1 / 140

Understanding Business Finance Essentials

Learn the fundamentals of finance, including financial statements, investment decisions, and business financing. Explore key concepts of balance sheets, accrual vs cash flow, and income statements. Discover essential financial disciplines to manage your business effectively.

mstauffer
Download Presentation

Understanding Business Finance Essentials

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript


  1. 1

  2. What is Finance all about? Finance is about three things: • raising money • allocating it • controlling return on money invested • Spreadsheets and Finance

  3. Course Overview • Financial statements (1) • Revenues and Costs (nonfinancial) (2-3) • Net Working Capital Management (4) • Time Value of Money Concept (5) • Investment Decisions (6) • Responsibility centers and managerial accounting (7) • Financial ratios (8) • Business Financing (9) • Business Modelling and Forecasting (10) • Financial Disciplines (11)

  4. Books & Evaluation Rules • Books: • Brealey Richard A., Myers Stewart C.: Principles of Corporate Finance. McGraw-Hill, New York, 1996 (or any other edition, incl. Polish version) • Shim Jae K., Siegel Joel G.: Vest Pocket CEO. Prentice Hall, New York, 1992 (a very good Polish edition by ABC, 1999) • Atrill Peter, McLaney Eddie: Management Accounting for Decision Makers. Prentice Hall, Harlow, 2007. • Evaluation: • Written, in- class, closed books Exam, with 3 out of 4 topics to be discussed • Near to all topics will require both calculations and assessment of a problem challenged • After class assignments not graded at all but instrumental to succeed on the final exam

  5. Session One Topics • General concept of financial statements • Balance sheet • Accrual vs cash flow approach • Profit and Loss (Income) Statement • Cash Flow Statement • Brealey, Myers pp.

  6. Key financial questions • How much does the business own (at present, in the past, in near future)? • How much has the business earned (over a given period of time)? • How much it will earn in future? • The above indicated are key financial questions for every person but also enterprise, institution, government. • We will discuss almost exclusively non-financial businesses although some concepts apply to other types, too.

  7. Balance Sheet – key notions to remember • Assets: properties owned (now: or under control and with entitlement to key benefits): • Long-term (with useful life over 1 year): laptop. • Current (with useful life up to 1 year): enrolment. • Tangible: laptop. • Intangible: enrolment right. • Liabilities and equity: • Long-term (due later than within 1 year): Father’s loan and, by definition, equity. • Current (due within 1 year): instalments. • A Balance Sheet: a statement of properties and sources financing them

  8. Reasons why assets and liabilities have to be recorded separately • Even if we have a dual entry approach and transactions are not divisible their results are: • if granted a loan to purchase a specific equipment one cannot use the proceedings for other purpose, • however • when transaction is closed one has to repay a loan regardless the machine purpose and, of no specific arrangements are made, can do whatever it wishes with the equipment. • Both relations can be discontinued separately in a different time and circumstances.

  9. Accruals vs cash flow • In private life we tend to equalize revenues with cash inflows and costs with cash outflows, sometimes recognizing special character of investments (eg. nobody would treat creating a bank deposit as a cost albeit identifying it as a cash outflow). • In the least complex business activity it is a handy approach but: • even in such cases carries certain risk, • it would be dangerous in case of complex businesses.

  10. Reasons why not all costs are represented by cash outflows (1) • Long term assets will loose their value over time and eventually become useless (except for ground plots and some other specific items). • The above mentioned process may be long and involve very valuable items (f.e. a car) • Consequently we need a mechanisms to allocate expenses incurred to acquire them over pertain time. • We say, we „depreciate” them (amortise intangible assets, deplete natural resources)

  11. Reasons why not all costs are represented by cash outflows (2) • Commercial credit. • Concurrent services (eg. electricity, employment costs). • Deferred obligations and revenues (f.e. in construction business).

  12. Two financial statement addressing the issue of results • Income (Profit and Loss) Statement • Cash Flow Statement

  13. Income Statement – key notions to remember • Revenues: Cash inflows or other enhancements of assets (for example acceptance of services delivered) • Costs: use of assets attributable directly or indirectly to the revenues recognised • cash costs. • non-cash costs (DDA) • Income (gross): revenues – costs • Income tax(es): obligatory levies on income (but not VAT, stamp duties, etc.) • Income (net): Income (gross) – taxes

  14. Cash Flow Statement – key notions to remember (1) • Operational activities : • receipts from the sale of goods or services, • payments to suppliers for goods and services, • payments to employees or on behalf of employees, • buying Merchandise • some otherwise typically financial items if strictly connected with operational activities (eg. interests on delayed payments for services).

  15. Cash Flow Statement – key notions to remember (2) • Financial activities: • dividends paid (with tax if applicable), • sale or repurchase of the company's stock, • net borrowings, • interests paid & other borrowing costs (incl. certain leasing related payments), • repayment of debt principal, including capital leases. • Investing activities: • Payments resulting from purchase or sale of a long term asset (assets can be land, building, equipment, marketable securities, etc.) • Payments related to mergers and acquisition. • (Under certain regimes) loans made to suppliers or received from customers

  16. 2

  17. Session Two Topics • Revenues • Management accounting • Relevant costs • Cost allocation under full absorption

  18. Financial vs Managerial Accounting • Financial Accounting: • highly regulated • independent check of statements • accuracy oriented • backward perspective • generally external use • Managerial Accounting • company dependent • no direct independent control • speed oriented • onward perspective • generally internal use

  19. Financial vs Managerial AccountingFAQ • Financial Accounting: • what was the A’s equity at the date of? • What was the profit made over a period of? • Was the Company solvent at the closing date? • Managerial Accounting • shall we buy/sell a business segment? • shall we launch a new product line? • shall we increase/decrease prices? • is our cost level still competitive?

  20. Financial vs Managerial Accountingrelevant costs (items) • Financial Accounting: • only costs incurred matter • almost no estimates allowed • full absorption approach • no scenario analyses • Managerial Accounting • only future costs matter (sunk costs!!!) • estimates widely used • marginal costs approach • scenario analysis and hybrids (opportunity costs)

  21. A concept of revenue – definition and traps • Revenue defined as an increase in assets or decrease in liabilities that is caused by the provision of services or products to customers. • Under the accrual basis of accounting, revenue is usually recognized when goods are shipped or services delivered to the customer. Under the cash basis of accounting, revenue is usually recognized when cash is received from the customer following its receipt of goods or services. • Revenue vs cash inflow • Revenue vs price (rebates, discounts other provisions)

  22. A concept of cost – definition and use • Cost defined 1 = monetary value of economic resources used in performing an activity • Cost defined (measured) 2 = the amount of cash or cash equivalents paid or the fair value of the other consideration given to acquire an asset at the time of its acquisition (IAS 16) • Cost vs expense (very close to the second definition of a cost) • Cost vs price (quantity of payment or compensation given by one party to another in return for goods or services) • Cost vs investment (money committed or property acquired for future income)

  23. Typical costs items by origin • Remuneration (salaries, wages, fringe benefits) • Raw materials • Energy • External services • Taxes and duties allocated to costs (real estates tax, stamp duties but neither VAT nor excise tax • Depreciation, Depletion & Amortisation

  24. Cost absorption • Cost of goods sold • General costs (period costs) • Logically there should be no costs left after allocation (orphan costs) since ultimately every dollar spent has to be covered • The problem is that share of direct costs (naturally allocated) decreases while the one of general costs growths rapidly and in some most advanced and valuable businesses gets dominance

  25. Cost absorption • Profit = Revenues – costs • Revenues (excl. bounded sales) are always direct and objective • Costs must be fully allocated to products & services sold • Cost allocation is always to some extend subjective • According to various studies indirect costs account between 30-42 % of the total costs (Laney, Atrill, p. 316)

  26. Use of the full absorption approach • Long -term pricing • Long-term resource allocation • Financial accounting

  27. Cost allocation – types of costs • Direct vs indirect costs • Direct vs variable costs • raw material • wages • Indirect vs fixed costs • office rent

  28. Cost allocation – targets • Products (individual, group) • Business segments • Customers (individual, segments, markets)

  29. Typical manufacturing processes • Job order • order • batch • assembly • Process • process (often with joint products issue)

  30. Cost allocation – job order • Cost pools • Overheads • For one-factory firm: typically two levels: factory shared services + supporting activities • For international corporations: multilayer structure

  31. Cost allocation – job order • Cost drivers: • Typically related to the time used • e.g. machine hours (production lines) • e.g. employees’ working hours (services) • A need for standardized (normative) costing: otherwise forecasting ability non-existent • Process costing skipped as too complicated atthis level

  32. Cost allocation – exercises • Atrill Activity 10.5 • Atrill Exercise 10.6 (Homework)

  33. Cost allocation – Critique of conventional costing • Not a tool to analyse overheads: a growing portion of total costs • Inability to provide analytical background in responding key strategic and operational questions: • shall we enter a new market (say Ukraine)? • shall we keep servicing this very group of customers (say students?)

  34. 3

  35. Session Three Topics • Fundaments of ABC costing • Applications of ABC costing

  36. Cost allocation – Rising share of overheads

  37. Cost allocation – A(ctivity) B(ased) C(osting) • Fundamental questions underlying ABC • What activities are being performed? • What resources are used in these activities? • How much do these resources cost? • What really drives these costs (activity drivers)?

  38. ABC vs. conventional costing – cost drivers

  39. ABC vs. conventional costing – Example (1) An inbound warehouse employs 12 people with the total cost (not limited to labour cost) of 20 000 USD: first stage cost driver = number of employees receiving parts – requires 6 employees so cost is 10 000 USD;second stage allocation basis is number of shipments of purchased parts (250 per month)receiving raw material – requires 3 employees so cost is 5 000 USD;second stage allocation basis is number of shipments of raw materials (50 per month)distributing material – requires 3 employees so cost is 5 000 USD;second stage allocation basis is number of production runs (200 per month)

  40. ABC vs. conventional costing – Example (2) Stage 2    Remove costs from activity cost pools and assign to products using second stage cost drivers:receiving purchased parts        10 000 USD/250 = 40 USD per shipmentreceiving raw material               5 000 USD/50 = 100 USD per shipmentdistributing materialrun 5 000 USD/200=25 USD per run For product A, the 100 produced require 200 purchased part shipments, 40 raw material shipments and 100 production runs. The direct labour requirement is 2 000 hrs. For product B, the 2 000 produced require 50 purchased part shipments, 10 raw material shipments and 100 production runs. The direct labour requirement is 3 000 hrs.

  41. ABC vs. conventional costing – Example (3) If we use this information to compute conventional cost allocation, we see the following results:  Warehouse (indirect) cost is 20 000 USD allocated to 5 000 hrs gives 4 USD/hr, what translates into: for product A: 2000hr/100*4 USD = 80 USD/unit; for product B: 3000 hrs/2000*4USD =6 USD/unit If we use this information to compute the ABC cost based, we see the following results:   A Parts receipt200 * 40 USD =  8 000 USD Raw material receipt40 * 100 USD = 4 000 USDDistributing material   100 * 25 USD =  2 500 USD 14 500/100 = 145 USD per unit B Parts receipt50 * 40 USD =    2 000 USD Raw material receipt10 * 100 USD = 1 000 USDDistributing material   100 * 25 USD =  2 500 USD 5 500 USD/2000 = 2,75 USD per unit

  42. ABC – sources of differences to conventional costing • Complexity (more operations – more costs) – an example of newspapers attachments • Volume (large vs. small batches) • Size of products – an example of packaging line • Value of fixed assets used

  43. ABC – advantages for services • Minimal level of variable and small of direct costs • Focus on customers rather than on products • Products definition very complex, flexible and customized • High operational gearing

  44. ABC – advantages for services This enabled managers to examine indirect cost in more detail. For example, consider this example from an order processing department: Using the traditional costing system, the question that managers would ask was: Why was £74,000 spent on travel?Using ABC, the new question is: Why was £35,000 spent on resolving problems?

  45. Cost allocation – Homework Exercise 11-1 in Excell

  46. Cost allocation – exercises Buccaneers

  47. 4

  48. Session Four Topics • Net Working capital • Current assets and liabilities • Balancing NWC management

  49. (Net) Working Capital: Introduction to • Revenues (accrual) not settled turn into accounts receivables • other accounts receivables are f.e. advances paid for supplies. • Supplies (of labour, raw materials) received but not settled turn into accounts payable • other accounts payable are f.e. advances received. • Raw materials, semi - products & products not sold turn into stock.

  50. Net Working Capital on a balance sheet

More Related