Management: operations,

organisations and financial analysis

Yoram Krozer, University of Twente CSTM and Sustainable Innovations
Academy

5/19/15

MEEM accounting, krozer@xs4all.nl

Financial analysis
Lecture 1

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Lectures
1. Financial accounts (terms, depreciation,
reporting)

2. Management accounting (allocation,

capital, profit)

3. Public decisions (cost-effectiveness, cost Exam:

benefit)knowledge and understanding of
the slides
On group request: classes for exercises
On group request: discussions about
topics (e.g. income growth, distribution,
MEEM accounting, krozer@xs4all.nl
innovations, etc.

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Learning goals
Lecture 1 Financial accounting
1. Costs and Revenues
2. Depreciation
3. Financial reports
4. Cash flow
5. Financial analyses

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Costs and Revenues

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Why Accounting?

Various demands and compliance

options
Given scarce resources choices are
necessary
Accounting provides information to
decide

Examples
- What are costs of energy and
environment?
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- What are profits
of environmental

Economics
Value about is peoples appreciation of
natural and moral goods
Natural and moral goods in economics
are about products, services, images,
and so on
Economics is about decisions how to
create and allocate the natural goods
for welfare
Welfare means satisfying individual and
collective demands given scarce
resources
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Costs
A cost is an efforts usually expressed in
the money term (also proxies of the
costs)
Variable or direct cost is proportional to
volume
Fixed or indirect cost is not proportional
to volume
Unit cost or marginal cost is the total
cost divided by volume of product,
service or image
Not all costs matter but particularly
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Types of costs and revenues

Cost: 1. land, 2. material, 3. labour, 4.
machine 5. building, 6. third-party
services, 7. taxes, 8. patent, 9.
research, 10. licence, 11. staff, 12.
management, 13. boards, 14. waste
treatment, 15. emission taxes, 16.
emission permits.
- Is nr. 1 variable or fixed?
- Is nr. 6 variable or fixed?
- Is nr 11 variable or fixed?
- Is nr 15 variable or fixed?
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Approximations (proxies)
Sunk costs are costs created by past
decisions that are unavoidable, e.g.
costs of old roads.
Costs of unsold goods, which are
reported as an inventory or a stock
value, e.g. books on shelves.
Depreciation, which is the cost of
wearing-off of products
Amortisation, which is the cost wearingoff of services and images, e.g. licence
and brand name
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In calculations
The total cost: all cost + proxies in a unit
of time (e.g. year)
Incremental or additional costs: the cost
difference between alternatives (e.g. a
cost of energy saving)
Opportunity costs, i.e. a value loss due
to decision, (e.g. 1 hour study means 1
hour less earning)
Also considered in management
Product costsMEEM
related
to a good, service, or11
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Revenues
Various names for generation of money:
revenues income, sales, turnover,
proceeds
Revenues are due to willingness and
ability to pay
Revenue are sales, rents, interest,
dividend, license
Do not confuse a cost and a revenue
because they can differ a lot
In the energy and environment
management:
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A few basic equations

Turnover or Sales = quantity units x
unit price
Gross Profit = sales costs of sales
costs of sales =purchase + manufacturing
cost

Net Profit = turnover total costs,

total costs = costs of sales + overhead* +
tax

Retained Profit (owners income) = Net

Profit Dividend
What is dividend?

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Exercise:
what are the fixed and variable
costs in this classroom?

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Commuting 20 000 km a year

You bought a car at a cost of 2 000 for 2 years.
The drive cost per km is 0.10 (e.g. fuel, repair)
The train ticket for 50 km costs 10
a. What costs can be fixed, variable, relevant,
sunk?
b. What are the annual costs of the car?
c. What are the car unit costs?
d. Was it a good decision to buy this car?

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Fixed asset depreciation

What is the main fixed asset
around you ?
How many years is this asset fixed
?
What can be its value per year?
Depreciation
is
only
a
value
in
accounts
Is your computer depreciated?
(a proxy)
P.M. depreciation is included in the
profit-loss accounts and in balance
sheets but it is excluded in the cash
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Depreciation of the fixed costs

Fixed costs must divided in time:
Depreciation is spreading fixed asset in
time
Original price (- expected Salvage
Value*) Accumulated Depreciation =
Book value
Accumulated is value t2 adds to value t1,
etc.
Salvage value is the remaining value
after use
Main methods are straight line,
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Straight line depreciation

Asset
(usual)
Value
(euros)

Depreciation = Original
price : number of years in
use

Years
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Declining (double) balance

depreciation
Asset
Value
(euro
s)

Depreciation = Original prices x

fixed percent that corresponds to
the years in use
A: declining = percent
A
x1

B: double declining =
percent x 2
Years

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Depreciation: linear and

(double) declining balance
Year

0
1
2
3
(idem accelerated)

Deprec. Linear

125

125

125 125 125 125 125 125

BV linear

1000 875

750

625 500 375 250 125 0

125

109

96

1000 875

766

670 586 513 449 393 344

Deprec. declining 0
balance 12.5% (*)
BV accelerated

84

73

64

56

100% : 8 years = 12.5% a year

Usually double declining balance: 100% : 8 = 12.5 x 2 = 25% a year
What would be the annual depreciation for a triple
declining
balance? MEEM accounting, krozer@xs4all.nl
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Total, unit and incremental

costs

Is your computer fixed of variable cost?

What is the total cost of it?
What is the annual cost of it?
What is the unit cost (think about volume)?
Suppose you have extra software for 200
euro
What is the incremental cost?
What is the total cost?
What is the unit cost?
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Accountants perspective

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Different companies
One person company: one person
provides the equity, bears the risks and
holds all possession
partnership firm: more people provide
equity. Private liabilities cannot be
taken from the firm capital.
Ltd (private limited company/close
company; Dutch: BV, Germany GmbH);
a legal entity.
Plc (public limited company/public
corporation; Dutch: NV, Germany:
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Various interests
Various groups ask for information
about past, present and future:
- investors (dividends?)
- lenders (due repayment?)
- employees (wage and job
prospects?)
- suppliers (due payment?)
- customers (reputation?)
- community (economic and societal
impacts?)
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Financial statements
1. Balance sheet summarizes the
financial position at a point of time
(usually annually)
2. Profit and loss account summarizes
principal components of the activities
in a period.
Both are legally demanded
(sometimes also social and
environmental reports).
3. Cash-flow summarizes summarized
income and expenditures to assess
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Balance sheet
Title, year, comparative year
Few details, extra information in
footnotes
Specifications in the financial
statements: assets, liabilities,
capital
Basic formula: Assets Liabilities
= Capital (or Equity)
It also means:
Debit or Assets (left side of the
balance) = Credit or Liabilities +

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Items on a balance sheet

Assets (debit)
Equity (credit)
Buildings (fixed)

Purchases (short term)

Machine (fixed)

Loans (long term)

Inventory (current)

Capital:

Cash money (current)

Liabilities &

- Shares
- Profits or losses
- Reserves/Provision

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Assets (Debit)
Fixed assets are owned or controlled
values that cannot be turned to cash in a
short period of time
Current assets can be turned to cash
within a year like stock, cash, bank,
debtors.
Stock are valued at cost to bring product to
its present condition, not its sales price for
prudence
Large stocks imply high costs of bringing to
the present condition, or high risk of losses

Many disputes about assets value, e.g.

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Liabilities and Capital (Credit)

Equity or Capital is shareholders financial
stake that can bring a profit or loss;
The financier expenditure to get stake is
called investments
Provision is an amount to compensate
possible losses caused by doubtful debtors,
or incidents
Liability money owed to a person or
organisation:
- current: suppliers, taxes, dividends
- long term: loans
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Basic in any balance sheet

Double entry bookkeeping: always in
balance
Fixed assets
Equity
- intangible (godwill) - share capital
- tangible
- reserves/provision
(retained profits)
Current assets
- inventories
- claims
Long Liabilities
- cash / bank
Current

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Balance sheet
Make your balance sheet by September,
17, 2013
Specify:
Assets: fixed and current
Equity: share and reserves
Liabilities: long and current
Items should be realistic, numbers can
be fictive
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Profit loss account

+
=
=
=
=

Sales turnover
100
costs of sales (manufacturing)
80
Focus of the
gross profit
course20
period cost (non-manufacturing) 10
profit before tax
10
tax
2
provision (reserves)
2
profit after tax
6
dividends
2
retained profits
4

Check the lay-out

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Profit and Loss Account

Vertical analysis: comparison to the

sales
Horizontal analysis: comparison

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Useful PL information
Comparing of two years (horizontal
analysis)
Estimate growth: (Cost period 2 / Cost
period 1): what are the main changes

Comparing cost and profits to the

sales (vertical analysis)
Estimate the share of profits and cost
factors: what are the main issues and
changes.

Exercise: answer question of a

simple PL (next slide)

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Profit Loss (PL)

of a trading
company

PL report year
201Y

Sales

PL report year
201X

1100

Horizontal Vertical
1Y/1X
201Y
201X

950

Cost of sales
opening stock

100

add purchases

300

250

closing stock

-60

-10

116%

100%

100%

Cost of sales

340

240

Gross profit

760

680

107%

69%

75%

600

490

122%

55%

52%

160

190

73%

15%

23%

73%

11%

36
17%

Expenses
Shop rental
Electra, water
Wages
Insurances
Delivery vans
Net profit
Taxes
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Profit
after tax

40

150

150

20

10

250

150

30

30

150

150

50
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120
140

Cash flow (or Operational)

analysis
Purposes: select profitable projects,

assess if a company can meet

obligations
Comparing the incoming and outgoing
cash flows
Cash flows = outgoing (-) + incoming
money (+) = expenditure (-) +
revenues (+)
Outgoing money = total costs
(depreciation + amortisation +
inventory value)
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Cash flows: operational and

F = Financial; O =
financial

Operational
Cash
inflow

Cash outflow

Equity capital (F)

Loan (F)

Dividends (F)
Loan repayment (F)
Interest payment (F)
Fixed investment (O)
Pre-production expenditures
(O)
Working capital (O)
Operating costs (O)
Marketing costs (O)
Corporate tax (O)

Sales Revenue (O)

Savings (O)
Working capital
repayment (O)
Scrap values (O)
Subsidies (O)
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A cash flow
Cash flow
Operations
sales
Material costs
labor
subtotal
Financing
Loan taken
loan repayment
taxes
subtotal
Investments
purchased capital
Net Cash flow

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Incoming

Outgoin
g
Net

100
20
60
80

20

40

10
10
20

20

20

100
40

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-20
20

39

Operational or Liquidity
analysis (not exam)
time
Operational

time
Loan

time
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Equity

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Operational, Liquidity
analysis
Total annual Net cash flows
time

Cumulative Net cash flows

time

Decision rule: if the cumulative NCFs is positive

every year, the organization will be able to meet
its5/19/15
financial obligations
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Ratio analyses
indicators of business
performance (not on exam)

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Liquidity
Is there enough cash to meet current
liabilities? If not, companys survival is
at stake. Options
1. Net working capital = current assets curent liabilities
2. Current ratio = current assets /current
liabilities
3. Quick ratio = (current assets inventories) / current liabilities
The higher the outcome, the more
positive.
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Solvability

Can the company meet all liabilities?

Solvable means that it can pay debts
(risk for financiers)
1. Debt ratio = total liabilities / total
assets (in Gowthorpe called gearing
ratio)
2. Interest coverage ratio = (profit before
tax + interest liability)/ interest
liabilities
. Debt ratio: the lower ratio, the better
solvability, the less risk for financers.
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Profitability
Comparing revenue to the
investments that has generated this
revenue
1. Pretax = (net profit* / equity) x 100%
2. Posttax = (profit after tax+interest
burden)/ equity
3. Return on capital (ROI) = (profit
before interest and tax / equity and
long term capital)
* Net profit = sales (costs of sales +
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Activities (leverage)
How intense production factors are used
1. Turnover rate = Turnover (sales) / Total
capital
2. Turnover rate inventories =
Turnover/Average inventory
3. Average length buyers credits =
Average buyers credits / sales on
account * 12
4. Average length suppliers credits =
Average supplier credits / purchases on
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Summary
We have learned:
Many basic terms in financial
assessments
Define fixed and variable costs
Two methods of depreciation
Calculate total, incremental and unit costs
Basics of Balance and Profit-Loss sheet
Basics of the Cash Flow Analysis
Touched Ratio analysis

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