WORKSHOP 3 FINANCE FOR THE BUSINESS LEADER › migrated-assets › applicationpdf › aston-b… · FINANCIAL PERFORMANCE RATIOS a) alculate profitability and efficiency ratios for

WORKSHOP 3

FINANCE FOR THE BUSINESS

LEADER

ASTON PROGRAMME FOR

SMALL BUSINESS GROWTH

WEDNESDAY 1ST

NOVEMBER 2017

2

NOTES

3

TIMETABLE

TIME SESSION DESCRIPTION LEAD 12:30 - 13:00 Arrival and Refreshments

13:00 - 13:15

15 mins

Internationalisation Overview of opportunities from

Department of International Trade

Christine

Hancock

13:15 - 13:30

15 mins

Workshop Overview Introduction

Objectives

Mark,

Paula

13:30 - 14:25

55 mins

Financial Statement

Fundamentals:

Construction

Review of Balance Sheet and Profit

& Loss Account

Exercise: Financial Statement

Puzzle

Matt

14:25 - 14:40

15 mins

Break

14:40 - 15:55

75 mins

Financial Statement

Fundamentals: Analysis

of Financial Performance

Profitability and Efficiency Ratios

Exercise: Key Performance Ratios

Matt

15:55 - 16:10

15 mins

Break

16:10 - 17:05

55 mins

Financial Statement

Fundamentals: Analysis

of Financial Status

Liquidity and Stability Ratios

Exercise: Key Financial Status

Ratios

Matt

17:05 - 17:35

30 mins

Break

17:35 - 18:50

75 mins

Financial Statement

Fundamentals: Cash

Flow Forecasting

Cash Flow: Forecasting and

Working Capital

Exercise: Cash Versus Profit

Matt

18:50 - 19:00

10 mins

Wrap - Up Workshop Conclusions Paula

4

INTRODUCTION

DID YOU KNOW THAT?

• Only 17% of small businesses sought finance in the last 12 months

• 11% didn’t apply for finance despite wanting it:

• 53% did not want to take on additional risk

• 45% thought it would be too expensive

• 31% thought decision would take too long

• 29% thought the time was not right – economic conditions

• 37% of these didn’t apply because they thought they would be rejected

• 20% did not know where to find the appropriate finance

BEIS Small Business Survey 2015: SME employers

…AFTER BUSINESS GROWTH SUPPORT

• 84% of participants said they use financial data to drive business decisions more than they did before

• 87% have a clearer understanding of which financial metrics are critical to the success of their business

5

INTRODUCTION

HOWEVER… AFTER BUSINESS

GROWTH SUPPORT

• 70% of participants sought external financing

• Which was 4X higher than for all UK small business owners

6

NOTES

7

OBJECTIVES

OBJECTIVES

By the end of the workshop you will:

• Understand the Profit & Loss Account and Balance Sheet and what they say about your business

• Have identified financial metrics and ratios to measure your business’s performance and growth

• Have considered the financial information you need in your business to support strategic decision-making

AGENDA

• Review of balance sheet and profit and loss account

• Key financial ratios:

– Financial performance

– Financial status

• Cash flow:

– Working capital management

– Cash flow forecasts

• Wrap Up

8

REVIEW OF BALANCE SHEET/

PROFIT AND LOSS ACCOUNT

THE BALANCE SHEET RELATIONSHIP

ASSETS = LIABILITIES + CAPITAL & RESERVES

ASSETS - LIABILITIES = CAPITAL & RESERVES

KEY BALANCE SHEET CONCEPTS

• Working capital = current assets less current liabilities

• Capital employed = long term liabilities plus capital & reserves

• Liquidity = ability to meet short term liabilities

• Solvency = ability to meet all liabilities

9



THE PROFIT AND LOSS ACCOUNT

• A summary of the business’ financial performance during a period of time (usually 1 year)

• Compares income (e.g. turnover) earned and expenses ‘consumed’ to determine profit or loss for the period

• Based on the ‘matching concept’: income and expenses should be accounted for in the period to which they relate, and expenses should be matched against related income

KEY PROFIT AND LOSS ACCOUNT

CONCEPTS

• Mark up % = profit as a % of cost

• Margin % = profit as a % of sales price

• EBITDA = Earnings Before Interest Tax Depreciation & Amortisation

10

EXERCISE:



a) Arrange the items provided into the correct format for a balance sheet and profit and

loss account.

b) Review the balance sheet for this company and answer the following questions:

i) What is the business’ investment in ‘working capital’?

ii) What is the business’ ‘capital employed’?

iii) Is this business ‘liquid’?

iv) Is this business ‘solvent’?

c) Review the profit and loss account for this company and answer the following

questions:

i) Is this business ‘profitable’?

ii) What ‘mark up %’ explains the relationship between gross profit and cost of sales?

iii) What ‘gross margin %’ explains the relationship between gross profit and sales

revenue?

iv) Assuming the depreciation expense is £60,000 and there is no amortisation expense,

what is the business’ ‘EBITDA’?

11

NOTES

12

KEY FINANCIAL RATIOS

KEY FINANCIAL RATIOS

• Ratios measure the relationship between numbers in the accounts

• Key types of ratios:

• Financial performance:

• Profitability

• Efficiency

• Financial status:

• Liquidity

• Stability

• Important to compare v appropriate benchmarks

13

KEY FINANCIAL RATIOS:

PERFORMANCE

PERFORMANCE:

1. PROFITABILITY RATIOSRatio Definition Purpose

Return on Capital Employed %

Operating profit x 100

(Long term liabilities + Capital and reserves)

How well has the business used its capital to generate operating profits?

Return on Sales % (Operating Margin %)

Operating profit x 100

Turnover

How well has the business converted sales into operating profits?

Gross Margin % Gross profit x 100

Turnover

How well has the business converted sales into gross profits?

PERFORMANCE:

2. EFFICIENCY RATIOS

Ratio Definition Purpose

Turnover on capital employed

Turnover

(Long term liabilities + Capital and reserves)

How well has the business used its capital to generate sales?

14


PERFORMANCE

THE RELATIONSHIP BETWEEN

PROFITABILITY AND EFFICIENCY

Operating profit

Capital employed

Return on Capital Employed

Return on Sales Turnover On Capital Employed

Operating profit

TurnoverTurnover

Capital employedX

THE PYRAMID OF RATIOS

Return on Capital

Return on Sales

Gross MarginOverhead as % of Sales

Turnover on Capital

Turnover on Fixed Assets

Turnover on Working Capital

Stock days Debtor days Creditor days

15

NOTES

16

EXERCISE:

FINANCIAL PERFORMANCE RATIOS

a) Calculate profitability and efficiency ratios for Smith Ltd for 2016.

b) What might have caused the movement in the ratios you have calculated?

2016 2015

Return on capital employed %

50/(320+30) x 100 =

14.3%

Return on sales %

50/420 x 100 = 11.9%

Gross margin %

95/420 x 100 = 22.6%


420/(30+320) = £1.20

Possible reasons for movement


Return on sales %

Gross margin %


17

EXERCISE:

FINANCIAL PERFORMANCE RATIOS

c) What are the drivers of these ratios in your business? How useful are these ratios for your

business?

Drivers in your business Is the ratio useful

for your business?


Return on sales %

Gross margin %


18

NOTES

19

STATUS:

3. LIQUIDITY RATIOS


Current

Ratio

Current Assets

Current Liabilities

How well can the business meet its short-term obligations from current assets?

Quick Ratio

(Acid Test)

(Current Assets – Stock)

Current Liabilities

How well can the business meet its short-term obligations from liquid current assets in an emergency?

STATUS:

4. STABILITY RATIOS


Gearing

Ratio %

Debt x 100

(Debt + Capital and reserves)

What proportion of finance used by the business does ‘debt’ (interest-bearing finance) represent?

Interest Cover

Operating profit

Net interest payable

How easily can the business cover its interest charge (net of interest receivable) from profits available?


STATUS

20

EXERCISE:

FINANCIAL STATUS RATIOS

a) Calculate liquidity and stability ratios for Smith Ltd for 2016.

b) What might have caused the movement in the ratios you have calculated?

2016 2015

Current ratio

150/50 = 3.0

Quick ratio (acid test)

(150-90)/50 = 1.2

Gearing %

30/(30+320) x 100 = 8.6%

Interest cover

50/2 = 25.0 times


Current ratio


Gearing %

Interest cover

21

EXERCISE:

FINANCIAL STATUS RATIOS

c) What are the drivers of these ratios in your business? How useful are these ratios in your

business?

Drivers in your business Is the ratio useful for

your business?

Current ratio


Gearing %

Interest cover

22

CASH FLOW:

WORKING CAPITAL MANAGEMENT

PROFIT V CASH FLOW

Profit ≠ Cash flow

Expenses are recorded when costs are consumed not when paid for

Cash flows arising from financing activities are not recorded in the P&L

Turnover includes sales made on credit not yet received in cash

Cash spent on capital investment is not recorded in the P&L and depreciation/amortisation in the P&L are non cash expenses

Cash spent on stock is only recorded as an expense when goods are sold


• working capital = current assets – current liabilities

• growth usually requires an increase in working capital and an increase in working capital has to be financed

• even profitable companies can run out of cash because of poor management of working capital

• so how much working capital do you want?........

23

CASH FLOW:


FINANCING WORKING CAPITAL

Stock holding period* Debtor days

Creditor days WorkingCapital

Time

Most businesses have to finance working capital.......

*In service organisations this is equivalent to ‘WIP days’

WORKING CAPITAL RATIOS

Ratio Definition Meaning

Stock holding period

Stock x 365

Cost of sales

How many days of cost of sales are represented by year end stock?

Debtor days Trade debtors x 365

Turnover

How many days of sales are represented by year end trade debtors?

Creditor days Trade creditors x 365

Cost of sales

How many days of cost of sales are represented by year end trade creditors?

24

EXERCISE:


a) Working capital ratios for Smith Ltd for 2016 and 2015 are provided below. (Trade

creditors for 2016: £49,000; for 2015: £40,500).

b) What might have caused the movement in the ratios above?

2016 2015


110 x 365/390 = 103 days

90 x 365/325 = 101 days

Debtor days

70 x 365/510 = 50 days

50 x 365/420 = 43 days

Creditor days

49 x 365/390 = 46 days

40.5 x 365/325 = 45 days



Debtor days

Creditor days

25

EXERCISE:


c) What are the drivers of these ratios in your business? How useful are these ratios in

your business? (Calculations for your business are not required at this stage).

Drivers in your business Is the ratio useful for

your business?


Debtor days

Creditor days

26

CASH FLOW FORECASTS

CASH FLOW STATEMENT V CASH

FLOW FORECASTCash flow statement:

• analysis of actual cash flow for a period:

• operating cash flows

• investing cash flows

• financing cash flows

• produced within financial accounts (unless company is exempt)

Cash flow forecasts:

• analysis of future cash inflows and outflows (usually monthly) to identify future surpluses or deficits

• produced for management accounts or for a business plan

CASH FORECAST: ILLUSTRATION

Jan Feb March April

Cash receipts (1) 20 60 40 50

Cash payments (2) (30) (20) (200) (30)

Monthly cash flow (3 = 1 - 2) (10) 40 (160) 20

Opening balance (4) 100 90 130 (30)

Closing balance (5 = 3 + 4) 90 130 (30) (10)

27

CASH FLOW FORECASTS

CASH FORECASTS: KEY ISSUES

• Identify key assumptions (e.g. sales, production, stock holding, debtor and creditor days)

• Consider your cost structure (variable, fixed costs etc)

• Do include ‘capital expenditure’ (e.g. new plant and equipment)

• Do include ‘financing’ cash flows (e.g. new loans, loan repayments, dividends)

• Don’t include non-cash items (e.g. depreciation)

28

EXERCISE:

CASH VERSUS PROFIT

Part A Profit Statement

On 1st April 2018, a manufacturing business will start trading. The business has the following manufacturing costs per unit:

In addition, excluding depreciation, the company will incur selling, general and administrative (‘S, G & A’) overheads of £4,000 per month. In addition, on 1st April 2018 the company will invest £120,000 in machinery and equipment which is expected to have a 5-year economic life, with a zero residual value. The depreciation on this machinery and equipment will be treated as an operating expense and not added to the cost of production.

The company has a selling price of £30 per unit.

The company expects to make and sell the following during the first 6 months of trading:

£

Materials 10

Labour 8

Manufacturing overheads 2

Total unit cost 20

Production quantity Sales quantity

April 1000 500

May 1000 600

June 1000 700

July 1000 800

August 1000 900

September 1000 1000

29

EXERCISE:

CASH VERSUS PROFIT

a) Using the table below, calculate the amount of profit which is expected to be generated by the business during the first 6 months of trading.

April

£000

May

£000

June

£000

July

£000

August

£000

Sept

£000

Total

£000

Sales Revenue

Cost of Sales

Gross Profit

S, G & A

Depreciation

Total expenses

Profit

30

EXERCISE:

CASH VERSUS PROFIT

Part B Cash Flow Forecast

Using the information on page 31 and the table below, calculate the amount of cash generated by the business for the first 6 months of trading.

April

£000

May

£000

June

£000

July

£000

August

£000

Sept

£000

Total

£000

Cash Receipts:

Owners’ investment

From customers

Total receipts

Cash Payments:

Materials

Labour

Manufacturing overheads

S, G and A

Capital expenditure

Total payments

Surplus/deficit

Opening balance

Closing balance

31

EXERCISE:

CASH VERSUS PROFIT

a) You are provided with the following further information relating to the cash flows for this business:

1. On 1st April 2018 the business will have a £50,000 balance on its bank account being the original amount invested by the owners of the business before it will start trading. The owners plan to invest a further £50,000 in the business during June 2018.

2. Materials, salaries and manufacturing overheads will be paid in the month in which they are incurred. The company will maintain no surplus stock of raw materials.

3. ‘S, G and A’ overheads are to be paid on one month’s credit terms.

4. Customers will be given 2 months’ credit.

5. The machinery and equipment will be paid for in April 2018.

b) What actions would you recommend this business should take to improve its cash flow performance? (Identify 3 - 5).

1.

2.

3.

4.

5.

32

NOTES

33

APPENDICIES

Appendix

Financial Performance Ratios Solution 1

Financial Status Ratios Solution 2

Cash v Profit Part A Profit Statement Solution 3

Cash v Profit Part B Cash Flow Forecast Solution 4

34

APPENDIX 1

Financial Performance Ratios Solution

a) Calculate profitability and efficiency ratios for Smith Ltd for 2016 and 2015.

2016 2015


54/(40+400) = 12.3%

50/(320+30) = 14.3%

Return on sales %

54/520 = 10.6%

50/420 = 11.9%

Gross margin %

120/510 = 23.5%

95/420 = 22.6%


510/(40+400) = £1.16

420/(30+320) = £1.20

35

APPENDIX 2

Financial Status Ratios Solution

a) Calculate liquidity and stability ratios for Smith Ltd for 2016.

2016 2015

Current ratio

180/70 = 2.6

150/50 = 3.0

Acid test

(180-110)/70 = 1.0

(150-90)/50 = 1.2

Gearing %

(40+10)/(40+10+400) = 11.1%

30/(30+320) = 8.6%

Interest cover

54/4 = 13.5 times

50/2 = 25.0 times

36

APPENDIX 3

Cash Versus Profit

Part A Profit Statement Solution

Workings:

1. Sales revenue = sales quantity x sales price

2. Cost of sales = sales quantity x unit cost

3. Depreciation = £120,000 / 5 years = £24,000 per annum = £2,000 per month

April

£000

May

£000

June

£000

July

£000

August

£000

September

£000

Total

£000

Sales Revenue 15 18 21 24 27 30 135

Cost of Sales (10) (12) (14) (16) (18) (20) (90)

Gross Profit 5 6 7 8 9 10 45

S, G & A (4) (4) (4) (4) (4) (4) (24)

Depreciation (2) (2) (2) (2) (2) (2) (12)

Total expenses

(6) (6) (6) (6) (6) (6) (36)

Profit (1) - 1 2 3 4 9

37

APPENDIX 4

Cash Versus Profit

Part B Cash Flow Forecast Solution

What improvements would you recommend to improve the cash performance of this

business?

1. negotiate better credit terms with suppliers (so we pay them later)

2. negotiate better credit terms with customers (so they pay soon)

3. improve management of stock of finished production (so less cash tied up in stock)

4. spread capital expenditure (e.g. by leasing equipment)

5. obtain more finance (e.g. from owners or via bank loan)

April

£000

May

£000

June

£000

July

£000

August

£000

September

£000

Total

£000

Cash Receipts:

Owners’ investment

50 50

From customers 15 18 21 24 78

Total receipts - - 65 18 21 24 128

Cash Payments:

Materials (10) (10) (10) (10) (10) (10) (60)

Labour (8) (8) (8) (8) (8) (8) (48)

Manufacturing overheads

(2) (2) (2) (2) (2) (2) (12)

S, G and A (4) (4) (4) (4) (4) (20)

Capital expenditure

(120) (120)

Total payments (140) (24) (24) (24) (24) (24) (260)

Surplus/deficit (140) (24) 41 (6) (3) - (132)

Opening balance

50 (90) (114) (73) (79) (82) 50

Closing balance (90) (114) (73) (79) (82) (82) (82)

38

NOTES

39

Matt Davies

Aston University

Matt is a Senior Teaching Fellow at Aston Business School

where he teaches accounting and finance modules on Aston’s

MBA, MSc and Executive Development programmes.

Since qualifying as a Chartered Accountant with PwC, Matt has

acquired more than 20 years of experience developing and

delivering financial training and education to students and

business managers.

In recent years he has focused on finance training and development for entrepreneurs.

Between 2011 and 2015 he was Deputy Director and Finance faculty-lead for the

Midlands-run Goldman Sachs 10,000 Small Businesses Programme, and continues to act

as Finance lead for the current UK-wide programme. Through this and similar

programmes, Matt has provided finance training and support for more than 500

entrepreneurs in the past 6 years.

Matt is currently leading an Erasmus+ project (funded by the European Commission) to

develop a digital ‘serious game’ aimed at developing the financial literacy of future

entrepreneurs (www.fefeproject.eu).

[email protected]

PROFILE

SCHEDULE

@AstonGrowth

#APFSBG

DATE EVENT VENUE

Mon 6th Nov 2017 Sustainable Business Birmingham Rep Theatre,

Broad St, Birmingham

B1 2EP

Thu 23rd Nov 2017

13:00-19:00

Leadership Techno Centre, Coventry

University Technology Park,

Puma Way, Coventry

CV1 2TT

Thu 30th Nov 2017

13:00-19:00

Marketing Strategies

Park Inn by Radisson Telford

Forgegate Telford Centre

TF3 4NA

Thu 7th Dec 2017 Cash flow Aston Business School

Birmingham

B4 7ET

Tue 9th Jan 2018

13:00-19:00

Culture and People Clayton Hotel (Previously

known as Hotel La Tour)

Albert Street, B’ham

B2 5EP

Mon 22nd Jan 2018 Pitching for Finance Growth TBC

Wed 24th Jan 2018

13:00-19:00

Operations and Processes Clayton Hotel B’ham

Albert Street

B2 5EP

Tue 6th Feb 2018

13:00-19:00

Options for External Finance Clayton Hotel B’ham

Albert Street

B2 5EP

Tue 27th Feb 2018

11:00-19:00

Presenting your Growth Strategy Clayton Hotel B’ham

Albert Street

B2 5EP

* To allow flexibility all additional workshops (highlighted in blue) will be run twice on the day

in question generally from 13:00-16:00 and 16:30-19:30. Please inform Faye Oliver of your

preferred time for planning purposes: [email protected]

Documents

WORKSHOP 3 FINANCE FOR THE BUSINESS LEADER › migrated-assets › applicationpdf › aston-b… · FINANCIAL PERFORMANCE RATIOS a) alculate profitability and efficiency ratios for