sum, Shatabdi creditors should love the company, but its
shareholders would prefer a far more aggressive financial policy.It is quite likely that all our readers may not fully agree with our evaluation of Shatabdi
Industries. The interpretation of ratios involves a fair amount of judgment and
subjectivity. A ratio can rarely be interpreted in isolation, as its significance has to be
judged in relation to the other ratios for the firm. The impacts of accounting policies of
the firm must also be taken into consider action as explained later in this chapter.
Break-even and Contribution Analysis.
Break-even analysis deals with the relationship of profits with costs, price and the level
of output. As the name indicates, it is centered on the concept of that level of output at
which the firm makes no profit or loss, that is, it just breaks even. The analysis requires
identification of Fixed and Variable costs of production; the Fixed Costs being those
costs that do not vary with the volume of output, while the Variable Costs are those costs
that vary linearly with the volume of output. The typical examples of variable costs are
raw material cost, sales commissions, etc. A moment’s reflection makes it clear that
many costs cannot be fitted into just these two categories, as they are semi-variable in
nature. The costs of maintenance, the costs of stores and spares, the cost power, etc. fall
in this category. For such costs, judgment based on the process of production may have
to be used to decide what proportion of the cost may be regarded as fixed (the balance
being variable).
Since the annual financial statements do not present costs classified into fixed and
variable, we have to examine the details given in the schedules contained in the annual
report to arrive at the proportion of fixed and variable costs. It is obvious that condensed
statements of the kind published in the BSE Directory will be absolutely inadequate for
such an analysis.
In the case of Shatabdi Industries, we looked at the detailed annual report and identified
the variable and fixed expenses. In terms of Table 2, Stock Consumed is fully variable.
After examining the items of cost that comprise Direct Manufacturing Expenses we
concluded that 60 % of this expense can be regarded as variable. All other expenses are
fixed in nature.
Using this information, we can recast the P&L Account of Shatabdi Industries as follows:
Sales 61527
Less: Variable expenses 24008
Contribution 37519
Less Fixed costs 30184
Add Non-operating surplus 277
Profit before tax 7612