Learning Curve Case

L E A R N I N G C U R V E S I M U L AT I O N

C ROS S F U N C T I O N A L D EC I S I O N

M A K I N G & B U S I N ES S I M PAC T

C A S E S T U D Y

e n P a r a d i g m K n o w l e d g e S o l u t i o n s

Learning Curve Case Study

Copyright © 2010-2012 enParadigm Knowledge Solutions

1

Copyright © 2010-2012 enParadigm Knowledge Solutions. All rights reserved.

No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any

form or by any means — electronic, mechanical, photocopying, recording, or otherwise — without

prior written permission from enParadigm Knowledge Solutions.

enParadigm Knowledge Solutions,

CIIE, IIM New Campus, Vastrapur

Ahmedabad – 380015, India

Website: www.enparadigm.com

Ph: +91 89517 66681

Email: [email protected]

http://www.enparadigm.com/

mailto:[email protected]



2

Table of Contents

INTRODUCTION ....................................................................................................................................... 3

Product .................................................................................................................................................... 4

MARKETING............................................................................................................................................. 4

Geographies .................................................................................................................................... 4

Customer Segments ........................................................................................................................ 6

Advertising ...................................................................................................................................... 7

SALES ....................................................................................................................................................... 9

AFTER-SALES ......................................................................................................................................... 10

OPERATIONS ......................................................................................................................................... 11

LOGISTICS .............................................................................................................................................. 11

RESEARCH & DEVELOPMENT ................................................................................................................ 12

HUMAN RESOURCES ............................................................................................................................. 14

Performance Management System .............................................................................................. 14

Workforce Planning ...................................................................................................................... 16

Compensation & Benefits ............................................................................................................. 16

Organizational Effectiveness Initiatives ........................................................................................ 17

FINANCE ................................................................................................................................................ 17

ACCOUNTING ........................................................................................................................................ 19

Balance Sheet ................................................................................................................................ 20

Profit and Loss Statement ............................................................................................................. 23

Cash Flow Statement .................................................................................................................... 24



3

INTRODUCTION

MEMO

From: Mahendra Nath Singhania, Group Chairman, Singhania Group

Subject: Mini Robot Division Spinoff

Hello Top Management Team,

Congratulations! You have been selected to head our company’s mini robot division based

on the exceptional performance you have exhibited in your career so far. This is your

biggest responsibility to date. You will be briefed on the industry, the mini robot division,

and the roles that you will step into. We have decided to spin off the mini robot division into

a standalone company, with its own top management and financial responsibilities. The

Singhania Group is the sole shareholder of this subsidiary company. You will have to take

charge of the company and rebuild it.

While the entire mini robot industry may currently be struggling for profitability, I am

expecting you to deliver good profits in the long run to justify our continued investment in

the mini robot industry. In other words, I will be looking at the return on shareholders’

equity investment (ROE) as the definitive measure of your performance vis-a-vis your

competitors. You will do well to remember that being part of the top management team

also means that the entire responsibility of ensuring company performance is on you.

You will now be debriefed by the heads of the different departments of the mini robot

company.



4

Product

Robots are used to carry out tasks that are repetitive in nature

or performed in areas that are hazardous to human life. The

robot market has seen a revolution through the introduction of

autonomous mini robots which can operate in areas which

were hitherto considered inaccessible to robots. Only a few

companies, including us, have the technology to manufacture

mini robots. Though other companies are trying to acquire this

technology, it is felt that entry barriers are too high for a new

entrant to launch within the next few years.

MARKETING

Mr. Ashish Gupta (Senior Vice President, Marketing - He has been with the company for

20 years, and he travels widely across the world to keep in touch with fast changing

customer requirements)

Our responsibility as a company lies in delivering profits

to our shareholders, the Singhania Group. To fulfil this

objective, our marketing plan must take into account

the business environment and the moves of our

competitors. We have seen that customer buying

behaviour depends heavily on competition, and

customers switch fast if they feel that a competitor is

offering them a better deal. Therefore, to remain

profitable in the long run, our focus has to be on

building sustainable competitive advantage over our competitors.

Geographies

As you all know, our company has its headquarters in India, Asia. Our main export

geography, North America (NA) has already adopted the new product, and a majority of the

mini robots there use our technology. As of date, Asia, our home geography, is yet to have

the same demand prospects as North America. However Asia is a fast growing geography,

unlike North America, which is nearing maturity. We can also decide to enter Latin America



5

(LA), currently a very small geography, but with high growth potential. We feel that Latin

America could be the future engine of growth once North America and Asia slow down. The

marketing, sales and after-sales plans for each geography should be relevant to the

industry situation in that geography.

An industry market research team has provided the following demand forecasts for the

entire mini robot industry across the three geographies in Table 1. This demand will be

catered to by us and our competitors in the mini robot industry.

Table 1: Expected Future Quarterly Demand

North America Asia Latin America

Q1, Year 1 4180 1585 340

Q1, Year 2 7300 5100 2900

The actual growth rates of these geographies will depend on several parameters and might

differ from research projections, based on the attributes of the products and services made

available in each market.

Entering / exiting a geography

The company does not have a presence in any geography as of now, due to the revamp in

operations. We can choose to enter in any combination of the above geographies in the

coming quarters. The main overheads incurred due to presence in geography are the

quarterly operating costs of our sales offices. The sales office maintenance cost has to be

incurred every quarter to operate in a region. These increase by about 10% quarter on

quarter as we delay the entry decision. Therefore, early movers into a region will benefit

from lower fixed costs for each quarter. However, in the upcoming quarters, the demand

from some of the geographies may not be enough to support the overheads that we will

have to incur if we enter them early. Besides, our focus in terms of advertising, sales force,

after-sales force and top management mind share will be split among the different



6

geographies we enter. Once we enter a geography, we are free to exit it in any future

quarter, but we will lose the advantages gained by early entry.

Customer Segments

There are three customer segments in each of our geographies - Original Equipment

Manufacturers, Value Added Resellers and Wholesalers. Though the core technology used

in the mini robots sold across all segments is the same, the services required by each

segment are very different. These services include on-time delivery, advertising and after-

sales service support. Customer segment focus must be a key element in our business

strategy to deliver profitability to our shareholders in the long run.

Original equipment manufacturers (OEM) are the

largest market segment in volume for mini robots. OEMs

are more sensitive to price than the other customer

segments. They generally buy mini robots priced in a

range of INR 4,500 and INR 5,500. They prefer to use

newer versions of mini robots, and rely little on

advertising and sales as they keep themselves highly

informed about the various product offerings in the

market.

Value added resellers (VAR) – They specialize in

providing customized solutions to their customers and

make several modifications to our mini robots. Though

they are the smallest market segment in terms of

quantity requirements, they are willing to pay a premium

if they get the services they require. They buy mini robots

priced between INR 6,000 and INR 8,000. They are always

on the lookout for the newest product versions of mini

robots in the marketplace.

Wholesalers (WHL) – They are players who sell to

dealers. Each wholesaler buys only limited quantities,

but the whole segment put together constitutes a large

share of the market. They are very particular about on-

time delivery of goods. Advertising is also important to

them to as it helps generates awareness about mini

robots within their customers. The recommended price

range to wholesalers is between INR 5,000 and INR



7

7,000. They do not have a direct relationship with the actual users of our mini robots. Hence

they are less informed about various product offerings available in the market, and they

prefer older versions of mini robots that are tried and tested.

Figure 1 indicates the importance of different attributes for the 3 customer segments.

Figure 1: Importance of various attributes to customer segments

As the needs of each segment are very different, it will not be possible to satisfy all the

segments at the same time. If we try and aggressively sell to all segments, our focus in

terms of product offering, spend on advertising, sales and after-sales may be diluted. On

the other hand, if we align the rest of our business functions such as R&D, production &

planning based on a key segment, our costs may be rationalized and profits could increase.

Advertising

Advertising is an important pre-sales

component for us. In the initial quarters,

awareness about our brand may not be very

high, and hence advertising will be required.

Once there is enough brand awareness, we

can then take a call on how to go about

advertising. Advertising is especially



8

important for wholesalers, as it makes it easier for them to sell to their clients.

There are three different mediums for advertising – Research Journals, Trade Journals and

Trade Fairs. The relevance of each medium differs from customer segment to customer

segment. Our marketing research team has compiled the relative importance of each

medium for the different segments in Figure 2.

Figure 2: Advertising Guidelines

Spending more than INR 200,000 in a quarter on any single medium in a geography is not

advisable. The additional sales as a result of advertising vary according to the curve shown

in Figure 3. Beyond a level, the additional sales from every additional INR 10,000 of ad

spend in a quarter decreases.

Figure 3: Impact of Advertising

Advertising Spend

Imp

act

on

Dem

and



9

SALES

Mr. Karthikeyan Narain (Senior Vice President, Sales - He has

been with the company for 15 years and has grown through

the ranks. He commands a lot of respect among our sales

team and is considered an outstanding leader) – Our sales

structure is organized geography-wise and then customer

segment-wise. Since the costs of operating in a geography are

very high, we have to carefully choose the geographies we will

operate in.

The industry market research team has provided the demand

forecasts for the three customer segments across the three

geographies in Table 2. This demand will be catered to by all the players in the mini robot

industry. You will have to arrive at a sales forecast for our company based on our business

strategy, taking into account the expected moves of our competitors. As the industry is

intensely competitive, with all players having very similar product offerings and capabilities

as of date, we can expect an average market share in each segment in each geography to

start with. We recommend that you conduct a bottom-up forecast (for each segment for

each geography), and arrive at the aggregate market share forecast by adding up the

individual forecast numbers, rather than getting fixated on an overall market share target

and force-fitting sales forecast numbers for each individual segment.

Table 2: Expected Segment-wise Industry Demand for the next quarter

OEM VAR WHL

North America 1,500 980 1,700

Asia 1,100 90 395

Latin America 140 120 80

The number of salespeople required per customer segment is also different. We should

ideally have salespeople for each client as the chances of getting orders increase as per the

curve shown in Figure 3 below. However, when the number of salespeople goes beyond a

level, the additional orders per every new salesperson decrease.



10

Figure 3: Impact of Sales

AFTER-SALES

Mr. Gaurav Rastogi (Senior Vice

President, After-Sales - He has been

in charge of this new division since

its inception one year ago. He is from

an engineering background and has

an experience of 10 years) – Our

department provides customer

service personnel who help our

customers solve problems that arise

due to defects in our products. The defect rate indicates the percentage of finished goods

which have technical defects. The decrease in demand due to high defect rate can be

completely offset by employing after-sales people. Our current defect rate is 10%.

Identifying the root cause of defects is difficult. However, we can reduce the defect rate by

running successful Quality Improvement research projects, and thus reduce the number of

after-sales people required.

Sales Spend

Imp

act

on

Dem

and



11

OPERATIONS

Mr. Kapoor (Senior Vice President, Operations - He graduated from a premier engineering

college and has been with the company for 15 years. He has a clear focus on keeping the

production costs low, and was instrumental in shifting the plants to China) – We have a

plant in China for manufacturing mini robots, with a quarterly capacity of 1,000 units. The

mini robots are then shipped to our customers in Asia, North America and Latin America.

The cost of production is INR 4,000 and is almost the same for all segments. We also have a

long term contract with a Chinese vendor, CunningFox, who produces mini robots for us at

INR 4,500. The contract has a technology transfer clause which enables CunningFox to

produce to our technology specifications.

We can add capacity by building new plants with a quarterly capacity of 1,000 units. The

investment required to build a new plant is INR 1,500,000. Plant construction will take one

quarter for completion irrespective of the number of plants we want to construct.

Our plants and supply chain are configured in such a manner that we can only sell one

version of mini-robots in any quarter. We must make an annual production plan, based on

data compiled from different market research reports. This will enable us to plan our

capacity accordingly.

LOGISTICS

Mr. Roshan (General Manager,

Logistics. Logistics has become

important with expansion into North

America and Latin America. He works

under Mr Kapoor and has been in his

team since he joined us) – The goods

produced at our main plant in China,

along with those purchased from

CunningFox are stored at external

warehouses in China. Cunning Fox

pays for the transportation costs to

our warehouses for goods purchased

from it. Customers, once informed of the availability of the goods, collect them from the

warehouses, and pay the loading and transportation costs themselves. Goods are made

available to customers on the basis of the delivery priority given to each customer segment

in each geography. If a customer segment is given the 1st priority, our goods will be allocated



12

to that customer before we look at fulfilling orders from any other customer. Since we plan

our production before receiving customer orders, we may not be able to clear the mini

robots immediately from the warehouses. The warehouses charge an inventory holding cost

of INR 50 per unit quarter for any inventory that does not get sold during the quarter.

If we stock out in a quarter to any customer, we lose the unfulfilled demand to our

competitors. The customers to whom we failed to deliver will perceive us as unreliable and

reduce their orders for the next quarter. On the other hand, if we are able to supply to our

customers the unfulfilled orders of competitors, they will reward us by increasing their

orders to us in the next quarter.

We can avoid stock outs to customers who are more important to us, by assigning a higher

priority to them. However if a customer makes a demand for mini robots late in the quarter

as a result of the competition failing to meet their supply commitments, this demand will

be fulfilled only after the previous orders of other customers are met.

RESEARCH & DEVELOPMENT

Mr. Burman (Chief Scientist, R&D. He

has a PhD in Electronics. He has

improved our technical capabilities

and has built a good team in the 10

years that he has been with us) – Our

R&D focus has to be specific to the

customer segments that we are

targeting. You would know that

different segments have different

level of interest in the type of R&D

that we do. There are three types of

research projects that can be

undertaken by our team.

Version Enhancement projects are aimed at upgrading the functionalities of our mini robots

and to develop the next generation of mini robots. Value Added Resellers and OEMs scan

the market closely for new versions, so that they can then differentiate their offerings to

their customers. Wholesales prefer older versions that are tried and tested. We are right

now at Version 1 of our product. The market research studies conducted by our Corporate

Marketing team indicate that having a version two levels higher than competition could give

us around 20% additional demand in the value added reseller segment, while having a

version two levels lower than competition could give us around 20% additional demand in



13

the wholesaler segment. Each version enhancement will increase the production cost per

unit by INR 100 - 200. Once we successfully complete a project, all our inventory would get

upgraded to the latest version at no additional cost to us. Our Chinese vendor, CunningFox,

also produces mini robots of our latest version for us due to the technology transfer

agreement. Due to the high costs incurred in carrying out Version Enhancement projects,

our corporate marketing guidelines specify that we will not be allowed to roll back our

offering to previous versions once a project is successful. A maximum of one version

enhancement can be carried out in a quarter.

Automation projects improve the efficiency of our plants by replacing human labour with

automated machines, and by reducing wastage. The variable cost of production decreases

as a result and the margin on each unit will increase. A successful automation project shall

result in all our plants getting upgraded and this will be indicated by the Automation Level

of our plants. Our plants in China are currently at Automation Level 1. The variable cost per

unit is INR 4,000, which can decrease by around INR 30 - INR 50 following each successful

automation project. A successful automation project has a smaller variable cost reduction

on higher versions of our mini robots than on lower versions, as higher versions require

more complex machinery to be installed. The automation of our plants can be increased by

a maximum of one level in a quarter.

Quality Improvement projects help in reducing the defect rate of our products. The defect

rate indicates the number of mini robots with technical defects for every 100 mini robots

sold. A high defect rate does not result in wastage as the product can be used after

adequate repair work, but will reduce demand for our product. These repairs are carried out

by our after-sales people and hence we can offset the impact on demand by providing our

customers with the required number of after-sales people. At present our plants have a

defect rate of 10%. A successful quality improvement project will reduce the defect rate by

around 2 percent. Only one quality improvement project can be carried out during a

quarter.

Research Budgets – Research budgets have to be allocated as a part of the decisions for the

quarter. If the cost of a project is within the budget allocated, the project will be successful;

otherwise additional funds will have to be allocated next quarter. If the project requires a

budget less than what was allocated, the additional funds shall be utilized for the next

project. The initial Version Enhancement, Automation and Quality Improvement projects

will require an investment in the range of INR 90,000 - INR 110,000, INR 40,000 - INR 55,000

and INR 8,500 - INR 10,000 respectively. Due to the inherent uncertainty of research

projects, the costs for each project can only be approximated, and can be off target by as

much as 10%. The investments in research projects have to be closer to the upper



14

investment limit to increase the probability of success. The research budgets required for

further projects need to be exponentially increased as we keep improving our products,

and we will need your help to understand how we should go about our R&D investment.

HUMAN RESOURCES

Ms. Kavitha Maheshwari (Senior Vice President, HR - She is a decade old veteran in the

Singhania Group, and has been the main force behind our talent management efforts

across various Singhania Group companies) –

The Human Resources Department is a key player in ensuring both the performance of the

company, and that of each individual manager in the company. We ensure that

responsibilities for carrying out day to day business activities are allocated clearly to the

different managers. We also try to create a positive and healthy work environment, so that

all departments are able to contribute in full towards business decision making. The

challenging business environment in front of us ensures that all of us will be under pressure

to perform. Therefore, conflict resolution and consensus building are key elements in

ensuring that top management make good decisions.

HR conducts a leadership engagement survey at

the beginning of every quarter to get a pulse on

employee morale and fulfilment. Through this

exercise, HR is expected to resolve the various

interpersonal issues that may have cropped up

within the leadership team during their work. It

has been observed that engagement of managers

generally depends on the overall performance of

the company, how much their contribution is

being valued by the rest of the team, and of

course, their compensation and performance

incentives. HR has to ensure that the morale, happiness and satisfaction of the members

of the top management team remain high.

Performance Management System

The Singhania Group is a merit based conglomerate, and there is no limit to what you can

achieve here if you work hard and perform well. We have identified certain key

performance metrics for each department to give you overall guidance on evaluating your

performance. In every quarter, each top manager will have to set the targets for the key

performance metric pertaining to his/her department. At the beginning of the following



15

quarter, you will need to check the actual results against the targets set and determine

whether you are on the right track. The different metrics are given below in Table 3.

Table 3: Performance Metrics for Heads of Departments

Manager Key Performance Metric Explanation

CEO

% Return on Sales (ROS) It is the ratio of profit after tax (PAT) to

the revenue generated by the company

in the quarter

Head, HR Employee Engagement

Rating (ESAT)

It is the average of engagement ratings

given by managers in the employee

engagement survey for the quarter

Head, MKT &

Sales

% Market Share By Revenue It is the ratio of revenue of the

company to the revenue of the

industry as a whole in the quarter

Head, R&D No. of Successful Projects It is the number of research projects

attempted in a quarter that have

resulted in a change in version, defect

rate or automation level in the next

quarter

Head, Operations Effective Cost per Unit It is the weighted average of the unit

cost of inventory of the previous

quarter, the unit cost of production for

the current quarter, and the unit cost

of outsourcing for the current quarter.

The unit cost of inventory for each

quarter is the effective cost per unit

from the previous quarter

Head, Finance Interest Coverage Ratio It is the ratio of profit before interest

and tax (PBIT) to the interest expenses

of the company in the quarter

All Functions Return on Equity (ROE) It shows the return to shareholders for

the capital that they have invested in

the business. It is the ratio of the net

profit to the total equity held by

shareholders in the company



16

In lieu of our merit based philosophy, each member of the top management team is

entitled to get a quarterly bonus of INR 50,000 if s/he meets or exceeds his/her respective

performance target. This money will be paid out by the Singhania Group, and will not be an

expense for your mini robot company.

Workforce Planning

We will need to ensure adequate staffing to meet the business needs of the organization.

We can hire more talent from the marketplace, and also retrench them as the need arises.

Having too few people prevents us from fulfilling the needs of the market and making

profits, while having too many people increases our fixed overheads, and again reduces our

profits.

Our corporate head office allows a quarterly budget for a maximum of 15 salespeople for

OEMs, 10 for value added resellers and 20 for wholesalers in each geography. We incur a

one-time expense of INR 15,000 for hiring or retrenching a salesperson.

The corporate head office has given us a quarterly budget to have a maximum of 5, 10 and

15 after-sales people on our rolls in each geography for OEMs, VARs and WHLs respectively.

We incur a one-time expense of INR 30,000 for hiring or retrenching an after-sales person.

Each sales / after-sales person can be allocated to only one customer segment in one

geography for a quarter. However, salespeople and after-sales people can be shifted

between different customers / geographies in subsequent quarters without any additional

cost.

Compensation & Benefits

The HR function is also responsible for deciding the compensation and benefits that our

employees receive. While increasing compensation improves employee morale and

productivity, we have to keep an eye on the impact of the same on the profitability of the

company.

The compensation for a salesperson is currently INR 30,000 a quarter, while that for an

after-sales person is currently INR 60,000 per quarter. HR can vary the compensation of

salespeople between INR 25,000 and INR 35,000, and that of after-sales people between

INR 55,000 - INR 65,000.



17

Organizational Effectiveness Initiatives

We invest in training and development to improve the effectiveness of our people and the

company as a whole. Improving processes within the company increases the productivity

level of our employees, thus enabling us to conduct more business with lesser people, and

hence reduces the dependence on individual capabilities. We need to invest an amount of

INR 100,000 to improve our sales process level in a quarter, and an amount of INR 200,000

to improve our after-sales process level in a quarter.

FINANCE

Mr. Rao (Senior Vice President,

Finance) – The finance department

keeps an eye on the key metrics of

the company. It is critical for us to

ensure profitability (net profits),

solvency (sufficient cash for our

planned operations, investments and

financial commitments), sustainability (new business and repeat business in the long run),

and growth (improvement in key metrics quarter on quarter) of the company. While all

these metrics may be tracked by the finance team, we have to ensure that all functions in

the business consistently follow a well-defined business strategy and work in a holistic

manner to ensure that our targets for these metrics are met. The role of each function in

the company is equally important in the overall performance of the company. Our

shareholders expect us to deliver on these metrics.

For each quarter, we will have to pay 55% of the money we owe our raw material suppliers

on the spot, and the balance 45% in the next quarter. Our customers pay us 40% of the

money they owe us on the spot, with the balance 60% coming in the next quarter.

Whenever we do not have sufficient cash for a quarter, we can borrow from the bank

through working capital or long term loans. A working capital loan is currently available at a

quarterly interest rate of 6%, and will be due for repayment in the next quarter after it is

taken. A long term loan will remain on our balance sheet till we pay it back. The interest we

have to pay on a long term loan we have taken will be at the fixed long term interest rate

decided when taking the loan. The interest rates are different for the two types of loans,

and they might vary from quarter to quarter. The interest for each quarter is calculated by

the bank on the outstanding loan amount at the beginning of that quarter. In other words,

the interest for a working capital or a long term loan taken in a quarter is due only in the

next quarter, as the loan amount is released by the bank only by the end of the quarter.



18

There are some financial covenants imposed by the bank on borrowing. The maximum

working capital loan we can avail of in a quarter is INR 1,500,000, and the maximum long

term loan is INR 4,000,000. The bank will not lend us more than INR 12,000,000 as long

term loans in total.

The interest rate on working capital loans is currently 6%. The interest rate on long term

loans depends on the amount of long term loans we have taken till date. As the loan

amount increases, the risk incurred by the bank increases, and hence our long term interest

rate also go up. The interest rate goes up in slabs, as given in Table 4. For example, if the

loan amount is INR 2,300,000, then the first INR 1,000,000 is at 7%, the next INR 1,000,000

is at 7.5% and the next INR 300,000 is at 8%.

The interest rate slabs for long term loans are as follows

Table 4: Interest Rate for Different Loan Amounts (in INR million)

Slab (INR Million) Interest Rate

0 - 1 7

1 - 2 7.5

2 - 3 8

3 - 4 8.5

4 - 5 9

5 - 6 9.5

6 - 7 10.5

7 - 8 11.5

8 - 9 12.5

9 - 10 13.5

10 - 11 14.5

11 - 12 15.5

The interest for each quarter is calculated by the bank on the outstanding loan amount at

the beginning of that quarter. In other words, the interest for a working capital loan or a

long term loan taken in a quarter is due only in the next quarter.

If we run out of cash and have not borrowed from the bank, we will have to go for

emergency loans from loan sharks. Emergency loans come at a premium interest rate of



19

20% per quarter, and should be avoided by keeping a buffer of cash reserves. They have to

be repaid in the next quarter after they are taken.

Administrative Expenses

The quarterly administrative costs associated with our business are factory personnel costs

of INR 60,000 per plant, and the operating cost of INR 300,000 for sales offices in each

geography we have a presence in. This administrative cost for a geography will keep

increasing by 10% quarter on quarter as we delay our entry into that geography. The

administrative costs also include the hiring / retrenching costs and the investments in sales /

after-sales process upgrades.

Taxation

According to the Income Tax Act, our plants will be depreciated over a period of 20

quarters, while research investment will be amortized over a period of 3 quarters. While a

plant will be depreciated from the quarter it is ready for production, research investments

will be amortized once the respective research projects for that investment are successful.

We pay tax on a quarterly basis, at a tax rate of 30% on our profit before tax. The losses for

a quarter cannot be set off against the profits of any other quarter while computing our tax

liabilities.

ACCOUNTING

Mr. Shankar (Head, Accounts Department)

Welcome! I understand that most of you are not very comfortable with financial statements

and accounting terms. One of the key challenges faced by the senior leaders from non-

finance backgrounds is being able to interpret financial statements to make prudent

business decisions. I will take you through the various sample financial statements so that

you can have a good grip on how the big picture looks like, before embarking on the new

journey.

Financial statements are the records of the various activities performed by a company. They

can be used to compare our company’s performance against its past track record, and

against our competitors’ performance. The most commonly used financial statements are:

1. Balance Sheet

2. Profit and Loss Statement

3. Cash Flow Statement



20

Balance Sheet

The balance sheet is a snapshot of our company's assets, liabilities and shareholders' equity

at a specific point in time. It is usually computed at the end of every quarter / year. It shows

what the company owns and owes, as well as the amount invested by the shareholders. In

Table 5 below, you can have a look a sample balance sheet.

Table 5: Sample Balance Sheet (All figures in INR)

Assets Liabilities

Cash 1,500,000 Common Stock 3,000,000

Accounts Receivable 0 Accounts Payable 0

Inventory 0

Gross Plant 1,500,000

Accumulated Depreciation 0

Net Plant 1,500,000 Short Term Loan 0

Gross Research 0 Long Term Loan 0

Accumulated Amortization 0

Net Research 0 Retained Earnings 0

Total Assets 3,000,000 Total Liabilities 3,000,000

Assets

Our company’s assets are the tangible or intangible resources that it owns which can be

used to produce value for itself. Tangible assets owned by our company include its

production plants, its inventory of raw material, finished goods and goods being produced,

buildings, equipment etc, while intangible assets are those such as patents, copyrights,

trademarks, intellectual property, and financial assets such as cash, receivables from

customers, bonds and stocks owned by the company.

Current assets are those assets which can be converted into cash in the short-term. Current

assets include cash, receivables from our customers, inventory, short-term investments

which are expected to be redeemed within a year, etc.



21

Accounts Receivable represents the outstanding payments due from customers of

our company for the products and / or services that we have already provided them

with.

Inventory represents the value of the unsold goods that we have at the end of each

quarter / year.

Fixed assets are those which assets which cannot easily be converted into cash in the short-

term (perhaps a period of 1 year, or 1 operating cycle). Our company’s plant, equipment,

property, etc are fixed assets.

Depreciation

If you look closely at the asset side of the balance sheet, you will see notice a term called

accumulated depreciation. Depreciation is an accounting term that represents the cost of

using long term assets over a specific period of time such as a quarter or a year. Those

assets that are not directly consumed during the business of the firm, such as our plant etc,

are depreciated. The cost of an asset so allocated as depreciation, is the difference between

the total amount paid for the asset and the total amount expected to be received when it is

disposed by the company. One of the accounting methods used for depreciation is straight-

line depreciation. In this method, the difference between amount paid for the asset, and

amount expected to be received on disposal of the asset, is allocated as a cost to the

company in such a manner that it is equally split over the useful life of the asset.

Annual depreciation expense = (Gross value of asset – expected disposable value) / useful life

in years

Your company’s investment in plant and research will be depreciated based on the cost paid

for each investment and the quarter in which you invest.

Accumulated depreciation on an asset is the total depreciation on that asset from its initial

acquisition onwards.

Net value of a depreciable asset = Gross value of asset – accumulated depreciation on asset

Amortization

You would also have noticed a term called accumulated amortization. Amortization is the

equivalent of depreciation for intangible assets of our company, such as investments in

research, patents, copyrights, trademarks, intellectual property etc.



22

Annual amortization expense = (Gross value of intangible asset – expected disposable value)

/ useful life in years

Accumulated amortization on an intangible asset is of course, the total amortization on that

asset from its initial acquisition onwards.

Net value of an amortizable asset = Gross value of asset – accumulated amortization on

asset

Liabilities

Our company’s liabilities represent what it owes to the external world, such as its suppliers,

its lenders or banks, etc.

Current liabilities are those which are expected to be paid off in the next year or operating

cycle.

Accounts payable is the balance payment due to your suppliers against the raw

materials for your products.

Short term loan repayments are those payments for which payment is due within

the next one year.

Long term liabilities are those liabilities which are not expected to be discharged in a year’s

time. They include long term loans, long term leases, pension obligations etc.

Shareholders’ equity represents the benefit that shareholders of a company gain by virtue

of their stake in the company. Shareholders’ equity is comprised of common stock, which is

the capital invested into the company by its shareholders in return for shares, and retained

earnings, which is the value created / destroyed by the company for its shareholders by

virtue of its existence over time. Retained earnings can also be defined as the sum of profits

/ losses over the entire period of your company’s existence.

Accounting Equation

Now that you have come this far, I will introduce you to the accounting equation. The

accounting equation provides the mathematical structure of the balance sheet.

Assets = Liabilities + Shareholders’ equity

In simple words, any liability that our company incurs to an external agent will also result in

the creation of an equivalent asset for the company. For example, if a bank gives a loan of

INR 1,000,000 to our company (liability), it results in the company getting cash of INR



23

1,000,000 (asset). If our shareholders decide to increase the capital invested in the company

by INR 2,000,000, then it again results in the company getting cash of INR 2,000,000.

Profit and Loss Statement

The profit and loss statement summarizes the revenues and expenses incurred by our

company during a specific period of time - usually a quarter or a year. In Table 6 below, you

can have a look at a sample Profit and Loss Statement for a quarter.

Table 6: Sample Profit and Loss Statement

Head Amount (INR)

Revenue 5,000,000

Variable cost of goods sold (4,000,000)

Plant Depreciation (100,000)

Gross margin 900,000

Research Amortization 0

Inventory holding cost 0

Marketing Research cost (35,000)

Advertising cost 0

Sales cost (100,000)

After-sales cost (125,000)

General & Admin expenses (420,000)

Profit before interest and tax 220,000

Interest Cost 0

Profit before tax 220,000

Tax 66,000

Profit after Tax 154,000

Revenue consists of the total sales revenue for the period.



24

Cost of Goods Sold (COGS) comprises of all the costs that are associated directly with

production. It includes electricity charges, labor cost, plant maintenance, raw

material cost, plant depreciation etc. For our company, the variable cost of goods

sold consists of the direct costs involved in the production of goods such as the raw

material cost.

COGS = Variable cost of goods sold + Plant Depreciation

Depreciation in each quarter is shown as an expense in the profit and loss

statement. Depreciation is a notional expense that does not result in a cash outflow

for our company.

Inventory holding cost is the cost of storing inventory at warehouses for a quarter or

year. Inventory holding costs include rent for the required space; equipment,

materials, and labor to operate the space; insurance; security; interest on money

invested in the inventory and space, and other direct expenses. Another major cost

is cash held down in the form of inventory.

Advertising cost is the total amount spent on advertising for a quarter or year.

Sales cost reflects the salary payment to the sales force over a quarter or year.

After-sales cost consists of the salary payment to the after-sales people for a quarter

or year.

Other fixed costs represents the total cost of running operations in each geography,

along with the wages for factory personnel cost.

Profit before Interest and Tax (PBIT) consists of revenue less the above expenses.

Interest cost is the sum of the interest on short term loans, long term loans and

emergency loans.

Profit before tax (PBT) is derived by deducting interest from PBIT.

Tax is calculated as a percentage (tax rate) of PBT.

Profit after Tax (PAT) is PBT less tax. This is the profit available for company

shareholders after all expenses are met. It can also be termed as net profit.

Cash Flow Statement

It shows all cash inflows and cash outflows our company incurs during the course of its



25

operations, investments and financing activities, during a specific period of time – usually a

quarter or year. The cash flow statement is used to analyze how the cash position of our

company has changed from previous year, and to keep a tab on the short term viability our

company.

The cash flows resulting from the activities of our company can be divided into three

categories.

Cash flow from operating activities

Cash flow from investing activities

Cash flow from financing activities

Table 7 below shows how a hypothetical cash flow statement for a company could look like

Table 7: Hypothetical Cash Flow Loss Statement

Head Amount (INR)

Profit After Tax 154,000

Add: Depreciation & Amortization 100,000

Decrease (Increase) in Accounts Receivable (848,000)

Decrease (Increase) in Inventory 0

Increase (Decrease) in Accounts Payable 702,000

Cash flow from operating activities 108,000

Add (Less) Investment in Plant 0

Add (Less) Investment in Research (100,000)

Cash flow from investing activities (100,000)

Increase (Decrease) in short term loans 100,000

Increase (Decrease) in long term loans 100,000

Cash flow from financing activities 200,000

Net change in cash 208,000

Opening cash balance 1,500,000

Closing cash balance 1,708,000



26

Cash flow from operating activities

Profit After Tax (PAT) – The PAT is taken from the Profit And Loss Statement. We

start from this figure, and make the necessary adjustments for inflow and outflow of

cash in the period that are not reflected in the Profit And Loss Statement, to arrive

at the actual change in the cash balance of our company during the period.

Depreciation & Amortization – As depreciation and amortization are notional

expenses, and do not result in any real outflow of cash, they are added to the net

profit of the company

Change in Accounts Receivable – If the accounts receivable of a quarter is higher

than the accounts receivable of the previous quarter, it results in a net outflow of

cash for our company and hence has a negative effective on our cash balance.

Change in Inventory – If our inventory in the current quarter is higher than that of

the previous quarter, our cash has been sucked up for the excess inventory, and

there is a net outflow of cash for the company.

Change in Accounts Payable – If the accounts payable of a quarter is higher than the

accounts payable of the previous quarter, it results in a net inflow of cash for our

company and hence has a positive effective on our cash balance.

The net change in cash due to the above heads consists of the cash flow from operating

activities.

Cash flow from investing activities

Investment in Plant – If the net investment in production plants is positive, it results

in an outflow of cash for our company

Investment in Research - If the net investment in research is positive, it results in an

outflow of cash for our company

The net change in cash due to the above heads consists of the cash flow from investing

activities.

Cash flow from financing activities

Change in short term loans – If the short term loan outstanding in the current



27

quarter is greater than those in the previous quarter, it results in an inflow of cash

for our company

Change in long term loans - If the long term loan outstanding in the current quarter

is greater than those in the previous quarter, it results in an inflow of cash for our

company

The net change in cash due to the above heads consists of the cash flow from financing

activities.

Net Change in Cash

It is the sum of the cash flow from operating activities, cash flow from investing activities

and cash flow from financing activities.

The closing cash balance at the end of a quarter or year is obtained by adding the net

change in cash to the opening cash balance at the beginning of the quarter / year.

Note: The closing cash balance in the cash flow statement must obviously be the same

figure as that shown in the Cash head of our balance sheet for the same date. This is a

simple, but effective check to see whether the accounting has been done properly.



2



3

enParadigm Knowledge Solutions,

CIIE, IIM New Campus, Vastrapur

Ahmedabad – 380015, India

Website: www.enparadigm.com

Ph: +91 89517 66681

Email: [email protected]

Copyright © 2010-2012 enParadigm Knowledge Solutions. All rights reserved.

No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any

form or by any means — electronic, mechanical, photocopying, recording, or otherwise — without

prior written permission from enParadigm Knowledge Solutions.

http://www.enparadigm.com/

mailto:[email protected]

Learning Curve Case

Documents

Transcript of Learning Curve Case