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ELE 2EMT Engineering Management Accounting – Lecture 4 George Alexander G.Alexander@latrobe.edu.au http://www.latrobe.edu.au/eemanage/ 17 August, 2007 Last week A closer look at why we classify certain expenditure as capital expenditure - assets The importance of accurately valuing assets

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engineering management accounting lecture 4

ELE 2EMT

Engineering ManagementAccounting – Lecture 4

George Alexander

G.Alexander@latrobe.edu.au

http://www.latrobe.edu.au/eemanage/

17 August, 2007

last week
Last week
  • A closer look at why we classify certain expenditure as capital expenditure - assets
  • The importance of accurately valuing assets
  • The role of depreciation and how it works
  • Types of Depreciation
  • Depreciation Terminology
  • Straight Line Depreciation
  • Declining Balance Depreciation
this week
This week
  • Need for Business Analysis
  • The Profit & Loss Statement
  • Performance Ratios
  • Return on Investment
  • Break-Even Calculations
  • Price Elasticity
  • Economic Order Quantity
need for business analysis
Need for Business Analysis
  • Stakeholders and potential stakeholders need to know how to evaluate an organisation’s financial success.
  • The evaluation process requires a good understanding of financial statements and performance ratios.
balance sheet statement of financial position
Balance SheetStatement of Financial Position
  • Every company publishes a balance sheet at the end of each fiscal year (FY)
    • Assets - a summary of all resources owned by or owed to the company
    • Liability - a summary of all financial obligations of the company
    • Net Worth - a summary of the financial value of ownership
balance sheet relationship
Balance Sheet Relationship

Assets = Liabilities + Net Worth

Net Worth = Assets - Liabilities

Net Worth also called:

Owner’s Equity or Proprietorship

A = L + P

P = A - L

profit loss statement statement of financial performance
Profit & Loss StatementStatement of Financial Performance
  • The basic equation for profit is:

Profit = Sales - Costs

  • P & L Statement shows an organisation’s sales revenues and costs over a given period, typically a year, quarter or month.
slide8
A well-written statement can help in identifying the areas of the business associated with profit or loss.
  • Assessment can be based on a division, department, business unit, product line, etc.
example profit loss statement
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

performance ratios
Performance Ratios
  • The gross margin percentage
  • The net profit percentage
  • The operating expenses ratio
  • Market ratios
  • Other financial ratios
  • Employee ratios
  • The stock turnover ratio
the gross margin percentage
The Gross Margin Percentage

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

Gross Margin Percentage =

Net Sales

$367,500

=

= 0.52 or 52%

$707,500

the net profit percentage
The Net Profit Percentage

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

Net Profit

Net Profit Percentage =

Net Sales

$42,000

=

= 0.06 or 6%

$707,500

the operating expenses ratio
The Operating Expenses Ratio

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

Total Operating Expenses

Operating Expenses Ratio =

Net Sales

$325,500

=

= 0.46

$707,500

or in percentage 46%

company financial reports
Company financial reports

All publicly listed companies provide access to their financial reports on their web sites –

http://www.telstra.com.au/abouttelstra/investor/index.cfm

http://www.qantas.com.au/info/about/investors/index

http://www.wesfarmers.com.au/default.aspx?MenuID=33

and so on.

improving net profit
Improving Net Profit
  • Increasing prices
    • Pricing objectives
    • Supply v demand, etc.
    • Price Elasticity (refer later slides)
  • Reducing cost of goods sold
    • Alternative sources
    • Make or buy, etc.
  • Reducing operating expenses
    • Efficient use of resources
    • Management policies, etc.
financial ratio analysis
Financial Ratio Analysis
  • Financial ratios are somewhat limited in meaning when viewed in isolation.
  • They are more useful when used to compare similar companies (benchmarking), or when examining trends.
  • Some ratios are available on financial websites such as Commsec and InvestorWeb.
  • More detailed data is available on individual company websites.
return on assets
Return on Assets
  • Defined as the ratio of net profit to assets of an organisational segment (company, division, business unit, or the like), product line or brand.
  • It is a measure of financial efficiency that is often used to set marketing objectives.
  • The information required for calculating return on assets is obtained from the organisation’s balance sheet and profit and loss statement.
example roa calculation
Example ROA Calculation

ROA = Net Profit / Total Assets

Suppose that the total assets for the organisation is $425,000 and the net profit is $42,000.

ROA = 42,000 / 425,000 = 0.0988 or 9.88 %

roi return on investment
ROI Return on investment

ROI = Net Profit / Net Worth

This shows the profitability of shareholders’ equity.

Suppose that the total assets for the organisation is $425,000, the net profit is $42,000 and the total liabilities are $200,000.

ROI = 42,000 /( 425,000 – 200,000) = 0.187

or 18.7%

market ratios
Market ratios
  • Dividend Yield % = Annual dividend

Share price

  • Price/Earnings P/E = Share price

Earnings per share

  • Dividend payout = Dividend per share

Earnings per share

other financial ratios
Other financial ratios
  • Debt/Equity measures proportions of financing by creditors and owners.
  • Sales/Total assets measures how well the total assets are being used to generate sales.

similarly for

  • Sales/Fixed assets
employee ratios
Employee ratios
  • Sales per employee
  • Earnings per employee

These need to be viewed cautiously as they are sensitive to initiatives such as outsourcing, and can vary greatly with the nature of the business – e.g.capital vs labour intensive.

the stock turnover ratio
The Stock Turnover Ratio

The Stock (Inventory) Turnover Ratio indicates the number of times stock turns over (sold) during the period specified in the profit and loss statement. The calculation is done in two steps as follows:

Beginning Stock + Ending Stock

Average Stock =

2

$100,000 + 160,000

=

= $130,000

2

the stock turnover ratio cont
The Stock Turnover Ratio - Cont.

Net Sales

Stock Turnover Ratio (Retail) =

Average Stock

$707,500

=

= 5.44 times per period

$130,000

Cost of Goods Sold

Stock Turnover Ratio (Cost) =

Average Stock

$340,000

=

= 2.62 times per period

$130,000

break even calculations

Fixed Costs

Break-Even Point =

Selling Price - Variable Costs

Break-Even Calculations
  • The Break-Even Point is defined as the point at which costs and revenues meet (costs = revenue).
  • The concept is best described graphically, mathematically it is written as:
example break even calculation

$ 50,000

Break-Even Point =

= 10,000 units

$ 10 - $ 5

Example Break-Even Calculation

Suppose the following:

Selling price $ 10

Variable cost $ 5

Fixed cost $ 50,000

price elasticity

(Q1 - Q2) / Q1

E =

(P1 - P2) / P1

Price Elasticity
  • Defined as the effect of a change in price on the quantity of product demanded.
  • It involves calculating the ratio of the percentage change in quantity to the percentage change in price.

E = Elasticity

Q1 = Initial quantity demanded

Q2 = New quantity demanded

P1 = Initial price

P2 = new price

example price elasticity calculation

(100 - 90) / 100

0.1

E =

=

= - 0.5

(5 - 6) / 5

- 0.2

Example Price Elasticity Calculation

Suppose that the initial price was $5 and the initial quantity demanded was 100 units. If the price was raised to $6 and the quantity demanded declined to 90 units, then the Price Elasticity would be:

Normally stated as 0.5

economic order quantity
Economic order Quantity
  • There are several factors to consider when deciding on the order size at which total costs can be minimised.
  • The main factors include:
    • Annual demand in units,
    • unit cost of placing an order, and
    • Annual holding costs as a percentage of the cost of one unit.
example

2 x (Annual demand in units x Unit cost of placing an order)

EOQ =

Annual holding costs as a percentage of cost of one unit

x Cost of one unit in dollars

Example

Annual demand 5,000 units

Unit cost of the merchandise $ 1.50

Per-unit holding costs $ 0.30 (20% of unit cost)

(warehousing, insurance, etc.)

Cost of placing an order $ 5.00

slide32

$50,000

2 x ( 5000 x $5 )

EOQ =

=

=

408.25 units per order

0.2 x $1.50

$0.30

Cont.
stock cycle
Stock Cycle

stock

level

initial

stock

trigger

level

time

order

order

order

order

order

regulatory authorities
Regulatory Authorities
  • ASIC –Australian Investment & Securities Commission “enforces company and financial services laws to protect consumers, investors and creditors”

http://www.asic.gov.au/asic/asic.nsf

  • ACCC – Australian Competition and Consumer Commission – national competition policy

http://www.accc.gov.au/content/index.phtml/itemId/142

  • ACA – Australian Telecommunications Authority

http://www.aca.gov.au/