Wednesday, 14 August 2013

Chinese Steel Stock Continues to push the Iron Ore Price higher.

The base level for Iron Ore has reached its highest in 5 months.

The data provider Steel Index says the rise is on the back of heavy steel re-stocking in China, fuelled by an improvement in its property sector. Prices reached US $141.80 a tonne.  At this time last year, the iron ore price had already begun its terrifying descent towards a September low of $US86.70 ($94.10) per tonne, a price that prompted more than a few Australian miners to contemplate their existence.

Despite this rise investors are remaining cautious pending the decision from the US Federal reserve on the stimulus measures next month. A Bloomberg survey of economists found 65% believed the Fed would reduce its monthly bond purchases at next month’s meeting, up from 50% last month.

The Dow Jones Industrial Average fell 0.7%, while the S&P 500 dropped 0.5%. Like the Australian market yesterday, stocks in Toronto were flat. 

Philip Kirchlechner of the Steel Index said stocks at steel mills in China have been fairly low: about 20 days  worth of supply, whereas typically they are at 30 - 40 days.

"They're getting caught short,'' he said, ''and that causes buying to increase again and the price to spike."
Rob Brierley of Patersons Securities said other factors had also played a part: "I think China (is) ... running a leaner inventory system,'' he said.

Earlier predictions were that the price could fall below $US100 per tonne later this year. This is just one price spike in what's been a buoyant few months for iron ore miners.

While Mr Brierley admits initial predictions of a dramatic price fall were probably slightly overstated, he's still anticipating the price will moderate towards the end of the year.

"I think there's reasons why it should be a little bit softer this year than say last year but I would expect the price to moderate in the September and October period.

"We are transforming, there are a number of expansions that Rio Tinto and BHP have done and what Vale in Brazil are doing, and that will increase supply.

"So there are a lot of forecasters out there saying there will be a glut of supply coming on next year and the year after."

Mr Brierley says China is moving into a new phase of slower growth but it will still need steel.
"China is transitioning from a construction driven economy to a consumer driven economy so that means steel demand will airball or consumption will slow down but it's still very strong and not expected to peak until 2020," he said.

Iron ore miners are expected to report some of the best annual results this reporting season.

Friday, 9 August 2013

CVP Analysis: Contribution Margin Ratio


The contribution margin (CM) ratio is the ratio of contribution margin to total sales:

If the company has only one product, the CM ratio can also be computed using per unit data:

The CM ratio shows how the contribution margin will be affected by a given change in total sales.

Q = Break-even quantity
Sales = Variable expenses + Fixed expenses + Profits
Q x selling price/unit = (Q x variable expense/unit) + Fixed expenses + Profits

Break-even quantity = Fixed Expenses

To calculate the breakeven point in sales dollars, substitute ratios as a percent of sales for dollars. Or, calculate the breakeven point in units and multiply by the selling price/unit.

     The margin of safety is the excess of budgeted (or actual) sales over the break-even sales. The margin of safety can be expressed either in dollar or percentage form. The formulas are:

Operating leverage measures how a given percentage change in sales affects net operating income.  It is a measure of volatility in net income caused by high fixed expenses relative to variable expenses.

Use the income statements for Company X and Y to compute:
a.    Breakeven point in units and sales dollars.
b.    Margin of safety.
c.    Degree of operating leverage.
d.    The change in net income caused by a 10% increase in sales.

Company X
Company Y
Sales  (5,000 units) ..................
Less variable expenses..............
Contribution margin..................
Less fixed expenses...................


Net operating income................
$ 60,000

$ 60,000

Thursday, 8 August 2013

Cost Volume Profit Analysis: The Break Even Point, Contribution Margin and the Cost of Things

Break-even (or break even) is the point of balance between making either a profit or a loss. The term originates in finance, but the concept has been applied widely since.

The contribution margin approach to calculate the break-even point (i.e. the point of zero profit or loss) is based on the Cost Volume Profit (CVP) analysis concepts known as contribution margin and contribution margin ratio.

Here the Contribution margin is the difference between the sales and variable costs. When calculated for a single unit, it is called unit contribution margin. Contribution margin ratio is the ratio of contribution margin to sales.

In this method simple formulas are derived from the CVP analysis equation by rearranging the equation and then replacing certain parts with Contribution Margin formulas.


Contribution Margin = Sales Revenue - Variable Expenses

Per Unit Basis the equation is as follows:

Contribution Margin per unit of sales = Sales Revenue per Unit - Variable Expenses per Unit

Contribution Margin - Fixed Costs = Net Operating Profit or Loss

Break even can be calculated onward to the point at which a company's sales are zero - there is no profit or loss:

Break-even in Units = Total Fixed Costs/Contribution Margin per unit

In other words:

Total Revenue = Total Costs

Unit Sale Price x Number of units sold = (TFC + V) Number of Units Sold

TFC is Total Fixed Costs, P is Unit Sale Price, and V is Unit Variable Cost.

BEP in Sales Dollars

Break-even point in dollars can be calculated via:

Break-even Sales Dollars = Price per Unit × Break-even Sales Units

; or

Break-even Sales Dollars = FC ÷ CM Ratio

Tuesday, 6 August 2013

Rio Pushes On

The worlds second biggest iron ore producer continued with its plans to increase production throughout late 2012 and inter the first half of 2013. The recent uncertainty in the industry has given many of the smaller mining companies reason to want to scale back operations to combat higher costs and falling prices. The Australian metals industry has remained highly cyclical, but thanks to the long term growth of the Asia Pacific market and long term plans of the big minors we are now experiencing the boom in production that follows the boom in growth.

Rio’s reported ore production increased 5 percent in the third quarter of 2012 as mines in Western Australia’s Pilbara region achieved a quarterly record of 63 million tonnes. Analysts are predicting a massive US$4.5b in interim earnings from iron ore in the six months ended June, overcoming predicted losses in other commodities.

Cost cutting remains a focus for all the minors. Once the global growth begins to accelerate demand prices will pick up again. Production will remain the focus for the miner.

Jenny Purdie, Rio Tinto's Global Practice Leader, Technology Delivery, Innovation recently stated: "In a volatile post-GFC environment, businesses are all looking for ways to be more efficient, effective and competitive to be successful.

"Rio Tinto is no different.  Mining is cyclical and like all miners we're operating in a challenging environment of lower commodity prices, a high Australian dollar and high input costs," she said.

Productivity remains the buzz word for 2013 and the company plans to expand production capacity in the Pilbara region to 283 million tonnes annually by the end of 2013 and to more than 350 million tonnes by mid-2015.

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Costing :LIFO and FIFO

FIFO and LIFO Methods are accounting techniques used in managing inventory and financial matters involving the amount of money a company has tied up within inventory of produced goods, raw materials, parts, components, or feed stocks. These methods are used to manage assumptions of cost flows related to inventory, stock repurchases (if purchased at different prices), and various other accounting purposes.
FIFO stands for first-in, first-out, meaning that the oldest inventory items are recorded as sold first but do not necessarily mean that the exact oldest physical object has been tracked and sold.
LIFO stands for last-in, first-out, meaning that the most recently produced items are recorded as sold first. Since the 1970s, some U.S. companies shifted towards the use of LIFO, which reduces their income taxes.
The difference between the cost of an inventory calculated under the FIFO and LIFO methods is called the LIFO reserve. This reserve is essentially the amount by which an entity's taxable income has been deferred by using the LIFO method

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