Understanding Business Numbers YR20

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Understanding Business NumbersYR20

• Researcher Timo Einari Toivonen
• Business and Innovation Development
• Turku School of Economics
• 5.11.2008

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Business and Innovation Development BID

• A new special unit of TSE
• A leading expert of knowledge-intensive business,
  innovation and entrepreneurship
• A leading actor in creating Turku Innovation
  Platform
• Research with Innovation Potential
• Research on innovation and entrepreneurship
• Education and training
• Business Development, e.g.
• Business Development Laboratory

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Objectives of business numbers

• To deliver an initial understanding of financial
  information in a business context
• To be able to understand how financial numbers
  are constructed in business plans

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The Business Process
INPUT WORK RAW MATERIAL SERVICES MACHINERY BUILDIN
GS LAND SHARES INTANGIBLES
OUTPUT PRODUCTS SERVICES
REAL PROCESS
CASH
CASH IN
CASH OUT
CASH PROCESS
FIN. RETURN
CAPITAL INPUT EQUITY OWN CAPITAL DEBT
CAPITAL REPAYMENT
CASH FOR PROFITS INTEREST TAX DIVIDENDS
PROFITABILITY ABILITY TO PAY THE OPPORTUNITY
COST TO EQUITY
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What do we measure?

• The extent of operations
• Usually measured as turnover
• The profitability of operations
• Several ratios for various accounting situations
• The financial solidity of the firm
• Comparison of equity and debt as sources of
  finance
• Risk of financial structure
• The financial liquidity of the firm
• Some ratios that tell what you can pay with
  liquid assets
• Some ratios that tell how capital is tied to
  cash, inventories etc
• Productivity
• Information about the efficiency of personnel and
  capital usage

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PROFITABILITY Profit-and-Loss-Statement

• Based on principle Turnover starts and then one
  deducts costs OF TURNOVER in a certain order,
  first short-term
• Prepared at least once a year (quartal economy
  says 4 times a yeaR, internally perhaps once a
  month)
• External reporting heavily structured
• Accounting Law (IFRS)
• Company Act
• Tax laws
• etc
• Objective of P-L-S inform owners how much profit
  they can take out without lowering their capital
  input (owners might also seek increase in
  shareholder value)
• Pitfall in SMES!!! entrepreneurial compensation

• TURNOVER
• VARIABLE COST OF GOODS SOLD (labour, raw-mat.,
  etc)
• FIXED COST (rents, insurance. Admin, marketing,
  etc. )
• OPERATING MARGIN
• DEPRECIATION(need to invest to maintain capacity)
• OPERATING PROFIT
• INTEREST
• TAX
• NET PROFIT

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Financial Position Balance Sheet

• Balance Sheet informs about the financial
  structure at the end of the accounting year
• BS records SOURCES (CREDIT) and USES (DEBIT) of
  funds
• BS is the technical device that conveys the
  previous year into the next one
• The future IFRS-standard will introduce also
  expectation values into BS (brand values etc)

• The Balance Sheet

• FIXED ASSETS
• equipment, space, land,
• shares etc.
• intangibles
• VARIABLE ASSETS
• inventory, w-i-p
• accounts receivable
• cash other liquid assets

• EQUITY
• basic equity
• funds
• retained earnings
• period profit
• DEBT
• long term
• short term

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Usage of balance sheet
ANNUAL REPORT
NEXT YEAR
TAXES DIVIDENDS SHAREHOLDER VALUE
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Uses and sources of funds (cash flow)
USF is a report that shows how far cash inlays
from sales can finance the cash outlays. The
statement is compulsory for larger companies.

• CASH FROM OPERATIONS
• Turnover -/ change in accounts receivable
• (variable and fixed cost) -/ (change in
  inventories) /- change in acc.payable
• (interest tax)
• NET CASH FROM OPERATIONS

CASH FROM INVESTMENT Fixed Assets t1
Depreciation Fixed Assets t0 NET CASH FROM
INVESTMENT

CASH FROM LONG TERM CAPITAL Net change of
long-term debt Net change of equity CHANGE OF
CASH BALANCE
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ASSESSING PROFITABILITY

• RATIOS CALCULATED USING PROFIT-AND-LOSS STATEMENT
• OPERATING MARGIN (EBITDA) (OPERATING MARGIN /
  TURNOVER) 100
• Good indicator of short-term profitability, easy
  to compute
• Sufficient level dependent on industry 10
  generally satisfactory
• OPERATING PROFIT (EBIT) (OPERATING PROFIT /
  TURNOVER) 100
• informs about the firms ability to cover the
  cost of long-term assets, too
• also heavily dependent on industry (5 10 )
• NET RESULT (NET PROFIT) (NET PROFIT /
  TURNOVER) 100
• indicates if all means of production have been
  properly compensated and what percentage of
  turnover could be paid to the owners as dividends
• should be positive ( industry dependent, 0- 10
  )
• PROFITABILITY RATIOS THAT ALSO OBSERVE CAPITAL
  EMPLOYED
• RETURN ON INVESTED CAPITAL (((NET RESULT
  INTEREST TAXES)/((BALANCE SHEET TOTAL)
  (NON-INTEREST-PAYING SHORT-TERM LIABILITIES)))
  100
• most informative and comprehensive measure
• sufficient level dependent on company
  development needs market value of share capital
  opportunity cost competition

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ASSESSING PROFITABILITY

• PROFITABILITY RATIOS THAT ALSO OBSERVE CAPITAL
  EMPLOYED
• ROI (Return On Investment)

((EBITDA / SALES) (SALES / INVESTED CAPITAL))
100 PROFITAB ILITY OF SALES ASSET TURNOVER
RATIO

• traditional and widely used measure that also
  tells about the structure of profit making
• it shows that efficient asset management is
  equally important as price/cost relations
• typical in large company management accounting
  profit centre objective is often defined as a
  certain level of ROI
• INVESTED CAPITAL is typically measured in
  current prices
• Guidance for target level lowest cost of debt
  highest strategic target of the firm
• also called duPont after the firm that first
  employed it

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FINANCE ratios 1

• SOLIDITY
• SOLIDITY (equity / (equity debt))
• indicates how safely the firm has financed its
  fixed and variable assets
• equity is considered safe, debt is regarded as
  more risky
• over 50 is generally OK, a much smaller
  percentage as risky
• GEARING (debt / equity)
• a popular measure that is often unstable and
  hard to interpret
• RELATIVE INDEBTEDNESS (total debt / turnover)
• measures, how heavily debt maintenance burdens
  turnover
• again heavily industry-dependent, life science
  business means extremely high values, mature
  service business perhaps regards 10-20 per cent
  as a good value
• LIQUIDITY
• QUICK RATIO (accounts receivable cash) /
  short-term debt
• ability to pay short term debt with liquid
  resources
• value 1.0 or greater is considered OK
• CURRENT RATIO (variable assets / short term
  debt)

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FINANCE ratios 2

• RATIOS DETERMINING THE LEVEL OF NET WORKING
  CAPITAL
• AVERAGE PAYMENT OF ACCOUNTS RECEIVABLE (days)
  (Accounts Receivable t1 / Turnover) 365
• Determines the average amount of investment tied
  up by sales
• Important With turnover growth, this tends to
  grow accordingly, representing hidden,
  non-disclosed investment
• AVERAGE PAYMENT OF ACCOUNTS PAYABLE (days)
  (Accounts Payable / Annual Purchases) 365
• AVERAGE NUMBER OF DAYS IN INVENTORY 365 /
  (Average Inventory Turnover)
• NET WORKING CAPITAL (Variable Assets)
  (Short-term liabilities)
• The amount of variable assets that has been
  financed with long-term sources of funds
• A very important item to consider NWC increase
  challenges the liquidity especially in
  fast-growing firms
• Indicates also, how efficient the management of
  short-term financing and logistics is

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Productivity

• Productivity is a measure that tells how much
  value-added personnel and/or capital bring to the
  company

TURNOVER
TURNOVER / PERSON VALUE-ADDED PER
PERSON VALUE-ADDED PER WAGES VALUE-ADDED PER
CAPITAL EMPLOYED
EXTERNAL PURCHASES
VALUE ADDED
WAGES RENTS
OPERATING MARGIN
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Growth impacts Finance
OPERATING MARGIN
NET WORKING CAPITAL
INTEREST
TAXES
DIVIDEND
INVESTMENT DIVESTMENT
/-CHANGE OF RECEIVABLES
/- CHANGE OF INVENTORIES
-/ CHANGE OF PAYABLES
Capital input
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Business Plan

• Usually constructed
• Profit-and-Loss statement t1 t5
• Balance Sheet t1 t5
• Cash Flow forecast t1 t5
• The Objective of this is
• to make sure that there is enough finance to fund
  the development of the company or
• To support the finance strategy of the company
• Venture funding rounds
• MA situations
• To observe the development of shareholder value
• To benchmark