically.

Resource allocation. If the process is conducted with the overall corporate mission and
objectives in mind, an organization should end up with strong targeting of funds in those areas
where they are most needed.
In short, many of the advantages of zero-base budgeting focus on a strong, introspective look at
the mission of a business and exactly how the business is allocating its resources in order to
achieve that mission.
Disadvantages of Zero-Base Budgeting
The main downside of zero-base budgeting is the exceptionally high level of effort required to
investigate and document department activities; this is a difficult task even once a year, which
causes some entities to only use the procedure once every few years, or when there are significant
changes within the organization. Another alternative is to require the use of zero-base budgeting
on a rolling basis through different parts of a company over several years, so that management
can deal with fewer such reviews per year. Other drawbacks are:

Bureaucracy. Creating a zero-base budget from the ground up on a continuing basis calls
for an enormous amount of analysis, meetings, and reports, all of which requires additional staff to
manage the process.

Gamesmanship. Some managers may attempt to skew their budget reports to concentrate
expenditures under the most vital activities, thereby ensuring that their budgets will not be
reduced.

Intangible justifications. It can be difficult to determine or justify expenditure levels for


areas of a business that do not produce concrete, tangible results. For example, what is the
correct amount of marketing expense, and how much should be invested in research and
development activities?

Managerial time. The operational review mandated by zero-base budgeting requires a


significant amount of management time.

Training. Managers require significant training in the zero-base budgeting process, which
further increases the time required each year.

Update speed. The extra effort required to create a zero-base budget makes it even less
likely that the management team will revise the budget on a continuous basis to make it more
relevant to the competitive situation