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2014/03/24
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New Managers Programme
Managing Resources & Financial information
Justin Spencer-Young Copyright
Programme Contents
! The big picture of business ! Where funding comes from ! How we use funding in business ! Profit, margin and volume ! Cost classification ! Cost behaviour ! Cost allocation ! Break even analysis
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The purpose of every business
! Add value and create wealth for its existence
! 4 main beneficiary groups " Employees " Owners " State " Society
Where does money come from?
! Owners ! Equity ! Share capital ! Shareholders loans ! Private equity ! Venture capital
! Loans ! Debt ! Short term - Overdraft ! Long term - Bond ! Equipment finance ! Working capital
finance
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Where do we use the money? ! Fixed assets
" Land & buildings " Plant &
machinery " Vehicles " Computers " Furniture and
fittings
! Current assets " Raw materials " Work in progress " Inventory " Finished goods " Debtors " Cash
Long term vs. short term
Long term
! Longer then 12 months
! Long term debt ! Bonds / mortgage ! Land & buildings ! Plant & equipment
Short term
! Overdraft ! Supplier credit ! Raw materials ! Working capital
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Making a profit
Volumes Expenses
Margins
Profits
Making a profit We sell tyres R100 The tyres cost R60 Our margin is then R40
If our sales volume is 500 our gross profit is R20 000 (R40 x 500)
If our expenses over the same period are R15 000 then we make a profit of R5 000 (R20 000 – R15 000)
Income statement for February 2007 Sales (500 tyres @ R100) Cost of sale (500 tyres @ R60) Gross margin / profit Expenses Net profit
50 000 30 000 20 000 15 000 5 000
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Changing the variables Change the selling price Reduce the selling price by 10% to R90 Cost of sales R60 New margin R30 To make a R5 000 profit how many tyres do we have to sell? Assuming our expenses remain at R15 000 we will have to sell a higher volume of tyres. We need to make a R20 000 gross profit to make a net profit of R5 000 R20 000/30 = 667 tyres to be sold
Making a profit …cont New price R90 The tyres cost R60 New margin R30
Expenses remain the same at R15,000
Income statement for February 2007 Sales (667 tyres x R90) Cost of sale (667 tyres x R60) Gross margin / profit (667 x R30) Expenses Net profit
60 000* 40 000* 20 000 15 000 5 000
Units = GP / M = 20,000 / 30 = 666.66 (rounded up to 667) * Rounding error
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Profit Exercise 1
Sales Cos Gp Exp Pbt
20 12 8
18 12 6
Units = 10,000
200,000 120,000 80,000 60,000 20,000
Sales Cos Gp Exp Pbt
Units = 10,000
180,000 120,000 60,000 60,000 0
Sales Cos Gp Exp Pbt
240,000 160,000 80,000 60,000 20,000
18 12 6
Units = 13,333
Units = 3,333
Profit Exercise 2
Sales Cos Gp Exp Pbt
20 12 8
22 12 10
Units = 10,000
200,000 120,000 80,000 60,000 20,000
Sales Cos Gp Exp Pbt
Units = 10,000
220,000 120,000 100,000 60,000 40,000
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Profit Exercise 3
Sales Cos Gp Exp Pbt
20 12 8
20 11.50 8.50
Units = 10,000
200,000 120,000 80,000 60,000 20,000
Sales Cos Gp Exp Pbt
Units = 12,000
240,000 138,000 102,000 60,000 42,000
Cost classifications
! Fixed costs " Rent " Salaries " Wages " Electricity " Insurance " Interest
! Variable costs " Cost of materials " Transport " Commissions " Wages " Consumables " Royalties
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Operating Leverage:
Sales % change Variable Fixed Total costs Profit % change
1,000 920 0 920 80
900 -10% 828 0 828 72 -10%
1,100 +10% 1,012 0 1,012 88 +10%
Variable" 1,000 520 400 920 80
900 -10% 468 400 868 32 -60%
1,100 +10% 572 400 972 128 +60%
Semi-fixed" 1,000 0 920 920 80
900 -10% 0 920 920 -20 -125%
1,100 +10% 0 920 920 180 +125%
Fixed"
Break even
! The point at which a business makes no profit and no loss (i.e PBT = 0)
! Information needed
" Fixed expenses " Selling cost per unit " Variable cost per unit
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Break even example
! A business has fixed monthly expense of R60,000
! The average selling price per unit is R 20
! The average cost price per unit is R 12
! Calculate the break even in units ! Calculate the break even in Rands
Break even example Per unit Units = 7500 20 Sales 150 000 12 Cos 90 000 8 Gp 60 000
Exp 60 000 Pbt 0
Fixed costs = break even units (Sales price – cost of sales)
Gross profit = break even units Margin 60 000 = 7500 units (20 – 12)
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Break even Rands
Fixed costs
Variable costs + Fixed costs
Sales
Break even
7500
R60 000
R150 000
Volume
Break even Rands
Fixed costs
Variable costs + Fixed costs
Sales
Break even
6,000
R60 000
132,000
Volume
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Break even Rands
Fixed costs
Variable costs + Fixed costs
Sales
Break even
10,000
R60 000
180,000
Volume
Draw the break-even graph for a product range with the following information
! Fixed expenses = R20,000 ! Gross margin = 30% ! Ave selling price = R140
! Discuss what happens if the selling price is increased.
! Discuss what happens if the COS is reduced.
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Break even Rands
Fixed costs
Variable costs + Fixed costs
Sales
Break even
476
R20 000
R66 667
Volume
Do you feel a bit like this guy?
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B/E Question 1
Sales Cos Gp Exp Pbt
100 70 30
100 70 30
Units = 100
10 000 7 000 3 000 3 000 0
Sales Cos Gp Exp Pbt
Units = 600
60 000 42 000 18 000 3 000 15 000
B/E Question 2
Sales Cos Gp Exp Pbt
300 200 100
300 200 100
Units = 500
150 000 100 000 50 000 50 000 0
Sales Cos Gp Exp Pbt
Units = 900
270 000 180 000 90 000 50 000 40 000
(a) and (b) (c)
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B/E Question 2 d
Sales Cos Gp Exp Pbt
300 200 100
300 200 100
Units = 800
240 000 160 000 80 000 80 000 0
Sales Cos Gp Exp Pbt
Units = 1 200
360 000 240 000 120 000 80 000 40 000
(a) and (b) (c)
My Website
www.groupspaces.com/jsy-finance
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Generic Example: Income statement
Sales COS GP Expenses PBT Tax (25%) PAT
1,000,000 800,000 200,000 100,000 100,000 25,000 75,000
PBT = PAT = 75,000 = R100,000 (1-tax) (1 - 0.25)
1,100,000 880,000 220,000 100,000 120,000 30,000 90,000
100% 80% 20%
100% 25% 75%
B/E Question 3
Sales Cos Gp Exp Pbt
40 30 10
40 30 10
Units = 5,000
200,000 150,000 50,000 50,000 0
Sales Cos Gp Exp Pbt
Units = 10,000
400,000 300,000 100,000 50,000 50,000
Sales Cos Gp Exp Pbt
360,000 270,000 90,000 50,000 40,000
40 30 10
Units = 9,000
a b c
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B/E Question 3
Sales Cos Gp Exp Pbt Tax Pat
40 30 10
40 30 10
Units = 7,666.66
306,666 230,000 76,666 50,000 26,666 6,666 20,000
Sales Cos Gp Exp Pbt Tax Pat
Units = 8,333.33
226,666 170,000 56,666 50,000 6,666 1,666 5,000
40 30 10
Units = 5,666.66
d e e
333,333 250,000 83,333 50,000 33,333 8,333 25,000
26,666
Sales Cos Gp Exp Pbt Tax Pat
100%
25%
75%
100%
25%
75%
100%
25%
75%
B/E Question 3
Sales Cos Gp Exp Pbt Tax Pat
40 30 10
Units = 7,000
280,000 210,000 70,000 50,000 20,000
g
216,000 162,000 54,000 54,000 0
Sales Cos Gp Exp Pbt
40 30 10
Units = 5,400
f
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Financial Information
The Business Objective
“The objectives of every business are to
endure and grow”
Erik Beinhocker, The Origin of Wealth
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To Endure and Grow
Capital
Profitability
Growth
Value
Use of Accounting
! Used to manage, like a pilots instrument panel
! Limitations " Own language " Can’t show non-monetary information " Figures may be approximations and opinions
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Our instrument panel
Use of Accounting
! Used to manage, like a pilots instrument panel
! Limitations " Own language " Can’t show non-monetary information " Figures may be approximations and opinions
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Income statement ! Sales/Turnover/Revenue ! Cost of sales ! Gross Profit ! Expenses ! Depreciation ! PBIT (Operating profit) ! Interest ! NPBT ! Tax ! Net profit after tax ! Dividends ! Retained Earnings
Typical Income Statement ABC Ltd for the year ending 31 December 2012
Rands 000’s Turnover/Revenue/Sales 10 000 Less: Cost of Sales (5 000) Gross Profit/Margin 5 000 Less: Operating Expenses:
Administration (1 000) Sales and Marketing (2 000) Depreciation (1 000) (4 000)
Operating Profit (NOP;EBIT;PBIT) 1 000 Less: Interest (200) Profit before tax 800 Less: Taxation (200) Profit after tax 600 Less: Dividends (200) Retained Earnings 400 Exceptional Items
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The Balance Sheet Version 1
Capital Net Assets
Equity Fixed Assets Share Capital + Retained Profits Current Assets + Debtors Debt Stock Long Term Cash
- Current Liabilities Creditors
Tax Overdraft
The Balance Sheet Version 2
Capital Net Assets
Equity Fixed Assets Share Capital + Retained Profits Current Assets + Debtors Debt Stock Long Term Cash + Current Liabilities Creditors Tax Overdraft
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Typical Company Balance Sheet ABC Ltd as at 31 December 2012 Layout 1
Rands 000’s Capital Employed
Equity Ordinary share Capital 700 Share Premium 250 Retained Earnings 450 Ordinary S/hlders Int 1 400
Non-Current Liabilities Provisions 150 Deferred Tax 100 Long Term Loan 500
750 2 150
Employment of Capital Fixed Assets Land and Buildings 1 000 Machinery 200 Motor Vehicles 500
1700 Investments 400 Current Assets Stock 250 Debtors 350 Cash 100
700 Current Liabilities Creditors 400 Taxation 50 Bank Overdraft 200
650
2 150
Typical Company Balance Sheet ABC Ltd as at 31 December 2012 Layout 2
Rands 000’s Capital Employed
Equity Ordinary share Capital 700 Share Premium 250 Retained Earnings 450 Ordinary S/hlders Int 1 400
Non-Current Liabilities Provisions 150 Deferred Tax 100 Long Term Loan 500
750 Current Liabilities Creditors 400 Taxation 50 Bank Overdraft 200
650
2 800
Employment of Capital Fixed Assets Land and Buildings 1 000 Machinery 200 Motor Vehicles 500
1700 Investments 400 Current Assets Stock 250 Debtors 350 Cash 100
700
2 800
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Accounting Equations
Debt + Equity ""= Fixed Assets + Current Assets - Current Liabilities"
""Net Assets "
"= Fixed Assets + Current Assets - Current Liabilities"""Cash "
"= Debt + Equity + Current Liabilities - Stock - Debtors - "Fixed Assets"
Introductory Exercise: Income statement
Sales COS Opening Stock Purchases Closing Stock GP Depreciation Bad debts Expenses PBIT
6,400 3,500 0 4,500 1,000 2,900 (1,000) (80) (580) 1,240
80 magazines x R80 0 + 4,500 -1,000 New business R40 x 50 & R50 x 50 20 magazines x R50 6,400 - 3,500 4,000 / 4 years 1 x R80 Given 2,900 - 1,000 - 80 - 580
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Introductory Exercise: Balance sheet
Assets Isuzu Stock Debtors Cash
3,000 1,000 240 2,000 6,240
Equities and Liabilities Share capital Retained E
5,000 1,240 6,240
Introductory Exercise: Cashflow Cash in Share capital Received from C Cash in Net Cash
5,000 6,080 11,080 2,000
Cash out Isuzu Stock Expenses Cash out
4,000 4,500 580 9,080
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Introductory Exercise: Income statement (Version 2)
Sales COS Opening Stock Purchases Closing Stock GP Depreciation Bad debts Expenses PBIT
6,400 3,700 0 4,500 800 2,700 (750) (80) (580) 1,290
80 magazines x R80 0 + 4,500 - 800 New business R40 x 50 & R50 x 50 20 magazines x R40 6,400 - 3,700 3,000 / 4 years 1 x R80 Given 2,700 - 750 - 80 - 580
Introductory Exercise: Balance sheet (Version 2)
Assets Isuzu Stock Debtors Cash
3,250 800 240 2,000 6,290
Equities and Liabilities Share capital Retained E
5,000 1,290 6,290
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Tyre Business: Income statement for the 1st month
Sales COS Opening Stock Purchases Closing Stock GP Expenses Depreciation Bad debts PBIT Interest PBT Tax Retained E
77,000 51,000 0 67,000 16,000 26,000 12,000 600 1,100 12,300 600 11,700 4,680 7,020
700 tyres x R110 0 + 67,000 -16,000 New business R70 x 500 & R80 x 400 200 tyres x R80 77,000 - 51,000 Given (R36,000 / 5 years) / 12 months 10 x R110 26,000 - 12,000 - 600 - 1,100 (R30,000 x 24%) / 12 months 12,300 - 600 11,700 x 40% 11,700 - 4680
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Tyre Business: Balance sheet as at the end of Month 1
Net Assets Fixed assets @ cost Acc dep CA Stock Debtors Cash CL Creditors Tax
50,000 7,020 57,020 30,000 87,020
Capital Share capital Retained E S/holders funds LT Loans
35,400 36,000 600 88,300 16,000 15,400 56,900 36,680 32,000 4,680 87,020
Calculating Cash
NA = FA + CA - CL
87,020 = 35,400+ (16,000+15,400+C) - 36,680
87,020 - 35,400 -16,000 -15,400 + 36,680 = C C = 56,900
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Tyre Business: Cashflow Cash in Share capital LT Loan Received from C Cash in Net Cash
50,000 30,000 60,500 140,500 56,900
Cash out Tyres Equip Expenses Interest Cash out
35,000 36,000 12,000 600 83,600
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Turnover is Vanity
Profit is Sanity
Cashflow is Reality
Profit vs Cash Flow
! Can a company that makes profits go bankrupt?
! Bankruptcy is related to a shortage of cash not a shortage of profits
! Profit is an opinion but cash is FACT
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Difference between Profit & Cash
! Making a profit can happen in Month 1
! But, receiving the cash may only happen in month 2 or 3
! Profit is an accounting term
! Cash is a reality
What if you are a supplier to:
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Selling to Pick n’ Pay
100,000 100,000 100,000 100,000 100,000 200,000 300,000 400,000 500,000 500,000 500,000 500,000
100,000 200,000 300,000 300,000 300,000 400,000 600,000 900,000
1,200,000 1,400,000 1,500,000 1,500,000
0 0 0
100,000 100,000 100,000 100,000 100,000 200,000 300,000 400,000 500,000
1 2 3 4 5 6 7 8 9 10 11 12
40,000 40,000 40,000 40,000 40,000 80,000
120,000 160,000 200,000 200,000 200,000 200,000
(60,000) (60,000) (60,000) (60,000) (60,000) (120,000) (180,000) (240,000) (300,000) (300,000) (300,000) (300,000)
(60,000) (120,000) (180,000) (140,000) (100,000) (120,000) (200,000) (340,000) (440,000) (440,000) (340,000) (140,000)
Month I/S
Sales I/S
Profit B/S
Debtors C/F In
C/F Out
C/F Bal
Managing Cash Flow
A growing business eats cash!!"
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Sources of Cash
! 1. Cash from operations ! 2. Cash from working capital ! 3. Cash from investing activities ! 4. Cash from financing activities ! 5. Cash from shareholder activities
From Profit to Cash Flow
! Operating profit ! Adjust for non-cash items
" Depreciation " Amortisation
! Movement in working capital " Stock " Debtors " Creditors
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From Profit to Cash Flow…cont
! Investing activity " Purchase/sale of fixed assets " Investments
! Financing activity " Loans received/repaid " Interest paid
From Profit to Cash Flow…cont
! Shareholder activity " New shares issued " Share buy-backs " Dividends
! Corporate tax paid ! Net cash movement ! Opening cash balance ! Closing cash balance
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“There is no innocent number” Bobby Godsell, retired CEO, Anglo Gold Ashanti
Financial Analysis
! Why? ! Find hidden information ! Compare like with like ! Ratio analysis ! What questions to ask ! Subjectivity ! Trends
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Fortune 500
! Top companies by revenue " Number 1 ~ Wal-Mart $500 Billion " Number 2 ~ Exxon Mobil $498 Billion
! Measured on profit " Exxon Mobil ~ $49 Billion (9%) " Wal-Mart ~ $4 Billion (3%)
How does SA compare?
! Massmart 2012 " Revenue ~ R50 Billion " PAT ~ R1.5 Billion (3%)
! Sasol 2012 " Revenue ~ R100. Billion " PAT ~ R16 Billion (16%)
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Staying in Business
! Profitability ratios " % of sales
! Liquidity ratios " Availability of cash
! Activity ratios " Debtors, creditors,
stock " Asset turnover
Key indicators
! Gearing ratios " Debt to equity " Debt to total capital
! Performance ratios " RONA " ROE
Profitability ratios
! Gross profit % = GP/Sales x 100 ! Operating profit % = OP/Sales x 100 ! Earnings after tax % = EAT/Sales x 100 ! Expenses as a % of sales
" Variable costs " Admin costs " Fixed expenses
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Staying in Business
Liquidity ratios
! Current ratio Current assets / Current liabilities
! Quick ratio (Current assets – inventory) / Current liabilities
Staying in Business
Activity ratios
! Debtor days (Debtors / Credit sales) x 365
! Creditor days (Creditors / credit purchases) x365
! Stock days (Stock / Cos) x 365
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Staying in Business Gearing ratio
! Debt to Equity ratio
LT Debt / Total Equity
! Debt to total capital LT Debt / Total Capital LT Debt / (LT Debt + Total Equity)
! Interest cover NPBIT / Interest
Staying in Business Performance ratio
! RONA or ROCE
Operating Profit / Net Assets Opertaing Profit / Total Capital
! ROE Profit After Tax / Total Equity
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Dupont Analysis All Star Trading Ltd
Debtor days" Creditor days" Stock days"
W/C Turnover"
ROE"
F/A Turnover"
Asset Efficiency"Profitability"
RONA" Gearing"
OPERATIONS" FUNDING"
Use of Debt A BUNGEARED GEARED
Equity 1000 600Debt (12%) 400
1000 1000
EBIT (OPERATING PROFIT) 200 200Less: Interest 0 48Profit Before Tax 200 152Tax (30%) 60 45.6Profit After Tax 140 106.4
Return on Assets 20% 20%
Return on Equity 14% 18%
Interest Paid 48Tax saved 14.4Real cost of debt 33.6Real rate of interest 8.4%
BOTH EXAMPLES HAVE THE SAME ASSET BASE
RETURN TO SHAREHOLDERS HAS BEEN "GEARED UP"
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Capital Structure and Share Price
Impact of Capital Structure on Share price
6000
6500
7000
7500
8000
8500
9000
0% 10% 15% 20% 25% 30% 35% 40% 45% 50% 55% 60% 65%
Debt to total capital
Sh
are p
ric
e
Share price
Capital Budgeting
! Budgets for new equipment ! Budgets for new projects ! Budgets for new businesses
! Business plan
! How do well ‘sell’ our plan to management?
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Discounted cash flow
! Capital outlay ! Forecast ! Hurdle rate or risk ! Time line ! External influences
" Interest rate " Exchange rates " Utilisation
DCF graph Rands
+
-
Time
Initial capex expense
Profits over time
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Net Present Value (NPV)
Present -200
Year 1 100
Year 2 120
Year 3 130
Year 4 150
83.30
83.28
75.27
72.30
114.15 = NPV Discount rate = 20%
A positive NPV implies that we will make a return on investment that is higher than the discount rate. At what discount rate will the NPV = 0?
Discount rates & expected returns
Gov bonds 10%
Cash
9%
JSE equity
15%
Private equity
35% SME
25%
Lotto
99.9%
Government bonds are considered to be Risk Free JSE equity on average returns 6% above the Rf rate
