KEY FINANCIAL
FORMULAS IN
CIPS LEVEL 4
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Introduction
Welcome to this presentation on Key Financial
Formulas in CIPS Level 4.
Understanding these essential financial concepts is
crucial for making informed decisions in
procurement and supply processes. Throughout this
presentation, we will explore various financial tools
and techniques that can help you analyse costs,
set pricing strategies, and assess profitability.
By mastering these concepts, you will be better
equipped to navigate the financial aspects of
procurement and supply chain management.
Costing Methods
Understanding Absorption Costing
Absorption costing includes all
manufacturing costs in product
costs. Absorption costing, also known as full costing,
It combines fixed and variable costs includes all manufacturing costs, both fixed and
for a comprehensive view. variable, when calculating product costs. This
method provides a complete understanding of
Example: A company producing the total production costs. For instance, if a
1,000 units incurs $10,000 in fixed company incurs $10,000 in fixed costs while
costs. producing 1,000 units, each unit would absorb
part of that fixed cost, affecting pricing and
profit analysis.
Activity-Based Costing Explained
Activity-Based Costing (ABC) is an accounting method
that allocates costs to products based on the activities
they require. This method offers a more accurate view of
product costs, leading to informed decision-making.
For example, if a product requires extensive machine
setups, the costs associated with those setups would be
allocated specifically to that product, providing better
insights into profitability.
Break Even
Analysis
Break Even Analysis
Break Even Analysis is a financial tool used to
determine the point at which total revenue equals
total costs, resulting in neither profit nor loss. This
point is known as the Break Even Point (BEP).
Understanding break-even analysis helps
businesses determine the minimum sales volume
needed to prevent losses and assess their financial
viability.
Importance of Break-Even Analysis
• Decision-Making: It assists businesses in making
informed decisions about pricing, production
levels, and cost management.
• Financial Viability: Analysing the Break Even Point
helps businesses evaluate their financial health and
future profitability
Break Even Analysis
Definition of Break Even Analysis
Break Even Analysis identifies the point where
total revenue equals total costs, indicating no
profit or loss.
Importance of Analysis
Understanding break-even analysis helps
businesses determine the minimum sales
volume needed to prevent losses.
Calculating Break Even Point
Understanding BEP
The Break Even Point (BEP) determines when total revenues equal total
costs, indicating no profit or loss.
BEP Formula
The formula to calculate BEP is: Fixed Costs divided by (Selling Price per
Unit - Variable Cost per Unit). This helps in decision-making.
Financial Viability
Analysing the Break Even Point assists businesses in assessing their financial
viability and future profitability.
Margin and Mark
Up
Margin and Mark Up
Understanding Margin
Margin is the difference between sales and the cost of goods sold,
expressed as a percentage. It is crucial for assessing profitability.
Understanding Mark Up
Mark Up is the amount added to the cost of goods to determine the
selling price, influencing pricing strategies.
Pricing Strategies
Both margin and mark up play a vital role in developing effective
pricing strategies for products and services.
Margin and Mark Up are crucial for pricing strategies.
Margin refers to the difference between sales and
cost of goods sold, expressed as a percentage of
sales. Mark Up, on the other hand, is the amount
added to the cost to determine the selling price.
Calculating Margin
Understanding Margin Calculation
Margin is calculated by subtracting the cost from the selling
price and dividing by the selling price. This formula helps in
assessing profitability.
Importance of Margin Percentage
The margin percentage indicates the profit made for each
dollar of sales, which is critical for business sustainability. Higher
margins generally mean better profitability.
Calculation
Margin can be calculated using the formula: Margin = (Selling
Price - Cost) / Selling Price. This percentage indicates how
much profit is made for every dollar of sales.
Calculating Mark Up
Markup Formula
The Markup formula is used to determine how much above cost price a
product is sold. It helps in pricing strategy.
Selling Price vs Cost
Understanding the difference between selling price and cost is crucial for
effective pricing decisions in business.
Business Insights
Calculating markup offers valuable insights into profitability and helps
businesses strategize their pricing effectively.
Calculation
Mark Up is calculated using the formula: Mark Up = (Selling Price - Cost) /
Cost. This provides insight into how much more than the cost price a product
is sold.
Understanding Margin
Margin is the difference between
selling price and cost of goods sold.
Expressed as a percentage of the
selling price.
Higher margin indicates better
profitability.
Margin Calculation Example
Cost of Goods Sold (COGS): £50
Selling Price: £100
Margin = (Selling Price - COGS) / Selling
Price x 100
To illustrate margin calculation,
consider a product with a cost of
goods sold of £50 and a selling price of
£100. The margin is calculated as:
Margin = (Selling Price - COGS) / Selling
Price x 100, resulting in a margin of 50%.
Understanding
Markup
Markup is the amount added to cost
to determine selling price.
Expressed as a percentage of the
cost price.
Important for setting pricing
strategies.
Markup Calculation Example
Cost of Goods Sold (COGS): £50
Desired Markup: 100%
Selling Price = COGS x (1 +
Markup/100)
For example, if a product has a cost
price of £50 and a desired markup of
100%, the selling price is calculated as:
Selling Price = COGS x (1 +
Markup/100), resulting in a selling price
of £100.
Marginal Costing
Marginal Costing
Understanding Marginal Costing
Marginal costing helps businesses understand the
variable costs linked to producing additional units,
essential for financial analysis.
Decision-Making Support
This practice aids in making informed decisions
regarding pricing strategies and production levels
based on variable costs.
Example:
Let's say a company produces and sells widgets.
The fixed costs (such as rent, salaries, and
equipment) are $10,000 per month. The variable
cost per widget (including raw materials and direct
labour) is $5. The selling price per widget is $15.
Scenario 2: Producing 1,500 Widgets
Scenario 1: Producing 1,000 Widgets
• Total Fixed Costs: $10,000
• Total Fixed Costs: $10,000
• Total Variable Costs: $5 * 1,500 = $7,500
• Total Variable Costs: $5 * 1,000 = $5,000
• Total Costs: $10,000 + $7,500 = $17,500
• Total Costs: $10,000 + $5,000 = $15,000
• Total Revenue: $15 * 1,500 = $22,500
• Total Revenue: $15 * 1,000 = $15,000
• Profit: $22,500 - $17,500 = $5,000
• Profit: $15,000 - $15,000 = $0
By producing and selling 1,500 widgets, the company
In this scenario, the company breaks even by makes a profit of $5,000.
producing and selling 1,000 widgets.
Absorption Costing Example
Absorption costing includes both
fixed and variable manufacturing
costs.
A company producing 1,000 units
incurs $10,000 in fixed costs.
Total cost calculation helps in pricing
strategies.
Activity-Based Costing Example
Activity-based costing assigns costs
based on specific activities.
It improves precision in product
costing and resource allocation.
Machine setup costs can significantly
impact overall costs.
Break Even Analysis Example
Break-even analysis determines
when total revenue equals total
costs.
Fixed costs are $10,000, selling price
is $15, and variable cost is $5.
The break-even point helps in
assessing financial health.
Margin Calculation Example
Margin indicates the profitability
of a product.
Margin is calculated as a
percentage of the selling price.
Understanding margin helps set
effective pricing strategies.
Mark Up Calculation Example
Markup helps determine the selling price
above cost.
A desired markup of 100% on a £50 COGS
gives a selling price of £100.
Calculating markup informs pricing decisions.
Benefits of Marginal Costing
Pricing Decisions
Marginal costing aids in making informed pricing decisions by analysing
variable costs and their impact on profitability.
Cost Control
It provides businesses with essential insights for effective cost control,
helping to identify and manage variable costs efficiently.
Profitability Analysis
Marginal costing is crucial for profitability analysis, enabling businesses to
assess the impact of variable costs on overall profits.
Price Elasticity of Demand
Price elasticity of demand (PED) measures
how the quantity demanded of a good or
service changes in response to a change in
its price.
It is a crucial concept in economics that
helps businesses and policymakers
understand consumer behaviour and
make informed decisions about pricing
strategies
Types of Price Elasticity
1. Elastic Demand: When the absolute value of
PED is greater than 1, indicating that a small
change in price leads to a significant change
in quantity demanded.
2. Inelastic Demand: When the absolute value
of PED is less than 1, indicating that a
change in price has a relatively small effect
on the quantity demanded.
3. Unitary Elastic Demand: When the absolute
value of PED is equal to 1, indicating that the
percentage change in quantity demanded is
equal to the percentage change in price.
PED
Elastic (PED > 1 in absolute value):
Consumers are sensitive to price
changes.
Inelastic (PED < 1 in absolute value):
Consumers are not very sensitive to
price changes.
Unit Elastic (PED = 1 in absolute value):
Changes in price lead to proportional
changes in quantity demanded.