Prague , 20.03.2014

1. The Cost Calculationunder Inflationary Conditions. The Impact of Inflationary Profit.(The Example of a Tourist Company) Prague, 20.03.2014

2. Definitions Inflation (wikipedia) isa sustained increase inthe general price level of goods and services in an economy over a period of time

3. In terms of inflation … • the real value of products is unchangedinflation is not a process that changes real value of goods (example – an apple) • what is changing it is the nominal expression of the value • we observe this process as increase of prices

4. Q1 - what is the reason of inflation? • no need to answer • what we analyze are not reasons of inflation in economy • we analyze the impact of inflation on the costs calculation in enterprises

5. Q2 - what for studying problems of inflation if it is so low today? • majority world economies run today under inflation • inflation is such a process in economy that it can rocket very quickly • inflation rate in Czech Republic during last 10 years

6. no one can assure that in the near future inflation rate in your economy will not jump • we should be prepared for such situation studying the problem of inflation

7. Definitions (2) • Inflationary profit for a company is such a profit that is resulting only from changes of nominal values of products during inflation period • seniorage – inflationary profit for a government

8. Profit in P&L • profit from activity (real profit) • profit from inflation (nominal, not real)

9. Example • we have 100.000Ckr • we buy 100 shirts at 1000 Ckr/shirt • we sale 100 shirts at 1050Ckr/shirt • We have 105.000 Ckr

10. Was this transaction profitable? • Yes • No

11. Yes • Sale 105.000 CKr • Costs of sold products: 100.000 CKr • Profit (105.000 – 100.000): 5.000 CKr

12. No Czech Republic in 2008 • price of 1 shirt was = 1000 CKr • price of 1 shirt is = 1080 CKr • we had money = 100 shirts • we have money = 97 shirts

13. Tax office and inflationary profit Tax office does not recognize inflationary profit Tax office works with nominal values Tax office recognize inflationary profit as real one Profit means income tax

14. We lost twice • First – we cannot renew our stock of shirts • Second – we must pay income tax

15. Recapitulation“Inflationary profit’’ • such a profit that is the result only of inflationary processes in national economy • results from differences between nominal and real value of goods (assets) • an inseparable part of the whole profit in P&L • deforms the real profitability of companies (deforms information to managers and investors) • results in increased outflow of cash from the company (income tax)

16. Definitions (3) • Cost calculation is a process which aims to provide the management of a company with information on: - the value of expenditures (costs) incurred to produce a product (service) - the profitability of the product (service)

17. Cost calculation • an indispensable tool in management decision being madein a company • helps them decide what services to provide on market • informs how profitable services are

18. Cost calculation as a chart • Name of a product • List of costs burdened on a service: - depreciation - labor costs - raw materials - transportation ================ Total costs • Price of a service ================ • Profit

19. The impact of inflation on depreciation costs • depreciation of fixed assets is a very important component of the cost calculation of a hotel service • up to 30-50% of total costs

20. How is depreciation calculated ? • on the basis of the depreciation rate = specified percentage of an asset value • asset is valued as of the date of its purchase, or after putting a facility into use after an investment period • asset is valued in nominal terms and during inflation it can not be changed

21. Depreciationand deformation of costs calculation in terms of inflation • difference between nominal and real value = inflationary profit • inflationary profit = underestimated value of costs • underestimated value of costs = deformed real profitability of sale

22. Figure 1 Creation of inflationary profit from underestimated depreciation V Vn V0 Pi Vr V1 t1 0 t t – the axis of time V – the axis of value Vo – the nominal value of depreciation in t0 point Vn – the nominal value of depreciation Vr – the real value of depreciation V1 – the real value of depreciation in t1 point t1 – succeeding period of depreciation Pi – the value of inflationary profit = the value of underestimated depreciation Source: own elaboration

23. Scientists thesis“Inflationary profit – a result of assets’ nominal value deformation” • inflationary profit was a result of underestima-ted depreciation • depreciation is a result of fixed assets possession

24. Cash reserves and inflationary profit • customers pay in advance (pre-payment) • banking deposits make income (profit) in the form of interest paid by banks • firms calculate such interest as an additional profit of a service

25. Irving Fisher equation • relation between inflation rate and rate of interest • 1930 - “The Theory of Interest” In = Ir + f • decrease of real value of deposit must be paid

26. Figure 2Creation of inflationary profit from cash deposits V Vni V1 Pi = f Vri Pr = Ir Vno Vo f= Pi Vro 0 t1 t t – the axis of time V – the axis of value V0 – the initial value of the cash deposit Vno – the nominal value of the cash deposit (interest excluded) Vni – the nominal value of cash deposit (interest included) Vro – the real value of the cash deposit (interest excluded) Vri – the real value of the cash deposit (interest included) t1 – day of the expiry of the cash deposit V1 – the nominal value of the cash deposit in t1 point Pi – the inflationary profit in t1 point Pr – the real profit In t1 point = the real value of interest Source: ownelaboration

27. Conclusion the part of the interest value corresponding to the rate of inflation is nothing else but an inflationary profit financial income during inflation is overestimated in real terms – it deforms costs calculation of services

28. Can a price of a productcreate the inflationary profit? • inflationary profit is created by changes of nominal value of an asset • what an asset is connected with the price of a product

30. Receivables • How they occur ? • the nominal value of a price (a receivable) is specified in a contract or in an invoice. • can not be changed (during inflation) • but during inflation real value of a receivable is declining

31. How the inflationary profit is created? • difference between nominal and real value of an asset = inflationary profit • there is difference between nominal and real value of receivables • inflationary profit must be created

32. Figure 3 Creation of inflationary profit from receivables V Vn Pi Vr Vo V1 f Vr 0 t1 t t – the axis of time V – the axis of value Vo – the nominal and real value of a receivable in t0 point (non-inflationary conditions Vn – the nominal value of a receivable (inflationary conditions) Vr – the real value of a receivable (inflationary conditions) V1 – the real value of a receivable in t1 point t1 – day of payment of a receivable Pi – the value of inflationary profit Source: own elaboration

33. Final summary • In terms of inflation – the nominal profitability of products is increased (overestimated) - managers of enterprises should know it • The part of profit, that is a result of inflationary process, is called “inflationary profit”

34. Inflationary profit distorts costs calculations in 3 ways : - First, it distorts the actual revenue from sale (prices) - Second, it distorts the real level of cost burdens - Third, it changes the actual amount of the company’s tax burden (income tax), which under non-inflationary conditions is not part of the cost calculation. In terms of inflation the tax effects of inflationary profit must be taken into consideration • Inflationary profit can constitute up to 40% of total profit in P&L (acc. American scientists)

35. Thank you www.robertsobkow.weebly.com r.sobkow@interia.pl