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General Business Topics ELE 4EMT

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General Business Topics ELE 4EMT

  1. 1. General Business Topics ELE 4EMT 17 April, 2007 George Alexander [email_address] www.latrobe.edu.au/eemanage
  2. 2. Topics <ul><li>Business as a System </li></ul><ul><li>Business Requirements </li></ul><ul><li>Sources of Funds </li></ul><ul><li>Business Finances/Analysis </li></ul><ul><li>Cost Accounting Objectives </li></ul><ul><li>Elements of Product Cost </li></ul><ul><li>Fixed & Variable Costs </li></ul><ul><li>Assets/depreciation </li></ul>
  3. 3. Transformation Process Inputs Outputs <ul><li>Resources: </li></ul><ul><li>Human </li></ul><ul><li>Materials </li></ul><ul><li>Equipment </li></ul><ul><li>Financial </li></ul><ul><li>Information </li></ul><ul><li>Managerial: </li></ul><ul><li>Planning </li></ul><ul><li>Organisation </li></ul><ul><li>Leading </li></ul><ul><li>Controlling </li></ul><ul><li>Technology </li></ul><ul><li>Outcomes: </li></ul><ul><li>Products & services </li></ul><ul><li>Profit & loss </li></ul><ul><li>employees growth & satisfaction </li></ul>Bartol – Management: A Pacific Rim Focus, McGraw-Hill, 2001
  4. 4. Types of Capital <ul><li>Working Capital - Required to finance the day-to-day running of the business. </li></ul><ul><li>Long-term (Fixed) Capital - Required to finance the purchase of assets which will, directly or indirectly, contribute to profit over a period of years. </li></ul><ul><li>When starting a business, all of this needs to be financed. </li></ul>
  5. 5. Sources of Funds <ul><li>Shareholders’ funds (equity capital) </li></ul><ul><li>Loans from directors </li></ul><ul><li>Bank overdrafts & loans </li></ul><ul><li>Trade & other creditors </li></ul><ul><li>Government grants </li></ul><ul><li>Venture capital companies </li></ul><ul><li>Other loans </li></ul>
  6. 6. 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
  7. 7. Objective 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
  8. 8. Negatives about VC <ul><li>The major negatives of investing in VC are: </li></ul><ul><li>Long time frames, </li></ul><ul><li>Lack of liquidity, and </li></ul><ul><li>High management fees. </li></ul>
  9. 9. NOTE <ul><li>Regardless of the source of funds, you will need a convincing business plan to persuade investors to risk their money in your venture. </li></ul><ul><li>If things do go wrong, there will be a priority allocation of the remaining assets. You, the owners , will be last in line. </li></ul>
  10. 10. Need for Business Analysis <ul><li>The marketing concept stresses profitability as well as consumer orientation. </li></ul><ul><li>Marketing managers need to know how to evaluate an organisation’s financial success. </li></ul><ul><li>The evaluation process requires a good understanding of financial statements and performance ratios from a marketing perspective. </li></ul>
  11. 11. Profit & Loss Statement <ul><li>The basic equation for profit is: </li></ul><ul><li>Profit = Sales - Costs </li></ul><ul><li>Profit & Loss Statement shows an organisation’s sales revenues and costs over a given period, typically a year, quarter or month. </li></ul><ul><li>Note: Profit and Loss Statement is increasingly referred to as Statement of Financial Performance. </li></ul><ul><li>A well-written statement can help in identifying the areas of the business associated with profit or loss. </li></ul><ul><li>Assessment can be based on a division, department, business unit, product line, etc. </li></ul>
  12. 12. Example Profit & Loss Statement Net Sales $ 707,500 Less cost of goods sold $ 340,000 Gross Margin (gross profit) $ 367,500 Less operating expenses $ 325,500 Net Profit $ 42,000 Note: Tax is calculated on the Net Profit
  13. 14. Performance Ratios <ul><li>Return on Investment (refer last lecture) </li></ul><ul><li>The gross margin percentage </li></ul><ul><li>The net profit percentage </li></ul><ul><li>The operating expenses ratio </li></ul><ul><li>Debt/Equity (Gearing) Ratio </li></ul><ul><li>The stock turnover ratio </li></ul>
  14. 15. The 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%
  15. 16. The 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%
  16. 17. The 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%
  17. 18. Improving Net Profit <ul><li>Increasing prices </li></ul><ul><ul><li>Pricing objectives </li></ul></ul><ul><ul><li>Supply v demand, etc. </li></ul></ul><ul><li>Reducing cost of goods sold </li></ul><ul><ul><li>Alternative sources </li></ul></ul><ul><ul><li>Make or buy, etc. </li></ul></ul><ul><li>Reducing operating expenses </li></ul><ul><ul><li>Efficient use of resources </li></ul></ul><ul><ul><li>Management policies, etc. </li></ul></ul>
  18. 19. <ul><li>Balance Sheet (Statement of Financial Position) as at … </li></ul><ul><li>Current Assets </li></ul><ul><li>Cash at Bank $8 000 </li></ul><ul><li>Inventory $1 500 </li></ul><ul><li>Total Current Assets $9 500 </li></ul><ul><li>Non-Current Assets </li></ul><ul><li>Equipment $5 000 </li></ul><ul><li>Total Non-Current Assets $5 000 </li></ul><ul><li>Total Assets $14 500 </li></ul><ul><li>Current Liabilities </li></ul><ul><li>Accounts Payable $4 000 </li></ul><ul><li>Total Current Liabilities $4 000 </li></ul><ul><li>Net Assets $10 500 </li></ul><ul><li>Owner’s Equity </li></ul><ul><li>Owner - Capital $10 500 </li></ul>
  19. 20. Debt/Equity (Gearing) Ratio <ul><li>Sometimes referred to as ‘leverage’ </li></ul><ul><li>Ratio of total debt to owners equity </li></ul><ul><li>In the example balance sheet </li></ul><ul><ul><ul><li>= 4000/10,500 = 38% </li></ul></ul></ul><ul><li>The higher the ratio, the greater the risk of the company failing. </li></ul><ul><li>High gearing means high interest which still has to be paid in times of business slowdown. </li></ul>
  20. 21. Break-Even Calculations <ul><li>The Break-Even Point is defined as the point at which costs and revenues meet (costs = revenue). </li></ul><ul><li>The concept is best described graphically, mathematically it is written as: </li></ul>Break-Even Point = Fixed Costs Selling Price - Variable Costs
  21. 22. Elements of Product Cost <ul><li>Direct material </li></ul><ul><li>Direct labour </li></ul><ul><li>Manufacturing overhead </li></ul><ul><ul><li>Indirect material, </li></ul></ul><ul><ul><li>Indirect labour, </li></ul></ul><ul><ul><li>Light and power, </li></ul></ul><ul><ul><li>Repair and maintenance, and </li></ul></ul><ul><ul><li>Depreciation of equipment, etc. </li></ul></ul>
  22. 23. Fixed & Variable Costs <ul><li>Fixed Costs </li></ul><ul><ul><li>These are costs which do not vary with changes in the volume of production. </li></ul></ul><ul><li>Variable Costs </li></ul><ul><ul><li>These are costs which vary proportionately with the volume of production. </li></ul></ul>
  23. 24. Break-Even Analysis Revenue and cost $ Quantity of units produce and sold Area of loss Area of profit Break-even point Loss Profit Cost Revenue
  24. 25. Example Break-Even Calculation Suppose the following: Selling price $ 10 Variable cost $ 5 Fixed cost $ 50,000 Break-Even Point = $ 50,000 $ 10 - $ 5 = 10,000 units
  25. 26. Interpretations of breakeven analysis <ul><li>The example showed how many units need to be sold in order to break even </li></ul><ul><li>The question then may be how long will it take to sell that many units? </li></ul><ul><li>A more detailed method, based on time may need to be used </li></ul><ul><li>Note that the fixed costs and volume refer to a monthly or annual rate. E.g. for an annual fixed cost, there will be an annual breakeven volume. </li></ul><ul><li>‘ Breakeven’ should not be confused with ‘payback’ </li></ul>
  26. 27. Payback <ul><li>Payback can be expressed as the volume of product to be sold before the initial investment outlay is recovered </li></ul><ul><li>Initial outlay/Average unit profit </li></ul><ul><li>E.g. $200,000/$2.00 = 100,000 units </li></ul><ul><li>Alternatively it can be expressed in time – </li></ul><ul><li>Initial outlay/(annual volume X average unit profit) </li></ul><ul><ul><li>E.g. $200,000/(50,000 X $2.00) = 2 years </li></ul></ul><ul><li>Payback is not highly regarded as a means of assessing an investment but does provide a simple guide. </li></ul><ul><ul><li>(More detail available in ELE22EMT Economics Lecture 5) </li></ul></ul>
  27. 28. Cost Accounting Objectives <ul><li>To measure, for profit determination purposes: </li></ul><ul><ul><li>The cost of goods manufactured, or </li></ul></ul><ul><ul><li>The cost of services performed </li></ul></ul><ul><li>To measure the cost and thus the Balance Sheet value of inventories, which include: </li></ul><ul><ul><li>Raw materials </li></ul></ul><ul><ul><li>Work in process </li></ul></ul><ul><ul><li>Finished goods </li></ul></ul><ul><ul><li>Store and supplies </li></ul></ul>
  28. 29. Cost Accounting Objectives - Continued <ul><li>To assist management in their planning and decision making by reporting costs relevant to decisions: </li></ul><ul><ul><li>Targeted volume, </li></ul></ul><ul><ul><li>Pricing levels, </li></ul></ul><ul><ul><li>Make or buy, </li></ul></ul><ul><ul><li>Purchase or lease, and </li></ul></ul><ul><ul><li>Introducing or phasing out products, etc. </li></ul></ul>
  29. 30. Cost Accounting Objectives - Continued <ul><li>To assist management in monitoring and controlling costs in order to ensure that, as far as possible, management strategies and plans are implemented. </li></ul><ul><li>In summary, cost accounting objectives cater for: </li></ul><ul><ul><li>Requirements of financial accounting </li></ul></ul><ul><ul><li>Management planning and control </li></ul></ul>
  30. 31. Why capitalise/depreciate? <ul><li>Capital assets have an estimated useful lifetime. </li></ul><ul><li>Consequently, it would be misleading to account for the associated expenditure in just one accounting period. </li></ul><ul><li>As a result, the expenditure is accounted for over the asset’s lifetime through depreciation. </li></ul><ul><li>This also provides a basis for valuing the asset. </li></ul><ul><li>ATO requires that the asset expense deduction is claimed over the asset’s lifetime. </li></ul>
  31. 32. Depreciation <ul><li>Capital investment in tangible fixed assets - equipment, computers, vehicles, buildings, and machinery - are commonly recovered through depreciation. </li></ul><ul><li>Depreciation also referred to as capital recovery (US) and capital allowance (ATO) </li></ul><ul><li>Visit www.ato.gov.au - search for depreciation. </li></ul><ul><li>The depreciation amount itself is not an actual cash flow. </li></ul>
  32. 33. - cont. <ul><li>The process of depreciating an asset accounts for the decrease in an asset’s value because of age, wear, and obsolescence. </li></ul><ul><li>Depreciation is a tax-allowed deduction included in tax calculations. </li></ul><ul><li>Taxes = (income - deductions)(tax rate) </li></ul>
  33. 34. Depreciation Terminology - cont. <ul><li>Salvage Value </li></ul><ul><ul><li>The estimated trade-in or market value at the end of the asset’s useful life. </li></ul></ul><ul><li>Market Value </li></ul><ul><ul><li>The estimated amount realisable if the asset was sold on the open market. </li></ul></ul><ul><ul><li>The market value and book value may be substantially different. </li></ul></ul><ul><li>Book Value </li></ul><ul><ul><li>The remaining, undepreciated capital investment on the books after subtracting all depreciation to date. </li></ul></ul>
  34. 35. Straight Line Depreciation <ul><li>The book value decreases linearly with time. </li></ul><ul><li>The depreciation rate, d = 1/n, is the same each year of recovery period n. </li></ul><ul><li>It is considered the standard against which any depreciation model is compared. </li></ul><ul><li>The annual SL depreciation is determined by: </li></ul><ul><li>(first cost - salvage value) d </li></ul>
  35. 36. Example <ul><li>B = $50,000; </li></ul><ul><li>“ n” = 5 years; </li></ul><ul><li>S = $10,000 at t = 5; </li></ul><ul><li>D t for each year is: </li></ul><ul><ul><li>($50,000 - $10,000)/5 = $8,000/year </li></ul></ul>
  36. 37. Table of Results 10,000 8,000 5 18,000 8,000 4 26,000 8,000 3 34,000 8,000 2 $42,000 $8,000 1 BV t D t t
  37. 38. Useful References <ul><li>The Small business handbook: how to start and successfully operate a small business, ISBN 1-86350-004-9, Small Business Corporation (Vic.) </li></ul><ul><li>How companies work, ISBN 0-725-10689-1, Nicholas Brash, Timothy Lindsey </li></ul><ul><li>The Australian Taxation Office website </li></ul><ul><li>http://www.business.vic.gov.au – Refer ‘Plan to Succeed’. </li></ul>Note: Please search for newer editions for the above references
  38. 39. Group Presentations <ul><li>At this stage, it looks like these will take place in Weeks 12 and 13 – beginning 21/5 and ending 30/5. </li></ul><ul><li>We will use all lecture timeslots over these 2 weeks. </li></ul><ul><li>A detailed schedule will be provided beginning of May. </li></ul><ul><li>As a general rule, the larger teams will present earliest. </li></ul>
  39. 40. Thanks for your attention