Your SlideShare is downloading. ×
0
Unit2 Operational Ratios
Unit2 Operational Ratios
Unit2 Operational Ratios
Unit2 Operational Ratios
Unit2 Operational Ratios
Unit2 Operational Ratios
Unit2 Operational Ratios
Unit2 Operational Ratios
Unit2 Operational Ratios
Unit2 Operational Ratios
Unit2 Operational Ratios
Unit2 Operational Ratios
Unit2 Operational Ratios
Unit2 Operational Ratios
Unit2 Operational Ratios
Unit2 Operational Ratios
Unit2 Operational Ratios
Unit2 Operational Ratios
Unit2 Operational Ratios
Unit2 Operational Ratios
Unit2 Operational Ratios
Unit2 Operational Ratios
Unit2 Operational Ratios
Unit2 Operational Ratios
Unit2 Operational Ratios
Unit2 Operational Ratios
Unit2 Operational Ratios
Unit2 Operational Ratios
Unit2 Operational Ratios
Unit2 Operational Ratios
Unit2 Operational Ratios
Unit2 Operational Ratios
Upcoming SlideShare
Loading in...5
×

Thanks for flagging this SlideShare!

Oops! An error has occurred.

×
Saving this for later? Get the SlideShare app to save on your phone or tablet. Read anywhere, anytime – even offline.
Text the download link to your phone
Standard text messaging rates apply

Unit2 Operational Ratios

1,192

Published on

We will look at ROCE, what it means and how to drill into to explain its movements

We will look at ROCE, what it means and how to drill into to explain its movements

Published in: Education
0 Comments
0 Likes
Statistics
Notes
  • Be the first to comment

  • Be the first to like this

No Downloads
Views
Total Views
1,192
On Slideshare
0
From Embeds
0
Number of Embeds
0
Actions
Shares
0
Downloads
59
Comments
0
Likes
0
Embeds 0
No embeds

Report content
Flagged as inappropriate Flag as inappropriate
Flag as inappropriate

Select your reason for flagging this presentation as inappropriate.

Cancel
No notes for slide

Transcript

  • 1. Unit 2 Understanding Accounts Operating Efficiency
  • 2. A summarised balance sheet A typical UK balance sheet Fixed assets 1,000 Share capital 500 Debtors (receivables) 500 Retained profits Stocks (inventories) 300 (earnings) 325 Cash 25 Other assets 100 Creditors (payables) (350) Borrowings (750) Net assets 825 Equity 825
  • 3. A summarised balance sheet HOWEVER A BETTER WAY TO SHOW THE BALANCE SHEET – MOVE THE BORROWINGS TO THE “OTHER” SIDE Fixed assets 1,000 Share capital 500 Debtors (receivables) 500 Retained profits Stocks (inventories) 300 (earnings) 325 Cash 25 Other assets 100 Creditors (payables) (350) Borrowings (750) Net assets 825 Equity 825
  • 4. A summarised balance sheet Fixed assets 1,000 Share capital 500 Debtors (receivables) 500 Retained profits Stocks (inventories) 300 (earnings) 325 Cash 25 Other assets 100 Creditors (payables) (350) Borrowings 750 Capital employed 1,575 1,575 Note the change of title
  • 5. A summarised balance sheet Fixed assets 1,000 Share capital 500 Debtors (receivables) 500 Retained profits Equity Stocks (inventories) 300 (earnings) 325 Cash 25 Other assets 100 Creditors (payables) (350) Borrowings 750 Debt Capital employed 1,575 1,575 This side of the balance sheet is the funding side = debt + equity
  • 6. A summarised balance sheet Fixed assets 1,000 Share capital 500 Debtors (receivables) 500 Retained profits Stocks (inventories) 300 (earnings) 325 Cash 25 Other assets 100 Creditors (payables) (350) Borrowings 750 Capital employed 1,575 1,575 This side of the balance sheet is the funding side = debt + equity As the balance sheet must “balance” so every £ on the funding side must be represented by a £ on the other side
  • 7. A summarised balance sheet Fixed assets 1,000 Share capital 500 Debtors (receivables) 500 Retained profits Stocks (inventories) 300 (earnings) 325 Cash 25 Other assets 100 Creditors (payables) (350) Borrowings 750 Capital employed 1,575 1,575 This side of the balance sheet is the funding side = debt + equity So this side represents what is done with the funding – the “operating” side of the balance sheet
  • 8. A summarised balance sheet OPERATING FUNDING Fixed assets 1,000 Share capital 500 Debtors (receivables) 500 Retained profits Stocks (inventories) 300 (earnings) 325 Cash 25 Other assets 100 Creditors (payables) (350) Borrowings 750 Capital employed 1,575 1,575 This side comes at a cost – the weighted average cost of capital (WACC – unit 4)
  • 9. A summarised balance sheet OPERATING FUNDING Fixed assets 1,000 Share capital 500 Debtors (receivables) 500 Retained profits Stocks (inventories) 300 (earnings) 325 Cash 25 Other assets 100 Creditors (payables) (350) Borrowings 750 Capital employed 1,575 1,575 This side comes at a cost – the weighted average cost of capital (WACC – unit 4) This is the side that needs to pay the cost of finance – the operating side produces “operating profit”
  • 10. Return on capital employed So, OPERATING = FINANCING This side comes at a cost – WACC, say 10%. So each £1 invested costs 10p
  • 11. Return on capital employed So, OPERATING = FINANCING This side produces operating profit. For each £1 invested it must yield at least 10p to cover the cost of capital. This yield is: operating profit/capital employed% This is called the return on capital employed - ROCE
  • 12. Return on capital employed ROCE = operating profit x 100 capital employed (= debt+equity)
  • 13. Return on capital employed ROCE = operating profit x 100 capital employed (= debt+equity) = operating profit % sales sales x capital employed Return on sales or asset turnover operating margin
  • 14. Return on capital employed ROCE = operating profit x 100 capital employed (=borrowings+equity) = operating profit % sales sales x capital employed Return on sales/margin asset turnover profitability asset efficiency
  • 15. ROCE This framework allows us to drill into the operating aspect of the business to investigate what is happening. For example return on sales can be further broken down into : operating profit Sales Cost of sales Operating costs sales sales Which in turn can be drilled into more detailed costs where available.
  • 16. ROCE This framework allows us to drill into the operating aspect of the business to investigate what is happening. For example return on sales can be further broken down into : operating profit Sales Labour HR Cost of sales raw materials Operating costs Training sales Utilities sales Salaries Which in turn can be drilled into more detailed costs where available.
  • 17. Asset turnover Asset turnover = sales/capital employed This is a measure of how efficiently a business uses its assets Eg a company needs to be make 20 deliveries a day. It can use 5 vans making 4 drops each or 4 vans making 5 drops each .
  • 18. Asset turnover Asset turnover = sales/capital employed This is a measure of how efficiently a business uses its assets Eg a company needs to be make 20 deliveries a day. It can use 5 vans making 4 drops each or 4 vans making 5 drops each . If a delivery is worth £100 and a van costs £1,000 the asset turnovers are: 2000/5000 = 0.4 or 2000/4000 = 0.5 The latter case is more efficient. So the higher the asset turnover the more efficiently assets are being used. Note: it is not normally expressed as a percentage.
  • 19. Asset turnover Asset turnover = sales/capital employed Capital employed = the financing OR the operating assets This can be drilled into its operating component parts For example, Sales/fixed assets, Sales/debtors, Sales/stocks Sales/creditors
  • 20. Asset turnover For example, Sales/fixed assets, Sales/debtors, Sales/stocks Sales/creditors Though the latter are more usually shown as “days” Debtor days = debtors x 365/sales = average collection time Eg if annual sales are £365,000 and debtors are £36,500 then it takes 10% of a year on average to collect the payments from customers. (1 day’s sales = £1,000, so £36,500 = 36.5 days’ sales. Or Debtor days = 36500 x 365/365000 = 36.5 days)
  • 21. Asset turnover For example, Sales/fixed assets, Sales/debtors, Sales/stocks Sales/creditors Though the latter are more usually shown as “days” Debtor days = debtors x 365/sales = average collection time Creditor days = creditors x 365 / cost of sales Stock days = stocks x 365/cost of sales These use cost of sales in order to strip out the profit element
  • 22. Example Given the following 2010 data about a company: 1 Calculate the ROCE for 2010 2 Identify which is the main element of the business causing the movement. Profit and loss/£ Balance sheet Revenue 10,000 Fixed assets 20,000 Cost of sales 2,500 Debtors 2,200 Operating costs 1,500 Stocks 1,100 Creditors (800) Operating profit 6,000 Capital employed 22,500 Last year’s key figures: ROCE = 32%. Return on sales = 58%, Asset turnover = 0.8 Cost of sales/sales = 23%, operating costs/sales = 17%, Sales/fixed assets = 0.52, debtor days = 50 days, stock days = 158 days, creditor days = 120 days [Note: for this exercise, due to time constraint, we will just use the year end capital employed figure – strictly we should use an average of the start and end figures]
  • 23. Example ROCE = 6000/22500 = 27% [32%] Return on sales = 6000/10000 = 60% [58%] Asset turnover = 10000/22500 = 0.44 [0.8] So issue is around asset turnover. So only need to look at those items: Profit and loss/£ Balance sheet Revenue 10,000 Fixed assets 20,000 Cost of sales 2,500 Debtors 2,200 Operating costs 1,500 Stocks 1,100 Creditors (800) Operating profit 6,000 Capital employed 22,500
  • 24. Example ROCE = 6000/22500 = 27% [32%] Return on sales = 6000/10000 = 60% [58%] Asset turnover = 10000/22500 = 0.44 [0.8] So issue is around asset turnover. So only need to look at those items: Sales/fixed assets = 10000/20000 = 0.5 [0.52] Debtor days = 2200/10000 x 365 = 80 days [50 days] Creditor days = 800/2500 x 365 = 117 days [120 days] Stock days = 1100/2500 x 365 = 161 days [158 days] Profit and loss/£ Balance sheet Revenue 10,000 Fixed assets 20,000 Cost of sales 2,500 Debtors 2,200 Operating costs 1,500 Stocks 1,100 Creditors (800) Operating profit 6,000 Capital employed 22,500
  • 25. Example ROCE = 6000/22500 = 27% [32%] Return on sales = 6000/10000 = 60% [58%] Asset turnover = 10000/22500 = 0.44 [0.8] So issue is around asset turnover. So only need to look at those items: Sales/fixed assets = 10000/20000 = 0.5 [0.52] Debtor days = 2200/10000 x 365 = 80 days [50 days] Creditor days = 800/2500 x 365 = 117 days [120 days] Stock days = 1100/2500 x 365 = 161 days [158 days] Profit and loss/£ Balance sheet Revenue 10,000 Fixed assets 20,000 Cost of sales 2,500 Debtors 2,200 Operating costs 1,500 Stocks 1,100 Creditors (800) Operating profit 6,000 Capital employed 22,500 So increase in debtors appears to be main cause in drop in ROCE
  • 26. ROCE in real life Recall we started this analysis with a simple balance sheet: Fixed assets Share capital Debtors Retained profits Stocks Borrowings Cash Creditors But in real life there are a number of other items that might appear on a balance sheet, for example De La Rue (p108 unit 2)
  • 27. De La Rue – Summary balance sheet Cash 86 Share capital 48 Receivables 89 Other reserves (82) Inventory 73 Retained profits 194 Other current assets 17 Tangible fixed assets 240 Intangible fixed assets 3 S/T debt 26 Payables 34 Other current liabs 165 L/T debt 58 Other L/T liabs 2 L/T provisions 60 Minority interests 3 160 160
  • 28. De La Rue – Summary balance sheet Cash 86 Share capital 48 Receivables 89 Other reserves (82) Inventory 73 Retained profits 194 Other current assets 17 Tangible fixed assets 240 Intangible fixed assets 3 S/T debt 26 Payables 34 Other current liabs 165 L/T debt 58 Other L/T liabs 2 L/T provisions 60 Minority interests 3 160 160 Need to move “financing” to the right hand side.
  • 29. De La Rue – Summary balance sheet Cash 86 Share capital 48 Receivables 89 Other reserves (82) Inventory 73 Retained profits 194 Other current assets 17 Tangible fixed assets 240 Intangible fixed assets 3 S/T debt 26 Payables 34 Other current liabs 165 L/T debt 58 Other L/T liabs 2 L/T provisions 60 Minority interests 3 160 160 Need to move “financing” to the right hand side. Obviously debt. But what else?
  • 30. De La Rue – Summary balance sheet Cash 86 Share capital 48 Receivables 89 Other reserves (82) Inventory 73 Retained profits 194 Other current assets 17 Tangible fixed assets 240 Intangible fixed assets 3 S/T debt 26 Payables 34 Other current liabs 165 L/T debt 58 Other L/T liabs 2 L/T provisions 60 Minority interests 3 160 160 Need to move “financing” to the right hand side. Obviously debt. But what else? Anything else that might result in interest (or equivalent) being paid eg pension deficits
  • 31. De La Rue – Summary balance sheet Cash 86 Share capital 48 Receivables 89 Other reserves (82) Inventory 73 Retained profits 194 Other current assets 17 S/T debt 26 Tangible fixed assets 240 L/T debt 58 Intangible fixed assets 3 L/T provisions 60 Payables 34 Other current liabs 165 Other L/T liabs 2 Minority interests 3 304 304 In calculating “capital employed” it is usually easier to decide what is “financing” and add that up (everything else = operating side as the balance sheet “balances”)
  • 32. Next Time We shall look at more ratios concerning financing, liquidity and investment markets

×