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General Business Topics General Business Topics

ELE 4EMTELE 4EMT

17 April, 200717 April, 2007George AlexanderGeorge AlexanderG.Alexander@latrobe.edu.auG.Alexander@latrobe.edu.auwww.latrobe.edu.au/eemanagewww.latrobe.edu.au/eemanage

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TopicsTopics

Business as a SystemBusiness as a System Business RequirementsBusiness Requirements Sources of FundsSources of Funds Business Finances/AnalysisBusiness Finances/Analysis Cost Accounting ObjectivesCost Accounting Objectives Elements of Product CostElements of Product Cost Fixed & Variable CostsFixed & Variable Costs Assets/depreciationAssets/depreciation

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TransformationProcess

InputsOutputs

Resources:•Human•Materials•Equipment•Financial•Information

Managerial:•Planning•Organisation•Leading•Controlling•Technology

Outcomes:•Products & services•Profit & loss•employees growth & satisfaction

Bartol – Management: A Pacific Rim Focus, McGraw-Hill, 2001

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Types of CapitalTypes of Capital

Working Capital - Required to finance the day-to-day Working Capital - Required to finance the day-to-day

running of the business.running of the business.

Long-term (Fixed) Capital - Required to finance the Long-term (Fixed) Capital - Required to finance the

purchase of assets which will, directly or indirectly, purchase of assets which will, directly or indirectly,

contribute to profit over a period of years.contribute to profit over a period of years.

When starting a business, all of this needs to be When starting a business, all of this needs to be

financed.financed.

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Sources of FundsSources of Funds

Shareholders’ funds (equity capital)Shareholders’ funds (equity capital) Loans from directorsLoans from directors Bank overdrafts & loansBank overdrafts & loans Trade & other creditorsTrade & other creditors Government grantsGovernment grants Venture capital companiesVenture capital companies Other loansOther loans

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What is Venture Capital ?What is Venture Capital ?

Venture capital (VC) is the process of investing private equity in companies, typically in early stages of development, that are believed to offer significant potential to grow substantially and reward investors accordingly.

Ref.: www.investorhome.com

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Objective of VCObjective of VC

The objective of VC is to generate high rates of return over long periods of time. VC offers institutional investors and high-net-worth individuals high returns (historically better than stocks) and strong diversification benefits from very low correlation with other asset classes.

Ref.: www.investorhome.com

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Negatives about VCNegatives about VC

The major negatives of investing in VC are:

• Long time frames,• Lack of liquidity, and• High management fees.

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NOTENOTE

1.1. Regardless of the source of funds, you will Regardless of the source of funds, you will need a convincing business plan to persuade need a convincing business plan to persuade investors to risk their money in your venture.investors to risk their money in your venture.

2.2. If things do go wrong, there will be a priority If things do go wrong, there will be a priority allocation of the remaining assets. You, the allocation of the remaining assets. You, the owners , will be last in line.owners , will be last in line.

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Need for Business AnalysisNeed for Business Analysis

The marketing concept stresses profitability as The marketing concept stresses profitability as well as consumer orientation.well as consumer orientation.

Marketing managers need to know how to Marketing managers need to know how to evaluate an organisation’s financial success.evaluate an organisation’s financial success.

The evaluation process requires a good The evaluation process requires a good understanding of financial statements and understanding of financial statements and performance ratios from a marketing perspective. performance ratios from a marketing perspective.

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Profit & Loss StatementProfit & Loss Statement

The basic equation for profit is:The basic equation for profit is:Profit = Sales - CostsProfit = Sales - Costs

Profit & Loss Statement shows an organisation’s sales Profit & Loss Statement shows an organisation’s sales revenues and costs over a given period, typically a revenues and costs over a given period, typically a year, quarter or month.year, quarter or month.

Note: Profit and Loss Statement is increasingly Note: Profit and Loss Statement is increasingly referred to as Statement of Financial Performance.referred to as Statement of Financial Performance.

A well-written statement can help in identifying the A well-written statement can help in identifying the areas of the business associated with profit or loss.areas of the business associated with profit or loss.

Assessment can be based on a division, department, Assessment can be based on a division, department, business unit, product line, etc.business unit, product line, etc.

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Example Profit & Loss StatementExample Profit & Loss Statement

Net Sales $ 707,500 Less cost of goods sold $ 340,000Gross Margin (gross profit) $ 367,500 Less operating expenses $ 325,500Net Profit $ 42,000

Note: Tax is calculated on the Net Profit

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Gross sales $730,500.00Less returns $15,200.00

Less allowances $7,800.00Total: $23,000.00

$707,500.00

Net salesLess cost of goods sold $340,000.00

Gross margin (Gross profit) $367,500.00

Less operating expensesMarketing expenses

Advertising $53,000.00Sales salaries $89,000.00

Delivery $18,000.00Total: $160,000.00

Administrative expensesOffice salaries $102,000.00Office supplies $9,600.00Miscellaneous $4,500.00

Total: $116,100.00

General espensesRent $43,000.00

Miscellaneous $6,400.00Total: $49,400.00

Total operating expenses $325,500.00

Net profit before taxes $42,000.00

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Performance RatiosPerformance Ratios

Return on Investment (refer last lecture)Return on Investment (refer last lecture) The gross margin percentageThe gross margin percentage The net profit percentageThe net profit percentage The operating expenses ratioThe operating expenses ratio Debt/Equity (Gearing) RatioDebt/Equity (Gearing) Ratio The stock turnover ratioThe stock turnover ratio

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The Gross Margin PercentageThe Gross Margin Percentage

The Gross Margin Percentage is the percentage of revenue available to cover expenses and provide profit after the cost of goods sold has been paid.

Gross Margin Percentage =Net Sales

Gross Margin

$707,500

$367,500= = 0.52 or 52%

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The Net Profit PercentageThe Net Profit Percentage

The Net Profit Percentage (Net Income ratio) identifies the percentage of profit from each sales dollar.

Net Profit Percentage =Net Sales

Net Profit

$707,500

$42,000= = 0.06 or 6%

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The Operating Expenses RatioThe Operating Expenses Ratio

The Operating Expenses Percentage is the percentage of operating expenses needed from each sales dollar.

Operating Expenses Ratio =Net Sales

Total Operating Expenses

$707,500

$325,500= = 0.46

or in percentage 46%

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Improving Net ProfitImproving Net Profit

Increasing pricesIncreasing prices Pricing objectivesPricing objectives Supply v demand, etc.Supply v demand, etc.

Reducing cost of goods soldReducing cost of goods sold Alternative sourcesAlternative sources Make or buy, etc.Make or buy, etc.

Reducing operating expensesReducing operating expenses Efficient use of resourcesEfficient use of resources Management policies, etc.Management policies, etc.

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Balance Sheet (Statement of Financial Position) as at …Balance Sheet (Statement of Financial Position) as at …

Current AssetsCurrent Assets

Cash at BankCash at Bank $8 000 $8 000

InventoryInventory $1 500 $1 500

Total Current AssetsTotal Current Assets $9 500 $9 500

Non-Current AssetsNon-Current Assets

EquipmentEquipment $5 000 $5 000

Total Non-Current AssetsTotal Non-Current Assets $5 000 $5 000

Total AssetsTotal Assets $14 500$14 500

Current LiabilitiesCurrent Liabilities

Accounts PayableAccounts Payable $4 000 $4 000

Total Current LiabilitiesTotal Current Liabilities $4 000 $4 000

Net AssetsNet Assets $10 500$10 500

Owner’s EquityOwner’s Equity

Owner - Capital Owner - Capital $10 500$10 500

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Debt/Equity (Gearing) RatioDebt/Equity (Gearing) Ratio

Sometimes referred to as ‘leverage’Sometimes referred to as ‘leverage’ Ratio of total debt to owners equityRatio of total debt to owners equity In the example balance sheetIn the example balance sheet

= 4000/10,500 = 38%= 4000/10,500 = 38%

The higher the ratio, the greater the risk of the The higher the ratio, the greater the risk of the company failing.company failing.

High gearing means high interest which still has High gearing means high interest which still has to be paid in times of business slowdown.to be paid in times of business slowdown.

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Break-Even CalculationsBreak-Even Calculations

The Break-Even Point is defined as the point at which The Break-Even Point is defined as the point at which costs and revenues meet (costs = revenue).costs and revenues meet (costs = revenue).

The concept is best described graphically, The concept is best described graphically, mathematically it is written as: mathematically it is written as:

Break-Even Point =Fixed Costs

Selling Price - Variable Costs

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Elements of Product CostElements of Product Cost

Direct materialDirect material Direct labourDirect labour Manufacturing overheadManufacturing overhead

Indirect material,Indirect material, Indirect labour,Indirect labour, Light and power,Light and power, Repair and maintenance, andRepair and maintenance, and Depreciation of equipment, etc.Depreciation of equipment, etc.

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Fixed & Variable CostsFixed & Variable Costs

Fixed CostsFixed Costs These are costs which do not vary with changes in These are costs which do not vary with changes in

the volume of production.the volume of production. Variable CostsVariable Costs

These are costs which vary proportionately with the These are costs which vary proportionately with the volume of production.volume of production.

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Break-Even Analysis

Revenue and cost $

Quantity of unitsproduce and sold

Areaof loss

Areaof profit

Break-even point

Loss Profit

Cost

Revenue

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Example Break-Even CalculationExample Break-Even Calculation

Suppose the following:

Selling price $ 10Variable cost $ 5Fixed cost $ 50,000

Break-Even Point =$ 50,000

$ 10 - $ 5= 10,000 units

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Interpretations of breakeven analysisInterpretations of breakeven analysis

The example showed how many units need to be sold The example showed how many units need to be sold in order to break evenin order to break even

The question then may be how long will it take to sell The question then may be how long will it take to sell that many units?that many units?

A more detailed method, based on time may need to be A more detailed method, based on time may need to be usedused

Note that the fixed costs and volume refer to a monthly Note that the fixed costs and volume refer to a monthly or annual rate. E.g. for an annual fixed cost, there will or annual rate. E.g. for an annual fixed cost, there will be an annual breakeven volume. be an annual breakeven volume.

‘‘Breakeven’ should not be confused with ‘payback’ Breakeven’ should not be confused with ‘payback’

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PaybackPayback

Payback can be expressed as the volume of product to be sold Payback can be expressed as the volume of product to be sold before the initial investment outlay is recoveredbefore the initial investment outlay is recovered

Initial outlay/Average unit profitInitial outlay/Average unit profit

E.g. $200,000/$2.00 = 100,000 unitsE.g. $200,000/$2.00 = 100,000 units Alternatively it can be expressed in time – Alternatively it can be expressed in time –

Initial outlay/(annual volume X average unit profit)Initial outlay/(annual volume X average unit profit)

E.g. $200,000/(50,000 X $2.00) = 2 yearsE.g. $200,000/(50,000 X $2.00) = 2 years

Payback is not highly regarded as a means of assessing an Payback is not highly regarded as a means of assessing an investment but does provide a simple guide.investment but does provide a simple guide.

(More detail available in ELE22EMT Economics Lecture 5)(More detail available in ELE22EMT Economics Lecture 5)

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Cost Accounting ObjectivesCost Accounting Objectives

To measure, for profit determination purposes:To measure, for profit determination purposes: The cost of goods manufactured, orThe cost of goods manufactured, or The cost of services performedThe cost of services performed

To measure the cost and thus the Balance Sheet value To measure the cost and thus the Balance Sheet value of inventories, which include:of inventories, which include: Raw materialsRaw materials Work in processWork in process Finished goodsFinished goods Store and suppliesStore and supplies

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Cost Accounting Objectives - ContinuedCost Accounting Objectives - Continued

To assist management in their planning and To assist management in their planning and decision making by reporting costs relevant to decision making by reporting costs relevant to decisions:decisions: Targeted volume,Targeted volume, Pricing levels,Pricing levels, Make or buy,Make or buy, Purchase or lease, andPurchase or lease, and Introducing or phasing out products, etc.Introducing or phasing out products, etc.

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Cost Accounting Objectives - ContinuedCost Accounting Objectives - Continued

To assist management in monitoring and To assist management in monitoring and controlling costs in order to ensure that, as far as controlling costs in order to ensure that, as far as possible, management strategies and plans are possible, management strategies and plans are implemented.implemented.

In summary, cost accounting objectives cater In summary, cost accounting objectives cater for:for: Requirements of financial accountingRequirements of financial accounting Management planning and control Management planning and control

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Why capitalise/depreciate?Why capitalise/depreciate?

Capital assets have an estimated useful lifetime.Capital assets have an estimated useful lifetime. Consequently, it would be misleading to account Consequently, it would be misleading to account

for the associated expenditure in just one for the associated expenditure in just one accounting period.accounting period.

As a result, the expenditure is accounted for over As a result, the expenditure is accounted for over the asset’s lifetime through depreciation.the asset’s lifetime through depreciation.

This also provides a basis for valuing the asset.This also provides a basis for valuing the asset. ATO requires that the asset expense deduction is ATO requires that the asset expense deduction is

claimed over the asset’s lifetime. claimed over the asset’s lifetime.

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DepreciationDepreciation

Capital investment in tangible fixed assets - equipment, Capital investment in tangible fixed assets - equipment, computers, vehicles, buildings, and machinery - are computers, vehicles, buildings, and machinery - are commonly recovered through depreciation.commonly recovered through depreciation.

Depreciation also referred to as Depreciation also referred to as capital recoverycapital recovery (US) (US) and and capital allowancecapital allowance (ATO) (ATO)

Visit Visit www.ato.gov.auwww.ato.gov.au - search for depreciation. - search for depreciation. The depreciation amount itself is not an actual cash The depreciation amount itself is not an actual cash

flow.flow.

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- cont.- cont.

The process of depreciating an asset accounts The process of depreciating an asset accounts for the decrease in an asset’s value because of for the decrease in an asset’s value because of age, wear, and obsolescence.age, wear, and obsolescence.

Depreciation is a tax-allowed deduction Depreciation is a tax-allowed deduction included in tax calculations.included in tax calculations.

Taxes = (income - deductions)(tax rate)Taxes = (income - deductions)(tax rate)

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Depreciation Terminology - cont.Depreciation Terminology - cont.

Salvage ValueSalvage Value The estimated trade-in or market value at the end of the The estimated trade-in or market value at the end of the

asset’s useful life.asset’s useful life. Market ValueMarket Value

The estimated amount realisable if the asset was sold The estimated amount realisable if the asset was sold on the open market.on the open market.

The market value and book value may be substantially The market value and book value may be substantially different.different.

Book ValueBook Value The remaining, undepreciated capital investment on the The remaining, undepreciated capital investment on the

books after subtracting all depreciation to date.books after subtracting all depreciation to date.

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Straight Line DepreciationStraight Line Depreciation

The book value decreases linearly with time.The book value decreases linearly with time. The depreciation rate, d = 1/n, is the same The depreciation rate, d = 1/n, is the same

each year of recovery period n.each year of recovery period n. It is considered the standard against which It is considered the standard against which

any depreciation model is compared.any depreciation model is compared. The annual SL depreciation is determined by:The annual SL depreciation is determined by:

(first cost - salvage value) d(first cost - salvage value) d

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ExampleExample

B = $50,000;B = $50,000;

““n” = 5 years;n” = 5 years;

S = $10,000 at t = 5;S = $10,000 at t = 5;

DDtt for each year is: for each year is:

($50,000 - $10,000)/5 = $8,000/year($50,000 - $10,000)/5 = $8,000/year

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10,00010,0008,0008,00055

18,00018,0008,0008,00044

26,00026,0008,0008,00033

34,00034,0008,0008,00022

$42,000$42,000$8,000$8,00011

BVBVttDDtttt

Table of ResultsTable of Results

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Useful ReferencesUseful References

The Small business handbook: how to start and The Small business handbook: how to start and successfully operate a small business, ISBN 1-86350-successfully operate a small business, ISBN 1-86350-004-9, Small Business Corporation (Vic.)004-9, Small Business Corporation (Vic.)

How companies work, ISBN 0-725-10689-1, Nicholas How companies work, ISBN 0-725-10689-1, Nicholas Brash, Timothy LindseyBrash, Timothy Lindsey

The Australian Taxation Office websiteThe Australian Taxation Office website http://www.business.vic.gov.au – Refer ‘Plan to http://www.business.vic.gov.au – Refer ‘Plan to

Succeed’.Succeed’.

Note: Please search for newer editions for the above referencesNote: Please search for newer editions for the above references

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Group PresentationsGroup Presentations

At this stage, it looks like these will take place At this stage, it looks like these will take place in Weeks 12 and 13 – beginning 21/5 and in Weeks 12 and 13 – beginning 21/5 and ending 30/5.ending 30/5.

We will use all lecture timeslots over these 2 We will use all lecture timeslots over these 2 weeks.weeks.

A detailed schedule will be provided beginning A detailed schedule will be provided beginning of May.of May.

As a general rule, the larger teams will present As a general rule, the larger teams will present earliest.earliest.

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Thanks for your attention