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This is done under an activity based costing abc

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Unformatted text preview: est Expense] + [Current year R/D expense – Current Year Amortisation expense for R/D] + [Closing Balance of ADD – Opening Balance of ADD] Weighted Average Cost of Capital + (Equity + Net Capitalised R/D + Closing Balance of ADD)/Total CE * Cost of Equity + LTD/Total CE * After ­Tax Cost of LTD + STD/Total CE * After ­Tax Cost of STD Capital Employed Equity + LTD + STD + Net Capitalised R/D + Closing Balance of ADD Interpreting EVA™ A positive EVA means that the entity is generating shareholder value. In contrast, a negative EVA means that the entity is losing shareholder value. Benefits of EVA™ EVA™ is said to be good in that: • • • • It better reflects economic reality by adjusting for events that have not taken place and conservatism. It reflects the risk and opportunity cost of equity. It can reduce agency costs if linked to managerial compensation. Is versatile Limitations of EVA™ EVA™ is limited in that: • • • • • It is very complex. There are many adjustments to do. Comparison between firms is almost impossible due to the adjustments. It is a summarised measure. As such, can we really do things based on it? Is it really superior to the other, much easier to calculate, accounting measures? It is a short ­term performance measure. Rappaport’s Shareholder Value Analysis Rappaport’s Shareholder Value Analysis (SVA) is a model where shareholder value is equal to corporate value minus all debt. Corporate value is defined as the present value of all cash flows from operations in the forecast period plus the residual value of the business (Note: You do not need to know how to calculate cash flows from operations). Value is created when each successive SVA is greater than the previous. Management Accounting 2 – Semester 2 2010 18 Managing Shareholder Value Rappaport’s 7 Shareholder Value Drivers Rappaport’s seven shareholder value drivers are used to help analyse how a specific strategy will help increase shareholder value. These value drivers are: 1) 2) 3) 4) 5) 6) 7) Value Growth Duration Sales Growth Operating Profit Margin Income Tax Rate Working Capital Fixed Capital Cost of Capital Management Accounting 2 – Semester 2 2010 19 Managing Customer Relationships Managing Customer Relationships Background Good customers are important to an entity. We use Customer Relationship Management (CRM) to manage an entity’s customers. Not all customers are equal and just increasing customer satisfaction will not necessarily increase the profitability of a customer. A Profitable Customer A profitable customer is one that buys profitable products/services and does not cost much to serve. To find out our most profitable customer, we conduct a Customer Profitability Analysis (CPA) which compares the costs to serve and all revenues from that customer. This is done under an Activity Based Costing (ABC) system. Product and Customer Costs Costs should be allocated back to either product or customer depending on the nature of the cost. These should then be allocated to resource drivers and then allocating to activity drivers. The table below lists the activity drivers for both product and customer costs. Product Cost Facility Level Market Level Batch Level Unit Level Customer Cost Facility Level Market Level Customer Level Order Level Customer Profitability Analysis In a CPA, we simply calculate the gross margin (i.e. Revenues minus Expenses) for that particular customer and also customer driven costs. These customer driven costs (also known as Selling, General and Administration Costs) can be allocated in a few ways including: • • Volume ­Based Approach ABC Approach In a Volume ­Based Approach, SG&A costs are allocated simply based on the volume of revenue that each customer generates. If one customer generated 70% of the year’s revenue, then 70% of SG&A costs would be allocated to that customer. In an ABC Approach, SG&A costs are allocated based on activity drivers. Allocation of costs is the same as how ABC was taught back in Management Accounting 1. Managing Customers Customers can be split into four distinct groups: • • Passive: High gross margin, Low cost to serve. Savvy: High gross margin, High cost to serve. Management Accounting 2 – Semester 2 2010 20 Managing Customer Relationships • • Cheap: Low gross...
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