Financial Concepts for Loans and Real Estates

Consumer’s Price Index (CPI):

We compare over a period of time, the money outlays to purchase a basket of consumption of goods and services. This basket compromises pattern of a typical family from specific group. Taste varies across families even geographically. Therefore, CPI is constructed for different population group. Most of the CPI uses the uses the Laspeyre’s formula. The prices are retail prices actually paid by consumer.

CPI = cost of purchasing the base year basket in current/cost of purchasing the base year basket in base year x 100

CPI – consumer price index:

The consumption basket date comes from family budget survey, which carried from time to time, price data are taken from retail outlets. The base year is changed every few years, to take changes in taste appearance of few items. Such updating is required so that the usefulness is not lost.

Wholesale Price Index (WPI):

The items included in WPI are different from those included in CPI. They are fertilizers, minerals, industrial raw materials and semi-finished goods, machinery even light and power group. It is an index of prices paid by producers for their inputs. WPI is published monthly by the offices of economy adviser to Government of India.

National Income Deflators:

It is a price index, which covers all final goods and services. It is the ratio of current price GDP (Gross Domestic Product) to constant price GDP. The goods basket entering the calculation of GDP deflator is the basket produced in the current year. Deflator can also be calculated for NDP (National Domestic Product), GNP (Gross National Product), GDP etc.

Conclusion:

For inflation statistics, government refers to WPI, for cost of living adjustments in allowance, wage bargaining etc. It is the CPI that is relevant.

Use of Index Numbers:

Index number is used for many purposes and has economic significance.

Measuring the change in value of money:

Stable price is essential for a stable economy. Many policies are framed for price stability in economy. But, before framing such policies there is a need o measure the change in value of Money. This can be done with the help of index number.

Change in wages:

Changes in living of the people are known CPL – reflects the change in money outlay required to maintain a given standard of living.

Useful of planner:

There are different types of index numbers that the planning authorities can get the information from various sectors and get important data about economic changes.

Overall we learn about macro economics and the management decision making. There are some basic macro economics concepts also which has been dealt in another chapter. This subject is fully dedicated to national income and use of index number.

A Dead Wight Loss is a permanent loss of well being of the society. It occurs when equilibrium for a commodity is not Pareto Optimal. Pareto Efficiency is a broad concept with a broad application in economics. A change that can make at least one individual better off without making any other individual worst off is Pareto Efficiency. A situation is Pareto Optimum when no further improvement is needed. Many natural wastes in a system for e.g., leakage in water pipe are equal to Dead Weight Loss. Monopoly leads to lack of economic competition; it also creates Dead Weight Loss. In loss of benefits due to indirect tax there is some amount of Dead Weight Loss or excess burden which the society has to bear. In case of relatively elastic commodities the Dead weight Loss is more than the revenue earned by the government though the indirect tax. This is the reason why inelastic commodities are taxed more than elastic commodities.

Producer’s Surplus

Producer’s Surplus exists when actual price exceeds the minimum price that the seller is ready to accept. Let us take an example. If Sam considers as CD worth Rs. 50 and Ram, who owns it values the CD for Rs. 10 then, if Ram sells the CD for Rs. 30, Sam, who willing to pay Rs. 50 maximum for the CD actually got it for Rs. 30. Sam is now enjoying a consumer surplus of Rs. 20 and Ram who was ready to accept the minimum price of Rs 10 for the CD, sold it for Rs. 30 and enjoys the producer’s surplus of Rs. 20.

Producer’s surplus may appear to be a profit, but it takes different forms. To understand how Produer’s surplus takes different forms. Let us see one example.

Suppose the price of wheat is Rs. 35 per kg for many years, but now it has increased to Rs. 45 per kg. This increase in price of wheat draws more land under wheat cultivation. Now, farmers, who are cultivating and selling wheat, are enjoying Producer’s surplus of Rs. 10 which they are having due to increase in the price.

About the competition of market a good example came in light in 1984. It was Upjoh’s patent on ibuprofen-a painkiller that the company still markets under the brand name Motrin-expired. It got the good popularity soon. The most people who use ibuprofen, like most people who use aspirin, now purchase a generic version made by one of many producers.

The shift to perfect competition, not coincidentally, is accompanied by a sharp fall in the market price. When its patent expired, Upjohn immediately cut the price of Motrin by 35 percent, but as more companies started selling the generic drug, the price of ibuprofen eventually fell by another two-thirds.

Ten years later the patent on the painkiller naproxen-sold under the brand name Naprosyn-expired. The generic version of naproxen was soon selling at only one-tenth of the original of naprosyn.

It was Paul Krugman and Robin Wells who wrote about this competition in Perfect Competition of Micro Economics.

On the other hand, there is monopoly. It happens when one seller constitutes the whole industry, market comes under the monopoly. Monopoly exists when there is a single seller or producer.

There are some features and example of Monopoly –

Single seller or producer:

Mono is known as one. Poly is used for one seller.

No close substitutes

Barrier for entry of firm

Demand curve monopoly shows, a monopoly seller are the sole producer in the industry; it has total control over the price and production. So, the demand curve will be downwards slopping. It can increase the price if it is ready to sacrifice the demand a title and can decrease the price if it wants the sales to increase.

Competition ends under monopoly. It is the highest position of competition where all firms convert into single firm. Under the monopoly of market buyers are depended on sellers. There is no meaning of demand under monopoly.

We can say that production is an activity which transforms the input into output. For example, there is need of labour and machinery to manufacture car. It is the technical aspect between input and output. The function of production express the relationship between quantity of output produced and quantity of input required. Production function can be expressed as:

Q = f (L,K)
L = Labour
K = Capital
Q = Output

Production function has four ways:

Law of variable proportion:

We can understand it as:

Total Product (TP), which is produced by a firm; Average Product (AP), it is the divided quantity of variable factors which is used to produce.

AP = TP/Q

AP = Average Product
TP = Total Product
Q = Number of Variable Factors

Marginal Product (MP) – Law of variable proportion is also known as law of diminishing returns. When variable factors are increased in equal doses, keeping the fixed factor constant, the total product will increase.

Law of Variable Proportion is an old economic principle, which was the firs redefined version of Marshall. Most of the examples of production function involve manufacturing sectors and agriculture.

Law of Return to scale:

It is known as long run production function also. The Law of Returns to Scale will show the change in the output when all the factors of production are increased together. It describes the relationship between output and scale of input.

Law of Economies of Scale:

It exists when larger output is associated with low per unit cost. It has been divided into two economies – Internal Economies and External Economies.

At last, economies of scale exist when large output is associated with low per unit cost. Economies of scale have two parts, internal and external economies of scale. Dis-economies of scale arise to a firm beyond optimum level, as the firm may face problem like lack of co-ordination, management, marketing etc. Economies of scope are decline in the average cost due to change in the product mix of output. A production process becomes chapter when there are more than one products produced instead of one as there is more efficiency in distribution of making.

If you are struggling with your debts, then you may benefit from financial support.

Many organisations offer free financial support to people finding their finances difficult to manage. One example of this support is help with budgeting.

Budgeting is all about understanding and managing your finances – in other words, keeping control of your monthly income (the money you earn/receive) and expenditure (the money you spend/pay out).

Your total income should include everything you earn/receive: your salary, benefits, grants, etc. Your total expenditure should include your ‘priority’ debt repayments – for example, your mortgage/rent payments – and your day-to-day living expenses. You should not include payments to your ‘non-priority’ debts (credit cards, store cards, etc.) at this point.

Once you have noted down your total income and total expenditure, you should be able to work out your disposable income. This is done by simply subtracting your total expenditure from your total income. Your disposable income is the amount of money available for non-priority debt payments and, if there is any left over, for saving and non-essential spending.

Now that you have your disposable income, you should make a list of all your non-priority debt repayments (unsecured loans, credit cards, etc.) and ask yourself: Is it enough to cover all the repayments?

If it isn’t, then you really should consider seeking further financial support to help you address the problem. You may be advised to look into a professional debt solution.

Even if you do find that your disposable income is enough to cover the cost of servicing your debts, you may save yourself a lot of money in interest if you ‘overpay’ your monthly payments – in other words, make more than the required minimum monthly payment.

If you can do this, you’ll clear your debts faster – and that means you’ll pay less interest in the long run.

“Managerial Economics” term is very old. The word has taken place in last fifty years or so. Economics is the study of human behaviour in production, distribution and consumption of material goods. Management is the disciplinary work of organizing and allocating a firm’s resources and objectives. So, these two definitions give the appropriate understanding of managerial economics.

Managerial economics is interchangeable with Business Economics. In spite of, there are some differences between these two terms.

Business Economics is known to understand for running any business.

Managerial Economics emphasizes on the function of managerial function of a business firm.

We can take some definition of Managerial Economics to clear its essence. Dean writes in his book Managerial Economics Text book, “Managerial Economics is the use of economic analysis in the formulation of business policies.” So, he emphasizes it as business policies.

On the other hand, Spencer and Seigelman, define it, “the integration of economic theory with business practice to facilitate decision making and forward planning.” So, the definition reveals it as business practices, decision making and forward planning.

Scope of Managerial Economics:

We will conclude it as a manager decision. So, for a manager there is different areas in which decision are required to be taken. These can be classified as:

Decision relating to demand – We already know, every manager is concerned with the demand for his product. So, a manager takes decision regarding the quality and quantity of his product. There are many economic tools which are applied during the decision making – Demand, Elasticity of Demand and Demand Forecasting.

Decision related to cost and production – Every manager has to analyze the cost and various laws governing production that is also a part of managerial economics.

Decision relating to price and market – We can’t escape with market analysis. So, Market analysis is the part of managerial economics. A manager should have various market structures and various pricing policies.

Decision relating to profit management – Maximum profit is the essence of every firm. So, these can be related to profit management.

Macro economic factor – A firm depends on socio-economic environment. So, to understand macro level factors there are needed of macro factors.

Significance of Economic Analysis:

All the economic has been divided into two categories – Macro and Micro. Micro economics are related to consumer products, individual products, whereas Macro is attached with aggregate demand, national income.

The same situation comes in a business man life. There is also needed of priority of business and products. A business man decides market segmentation, product segmentation and takes proper decision.

Definite and indefinite results are the outcome of market. These are inevitable in market society. This can be called as uncertainty.

Financial planning is a process by which funds required for each course of action is decided. It must consider expected business scenario and develop appropriate course of action. A financial plan has to consider capital structure, capital expenditure and cash flow.

Steps in financial planning:

1) Establish corporate objectives: Corporate objectives could be grouped into qualitative and quantitative. For example, a company’s mission statement may specify “create economic value added”. But this qualitative statement has to be stated in quantitative terms such as a 25% ROE or a 12% earnings growth rates. Since business enterprises operate in a dynamic environment, there is a need to formulate both short run and long run objectives.

2) Next stage is formulation of strategies for attaining the objectives set. In this condition connection corporate develops operating plans. Operating plans are framed with a time horizon. It could be a five year plan or a ten year plan.

3) Once the plans are formulated, responsibility for achieving sales target, operating targets, and cost management bench marks, profit targets, etc. is fixed a respective executives.

4) Forecast the various financial variables such as sales, assets required, flow of funds, cost to be incurred and then translate the same into financial statements. Such forecasts help the finance manager to monitor the deviations of actual from the forecasts and take effective remedial measure to ensure that targets set are achieved without any time overrun and cost overrun.

5) Develop a detailed plan for funds required for the plan period under various heads of expenditure.

6) From the funds required plan, develop a forecast of funds that can be obtained from internal as well as external sources during the time horizon for which plans are developed. In this connection legal constrains in obtaining funds on the basis of covenants of borrowing should be given due weight age. There is also a need to collaborate the firm’s business risk with risk implications of a particular source of funds.

7) Develop a control mechanism for allocation of funds and their effective use.

At the time of formulating the plans certain assumptions need to be made about the economic environment. But when plans are implemented economic environment may change. To manage such situations, there is a need to incorporate an inbuilt mechanism which would scales up or scale down operations accordingly.

After a huge discussion on financial chapter we have come to “Standard Costing” chapter to discuss about it. About it management says that it is the standard costing is an important tool to planning and cost control.

Objectives of Standard Costing:

Meaning of Standard Costing

Nature of Variance Analysis

Calculate Variances

According to the ICMA, London Standard Cost is, “the pre-determined cost based on technical estimate for materials, labour and overhead for a selected period of time and for a prescribed set of working conditions.”

You should know that Standard Cost is different from “Estimated Cost” and it express what should be the cost, in advance of actual production.

Along with we should know about Standard Costing also. The definitions of Standard Costing also look from ICMA, London, “the preparation of standard costs and applying them to measure the variations from standard costs and analyzing the causes of variations with a view to maintain maximum efficiency in production.”

Standard Costs involves in:

a. Ascertainment of standard costs for each element costs – material, labour, overhead
b. Use of standard costs as a guide and measure of actual costs
c. Measurement of actual costs
d. Comparison of actual costs with the standard costs
e. Measurement and analysis of deviations of actual costs from standard costs

After having understood about the standard costs we should proceed with Variance Analysis. According to the MBA book of SMU variance is, “the difference between a standard cost and the actual cost incurred during a period.

In the variance analysis mainly two elements involved which are:

Measurement of individual variances and
Identification of causes of each variance

We can illustrate here some formula about variance:

Material usage variance = (Standard Quantity – Actual Quantity) x Standard Price

[MUV = (SQ –AQ) x SP]

Computing mix variance:

Material mix variance = [standard cost of standard mix] – [standard cost of actual mix]

Or

[Standard mix – actual mix] x standard rate per unit

Or

[Revised standard mix of actual input – actual mix] x Standard price.

I think now all the things are clear about the standard costs and variance from the financial book. I have already explained the entire chapter before much clearly with some example. I think to publish here about some new chapter of finance and loans also.

Before proceeding to the budgetary control we should explain 1st budget. According to ICMA London Budget has been defining as, “A financial and/ or quantitative statement prepared and approved prior to a defined time of the policy to be pursed during that period for the purpose of attaining a given objective.”

Budgets mainly work for:

Preparing statement in terms of money or equivalent of money

It is for prior to a future period of time

The objectives to be attained and the policies to be adopted are laid down in advance.

Like it about the budgetary control ICMA London writes, “The establishment of budgets relating to responsibilities of executives to the requirement of a policy and continuous comparison of actual with budgeted results either to secure by individual action the objectives of that policy or to provide a basis for its revision.”

Now, we will define alls along with one – budget, budgeting and budgetary control:

About it we will look some references from MBA books of SMU, “Budget is the target or the objective of each section of an organization. Budgeting is the process of preparing the budgets. Budgetary control is the technique and process of fixing the targets, preparing the budgets and using them as an effective tool of planning and control.”

Most simply now we can define the objectives of budgetary control as:

Planning the policies

Coordinating activities

Controlling costs

Increases efficiency

Like this there involves some steps also in budgetary control are:

Preparation of organization chart

Establishment of budget centers

Appointment of budget committee

Preparation of Budget Manual

Determination of Budget Period

Determination of Key Factor or Budget Factor

After the huge discussion about budgetary control we can know about its some limitation also which are:

Its limitations show that it is changeable.

Budgets may kill managerial initiative.

About it people says that it is costly and time consuming. However, it is decisive chapter about accounting. For more details read continuously the financial blog, I will write the chapter with more examples.