SITXFIN008A – Manage Financial Operations

1. SITXFIN008A – Manage Financial Operations Analysing your accounts Creaded by: Oimi tam

2. Expected outcomes today By the end of the session you will be able to: • List 3 components of a Profit & Loss report • List 3 components of a Balance Sheet • Use ration to analysis you accounts Creaded by: Oimi tam

3. Analyse your accounts Today we will be examining how to: • Read a Profit & Loss statement • Read a Balance Sheet Creaded by: Oimi tam

4. Analyse your accounts Once you understand the information contained in your financial statements you then need to analyse your figures to gain a better understanding of your business. Creaded by: Oimi tam

5. The benefits of financial analysis Financial analysis can tell you a lot about the performance of your business and will help you to determine the overall financial health of your business. Creaded by: Oimi tam

6. The benefits of financial analysis Issues such as Liquidity (does the business have enough cash to pay its debts on time) Profit (the percentage of net profit to total sales) are only part of the financial analysis of your business that puts the information from your financial statements into perspective. Creaded by: Oimi tam

7. The benefits of financial analysis Financial analysis will help you • Identify problems • Implement the necessary corrective actions • Improve your operations. Creaded by: Oimi tam

8. The benefits of financial analysis • You should develop some "snapshot" measures of your business and set aside time each month to regularly review and analyse your financial statements. • In this way you will have better control over your business operations. Creaded by: Oimi tam

9. The benefits of financial analysis You will need information from your annual profit and loss statement to calculate the ratios. Creaded by: Oimi tam

10. Gross Profit • Gross profit is the difference between sales and the cost of producing or purchasing products or providing services before subtracting operating expenses such as wages, rent, accounting fees, or electricity. • Gross profit reflects how efficiently materials are used to produce goods Creaded by: Oimi tam

11. Gross Profit Gross profit = sales – cost of goods sold The gross profit margin is one indicator of the financial health of a business. Larger gross profit margins are better for business – the higher the percentage, the more the business retains of each dollar of sales for other expenses and net profit. Creaded by: Oimi tam

12. Net Profit Net Profit = Gross Profit – Expenses Net Profit (net income; net earning; the bottom line) is calculated by subtracting expenses from the gross profit, showing what the business has earned (or lost) in a given period of time (usually monthly, quarterly, or annually) after both the cost of goods sold and operating expenses have been taken into account. Creaded by: Oimi tam

13. Converting financial data to ratios or percentages Comparing the absolute dollar values over time is not very meaningful and does not provide a complete view of your business. Creaded by: Oimi tam

14. Converting financial data to ratios or percentages It does not correct for inflation or allow you to make comparisons with other businesses in your industry. We can overcome many of these shortfalls when we convert the financial data to ratios or percentages. Creaded by: Oimi tam

15. Introduction to financial ratios • A ratio shows the relationship between two or more financial statement items • eg, gross or net profit in relation to sales • ratios are a common analysis tool; calculation is straightforward while interpretation requires skill, especially in determining the reasons for particular ratio results • ratios can be expressed as a percentage, fraction, proportion (etc), according to the needs of users Creaded by: Oimi tam

16. A ratio by itself means little unless it is benchmarked A ratio needs to be compared to some expected or required outcome. For example, ratios might be compared to different time periods in the same business or to industry expectations to determine whether there has been a significant change. Creaded by: Oimi tam

17. Profitability ratios • Profitability ratios measure the ability of the business to make a profit. • Use profitability ratios to answer the question, "Is my business as profitable as it should be?" An increase in the ratios is viewed as a positive trend. Creaded by: Oimi tam

18. Profitability ratios The profitability ratios for analysing the profit and loss statement are: • Gross profit margin ratio • Net profit margin ratio • Break even analysis Creaded by: Oimi tam

19. Gross Profit Margin Ratio The gross profit margin ratio expresses the gross profit as a proportion of sales The gross profit margin ratio is used as one indicator of a business's financial health. Creaded by: Oimi tam

20. Gross Profit Margin Ratio It shows how efficiently a business is using its materials and labour in the production process and gives an indication of the pricing, cost structure, and production efficiency of your business. The higher the gross profit margin ratio the better. Creaded by: Oimi tam

21. Gross Profit Margin Ratio Gross profit= income – cost of goods sold (COGS) Gross profit margin ratio = gross profit ÷ income Creaded by: Oimi tam

22. Gross Profit Margin Ratio The gross profit margin is simply the gross profit margin ratio expressed as a percentage: Gross profit margin (%) = (gross profit ÷ income) x 100 Larger gross profit margins are better for businesses Creaded by: Oimi tam

23. Gross Profit Margin Ratio Analysis • The higher the percentage, the more the business retains of each dollar of sales, which means more money is left over for other operating expenses and net profit. • A low gross profit margin ratio means that the business generates a low level of revenue to pay for operating expenses and net profit. • It indicates that either the business is unable to control production and inventory costs or that prices are set too low. Creaded by: Oimi tam

24. Net Profit Margin Ratio • The net profit margin ratiois the net profit as a proportion of sales. • The net profit margin ratio shows the proportion of every dollar of sales that is left after all expenses have been paid, and remains as net profit. Net profit is used to pay for interest, tax and distribution to the owners. • The higher the net profit margin ratio the better. Creaded by: Oimi tam

25. Net Profit Margin Ratio Net profit margin ratio = net profit ÷ income The net profit margin is simply the net profit margin ratio expressed as a percentage: Net profit margin (%) = (net profit ÷ Income) x 100 Creaded by: Oimi tam

26. Net Profit Margin Ratio A high net profit margin ratio demonstrates how effective your business is at converting sales into profit. It may mean that you are capitalising on some competitive advantage that can provide your business with extra capacity and flexibility during the hard times. Creaded by: Oimi tam

27. Net Profit Margin Ratio • A low net profit margin ratio may mean that you are not generating enough sales • the gross profit margin is too low, or that you are not keeping your operating expenses under control to leave an acceptable profit. Creaded by: Oimi tam

28. Net Profit Margin Ratio A decrease in the net profit margin ratio over time may indicate cost blowouts that require efficiency improvements. A business with a low ratio might need to take on debt to pay its expenses Creaded by: Oimi tam

29. Break Even Analysis The break even analysis is critical for any business owner, because you will know exactly when you begin to make a profit. The break even point is the lowest limit when determining profit margins. You will know how low a price you can offer, and the effects of discounting on your net profit. You can calculate the break even for any period of time – a year, quarter, month, week, day – just make sure all three estimates relate to the same time period. Creaded by: Oimi tam

30. Break Even Analysis • A person starting a new business often asks, "At what level of sales will my company make a profit?" or ask At what point will I be able to draw a fair salary from my company?" • Our discussion of break-even point and break-even analysis will provide a thought process that may help to answer those questions and to provide some insight as to how profits change as sales increase or decrease. • Technique to determine the break-even point & analyse consequences of changes on this point Creaded by: Oimi tam

31. Class activities Fixed Costs: • Monthly Rent $100 • Insurance ($600 per year $600/12 months = $50) $50 • Total Monthly Fixed Costs $150  Variable Cost: • Materials $3 • Labor $4 • Total Variable Cost $7 Selling Price: $10 Required • To break even the company must sell how many units per month. • Prepared Monthly Profit and Loss Statement Creaded by: Oimi tam

32. Answers Break Even Point Calculation • Break Even Point = Fixed Costs / (selling price - variable costs) • Break Even Point = $150 / ($10-$7) • Break Even Point = $150 / $3 • Break Even Point = 50 • To break even the company must sell 50 units per month. Creaded by: Oimi tam

33. If the Company just broke even, then its Profit and Loss Statement would look like the following: Creaded by: Oimi tam

34. What causes an increase in break-even point? 1. One reason is an increase in the company’s fixed costs, such as rent, depreciation, salaries of managers and executives, etc. 2. A second reason is a reduction in the contribution margin. Creaded by: Oimi tam

35. What causes an increase in break-even point? • Contribution margin is sales minus the variable costs and variable expenses. • An increase in the variable costs and expenses without a corresponding increase in selling prices will cause the contribution margin to shrink. Of course, a decrease in selling price will also increase the break-even point. Creaded by: Oimi tam

36. What causes an increase in break-even point? 3. Another reason is a change in the mix of products or services delivered. In other words, some products have higher contribution margins, and some products have lower contribution margins. If a company continues to sell the same total number of units of product, but a greater proportion of the units sold have a lower contribution margin, the company’s break-even point will increase. Creaded by: Oimi tam

37. How much of the contribution margin is profit on units sold in excess of the break-even point? • After the break-even point is reached, the entire contribution margin on the next units sold will be profit…provided the total fixed costs and expenses do not increase. • Once the contribution margins have covered the total amount of fixed costs and expenses, the entire contribution margin on the next units will go to profit. Creaded by: Oimi tam

38. Contribution Margin Ratio • This ratio indicates the percentage of each sales dollar that is available to cover a company's fixed expenses and profit. • The ratio is calculated by dividing the contribution margin (sales minus all variable expenses) by sales. • Contribution margin ratio =Contribution margin ÷ sales Creaded by: Oimi tam

39. Liquidity Ratios There main ration that can used to measure the liquidity of business is The current ration Creaded by: Oimi tam

40. Current Ratio • The current ratio is mainly used to give an idea of the company's ability to pay back its short-term liabilities (debt and payables) with its short-term assets (cash, inventory, receivables). • The higher the current ratio, the more capable the company is of paying its obligations. Creaded by: Oimi tam

41. Current ratio • higher ratio is generally better • very high may indicate inefficient use of funds • rules of thumb are ‘dangerous’ and should not be generalised The Current Ratio formula is: Current assets / Current liabilities Creaded by: Oimi tam

42. The current ratio Creaded by: Oimi tam

43. $ 250000 = --------------- = 1.39 $ 180000 Creaded by: Oimi tam

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45. Ratios and prediction models • Ratios have been used in various models to help make predictions in certain areas: • financial distress • takeovers Creaded by: Oimi tam

46. End of today lesson Any Questions??? Creaded by: Oimi tam