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businessanalysis.ppt businessanalysis.ppt Presentation Transcript

  • Business analysis Concepts 2008 revision
  • References
    • Making the most of your tax accounts
    • John Warrington Milk Development Council
    • Financial & Management Accounting
    • Pauline Weetman Financial Times/Pitman
    • Applied Farm Management
    • J Turner and M Taylor BSP
    • Business analysis with Excel
    • Conrad Carlburg QUE
    • Using your accounts
    • Family Farm Series ATB
    • Financial Management for Farmers and Rural Managers
    • Martin F Warren Stanley Thornes
    • Interpreting Company Reports and Accounts
    • G. Holmes and A. Sugden Prentice Hall
  • Comparative analysis
  • Comparative analysis http://www.rugbyworldcup.com/statistics/season=2007/type=Points/team=0/statistics/index.html 1 0 1 2 3 3 30 4   Namibia 0 1 1 3 3 4 38 4   Portugal 0 1 0 3 3 5 40 4   Romania 0 2 0 5 5 5 50 4   Georgia 0 1 0 5 3 6 51 4   Canada 0 4 0 6 4 7 61 4   USA 0 0 0 7 4 7 64 4   Japan 0 2 1 2 5 9 64 4   Ireland 0 1 0 12 4 5 69 4   Samoa 0 3 0 11 6 8 85 4   Italy 1 3 0 10 7 9 89 4   Tonga 0 1 0 8 15 15 129 5   Scotland 0 3 0 10 12 16 134 5   Fiji 0 1 5 17 7 12 140 7   England 0 0 0 7 16 23 168 4   Wales 0 3 4 18 14 23 209 7   Argentina 0 2 2 8 20 31 225 5   Australia 0 2 0 18 19 27 227 7   France 0 3 0 21 25 33 278 7   South Africa 0 2 0 5 36 48 327 5   New Zealand RC YC DG PEN CON TRS PTS MT Team
  • Comparative analysis
    • A comparison of results with other information sources
    • Internal
      • previous years accounts
      • current budgets
    • External
      • Independent surveys
  • Comparative analysis
    • Comparison has to be on a “like for like” basis
    • Farm Income
      • debt free tenant farmer without salaried management
        • Management and Investment Income
        • Net Farm Income
  • Management and Investment Income
    • The reward for the farmer’s (and spouse) management and interest on the tenant’s capital employed on the farm
  • Management and Investment Income
    • +
    • Overdraft interest
    • +
    • Mortgage interest
    • +
    • Management fee
    • -
    • Notional rent
    Overdraft interest, Mortgage interest and Management fee will have been included in EXPENDITURE and are deductions which reduce Profit. By adding them back to profit the deduction is cancelled and has no effect on the measure of output (MII). Notional rent is an additional deduction to convert all farms to a tenanted basis. This allows for ‘like for like’ comparisons Deducting notional rent from profit reduces the measure of output (MII). less TPLA profit/loss REVENUE Closing valuation EXPENDITURE Opening valuation MII equals
  • Management and Investment Income (example)
    • +
    • Overdraft interest
    • +
    • Mortgage interest
    • +
    • Management fee
    • -
    • Notional rent
    £20 000 £5 000 Includes £5 000 overdraft £25 000 £100 000 £80 000 less TPLA profit/loss REVENUE Closing valuation EXPENDITURE Opening valuation MII equals - £5 000 + £5 000 Effect on MII is £ 0
  • Net Farm Income
    • The return to farmer and spouse on tenant type capital for their labour and management
    • Calculated as if all farms are tenanted
  • Overhead costs NFI vs MII vs Profit
  • Comparative analysis
    • Gross Margins
      • Gross margin per head (GM per hd)
      • Gross margin per hectare (GM per ha)
    • Overheads
      • Overhead cost per hectare
      • Overhead costs per £100 output
      • Overhead costs as a proportion of gross margin
  • Gross Margin per head to Gross Margin per hectare
    • Gross Margin per head (£/hd)
    • X
    • Stocking rate (no./ha)
    • =
    • Gross Margin per hectare (£/ha)
  • Proportional analysis
    • Assessment of technical and financial efficiency of the business
    • Costs are expressed as a % of total output
    • Commonly used for dairy herd analysis
  • Proportional analysis example
  • Unit cost of production
    • Used when large proportion of output from one source
    • Dairy production
      • Output and costs divided by total litres produced
    • Beef production
      • Output and costs divided by total kg meat produced
  • Unit cost of production (1)
  • Reductionalist theory
    • Break down results into individual components
    • Allows physical and financial analysis to proceed
  • Sensitivity analysis
    • Analyse effect of change (in advance) on enterprise profitability
    • Sensitive items cause large changes e.g. commodity prices
    • Insensitive items cause small changes e.g. vet and med, sundries
    sensitivity response
  • Sensitivity analysis input output less sensitive more sensitive response
  • Sensitivity analysis example
    • Cow yield 6000 litres
    • Milk price 16 ppl
    • 100 cows in herd
    • Vet and Med £15 per cow
    • Assess the effect of 10% change in milk price vs Vet and Med
  • Sensitivity analysis – change in margins
    • Milk
      • ± 10% x 16ppl x 6000 litres x 100 cows
      • = ± £9600
    • Vet. and Med.
      • ± 10% x £15 per hd x 100 cows
      • = ± £150
  • Business analysis Methods
  • Quote “… .published accounts are utterly and absolutely useless….” Clive Jenkins Union Leader
  • Purpose of business analysis
    • Identify strengths and weaknesses
    • Is the business sustainable?
      • Short term
        • Cash flow, Operational requirements
      • Long term
        • Profitability, Equity
  • Core analysis
    • Profit
    • Capital
    • Cash
  • Analysing profit PROFIT EXPENDITURE REVENUE OPENING VALUATION CLOSING VALUATION
  • Why does a business need a profit?
    • Profit provides for:-
      • Personal drawings
      • Taxation
      • Repayment of borrowed money
      • Replacement of machines
      • Investment or expansion purposes
  • Profit sufficiency
    • Profit requirements are specific to a business
    • A business with “ profit sufficiency ” provides adequate cover for personal and investment needs
  • Profit sufficiency example PROFIT 8 000 3 000 Investment or expansion purposes remainder requirement
      • PROFIT
    5 000 PROFIT SUFFICIENCY 28 000 20 000 Replacement of machines 35 000 7 000
      • Repayment of borrowed money
    40 000 5 000
      • Taxation
    50 000 10 000
      • Personal drawings
  • Analysing Profit
    • Have you a profit or a loss ?
    • Is the profit sufficient ?
    • Does profit cover private drawings ?
    • How was the profit earned ?
    • Are there extraordinary items ?
  • Profit does not cover private drawings
    • Private drawings and taxation
    • Lifestyle?
  • How was profit earned ?
    • Sales
    • Costs
    • Valuations
    • Depreciation
      • Level of investment
    • What are the main contributory elements?
  • Sales example 43500 TOTAL 1200 Breeding stock 500 Wool 1800 Cull ewes 5000 Store lambs 35000 Finished lambs £ Item (Year 1) 46600 TOTAL 2400 Breeding stock 700 Wool 1500 Cull ewes 15000 Store lambs 27000 Finished lambs £ Item (Year 2)
  • Analysis overall A negative value would indicate a decrease in sales
  • Individual component analysis Is this misleading?
  • Proportional analysis of sales (Year 1) 43500 TOTAL 1200 Breeding stock 500 Wool 1800 Cull ewes 5000 Store lambs 35000 Finished lambs £ Item
  • Proportional analysis of sales (Year 2) 46600 TOTAL 2400 Breeding stock 700 Wool 1500 Cull ewes 15000 Store lambs 27000 Finished lambs £ Item
  • Sales and Costs
    • Breakdown into physical and financial aspects
    • How do they compare to last year?
    • How do they compare to budget?
    • How do they compare to others?
    • What are the main contributory elements?
  • Comparative time frame current accounts budgets more accurate less accurate more accurate less accurate Sales Costs -1 -2 -4 -3 Sales Costs Sales Costs Sales Costs Sales Costs Sales Costs Sales Costs Sales Costs
  • Valuations
    • Are they realistic?
    • Retained or unsold livestock increase Closing Valuation and Profit
    • Knock on effect for following year
    • Valuations are an unsustainable source of profit
  • Valuation as a source of Profit 10 000 PROFIT + 10 000 Change in valuation (CV-OV) 0 Revenue - Expenditure 25 000 Opening valuation 35 000 Closing valuation 100 000 Expenditure 100 000 Revenue
  • Depreciation and investment (1)
    • Investing in machinery and buildings increases depreciation charge
    • High depreciation costs indicate high levels of investment
    • Low depreciation charges indicate low levels of investment
  • Depreciation and investment (2)
    • High depreciation could indicate over investment
    • High depreciation could indicate compensatory investment
    • Low depreciation might trigger compensatory investment in the future
  • Depreciation vs investment Total costs greater than original costs - reinvest
  • Are there extraordinary items?
    • Unexpected items of revenue
      • Rare (windfall)
    • Unexpected items of expenditure
      • Common
        • building repairs
        • high replacement rate
        • Labour
      • Likely to increase with uncertainty in weather patterns
  • Analysing gross margins
    • A measure of enterprise productivity
      • Physical efficiency
      • Financial efficiency
  • Relationship between Profit and Gross Margin Profit Gross Margin Fixed Costs (Overheads) Variable Costs Enterprise Output Other Enterprise Gross Margins
  • Physical and Financial analysis
    • Comparative
      • Per ha
      • Per £100 working capital
      • Per 100 hours labour
    • Published information
  • Strengths of gross margins
    • Simple to construct and use
    • Useful tool for business planning
    • Indicates inter enterprise strength and weakness
    £100 GM per ha £50 £25
  • Weaknesses of gross margins
    • Does not produce profit figure
    • Overheads excluded
      • Gross margin must be interpreted in relation to overhead cost
    • Profit is not proportional to gross margin
    • Does not allow for compensatory or detrimental relationships between enterprises
  • Profit is not proportional to gross margin Lower Fixed Costs result in higher proportion of Gross Margin as Profit Higher Fixed Costs result in lower proportion of Gross Margin as Profit Gross Margin Fixed Costs Profit Gross Margin Fixed Costs Profit
  • Scatter graph analysis Total Overhead costs £ per ha Gross Margin £ per ha HI HI LO LO Highly profitable business Less efficient business Efficient business Loss making business INTENSIVE EXTENSIVE
  • Dairy herds FBS 2003/04
  • Constructing the breakeven line Total Overhead costs £ per ha Gross Margin £ per ha Breakeven line where Gross Margin=Overheads (0,0) (500,500) (750,750)
  • Zone of profitability GM >Overheads = PROFIT Total Overhead costs £ per ha Gross Margin £ per ha Breakeven line where Gross Margin=Overheads Overheads >GM = LOSS
  • Breakeven does not usually pass through the averages Overheads Gross Margin Overheads Gross Margin Overheads Gross Margin Overheads Gross Margin Overheads Gross Margin Business results GM per ha & Overheads per ha
  • Coping with uncertainty
    • Less values near the mean
    • Greater proportion of distribution away from the mean
    • Unpredictable behaviour of biological, physical and financial systems
  • Analysing Capital
    • Capital is a resource
    • The balance sheet provides a snapshot of capital in a business
    • Net worth is an indication of the size the business and the amount of resource available
  • Establishing long term stability and viability
    • The potential to survive adverse trading conditions
      • Sufficient proprietor capital
    • Potential to raise creditor finance
      • Solvency
      • Favourable equity ratios
  • Establishing long term stability and viability (1)
    • The ability of a business to meet its trading commitments on time
      • Liquidity
    • Capacity of the business to make an adequate return on capital employed
      • Return on capital
  • Establishing long term stability and viability (2)
    • The ability of a business to generate sufficient profits that cover personal drawings, loan repayment, reinvestment and taxation.
  • Solvency
    • The first indicator of balance sheet strength
    • Assets > Liabilities
  • Solvency (1)
    • A solvent and profitable business might not be healthy
    • Downturn in profits could erode low proprietor capital
  • Ratio analysis
    • Short term analysis
      • Liquidity ratio
      • Current ratio
      • Equity ratios
  • Ratio analysis
    • Longer term analysis
      • Liquidity ratio
      • Current ratio
      • Owner equity ratio
      • Debt/Equity ratio
  • Liquidity ratio
    • The availability of cash in the near future i.e. can short term debts be covered without selling live or deadstock
    • cash + debtors : creditors + overdraft
    • ideal ratio 1 : 1
  • Current ratio
    • Similar to Liquidity ratio. Can current liabilities be met without selling fixed assets or raising long term loans?
    • Current assets : Current liabilities
    • ideal ratio 2 : 1
  • Current ratio (1)
    • Acceptable ratio dependent on composition of current assets
    • A lower ratio may be acceptable if you have a high proportion of cash and debtors (i.e. liquid assets) in current assets as opposed to high proportion of growing crops or stock (i.e. less liquid assets)
  • A lower Current ratio Which is acceptable ?  
  • Current ratio ( 2 )
    • Low ratios may be acceptable if creditors are willing to wait for payment
    • Large quantities of underutilized cash sitting in a bank account produce high ratios and indicate poor cash management
  • Acid test
    • Highlights liquidity of current assets
    • Might explain low current ratio
    • Identifies the ratio of very high liquid assets to current liabilities
  • Acid test (1)
  • Acid test (2)
    • Which are the liquid assets?
      • Some debtors excluded when extended credit operative
      • Unused overdraft can be considered a liquid asset
    • Guide ratio 1:1
  • Factors that affect liquidity + -
    • Tax payments
    • Credit repayment
    • Dividends
    • Drawings
    • Bonuses
    • Reduction in credit facilities
    • Losses
    • Re-investment in fixed assets
    • Inflation
    LIQUIDITY
    • Sale of fixed assets
    • Profit
    • Capital injection
    • Increase in credit
    • Tax refund
    • Government grants
    Internal factors External factors
  • Working capital ratio
    • Capital required to fund a production cycle
    • Ratio gives indication of amount of additional WC required to fund increase in sales
  • Working capital ratio (1)
  • Working capital ratio example
    • Current assets £110,000
    • Current liabilities £60,000
    • Sales £250,000 projected to increase by £75,000
    • Calculate change in working capital
  • Working capital example (1) Every £100 of additional sales will require £20 additional working capital therefore increasing sales by £75,000 increases working capital requirement by £15,000
  • Equity ratios
    • The proportion of a proprietors equity in a business
    • Exposure of a business to outside creditors
    • Traditionally high in the land based sector
  • Be careful with terms Net Worth ≡ ≡ Net Capital Equity
  • Equity ratios (1)
    • Equity to total capital employed
      • Owner equity ratio
    • Equity to equity plus long term debt
    • Equity to long term debt
      • Gearing
    • Total borrowing to equity
      • Debt/equity ratio
  • Owner equity ratio
    • Proportion of capital supplied by the owner
    • Can be expressed as a %
  • Owner equity ratio - example = 80% Net Worth Liabilities £80 000 £20 000 Assets
  • Equity to equity plus long term debt
    • Proportion of long term capital supplied by the owner
  • Gearing
  • Gearing (1)
    • Measure of the drain on resources by long term debt
    • Normal <25%
    • Critical 25-30%
    • Trouble ahead >30%
  • Debt/Equity ratio
  • Performance ratios
    • A measure of the return on resource utilised by the business
  • Return on Capital
  • Return on Capital (1)
  • You can manipulate numbers Profit = £10 000 Assets=£100 000 Liabilities = £20 000 = 10% = 12.5% WHICH ONE DO YOU CHOOSE ?
  • You can manipulate numbers AGAIN Profit = £10 000 Assets=£100 000 Liabilities = £50 000 = 10% = 20% WHICH ONE DO YOU CHOOSE ?
  • Interpretation of ratios
    • Identify “unusual” information
    • Identify reason for “unusual” information
    • Identify trends
    • Corroborate information by using other sources
    • Use ratio analysis as a tool for creating questions (table 5.6 p70 Turner and Taylor)
  • Limits of ratio analysis
    • Ratios indicate trends away from expectation
    • No two businesses are alike
    • Ratios are not an answer – they are a platform on which to ask more questions
  • Business trends
    • Deriving conclusions about the health of a business from a single balance sheet or TPLA are difficult
    • Information is best from
      • Studying a series of statements from the business
      • Investigating trends between statement components
  • References on ratio analysis
    • Financial management for farmers and rural managers Martyn Warren Blackwell Science Chapter 3 pp 28-41
    • Applied Farm Management Turner and Taylor BSP Chapter 5 pp 52-78
  • Rental equivalents
    • The financial commitment of a business and the cost of owning or renting land
    Rent and rates + Overdraft interest + Loan and mortgage interest + Capital repayments + Hire purchase and leasing charges
  • Rental equivalent measures From Applied Farm Management Turner and Taylor p229-230 Rental equivalent per ha 150 90 Beef / Sheep 350 180 Arable 220 140 Cereals / Dairy 200 95 Cereals 350 190 Dairy (flying herd) 270 150 Dairy (rearing replacements) High performance farm Average farm Farm type
  • Disposal of funds statement
    • Traces flow of cash through business during year
    • Monitor of changes in assets and liabilities
    • Looks at sources and uses of cash
  • Disposal (Flow) of Funds Statement TOTAL CASH USED Purchase of of land, property, investments Net purchase of buildings Purchase of machinery Less sale of machinery Repayment of Overdraft Increase in cash balances Add TOTAL COMMITMENTS Commitments Private drawings Tax Payments Reduction in loans Uses TOTAL CASH AVAILABLE CASH FROM OTHER SOURCES Capital introduced Sale of land, property, investments Increase in overdraft Increase in loans Reduction in Cash balances Add CASH FROM TRADING Net Profit (loss) Depreciation (+) Debtors (increase -, decrease +) Creditors (increase +, decrease -) Valuations (increase -, decrease +) Benefits in kind (-) Sources
  • Sources of cash
    • Trading activities
      • Profits
    • External sources
      • Grants
    • Increase in liabilities
      • More overdraft/loan cash available
    • Reduction in assets
      • Realise asset into cash
  • Uses of cash
    • Losses
      • Loss of wealth
    • External uses
      • Removed from trading horizon
    • Reduction in liabilities
      • Pay off debt
    • Increase in assets
      • Make the business less liquid by investing
  • Using the disposal of funds statement
    • Significant increases in liabilities
    • Growth of fixed assets at expense of current assets
    • Growth in fixed assets financed though short term liabilities
    • Excessive private drawings
  • Cash flow analysis
    • Cash is the most sensitive financial indicator
    • Warns of trading difficulties as they happen
    • Indicator of business liquidity
  • Cash flow analysis budget actual good actual bad time
  • Cash flow analysis – weak 1 st 6 months 89869 Total 89869 23060 Dec 66809 10086 Nov 56723 14577 Oct 42146 16292 Sep 25854 13194 Aug 12660 20728 Jul -8068 -4434 Jun -3634 -3462 May -172 2991 Apr -3163 3309 Mar -6472 -2052 Feb -4420 -4420 Jan Cumulative Net Cash Flow  
  • Cash flow analysis – consistent cash flow 84000 Total 84000 7000 Dec 77000 7000 Nov 70000 7000 Oct 63000 7000 Sep 56000 7000 Aug 49000 7000 Jul 42000 7000 Jun 35000 7000 May 28000 7000 Apr 21000 7000 Mar 14000 7000 Feb 7000 7000 Jan Cumulative Net Cash Flow  
  • Cash flow analysis
    • Inconsistent cash flow usually leads to increased interest charges and lower profits
    • Limits ability to deal with uncertainty
    • Limits capacity to plan capital spending
  • Variance analysis
    • Measures discrepancies in cash flow between budgeted and actual
    • It accounts for
      • VOLUME (size of enterprise)
      • OUTPUT (yield) or INPUT per unit volume
      • PRICE per unit produced or consumed
  • Variance analysis (1)
    • Favourable variance
      • Increase in output
      • Decrease in input
    • Unfavourable variance
      • Decrease in output
      • Increase in input
  • Variance analysis (2)
    • Two way
      • PRICE vs INPUT/OUTPUT
    • Three way
      • PRICE vs INPUT/OUTPUT vs VOLUME
  • Two way analysis
    • Budget
      • Cereal yield 8t/ha
      • Cereal price £90/t
    • Actual
      • Cereal yield 9t/ha
      • Cereal price £85/t
    t/ha £/t BUDGET 8 90 ACTUAL 9 85 Unfavourable variance due to price Favourable variance due to quantity
  • Two way analysis (1)
    • Actual revenue = 9t/ha x £85/t = £765
    • Budget revenue = 8t/ha x £90/t = £720
    • Difference = +£45
  • Two way analysis (2) Example Total variance = +£45
  • Three way analysis
  • Three way analysis (1)
    • Budget
      • Cereal yield 8t/ha
      • Cereal price £90/t
      • Cereal area 22 ha
    • Actual
      • Cereal yield 9t/ha
      • Cereal price £85/t
      • Cereal area 25 ha
    • Calculate the variance
  • Limits of variance analysis
    • Time consuming and complicated
      • OK if limit analysis to major items
    • Not suitable for inter farm comparisons
    • Formula is imprecise
  • Favourable price and quantity variance quantity price BUDGET ACTUAL favourable variance due to price favourable variance due to quantity Interaction price x quantity Attributed to price alone
  • Unfavourable price and quantity variance quantity price BUDGET ACTUAL unfavourable variance due to price unfavourable variance due to quantity Interaction price x quantity Attributed to quantity alone
  • Favourable quantity and unfavourable price variance quantity price BUDGET ACTUAL Price variance = diff price x budget quantity Quantity variance = diff quantity x actual price Over estimation
  • A health warning
    • It is not always possible to calculate/construct every analysis technique.
    • Calculated analyses are often in conflict with each other
    • Interpretation is not always clear
    • Always ask why and find an explanation
    • Commonsense must prevail