23/04/2018
Turnaround is possible for all Business Entity - fifth part continued from posts dated 19.04.2018, 20.04.2018, 21.04.2018 & 23.04.18
We determine earnings periodically. That does not mean that the earnings have occurred on that date on which we calculate the earnings; rather earnings have occurred during the whole period of time i.e. on all days of the period of time, but we become aware of it at the end of the specified time. For better financial management, the expected earnings are broken down into smaller period of time and actual earning is determined for those smaller periods of time to know whether the business has given the desired result. This analysis is required to be done concurrently.
A simple example is stated for better understanding of this concept.
In the operation of one unit of business process, the outflow of cash takes place in the form of expenses and cost. The linking of outflow of cash with the inflow resulting from operation of business process for each unit of operation is an effort to establish one-to-one relationship between the inflow and outflow of cash with resultant establishment of relationship in the form of Return of Investment in Working Capital. Depreciation, interest and tax are deducted to arrive at Return on Equity.
All the above hold good for the simplest form of Business Organisation where discrete business operations are carried out at unit level. An illustration of the same is as below:
A man needs Rs 3000 per month for his livelihood and thus his daily requirement of money is Rs 100. He has come to know that he can earn Rs 100 per day by selling vegetables. For that purpose, he needs an amount of Rs 1000, out of which Rs 500 is required for purchase of vegetables from wholesaler and he will require weighing scale, baskets etc., the cost of which is Rs 500. He starts business after buying the necessities such as weighing scale, baskets etc. by spending Rs 500 and the other Rs 500 is spent for buying vegetables from nearby wholesale market.
The man daily buys vegetables from wholesale market by spending Rs 500 and sells the vegetables for Rs 600 – thereby he earns Rs 100 per day.
The outflow for one business cycle is Rs 500 and the inflow is Rs 600 with the business cycle time of one day.
An extension of the same is the business organisations having batch level business operations. Expending the illustration further, we see the following.
The man finds that he can buy vegetables at lesser rate is he buys it from the producers. But then he will have to buy vegetables in such a greater quantity that he will not be able to sell it within the same day. He will have to find a place to store the unsold quantity of vegetables. He will not need any extra amount to buy the extra quantity of vegetables as the producers have agreed to sell the vegetables on credit. This will result larger earning for him and he starts doing the business in this way.
Now he links his inflow of money received by selling vegetables with the outflow occurred for purchase of the same quantity of vegetables by assigning a serial number for the vegetables purchased on a day. He keeps proceeds of every lot in separate boxes. When all the vegetables of a particular lot is totally sold, he pays the price of that lot to the producer and by this way, he links every outflow of money with the resultant inflow. His business flourishes; he starts selling vegetables on credit to his customers who pays him once in a week. He maintains separate boxes for each customer. Whenever a customer buys vegetables on credit, he puts ① a card in the box of that lot in the name of the customer along with the value of the vegetables written on it and ② another card in the box maintained for that customer mentioning the value of the vegetables written on it. When time comes for making payment to the producer, he replenishes the money against the cards in the box from the capital and pays the money to the producers. At one stage it appears that the business cycles are not discrete. But his box system and maintenance of serial number for every lot of vegetables purchased and sold along with maintenance of cards for credit sale results linking amounts of inflow with the amount of outflow. At the end of a period of time, say a year, he calculates his earnings from business in the following way.
1. He first calculates the number of lots of vegetables sold in the year and this gives the number of operating cycles completed in the year with duration of each business cycle. Here he also gets the total number of business cycle completed in the year and the time taken for each business cycle
2. He puts down inflow of cash against all the lots of vegetables sold and operating cycles completed in the year individually mentioning their lot number and by adding all the inflow, he gets the amount of turnover achieved during the year.
3. Similarly he puts down outflow of cash against all the lots of vegetables purchased and operating cycles completed in the year individually mentioning their lot number and by adding the entire outflow, he gets the amount of Cost of Sales incurred during the year.
4. Finally, he puts down earnings (amount left in the box of each lot of vegetables sold) against all the individual lots of vegetables sold and cycles completed in the year mentioning their lot number and by adding all the individual earnings, he gets the amount of earnings during the year.
5. The men, at the end of the year, have information about
(a) The duration of each business cycle;
(b) Number of business cycle completed during the year;
(c) Inflow of cash against each individual lot of vegetables sold and business cycle completed during the year;
(d) Outflow of cash for each individual lots of purchases of vegetables against the business cycles completed during the year;
(e) Earning from each lot of vegetables and business cycles completed.
The man knows that he can increase his profitability, if
a. He can reduce operating cycle time without affecting the outflow and inflow;
b. Outflow is minimized without affecting resultant inflow and operating cycle time
c. Inflow is maximized without affecting the outflow and operating cycle time
