Connecting the numbers to the business

Connecting the numbers to the business

Global Financial Bridge training

Comprehensive training in the basic concepts of financial statement

relationships and analysis techniques

Course Content

The why Creating value the ROCE way Profitability management Working capital Cash flow Revenue (good and bad growth) Integrating with quick books Using GFB

The why

I have never heard a business person say “I don’t want to make more money”

Yet the solution is not always obvious Our mission is to communicate, bridge and

connect the numbers to the story behind the numbers.

We assist in in the why (why we can improve), the what (what needs to be done) and how (how it will be done)

The problem

?

?How do these statements help the

business person Was growth good or bad

Identify where money is been made or lost

What is the quality of my cash flows

How fixed are my costs

Do I have good debt or bad debt

Where to focus limited resources

Am I in a position to pay a dividend

Our solution – the one page financial scorecard Telling the total

story in one interactive platform

Perform what ifs Communicating

the impact of the what if

Driving the future creating the budget

Setting 2 or 3 key goals

To be touched on but not the focus of this course

The basics

The ultimate reason why people go into business in to make money

The key way to measure the ability to make money is the return on capital provided into the business

ROCE = Return on Capital Employed

ROCE – how we fund the business The only way a business can be funded in

through debt and equity. Debt is defined as interest bearing debt only.

It does not include non interest bearing liabilities.

Calculate the funding base. See work book (WB 2)

Calculate the equity for the 2007 (WB3)

ROCE – how the funds are used

At the end of the day we have to have a balanced balance sheet

If one half of the balance sheet is how we fund the business the other half is …

How the funds are used in the business Calculate how the funds are used see (WB 4)

Calculating ROCE %

ROCE %

=

EBIT (Earnings before interest and tax commonly called operational profit)

÷

Net operating assets (NOA) or capital employed see WB2

How do business improve performanceROCE % = $EBIT/$NOA

The heart of the scorecard

DO MORE EBIT WITH LESS NOA.

Think about how many decisions can be made using this guide.

ROCE – Combining income statement and balance sheet management ROCE=EBIT/NOA = 300,000/357,534=83.91%

Expressed differently

X

Revenue

NOA

Income statementBalance sheet

300,000/1,500,000x

1,500,000/357,534

20% 4.2 = 83.91%

EBIT

Revenue

In summary

Profitability x balance sheet turnover

= ROCE %

ROCE – Combining income statement and balance sheet management

Benchmarks

Business type

Industrial Service

Profitability 10% 15%

Balance sheet turns

3 4

ROCE 30% 60%

Where is the problem?1. In the income statement

performance2. In the balance sheet

performanceCompare with 3. Benchmark4. Prior periods profitability and

balance sheet turnover

Using ROCE to diagnose

Benchmarks

Business type

Industrial Service

Profitability 10% 15%

Balance sheet turns

3 4

ROCE 30% 60%

ROCE and the scorecard

Reflecting the profitability measure (EBIT %) and the balance sheet measure (Operating asset turnover) 12.16% x 2.04 = 24.85%Reflecting the profitability measure (EBIT %) and the balance sheet measure (Operating asset turnover) 12.16% x 2.04 = 24.85%

EBIT NOA decision example

We are a building supplies distribution company Want to make a decision about hiring a new sales

person. Facts

Cost of sales person $150,000 Sales person sales $1,500,000 PA

What other information would assist you in making a good decision

See WBS 5

Working Capital

Working Capital

Calculate the total working capital for the 2007 and 2008 periods WB 5

The working capital needs for 2008 Calculate Accounts receivable days,

Inventory days and Payable days for 2008 year WB 6

Working Capital

A quick test is to compare the the growth % of total working capital from one period to the nexxt with the annualized revenue growth rate.

If WC % growth > working may be mismanaged If less determine the reason if mainly due to high

increase in payables explain the risk. If less due to all components working in the right

direction. Determine what actions were taken to achieve this improvement and can we do more of them

Cash flow and funding


Cash Gross profit % = Gross profit per cash flow statement. (reports cash flow statement) Compare this with the accounting gross profit %.

Big differences highlight the inefficiencies of working capital management.

the inefficiency (difference between income statement gross profit and cash gross profit ) is quantified by working capital efficiency $


Operational cash flow. (reports cash flow) This is one of managements key performance measures.

Always advise clients if they ever consider a performance remuneration system to include this measure in the formula.

What is the operational cash capability to (a) pay interest (b) taxes (c) capital expenditures

Most importantly what is the capability to pay a dividend


!Operating cash not able to cover current period interest payment.

Bankers are now paying more attention to this servicing capability. Additional debt has to be incurred to repay the cost of the debt. This is not a good indicator

!Operating cash not able to cover current period interest payment.

Bankers are now paying more attention to this servicing capability. Additional debt has to be incurred to repay the cost of the debt. This is not a good indicator

Good vs. bad debtCompare the ROCE with the average cost of debt

ROCE % = (1) ability assess leverage. How much money do we make from other peoples money. Measured by difference in interest rate and ROCE% = margin of safety.

Larry help

Way to automate this process Provide red and green lights

Step 2- Profitability review

BHT Techniques

The what if on the best The comparative what if The challenge what if The price volume what if

Work books (WB)

Workbook –income statement

Workbook - balance sheet

WB 1 – Funding calculation

2007 2008

Debt

Equity

Total funding

WB 2– calculate how the funds are used

2007 2008

WB 3 – Calculate equity

2008 Equity

WB 4 Calculating working capitalWorking Capital components

2007 2008 Movement

Work book solutions (WBS)

WBS 1 Funding solution

2007 2008

Short term debt $ 348,000 $ 304,931

Long term debt $ 500,000 $ 800,000

Total debt $ 848,000 $ 1,104,931

Total equity $ 445,000 $ 705,946

Debt plus equity $ 1,293,000 $ 1,810,877

WBS 2 Capital Employed/net operating assets calculation

Funding 2007 2008

Short term debt $ 348,000 $ 304,931

Long term debt $ 500,000 $ 800,000

Total debt $ 848,000 $ 1,104,931

Total equity $ 445,000 $ 705,946

Debt plus equity $ 1,293,000 $ 1,810,877

Capital employed (net operating assets)Cash at bank $ 22,000 $ 8,000

Accounts receivable $ 380,000 $ 557,000

Inventory $ 420,000 $ 7,770,000

Other current assets $ 56,000 $ 62,000

Total current assets $ 878,000 $ 8,397,000

Fixed assets $ 850,000 $ 1,050,000

investments

Other Non current assets $ 55,000 $ 61,000

Total non current assets $ 905,000 $ 1,111,000

Accounts payable $ 380,000 $ 567,123

Other current liabilities $ 65,000 $ 75,000

other non current liabilities $ 45,000 $ 55,000

Total other liabilities $ 490,000 $ 697,123

Total capital employed $ 1,293,000 $ 8,810,877

WBS 3 Calculating retained earnings 2008

Retained earnings per current period (2008) income statement

$ 260,946

Retained earnings per balance sheet previous period (2007)

$ 425,000

Retained earnings per the balance sheet for the current period 2008

$ 685,946

WBS 4 Working capital

Working Capital component 2007 2008 Variance

Variance %

Accounts Receivable $380,000 $557,000 ($177,000) 47%

Inventory $420,000 $770,000 ($350,000) 83%

Accounts payable ($380,000) ($567,123) $187,123 49%

Working Capital $420,000 $759,877 ($339,877) 81%

WBS 5 – EBIT NOA decision example

Further information- EBIT driven What is the margin on the sales Answer 30%

Further information NOA driven Are we selling to our existing customers If what is the average collection period Answer 55 days Will the salesperson be selling our existing product range Answer – no What is the average inventory holding of the new product line 90 days The average payable days is 30

Is this a good decision Things to consider

Income statement contribution Balance sheet (NOA) impact Cash flow.

You have just performed a customer or product one unit analysis at the same time .

WBS 5.1 – EBIT NOA decision example


Go to a blank GFB scorecard Enter $1,500,000 into revenue Enter 70 into COGS % Enter $150,000 into operating cost Enter 55 in receivable days Enter 90 into receivable days Enter 30 into payable days
